Econ 201
Lecture 10.1d
Taxes, Standards
and Tradable Permits
6-09-2009
Things You Ought to Look At
• http://facweb.northseattle.edu/dperry/econ
201/Harris_AER_EnvEcon.pdf
• http://facweb.northseattle.edu/dperry/econ
201/The%20(Tuna)%20Tragedy%20of%2
0the%20Commons%20%20Dot%20Earth%20Blog%20%20NYTimes_com.mht
Negative Externality
• Marginal Private Costs < Marginal Social Costs
Ideal
Actual
Pi
Pa
Remedies for Negative
Externalities
• Standards
– Permissible level of emissions for each factory in an
industry (each industry gets same target), or
– Targets how much emissions must be reduced by
each factory (again, same target for all)
• Taxes
– Direct tax on emissions
• Indirect on input/output if there is a direct correlation between
input/output and pollution
– E.g., tax on gasoline, coal based on sulfur content
• Tradable permits
– Gives each firm the “right” to pollute to a certain level
– Firms are allowed to trade/sell permits
Negative Externalities & Taxes
•
How to Set the Optimal tax
– Set at point where MBen = MCost of Pollution
• Tax: equals difference between MSC and MPC and
– “internalizes” it into the consumption decision
• Firm’s cost = price*quantity of inputs plus tax*emissions/output
Tax
Coase’s Theorem
• If property rights exist and transaction
(bargaining) and information costs are low
– Then parties will be able to bargain among
themselves (without government intervention)
to obtain an efficient outcome
Comparison of Approaches
• Standards
– Can also produce optimal level of pollution
• But set same standard for all firms (and are not productively
efficient, e.g. min cost)
• To set individual quotas: requires knowledge of each firm’s
costs
– But have higher administrative costs
• Not only have to monitor emissions
• Enforcement costs: legal proceedings (time delays and
expense)
• Not very flexible: regulatory process for changing standards
– Provide no incentive for firms to reduce pollution
below current “authorized” levels
Comparison of Approaches
• Standards
– Are most useful when:
• Problem is short-lived (“burn” bans for high
pollution days)
• Optimal level is zero
Comparison of Approaches
• Taxes
– Can produce “optimal” amount of pollution at
minimum costs and lower administrative costs
• Kneese (1977): comparing taxes versus standards found
that desired quality costs half as much using taxes
– Automatically allocates pollution levels among firms
based on their costs
• Provides incentive for firms to reduce pollution levels through
technological innovation
– Easy to adjust/”tune”
– Tax revenues can be used finance admin costs
And They Are Endorsed
by the Sierra Club!
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Sierra Club Conservation Policies
Pollution Taxes
make it less expensive for a polluter to adopt alternative processes or invest
in additional equipment to curtail releases to the environment
Taxes would supplement, and not replace, standards on maximum
permissible emissions.
Taxes should be imposed when the following conditions are found to prevail
generally:
for competitive or other reasons, cost-minimizing behavior tends to exist in
the company or industry;
the cost of abatement is significant,
the quantity of the pollutant released can be determined with reasonable
accuracy,
– cost of monitoring should be small in relation to the tax revenue expected in the
absence of abatement.
•
Adopted by the Board of Directors, February 13-14, 1997
Comparison of Approaches
• Tradable Permits
– Cost efficient
• Firms will purchase permits from more efficient firms if permit
cost < abatement (technology) costs
– Technological incentive to reduce pollution
• Marginal cost of abatement = permit cost
– Similar to taxes
– Administratively simpler
• Require less information about the firms’ cost
• Better able to handle “spatial” variation in pollution
– Fewer permits auctioned in bad areas
• Adjust “automatically” for changes in inflation and growth
– If auctioned -> revenues for admin costs
Text’s Taxonomy
Distinguishing between private and public goods
•
Non-excludability: no way to prevent consumers from deriving
benefits from provided good (e.g., national defense, parks?)
• Non-rival consumption: my consumption of the good does not
reduce the amount available to another
Consumption Excluded Non-excluded
Rival
Private Goods Common Property
Non-Rival
Club Goods Pure Public Goods
Positive Externality
• Private Marginal Benefits < Social Marginal Benefits
What’s the Regulatory Solution?
• Problem is:
– Since SMB > PMB
• Underproduction of the good
• “Free-rider” problem
• Traditional Solution
– Increase production by subsidizing production of the
good (i.e., reducing its costs of production)
– In this case: subsidy does not lead to inefficiency
– Use of income taxes, license fees -> not linked
directly to consumption of the good
• Tax reductions – reduce taxes on good (e.g. low
income housing, green buildings)