Field (11 y 12) PDF

Chapter
11
Command-and-Control
Strategies: The Case
of Standards
A command-and-control (CAC) approach to public policy is one where, in or-
der to bring about behavior thought to be socially desirable, political authorities
simply mandate the behavior in law, then use whatever enforcement machinery—
courts, police, fines, and so on—that is necessary to get people to obey the
law. In the case of environmental policy, the command-and-control approach
consists of relying on standards of various types to bring about improvements
in environmental quality. In general, a standard is simply a mandated level of
performance that is enforced in law. For example, a maximum level of a toxic,
such as ppm (parts per million) of arsenic in drinking water. A speed limit is a
classic type of standard; it sets maximum rates that drivers may legally travel.
An emission standard is a maximum rate of emissions that is legally allowed.
The spirit of a standard is, if you want people not to do something, simply pass
a law that makes it illegal, then send out the authorities to enforce the law.
Figure 11.1 is our familiar graph showing marginal abatement costs and
marginal damages related to the rate at which some production residual is
emitted into the environment. Suppose that initially the actual level of efflu-
ent is at e1, a rate substantially above the efficient rate of e*. To achieve e* the
authorities set an emission standard at that level; e* becomes a mandated up-
per limit for the emissions of this firm. The standard is then enforced by send-
ing out whatever enforcement authorities are necessary to measure and detect
any possible violations. If infractions are found, the source is fined or subject
to some other penalty. If the firm reduces emissions in accordance with the
standard, it will be incurring an amount equivalent to area a per year in total
abatement costs. These total abatement costs are the compliance costs of meet-
ing the standard.
Standards are popular for a number of reasons. They appear to be simple
and direct. They apparently set clearly specified targets. They appeal, therefore,
202
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Chapter 11 Command-and-Control Strategies: The Case of Standards 203
FIGURE 11.1 Emission Standards
Marginal
abatement
costs
$ Marginal
damages
et eo e* e1
Emissions (tons/year)
to the sense that everybody has of wanting to come directly to grips with envi-
ronmental pollution and get it reduced. Standards also appear to be congenial
to our ethical sense that pollution is bad and ought to be declared illegal. The
legal system is geared to operate by defining and stopping illegal behavior, and
the standards approach conforms to this mind-set.
We will see, however, that the standards approach is a lot more complex
than might first appear. Standards appear to offer a method to take away the
freedom of sources to pollute, replacing it with mandated changes in behav-
ior. In fact, a very practical reason for the popularity of standards is that they
may permit far more flexibility in enforcement than might be apparent. What
appears to be the directness and unambiguousness of standards becomes a lot
more problematic when we look below the surface.
Types of Standards
There are three main types of environmental standards: ambient, emission, and
technology.
Ambient Standards
Ambient environmental quality refers to the qualitative dimensions of the sur-
rounding environment; it could be the ambient quality of the air over a particu-
lar city or the ambient quality of the water in a particular river. So an ambient
standard is a never-exceed level for some pollutant in the ambient environ-
ment. For example, an ambient standard for dissolved oxygen in a particular
river may be set at 3 parts per million (ppm), meaning that this is the lowest
level of dissolved oxygen that is to be allowed in the river. Ambient standards
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204 Section Four Environmental Policy Analysis
cannot be enforced directly, of course. What can be enforced are the various
emissions that lead to ambient quality levels. To ensure that dissolved oxygen
never falls below 3 ppm in the river, we must know how the emissions of the
various sources on the river contribute to changes in this measure, then intro-
duce some means of controlling these sources.
Ambient standards are normally expressed in terms of average concentra-
tion levels over some period of time. For example, the current national primary
ambient air quality standard for carbon monoxide (CO) is 9 ppm based on an
8-hour averaging time and 35 ppm based on a 1-hour averaging time. Neither
can be exceeded more than once per year. The reason for taking averages is to
recognize that there are seasonal and daily variations in meteorological condi-
tions, as well as in the emissions that produce variations in ambient quality.
Averaging means that short-term ambient quality levels may be worse than
the standard, so long as this does not persist for too long and it is balanced by
periods when the air quality is better than the standard.
Emission Standards
Emission standards are never-exceed levels applied directly to the quantities of
emissions coming from pollution sources. Emission (or effluent) standards are
normally expressed in terms of quantity of material per some unit of time—for
example, grams per minute or tons per week. Continuous emissions streams
may be subject to standards on “instantaneous” rates of flow: for example, up-
per limits on the quantity of residuals flow per minute or on the average re-
siduals flow over some time period. These are sometimes called “performance
standards.”
It is important to keep in mind the distinction between ambient standards
and emission standards. Setting emission standards at a certain level does not
necessarily entail meeting a set of ambient standards. Between emissions and
ambient quality stands nature, in particular the meteorological and hydrologi-
cal phenomena that link the two.
Research to study the linkage between emission levels and ambient quality
levels is an important part of environmental science. The environment usually
transports the emissions from point of discharge to other locations, often dilut-
ing and dispersing them along the way. Chemical processes occur in all envi-
ronmental media that often change the physical character of the pollutant. In
some cases this may render the emitted substance more benign. Organic wastes
put in rivers and streams will normally be subject to natural degradation pro-
cesses, which will break them down into constituent elements. Thus, the ambi-
ent quality of the water at various points downstream depends on the quantity
of emissions as well as the hydrology of the river: its rate of flow, temperature,
natural reaeration conditions, and so on.
The link between emissions and ambient quality also can be vitally affected
by human decisions. A classic case is automobiles. As part of the mobile-source
air pollution program, emission standards have been set for new cars in terms
of emissions per mile of operation. But because there is no effective way of con-
trolling either the number of cars on the roads or the total number of miles each
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is driven, the aggregate quantity of pollutants in the air, and thus, ambient air
quality, is not directly controlled.
Emission standards can be set on a wide variety of different bases. For example:
1. Emission rate (e.g., pounds per hour).
2. Emission concentration (e.g., parts per million of biochemical oxygen
demand, or BOD, in wastewater).
3. Total quantity of residuals (rate of discharge times concentration times
duration).
4. Residuals produced per unit of output (e.g., SO2 emissions per kilowatt-hour
of electricity produced).
5. Residuals content per unit of input (e.g., SO2 emissions per ton of coal burned
in power generation).
6. Percentage removal of pollutant (e.g., 60 percent removal of waste material
before discharge).
In the language of regulation, emission standards are a type of performance
standard because they refer to end results that are meant to be achieved by the
polluters that are regulated. There are many other types of performance stan-
dards: for example, workplace standards set in terms of maximum numbers of
accidents or levels of risk to which workers are exposed. A requirement that
farmers reduce their use of a particular pesticide below some level is also a per-
formance standard, as is a highway speed limit.
Technology Standards
There are numerous standards that don’t actually specify some end result, but
rather the technologies, techniques, or practices that potential polluters must
adopt. We lump these together under the heading of technology standards.
The requirement that cars be equipped with catalytic converters or seat belts
is a technology standard. If all electric utilities were required to install stack-
gas scrubbers to reduce SO2 emissions,1 these would be, in effect, technology
standards because a particular type of technology is being specified by central
authorities. This type of standard also includes what are often called design
standards or engineering standards. There are also a variety of product stan-
dards specifying characteristics that goods must have and input standards that
require potential polluters to use inputs meeting specific conditions.
At the edges, the difference between a performance standard and a technol-
ogy standard may become blurred. The basic point of differentiation is that a
performance standard, such as an emission standard, sets a constraint on some
performance criterion and then allows people to choose the best means of achiev-
ing it. A technology standard actually dictates certain decisions and techniques
to be used, such as particular equipment or operating practices to be used by
polluters. For illustrative purposes, Exhibit 11.1 shows some typical standards,
1
A scrubber is a device that treats the exhaust gas stream so as to remove a substantial proportion
of the target substance from that stream. The recovered material then must be disposed of
elsewhere.
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Standards Applicable
to Snowmobiles 1 EXHIBIT 11.1
Snowmobiling is a major wintertime ac- in 24,300 miles of driving. Snowmobiles

