Berkeley Program in Law and Economics

Cap and trade is controversial in part because of claims that it is unjust, an issue that was highlighted by recent litigation against California’s proposed carbon market. This essay considers an array of fairness issues relating to cap and trade. In terms of fairness to industry, the conclusion is that distributing free allowances overcompensates firms for the cost of compliance, assuming any compensation is warranted. Industry should not receive, in effect, ownership of the atmosphere at the expense of the public. Environmental justice advocates argue that cap-and-trade systems promote hotspots and encourage dirtier, older plants to continue operating to the detriment of some communities. Designers of cap-and-trade systems should be alert to possible hotspots, particularly in disadvantaged communities. Little reason exists, however, to believe that any such hotspots are systematically linked with disadvantage. Finally, any regulation of emissions raises costs, with a disproportionate impact on low-income consumers. This effect can be greatly ameliorated through adroit use of revenue from auctions. The bottom line is that fairness issues are not a deal-breaker for cap and trade, but do deserve thoughtful consideration in designing a system.