Economics of Environmental Policy. Environmental Policies Decentralized Policies Liability Laws and...

Economics of Environmental

Policy

Environmental Policies Decentralized Policies

Liability Laws and Property Rights Moral Suasion

Command and Control Emission Standards Technology Standards

Incentive-Based Policies Emission charges Subsidies Tradable discharge permits

Decentralized Policies Liability Laws and Property Rights Moral Suasion

Command and Control Emission Standards Technology Standards

Incentive-Based Policies Emission charges Subsidies Tradable discharge permits

Criteria for Evaluating Policies Efficiency Cost Effectiveness Fairness Incentives for Technological Improvements Enforceability Morality

Efficiency Cost Effectiveness Fairness Incentives for Technological Improvements Enforceability Morality

Efficiency Maximum net benefits

Requires balancing MAC and MD Decentralized……………….Centralized

Hayek’s critique

Cost Effectiveness:When damages (benefits) can’t easily be measured

Cost Effectiveness:When damages (benefits) can’t easily be measured

Rational central planning is impossible

Rational central planning is impossible

Adam Eve

12 0

9 3

5 5

4 8

0 12

Garden of Eden

Adam and Eve in the Garden of Eden, by Titian (c. 1550)

Which allocation would you choose?

1. Choice One2. Choice Two3. Choice Three4. Choice Four5. Choice Five

0% 0% 0%0%0%

Adam Eve

12 0

9 3

5 5

4 8

0 12

Tradeoff: Efficiency vs. Fairness ?

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Fairness Distribution of benefits/costs across regions,

incomes, race, etc

Distribution of Net Benefits

Program Total Cost

Total Benefits

Net Benefits

Low Income

High Income

A 50 100 50 25 25

B 50 100 50 30 20

C 50 140 90 20 70

D 50 140 90 45 45

If you could impose any of the four Programs, which would you choose?

Distribution of Net Benefits

Program Total Cost

Total Benefits

Net Benefits

Low Income

High Income

A 50 100 50 25 25

B 50 100 50 30 20

C 50 140 90 20 70

D 50 140 90 45 45

0% 0%0%0%

a) Program Ab) Program Bc) Program Cd) Program D

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

If your choices were limited to Program C or Program A, which would you choose?

Distribution of Net Benefits

Program Total Cost

Total Benefits

Net Benefits

Low Income

High Income

A 50 100 50 25 25

B 50 100 50 30 20

C 50 140 90 20 70

D 50 140 90 45 45

0%0%

1. Program A2. Program C

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Incentives for Technological Improvements Shift the MAC curve down

EmissionsE0

MAC1

MAC2

MD1

E1E2

Incentives for private sector to innovate Profit motive New ideas are a public good

undersupply problem

Pollution Control industry: “envirotech” Driven by regulations and profit motive

Incentives for private sector to innovate Profit motive New ideas are a public good

undersupply problem

Pollution Control industry: “envirotech” Driven by regulations and profit motive

Incentives for Technological Improvements

Enforceability Enforcement is costly

Reliance on self-reporting Monitoring Sanctioning

Courts Fines

Enforcement is costly Reliance on self-reporting Monitoring Sanctioning

Courts Fines Paradox of the Reluctant Enforcer

Moral Considerations Right vs. wrong Taxes vs. Subsidies vs. Permits

The Animal Liberation Front (ALF) carries out direct action against animal abuse in the form of rescuing animals and causing financial loss to animal exploiters, usually through the damage and destruction of property.

Decentralized Policies Liability Laws Property Laws Voluntary action

Liability Law Polluters must compensate those harmed

Provides incentive to make careful decisions “internalize the externality”

Which of the following situations would provide a system of liability rules the best chance for generating an efficient level of emissions?

a) b) c) d)

0% 0%0%0%

a) many people are involved, causal links are clear, and damages are difficult to measure.

b) few people are involved, causal links are clear, and damages are difficult to measure.

c) many people are involved, causal links are muddy, and damages are easy to measure.

d) few people are involved, causal links are clear, and damages are easy to measure.

a) many people are involved, causal links are clear, and damages are difficult to measure.

b) few people are involved, causal links are clear, and damages are difficult to measure.

c) many people are involved, causal links are muddy, and damages are easy to measure.

d) few people are involved, causal links are clear, and damages are easy to measure.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Liability Law…MD1MAC1

E0

$

EmissionsE*

b c

d

Suppose firm is liable for pollution damages At E0: TD = b + c + d

Reducing emissions reduces Damage Liability (saves “c+d”) Reducing emissions increases Abatement Costs (costs “c”) Threat of lawsuit could encourage optimal emissions

Legal Doctrines Strict Liability

Liable for damages regardless the circumstances Negligence

Liable only if appropriate precautions are not taken Burden of Proof?

