Economic theory and common sense argue that
incentive mechanisms should enhance the efficiency of
pollution control relative to traditional command and
control approaches. The reasons for this conclusion are
several. First, some incentive-based mechanisms
explicitly allow trading of pollution reduction
obligations. With trading, sources with high incremental
costs of control can have their obligations satisfied by
sources with low incremental costs of control. Other
incentive-based mechanisms levy a charge or tax on each
unit of pollution. Under such an approach sources would
control pollution only to the point at which the
incremental cost of control equaled the charge or tax. In
an idealized world without transactions costs and
competitive markets, both permit/credit trading and
pollution charge approaches should result in the marginal
cost of controlling pollution being the same at each
source. At every level of pollution, control costs should
be lower than (or at worst the same as) costs associated
with a command and control approach.
A number of other incentive-based mechanisms, such as
information reporting requirements, liability, and
voluntary programs, rely on implicit charges for
pollution. The efficiency consequences of such mechanisms
are more difficult to predict because sources are
reducing pollution for reasons that have only an indirect
financial conse-quence. And sometimes that financial link
is very tenuous. The motives for participating in
voluntary programs are largely one of improving corporate
image to customers, to employees, and to regulators,
though management concern for the environment certainly
could be a factor. While the motives for controlling
pollution are very real, the benefit to the firm of
reducing emissions is difficult to express in financial
terms. Perhaps the best that could be done is to examine
what firms actually spend as part of such programs to
generate a willingness to pay for pollution reduction.
One might find that forms respond in a systematic fashion
to various of the indirect incentives. For example across
a sample of firms, liability might generate higher
willingness to pay for a unit of pollution reduction than
does an information reporting requirement, which in turn
might exceed the willingness to pay for strictly
voluntary activities.
Examining the performance of trading systems in
particular, one finds that existing applications fail to
achieve anywhere near their theoretical potential cost
savings. Trades have been fewer and cost savings smaller,
according to this analysis, than indicated by economic
modeling.
A number of explanations have been offered about why
the predicted savings are not realized. Regulatory and
legal requirements of the actual programs may limit the
trading opportunities to a greater extent than portrayed
in the models, especially where the incentive programs is
in addition to existing command-and-control programs.
Various models have not fully reflected aspects of real
regulatory programs, including the transaction costs,
restrictive trading rules, monitoring and reporting
requirements, and the administrative burden placed on
both emission sources and regulatory agencies.
In addition to limitations imposed by the regulatory
structure, potential participants in trading systems may
be reluctant to trade paper credits, preferring instead
the greater certainty of installing pollution control
equipment at their facilities. Moreover, pollution
credits have a limited life whereas engineering controls
in principle last for the life of a facility. In most
trading systems, the vast majority of trades that take
place occur within firms, not between firms. Further,
markets in rights available for sale tend to be thin
(Hahn) and it may be difficult to locate potential
sellers of rights.
For tax, charge and fee systems, with a couple of
exceptions in Sweden, the principal limitation to
achieving the theoretical efficiency gains has been the
generally low level of charge relative to what would be
required to have a significant impact on pollution.
Charges typically are set to recover administrative costs
for a program, not to impact pollution.
Even if the cost savings are less than predicted, the
actual savings are still impressive. In the appropriate
circumstances, the wider use of incentive programs that
are feasible in an actual policy setting will result in
substantial costs savings while achieving equivalent
environmental goals. In other circumstances, the cost
differences between an incentive program and a well
designed command-and-control program will be less,
although the 7 incentive program will provide a stronger
stimulus for innovation and technical change.
Source: Robert Anderson et al., 'The United States
Experience with Economic Incentives in Environmental
Pollution Control Policy', Environmental Law Institute
and EPA, 1997.
