A working paper recently issued by Resources for the Future argues that an auction of carbon permits is the best way to achieve carbon caps set by international negotiation to limit global climate change. The paper's authors outline how to design a carbon auction and then demonstrate through examples that an auction would be relatively efficient and simple to run.
Permits allow a one-time use of one metric ton of carbon.
The bonus is that the revenue from the auctions would be refunded through tax cuts to all citizens of the United States. This 'revenue recycling' means that polluters are effectively buying the right to pollute from the public. If permits are grandfathered to companies in the energy sector, two percent of GNP is given away. To minimize administrative costs, Cramton and Kerr argue that permits be required at the level of oil refineries, natural gas pipe lines, liquid sellers, and coal processing plants. To maximize liquidity in secondary markets, they advocate that permits be fully tradable and bankable, with the government conducting quarterly auctions.