Burden is on victims Statute of limitations

Standard of Proof? Direct causal link must be established Difficult given the probabilistic nature of many

exposures

Common Law

Smoking “causes” cancer? Exxon Valdez “caused” shoreline damages? Particular power plant “caused” SO2 damages?

Best Case Scenario for Common LawFew people involved, causal link is clear, damages

easily measured

Examples

Under a system of negligent liability, a firm disposing hazardous materials into a river would:

0% 0%0%0%

a) be liable for any damages regardless of the circumstances.

b) be liable for any damages only if the firm did not take reasonable steps to avoid damage.

c) not be liable for any damages. d) none of the above.

a) be liable for any damages regardless of the circumstances.

b) be liable for any damages only if the firm did not take reasonable steps to avoid damage.

c) not be liable for any damages. d) none of the above.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Legislative enacted laws Tax-financed victim’s fund (Netherlands) Law for the Compensation of Pollution-Related

Health Injury (Japan) CERCLA (US)

Example: #4 from Problem Set

Statutory Law

4. Accidents with trucks carrying cow renderings are fairly common in Marietta. Suppose regulators enact a rule requiring that the perpetrators of such an accident be liable for a sum equal to the average damages of all such accidents in the industry. Would this lead trucking companies to take the socially efficient amount of precaution against such accidents? Explain.

In March a small dump truck overturned in Marietta, Ohio, littering the street with cow parts. A smaller shipment fell off of a truck on the same street the following week, running the total of cow-parts spills to four within a year. Said City Councilwoman Katie McGlynn, "I would just like to know why this continues to happen. Maybe we need a stronger ordinance to make this a more serious crime." [Marietta Times, July 1993]

Property Rights

Coase Theorem If property rights are well-defined and

transactions costs low, then private bargaining will lead to an efficient allocation of resources

Corollary: efficient allocation does not depend on initial allocation of property rights

Conditions “well-defined” property rights low transactions costs complete markets

Ronald Coase1991 Nobel Prize in Economics

6. A factory's production process creates sludge which pours into a river. This sludge makes it difficult to fish in the river, increasing the costs of the local fishermen by $6000. The factory can install a water filter system for $4500, and the fishermen can utilize a weighted fishing net system (to get under the sludge) for $3750. Both systems would remedy the sludge damage to the fishermen.

a) Suppose transactions costs are zero. If the factory is not liable and can continue to produce sludge, what outcome do you predict and why?

b) Suppose transactions costs are zero. If the factory is assigned liability for sludge damage, what outcome do you predict and why?

c) Now suppose transactions costs preclude the possibility of private bargaining between the factory and fishermen. If a pollution tax is levied on the factory with the proceeds given to the fishermen, then what outcome do you predict and why?

d) How do your answers to parts (a), (b), and (c) change if the cost of the water filter system was $3500?

e) Discuss the results of parts (a), (b), (c), and (d) in terms of the Coase Theorem.

Voluntary Action Moral suasion Informal community pressure

Command and Control Policies Mandate behavior coupled with enforcement Examples

Speed limits Minimum age restrictions Minimum wage

Why are standards popular? Simple and direct Moral appeal

Ambient Standards Never exceed level of a pollutant in

ambient environment DO can not fall below 3ppm

Expressed in terms of average concentration over time SO2: 80 μg/m3 annual; 365 μg/m3 daily

Can’t be enforced directly; must monitor emissions that lead to AQ levels

Emission Standards Never exceed levels applied directly to

quantities of emissions Expressed in terms of quantity per time

Tons per week Grams per hour

Emissions Environment AQ Meteorlogical Hydrological Human decisions

Technology Standards Mandated technologies, techniques, and

practices Examples

seat belts catalytic converters Scrubbers/baghouses

Emission Standards Applicable to New Snowmobiles

Carbon Monoxideg/kw-hr

Hydrocarbonsg/kw-hr

2005 397 150

2006/2007 275 100

2010 275 75

2012 200 75

Yellowstone 2005 120 15

Yellowstone Entry Standards Number of Snowmobiles Allowed (vehicles/day)

Clinton 2003 0

Bush 720

Noise Standards for Yellowstone

Decibels

Yellowstone 73 db

Elsewhere None

Economics of Standards

Setting the standard Should EPA consider damages and abatement costs?

