Chapter II. Cap and Trade in Action

(A.) The U.S. Acid Rain Program: A Case Study on the Use of Cap and Trade

The Problem:
In the late 1970's public attention became increasingly focused on the potential environmental damage being sustained by the Eastern United States from acid rain. To address this issue, the U.S. Congress invested over $570 million in a 10-year scientific study known as the National Acid Precipitation Assessment Program or NAPAP.

Scientists identified the cause of the continuing environmental damage as air pollutants arising from power plants and industrial facilities. Sulfur dioxides (SO2) and nitrogen oxides (NOx), were undergoing a chemical reaction in the atmosphere when combined with moisture. The reaction involving SO2 forms a destructive dilute sulfuric acid, which became known as "acid rain." The primary source of SO2 and NOx are large plants that burn fossil fuels to produce energy, although there are other significant sources as well.

The Program:
Congress, in agreement with the NAPAP study, decided that a 50% reduction in SO2 emissions from power plants and a significant reduction in NOx emissions from power plants were necessary first steps to address the acid rain problem. The resulting 1990 Clean Air Act Amendments created the U.S. Acid Rain Program, which made a wholesale change in the way SO2 emissions were regulated. Rather than relying on command-and-control, it set a strict emissions cap for power plants and, in return, provided them with unprecedented flexibility in determining how to meet that cap.

The Acid Rain Program set the cap at 8.95 million tons of SO2 per year. The program is implemented in two phases. In Phase I, which began in January 1995, the largest, highest emitting electric utility generating units were required to reduce emissions. In Phase II, which will begin in 2000, virtually all electric utility units will be required to reduce their emissions to roughly one-half of 1980 levels or the 8.95 million ton cap. Under the program, sources are required to hold allowances equal to each year's emissions. Participants are free to choose how they want to comply, but at the end of each year they have to surrender enough allowances to EPA to cover their actual emissions. Failure to comply with this provision results in automatic penalties, which are enforced by EPA.

An effective tool for harnessing the power of the open market was found in a cap and trade system. It is viewed by many as a model for other environmental programs. Under the Acid Rain Program, the "cap" was firmly set and reduced emissions to levels that were roughly half of those in 1980. Looked at another way, the cap reduced the level of SO2 emissions utilities were allowed to emit by 50%.

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