tivity in the United States. Historically, also emit as much carbon monoxide in an
snowmobiles were built with two-stroke hour as a 2001 model auto does in 1,520
engines, the same kind of engine that miles of driving. They are also very noisy.
has been used to power lawn mowers In the last two decades, there has been a
and outboard motors. In a two-stroke en- political struggle over emission standards
gine, fuel enters the combustion chamber applicable to snowmobiles. Another as-
at the same time that exhaust gases are pect of the fight has been over efforts
expelled from it. As a result, as much as to control the entrance of snowmobiles
one-third of the fuel passes through the into national parks, especially Yellowstone
engine without being combusted. This National Park. The tabulation shows stan-
causes poor fuel economy and high levels dards adopted by the EPA after extensive
of emissions, particularly hydrocarbons review, mediation, and court battles, as
and carbon monoxide. In 1 hour, a typi- the snowmobile industry regards them as
cal snowmobile emits as much hydrocar- too restrictive, and environmental groups
bon as a 2001 model automobile emits regard them as not restrictive enough.
Emission Standards Applicable Carbon Monoxide Hydrocarbons

to New Snowmobiles g/kw-hr g/kw-hr
Before 2006 397 150
2006/2007 275 100
2010 275 75
2012 200 75
Yellowstone 2003 120 15
Yellowstone 2015–2016 90 15
Yellowstone Entry Standards Number of Snowmobiles Allowed (vehicles/day)

Clinton 2003 0
Bush 950
2011–2012 season 318
2015–2016 season 4802
Noise Standards for Yellowstone Decibels

Yellowstone 2015–2016 season 67 dBA @ 35 mph
1
Snowcoaches, another type of oversnow vehicle (OSV), have another set of specific emissions
and noise standards.
2
Limited to 48 transportation events with up to 10 snowmobiles per event.
Sources: Department of the Interior, National Park Service, Special Regulations; Area of
the National Park System; Yellowstone National Park; Winter Use, Final Rule Federal Register
78(205), October 23, 2013, pp. 63069–63093. National Park System Yellowstone, Oversnow
Vehicle (OSV) Noise Emissions Testing, 2015–16 update, http://www.nps.gov/yell/learn
/management/osvtest.htm.
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applicable in this case to snowmobiles. The carbon monoxide, hydrocarbon,

and noise limits are emission standards; the limit on snowmobiles entering
Yellowstone National Park can be thought of as a technology standard, as it
restricts the use of certain machines in this setting.
Standards Used in Combination

In most actual pollution-control programs, different types of standards are
used in combination. National air pollution-control policy contains all three,
as we will see in Chapter 15. In the Total Maximum Daily Load program for
water pollution control, authorities establish ambient standards for water qual-
ity, emission standards to reduce incoming pollution loads, and technology
standards in the form of best management practices. We will encounter this
program in Chapter 14.
The Economics of Standards

It would seem to be a simple and straightforward thing to achieve better envi-
ronmental quality by applying standards of various types. Standards appear to
give regulators a degree of positive control to get pollution reduced, but stan-
dards turn out to be more complicated than they first appear. The discussion
in the rest of this chapter will focus on the efficiency and cost-effectiveness of
standards, as well as the problem of enforcement.
Setting the Level of the Standard

