The reallocative and heterogeneous effects of cap-and-trade

Abstract This paper explores the heterogeneous response of manufacturing firms to the NOx Budget Trading Program (NBP), a large scale cap-and-trade program that was implemented in nineteen states in 2004. Specifically, we examine the differential effect of the program across firms of different ages and sizes. Results show that while overall employment in polluting industries declines, this decline is driven entirely by incumbent firms and that new firm activity increased following the NBP. The findings provide evidence that, unlike command-and-control programs, cap-and-trade results in reallocation of production from older to younger firms and changes the firm size distribution.