Topics in Environmental Economics: Taxes, Emissions Trading, and Other Topics in the Economics of Pollution

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Topics in Environmental Economics Taxes,
Emissions Trading, and Other Topics in the
Economics of Pollution

• Guest Lecturer Hans Zigmund
• DePaul University
• PPS 329/359 Special Topics Applied Urban and
  Environmental Economics

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Purpose

• To provide students with the tools of economic
  theory for analyzing environmental issues from an
  economic perspective.
• To that end this lecture will be largely
  theoretical with relevant applications in the
  second half of the talk.

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Outline

• Macroeconomics (Growth Theory)
• Microeconomics Theory
• Utopian Capitalist View
• Cost Benefit Analysis
• Adjustments at the Margin (Taxes, Subsidies, and
  Markets)
• Microeconomics applied to policy
• Kyoto Protocol
• European Union Emission Trading Scheme (ETS)
• Alternative International Agreements
• Boulder Carbon Tax

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Economic Growth

• Increase GDP/Capita (Economic Output)
• Factors of production
• Land (L)
• Labor (N)
• Capital (K)
• Economic output requires the exploitation of
  natural resources.

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Areas of Government Intervention

• Reduce Pollution (Todays area of focus)
• Reduce Depletion of Natural Resources
• Manage Public Lands
• Compensation from Natural Disasters

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Environmental Perspective on GDP

• Focus of economic growth is on increasing
  GDP/capita.
• Hides negative impact on ecosphere of producing
  goods and services.
• Pollution related healthcare costs
• Exxon Valdez clean up 2.2bn

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Environmental Perspective on GDP

• GDP does not account for the degradation of
  natural resources.
• Erosion
• Water Pollution
• Exhausting Mineral Resources
• Depleting Fisheries (until possibly too late)

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Environmental Perspective on GDP

• Hides negative or underestimates some positive
  effects.
• Energy efficient light bulbs and appliances.
• Fuel efficient cars.

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Index of Sustainable Economic Welfare (ISEW) and
Genuine Progress Indictor (GPI)

• Created by Herman E Daly and John Cobb Jr. (1989)
  and Philip Lawn (2003)
• Adjusts GDP/capita for
• Income Distribution
• Depletion of natural resources
• Loss of wetlands
• Loss of farmland from soil erosion and
  urbanization.
• Cost of air and water pollution
• Estimate of long term cost of global warming.

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Utopian Capitalist View Pareto Optimality

• Edgeworth Box
• Exhausting Gains On Trade
• Conditions of Pareto Optimality
• You cannot make one party better off without
  making another worse off.
• Parties involved in exchange bear the full true
  cost of the transaction.(no externalities)

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Cost Benefit Analysis Pollution Abatement

• Seek out the point that minimizes both the cost
  of abatement and environmental damage costs (or
  maximize environmental benefit).
• Total Cost curve is minimized at the point of
  intersection.
• 1 in abatement cost 1 in damage cost control
  or environmental benefit.

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Cost Benefit Analysis Pollution Abatement
TC
Damage Cost
Socially optimum amount of pollution abatement
Abatement Cost (Environmental Benefit)
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Cost Benefit Analysis Pollution Abatement

• On the right side, spend too little leads to high
  environmental costs.
• On the left side, spend too much and it trade
  offs will have to be made with other social
  programs such as public health.

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Regulatory Approach

• Historically the regulatory approach has been
  effective.
• Example
• Automobile emissions and MPG standards.
• Leads to reductions in Carbon Monoxide emissions
  and other pollutants.
• Is the regulatory approach the most efficient?

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Regulatory Approach

• Two Firm Model
• Marginal Cost/Marginal Benefit and
  inefficiencies.
• Because hypothetical firm A and firm B to abate
  the same quantity under different marginal cost
  structures, firm A may abate in excess of
  marginal benefit while firm B may abate less than
  optimal.

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Regulatory Approach
MCA
MCB
I
Damage Per Unit
II
QR
QeA
QeB
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Regulatory Approach

• Area I represents abatement cost in excess of
  benefits for firm A.
• Area II represents opportunity cost loss of firm
  B for stopping abatement while marginal benefits
  were still greater than marginal costs.

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Adjustments at the Margin Pollution Taxes

• In efficient markets P MC.
• True only when firms marginal cost equals the
  real cost of the next unit of production.
• If pollution create costs on society not incurred
  by business (externality), then an over
  allocation of resources into production will
  occur.
• Taxes can correct for this over allocation by
  internalizing the externality.

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Adjustments at the Margin Pollution Taxes
P
MCt
Spillover costs
MC
P0
Pe
D
TAX
Overallocation Corrected
Q
0
Qe
Q0
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Adjustments at the Margin Subsidies

• RD that leads to reduction in pollution has
  positive societal benefits.
• RD will only be invested in if profitable.
• Subsidizing RD can reduce the time it takes to
  develop new technology.
• RD doesnt always generate a outcome on the
  income statement. The subsidy helps offset the
  risk of investment.

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Adjustments at the Margin Subsidies
P
RD Subsidy to producers Decreases marginal cost
MC
Pe
MCs
P0
D
Underallocation Corrected
Q
Q0
Qe
0
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Adjustments at the Margin Markets for Pollution
Rights

• Politically more palatable to business because it
  relies on markets rather than taxes for
  corrections.
• Firms (such as public utilities in the market for
  SO2 ) receive a fixed number of pollution
  allowances.
• These credits can be sold and bought on the CBOT.
• If firms use more pollution than they own credits
  for they pay a fine.