Perhaps the first perplexing problem is where to set the standard. We saw in
the case of the decentralized approaches to pollution control—liability laws and
property rights regimes—that there was, at least, the theoretical possibility that
the interactions of people involved would lead to efficient outcomes. But with
standards we obviously can’t presume this; standards are established through
some sort of authoritative political/administrative process that may be affected
by all kinds of considerations.
The most fundamental question is whether, in setting standards, authorities
should take into account only damages or both damages and abatement costs.
Look again at Figure 11.1, particularly at the marginal damage function. One
approach in standard setting has been to try to set ambient or emission stan-
dards by reference only to the damage function. Thus, one looks at the damage
function to find significant points that might suggest themselves.
A principle used in some environmental laws has been to set the standard at
a “zero-risk” level: that is, at the level that would protect everyone, no matter
how sensitive, from damage. This would imply setting emission standards at the
threshold level, labeled et in Figure 11.1. This concept is fine as long as there is
a threshold. Recent work by toxicologists and other scientists, however, seems
to indicate that there may be no threshold for many environmental pollutants,
that in fact marginal damage functions are positive right from the origin. In fact,
if we followed a zero-risk approach, we would have to set all standards at zero.
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This may be appropriate for some substances, certain highly toxic chemicals, for
example, but it would be essentially impossible to achieve for all pollutants.
The standard might instead be set at a level that accepts a “reasonably small”
amount of damages, for example, e0, the point where the marginal damage
function begins to increase very rapidly. Here again, however, we would be
setting the standard without regard to abatement costs. A different logic might
suggest that in setting the standard, damages ought to be balanced with abate-
ment costs. This would put us squarely within the logic used in discussing the
notion of economic efficiency and, in this way, lead us to set the standard at e*,
the efficient emission level.
Note that there is, in effect, a certain amount of “balancing” going on when
standards are set on the basis of an average over some time period. In this
case short-run periods, when ambient quality is relatively low, are considered
acceptable as long as they do not last “too” long. A judgment is being made, in
effect, that it is not necessary to install enough abatement technology to hold
ambient quality within the standard under all conceivable natural conditions.
In other words, an implicit trade-off is being made between the damages that
will result from the temporary deterioration of ambient quality below the stan-
dard and the high costs that would be necessary to keep ambient quality within
the standard under all conditions.
Uniformity of Standards
A very practical problem in standard setting is whether it should be applied
uniformly to all situations or varied according to circumstances. This can be
illustrated by using the problem of the spatial uniformity of standards. The
ambient air quality standards in the United States, for example, are essentially
national. The problem with this is that regions may differ greatly in terms of
the factors affecting damage and abatement cost relationships, so that one set
of standards, uniformly applied across these local variations, may have serious
efficiency implications.
Consider Figure 11.2. It shows two marginal damage functions, one of which
(labeled MDu) is assumed to characterize an urban area, whereas the other
(labeled MDr) applies to a rural area. MDu lies above MDr because there are
many more people living in the urban area, so the same quantity of emissions
will affect the health of more people there than in the rural region. Assume
that marginal abatement costs (labeled MAC) are the same in the two regions.
Because the marginal damages are much higher in the urban than in the rural
area, the efficient ambient level of benzene is much lower in the former than in
the latter region; the efficient level is er in the rural region and eu in the urban
area. Thus, a single, uniform standard cannot be efficient simultaneously in the
two regions. If it is set at eu, it will be overly stringent for the rural area, and if
it is set at er, it will not be tight enough for the urban region. The only way to
avoid this would be to set different standards in the two areas. Of course, this
confronts us with one of the great policy trade-offs: the more a policy is tailored
so that it applies to different and heterogeneous situations, the more efficient
it will be in terms of its impacts, but also the more costly it will be in terms of
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FIGURE 11.2 Regional Variation in Efficiency Levels
MAC MDu
MDr
0 eu er
Ambient levels of benzene
getting the information needed to set the diverse standards and enforcing them
once they have been established.
The curves in Figure 11.2 could be used to represent other heterogeneous
situations as well as differences in geographical regions. For example, MDu
might represent marginal damages in a particular region under some meteoro-
logical conditions such as high humidity, or in one season of the year, whereas
MDr could represent the marginal damage function for the same area but under
different meteorological conditions, like windy conditions, or at a different time
of year. Now a single standard, enforced throughout the year, cannot be effi-
cient at all points in time; if it is efficient at one time, it will not be at the other.2
Standards and the Equimarginal Principle

Having discussed the issue of setting the standard at the efficient level of
emissions, we need to remember that the efficient level itself is defined by the
minimum marginal abatement cost function. This means that where there are
multiple emissions sources producing the same effluent,3 the equimarginal
principle must hold. The principle states that in order to get the greatest reduc-
tions in total emissions for a given total abatement cost, the different sources of
emissions must be controlled in such a way that they have the same marginal
abatement costs. This means that different sources of a pollutant would nor-
mally be controlled to different degrees, depending on the shape of the mar-
ginal abatement cost curve at each source. A major problem with standards is
that there is almost always an overwhelming tendency for authorities to apply
2
Uniformity is an issue in other environmental cases; for example, California water restriction set
at 25% for all except agriculture.
3
That is, in cases of “uniformly mixed” emissions.
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FIGURE 11.3 Marginal Abatement Costs for Two Sources
Marginal
Abatement
Costs ($)
Emission
Level (tons/
month) A B
20 0.00 0.00
19 1.00 2.10
18 2.10 4.60 MAC B
17 3.30 9.40
16 4.60 19.30 204.9
15 6.00 32.50
14 7.60 54.90 MACA
13 9.40 82.90 $
12 11.50 116.90
11 13.90 156.90 32.5
10 16.50 204.90
16.5
9 19.30 264.90
8 22.30 332.90
5 10 15 20
7 25.50 406.90
Emissions (tons/month)
6 28.90 487.00
5 32.50 577.00
4 36.30 677.20
3 40.50 787.20
2 44.90 907.20
1 49.70 1,037.20
0 54.90 1,187.20
the same standards to all sources. It makes their regulatory lives much simpler,
and it gives the impression of being fair to everyone because all are apparently
being treated alike. But identical standards will be cost-effective only in the un-
likely event that all polluters have the same marginal abatement costs.
Consider Figure 11.3, showing the marginal abatement cost relationships
for two different sources, each emitting the same waste material. Note that
the marginal abatement cost functions differ; for Firm A they increase much
less rapidly as emissions are reduced than they do for Firm B. Why the dif-
ference? They may be producing different outputs with different technolo-
gies. One firm might be older than the other, and older technology may be
less flexible, making it more costly to reduce emissions than at the plant with
the newer equipment. One plant may be designed to use a different type of
raw material input than the other. This, in fact, mirrors the situation in the
real world. Normally one can expect considerable heterogeneity in abate-
ment costs among groups of firms even though they are emitting the same
type of residual.
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TABLE 11.1 Illustrative Values for Polluters Shown in Figure 11.3

Firm A Firm B Total
Beginning Solution
Emissions (tons) 20 20 40
Marginal abatement costs $0 $0 $0
Total abatement costs $0 $0 $0
Equiproportionate Reduction
Marginal abatement costs $16.50 $204.90
Total abatement costs $75.90 $684.40 $760.30
Equimarginal Reduction
Marginal abatement costs $32.50 $32.50
Total abatement costs $204.40 $67.90 $272.30
The essential numbers are summarized in Table 11.1. Uncontrolled emis-

