Pollution Control: Instruments

1. Pollution Control: Instruments READING Common: Chapter 5 Perman et al (2nd edition): Chapters 12 and 13 Perman et al (3rd edition): Chapters 7, 8 and 10.

2. Six ways of achieving an emissions target: • A quantitative regulation on output • A quantitative regulation on inputs • A quantitative regulation on technology used • An emissions tax • An emissions abatement subsidy • A system of marketable permits

3. The efficient level of pollution (M) EMCM PMNBM = Marginal damage caused by the pollution M2 M1 M3 Pollution emissions, M

4. An emissions tax as a pollution control instrument The tax should be levied on units of emissions, not units of output.

5. A Special Situation. If there a constant proportionality between output of the good or service (Q) and pollutant emissions (M), then a tax on emissions and a tax on output are equivalent. Hence can use the following diagram, in goods output space, to visualise matters:

6. Taxation of a negative externality SMC=PMC+EMC PMC P2 P1 EMC SMB+D Q Q2 Q1

7. But if the output-emissions ratio is variable (which it will be in most cases), it is better to think about this in terms of pollution (or, better still, emissions).

8. COST EFFICIENCY A cost-effective pollution abatement programme is one that achieves any desired pollution (or, equivalently, pollution abatement) target at least cost. A necessary condition for this least cost property is that the marginal cost of abatement is equalised over all abaters.

9. With uniform taxation across discharge sources, the overall reduction is achieved at least cost PMNB1 PMNB2 a b t t M1 P2 M2t M2* M1t M1* PMNB is Marginal Net Private Benefit = PMB – PMC No tax - Profit maximised where PMNB = 0 With tax – Profit maximised where PMNB = t Total Cost of pollution reduction = aM1*M1t + bM2*M2t There is no re-allocation of pollution reduction as between the two firms that can reduce the total cost

10. EMISSION ABATEMENT SUBSIDIES Emission abatement subsidies can be used instead of taxes. Subsidies can be thought of as negative taxes. Taxes and subsidies have different distributional effects. Short-term effects on quantity of pollution attained are identical to taxes. But long-run effects may differ (as they affect industry profitability in different ways).

11. There is a problem with emissions taxation (and subsidies) – if the firms’ PMNB functions are not known, it is not possible to calculate the tax rate that will bring about the desired overall reduction in pollution. Whatever reduction is achieved will be brought about at least cost, but it could be too big or too small. Tradeable permits avoid this problem. Since the quantity of permits issued is equal to the desired level of total emissions, assuming compliance, the achieved reduction is that intended. Tradeable permits are dependable, as well as least cost. They have the least cost property because with a single market price per permit, all firms move to where their PMNB = permit price, and the situation is as in the previous slide. If the permits are initially issued free, there is no revenue arising, as there is with taxation.

12. The Market for Emissions Permits (Permits sold in a competitive auction) Total quantity of permits issued (sold) P* Demand for permits M M*

13. The Market for Emissions Permits (After permits have been issued at zero price) Supply of permits P* Demand for permits M Quantity of permits exchanged

14. Tradable permits in practice Where the pollutant is a stock pollutant, damage depends on location of emissions (and possibly on timing too)….. it is then not efficient, nor reliable, to have freely-tradable permits based solely on emission quantities. More complex trading arrangements required. But the information requirements to implement these can be very high.

15. The efficient level of pollution abatement (Z).

16. The privately efficient level of pollution abatement (Z) MCZ PMNBZ Pollution abatement, Z 0 = Privately optimal abatement

17. The socially efficient level of pollution abatement (Z) MCZ SMNBZ Pollution abatement, Z Z2 0

18. An emissions tax can attain the socially efficient level of pollution abatement (Z) MCZ t* tax rate Pollution abatement, Z Z2 0

19. An abatement subsidy can attain the socially efficient level of pollution abatement (Z) MCZ SMNBZ Subsidy rate S* Pollution abatement, Z Z2 0

20. An abatement subsidy can attain the socially efficient level of pollution abatement (Z) MCZ Subsidy rate S* Pollution abatement, Z Z2 0

21. An emissions tax can attain the socially efficient level of pollution abatement (Z) MCZ SMNBZ t* tax rate Pollution abatement, Z Z2 0

22. Who bears the cost of pollution control? P S2 t S1 P2 P1 P3 t D Q Q2 Q1

23. Is pollution control necessarily bad for business? • It may promote technological innovation that reduces costs • Reputation effects • Niche marketing – environmentally concerned customers • First mover effects – international trade • Environmental tax revenues can be used to reduce other taxes on business