Zero-Risk? Reasonably small level? Efficient level?

tradeoffs made by using avg. concentration levels over time

MDMAC

E0Et E*Emissions

$

E1

Uniformity of Standards Geographic differences: MDu > MDr

Single standard can’t be efficient

tradeoff: regulatory costs vs efficiency gains

$ MDuMAC

E0

Emissions

MDr

ErEu

Incentives for Improvements Technology Standards: no incentive

All or nothing!

Emission Standards: some incentive Polluters seek to reduce abatement costs Remember: pollution control R&D carried out by

pollution-control industry rather than polluting industries themselves

MD

MAC1

MAC2

Emissions

$

a

bc

d

e

E1E2

With MAC1: cost at E1 = a + bWith MAC2: cost at E1 = b

If E1 is the standard, then the incentivefor R&D = a “cost savings”

If standard is changed to E2 as new technology is adopted, then incentiveto innovate is (a – c)

Technology Forcing: If standard is set at E2 from the start then incentive to Innovate is (a + d + e)

E0

Input Standards or Output Standards?

Total Emissions =

Total Output X

Inputs used per unit of

outputX

Emissions per unit of

input

E = [Q] x [Inputs/Q] x [E/Inputs]

Auto Emissions = [# Vehicles] x [Miles/Vehicle] x [Emissions/Mile]

Emission Standards“end of tail pipe”

Economics of Enforcement Monitoring & Sanctioning Costs

MPC = Marginal Penalty Curve = P x F x E

With MPC1, firm only cuts back to E1

To get to E*, must raise MPC1 to MPC* Raise P Raise F

E* E1

MPC1

MPC*MAC

Emissions

$

E0

P = probability of detectionF = monetary fineE = emissions

P = 0.25F = $100/EE = 10,000

MPC = (.25)(100)(10,000) = $250,000

How do Standards Hold Up? Efficiency Cost Effectiveness Fairness Incentives for Technological Improvements Enforceability Morality

Efficiency Cost Effectiveness Fairness Incentives for Technological Improvements Enforceability Morality

Incentive-Based Strategies Emission Taxes Emission Subsidies

Emission Taxes Pigouvian taxes Government sets tax = $t per unit of emissions Polluter has incentive to reduce emissions until MAC = t Standard at E1 would only cost firm area "b"; much less

than the tax

b

E0E1

MAC

t

Emissions

Tax bill

Abatement Cost

$

MD

Optimal Tax Optimal t* occurs where MD = MAC

b

c

E1

MAC

E* E0

f

ed

a

t*

Reduced damages = e + f

Remaining damages = b + d

[Tax revenues are not includedin social cost calculation]

Two-part tax?Allow E1 emissions freeApply t* to anything above E1

Tax payment = c + d If MD is unknown, use iterative process:If AQ doesn’t improve raise tIf AQ improves too much lower t

Tax cost = a + b + c + d

Suppose that society's marginal abatement cost function is given by MAC = 50 - 2E and society's marginal damage function is given by MD = 3E. What is the optimal level of pollution emissions?

50 30 20 10 5

0% 0% 0%0%0%

a) 50b) 30c) 20d) 10e) 5

a) 50b) 30c) 20d) 10e) 5

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

According to the situation above, what would be the optimal per unit pollution tax?

50 40 30 20 10

0% 0% 0%0%0%

a) $50b) $40c) $30d) $20e) $10

a) $50b) $40c) $30d) $20e) $10

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Uniform Emissions Equimarginal principle is satisfied efficiency results possible even though agencies may know nothing

about MAC at sources (unlike standards, where agencies must know MAC)

Non-Uniform Emissions single tax not fully efficient: deals with differences in MAC, but not

differences in MD 1 unit reduction by Firm B is better than 1 unit reduction by Firm A

Firm A

Firm B

Efficiency

Warning: reducing emissions through one medium may increase emissions elsewhere

Zoned Taxes?

d

E0E1E2

a bc

e

MAC1

MAC2

t*

With tax t*:

MAC1: Cost = (d + e) + (a + b + c)

MAC2: Cost = (b + e) + (a)

Cost savings = c + dRecall: cost savings for standardat E1 was only d.