sions are 20 for each firm, and control costs, marginal and total, are zero.
Under an equiproportionate rule, 4 each firm would cut back by 50 percent, to
10 tons each. Marginal control costs are then unequal, $16.50 for A and $204.90
for B. Total pollution control costs are $75.90 for A and $684.40 for B, for a total
of $760.30.5
With equimarginal cutbacks, A goes to 5 tons and B to 15 tons. Pollution
control costs total $272.30 for this situation. Compliance costs for a cutback that
satisfies the equimarginal criterion are only about 36 percent of compliance
costs in an equiproportionate reduction.
To summarize: Standards are usually designed to be applied uniformly
across emission sources. This practice is almost inherent in the basic philoso-
phy of the standards approach, and to many people this strikes them as an
equitable way to proceed. But if marginal abatement costs in the real world vary
across sources, as they usually do, the equal-standards approach will produce
less reduction in total emissions for the total compliance costs of the program
than would be achieved with an approach that satisfied the equimarginal prin-
ciple. The greater the differences in marginal abatement costs among sources,
the worse will be the performance of the equal-standards approach. We will see
in the chapters ahead that this difference can be very large indeed.
Could command-and-control-type standards be set in accordance with
the equimarginal principle? Unless the applicable law required some sort of
4
An equiproportionate cutback is one that reduces each source by the same percentage of its
original emissions. In the example in the text, the 10-ton cutback for each source was equal in
absolute terms and also equiproportionate, as each source was assumed to be initially at an
emission level of 20 tons per month.
5
Note total abatement costs in Table 11.1 are the sum of MAC from Figure 11.3.
Firm A: 1.00 + 2.10 + 3.30 + 4.60 + 6 + 7.60 + 9.40 + 11.50 + 13.90 + 16.50 = $75.90
Firm B: 2.10 + 4.60 + 9.40 + 19.30 + 32.50+ 54.90 + 82.90 + 116.90 + 156.90 + 204.90 = $684.40
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equiproportional cutback, there may be nothing to stop the authorities from set-
ting different standards for the individual sources. To get an overall reduction to
20 tons/month in the previous example, they could require Source A to reduce
to 5 tons/month and Source B to cut back to 15 tons/month. The difficult part
of this, however, is that to accomplish this, the authorities must know what
the marginal abatement costs are for the different sources. This point needs to
be stressed. For almost any real-world pollution problem, there will normally
be multiple sources. For a public agency to set individual standards in accor-
dance with the equimarginal principle, it would have to know the marginal abate-
ment cost relationship for each of these sources. We talked in Chapter 9 about the
problem of asymmetric information. Polluters normally have a substantial
amount of private information about pollution-control costs. These costs will
usually vary among sources, so for the regulators to establish cost-effective
pollution-control regulations, they will have to find some way to obtain this
information. The primary source of data would have to be the polluters themselves,
and there is no reason to believe they would willingly share this information. In
fact, if they realize, as they certainly would, that the information would be used to
establish individual source standards, they would have every incentive to provide
the administering agency with data showing that their marginal abatement costs
rise very steeply with emission reductions. Thus, there are real problems with au-
thorities attempting to establish source-specific emission standards. Nevertheless, a
considerable amount of this is done informally, through the interactions of local
pollution control authorities, charged with enforcing common standards, and local
sources, each of which is in somewhat different circumstances. We will come back
to this later when we discuss issues of enforcement.
Standards and Incentives

An important issue for any policy is whether it creates incentives for sources to
reduce emissions to efficient levels and in cost-effective ways. The command-
and-control approach based on standards is seriously deficient in this regard.
A basic problem is that standards are all or nothing; either they are being met
or they are not. If they are being met, there is no incentive to do better than
the standard, even though the costs of further emission reductions may be
quite modest. By the same token, the incentives are to meet the standards, even
though the last few units of emission reduction may be much more costly than
the damages reduced.
It is easy to deal with the case of technology standards. Here, the incentives
to find cheaper ways (considering all costs) of reducing emissions are effec-
tively zero. If control authorities dictate in detail the specific technology and
practices that polluters may legally use to reduce emissions, there are no re-
wards to finding better approaches.
Now consider emission standards. Figure 11.4 shows marginal abatement
costs of a firm in two situations: MAC1 refers to such costs before a given
technological improvement; MAC2 is the marginal abatement cost curve the
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FIGURE 11.4 Cost Savings from Technological Change:

The Case of Standards
MAC1
MD
MAC2
e
d
a
c
b
0 e3 e 2 e1
Emissions
firm could expect to have after investing some large amount of resources in
an research and development (R&D) effort to develop better treatment or re-
cycling technology. Without any pollution-control program at all, there is ab-
solutely no incentive to spend the money on the R&D. But suppose the firm is
now faced with having to meet emission standards of e2 tons/year. With the
original marginal abatement costs the total annual cost of compliance for this
firm is (a + b) per year. If the R&D program is successful and MAC1 reduces
to MAC2, compliance costs would be only b/year. The difference, a/year, is
the amount by which compliance costs would be reduced and represents, in
fact, the incentive for engaging in the R&D effort. We will see in the next chap-
ter that this is a weaker effect than is provided by economic-incentive types of
programs. Nevertheless, it is an incentive, which is more than we could say for
technology standards.
To understand fully the incentive effects of standards, one has to look closely
at the details. Figure 11.4 depicts a standard applied to total emissions. His-
torically, most standards have been applied to emissions per unit of input or
output of industrial firms. For electric utilities, an emission standard per unit
of fuel burned is a standard per unit of input. There are important incentive
implications of setting standards this way. Consider the following expression,
showing how total emissions from an industrial operation are related to under-
lying performance factors:
Total = Total × Inputs used for × Emissions per
emissions output unit of output unit of input
Suppose authorities apply an input standard to, for example, coal-
burning power plants. The standard could be expressed in terms of
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maximum amounts of SO2 emissions allowed per ton of coal burned. This
is a standard applied to the last term of the equation, and so the power
plant will presumably reduce its emissions per unit of input to the level
of the standard. But there are two other ways of reducing total emis-
sions, as depicted in the first two terms to the right of the equals sign.
One is to reduce total output through, for example, encouraging consumers
to conserve electricity. The other is to reduce the amount of coal needed per
unit of electricity generated, in other words, for the plant(s) to increase fuel
efficiency. But the plants will have no incentive to reduce emissions in these
last two ways because the standard has been written in terms only of the last
factor in the expression.
In recent years, regulators have been moving more toward output-based
standards, that is, standards expressed in terms of allowable emissions per unit
of output.6 If you multiply together the last two terms of the expression, you
get emissions per unit of output. If you now place a standard on this factor,
note that polluters can reduce it in two ways: by reducing inputs per unit of
output and by reducing emissions per unit of input. The incentives of the pol-
luters have been broadened. So in the case of a power plant, an output-based
standard would involve both incentives: to reduce emissions per unit of coal
burned (perhaps by switching to low-sulfur coal) and to become more fuel ef-
ficient (perhaps by upgrading the boilers of the plant).
Political-Economic Aspects of Standards

