Measuring the costs of improving the quality of the environment in the United States

M E A S U R I N G THE COSTS OF IMPROVING THE QUALITY OF THE

E N V I R O N M E N T IN THE UNITED STATES

ROY BOYD

Department of Economics, Ohio University, Athens, 0H45701, U.S.A.

and

N O E L D . U R I * ' * * RTD/ERS (Room 428), U.S. Department of Agriculture, 1301 New York Avenue, NW,, Washington, D.C.

2000L U.S.A.

(Received May 9, 1990; revised November 5, 1990)

Abstract. The analysis in this paper is directed at comparing the relative effectiveness of meeting the objectives outlined in the recently passed Clean Air Act Amendments of 1990 through taxation and through regulation. The analytical vehicle used in the analysis consists of a computable general equilibrium model composed of 12 producing sectors, 13 consuming sectors, 6 household categories classified by income, a foreign sector and a government. We find first that, irrespective of what type of strategy is followed, both output and consumption decline. Hence, there is an identifiable and quantifiable tradeoff between economic activity (economic growth) and the quality of the environment. Beyond this, the aggregate loss in production and economic welfare (measured by consumption expenditures and utility) is less under a policy which stresses reliance on alternative fuels than through one that requires the installation of pollution abatement devices.

1. Introduction

Sustained economic growth and improved environmental quality are generally regarded as two of the most important objectives towards which the United States should work. Historically, it has been viewed that these are competing objectives and it has been argued that economic growth necessarily results in environmental degradation.*** Increasingly, however, this conclusion is being questioned. It has been Suggested that economic growth and environmental quality need not be incompatible (see, e.g., Council of Economic Advisors (1990) and Freeman (1990)). In fact, it is argued, they can be complementary. For example, economic growth provides firms with the opportunity to invest in new plant and equipment that are cleaner (in terms of emissions) and more efficient. Given the conflicting assessment of the situation, the nature and extent of this interrelationship continues to be debated among policy makers (in addition to those interested in policy related issues).

* Author for all correspondence. ** The view expressed are those of the authors and do not necessarily represent the policies of the organizations with which they are affiliated. They would like to thank two anonymous referees for helpful comments. *** The literature on this is enormous. For the reader interested in reviewing this literature, good references include are Baumol and Oates (1988), Buchanan (1969), Maloney and McCormick (1982), and Seskin et al. (1983).

Water, Air and Soil Pollution 55: 355-377, 1991. © 1991 Kluwer Academic Publishers. Printed in the Netherlands.

356 ROY BOYD A N D NOEL D. URI

Beyond this concern for the relationship between economic growth and the environment is the need to provide a level of environmental quality that will sustain or enhance the quality of life for the citizens of the United States. In striving for this goal, it is necessary to understand the nature of environmental problems. They arise in market economies when private individuals and business lack incentives to take full account of the environmental consequences of their actions. (A good technical discussion of this is contained in Dasgupta and Heal (1979)).

This concern for improving environmental quality has been most recently expressed in the 'Clean Air Act Amendments of 1990'. This legislation to amend the Clean Air Act was recently (October 1990) passed by both the U.S. Senate and U.S. House of Representatives and sent to the President for his signature. Its main provisions were originally proposed by President Bush in June 1989 (The White House, 1989). The amendments include initiatives to cut SO2 emissions in half by the year 2000, bring all cities currently not meeting the health standards for 03 and CO into attainment, and require factories and plants emitting toxic compounds (e.g., nitric oxides, NOx) into the air to employ the best technology currently available in order to achieve in the near term a cut estimated at 75 to 90% in pollutants suspected of causing cancer.

A variety of ad hoe analyses have been performed to assess the costs associated with improving environmental quality as outlined in the 1990 Amendments to the Clean Air Act. These incluse the studies by the Congressional Budget Office (1990), Montgomery and Marcuss (1990), and Koskores (1990). There is no consensus, however, among these and other studies addressing the environmental quality issue as to the net social benefits that would result from the implementation of the various policy initiatives. One of the reasons that these and other studies fail to agree is that they typically take a simple, partial equilibrium approach to analyzing the impact of the initiatives. This sort of approach frequently leads to incomplete and misleading estimates of the costs associated with the initiative because even though the direct impacts might be properly calculated, the indirect effects (i.e., the effects precipitated by the initial action) are ignored. Consequently, in order to avoid such potential shortcomings, the problem must be viewed from a comprehensive, economy-wide perspective. This will be done in what follows. After briefly reviewing the background of the environmental problem and the ways the problem can be mitigated, we describe the Computable General Equilibrium (CGE) model used in the analysis. We then present two alternative pollution abatement strategies and Use the CGE model to evaluate the effects of these strategies on production, consumption and consumer welfare.

2. Methods and Materials

2.1. BACKGROUND

Improving environmental quality is complicated by many factors. One is the sheer

M E A S U R I N G T H E COSTS OF IMPROVING T H E QUALITY 357

number of pollution sources. There are an estimated 27 000 major industrial and utility sources of air pollution in the United States. Mobile sources of pollution (automobiles, trucks, aircraft, and locomotives) number well over 150 × 106, and the number of vehicle miles travelled has been steadily increasing. In 1987, more than 100 × 106 people lived in areas where the air quality standards implemented in 1970 have not been met (Johnson (1990) reports these data).

