The basic concept is to either force firms to become more efficient in their business processes so that they pollute less, or alternatively make business more expensive so that customers will seek to buy products and services from suppliers who are cheaper because they are not paying a tax on their CO2 emission.

Cap and trade is a more sophisticated version of a carbon tax, and it is known to be significantly more effective in reducing the amount of national pollution. The point with a cap and trade system is that costs will only increase where firms choose not to install more efficient energy-saving technologies.

What the Australian government is trying to do with a cap and trade system is to make it more economically viable for a company to spend money on new manufacturing equipment. If the management of a firm chooses not to buy new equipment, then the government will take the money instead as a tax. The government progressively increases the amount of tax that a firm has to pay until the will of the firm is broken and they have to succumb to installing new technologies.

The ‘cap’ in a cap and trade system is where the government puts an upper limit on the amount of CO2 pollution a firm can release into the atmosphere each year. For every single tonne over that limit, the firm must pay a significant tax. Each year the government reduces the limit, making the cap lower and lower. Soon the only way the firm can avoid paying a large tax bill is to “voluntarily” reduce the amount of CO2. So the cap is a moving target over a number of years, until it gets down to the level of the national commitment on emission levels.

The ‘trade’ in cap and trade is when a firm that is below the target set by the government for that year can sell the balance to another firm that is unable or unwilling to reduce their emissions. This way if a firm does an incredibly good job reducing their CO2 emissions they can be rewarded by being able to sell their leftover target.

However, for firms to be allowed to purchase the balance of the emissions target, they must be part of the cap and trade system. If a company is unable or unwilling to put in new technology, they can avoid paying a tax to the government, but they do pay a fee to another company for the use of their efficiency.

The cap and trade system does a number of positive things in regard to the accounting of carbon emissions. Firstly it ensures a good price for carbon. By reducing the cap each year, the government continues to reduce the available number of carbon credits available in the market. The next thing is that it demands a smarter industry sector, which has to be good for Australians.

Phillip Lawrence is a consultant and speaker who specialises in print and the environment