"Cap and Trade" is shorthand for what economists call emissions trading. It is a method of regulating pollution, primarily from power plants. We've been successfully using emissions trading to control pollutants - specifically sulfur dioxide - for almost two decades. It is pretty important to understand the Cap and Trade debate because the Obama administration proposes it for carbon dioxide. The effect on energy costs and hence our economy could range from negligible to breathtakingly extreme.

The way Cap and Trade works is that each power producer would be given permits to pollute, probably based on the amount of power they produce. These permits will allow them to release into the air, some quantity of carbon dioxide, but it "caps" the total level of pollutants.

Power producers are polluting already, but different power sources (for example coal, natural gas or nuclear) release different levels of pollutants for each Kilowatt hour of energy they produce. As a consequence, some of the power plants will have too many permits, others too few. Here’s where the trade part comes in. The government establishes a secondary market for these permits. Companies that have excess permits can sell them, while those with too few can buy them. The price of these permits is then established by their scarcity. This incentivizes firms to choose technologies and fuels that reduce pollution, but also allows them to phase-in the costs. Anyone can purchase these permits, and simply remove them from the market (this is called retiring them, in the trade lingo). Sulfur dioxide is currently selling at about 75 cents a pound.

Trading emissions works very well for pollutants that are widely dispersed, affecting us all. The Sulfur dioxide trading has reversed the acid rain catastrophe which loomed in the 1970s and 80s. Emissions trading does not work well for highly localized pollutants such as mercury or lead. Obviously in this case, a single plant could discharge huge amounts of pollutants in a single area, making it unlivable. Markets are the single most successful human invention for organizing resources, but they don’t solve all our problems.

Not everyone likes Cap and Trade. They come in two flavors. First, there is a strong sub-current of environmentalists who don’t like anything that smacks of market based solutions. They want government to establish rules without any market based considerations. Given the success of emissions trading thus far we should let them dwell on the fringe of the debate.

The other group of folks who are worried about Cap and Trade are those worried about geographic equity. Some regions can be economically devastated by Cap and Trade. This depends on the level of the cap. Any region that relies upon coal (the Midwest or Southeast) is at risk of much higher energy costs, which could cripple manufacturing in our state. It also offers great opportunity in alternative energy.

Cap and Trade can lead us to a much cleaner more prosperous future or devastate our economy. We all need to pay close attention to the details of the debate.