Because pollutants are transformed and transported in the atmosphere, the selection of control strategies is complicated. Many of the environmental programs enacted between 1970 and 1980 rely heavily on command-and-control regulation and emissions standards. Command-and-control regulations uses a system of admini- strative or statutory rules that requires use of specific control devices on classes of selected pollution sources or applies emissions standards to pollution sources. Emissions standards are usually expressed as a limit applied to an individual pollution

source. (See, e.g., Baumol and Oates (1988), for a comprehensive discussion of pollution control options). More recently, consideration of the use market incentives to further environmental goals has been gaining acceptance. (See, e.g., U.S. GAO (1982), Noll (1982), McGartland (1988), and Malueg (1989) for a review). Such market incentives take the form of emissions charges and tradeable emissions allowances. Emissions charges are fees levied by the government on each unit of pollutant emitted. Tradable emissions allowances involve a regulatory regime in which all sources of pollution are required to hold allowances for all emissions of covered pollutants. The government distributes a number of allowances equal to the target emissions level, which can be freely bought and sold within the private sector. It is argued that the use of such market based incentives can serve both the environment and the economy by reducing the costs of environmental protection. (Several good surveys of the arguments are available including Malueg (1990) and Tietenberg (1980).)

In the context of the Clean Air Act, which approach can reach the announced goals while coincidentally imposing the minimal cost on the economy? Thus, for example, will emissions charges (in the form of a tax) designed to reduce SO2 and

NO x emissions impose a smaller cost on the economy than regulation? An analysis and comparison of alternative control strategies will be investigated.

In the analysis to follow, the level of pollution abatement to be attained will be taken as given (these are delineated in the Clean Air Act Amendments of 1990). We will calculate the impacts of two different control strategies. Under the first strategy, pollution will be abated at the 'end of the pipe'. That is, fossil fuel burning electric utilities will be required to purchase and install emissions control devices and motor vehicle manufactures will be required to install 'clear air' devices on all new vehicles (both cars and trucks) produced. Under the second strategy, pollution will be reduced via taxes on intermediate inputs. More specifically, the ad valorem tax (sales tax) on gasoline will be increased while output taxes will be levied on the crude oil and mining sectors in order to emulate the impact of emissions charges whereby producers internalize the externalities associated with the products they

358 ROY BOYD AND NOEL D. URI

produce. (See, e.g., Uri (1983) for a discussion of this approach). The objective is to compare the relative impacts of these two alternatives. In

order to do this properly, a comprehensive analysis must be employed whereby the interrelationships between the sectors in the economy are explicitly taken into account and where the responsiveness of producers and consumers to changes in the prices (both absolute and relative) of the various goods and services is considered.

Such an analysis will be provided using a computable general equilibrium model that has been disaggregated into 12 producing sectors, 13 consuming sectors, 6 household (income) categories and the government. This level of disaggregation allows for an assessment of the direct effects as well as the indirect effects of the two alternative pollution abatement strategies. By measuring these effects using a general equilibrium approach, it is possible to identify which groups stand to gain and which groups stand to lose, and hence, equity considerations as well as efficiency considerations can be addressed.

2.2. A G E N E R A L E Q U I L I B R I U M M O D E L

2.2.1. I n t r o d u c t i o n

The use of a general equilibrium approach to modeling environmental impacts is a logical decision.* The interactions between supply and demand, both within the markets affected by environmental quality concerns as well as between these markets and the rest of the economy, are quite significant. Thus, for example, changes in government environmental policies have been shown to affect the agricultural sectors (see e.g., Huang and Uri, 1990a, b) and changes in the agricultural sectors have been shown to have important impacts on the remaining sectors of the United States economy (see e.g., Harrington et al . , 1986).

The use of a general equilibrium model to assess the impact of environmental quality initiatives on the economy seems to be unique to this study with one exception. The exception is the paper by Kokoski and Smith (1987). While it is not the purpose to critique this effort, it should be noted that it is subject to a variety of shortcomings. One of these limitations is that the sectors are highly aggregated with, for example, manufacturing and mining (which will be significantly impacted by the proposed changes in the environmental legislation) are only considered as a component of a larger sector. (See Hertel (1988) for additional limitations).

In the spirit of this earlier general equilibrium effort, the model developed here attempts to capture the interrelationships between environmental quality considerations and economic activity while at the same time endeavoring to overcome some of its limitations.

The model presented below follows in the tradition of the Shoven and Whalley (1972) tax analysis research and incorporates some of the methodological enhan-

* General equilibrium models in general are not going to be reviewed here. Rather, the interested reader is referred to Ballard, et al. (1985) and Harberger (1962, 1974).

MEASURING THE COSTS OF IMPROVING THE QUALITY 359

cements of the general equilibrium work of Hudson and Jorgenson (1974). For example, it recognizes the differences in preferences of consumers as a function of their incomes and specifies a distinct demand system for each group of households.

Additionally, a neoclassical microeconomic model of producer behavior is employed. The model of consumer behavior is integrated with the model of producer behavior (which contains a price-responsive input-output component) to provide a comprehensive framework for policy simulations.

The general equilibrium nature of the model is reflected by its attempt to determine a vector of prices for consumer goods and services and producer goods and services that will clear all markets. The equilibrium prices determine the optimal allocation of resources, given the endowment of labor, capital and natural resources (land).

On the production side, technologies are represented by production functions that exhibit constant elasticities of substitution. Technological progress (both em- bodied and disembodied (see e.g., Uri, 1984)) is assumed not to occur over the

period of investigation. On the demand side, the model captures the behavior of consumers (who can

also serve as investors), the government, and foreigners. Consumers are grouped according to income and a demand system is specified for each group. Each income group has an endowment of labor and capital and, given the vector of prices, decides the amount to save and invest and the amount of each good and service to consume (purchase). Investment, consequently, is determined by savings. The government levies taxes on both production and consumption. That is, there are taxes on factors of production, on output, on income and on consumption. Revenues are used to distribute income back to consumers and to purchase goods and servies,

as well as capital and labor. The foreign sector produces imports and consumes exports. Trade balance is

assumed (that is, the nominal value of exports is assumed to equal the nominal value of imports in equilibrium) but the exchange rate is not explicitly incorporated into the model specification. Exports are scaled to match imports. As a result, foreigners can be regarded as consumers who purchase United States exports with income from the sale of imports to the United States.

