Economic Solutions to Environmental Problems The Market Approach

1
Economic Solutions to Environmental Problems The
Market Approach

• Chapter 5

2
Overview

• Market approach refers to incentive-based policy
  that encourages conservative practices or
  pollution reduction strategies
• Difference between market approach and
  command-and-control approach is how each approach
  attempts to achieve its objectives
• Types of Market Instruments
• Pollution charge
• Subsidies
• Deposit/refund systems
• Pollution permit trading systems

3
Pollution Charges
4
Pollution Charge

• Fee that varies with amount of pollutants
  released
• Based on Polluter-Pays Principle
• Types of pollution charges
• Effluent/emission fees
• Product charge
• User charge
• Administrative charge

5
Product Charge

• Fee added to price of pollution-generating
  product, which generates negative externality
• Impose product charge as per unit tax on product,
  e.g., gas tax
• How does the tax on gasoline in the US compare
  with that of other nations?
• If the tax equals the marginal external cost
  (MEC) at QE, it is called a Pigouvian tax

6
Selected International Gasoline Tax Rates
Nation Tax Rate of Price (2004)
United States 20
U.K. 73
France 71
Italy 65
Japan 50
Spain 59
Source International Energy Agency, August 13,
2004
7
Modeling a Pigouvian Tax

MSC MPC MEC
MPCt
MPC
a
Amount of tax
b
MPB MSB
0
Q of gasoline
QE
QC
8
Assessing the Model

• In theory, achieves an efficient outcome
• In practice, difficult to identify the value of
  MEC at QE
• Allows only for an output reduction to reduce
  pollution

9
Emission (Effluent) Charge

• A fee imposed directly on the discharge of
  pollution
• Assigns a price to pollution
• Typically implemented through a tax

10
Model Single Polluter Case

• Government sets an abatement standard at AST
• Policy options to polluter are
• Abate up to AST and incur those costs OR
• Pay a constant per unit tax, t, on any abatement
  less than AST
• Total Tax t(AST - AO)
• where AO is actual abatement level
• Marginal Tax (MT) t
• Because t is constant, t MT
• Firm will choose the least-cost option the
  marginal tax (MT) or the marginal abatement cost
  (MAC)

11
Modeling Emission ChargeSingle Polluter

Firm abates up to Ao since MAC lt MT firm pays
tax between AO and AST, since MAC gt MT in that
range
MAC
0aAO cost to abate AO AOabAST tax on
pollution not abated up to AST
c
a
b
MT
t
0
AO
AST
Abatement (A)
12
Model Multiple Polluter Case

• To facilitate comparison, we use the same model
  as in the uniform standard case
• Assumptions
• 2 polluting sources in some region
• Each generates 10 units of pollution
• Government sets emissions limit for region as 10
  units, which implies AST 10
• Policy To achieve AST, government imposes an
  emission charge as a unit tax (t) of 5

13
Model Multiple Polluter Case

• Each firm responds as in the single polluter case
• Abates as long as MAC lt MT
• Pays emission charge when MAC gt MT
• Polluter 1 TAC1 1.25(A1)2 MAC1
  2.5(A1)
• where A1 is pollution abated by Polluter 1
• Polluter 2 TAC2 0.3125(A2)2 MAC2
  0.625(A2)
• where A2 is pollution abated by Polluter 2
• Find each firms abatement level. Then, find each
  firms total abatement costs (TAC) and tax
  payment at that level. Support with a graph.

14
Solution

• Polluter 1
• Abates up to the point where MAC1 MT,
• Set 2.5(A1) 5, or A1 2
• Incurs TAC1 1.25(2)2 5
• Incurs Total Tax 5(10 - 2) 40
• Polluter 2
• Abates up to point where MAC2 MT
• Set 0.625(A2) 5, or A2 8
• Incurs TAC2 0.3125(8)2 20
• Incurs Total Tax 5(10 - 8) 10

15
Modeling An Emission ChargeMultiple Polluter
MAC1
MAC2
Total Abatement Level 10 As TAC1 TAC2 25
(right triangles) Total Tax Payments 50
(rectangles)
25.00
MAC1
6.25
MT 5.00
MT 5.00
MAC2
0 10
10 0
2
Polluter 1s Abatement
8
Polluter 2s Abatement
16
Assessing the Model (pros)

• Abatement standard is met
• Generates 40 in tax revenues from high-cost
  abater and 10 from low-cost abater
• Low-cost abaters do most of cleaning up
• Cost-effective solution is obtained
• MACs are equal at 5 tax rate
• Combined TAC of 25 is lower than 39.06 under
  command-and-control with a uniform standard

17
Assessing the Model (cons)

• Tax authority will not know where MACs are equal
• Will have to adjust rate until objective achieved
• Monitoring costs potentially higher
• Firms might evade tax by illegally disposing
  pollutants
• Distributional implications
• Consumers may pay higher prices due to tax
• Job losses may result from polluter paying new
  taxes and/or changing technology to abate

18
Pollution Charges in Practice

• Internationally, the pollution charge is the most
  commonly used market-based instrument
• Some countries use effluent charges to control
  the noise pollution generated by aircraft
• Others levy charges on products such as motor
  vehicles, pesticides, fertilizers, batteries and
  gasoline

