Pollution Control: Instruments READING Common (2nd edition): Chapter 5 Perman 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 MCZ MBZ a c b d Noise Z2 Z1 Z3

Limitations to the Bargaining Solution to Pollution Problems Transactions Costs Large numbers of generators and/or sufferers 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-inefficiency Weakness/absence of incentives POSSIBLE STRENGTHS Certainty Flexibility Ease of use Public comprehension Firms build up working relationships with control authority

ECONOMIC INSTRUMENTS: TAXES AND SUBSIDIES POSSIBLE STRENGTHS Cost-efficiency Good static and dynamic incentives WEAKNESSES Lack of certainty about magnitude of pollution-reduction effect. Lack of flexibility Ease of use Public comprehension Firms 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 SMC=PMC+EMC PMC P2 P1 EMC SMB+D Q, M Q2 Q1

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.

M2t M2* MNPB2 a b MNPB is Marginal Net Private Benefit = MPB – MPC With uniform taxation across discharge sources, the overall reduction is achieved at least cost MNPB1 MNPB2 a b t t M1 P2 M2t M2* M1t M1* 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*M2t There is no re-allocation of pollution reduction as between the two firms that can reduce the total cost

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) Total supply of permits MNPBM P* Equilibrium permit price Emissions, M M*

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) MCZ PMBZ Pollution abatement, Z 0 = Privately optimal abatement

An emissions tax can attain the socially efficient level of pollution abatement (Z) MCZ SMBZ Pollution abatement, Z Z2

An emissions tax can attain the socially efficient level of pollution abatement (Z) MCZ SMBZ t* tax rate Pollution abatement, Z Z2

An emissions tax can attain the socially efficient level of pollution abatement (Z) MCZ t* tax rate Pollution abatement, Z Z2

An abatement subsidy can attain the socially efficient level of pollution abatement (Z) MCZ SMBZ Subsidy rate S* Pollution abatement, Z Z2

An abatement subsidy can attain the socially efficient level of pollution abatement (Z) MCZ Subsidy rate S* Pollution abatement, Z Z2

Who bears the cost of pollution control? D Q Q2 Q1

Is pollution control necessarily bad for business? It may promote technological innovation that reduces costs Reputation effects Niche marketing – environmentally concerned customers First mover effects – international trade Environmental tax revenues can be used to reduce other taxes on business