A cap-and-trade program works by the federal government mandating the maximum allowable level of annual CO2 emissions by giving out permits. For a company to operate and put out CO2 it must have enough permits to cover it's output. The tricky part is how do you determine who gets the permits? One thing to keep in mind is that these permits have significant economic value, since now CO2 emissions are a limited economic resource. There are basically three ways to do it:

1. Sell the permits for a price determined by congress to companies also determined by congres (ie lobbyists).
   • None of the candidates propose this
   
   
2. Auction them off to the highest bidder.
   • This is the Obama and Clinton plan. Selling all of the permits to the highest bidders ensures efficient market pricing of the permits and generates significant revenues to the government. These revenues can then be used for a variety of purposes (more on that later)
   
   
3. Give them away to companies.
   • This is the McCain plan. Since energy prices rise under any cap-and-trade program, giving the permits away results in a tremendous windfall to companies fortunate enough to recieve the permits. Furthermore, by basing permit allocation on historical emissions, the more a company pollutes, the greater the windfall. Can anyone see any potential for corruption in here?

It's important to understand that any cap-and-trade program can achieve the same environmental benefit of reducing emissions, but they are not all created equal. First, Obama and Clinton have a lower cap: 80% below 1990 CO2 levels by 2050, while McCain proposes 60% below 1990 levels by 2050. Second, because Obama and Clinton are auctioning permits instead of giving them away, the money raised can be spent on 1) reducing the economic costs to lower and middle class Americans (cap-and-dividend) and 2) investing in cleaner energy (cap-and-spend).

It's important to stress this: the economic costs to Americans under either cap-and-trade program would be the same, however, Obama's plan involves both cap-and-dividend and cap-and-spend to help ameliorate the costs to low and middle class American's, and make investments for all Americans.

Cap-and-dividend refers to distributing the revenues generated by auctioning permits to offset the costs to low and middle class Americans. The idea is that the lower your income, the greater the increase in energy costs as a portion of your income. This would eliminate the regressive aspects of rising energy costs.

Cap-and-spend refers to investing the revenues raised into projects, either through government spending or other tax cuts, for any variety of projects. Obama's plan has money allocated for a wide variety of infrastructure improvements, including in transportation and the electrical grid, and money for research and commercialization of renewable energy projects.

So Obama and Clinton have cap-and-trade with 100% auction, and they each have a mix of cap-and-spend and cap-and-dividend plans for the auction revenues. McCain does not.

As Kevin Drum says:

"So that's that. A cap-and-trade system with a 100% auction provides revenue for green research; it reduces the regressivity of the tax hit; and it helps keep lobbyists from gaming the system. The giveaway method, conversely, is highly regressive; provides windfall profits for big polluters; and would almost certainly end up as a congressional pork barrel that eviscerated the original emission targets bit by bit by bit. It just goes to show that policy details matter. Take your pick."

Furthermore, McCain would allow unlimited uise of domestic and international carbon offsets to remain in compliance with the cap. Carbon offsets are a tricky subject, because there are reputable, effective measures that can be and are being undertaken. However, there is also serious potential for abuse (how do we ensure that all the carbon offsets are actually being done, not just booked?) and the capacity for genuine, effective offsets is limited. The biggest problem with unlimited offsets, though, is that they reduce the economic pressure to actually retool industries to reduce emissions. As Dave Roberts says at Gristmill:

"for that very reason the massive changes needed in the American economy and infrastructure will be put off, and dirty coal plants may remain economical long enough for a new round to get built."

My emphasis added.

Finally, I'll also point out that McCain hasn't put out an energy plan yet, and as Dave Roberts notes, at the same link:

"(One important note: the speech is not on energy. McCain will be delivering a major speech on energy in a few weeks, probably early June, wherein he will lay out specific thoughts and policies on coal, nuclear power, renewables, etc. Today is all about climate policy.)"

The McCain Energy Policy Watch continues.