Table I details the specific producing sectors and types of consumer goods and services considered in the general equilibrium model. The various household categories (classified by income) are delineated in Table II. This choice of the level of disaggregation was predicated on the availability of data and on the economic variables (producing and consuming sectors and income categories) that are of interest.

2.2.2. The General Equilibrium Model Struture*

The production component of the general equilibrium model is composed of an

* A comprehensive description of the general equilibrium model together with its parameterization is found in Boyd (1988).

360 ROY BOYD AND NOEL D. UR1

input-output model with some flexibility with regard to the substitution of the factor inputs (capital, labor, and land). The degree of flexibility depends, of course, on the choice of functional form for the production function. In the current model, each sector is assumed to have a constant elasticity of substitution (CES) production function* where the value added by the specific sector is a function of labor and capital.

For four sectors (the three agricultural sectors and the forestry sector), however, a third factor of production - land - is included. This is done because of the special importance of this input to these sectors. (See, e.g., Heady and Dillon (1961) for a discussion of this issue). The incorporation into the production function of this factor is accomplished by nesting the CES production function. In particular, an input is defined which is solely a function (in CES form) of land and capital which, in turn, takes the place of capital in the orginal production function specification. While it would be possible to simply add land as an explicit input in the production function, this would implicitly assume that the elasticity of subsitution between all pairs of inputs are the same. By nesting, however, the substitution elasticities are permitted to be different between different inputs.

The output of the 12 producing sectors accrues to the owners of the factors of production (i.e., land, labor and capital) which they sell. With the receipts from sales, these individuals either consume domestic or foreign goods and services, save, or pay taxes to the government. The savings are used for investment and the taxes are ultimately returned to these individuals.

The demand for final goods and services comes from three primary sources. First, final goods and services may be directly consumed by individuals. Second, investment (which is equal to savings) consumes some of the goods and services produced. Finally, foreign demand (in the form of exports) consumes a portion of the goods and services.

A review of Table I will show that the composition of the consumer goods and services sectors does not match that of the producing sectors because the final goods and services produced by the producing sectors must go through various channels (i.e., transportation and distribution) before they can be consumed. To address this problem, a transformation matrix is introduced that defines the contribution of each producing sector to the composition of each of the final (consumer) goods and services.

For each category of households (Table II), utility is assumed to be a weighted constant elasticity of substitution (CES) function of the 13 consumer goods and services. The weights on these goods and services (which are household category specific) are computed as the share of total purchases going to a specific consumer good or service. The nature of the CES utility function implies that the elasticity of substitution is the same between any pair of goods and/or services. Because

* Little is gained by explicitly writing out the functional form of this production function since it is so well know. Those unfamiliar with it, however, can refer to, e.g., Arrow, et al. (1961).

MEASURING THE COSTS OF IMPROVING THE QUALITY

TABLE I

Classification of producing sectors and consumer goods and services

361

Industries Consumer goods

1. Manufacturing 1. Food 2. Mining 2. Alcohol and tobacco 3. Service 3. Utilities 4. Chemicals and plastics 4. Furnishings and appliances 5. Food and tobacco products 5. Housing 6. Petroleum refining 6. Clothing and jewelry 7. Financial 7. Transportation 8. Forestry 8. Motor vehicles 9. Crude oil and natural gas 9. Financial and other services

10. Agriculture 1 - Program crops 10. Reading and recration 11. Agriculture 2 - Livestock 11. Nondnrable household items 12. Agriculture 3 - All other agriculture 12. Gasoline and other fuels

13. Savings

TABLE II

Household categories based on income

Category Income range

I $ 0 - 9999 II $ 10000- 14999

II1 $ 15000- 19999 IV $ 20 000 - 29 999 V $ 30 000 - 39 999

VI $ 40 000 and over

reliable estimates of the respective subs t i tu t ion elasticities across pairs of goods

a n d / o r services is difficult to obta in , they are assumed to equal one for all of

the combina t ions . Final ly, consumers ob ta in util i ty f rom the consumpt ion of all

goods and services inc luding leisure (consumer good and service sector n u m b e r

10). Hence, it is necessary to determine a weight for this factor in the util i ty funct ion.

For the purpose of the current analysis, this value is assumed to be 0.5 times labor

income. The net effect of adding leisure is to incorpora te explicitly the fact that

consumers not only derive util i ty f rom the act of consuming goods and services

(which comes through owning the factors of p roduc t ion) but that they also derive

utility f rom leisure. Thus, an increase in leisure can lead to an enhancemen t of

indiv idual well-being in the model. (The astute reader will note that with this

specification, there is an explicit t rea tment of the labor-leisure trade-off. See, e.g.,

Dea ton and Muel lbauer (1980) for more on this).

A household ' s budget cons t ra in t is defined such that expendi ture on goods and

services mus t be less than or equal to its income, which is defined to equal its

por t ion of the re turns to labor plus the re turns to capital plus the re turns to land.


That is, expenditure by a household must be less than or equal to the total factor payments it receives. Maximizing utility subject to this expenditure constraint gives the demand for the various goods and services by household categories (see, e.g., Mixon and Uri (1985) for a discussion of this). Observe that since savings are considered as one of the items in an individual's utility function, the choice between consumption and savings is made explicit. That is, intertemporal tradeoffs are an integral part of the model.

The second component of the demand for goods and services is investment. Like the final demand by individuals, total investment is disaggregated (though a transformation matrix) by the sector of the economy that produces it. For the purpose of constructing the general equilibrium model and calibrating it, investment is taken directly from the national income and product accounts (as compiled by the Bureau of Economic Analysis of the U.S. Department of Commerce) and, since savings are assumed to exactly equal investment, personal savings are scaled to equal the gross investment observed (measured) for each of the 12 producing sectors.