19
Environmental Subsidies
20
Environmental Subsidies

• Two major types of subsidies
• Abatement equipment subsidies
• Pollution reduction subsidies

21
Abatement Equipment Subsidy

• Defined as a payment aimed at lowering the cost
  of abatement technology
• Goal is to internalize the positive externality
  associated with the consumption of abatement
  activities
• If the subsidy (s) equals the marginal external
  benefit (MEB) at QE, it achieves an efficient
  equilibrium and is called a Pigouvian subsidy

22
Pigouvian SubsidyMarket for Scrubbers
23
Assessing the Model

• It is difficult to measure the MEB
• May bias polluters decisions about how best to
  abate

24
Pollution Reduction Subsidy

• To implement, government pays the polluter a
  subsidy (s) for every unit of pollution abated
  below some pre-established level ZST
• Per unit subsidy s(ZST - ZO), where ZO is the
  actual level of pollution
• Analogous to an emission charge

25
Assessing the Model

• Might be less disruptive than an equipment
  subsidy
• Can have the perverse effect of elevating
  pollution levels in the aggregate since the
  subsidy lowers unit costs and raises profit,
  encouraging entry

26
Subsidies in Practice

• Environmental subsidies typically are implemented
  as grants, low-interest loans, tax credits or
  exemptions, and rebates
• Many countries around the world use these
  instruments, including Austria, Finland, Japan,
  and Turkey
• In the U.S., common uses include federal funding
  to build publicly-owned treatment works and
  subsidies to encourage the development of cleaner
  fuels and low-emission vehicles

27
Deposit-Refund Systems
28
Deposit/Refund Systems

• A deposit/refund system is a market instrument
  that imposes an up-front charge to pay for
  potential damages and refunds it for returning a
  product for proper disposal or recycling
• Targets the potential vs. actual polluter
• The deposit is intended to capture the MEC of
  improper waste disposal (IW) in advance
• Preventive vs. ameliorative

29
Modeling Deposit/Refund SystemIW disposal market

• MECIW health damages aesthetic impairment from
  litter, trash accumulation, etc.
• MPCIW costs to disposer (e.g., trash
  receptacles, collection fees, plus forgone
  revenue from not recycling)
• MSCIW MPCIW MECIW
• MPBIW demand for improper disposal
• Assume MEBIW 0, so MPBIW MSBIW

30
Deposit-Refund Model

Deposit converts of overall waste disposal,
measured by (QIW - QE), from improper methods to
proper
MSCIW
MPCIW Deposit
MPCIW
a
DepositMEC at Qe
b
MPBIW MSBIW
QE
QIW
Improper Waste Disposal ()
0
100
Proper Waste Disposal ()
0
100
31
Assessing the Model

• Promotes responsible behavior
• Requires minimal supervision by government
• Can help slow the use of virgin raw materials by
  improving availability of recycled materials

32
Deposit/Refund Systems in Practice

• Deposit/refund systems are used worldwide
• Many nations use these systems to encourage
  proper disposal of beverage containers
• In the US, 11 states have bottle bills
• Other applications include systems used to
  promote responsible disposal of used tires, car
  hulks, and lead-acid batteries

33
Pollution Permit Trading Systems
34
Pollution Permit Trading Systems

• A pollution permit trading system establishes a
  market for rights to pollute by issuing tradeable
  pollution credits or allowances
• Credits are issued for emitting below a standard
• Allowances indicate how much can be released
• Two components of the system are
• Fixed number of permits is issued based on an
  acceptable level of pollution set by government
• The permits are marketable
• Bargaining gives rise to a market for pollution
  rights

35
How Permit Trading Works

• There is an incentive to trade as long as
  polluters face different MAC levels
• Suppose a firm has 50 permits but normally emits
  75 units of SO2. What must it do?
• Answer
• Abate 25 units of emissions OR
• Buy 25 permits from another producer
• Which option will the firm choose?
• Answer
• Whichever option is cheaper

36
Result

• Low-cost abaters will clean up pollution and sell
  excess permits to other firms
• They will sell at any P higher than their MAC
• High-cost abaters will buy permits rather than
  abate
• They will buy at any P lower than their MAC
• Trading will continue until the incentive to do
  so no longer exists, at which point, the
  cost-effective solution is obtained, i.e., the
  MACs across firms are equal

37
Assessing the Model

• Trading establishes the price of a right to
  pollute without government trying to search for
  a price
• No tax revenues are generated
• Trading system is flexible
• Note that an emissions standard can be adjusted
  by changing the number of permits issued

38
Pollution Trading Systems in Practice

• International examples
• Trading of greenhouse gas allowances are part of
  the Kyoto Protocol, an international accord aimed
  at global warming
• Canada has a trading program for ozone-depleters
• Denmark has one for carbon dioxide emissions
• Most of the evolution of trading is occurring in
  the U.S.
• An important example is the establishment of an
  allowance-based trading program to control sulfur
  dioxide emissions under the Clean Air Act
  Amendments of 1990