U.S. Cap-and-Trade Markets: Constraining Participants, Transactions, and Prices

The U.S. Congress has recently considered legislation to establish a cap-and-trade program to reduce greenhouse gas emissions. Critics of such a program have raised concerns about its ability to identify allowance prices that minimize the cost of achieving a given reduction and the ultimate acceptability of those prices, even if they are cost minimizing. As a result, legislation has been proposed that includes policies to limit the cap-and-trade market through restrictions on participants, transactions, or allowance prices. Some of these restrictions are in place in other cap-and-trade programs around the world. This article evaluates those limits according to whether they accomplish their desired objective and the extent to which they might generate unintended consequences. We conclude that prohibitions on participants and transactions are unlikely to achieve their objectives and could, in fact, generate costly unintended consequences; however, some restrictions could prove useful. The use of price controls may achieve policymakers' objectives but, depending on how they are implemented, might also have unanticipated and undesirable effects. (JEL: D02, D78, G18, H23, P48) Copyright 2012, Oxford University Press.