Pollution Control: Instruments

READING

Common (2nd edition): Chapter 5Perman et al (3rd edition): Chapters 7 and 8

Pollution control options

Three broad classes of approach (think about this in case of greenhouse gases):

• Reduction of the rate of pollution inflow

• Increase of the “decay rate”of the pollution stock

• Ex-post clean up of the pollution stock

We will focus on the first of these.

However, there is first a point to note:

There may be no need for explicit control policy.

Bargaining may take care of matters (bringing about efficient outcomes) automatically.

Bargaining – The Coasian Solution

Noise

MBZ

MCZ

c

b d

a

Z1Z2 Z3

Limitations to the Bargaining Solution to Pollution Problems

1. Transactions Costs

b) Large numbers of generators and/or sufferers

c) Linkage identification

2. The effect is Public

a) non-excludable

b) non-rival

CRITERIA FOR "GOOD" INSTRUMENTS

* Cost-efficiency (cost-effectiveness): least cost method of attaining any given target.

* Certainty/reliability

* Efficiency consequences under conditions of uncertainty/poor information

* Acceptable effects on distributions of income and wealth

* Should contribute to sustainability

* Low admin cost

* Transparency/acceptability to general public

There are 3 classes of Instrument for controlling pollution

1. Command and Control

a. Limits on permitted discharges

b. Regulation of process and/or equipment

2. Discharge taxation, also known as emissions taxation

3. Tradeable discharge permits, also marketable emissions permits

Historically, class 1 has been the most popular with legislators.

But, economists favour classes 2 and 3 on the grounds that they involve lower costs.

COMMAND AND CONTROL INSTRUMENTS

POSSIBLE WEAKNESSES

Cost-inefficiencyWeakness/absence of incentives

POSSIBLE STRENGTHS

CertaintyFlexibilityEase of usePublic comprehensionFirms build up working relationships with control authority

ECONOMIC INSTRUMENTS: TAXES AND SUBSIDIES

POSSIBLE STRENGTHS

Cost-efficiencyGood static and dynamic incentives

WEAKNESSES

Lack of certainty about magnitude of pollution-reduction effect.Lack of flexibility Ease of usePublic comprehensionFirms build up working relationships with control authority

An emissions tax as a pollution control instrument

Note that in the diagram that follows, we are assuming a constant proportionality between output of the good or service (Q) and pollutant emissions (M).

Taxation of a negative externality

Q, M

SMB+D

EMC

PMC

SMC=PMC+EMC

Q2 Q1

P2

P1

COST EFFICIENCY

A cost-effective pollution abatement programme is one that achieves any desired pollution (or, equivalently, pollution abatement) target at least cost.

A necessary condition for this least cost property is that the marginal cost of abatement is equalised over all abaters.

With uniform taxation across discharge sources, the overall reduction is achieved at least cost

MNPB is Marginal Net Private Benefit = MPB – MPC

No tax - Profit maximised where MNPB = 0

With tax – Profit maximised where MNPB = t

Total Cost of pollution reduction = aM1*M1t + bM2*M2

t

There is no re-allocation of pollution reduction as between the two firms that can reduce the total cost

P2M1

t t

M2t M2*M1

t M1*

a b

MNPB1

MNPB2

There is a problem with emissions taxation – if the firms’ MNPB(P) functions are not known, it is not possible to calculate the tax rate that will bring about the desired overall reduction in pollution. Whatever reduction is achieved

will be brought about at least cost, but it could be too big or too small.

Tradeable permits avoid this problem. Since the quantity of permits issued is equal to the desired level of total emissions, assuming compliance, the achieved

reduction is that intended. Tradeable permits are dependable, as well as least cost. They have the least cost property because with a single market price per permit, all firms move to where their MNPB = permit price, and the situation is as in the previous slide.

If the permits are initially issued free, there is no revenue arising, as there is with taxation.

A tradeable permit system can attain the socially efficient level of pollution emissions (M)

Emissions, M

MNPBM

Total supply of permits

0 M*

Equilibrium permit priceP*

An alternative way of looking at things.

The following diagram shows the privately efficient level of pollution abatement (Z).

The privately efficient level of pollution abatement (Z)

Pollution abatement, Z

PMBZ

MCZ

0 = Privately optimal abatement

An emissions tax can attain the socially efficient level of pollution abatement (Z)

Pollution abatement, Z

SMBZ

MCZ

0 Z2

An emissions tax can attain the socially efficient level of pollution abatement (Z)

Pollution abatement, Z

SMBZ

MCZ

0 Z2

tax ratet*

An emissions tax can attain the socially efficient level of pollution abatement (Z)

Pollution abatement, Z

MCZ

0 Z2

tax ratet*

An abatement subsidy can attain the socially efficient level of pollution abatement (Z)

Pollution abatement, Z

SMBZ

MCZ

0 Z2

S* Subsidy rate

An abatement subsidy can attain the socially efficient level of pollution abatement (Z)

Pollution abatement, Z

MCZ

0 Z2

S* Subsidy rate

Who bears the cost of pollution control?

t

S1

S2

D

Q

P

Q1Q2

P2

P1

P3

t

Is pollution control necessarily bad for business?

1. It may promote technological innovation that reduces costs

2. Reputation effects

3. Niche marketing – environmentally concerned customers

4. First mover effects – international trade

5. Environmental tax revenues can be used to reduce other taxes on business