Incentive to Innovate

Enforcement costs Higher monitoring requirements compared to standards Non-point sources are difficult to monitor/tax Revenues give regulators incentive to monitor

Examples CO2 taxes: Scandinavia State emission fees for criteria pollutants

Enforcement and Examples

South Coast AQMD

For emissions in Calendar Year 2008

Annual Emissions (tons/yr)

Organic Gases ($/ton)

Specific Organics ($/ton)

Nitrogen Oxides ($/ton)

Sulfur Oxides ($/ton)

Carbon Monoxide

($/ton)

Particulate Matter ($/ton)

4 – 25 $517.08 $92.52 $302.52 $358.65 -- $395.41

> 25 – 75 $839.53 $146.58 $480.53 $579.77 -- $640.70

> 75 $1,2568.68 $219.87 $723.70 $870.45 -- $959.28

> 100 -- -- -- -- $6.18 --

Source: South Coast AQMD, Rule 301, Table III. Available at http://www.aqmd.gov/rules/reg/reg03/r301.pdf

Enforcement costs Higher monitoring requirements compared to standards Non-point sources are difficult to monitor/tax Revenues give regulators incentive to monitor

Examples CO2 taxes: Scandinavia State emission fees for criteria pollutants tax on cars to control auto emissions

total emissions per year = (E/mile) x (# miles per year)

Gasoline taxes

Enforcement and Examples

Federal tax is 18.4 cents per gallonSource: http://www.factsonfuel.org/gasoline/index.html

More examples… Non-point sources

Agricultural runoff pesticides fertilizer

Distortions? Trash stickers

pack more garbage into each bag tax on house windows

Tax the input, rather than output

Regulatory costs may be passed on to consumers through higher prices to workers through reduced employment (and lower

wages)

QuantityQ1Q2

P1

P2

S1S2

D1

$

Distributional Concerns

Subsidies Types

technology subsidies abatement subsidies

while emissions per firm may go down, new firms may be attracted to the industry!

Examples: deposit refund systems:

Cars Batteries Bottles/cans

Tax credits5¢: CA, CT, DE, HI, IA, ME, MA, NY, OR, VT10¢: MI

Current Models

Make ModelEstimated Tax

Credit

Chevrolet Malibu Hybrid $1,300

Chevrolet Tahoe Hybrid $2,200

Ford Escape Hybrid (2wd) $3,000

Ford Escape Hybrid (4wd) $2,200

GMC Yukon Hybrid $2,200

Honda Civic Hybrid (auto) $2,100

Lexus RX 400h $2,200

Lexus GS 450h $1,550

Mercedes GL 320 Bluetec (clean diesel) $1,800

Mercury Mariner Hybrid (2wd) $3,000

Nissan Altima $2,350

 Saturn Vue Green Line $ 650

Saturn Aura Green Line $1,300

Toyota Camry Hybrid $2,600

Toyota Highlander Hybrid $2,600

Toyota Prius $3,150

Volkswagen Jetta TDI (clean diesel) $1,300

http://www.hybridcars.com/federal-incentives.html

Pollution Worksheet Marietta-Parkersburg area emissions:

Current emissions = 90,000 units Optimal emissions = 60,000 units

Marginal Abatement Cost Cars: $5 Utilities: $10 Factories: $20

Controlling pollution through: Standards Taxes Tradable Permits

StandardsSet a maximum emissions of 20,000 units per source:

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

CARS

UTILITIES

FACTORIES

TOTAL

20,000

20,000

20,000

60,000

0

10,000

20,000

30,000

0

$100,000

$400,000

$500,000

StandardsRequire each source to cut emissions by 10,000 units:

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

CARS

UTILITIES

FACTORIES

TOTAL

10,000

20,000

30,000

60,000

10,000

10,000

10,000

30,000

$50,000

$100,000

$200,000

$350,000

StandardsRequire each source to cut emissions by 1/3:

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

CARS

UTILITIES

FACTORIES

TOTAL

$ 33,335

$100,000

$266,660

$399,995

13,333

20,000

26,667

60,000

6,667

10,000

13,333

30,000

StandardsCost-minimizing strategy of reducing emissions by 60,000 units.

