The Economics of Environmental Regulations

1. The Economics of Environmental Regulations Pollution Tax and Markets for Transferable Pollution Permits

2. Effluent Charge • An Effluent Charge is a tax or a financial penalty imposed on polluters by government authorities. The charge is specified on the basis of dollars or cents per unit of effluent emitted into an ambient environment. Example, a carbon tax (per ton of carbon emitted) to address the concern for global warming.

3. The Analytic of Effluent Charge • How does effluent charge work? Show this using Figure 6.1 (see the handout).

4. Principal Advantages of Effluent Charges • In principle, they are relatively easy to administer. • They are generally cost-effective, but not necessarily sociallyoptimal. • They generate revenues while correcting price distortions--the doubledividend feature of effluent charges. • They tend to provide firms with incentives to invest in pollution control technology.

5. Main Disadvantages of the Effluent Charges • Monitoring and enforcement costs could be high (i.e., high transactioncosts) • They could have a disproportionate effect on incomedistribution • They do not condemn the act of polluting on purely moral grounds. It is okay to pollute, provided on pays for it.

6. continue... • Firms are philosophically against taxes of any form, especially when they are perceived to cause increased prices and an uncertain business environment. • Environmental organizations generally oppose effluent charges for both practical and philosophical reasons. Pollution taxes are “licenses to pollute”. Taxes are generally difficult to tighten once implemented.

7. Transferable Emission Permits • Essentially, the main idea behind transferable emission permits is to create a market for pollutionrights. A pollution right simply signifies a permit which consists of a unit (pound, ton, etc.) of a specific pollutant.

8. continue... • In general, the system of transferable permit operate on the basis of the following basic postulates: • it is possible to obtain legally sanctioned right to pollute • These rights (permits) are clearly defined

9. The total number of permits and the initialdistribution of the total permits among the various polluters are assigned by government agencies. In addition, polluters emitting in excess of their allowances are subject to a stiff monetary penalty • Pollution permits are freely transferable. That is, they can be freely traded in the marketplace.

10. Transferable Pollution Permits in Theory • Show how transferable permits work in theory using the figure in the handout--Figure 6.4

11. Principal Advantages of emission Permits • they are least interventionist • they are are cost-effective, especially when the number of parties involved in the exchange of permits is large • they provide observable prices for environmental services • they can be applied to a wide range of environmental problems

12. Principal disadvantages of transferable emission permits • The mechanisms used to distribute permits among potential users could have significant equity implications. • The idea of permits to pollute conveys, to some, a reprehensible moral and ethical value. • The applicability is questionable for pollution problems with an international scope.

13. continue... • They are ineffective when there are not enough participants to make the market function. • Permits can be accumulated by firms for the purpose of deterring entrants or by environmental groups for the purpose of attaining the groups’ environmental objectives.

14. The Macroeconomic Effects of Environmental Regulations • Policies used to internalize environmental externalities could have economic-wide effects. • These effects are suspected to appears in the forms of general price increase (inflation) or unemployment. {show how this would be the case using a simple demand and supply analysis}

15. continue... • Despite this, at the aggregate level, the effects of environmental regulation on price and unemployment are not that clear cut for the following reasons: • The economy-wide effect of environmental regulation on unemployment is unclear since a decrease in employment in certain sector of an economy could be offset by a gain in other sectors.

16. continue... • Furthermore, some even claim that cleaning up the environment creates more jobs than it destroys--since firms associated with pollution control activities tend to be relatively more labor intensive. • In addition, some economists argued that strictly enforced environmental policy could have the effect of forcing firms to adopt more efficient production technology--the Porter Hypothesis.

17. continue... • On the other hand, it was argued that environmental regulations have negative effects on productivity (hence, aggregate output and unemployment ) for the following two reasons: • Pollution control expenditures displace investment in new plant and equipment, and require firms to use some inputs for compliance, hence adversely affecting the rate of increase in labor productivity.

18. continue... • Furthermore, regulation is believed to increase the uncertainty climate of private industry, hence adversely affecting the level of industry-wide investment.

19. continue... • At least in theory, the inflationary effect of environmental regulation seems to be indisputable. This is because environmental policy forces society to take into account costs that would have otherwise been neglected. • However, several empirical evidence suggests that the price effect of environmental regulation is very minimal at the aggregate level.