The final component of demand for goods and services is the demand by foreign consumers. In the model exports (i.e., foreign demand) are delineated by producing sector. That is, a transformation matrix analogous to that used for the consumption of final goods and services is employed. A similar delineation is utilized for imports (i.e., foreign supply). The exports and imports are then scaled so that the total foreign account is balanced. By employing elasticity estimates (both demand and supply) found in the literature, export and import demand relationships are constructed for each producing sector.

The government and its tax receipts are an integral part of the general equilibrium model formulation. Tax receipts do impact the model results with regard to factor use, factor prices and output.

First, there is a question of how to treat the government in a general equilibrium model. For the purpose at hand, it is treated as a separate sector with a constant elasticity of substitution utility function. That is, it is treated in a fashion analogous to one of the household sectors. The elasticity of substitution is assumed to be one. This means that the production function collapses to a Cobb-Douglas-type production function. The government collects tax revenue in various forms. The explicitly considered taxes include personal income tax, labor taxes (e.g., a social security tax), capital taxes (e.g., a corporate income tax), property taxes, and sales and excise taxes. All these are treated as ad valorem taxes and a marginal rate is used for each household category, consumer good and service sector, producing sector and factor input. (Note that in this model, labor is treated as a variable factor of production that is subject to taxation). In this respect, the model is a distinct improvement over earlier general equilibrium models (e.g., Shoven and Whalley (1972)) which simply employed lump sum transfer schemes or used average tax rates.


2.2.3. A Mathematical Statement of the Model

Given these foregoing considerations, it is useful to state precisely the conditions that the model being used here must satisfy for a general equilibrium to exist. First, there cannot be positive excess quantities demanded. That is,

m

ai jMj-Ei(P,Y)>~O for c.s. pi~>0 (1)

and where i (i = l, 2 . . . . . n) denotes the consumer goods and services, Mj (1' = 1, 2 . . . . . m) denotes the activity levels, a/j denotes the ij th element in the activity analysis matrix, Y denotes a vector of incomes for the k consumers, p denotes a vector of prices for the n consumer goods and services and E i denotes the excess demand for good or service i.

The notation c.s. implies that complementary slackness holds for each consumer good and service. That is, if the expression (for a specific good or service i) is multiplied by Pi, then the relationship will hold with equality (see, e.g., Takayama and Uri, 1983).

The second requirement for general equilibrium is that the profits associated with a given activity are not positive. That is,

n

- ~ aijPi >~0 for c.s. Mj~>0. (2) i=1

Finally, all prices and activity levels must be non-negative. That is,

and

pi>~O,i = 1 ,2 , . . . , n (3a)

M ) / > 0, j = 1, 2, ..., m. (3b)

The model is solved for a general equilibrium using the iterative algorithm nominally referred to as the Sequence of Linear Complementary Problems (SLCP) developed by Mathiesen (1985a, b).

A complete listing of the equilibrium conditions together with relevant definitions is found in the Appendix.

2.2.4. Data for the 1984 Base Year

The general equilibrium model is calibrated for 1984. For the producing sectors (the 12 enumerated in Table I), data on capital receipts and taxes are computed from data obtained directly from the Bureau of Economic Analysis of the U.S. Department of Commerce, the U.S. Department of Agriculture, the U.S. Department of Energy and from Hertel and Tsigas (1987). The various elasticities of substitution employed in the analysis were obtained from the empirical literature on production functions. (Boyd (1988) has the details on where the values of the elasticities of substitution were taken from).


Capital income (earnings) and labor income were obtained from the Bureau of Economic Analysis of the U.S. Department of Commerce. Land income was estimated using factor shares obtained from the Economic Research Service of the U.S. Department of Agriculture and applied to the capital income component noted above.

Data on expenditures on each of the 13 goods and services by each of the 6 household categories were obtained from the Consumer Expenditure Survey: Interview Survey, 1984 (Bureau of Labor Statistics, 1986). By combining this information with the number of households in each household (income) category (these data come from the Bureau of Economic Analysis), the aggregate expenditures on each category of consumer goods and services by each household category were computed.

The various tax rates used in the analysis were obtained from a variety of sources including the Internal Revenue Service, the Economic Research Service of the Department of Agriculture, Hertel and Tsigas (1987), and Ballard et al. (1985) These rates, as noted previously, are marginal rates.

The value of exports and imports in 1984 were taken from the Survey of Current Business (various issues) with the exception of the energy data which were obtained from the Energy Information Administration of the U.S. Department of Energy and the agriculture data which were obtained from the Economic Research Service of the U.S. Department of Agriculture.

2.3. A METHODOLOGICAL CAVEAT

Before proceeding to discuss the results obtained from the general equilibrium model, a short digression is in order. In particular, a discussion concerning the advantages and shortcomings of using the particular modeling approach that has been opted for here is in order.

The primary advantage of the general equilibrium modeling approach is that, with all economic entities maximizing their behavior (subject to the relevant constraints), all markets are required to clear. No transactions are conducted at prices other than equilibrium prices and for every factor of production and every good and service consumed, the quantity suppled must exactly match the quantity demanded. All interactions among markets are taken into account and, consequently all interrelationships between sectors (both consuming and producing sectors) are explicitly considered.

Another advantage of this modeling approach is that it performs the analysis at a disaggregated level and hence can identify sector specific impacts of the policy question being addressed. Frequently, small aggregate effects obfuscate the larger impacts at the sectoral level. Thus, for example, at the aggregate level a change might have little effect on income, but at the household level, the distributional impacts on income might be fairly substantial.

