Incentivebased IB Regulation Theory Drawing on Goodstein Polaskys

Incentive-based (IB) Regulation Theory Drawing on Goodstein & Polasky’s Chapter 15 Source of background picture: Chesapeake Bay Program (http: //www. chesapeakebay. net), Bay Resource Library

Introduction • Basic Ideas: – Make polluting expensive – Let polluters decide how to reduce it • Tools: – Emissions charge – Cap-and-trade system – (Tax pollution-intensive product)

Advantages over Commandand-Control (CAC) Incentives in: • short run to reduce more (less) where cost is lower (higher) • long run to seek new technologies to cut pollution & control costs Lower costs and, potentially, pollution Tax rebates or permit giveaways gain efficiency &/or political support

Cost-Effectiveness Rule: equal MC of reduction for all sources Reason: If not, cost of a given overall reduction falls when cutting pollution where cheap and raising it where cuts are expensive

IB Tools, Costs & Information • CAC-based cost-effective reduction requires information on all control costs • IB tools – induce it without prior cost information – limited by polluters’ ability to pay for pollution and control • Numerical examples – Grimeville, Fox River paper mills

Implementing IB Tools • Permit price = emission charge with same reduction & overall cost • Same results whether initial permits free or auctioned (Coase corollary)

Sharing Costs • Rebating avg. charge / auction revenue – To firms: same incentive & less opposition – To citizens: progressive redistribution • Free initial permits cost – Firms less (regressive) – Consumers the same in the short run • Substituting pollution revenues for labor (or capital) taxes increases production

Greater Incentives for New Technology with IB than CAC ′ c

Problems Any IB Tool: • Hot spots • Monitoring emissions Emission charge: • Hunt for right level • Need increase over time Cap-and-Trade: • Thin markets • Market power • Permit life

Hot Spots If emissions do not mix uniformly, – They concentrate around polluters with high control costs – Safety (equity) requires area-specific limits – IB systems become complex

Non-uniformly Mixed Pollutants in Grimeville For safety, set taxes higher (or permits lower) for sources of pollutants that concentrate in some areas

Monitoring emissions • CAC – Requires technology & checks installation & maybe operation • IB – Based on emissions, which must be directly monitored – Not yet adequate; vulnerable to budget cuts – Charges kept by regulators give incentive to monitor & enforce

Emission Charge Problems • Find needed charge by trial & error uncertainty & opposition • Must be raised over time – Economic growth raises benefit of pollution – Inflation cuts real cost of charge – Polluters lobby against

Cap-and Trade Problems • Thin markets, if – few buyers & sellers, uncertain availability & price • Market power, if – new firms must buy permits from dominant competitor • Permit life, if – too short use it or lose it; allow banking – too long must buy back to further cut emissions