What is a Cap and Trade Tax?

Cap and trade sets a limit on the amout of greenhouse emissions produced by a company.
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  • Written By: R. Anacan
  • Edited By: Bronwyn Harris
  • Last Modified Date: 12 August 2015
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A cap and trade tax is the additional cost that is incurred by businesses and consumers as a result of the implementation of a policy known as cap and trade. Cap and trade is a system enacted by the government that is designed to reduce the emissions of pollutants, especially greenhouse gases such as carbon dioxide, into the atmosphere. The basic premise of cap and trade is that the government sets a limit, or “cap,” on the amount of pollutants that may be released.

Companies are then given an allotment of credits, commonly known as carbon credits, for the amount of pollutants they would be allowed to emit. Some nations that have implemented cap and trade programs provide for an auction where companies bid on and purchase their carbon credits. Over time, the government would lower the amount of pollutants that could be released into the atmosphere, creating a steady reduction in the amount of carbon dioxide and other pollutants that are produced and released into the air.


The “trade” portion of cap and trade comes into play when companies produce more or less carbon dioxide than they were allotted. Companies that produce more pollution that their allotment may trade or purchase credits from companies that produce less pollution than they are allowed. The desired result of cap and trade is that companies that produce a lot of pollution will be motivated to reduce the amount of pollutants that they release into the air, in an effort to avoid continually having to purchase additional carbon credits.

The controversy that surrounds cap and trade is that companies who must purchase additional credits will, in all likelihood, pass on the additional cost of purchasing credits to consumers. Companies that are likely to be affected the most by the cap and trade tax are utility companies and major manufacturing companies that utilize large amounts of fossil fuels. Therefore cap and trade may result in higher prices for goods and services, such as utilities. This increased cost of doing business and the passing on of these costs to consumers as a result of government policy, is the reason that cap and trade is often referred to as the cap and trade tax, even though in many instances it is not technically called a tax.

Proponents of the cap and trade tax believe that it has resulted in the reduction of greenhouse gases in the nations where it has been implemented. Supporters of cap and trade also believe that the goal of reducing a nation’s carbon footprint and possibly preserving the environment is worth the additional expense. Opponents of cap and trade state that the data is inconclusive about the reduction in emissions, or they believe that the potentially high cost to companies and consumers is not worth the results. While the benefits and drawbacks of a cap and trade tax system may not always be so clear, it is clear that as more nations consider implementing it, the controversy surrounding cap and trade will continue for some time to come.


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