Second of two parts. Click here for the first part.
In 1986, the Environmental Defense Fund (EDF), a New York-based environmental group, began searching for a bipartisan solution for pollution. For years, environmentalists had favored top-down solutions: Simply define polluting behavior and then lobby Congress for a federal law that would regulate it or ban it.
That had been the winning approach to the Clean Water Act and the Clean Air Act, but the political setting for the next pollution frontier -- acid rain -- was different. Acid rain was caused by sulfur dioxide (SO2) emissions from coal-fired power plants, and the damage to lakes, trees and human health was spreading from the United States into Canada.
But this was the era of Ronald Reagan. Fred Krupp, a lawyer and the newly hired president of EDF, felt strongly that another "top down" solution -- which often had the government telling companies what pollution control equipment to use -- would simply not sell to Republicans in the White House or to Congress. So he hired Dan Dudek, a young agricultural economist, who had been studying a different, market-based approach. It worked from the bottom up, using emissions trading.
Very few people outside academia knew about the concept, which later became known as "cap and trade." But in his undergraduate days at the University of Massachusetts, Dudek had been steeped in a book written by a Canadian economics professor, John Dales. Dales' approach was for the government to impose a limit or "cap" on a particular pollutant and then issue what amounted to permits to pollute.
Over time, the number of government-issued permits would shrink, but each company would have the ability to figure out its own way to bring down its level of pollution. In essence, companies could trade their way into compliance. And if they did it cleverly, they might even make some money.
For example, if Company X bought new technology and lowered its pollution below the required levels, it would have excess permits to sell. If Company Y had an old, dirty plant and felt it was cost-effective to keep it running it for a few more years, it could either bid for the permits being put on the market by Company X or face a stiff fine for every unpermitted ton of SO2 it put into the air.
An idea escapes from campus
By 1986, the idea was all the rage in academia, but, as Dudek recalled, "there was very little in the way of literature" describing how the scheme might work in the real world. He and EDF were determined to change that.
It happened that the wives of two senators, Tim Wirth, a Democrat from Colorado, and John Heinz, a Republican from Pennsylvania, were on EDF's board of directors. Dudek, the two senators and others put together a plan called "Project 88" and later sent it to the camps of two candidates who would be running for president that year.
One of the co-authors of the plan, Robert Stavins, an economist at Harvard, recalls that the plan drew no response from the Democratic candidate, Massachusetts governor Michael Dukakis. But C. Boyden Gray, legal adviser to Vice President George H.W. Bush and later head of Bush's presidential transition team, responded with enthusiasm.
After the election, Gray had lunch with Krupp, who created an EDF team, headed by Dudek, to help draft an amendment to the Clean Air Act. Gray also contacted Stavins and asked him to come to Washington and work on the draft.
There were doubters within the Bush administration who felt the emissions-trading approach was too risky to apply to a big problem like acid rain. Meanwhile, other environmental groups were warning Democrats to stay away from the plan. They liked the more traditional command-and-control approach.
Gray was unaware of Dales' work and recalls he first heard about emissions trading from a New York University law professor. "This idea was out there in the ether. By then, it was well-discussed in the economic literature," explained Gray. He liked the idea of a market-based mechanism and felt it would appeal to Bush, who was then campaigning to be known as the "environmental president."
Creating paternity in Washington
What happened after that, according to Stavins, "was completely Boyden." He lined up Bush administration officials behind the proposals and began trying to lure Democrats into the fold while giving lavish praise to EDF for its role in devising the plan. He also developed a long list of others to be given credit for working on the concept, which was then called "tradable permits."
Stavins said Gray's list went way beyond the handful of people who actually worked on the amendment. "If you calculated it, it might work out to something like 1,800 percent." The calculus seemed odd, but the economist soon learned that political math was different. "Boyden said the way you get things done in Washington is not that you take the credit, but you spread the credit around," recalled Stavins.
In 1990, the amendment passed the Senate, 89-10, and was approved by the House, 401-25. Within 10 years, the EPA-run trading program applied to every coal-fired power plant in the United States. According to both government and academic studies, the market approach saved companies roughly $1 billion a year, compared with earlier, top-down regulations.
Utilities were enthusiastic about the trading aspect. There were also major public health benefits because both sulfur dioxide and soot levels dropped.
All of this attracted the attention of the incoming Clinton administration, which took the basic Republican scheme and enlarged it as the way for the world to reduce carbon dioxide emissions.