The theory of standards is that they are established by regulatory authorities,
then responded to by polluters. In fact, this process can lead to patterns of po-
litical give-and-take between the parties that will substantially affect the out-
come. Suppose that the authorities are making every effort to set the standard
at something approaching the efficient level of emissions. In Figure 11.4, e2 is
their view of the efficient level before the technical change. But the new tech-
nology lowers the marginal abatement cost curve, and we know from Chapter 5
that this will reduce the efficient level of emissions. Suppose the authorities
estimate that, given their view of marginal damages, the new technology
shifts the efficient emission level to e3 in Figure 11.4, and that they now
change the standard to reflect this. Now the firm’s compliance cost will be
(b + c) per year. The difference is now (a − c). So the firm’s cost savings
will be substantially less than when the standard was unchanged; in fact,
compliance costs may actually be higher than before the R&D program. In
other words, the firm could suppose that because of the way regulators may
tighten the standards, they would be worse off with the new technology than
with the old methods. The standard-setting procedure in this case has com-
pletely undermined the incentive to produce new pollution-control technol-
ogy. This is a case of what might be called perverse incentives. A perverse
incentive is one that actually works against the objectives of the regulation.
6
Automobile emission standards have always been in terms of output, for example, grams of
pollutant per mile driven. We will talk about this in Chapter 15.
fie21898_ch11_202-220.indd 214 15/12/15 10:01 am

In this case, standard setting can work against long-run improvements in

pollution-control technology.7
If emission standards create incentives for technological change, is it not desir-
able to establish very stringent standards so as to increase that incentive? This is
another place where political considerations come into play. If, in Figure 11.4, the
standard is set at e3 right at the beginning, this would mean cost savings of (a + d + e)
with the new technology rather than just a as it would be with the standard set at e2.
This type of approach goes under the heading of technology forcing. The principle
of technology forcing is to set standards that are unrealistic with today’s technol-
ogy in the hope that it will motivate the pollution-control industry to invent ways
of meeting the standard at reasonable cost.
But stricter standards also create another incentive: the incentive for pol-
luters to seek relief from public authorities by delaying the date when they
become applicable. In an open political system, firms may take some of the
resources that might have gone for pollution-control R&D and devote them
instead to influencing political authorities to delay the onset of strict stan-
dards. The stricter and more near-term the standards, the more of this activity
there is likely to be. Thus, technology forcing is another one of those strategies
where the effectiveness of moderate amounts does not imply that more will
be even more effective.
It needs to be remembered also that to a significant extent new R&D for
pollution control is carried out by a pollution-control industry rather than
the polluting industries themselves. Thus, to draw conclusions about the
incentives of pollution-control policy for technological change means to pre-
dict how these policies will contribute to the growth and productivity of the
pollution-control industry. Technology standards are stultifying on these
grounds because they substantially drain off the incentives for entrepreneurs
in the pollution-control industry to develop new ideas. Emission standards are
better in this respect, as we have seen. The evidence for this is the fact that rep-
resentatives of the pollution-control industry usually take the side politically of
stricter environmental standards; in fact, they see the fortunes of their industry
tied almost directly to the degree of stringency in the emissions standards set
by public authorities.
The Economics of Enforcement

All pollution-control programs (perhaps with the exception of voluntary
programs, mentioned in the last chapter) require enforcement. Much of the
ongoing political conflict over environmental regulations involves questions of
enforcement, with one side often saying that it is too harsh, the other side maintain-
ing that it isn’t harsh enough. In this section we deal briefly with some economic
7
There is another perverse incentive lurking in equiproportionate reductions. If polluters realize
that they will be subject to an equiproportionate cutback in the future, it is better for them to
increase their base now by increasing their emissions. When the cutback is imposed, they will be
able to emit higher amounts than they would have had they not inflated their base.
fie21898_ch11_202-220.indd 215 15/12/15 10:01 am

FIGURE 11.5 The Economics of Enforcement
MAC
$
MPC′
MPC
e* e1 e0
Emissions
issues related to enforcement, discussing these particularly in their relation

to enforcing standards. In later chapters we will discuss enforcement issues
related to other types of policy instruments.
Enforcing Emission Standards

There are two primary dimensions of enforcement, monitoring and sanctioning.
Consider Figure 11.5. This shows a marginal abatement cost function (MAC)
representing as usual the marginal costs to the firm of reducing emissions. But
on the other side, instead of a marginal damage function as in the standard
model, there is a marginal penalty function. The line marked MPC represents
the expected penalties that firms can be expected to face for violating an emis-
sion standard. Penalties arise when firms are detected to be exceeding their
emission standard and when fines or other penalties are levied as a result. Sup-
pose a standard is set at e*. Perhaps this was established by comparing abate-
ment costs with damages, or perhaps on some other criterion. What is relevant
here is the way firms will actually be motivated to reduce their emissions.8
MPC is zero below e*; the firm is only penalized for emissions in excess of the
standard, and the shape of the MPC curve shows how penalties would increase
as the size of the violation increases.
If current emissions are at e0, the firm will clearly reduce them because mar-
ginal abatement costs at this point are well below the marginal penalty costs
currently in effect. But it will stop reducing emissions at e1, because to go lower
8
In the last chapter we discussed liability rules as a way of controlling emissions. In penalty
function terms, liability rules turn the marginal damage function into an MPC curve, because they
would make firms responsible for paying for the damages their emissions produce.
fie21898_ch11_202-220.indd 216 15/12/15 10:01 am

