A cap and trade system is a method for managing pollution, with the end goal of reducing the overall pollution in a nation, region, or industry. Many supporters of pollution control are in favor of the concept of such systems, arguing that well-designed cap and trade systems are extremely effective, and that they make sense economically as well.
Under a cap and trade system, a government authority first sets a cap, deciding how much pollution in total will be allowed. Next, companies are issued credits, essentially licenses to pollute, based on how large they are, what industries they work in, and so forth. If a company comes in below its cap, it has extra credits that it may trade with other companies.
For companies that come in below their caps, this system is great, because they can sell their extra credits, profiting while reducing their pollution. For companies that cannot get their pollution under control, the system punishes them for their excess pollution while still bringing overall pollution rates down. In a sense, the need to purchase credits acts as a fine, encouraging companies to reduce their emissions.
By creating a cap, nations make it clear that they want to reduce overall emissions, rather than just fining companies for excessive emissions or trying to force all companies to reduce their emissions by a set percentage. Cap and trade systems allow for flexibility, which usually benefits the market. Some people view the concept as preferable to a taxation or fining system, because it is easier to administer and it results in a pollution reduction. These systems are most commonly used for carbon emissions, leading people to refer to it as "carbon trading", and there is a potential for a global carbon trading market, in which more efficient nations could trade credits with other countries.
