Document Type

Working Paper




emissions trading, cap and trade, market-based mechanisms, global warming, climate change




Economic Policy | Environmental Policy


This article addresses the problem of how to set caps for a cap-and-trade program, a key problem in pending legislation addressing global climate disruption. Previous scholarship on emissions trading programs focuses overwhelmingly on trading’s advantages and sometimes wrongly portrays environmental improvement as an automatic byproduct of adopting a cap-and-trade approach. A trading program’s success, however, depends critically upon timely and effective cap setting.

This article shows that often regulators have employed a best available technology (BAT) approach to cap setting for trading programs, i.e., setting the cap at a level that regulated polluters can achieve with government-identified technology. This descriptive claim suggests that trading does not necessarily provide an antidote to the problems associated with BAT regulation, as the literature often claims; instead trading programs often constitute a form of BAT regulation in many respects. The rest of the article explores this insight’s implications.

Analytically, this article reviews three ways to establish aggregate caps, effects-based, cost-benefit based, and technology-based cap setting. It shows that each of these approaches has theoretical and practical advantages and disadvantages, but only effects-based cap setting frees the regulator from the need to evaluate technologies in order to establish a cap.

Since trading does not automatically transcend BAT, this article provides recommendations on how to improve cap setting both generally and in the climate disruption context. It suggests that in the climate disruption context a legislative effects-based approach offers an attractive and viable cap-setting method. But normative acceptance of effects-based caps requires some adjustments in how we think about costs, mainly a recognition that they are neither fixed nor predictable, but can change as a result of a cap-and-trade program. This article also shows that auctions can play an important role in facilitating avoidance of the problems of administrative delay and strife that accompanied BAT regulation. While commentators usually agree that auctions offer economic advantages, the literature has not paid sufficient attention to their administrative advantages. We should think of auctions as essential to effective cap setting, not just as a nice way of avoiding unattractive distributional consequences like windfall profits. But this article also explores how the possibility of BAT-like administrative delay should influence criteria and administrative procedures for agency distribution of allowances to firms. Finally, this article makes recommendation on how cap-setting decisions can circumvent favoritism toward existing sources and the difficulty of revising limits once establishes - both BAT problems that can arise under trading as well. Thus, jettisoning the notion that trading automatically avoids problems traditionally associated with BAT leads to a set of useful insights about how to set caps.


Metadata from SSRN