than this would require higher abatement costs than it would save in terms of
reduced penalties. Unless something changes, therefore, the firm’s emissions
will end up at e1, and the amount of noncompliance will be e* − e1.
The only way to reduce noncompliance is to raise the penalty function.
Basically, there are two ways of doing this: raise monitoring activities so as to
be better able to detect noncompliance, or raise fines for those who have been
detected as noncompliant. Of course, authorities could do both and, if they did
so enough, the penalty function could be raised to something like the dotted
line labeled MPC’, which would then ensure a noncompliance rate of zero.
This analysis shows several things. It shows the basic result that there is a
trade-off in enforcement; to get higher levels of compliance authorities will
normally have to devote more resources to enforcement. There may be some
trade-off also between monitoring and fines. The MPC curve of Figure 11.5
can be raised or lowered by changes in either one of these enforcement
elements.
We should also note that monitoring in this case requires measuring, or
estimating, the quantities of emissions, because the MPC function is essen-
tially expressed in terms of deviations of actual emissions from the emission
levels set in the standard. This deviation could apply to hourly, daily, or an-
nual quantities. Over the years, there have been major advances in monitor-
ing technology. In the early days of rigorous pollution control, much of the
enforcement effort depended on self-monitoring, where sources themselves
kept the books on emissions flows over time. This permitted the agencies to
visit firms periodically to audit the records at each source. Agencies could
also make random checks to measure emissions. The rate of auditing and ran-
dom visits could be varied according to agency budgets. More recently, tech-
nologies have been developed for undertaking continuous measurement and
electronic reporting (via the Internet, for example) of emissions in some cases.
The future will undoubtedly also see new developments in remote monitoring
technology.
The other main factor behind the MPC function of Figure 11.5 is the size
of the fines or other sanctions (e.g., jail terms). Most pollution-control statutes
contain provisions on the size of the fine (or jail term) that may be levied against
violators if and when they are caught and found guilty. In many cases, fines
have been set too low, lower than the abatement costs required to meet the
standards. In these situations firms can actually save money by dragging their
feet on compliance. With low sanctions like this, enforcement is therefore likely
to be much more difficult and costly than if sanctions are higher. Sources faced
with the possibility of having to pay substantially higher fines would presum-
ably have a stronger incentive to come into compliance.
It needs to be kept in mind also that sanctioning ordinarily involves using
the court system to pursue legal action. The functioning of courts may put some
limits on what enforcing agencies may do. For example, if monetary fines or
other penalties expressed in the law are very high, courts may be reluctant to
hold sources in rigorous noncompliance because of the economic dislocation
this may produce.
fie21898_ch11_202-220.indd 217 15/12/15 10:01 am

Enforcing Technology Standards

Technology standards require that sources adopt and operate approved
technical means of pollution control. In this case an important distinc-
tion is between initial compliance and continued compliance. Initial
compliance is where a polluter charged with meeting a particular tech-
nology standard installs the appropriate equipment. To monitor ini-
tial compliance it is necessary to have inspectors visit the site, check to
see that the equipment is installed, and make sure it will operate in ac-
cordance with the conditions of the standard. Having ascertained this,
the administering agency can then give the firm the necessary operat-
ing permit, but this does not ensure that the equipment will continue
to be operated in the future in accordance with the terms of the permit. It may
deteriorate through normal use, it may not be maintained properly, future
operating personnel may not be properly trained, and so on. Without some
amount of monitoring, therefore, there is no assurance that the source will
continue to be in compliance. But here, again, the administering agency has
great flexibility in setting up a monitoring program. It can vary from very infre-
quent visits to randomly selected sites all the way up to permanent observers
stationed at each source.
The Enforcing Agency

When enforcement costs are included in the analysis, the question arises of
whether standards should be set, at least in part, with enforcement costs in
mind. Stricter standards may involve larger enforcement costs because they re-
quire larger operating changes on the part of sources. Less strict standards may
be achievable with fewer enforcement resources for the opposite reason. Pub-
lic environmental agencies are usually faced with budget stringencies. In some
cases, greater overall reductions in emissions may be obtained by using less
strict standards that can be easily enforced than by stricter standards involving
higher enforcement costs.
One very common feature of environmental standards is that they are
usually set and enforced by different groups of people. Standards often are
set by national authorities; enforcement is usually done by local authorities.
For example, the air quality standards established under the Clean Air Act
are set at the federal level, but enforcement is mostly carried out by state-
level agencies. This has a number of important implications. One is that stan-
dards often are set without much thought to costs of enforcement; it is more
or less assumed that local authorities will find the necessary enforcement re-
sources. Of course, this is not the case in practice. With limited enforcement
budgets, local authorities may react to new programs by reducing resources
devoted to other programs. Another implication is that, in practice, environ-
mental policies incorporating standards end up having a lot more flexibility
than might at first appear. Laws written at national levels are specific and
apparently applicable everywhere. But at the local level, “where the rubber
meets the road,” as they say, it’s a matter of local pollution-control authori-
ties applying the law to local sources, and in this process there can be a great
fie21898_ch11_202-220.indd 218 15/12/15 10:01 am

deal of informal give-and-take between the authorities and local plant man-
agers, with participation by local environmental groups as well. A cynic,
or a political realist, might conclude that standards approaches are favored
because of the very fact that in the real world of tight public agency budgets,
they permit partial or incomplete compliance. One of the advantages (some
might say disadvantages) of policies using standards is that they permit
flexibility in enforcement.
Summary
The most popular approach to environmental pollution control historically has
been the setting of standards. This has been called the command-and-control
approach because it consists of public authorities announcing certain limits
on polluters, then enforcing these limits with appropriate enforcement institu-
tions. We specified three primary types of standards: ambient, emission, and
technology. Initial discussion centered on the level at which standards should
be set and the regional uniformity of standards.
A leading problem with standard setting is the question of cost-effectiveness
and the equimarginal principle. In most standards programs, the administra-
tive bias is to apply the same standards to all sources of a particular pollutant.
But pollution control can be cost-effective only when marginal abatement costs
are equalized across sources. When marginal abatement costs differ among
sources, as they almost always do, uniform standards cannot be cost-effective.
In practice, differences among sources in their marginal abatement costs of-
ten are recognized informally by local administrators in applying a uniform
national standard.
We dealt at length also with the question of the long-run impact of standards
through their effects on the incentives to look for better ways of reducing emis-
sions. Technology standards completely undermine these incentives. Emission
standards do create positive incentives for R&D in pollution control, although
we will see that these are weaker than those of economic-incentive types
of pollution-control policies, the subject of the next two chapters. Finally, we
discussed the all-important question of enforcement.
Questions for Further Discussion

1. Environmental protection programs are frequently designed to require all
polluters to cut back emissions by a certain percentage. What are the perverse
incentives built into this type of program?
2. If emission standards are ruled out because of, for example, the impossibility
of measuring emissions (as in nonpoint-source emissions), what alternative
types of standards might be used instead?
3. In Figure 11.2, show the social cost of setting a uniform national standard,
applicable to both rural and urban areas (to do this, you can assume that the
national standard is set at either eu or er).
fie21898_ch11_202-220.indd 219 15/12/15 10:01 am