So it was that in the second week of December 1997, as 2,000 delegates representing over 160 nations went into round-the-clock negotiating sessions in a cavernous meeting hall in Kyoto, Japan, Al Gore, then the vice president of the United States, flew in to complete the deal.
After getting off the plane, Gore huddled with the man chosen to brief him on the state of play -- Dan Dudek. Dudek had helped sell enough groups on the idea of cap and trade to give the plan a fighting chance to be in what would become the Kyoto Protocol.
Gore pushed through the final version, although some European leaders were dubious and European environmental groups were angry about what they saw as leaving the matter of how to make emissions reductions in the hands of greedy companies.
But as the details of the final hours of the conference emerged, enthusiasts began to talk about the creation of a $120-billion-a-year market in trading emissions permits. President Clinton hailed the treaty "a huge first step" toward controlling greenhouse gases. "No nation is more committed to this effort than the United States," Clinton promised.
Cap and trade gets rebranded
True to the whiplash-inducing twists and turns of the politics behind cap and trade, that turned out to be wrong. In 2002, the incoming president, George W. Bush, abruptly took the United States out of the protocol.
Instead, it was the Europeans who took the Gore plan and created the world's largest cap-and-trade program. Called the E.U. Emissions Trading System, it was launched in 2005 and currently covers the greenhouse gas emissions from more than 10,000 factories, utilities and other business installations. In 2009, it handled about $119 billion worth of carbon allowances and derivatives, according to the World Bank.
In late June 2009, a Democrat-led House attempted to follow Europe's example, patching together a 1,200-page greenhouse gas regulation bill built around a still more complex cap-and-trade program. In the frenzy of the last-minute bargaining process to round up enough votes to eke out a 219-212 victory, party leaders made 310 pages of changes, including compromises that gave free pollution allowances to states, rural electric cooperatives and other entities that could sell them for a variety of purposes, including energy efficiency, job training, climate adaptation and even putting a halt to international deforestation.
Coal-fired utilities and refineries that would have to buy some allowances at auction to fully cover their emissions called this Christmas tree-like version of cap and trade a tax. Then Republicans rebranded the Democrat proposal "cap and tax." The new name stuck. The Senate's effort to pass a similar bill was abandoned in July 2010, falling short of the 60 votes needed for passage.
Polls showed that before the House vote, 75 percent of Americans supported controls on greenhouse gases, but, ominously, only 52 percent supported cap and trade, a percentage that plummeted during the 2010 elections, when Republicans took control of Congress. Once-enthusiastic Republican backers of the cap-and-trade concept backed away from it as though it were a corpse.
"Frankly, I'm tired of talking about it," said Boyden Gray, who practices law in Washington. "The auction of allowances made it a huge tax. Pigeonholing this as a tax is now going to be very hard to unwind."
"This is all about money," asserted Dudek, now an Environmental Defense Fund vice president. He blames industry lobbying and political donations by conservative groups. "The status quo is a vicious competitor."
7 CO2 pilot trading programs bloom in China
Stavins, the Harvard economist and cap-and-trade guru, admits he agonized over the defeat. "I bridled every time Republicans called it cap and tax." But he asserts that the onset of a severe recession and the growing partisan infighting in Congress were the real forces that killed the policy.
"Cap and trade was this tiny little pingpong ball inside this massive wind machine blowing it in different directions."
But the political forces that have gathered around an idea put forth by an obscure Canadian professor back in the 1960s aren't through yet. The next frontier is China, where Dudek, the Johnny Appleseed of cap and trade, has spent years explaining the policy. He was recently asked by Beijing officials to co-chair an international task force that will help oversee seven large carbon cap-and-trade pilot programs, some involving cities, others whole provinces.
They will be used to help China reach a number of pollution-reduction targets, including a 40 to 45 percent reduction in greenhouse gas emissions intensity compared with 2005 levels. Beijing officials don't have a partisan-split Congress to oppose their goals, but they have come to realize that top-down solutions in their sprawling, diverse country can have their drawbacks.
Or, as Dudek puts it: "There are real limits to regulation and the government's ability to have a sufficient level of resources to control emissions in every part of the country."
The answer, he is sure, is to harness the growing power of private companies through emissions trading. Using market signals to get entrepreneurs to do the government's regulating for them, he thinks, "is really the way of the future."