The general equilibrium model also includes a treatment of all taxes. These taxes can introduce a considerable differential between prices paid by consumers and prices received by producers. This can result in distortions in market signals that


lead to market failure (e.g., inefficient use of factors of production). (See e.g.,

Friedman (1984) for more on this). The model is solved numerically and, after any change in the exogenous (e.g.,

policy) variable(s), a new, independent (i.e., independent of the previous solution) equilibrium is computed. As a result, the conclusions do not depend on first-order or second-order approximations or the assumption of an infinitesimally small change in one or more of the variables.

The general equilibrium modeling approach is not devoid of deficiencies. The

values of the various parameters used in the model are not estimated directly by econometric means. Rather, as noted, they are taken from the literature and represent a consensus among researchers with regard to appropriate values. This does not mean that a complete set of econometric results cannot be generated at some future date. The complexities of such an undertaking, however, are enormous (see e.g., 3orgenson (1984) and MacKinnon (1984) for a discussion of these complexities) and so it is not attempted here.

Another assumption that does not emulate reality completely is that consumer and producer behavior is modeled with full and complete adjustment between perturbations. This means that the distributed lags associate with the adjustments of the various factors are not overtly modeled although the magnitude of the full adjustment by each producing and consuming sector is captured. Additionally, there is the implicit assumption that all economic agents know the vector of final equilibrium prices, thus allowing for full adjustment on their part.

Also, the model does not, as noted, make any provision for technological innovation and, hence, is not suitable for addressing policy issues that will take a long time to reach their full (cumulative) impact.

Next, in evaluating the impact of the Clean Air Act initiatives, the assessment is in terms of the nominal impacts on output, the costs of goods and services, and utility. There are other approaches to measure the benefits and costs of environmental policy changes involving alternative national accounting systems, option pricing, consumer surplus, etc. The reader interested in exploring these approaches further is referred to Johansson (1987).

Finally, the model is not an environmental model in the usual sense. That is, the model does not have environmental variables explicitly incorporated into it. Thus, for example, the model does not look at a tax per unit of pollutant but rather uses an ad valorem tax on the consumption of final goods (i.e., gasoline and coal) to asses the impact of a policy initiative. Thus, when we subsequently compare the regulatory strategy to the taxation strategy, the reader must be aware that this is not the usual context in which such a comparison is made.

These model limitations imply that the results of the subsequent modeling effort should not be unequivocally accepted but rather interpreted in the context of offering an improved, but not perfect, analysis of the impact of initiatives designed to enhance environmental quality.

366 ROY BOYD AND NOEL D. UR1

3. Results and Discussion

3 . 1 . G E N E R A L EQUILIBRIUM RESULTS - BENCH MARK

Before discussing the results of the general equilibrium model, a couple of items need to be mentioned. First, as observed in the preceding section, the model is solved by the SLCP algorithm of Mathiesen. This algorithm is based on the fixed point theorem proved by Scarf (1967).

Second, the magnitude of the effect of an increase in the price of automobiles, electricity and fuel will have on the quantity of these goods demanded is an important consideration. Consequently, the elasticities for these goods employed in the study by Ballard et al. (1985) are used here. These values are all roughly equal to - 1.0.* Because of their potential overall importance to the inferences drawn, however, a sensitivity analysis will be performed whereby the values of these parameters will be allowed to vary from those initially assumed.

Within the context of the CGE model, calculating the effect of various pollution abatement strategies is quite straightforward. Initially, we run the model for the 1984 bench mark year to make sure that we can replicate the actual data values for that year. We then alter the price of motor vehicles (both cars and trucks) and electricity by the estimated per unit amount (either car or truck (in the case of automobiles) or kilowatt-hour (in the case of electricity)) of the expenditures needed to reduce SO2 and NO x emissions so as to comply with the 1990 Amendmends to the Clean Air Act via an 'end of the pipe' strategy and solve the model again. The magnitude of the changes in the prices required to comply with the Clean Air Act Amendments of 1990 were taken from studies performed by the U.S. Environmental Protection Agency. The Council of Economic Advisors (1990) reports the relevant values and provides a complete discussion of their underlying assumptions. The resulting equilibrium values are then compared with the bench mark equilibrium in order to quantify all sectoral changes. Next, we impose a tax on the output of the mining and petroleum refining sectors so as to approximate the cost of the externalities (emissions) associated with the production and use of high s coal and gasoline. (The magnitude of the tax imposed on the output used in the analysis is based on studies done for the U.S. Environmental Protection Agency and reported in the Economic Report of the President (Council of Economic Advisors, 1990)). The equilibrium values are compared to the bench mark and the regulatory strategy.

The bench mark (reference case) results (both quantities and prices) are presented in Tables III, IV, and V for the producing sectors, the consuming sectors and households (income categories), respectively. By themselves, the values found in Table III through Table V provide little useful information beyond showing how

* This es t imate is cons i s ten t wi th those surveyed and repor ted in Bohi (1981), D a h l (1986), and Uri (1982).

MEASURING THE COSTS OF IMPROVING THE QUALITY

TABLE III

Reference case - equilibrium prices (normalized) and quantities (in hundreds of billions of dollars) for the producing sectors

367

Sector Price Quanti ty

1. Manufacturing 1.00000 18.87623 2. Mining 1.00000 0.46231 3. Service 1.00000 23.78182 4. Chemicals 1.00000 2.27375 5. Food and tobacco 1.00000 3.50574 6. Petroleum refining 1.00000 1.61241 7. Financial 1.00000 5.54883 8. Forestry 1.00000 0.10592 9. Crude oil 1.00000 1.29060

10. Agriculture - PC 1.00000 0.45210 ! 1. Agriculture - L 1.00000 1.09921 12. Agriculture - O 1.00000 0.61186

Total 1.00000 59.62015

Note: For the agriculture sectors, PC denotes program crops, L denotes livestock, and O denotes all other agricultural activities. Also, some of the other titles have been abbreviated. The complete titles are given in Table I.

