Incidence of Environmental Regulations Who pays for environmental regulations, and how much?

Motivation Group Project: One of the stipulations of AB32 is that environmental justice be taken into account in reducing GHG emissions. What are the environmental justice implications of a cap and trade system and how can the negative effects be reduced?

Some general rules Only people gain and lose – not organizations. “Corporations” never pay. Corporations are just paper. Corporation is owned by its shareholders – people. Consumers may benefit from improved environment and pay higher price for goods (e.g. pesticide regulation). Impose a regulation, typically who pays: Consumers Owners of inputs to production: Workers – owners of labor Shareholders – owners of capital Effects ripple through economy.

Example: New regulations on metal fabrication industry Industry costs go up Can industry raise prices, passing on costs? Can industry lower wages to keep competitive? Product price may go up Consumers will pay more Some consumers will do without Conclusion: Consumers and capital owners pay Citizens benefit from better environment

Key terms Backward Incidence: inputs pay (wage earners, capital owners, etc) Example: Regulation only covering California firms Forward Incidence: consumers pay Example: Regulation covers all US firms and no foreign competition Incidence by class: income, ethnicity, geographic region, age, education, etc. Example: gasoline tax would fall heavily on the poor

Firms vs. consumers First question is whether firms pay or consumers pay If firms pay, next question is which inputs pay? Labor Capital

Case 1: Reg. affects few firms in larger competitive market Demand S0S0 S1S1 Cost to the individual firm: “Backward incidence” Demand elastic For these few firms Reg shifts costs up

Case 2: Regulation covers entire industry Demand S0S0 S1S1 Regulation inc. costs: Supply shifts up, Price rises, quantity declines: forward and backward incidence $ Electricity

Loss to consumers Demand S0S0 S1S1 Electricity $ p0p0 p1p1 A B Old CS: A+B New CS: A Change: B

Loss to producers Demand S0S0 S1S1 Electricity $ p0p0 p1p1

Demand S0S0 S1S1 Electricity $ p0p0 p1p1 Old Producer Surplus

Demand S0S0 S1S1 Electricity $ p0p0 p1p1 New Producer Surplus Shift down by wedge, get net change in PS.

If producers pay, will owners of capital or labor end up paying? Do employees have alternative job opportunities? If yes, then producer can’t pass on costs to labor. Is capital mobile (fungible) or application specific? If mobile, then can’t pass on costs to capital. If either capital or labor has few alternatives, then that factor will probably eat the cost.

Incidence isn’t always what it appears Suppose we tax house sales in Santa Barbara – who pays? $ Houses D1D1 D0D0 S p0p0 p1p1 Tax House prices fall

If buyer pays tax… Burden is on seller They see lower price, buyer gets same CS $ Houses D1D1 D0D0 S p0p0 p1p1

If seller pays tax… Burden is on seller They see lower price, buyer gets same CS $ Houses D0D0 S p0p0 p1p1

SB News Press Headline “Goleta Developer Fees May Double” (Feb 11, 2003) Who pays for an increase in development fees? Who benefits from an increase in development fees?

If supply not fixed: tax development Who benefits from a development tax? S0S0 S1S1 D Houses $ p0p0 p1p1 Current home- owners benefit from increased house price

Example 1: The Isla Vista cliffs Isla Vista, CA: many houses on eroding sea cliffs; safety concern, eyesore, house stability concern College community, mostly student rentals. Consider a publicly-funded project to shore up the cliffs, paid for with an IV sales tax. Who would benefit from this action? Who would bear most of the costs?

A simple economic model $ Housing D 0 (risky) D 1 (safe) S p1p1 p0p0 Residents: Safety (+) Price (-) Landowners: Price (+) The real question: Are residents (students) better off? Conclusion: Landlords basic beneficiaries

Environmental Racism/Justice: A Special Kind of Incidence Environmental Justice (EJ) is the fair treatment and meaningful involvement of all people regardless of race, color, natural origin, or income with respect to the development, implementation, and enforcement of environmental laws, regulations and policies. (EPA) EPA examples: Low-income citizens, and quite often minorities, are more likely to live near landfills, incinerators, and hazardous waste treatment facilities. Low-income and African American children consistently have higher than normal levels of lead in their blood and asthma conditions. 80 percent Hispanic, 65 percent African American, and 57 percent White people live in areas which fail to meet some U.S. EPA air quality standards. Should “income” be included in this definition? If incinerator is choosing between locating in Bel Air or South Central LA, which should it choose and why? Applies to acts of government (eg, regulations) and acts of firms (polluters)

South Coast Santa Barbara, Hispanic Population

Dots are toxic facilities What do we find troubling about this? What should be done differently?

Issues with environmental racism Targeting regulations or plant siting based on race or ethnicity clearly wrong. Alesina et al (1999): shares of spending on public goods in U.S. cities are inversely related to the city's ethnic fragmentation Cutler and Glaeser (1997) African Americans in more segregated areas have significantly worse outcomes than African Americans in less segregated areas. Targeting regulations or plant siting based on income is more complex Low land prices often attract low income residents Factories typically attracted by low land prices Low environmental quality often depresses land prices

What to do with incidence (in evaluating a policy/project) Separately measure incidence and efficiency – two measures of the performance of a policy Adjust cost-benefit analysis using income weights Track costs and benefits to different income groups Weigh lower income groups higher than higher income groups Size of weights difficult to determine

Why is incidence and justice in economics? Framed as a positive question, totally appropriate for economics Distributional consequences of an action What to do about it is the reason we have a political system – NOT an economics question