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Environmental Policies

Econ 373Feb 27, 2012

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Topics to be covered during the class

•Decentralized Policies•Command-and-Control Policies•Market Based Policies

▫Emission Charges and Subsidies▫Cap-and-Trade

•Criteria for Evaluating Environmental Policies

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Decentralized Policies

•Advantages:▫Stakeholders has strong incentives to seek

out solutions▫People involved have better knowledge of

damage and abatement costs.

•Liability Laws•Property Rights•Voluntary Action

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Decentralized PoliciesLiability Laws•Liability: To be liable for some behavior

is to be held responsible for whatever untoward consequences result from that behavior

•Compensation: requires that those causing the damage compensate those damaged in amounts appropriate to the extent of the injury.

•Incentivize firms to internalize the external effects.

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Decentralized PoliciesLiability Laws

$

Emissions (tons/year)

a

b cd

e1e*

Compensation payments:

MarginalDamage

MarginalAbatementcost

b+c+d

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Decentralized PoliciesLiability Laws•Common law: court proceedings in which

plaintiffs and defendants meet to make claims and counterclaims.

•Statutory law▫U.S.: Oil Pollution Act of 1990 ▫Comprehensive Environmental Response,

Compensation and Liability Act of 1980 (CERCLA)

▫Japan: The Law for the Compensation of Pollution-Related Health Injury

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Decentralized PoliciesLiability Laws•Theoretically work well but depends on

the actual legal processes▫Specified time frame: 2-3 years▫Establish a direct causal link between the

pollution and the damage▫Transaction costs – the costs reaching and

enforcing agreements•Restricted to the case where relatively few

people are involved, causal linkages are clear and damages are easy to measure

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Recent Oil Spills Litigations-Exxon Valdez

• 1989 11 million gallons of oil leaked into Prince William Sound, Alaska

• Exxon spent 2 billion on cleanup

• 1994 ruling: $287 millions in actual damage; $5 billion as punitive damage.

• 2002 appeal reduced the punitive damage to $4 billion

• 2004 appeal: 4.5 billion• 2006 appeal: 2.5 billion• 2008 appeal: 500 million

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Recent Oil Spills Litigations-Cosco Busan Oil Spill•2007: half a million gallons of oil spilled in

California•Settlement worth $44M + $10M fine

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Recent Oil Spills Litigations-Deepwater Horizon Explosion• 2010: 200 million gallons of

oil leak in the Gulf of Mexico• Trial starts at 8am, Feb 27• 116,000 plaintiffs• 300 witness• 72m pages • 90 law firms and 340 lawyers

spent 230,000 hours so far for the private sector plantiffs

• Defendants’ legal fees has reached $1.73bn

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Decentralized PoliciesProperty Rights•Conditions for property rights to work:

1. Well defined, enforceable and transferable rights

2. Reasonable efficient and competitive system that allows stakeholders to come together and negotiate the usage of the rights

3. Complete set of markets such that private owners may capture all social values associated with the use of an environmental asset

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Decentralized PoliciesVoluntary Action•Moral Suasion•Informal Pressure•Corporate Social Responsibility

•Downside and upside of the voluntary action▫Indirect, unenforceable and cause free-

rider situation ▫Possible larger spillover effect

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Command and Control Strategies: The Case of Standards•Types of Standards•Economics of Standards•Standards and Incentives•Economics of Enforcement

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Command and Control Strategies: The Case of Standards- Types of Standards

•Standards: a mandated level of performance that is enforced in law

•Types of environmental standards:▫Ambient

Never-exceed level for some pollutant in an neighborhood. Example

▫Emission Emission rate, concentration, % removal of

pollutant▫Technology

Scrubber to reduce SO2 emission

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Economics of Standards

•Equimarginal Principle: When there are multiple polluting sources, the efficient abatement level is when MC1=MC2=…MCi

•Deficient in providing incentive to abate in a efficient way and technological innovation.

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The table shows the marginal abatement cost relationship for two different sources, each emitting the same waste material. Currently the emissions are uncontrolled at 20 tons/month at each firm. Assume now that authorities wish to reduce total emissions to 20 tons/month by setting emission standards. How should the standards be set and what is the associated cost?

In-class activity- Setting StandardsMarginal Abatement

Costs ($)

Emission Level (tons/month) A B

20 0 0

19 1.0 2.1

18 2.1 4.6

17 3.3 9.4

16 4.6 19.3

15 6.0 32.5

14 7.6 54.9

13 9.4 82.9

12 11.5 116.9

11 13.9 156.9

10 16.5 204.9

9 19.3 264.9

8 22.3 332.9

7 22.5 405.9

6 28.9 487.0

5 32.5 577.0

4 36.3 677.2

3 40.5 787.2

2 44.9 907.2

1 49.7 1037.2

0 54.9 1187.2

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Market Based Strategies: Emission Charges

•Emission charges: polluting firm pays for each unit of pollutant discharge

Emissions(tons/

month)