“$200,000 Solution”

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

CARS

UTILITIES

FACTORIES

TOTAL

0

20,000

40,000

60,000

20,000

10,000

0

30,000

$100,000

$100,000

0

$200,000

Taxes

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

TAX COSTS

CARS

UTILITIES

FACTORIES

TOTAL

0

30,000

40,000

70,000

20,000

0

0

20,000

$100,000

0

0

$100,000

A tax of t = $6 per unit of pollution is imposed:

$180,000

$240,000

$420,000

0

Taxes

SOURCE EMISSIONS EMISSIONSABATED

ABATEMENTCOSTS

TAX COSTS

CARS

UTILITIES

FACTORIES

TOTAL

0

0

40,000

40,000

20,000

30,000

0

50,000

$100,000

$300,000

0

$400,000

A tax of t = $11 per unit of pollution is imposed:

0

$440,000

$440,000

0

AuctionRevenue

Tradable Permits

permits

$

$20

$10

$5

40 70 90

F

U

C

D

S

60

Abatement Cost

P = $10Q = 60,000

“$200,000 Solution”

= MAC

Tradable Discharge Permits TDPs rely on decentralized cooperation

Central authority sets aggregate # permits (CAP) Each polluter is allocated certain number of

emission permits Each permit allows 1 ton of SO2

Polluter must then make a choice: Reduce emissions to level covered by allocated

permits Reduce emissions below original permit level,

then sell excess permits Buy additional permits (to enable expanded

production)

TDPs rely on decentralized cooperation Central authority sets aggregate # permits (CAP) Each polluter is allocated certain number of

emission permits Each permit allows 1 ton of SO2

Polluter must then make a choice: Reduce emissions to level covered by allocated

permits Reduce emissions below original permit level,

then sell excess permits Buy additional permits (to enable expanded

production)

Permit Market Buyers

New firms Existing firms looking to

expand Sellers

Firms leaving area/industry Those who’ve invested in

efficient technology

D

S

Q*

P*

Permits

$

Permits flow from low MAC polluters to high MAC polluters so as to satisfy equimarginal principle

2008 Spot Auction

2008 7-yr Advance Auction

Trading Rules Should be simple and clear to minimize

uncertainty Initial Permit Allocation?

Equal allocation? Ignores differences in firm size

According to existing emissions? Ignores that some firms have already cut emissions

Give away or auction? Coase Theorem

Trading Rules… Who may participate?

Local, regional, national, international polluters?

Environmental groups? Speculators?

How will trades take place? Sealed bids for annual EPA auction Brokers are used for secondary markets Do regulators have veto power?

Urban Area

Potential Problems Market power Thin markets Permit life span Hot spots (non-uniform emissions)

Tradeoff: competitive markets vs. enviro damage

PrevailingWind

A

BC

D

“transfer coefficient”

Enforcement EPA must monitor:

Number of permits in possession of each polluter CBOT

Quantity of emissions from each source Incentive for polluters to monitor each other to prevent

cheating (reduces demand for permits)

de

75

Incentives for Innovation

Cost savings as good as emission taxes

MAC1

MAC2

MAC1 = 200 - 2E1

MAC2 = 100 – E2

10050

Permit price = $50

$50

TAC with MAC1 = d + e = $625

TAC with MAC2 = b + e = $1250

Revenue from TDP = b + c = $1250

Cost Savings =

cba

(d+e) – (b+e) + (b+c) = d + c = $625

$$200

$100

emissions

Which of the following is a criterion for evaluating environmental policies?

20% 20% 20%20%20%a) efficiency b) fairness c) incentives to improvements d) enforceabilitye) All of the above

Private bargaining can lead people to the efficient outcome if

a) b) c) d)

0% 0%0%0%

a) transactions costs are low and property rights are well defined

b) transactions costs are high and property rights are ill defined

c) transactions costs are high and property rights are well defined

d) transactions costs are low and property rights are ill defined

The two defining features of command-and-control regulation are

a) b) c) d)

0% 0%0%0%

a) cost-effectiveness and flexible standards

b) pollution taxes and marketable permits c) uniform standards and technology-

based regulations d) monitoring and compliance

Emission taxes are generally regarded as efficient since

a) b) c) d)

0% 0%0%0%

a) they raise the maximum amount of revenue possible for the IRS

b) they encourage all pollution sources to completely eliminate their emissions

c) they require environmental regulators to know the individual source marginal abatement

d) they encourage all pollution sources to adjust their emissions so that the equimarginal principle is satisfied.

Emission taxes are more likely to be effective when applied to

a) b)

0%0%

a) nonpoint sources of pollution b) point sources of pollution

Marketable pollution permits require a slightly more complex system when there are geographic differences in pollution effects. One possible approach to designing a system of permits would be to:

a) b) c) d)

0% 0%0%0%

a) use technology-based standards in conjunction with the permits

b) auction off the permits one-by-one over time until all permits have been allocated

c) simply give the permits away to polluters based on their historic emissions rate

d) establish separate markets for each subregion