Copenhagen Primer: What Exactly Does “Cap and Trade” Mean?

Since the UN Climate Change Conference begins today in Copenhagen, I thought it might be helpful to read up on climate change policy, which is not something in which I feel particularly well-versed. I have a vague idea of what “cap and trade” means, but like most people, I wouldn’t feel comfortable explaining it to someone else.

Lucky for me, Krugman laid out the economics of cap and trade this morning in his characteristically lucid style in a post gently correcting famoust climate scientist James Hansen. The key sentence to understanding how cap and trade is different from a carbon tax:

The only difference is the nature of uncertainty over the aggregate outcome. If you use a tax, you know what the price of emissions will be, but you don’t know the quantity of emissions; if you use a cap, you know the quantity but not the price.

Update: I didn’t mean to argue, by the way, that I completely agree with Krugman on this. In fact, I agree with both of them. While Krugman is right to note that Hansen isn’t exactly correct regarding the economics of cap and trade, he also elides the fact that cap and trade, as opposed to a carbon tax, would require a ton of regulation and policing. Which means it would probably lead to loopholes, speculation, and a host of other ancillary problems. A carbon tax is, from a policy standpoint, the better, simpler, more direct option—but politically it’s a dead end.