4. Consider the example of Figure 11.3. Suppose we define as fair a cutback in

which the two sources have the same total costs. Would an equiproportion-
ate reduction be fair in this sense? A reduction meeting the equimarginal
principle? Is this a reasonable definition of fair?
5. It is sometimes suggested that the most equitable way to resolve issues
in international trade agreements would be for all countries to adopt the
same emission standards. What are the pros and cons of this from an eco-
nomic standpoint?
For additional readings and Web sites pertaining to the material in this
chapter, see www.mhhe.com/field7e.
fie21898_ch11_202-220.indd 220 15/12/15 10:01 am

Chapter
12
Incentive-Based
Strategies: Emission
Charges and Subsidies
In the last chapter we discussed some of the advantages and disadvantages of
using a standards approach to pollution control. Although standards seemingly
offer direct control of polluting activities, in many applications they have seri-
ous drawbacks by virtue of their tendency to treat all sources alike even though
they may be very different, and to lock in certain technologies. A major problem
is that they typically are unable to take advantage of the private information
that polluters have about means and procedures they could use to reduce pollu-
tion. Incentive-based (IB) environmental policies are designed to rectify these
drawbacks. IB plans work by having public authorities first set overall objec-
tives and rules, and then leaving firms enough latitude that their normal com-
mercial incentives will lead to the adoption of cost-effective pollution-control
procedures and technologies.
There are basically two types of incentive policies:
1. Charges (taxes) and subsidies, and
2. Market-based systems.
Both require centralized policy initiative to get started but rely on flexible
firm responses to attain efficient pollution control. In the first, firms are given
latitude to respond however they wish to what is essentially a new price for
using the services of the environment. The second is designed to work more
or less automatically through the interactions among polluters themselves or
between polluters and other interested parties. In recent years many coun-
tries, including the United States, have introduced market-based systems,
specifically transferable discharge permits. In Europe, many countries have
relied upon environmental charges to motivate emission reductions, as well
as raise public revenues. Exhibit 12.1 notes some of the plans adopted in
221
fie21898_ch12_221-244.indd 221 15/12/15 9:17 am

Environmental Taxes in Europe EXHIBIT 12.1
Charge or Tax Description
French aircraft TNSA (Tax sur les nuisances sonore aériennes) charged at 11
noise charges busiest airports, based on maximum take-off weight, certified
noise performance, and time of day
Czech Republic air Charges on power plants, covering SO2, NOx, particulate
pollution charges matter, and VOCs (excluding methane)
Plastic bag tax in Charges on all plastic bags (biodegradable or not) except bags
Ireland used for fresh meat and fruits
Pesticide tax in Tax on pesticides based on their components, a registration
Norway fee, a fee to fund efficiency and residue trials, and risk to
environment and human health
Landfill tax in U.K. Tax has two rates: a local rate on less polluting wastes (e.g.,
rocks and soils) and a higher rate for everything else
Water taxes in Consisting of a water supply tax and a waste tax based on
Denmark discharge of nitrogen, phosphorus, and organic matter
Swedish carbon tax The first country to introduce a tax on CO2 emissions, offset by
a reduction in personal income taxes
Energy tax in the A “downstream” tax applying to energy products used for
Netherlands heating and electricity generation in households and small and
intermediate-sized businesses
Natural resource Covers extraction of natural resources, waste disposal,
tax in Latvia hazardous goods, and air and water emissions
Source: Institute for European Environmental Policy, Environmental Tax Reform in Europe:
Opportunities for the Future, Annexes to Final Report, Brussels, May 2014.
Europe. In this chapter we examine the economics of emission charges and

subsidies. In the next chapter we will consider the technique of transferable
discharge permits.
Environmental economists have long favored the idea of incorporating IB
policies more thoroughly into environmental policies. These can serve to put
more teeth into environmental policies in many cases and substantially im-
prove the cost-effectiveness of these policies. They are especially important
to consider for the difficult task of reducing emissions of greenhouse gases
(GHG). But keep in mind something said before: No single type of policy is
likely to be the best in all circumstances. IB policies are no exception. They
have strengths and they have weaknesses. The strengths are sufficiently
strong to encourage greater reliance on them in many circumstances. But
there are many types of environmental problems where they may not be as
useful as other approaches.
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Chapter 12 Incentive-Based Strategies: Emission Charges and Subsidies 223
Emission Charges or Taxes1

Firms pollute because they do not take into account the social damage their ac-
tions cause. Thus, the most straightforward approach to controlling emissions
is for authorities to charge a price for these emissions. This can be done in two
ways: by charging for each unit of emissions or by giving a subsidy for each
unit of emissions that the source cuts back.
We deal first with emission charges, sometimes also called “emission taxes.”
In a charge system polluters are told: “You may discharge any amount of resid-
uals you wish, but your emissions will be measured and you will be required
to pay a certain charge for every unit (e.g., ton) of effluent you discharge.”2
For example, one of the first emission charges proposed in the United States
was in 1970, when President Nixon recommended a tax of 15 cents per pound
on sulfur emissions from large power plants. It was never adopted. When an
emission charge is put into effect, firms responsible for emissions must essen-
tially pay for the services of the environment—transportation, dilution, chemi-
cal decomposition, and so on—just as they must pay for all other inputs used in
their operations. And just as they have always had an incentive to conserve on
scarce labor and other conventional production inputs, they will now have an
incentive to conserve on their use of environmental services. How do they do
this? Any way they wish (within reason). This may sound flippant but in fact
it represents the main advantage of this technique. By leaving polluters free to
determine how best to reduce emissions, this type of policy attempts to harness
their own energy and creativity and their desire to minimize costs, to find the
least-cost way of reducing emissions. It could be any combination of treatment,
internal process changes, changes in inputs, recycling, shifts to less polluting
outputs, and so on. The essence of the charge approach is to provide an incen-
tive for the polluters themselves to find the best way to reduce emissions, rather
than having a central authority determine how it should be done. And in so do-
ing, they will have a strong incentive to use the private information they have
about the pollution-control costs of alternative technologies.
The Economics of an Emission Tax

The essential mechanics of an emission charge are depicted in Figure 12.1. The
numbers refer to a single source of a particular pollutant. The top panel shows
the analysis numerically, while the bottom shows essentially the same informa-
tion graphically. The tax has been set at $120/ton/month. The second column in
the top panel shows the firm’s marginal abatement costs and the third column
1
Terminology varies in this subject. Some people prefer to talk of emission charges, others
prefer emissions taxes. For our purposes, charges and taxes are synonymous and are used
interchangeably.
2
The idea of taxing “bads” was first put forth by A.C. Pigou in his Economic of Welfare (London,
Macmillan, 1920). Thus, Pigouvian taxes are taxes meant to achieve changes in the behavior of,
in this case, polluters, in contrast to standard taxes, whose purpose is primarily to raise public
revenues.
fie21898_ch12_221-244.indd 223 15/12/15 9:17 am

