Linking a U.S. Cap-and-Trade System for Greenhouse Gas Emissions: Opportunities, Implications, and Challenges

Abstract

The long-run cost of a U.S. cap-and-trade system for greenhouse gas (GHG) emissions could be significantly reduced by linking that system with other existing and emerging tradable permit systems for GHG emissions. However, along with the cost savings that it offers, linking carries with it other implications. For example, linking has distributional consequences and, under some circumstances, linked systems collectively will not achieve the same level of emission reductions as they would absent linking. Also, linking can reduce a government's control over the impacts of its tradable permit system. Thus, in considering linkages, the United States and potential linking partners may have to weigh linking's implications for potentially competing policy objectives, much as will be required in developing other elements of their respective domestic climate policies. Because linking's implications depend on the type of link that is established and the specific characteristics and design of the linked systems, in the near-term, some links will be more attractive and easier to establish than others. Importantly, those links that may be the easiest to establish - links with emission reduction credit systems such as the Clean Development Mechanism - likely can provide much of the near-term cost-saving and risk-diversifying advantages that linking can offer. Given the implications of links with other cap-and-trade systems, to facilitate such links, it may be necessary to harmonize certain elements of the design of the U.S. system and any system(s) with which it links. In particular, agreement on a unified set of measures to address cost uncertainty likely will be a necessary pre-condition for an unrestricted link with another cap-and-trade system. Also, in order to link with other cap-and-trade systems, it may be necessary to establish broader international agreements governing aspects of the design of the U.S. and linked systems beyond simply mutual recognition of allowances.