Smart Cap-and-Trade

June 12, 2025

Cap-and-trade is a commonly proposed policy for regulating carbon. But its design is challenged by asymmetric information between the carbon-emitting firms and the regulator. Firms have a lot more information than the regulator about the costs associated with abating carbon. In their paper, Karp and Traeger introduce and model a “smart” cap mechanism that overcomes this challenge and allows policy makers to modify existing institutions to achieve better outcomes.