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Adjustments at the Margin Markets for Pollution
Rights
S Supply of SO2 pollution rights
2010
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Allowance Trading Basics

• An emissions "cap" A limit on the total amount
  of pollution that can be emitted (released) from
  all regulated sources (e.g., power plants) the
  cap is set lower than historical emissions in
  order to reduce emissions.
• Allowances An authorization to emit a fixed
  amount of a pollutant.
• Measurement Accurate tracking of all emissions.
• Sourcehttp//www.epa.gov/airmarkets/trading/basic
  s.html

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Allowance Trading Basics

• Flexibility Sources can choose how to reduce
  emissions, including whether to buy additional
  allowances from other sources that reduce
  emissions.
• Allowance trading Sources can buy or sell
  allowances on the open market. Because the total
  number of allowances is limited by the cap,
  emission reductions are assured.
• Compliance At the end of each compliance period,
  each source must own at least as many allowances
  as its emissions.
• Sourcehttp//www.epa.gov/airmarkets/trading/basic
  s.html

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Trading the Right to Pollute

• The NOx Budget Trading Program is a market-based
  cap and trade program created to reduce emissions
  of nitrogen oxides (NOx) from power plants and
  other large combustion sources in the eastern
  United States.
• Source http//www.epa.gov/airmarkets/progsregs/n
  ox/sip.html

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Trading the Right to Pollute

• Market-based sulfur dioxide (SO2) allowance
  trading component of the Acid Rain Program
• Utilities regulated under the program, decide the
  most cost-effective way to use available
  resources to comply with the acid rain
  requirements of the Clean Air Act.
• Purchase pollution allowances.
• Switching to lower sulfur fuel.
• Reduce emissions by employing energy conservation
  measures
• Source http//www.epa.gov/airmarkets/trading/fact
  sheet.html

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Success of Acid Rain Program which includes
trading pollution allowances

• Reduced SO2 emissions by over 5.5 million tons
  from 1990 levels, or about 35 percent of total
  emissions from the power sector. Compared to 1980
  levels, SO2 emissions from power plants have
  dropped by more than 7 million tons, or about 41
  percent.
• Cut NOx emissions by about 3 million tons from
  1990 levels, so that emissions in 2005 were less
  than half the level anticipated without the
  program. Other efforts, such as the NOx Budget
  Trading Program in the eastern United States,
  also contributed significantly to this reduction.
  
• Led to significant cuts in acid deposition,
  including reductions in sulfate deposition of
  about 36 percent in some regions of the United
  States and improvements in environmental
  indicators, such as fewer acidic lakes.
• Source http//www.epa.gov/airmarkets/progress/arp
  05.html

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Kyoto Protocol

• Industrialized nations reduce CO2 5 percent from
  1990 levels by 2008-2012 compliance period.
• United States withdrew in 2001.
• China and India are not required to comply
  because they are developing nations.
• By 2002 Kyoto only covered about 30 percent of
  global CO2 emissions.
• Too little too fast.
• Not enough change to make a difference.
• Difficult to comply with for countries who
  experienced substantial growth in the 1990s.

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European Union Emissions Trading Scheme (ETS)

• Kyoto with teeth.
• Covers half of Europes carbon emissions. (8 of
  global)
• Each country creates a national allocation plan
  for specifying caps on greenhouse gases.
• Businesses can either reduce their emissions or
  purchase allowances from facilities with an
  excess of allowances.
• Allowances traded in the ETS are not printed but
  are held in electronic account registries set up
  by Member States and are overseen by a Central
  Administrator at the EU.
• Emissions considered a service under EUs VAT.
• Sources http//ec.europa.eu/environment/climat/em
  ission.htm and Nordhaus, William D. The American
  Economic Review, After Kyoto Alternative
  Mechanisms to Control Global Warming 96(2) May
  2006, 31-34

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Alternative International Treaty Options

• Link treaty to specific environmental objectives
  rather than a baseline year pollution level.
  (e.g. temperature, costs, damages) (Nordhaus
  2006)
• Use an extended time path. Depart gradually from
  a business as usual pattern becoming more severe
  over time. (Olmstead and Stavins 2006)
• Extend tradable allowances globally. (Olmstead
  and Stavins 2006)
• Extend participation beyond industrialized
  nations to include the developing world and
  United States. (Olmstead and Stavins 2006)
• Nordhaus, William D. The American Economic
  Review, After Kyoto Alternative Mechanisms to
  Control Global Warming 96(2) May 2006, 31-34 and
  
• Olmstead, Sheila M. and Robert N. Stavins. The
  American Economic Review, An International
  Policy Architecture for the Post-Kyoto Era 96(2)
  May 2006, 31-34 and

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Boulder Carbon Tax

• Boulder's City Council adopted the goals of the
  Kyoto Protocol in 2002 to reduce greenhouse gas
  emissions below 1990 levels by 2012.
• On November 14, 2006 with Initiative 202, the
  Climate Action Plan Tax, the Boulder Colorado
  city council approved a carbon tax which is
  applied to residents electric and gas bills.
• Average tax for homeowners 1.33/month and
  Business 3.80/month
• Estimated energy cost savings from implementing
  the Climate Action Plan are 63 million over the
  long term.
• Revenue estimated is 6.7 million by 2012, when
  the goal is to have reduced carbon emissions by
  350,000 metric tons.
• Source http//www.ci.boulder.co.us/index.php?opti
  oncom_contenttaskviewid6136Itemid169 and
  http//www.env-econ.net/2006/11/a_carbon_tax_in.ht
  ml