TABLE IV

Reference case - equilibrium prices (normalized) and quantities (in hundreds of billions of dollars) for the consuming sectors

1. Food 1.00000 4.52066 2. Alcohol and tobacco 1.00000 0.83300 3. Utilities 1.00000 1.17793 4. Furnishings 1.00000 1.46137 5. Housing 1.00000 3.74071 6. Clothing 1.00000 1.83323 7. Transportat ion 1.00000 0.28041 8. Motor vehicles 1.00000 1.46337 9. Financial 1.00000 5.84739

10. R and R 1.00000 1.66132 11. Non-durable goods 1.00000 0.67238 12. Gasoline 1.00000 0.91156 13. Savings 1.00000 3.03333

Total 1.00000 27.43668

Note: Some of the sector titles in the table have been abbreviated. The complete designations are given in Table I.

3 6 8 ROY BOYD AND NOEL D. URI

TABLE V

Reference case - equilibrium utility levels (in hundreds of billions of dollars) by household categories

Category Utility level

I 2.23826 II 2.10802

III 2.42417 IV 6.01311 V 5.49733

VI 13.73634 Total 32.01722

Government 7.45752

Note: The household categories correspond to those defined in Table II.

TABLE VI

Regulatory strategy - equilibrium prices (normalized) and quantities (in hundreds of billions of dollars) for the producing sectors


1. Manufactur ing 1.00000 18.88131 2. Mining 0.99972 0.46197 3. Service 0.99991 23.72031 4. Chemicals 0.99980 2.27117 5. Food and tobacco 1.00047 3.50680 6. Petroleum refining 0.99939 1.61235 7. Financial 0.99951 5.54882 8. Forestry 0.99958 0.10623 9. Crude oil 0.99924 1.28994

10. Agriculture - PC 1.00014 0.45212 11. Agriculture - L 1.00015 1.09958 12. Agriculture - O 1.00013 0.61247

Total 0.99992 59.56304

Note: For the agricultural sectors, PC denotes program crops, L denotes livestock, and O denotes all other agricultural activities. Also, some of the other titles have been abbreviated. The complete titles are given in Table I.

the model is calibrated. Rather, the significance the CGE model and the equilibrium values is how these values change in response to the two different pollution abatement strategies.

3.2. GENERAL EQUILIBRIUM RESULTS - THE REGULATORY STRATEGY

Tables VI, VII, VIII present the general equilibrium values for prices and quantities for the producing sectors, consuming sectors, and households, respectively, as a result of installing pollution control devices on motor vehicles and fossil fuel


TABLE VII

Regulatory strategy - equilibrium prices (normalized) and quantities (in hundreds of billions of dollars) for the consuming sectors

Sector Price Quantity

1. Food 1.00021 4.52504 2. Alcohol and tobacco 1.00018 0.83382 3. Utilities 1.04429 1.12904 4. Furnishings 0.99995 1.46276 5. Housing 0.99954 3.74599 6. Clothing 0.99992 1.83503 7. Transportation 0.99991 0.28069 8. Motor vehicles 1.03562 1.41430 9. Financial 0.99990 5.85320


Total 1.00359 27.36983


TABLE VIII

Regulatory strategy - equilibrium utility levels (in hundreds of billions of dollars) by household categories

I 2.23350 II 2.10203

lII 2.41772 IV 5.99710 V 5.48389

VI 13.70374 Total 31.93793

Government 7.52204


genera t ing plants .

By c o m p a r i n g the respect ive values in the re levant tables , we can see the sectora l

changes b r o u g h t a b o u t by the r educ t ion o f a i r po l lu t ion to mi t iga te the acid ra in

p rob l em. (Note tha t the Clean A i r Ac t specif ical ly addresses ac id ra in which results

f rom the f o r m a t i o n o f H2SO4 and H N O 3 in the a tmosphe r i c reac t ions involv ing

SO2 and NOx). Cons ide r the p r o d u c i n g sectors first. In response to in te rna l iz ing the external i t ies

a s soc ia ted with genera t ing electr ic i ty and using m o t o r vehicles (which has been

b r ough t a b o u t by ins ta l l ing emiss ions con t ro l devices), to ta l o u t p u t in the p r o d u c i n g

sectors d rops by $ 5.71 × 109 o r by a b o u t 0.096%. This fall is not un i fo rmly sp read


across all producing sectors, however. For example, domestic services (which includes the generation of electricity) fall by 0.259% ($ 6.15 x 109) while agricultural production (including forestry output) actually goes up by 0.10% ($1.88 × 109). This occurs because factors of production such as labor and capital migrate between industries over time in response to the changing demand conditions as consumers substitute food for motor vehicles and electricity in response to changing relative prices. (This latter substitution means that consumers use their electricity using appliances less and that, in the longer term, they replace these appliances with more energy efficient ones. Uri (1982) discusses this substitution in greater detail). The net effect on prices as a result of these movements is virtually no change.

As expected, losses are registered in the crude oil and mining sectors of 0.051% ($ 66 × 106) and 0.077% ($ 33 × 106), respectively. With regard to the manufacturing sector, however, we find that output, in fact, rises. This occurs primarily because with lower petroleum and coal prices, the cost of two of the intermediate inputs used in the production process falls, and, given the aforementioned requirement that the equilibrium conditions in all markets must be met, factor use (in physical terms) rises and, consequently, output goes up.

With regard to the consuming sectors, the installation of pollution abatement devices results in an increase in the cost of goods and services by about 0.244% ($6.68 × 109). As would be anticipated, by far the biggest (and indeed the only) sales declines occur in the utilities and motor vehicles sectors. Faced with higher relative prices for these items, consumers shift their purchases and buy more in each of the remaining sectors (including savings). It is interesting to note that this even includes gasoline. One reason for this seemingly anomalous result is that cars become less fuel efficient. (That is, they require more gasoline per mile travelled).* Both the public utility and motor vehicle industries tend to be capital intensive, and thus we find that the price of capital falls relative to the price of labor. Furthermore, since there is an increase in agricultural production, the price of capital falls relative to that of land.

