A mechanism for capping carbon emissions across an economy, cap-and-trade schemes have emerged as the most widely-adopted means of putting a price on carbon emissions.
Under carbon cap-and-trade schemes, a central authority such as a government or international body sets a limit on the total amount of carbon dioxide that can be emitted by an economy or group of companies.
Those organisations covered by the scheme then receive emission allowances or permits that are either issued freely or bought at auction. The total number of allowances issued is equivalent to the agreed cap, meaning that any organisation that exceeds its cap must buy in extra allowances from organisations that have emitted less than their cap.
In effect, those exceeding their cap have to pay for the right to pollute, while those who cut emissions receive financial rewards.
Advocates of the approach claim it is the most efficient means of curbing carbon emissions as it encourages the economy as a whole to identify and invest in the most cost effective means of cutting greenhouse gas emissions.
A cap-and-trade scheme has been in operation in the EU since 2007 and similar schemes are planned for other economies, including Japan, Australia and the US.
However, cap-and-trade schemes remain highly controversial with critics arguing that they place an unfair financial burden on carbon intensive industries, encourage firms to re-locate to countries without carbon pricing mechanisms, and are less effective at cutting emissions than carbon taxes.
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