CPA Australia believes that a properly designed emissions trading scheme that incorporates well-calibrated caps and emission trajectories is central to reducing carbon emissions.

The Australian government’s proposed Carbon Pollution Reduction Scheme (CPRS), which will put a price on emissions, is only one part (but the major part) of a comprehensive package of policies required to reduce emissions.

Mechanics of a cap and trade CPRS

• The government sets a cap on the total amount of carbon pollution allowed in the economy by covered sectors.
• The government will issue permits up to the annual cap each year.
• Industries that generate carbon pollution will need to acquire a 'permit' for every tonne of greenhouse gas that they emit.
• The quantity of carbon pollution produced by each firm will be monitored and verified.
• At the end of each year, each liable firm would need to surrender a permit for every tonne of carbon pollution the firm produced in that year.
• Firms compete in the market to purchase the number of permits they require. Firms that value the permits most highly will be prepared to pay the most for them, either at auction, or on a secondary trading market. For some firms, it will be cheaper to reduce emissions than to buy permits.
• As a transitional assistance measure, certain categories of firms might receive some emissions permits for free. These firms could use these permits or sell them.

The price of permits is not set by the government; the price emerges from the market. If a firm can reduce carbon pollution more cheaply than the prevailing market price of permits, it will chose to reduce carbon pollution rather than buy permits.

Therefore, this kind of scheme provides a strong incentive for participants to reduce their own carbon pollution. By making this business decision around whether to reduce carbon pollution or trade in permits, firms operate within the overall cap at least cost.

In this way, the scheme gives firms the flexibility to choose the most cost-effective way to meet the carbon pollution cap. At the same time, the carbon pollution market provides a greater financial incentive for firms to develop and adopt technologies to reduce emissions.