Utility falls for all six of the household categories. The aggregate loss in utility is 0.247% ($ 7.92 × 109) for all household categories. This gain does not fall evenly across households, however. Capital holdings increase substantially as household income goes up. Hence, we find that utility losses range from 0.21% for families with incomes less than § 10000 yr -1 to 0.45% for households with incomes over $ 40 000 yr -1. These results imply that pollution abatement via the regulatory strategy is a progressive policy from the standpoint of equity.*

3.3 . GENERAL EQUILIBRIUM RESULTS - THE TAXATION STRATEGY

Tables IX, X, and XI present the general equilibrium values for prices and quantities

* Note that this is the result of adding pollution abatement devices on automobiles. See e.g., Crandall et al. (1986) for a discussion of this. * There are also the equity considerations with regard to employment. For example, the total wage bill in the mining sector decline while the wage bill in the agricultural sectors and forestry increase.

M E A S U R I N G T H E COSTS OF IMPROVING THE QUALITY 371

TABLE XI

Taxation strategy - equilibrium utility levels (in hundreds of billions of dollars) by household categories

Category Utility level

I 2.23564 II 2.10506

IlI 2.42077 IV 6.00539 V 5.49087

VI 13.72104 Total 31.97873

Government 7.49134


TABLE IX

Taxation strategy - equilibrium pries (normalized) and Quantities (in hundreds of billions of dollars) for the producing sectors


1. Manufactur ing 1.00000 18.88522 2. Mining 1.07749 0.44997 3. Service 0.99896 23.75871 4. Chemicals 1.00073 2.27254 5. Food and tobacco 0.99950 3.50613 6. Petroleum refining 0.99828 1.59945 7. Financial 0.99806 5.55007 8. Forestry 0.99825 0.10631 9. Crude oil 0.99779 1.28264

10. Agriculture - PC 1.00052 0.45273 I I. Agriculture - L 1.00046 1.09954 12. Agriculture - O 1.00043 0.61206

Total 1.00011 59.57534

Note: For the agricultural sectors, PC denotes program crops, L denotes livestock, and O denotes all other agricultural activities. Also, some of the other titles have been abbreviated. The complete titles are given in Table I.

for all sectors as a result o f taxing gasoline and high S coal to meet the Bush Administration's pollution abatement targets.

Under this strategy, intermediate inputs responsible for dangerous SO2 and NO x emissions are taxed in order to bring less hazardous alternatives (such as higher priced methanol fuel and low sulfur content western coal) on line. The calculations are based on values contained in various issues of Petroleum Supply Annual and Coal Production. (Both of these are publications of the Energy Administration of the Department of Energy). The supply elasticities were taken from Labys and

372 ROY BOYD A N D NOEL D. UR1

TABLE X

Taxation strategy- equilibrium prices (normalized) and quantities (in hundreds of billions of dollars) for the consuming sectors

Sector Price Quantity

1. Food 0.99925 4.51987 2. Alcohol and tobacco 0,99923 0.83286 3. Utilities 0,99896 1.17778 4. Furnishings 0.99952 1.46035 5. Housing 0.99813 3.74346 6. Clothing 0.99970 1.83163 7. Transportation 0.99896 0.28037 8. Motor vehicles 0.99951 1.46235 9. Financial 0.99904 5.84615


Total 1.00129 27.39508


Yang (1989). If we compare the numbers in these tables with the corresponding

values in Tables III , IV, and V, we observe the total change due to such an abatement program. Alternatively, comparing the values in Tables IX, X, and XI with those

in Tables VI, VII, and VII gives us a general equilibrium perspective on the differing impacts of a taxation strategy v s a regulatory strategy.

Look first at the producing sectors. We see that under a taxation scheme, aggregate

output would decline by 0.075% ($4.48 × 109) f rom the bench mark. Although the aggregate losses here are less than under the regulatory strategy above, sectors such as petroleum refining, mining, and crude oil are much more heavily impacted than before. This is because they are now directly rather than indirectly affected

by the intervention of the government. Similar reasoning explains why production in the manufacturing and service sectors is higher under the taxation strategy than under the regulatory strategy.

With the exception of housing, consumption in all sectors is lower under the taxation strategy than for the bench mark case. Sector consumption is also lower than under the regulatory strategy with the exceptions of utilities and motor vehicles. Finally, as with the regulatory case, taxing coal and gasoline leads to lower utility for all income classes. Aggregate losses total 0.12% ($3.8 x 109), but these losses

are almost completely offset by the increase in government revenue. Finally, because the price of capital falls relative to that of land and labor with a taxation strategy, the cost of pollution abatement falls primarily on the higher income groups.


3.4. A COMPARISON

How do the results obtained here compare with the results obtained by others? Other recently available studies do not provide disaggregated (i.e., disaggregated by producing and consuming sectors and by household categories) estimates of specific provisions of the 1990 Amendmends to the Clean Air Act. They generally indicate just the aggregate values of any effects. Thus, for example, the Council of Economic Advisors (1990) estimate that 'end of the pipe' controls (via regulation) to reduce emissions would cost the economy $ 8 × 109 yr -1. We estimate the cost to be $ 5.7 x l09 in terms of lost output. Clearly, the results are comparable.

With regard to taxes, the Congressional Budget Office (1990) estimates that government revenue would increase $16.5 × 109 yr -1 if air polluting sources were taxed. We estimate that government revenue would rise by $ 3.38 × 109. It is difficult to explain the disparity since the approach used by the Congressional Budget Office in making its calculations is too obtuse.

