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A comprehensive cap-and-trade program requires a number of policy design decisions. These involve setting emissions targets, determining which sources will be regulated under the cap, how pollution permits will be assigned or auctioned, and how to generate emissions reductions from GHG pollution sources not included in the cap. Carbon offsets are reductions from uncapped sectors or sources that are used for compliance with the cap. Offsets are likely to play a crucial role in the design of a U.S. cap-and-trade program for limiting GHG emissions because they can help contain costs and expand compliance options. However, offsets are only one mechanism for achieving reductions at uncapped sources, and should be considered alongside other measures, such as complementary regulations (including GHG performance standards) or subsidies.

In principle, any GHG reductions (or increases in carbon sequestration) that occur at sources or sinks “outside the cap” can be used as offsets within a cap-and-trade system.1 However, not all GHG reductions are easy to certify as offsets. These include GHG reductions from forestry and agriculture activities, which face larger challenges in meeting basic offset certification criteria than activities in other sectors (e.g., projects involving methane capture and destruction). Overcoming these challenges may add costs that could be avoided by using other policies and mechanisms.

Policymakers must therefore confront a tradeoff in deciding whether certain kinds of GHG reductions should count as carbon offsets. Should they seek maximal inclusion of offset options as part of a cap-and-trade package in order to provide the greatest amount of flexibility and cost-containment for capped entities? Or should they think about the most efficient means to achieve GHG reductions, and exclude from an offset program those reductions that could be more cost-effectively achieved through other policy mechanisms? This brief argues the latter. Carbon offsets should be considered as an important element of an overall strategy to achieve national GHG reductions at the lowest cost to the economy, but cost containment should not be viewed only from the perspective of capped entities. The authors review some of the decisions policymakers will need to make as they consider designing the offsets component as part of a cap and trade program. Section I describes the basic criteria for certifying carbon offsets. Section II assesses differences in the ease with which various project types can satisfy these criteria. Section III discusses the implications of these differences for decisions about whether to include certain types of activities in a carbon offset program or address them through other policies. Section IV provides conclusions and recommendations.