Economics of Environmental Policy

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

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

Efficiency • Maximum net benefits • Requires balancing MAC and MD • Decentralized……………….Centralized • Hayek’s critique Rational central planning is impossible • Cost Effectiveness: • When damages (benefits) can’t easily be measured

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

Which allocation would you choose? • Choice One • Choice Two • Choice Three • Choice Four • Choice Five Tradeoff: Efficiency vs. Fairness ?

Fairness • Distribution of benefits/costs across regions, incomes, race, etc

If you could impose any of the four Programs, which would you choose? • Program A • Program B • Program C • Program D

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

Incentives for Technological Improvements • Shift the MAC curve down MAC1 MD1 MAC2 E2 E1 E0 Emissions

Incentives for Technological Improvements • 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

Enforceability • 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? • many people are involved, causal links are clear, and damages are difficult to measure. • few people are involved, causal links are clear, and damages are difficult to measure. • many people are involved, causal links are muddy, and damages are easy to measure. • few people are involved, causal links are clear, and damages are easy to measure.

Liability Law… $ 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 MAC1 MD1 d b c Emissions E0 E*

Common Law • 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

Examples • Smoking “causes” cancer? • Exxon Valdez “caused” shoreline damages? • Particular power plant “caused” SO2 damages? • Best Case Scenario for Common Law Few people involved, causal link is clear, damages easily measured

Under a system of negligent liability, a firm disposing hazardous materials into a river would: • be liable for any damages regardless of the circumstances. • be liable for any damages only if the firm did not take reasonable steps to avoid damage. • not be liable for any damages. • none of the above.

Statutory Law • 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

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] 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.

Ronald Coase 1991 Nobel Prize in Economics 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

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

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 $ MAC MD Emissions Et E1 E* E0

Uniformity of Standards • Geographic differences: MDu > MDr • Single standard can’t be efficient  tradeoff: regulatory costs vs efficiency gains $ MDu MAC MDr Emissions Eu Er E0

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

MAC1 $ MD MAC2 e d a c b Emissions E2 E1 E0 With MAC1: cost at E1 = a + b If E1 is the standard, then the incentive for R&D = a “cost savings” With MAC2: cost at E1 = b If standard is changed to E2 as new technology is adopted, then incentive to innovate is (a – c) Technology Forcing: If standard is set at E2 from the start then incentive to Innovate is (a + d + e)

Input Standards or Output Standards? 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 P = probability of detection F = monetary fine E = emissions $ MAC P = 0.25 F = $100/E E = 10,000 MPC = (.25)(100)(10,000) = $250,000 MPC* MPC1 Emissions E* E1 E0

How do Standards Hold Up? • 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 $ MAC Tax bill t Abatement Cost b Emissions E0 E1

Optimal Tax • Optimal t* occurs where MD = MAC MD Reduced damages = e + f MAC Remaining damages = b + d Tax cost = a + b + c + d f t* [Tax revenues are not included in social cost calculation] c a d e b Two-part tax? Allow E1 emissions free E0 E1 E* Apply t* to anything above E1 Tax payment = c + d If MD is unknown, use iterative process: If AQ doesn’t improve  raise t If AQ improves too much  lower t

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

According to the situation above, what would be the optimal per unit pollution tax? • $50 • $40 • $30 • $20 • $10

Efficiency • 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

Zoned Taxes? • Warning: reducing emissions through one medium may increase emissions elsewhere

Incentive to Innovate MAC1 MAC2 t* c d a b e E0 E2 E1 With tax t*: MAC1: Cost = (d + e) + (a + b + c) MAC2: Cost = (b + e) + (a) Recall: cost savings for standard at E1 was only d. Cost savings = c + d

Enforcement and Examples • 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

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

Enforcement and Examples • 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

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

Economics of Environmental Policy