Finally, we find that a taxation strategy imposes a smaller cost on the producing sectors that does regulation. This is consistent with the environmental economics literature on the issue (see, e.g., Baumol and Oates (1988) and Yohe (1979)).

3 . 5 . SENSITIVITY ANALYSIS

No analysis is complete without an examination of the sensitivity of the results to key assumptions. In the foregoing discussion, many assumptions were made with regard to model structure and parameter estimates. A full examination and discussion of these assumptions would be virtually impossible. Consequently, only the results from the sensitivity analysis of one crucial assumption will be discussed. Thus, what are the effects on the vector of equilibrium prices and quantities of the assumption concerning the substitutability of goods and services by consumers.

In our initial analysis, we followed Ballard et al. (1985) and took the elasticity of substitution between goods and services to be one (i.e. the Cobb-Douglas case). In subsequent simulations, however, we lowered these values for automobiles, electricity and fuel to 0.6 and then raised them to 1.4. In general, the effect of raising the elasticity of substitution is to magnify the influence of a pollution abatement regulation or tax on the quantity produced (or demanded). In reality, however, the effect on our results is minimal. Under both the regulatory strategy and the taxation strategy, no producing sector's output is affected by more than $100 × 106 and in no case is there any change in the qualitative results discussed above.

4. Conclusion

The foregoing analysis has been directed at comparing the relative effectiveness of two different methods of meeting the objectives Clean Air Act Amendments of 1990. The analytical vehicle used in the analysis consists of a computable general


equilibrium model composed of 12 producing sectors, 13 consuming sectors, 6 household categories classified by income, a foreign sector and a government.

In our analysis, we found first that irrespective of what type of strategy is followed directed at improving environmental quality, both output and consumption decline as does household utility. Hence, there is a quantifiable tradeoff between economic acitivity (economic growth) and the quality of the environment. Beyond this, the aggregate loss in production and economic welfare (measured by consumption expenditures and utility) is less under a policy which stresses reliance on alternative fuels (brought about by the taxation strategy) than through one that requires the installation of pollution abatement devices (i.e., regulation). An alternative fuels policy also has the advantage of conserving existing mineral stocks and collecting a considerable amount of revenue for the government. Unfortunately, however, it has the disadvantage of hurting extractive industries such as coal mining and crude oil. Hence, when weighing these alternatives, policy makers face a tradeoff between efficiency and equity.

II.

lII.

IV.

Appendix: Empirical Model

Overall Equilibrium by Sector 1) Y , + G E j + U M j : ~IRASy/+ G D j + C D j + U X j + INV. 2) ~c SLc = ~ . D L j + G D L 3) ~ . SK c = ~ . DKj + G D K 4) Z~. SD c = ~ j D D j + G D D

where 5) G D L = Y,;TLj 6) G D K = ~ ; T K y 7) G D D = ~ T D j

Consumer Goods and Services 8) CDj = ~j Zy i (GCE: - TCj) 9) Yc RCS/c = GCEi

(10) ~ i RCS/~. = SL c + SK c + SD e + TRN c - PIT c (t 1) G C c - Zi RCSic - S A V c + (1 - T A U c ) (ZTA c - 1) SL C (12) G C c - SL c + SK c + SD c + TRN c - PIT c + (1 - TAUt) (ZTAc - 1) SL c. (13) TE - (SL c (SL c ZTA c TAU,. + SK c TAU c + SD c T A U c - (q5 c + TRN))

where ~ c = SLc TAUc + SKc TAUc + SDc TAUc - PITc

(14) Foreign Sector Balance ~ / ( U M j j ( E M y / ( 1 + EM:)) + UMy/(1 + EMy)) = Y7 (UXj + FEd)

Consistency (15) ~ . (SL c + SK~ + SD c TRN c - PIT c - TCc) = ~c CGc

(Net household income equals household expenditures) (16) ~,j (GSKj + GEj + TLj TKj + TDj + TXOj) + G T L = £cTRN + £j (GDKj + GDj) + GDc)

(Government income plus endowments equals government outlays) (17) Y~j(EMj- UXj) = 0

(Net exports equal zero) (18) ~ j (CDy + G D j + UXj - GEj - UM:) = Y2 (DLj + DKj + TLj + TKj + TXOj)

(The value of demand equals value added plus taxes)


Yj C ~ GEj UMs ~'/RASj/ -

GDj TNVj uxj - SL~

SK~ S D c

DLj -

DKj - DDj - G D L - G D D - TLj - TKj - TDj - GCEi - zj~ - RCSic - TCj - TRN c - PIT,, TAU c - SAV~ -

GC c ZTA TE EMj FEj -

GSK: - G D K j - GTL T X O j -

TC~

CG C

Total production in sec to r j (,; = 1, 2, ..., 12) Consumer demand for product j Government endowment of product j Imports of product j RAS balanced input - output intermediate demands Government demand for product j Investment in sec to r j Exports of product j Supply of labor by household c (c = 1, 2, ..., 6) Supply of capital by household c Supply of land by household c Demand for labor in the i ndus t ry j Demand for capital in the industry j Demand for land in indus t ry j Government demand for labor Government demand for land Tax on labor in indus t ry j Tax on capital in indus t ry j Tax on land in indus t ry j Consumer demand for consumper product i (i - 1, 2 . . . . . 13) A 12 by 13 t ransformation matrix RAS balanced matrix of each household 's demand for each consumer good Excise tax on consumer g o o d j Transfer payment to household e Personal income tax payment for household c Marginal income tax rate for household c Savings in household c Gross consumption of household c Consumpt ion plus leisure coefficient Total government endowments Demand elasticity of export demand E n d o w m e n t / D e m a n d sector of adjusted elasticity of export demand Government endowment of capital in i ndus t ry j Government demand for capital in i ndus t ry j Government wage taxes on its own employees Government output tax on indus t ry j Consumpt ion taxes on household e Total government consumption by household c

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