Marginal Abatement

Cost

Total Abatement

CostTotal Tax BillAt $120/ton

Total Cost

10 0 0 1200 1200

9 15 15 1080 1095

8 30 45 960 1005

7 50 95 840 935

6 70 165 720 885

5 95 260 600 860

4 120 375 480 855

3 150 525 360 885

2 185 710 240 950

1 230 940 120 1060

0 290 1230 0 1230

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Market Based Strategies: Emission Charges

$

Emissions (tons/month)

MarginalAbatementcost

300

200

100

2 4 6 8 10

ab

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Market Based Strategies: Emission Charges

Marginal Abatement Costs ($)

Emission Level (tons/month) A B

20 0 0

19 1.0 2.1

18 2.1 4.6

17 3.3 9.4

16 4.6 19.3

15 6.0 32.5

14 7.6 54.9

13 9.4 82.9

12 11.5 116.9

11 13.9 156.9

10 16.5 204.9

9 19.3 264.9

8 22.3 332.9

7 22.5 405.9

6 28.9 487.0

5 32.5 577.0

4 36.3 677.2

3 40.5 787.2

2 44.9 907.2

1 49.7 1037.2

0 54.9 1187.2

• Questions: Under the effluence charge of $33/ton on each source, how much emission reduction will each source engage and what is the abatement costs?

• A:

• B:

Reduce by 15 ton/month

Reduce by 5 ton/month

Cost of $204.4

Cost of $67.9

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Market-Based Strategies: Cap-and-Trade• Basic features of cap-and-trade:

▫Government decides on the quantity of emissions to be allowed under the program for a stated time period => CAP

▫Government creates allowances (or “permits”), denominated in quantities of the pollutant in question. The total number of allowances issued is equal to the cap. (Grandfathering vs. Auction)

▫A regulated entity must hold and surrender to the government at the end of each compliance period allowances equivalent to that entity’s actual emissions during the period.

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Market-Based Strategies: Cap-and-Trade (Gains from trade)

$

Emissions (tons/year)

$

Emissions (tons/year)

A B

1500

1200

40 60 120

4000

1500

45 65 90

MAC

MAC

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The Least Cost Theorem

•Baumol and Oates 1971 and Montgomery 1972

•Under condition of perfect competition, absence of transaction costs, a market for tradable emissions permits can implement any aggregate emission reduction target at the least total abatement cost. This cost efficiency property is, moreover, independent of the initial allocation of the permits among the participants in the market.

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The Comparison between Emission Tax and Tradable PermitsCriterion Emission tax Tradable permits

Fulfillment of standard

Growth

Financial Burden

Revenue

Iterative process with changing tax rates is needed to reach the standard

Standard is automatically satisfied

In growing economy, the tax ratehas to be increased over time tomaintain the standard

An increase in demand for permitsis automatically reflected in the price

While from the point of view ofsociety, the tax revenue is just atransfer, from the point of viewof firms, it is a substantialfinancial burden.

If permits are distributed for free(grandfathering), then there is no additional financial cost. However,the financial burden reappear if thepermits are being auctioned away.

The revenue may be used to reduceother taxes and thereby reduce theoverall cost of the tax system(a double dividend)

Grandfathering generates no revenue and so, no double dividend. Auctioning does.

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The Comparison between Emission Tax and Tradable PermitsCriterion Emission tax Tradable permits

Transaction costs

Spatial consideration

No search costs but there maybe substantial adjustment costs associated with the fact that the tax rate has to be changes regularly.

Since trading has to take place unless the permits are being auctioned away, there may be substantial search costs involved.

Difficult to deal withenvironmental problems that have a spatial dimension.i.e. where the location of the source and the final place of deposition are important.

Tradable permit system can easier be adopted to environmental problems that have a spatial dimension.

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Nonpoint Source Pollution

•Point-source pollution problem:

•Nonpoint source emission problem:

Regulator can observe emission from individual sources

It’s either impossible or prohibitively expensive for the regulator to observe emission from each source and trace it to the receptor.

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Nonpoint Source Pollution-What to do?

•Ambient taxes

•Green taxes

•The principle of targeting (Bhagwati, 1970s)

Tax collected based on the total ambient pollution

Tax levied on inputs and outputs for environmental reasons. Works well if there is high correlation between input/output and pollution.

Optimal (first-best policy) policy should address the source of the distorting factor.

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Criteria for Evaluating Environmental Policies•Efficiency•Static Cost-effectiveness•Dynamic Cost-effectiveness•Fairness•Political Acceptability•Incentives for technological innovations•Enforceability•Agreement with moral precepts

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Ambient Air Standard Example•National Ambient Air Quality Standards

(NAAQS) required by Clean Air Act 1990 Amendment▫EPA sets standards for 6 principle pollutants

Carbon Monoxide Lead Nitrogen Dioxide Ozone Particle Pollution () Sulfur Dioxide

Measured in ppm (parts per million), ppb or

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Air Quality Example