FIGURE 12.1 An Emissions Charge

Marginal Total Total Tax
Emissions Abatement Abatement Bill at Total
(tons/month) Cost Cost $120/Ton Costs
10 0 0 1,200 1,200
9 15 15 1,080 1,095
8 30 45 960 1,005
7 50 95 840 935
6 70 165 720 885
5 95 260 600 860
4 120 375 480 855
3 150 525 360 885
2 185 710 240 950
1 230 940 120 1,060
0 290 1,230 0 1,230
300
250
MAC
200
$ 150
100
a
50
b
0 2 4 6 8 10
Emissions (tons/month)
shows total abatement costs. The last two columns show the total monthly tax
bill the firm would pay at different emission levels, and the total cost, consisting
of the sum of abatement costs and the tax bill. We see that the minimum total cost
of $855 occurs at an emission rate of 4 tons/month. Let’s pursue the logic of this
by considering marginal abatement costs. Suppose the firm is initially emitting
10 tons/month. If it does not reduce emissions, the firm’s tax, or payment for
using the environment, is $1,200. The firm has an incentive to reduce emissions.
fie21898_ch12_221-244.indd 224 15/12/15 9:17 am

If it were to cut emissions to 9 tons, it would cost $15 in abatement costs, but it
would save $120 in total tax bill, clearly a good move because total costs drop
to $1,095. Following this logic, it could improve its bottom line by continuing
to reduce emissions as long as the tax rate is above marginal abatement costs.
The rule for the firm to follow is thus: Reduce emissions until marginal abate-
ment costs are equal to the charge on emissions. This is shown diagrammatically
in the bottom part of Figure 12.1. With a continuous marginal abatement cost
function, it’s possible to talk about fractions of tons of emissions, something we
could not do in the upper panel. So the graph is drawn to agree with the integer
values above; that is, the charge of $120 leads the firm to reduce emissions to
exactly 4 tons/month.
After the firm has reduced its emissions to 4 tons/month, its total (monthly)
tax bill will be $480. Its monthly abatement costs will be $375. Graphically, to-
tal abatement costs correspond to the area under the marginal abatement cost
function, labeled b in the figure. The total tax bill is equal to emissions times
the tax rate, or the rectangle labeled a. Under a charge system of this type, a
firm’s total cost equals its abatement costs plus the tax payments to the taxing
authority.
Why wouldn’t the firm simply disregard the charge, continue to pollute
as it has been doing, and just pass the charge on to consumers in the form of
higher prices? If the firm stayed at 10 tons of emissions, its total outlay would
be $1,200/month, consisting entirely of tax payment. This is much higher than
the $855 it can achieve by cutting back to 4 tons/month. The assumption in an
emissions charge program is that competitive pressures will lead firms to do
whatever they can to minimize their costs. Thus, when there is competition in
the industry subject to the emission tax, it will lead firms to reduce emissions
in response to the tax. By the same token, however, we must recognize that if
competition is weak, firms may not respond in this way. Electric power plants,
for example, are usually operated by regulated monopolies subject to oversight
by public utility commissions. They may not respond to charges on sulfur diox-
ide (SO2) emissions in the same way as firms that operate in more competitive
economic climates.
For competitive firms, the amount of the response will depend on several
factors. The higher the charge, the greater the reduction, and vice versa. In the
example of Figure 12.1, a tax of $50/ton/month would have led the source to
reduce emissions only to 7 tons/month, whereas one of $180 would have pro-
duced a cutback to 2 tons/month; that is, the firm would select an emissions
quantity closest to where MAC equals the charge. Also, the steeper the mar-
ginal abatement cost function, the less emissions will be reduced in response to
a tax. We will come back to this later.
Compare the charge approach with an emission standard. With the tax the
firm’s total outlay is $855. Suppose that, instead, the authorities had relied on
an emission standard to get the firm to reduce emissions to 4 tons/month. In
that case, the firm’s total outlay would be only the $375 of abatement costs.
Thus, the charge system ends up costing the firm more than the standards ap-
proach. With a standard, the firm has the same total abatement costs as in the
fie21898_ch12_221-244.indd 225 15/12/15 9:17 am

charge system, but it is still essentially getting the services of the environment
free, whereas with a charge system it has to pay for those services. But although
polluting firms would thus prefer standards to emission charges, there are good
reasons, as we will see, why society would often prefer taxes over standards.
The Level of the Charge

In competitive situations, higher charges will bring about greater reductions in
emissions, but just how high should the charge be set? If we know the marginal
damage function, the answer presumably would be to set the charge so as to
produce the efficient level of emissions, as in Figure 12.2. At a tax rate of t*,
emissions are e*, and marginal damages equal marginal abatement costs. The
firm’s total costs of emission control are divided into two types: total abatement
costs (compliance costs) of e and total tax payments of (a + b + c + d). The former
are the costs of whatever techniques the firm has chosen to reduce emissions
from e0 to e*, whereas the latter are tax payments to the control agency cover-
ing the charge on the remaining emissions. From the standpoint of the firm, of
course, these are both real costs that will have to be covered out of revenues.
From the standpoint of society, however, the tax payments are different from the
abatement costs. Whereas the latter involve real resources and therefore real so-
cial costs, the emission charges are actually transfer payments, payments made
by the firms (ultimately by people who buy the firms’ output) to the public sec-
tor and eventually to those in society who are benefited by the resulting public
expenditures. When a firm considers its costs, it will include both abatement
costs and tax payments.
FIGURE 12.2 An Efficient Emission Charge
Marginal Marginal
abatement damage
costs
t*
c
a
d e
b
0 e1 e* e0
fie21898_ch12_221-244.indd 226 15/12/15 9:17 am

The reduction of emissions from e0 to e* has eliminated damages of (e + f ).

Remaining damages are (b + d), an amount less than the firm pays in taxes. This
underscores the idea that the emission charge is based on the right to use en-
vironmental resources, not on the notion of compensation. But a “flat tax” like
this (one tax rate for all emissions) has been criticized because it would often
lead to situations where the total tax payments of firms would substantially ex-
ceed remaining damages. A way around this is to institute a two-part emission
charge. We allow some initial quantity of emission to go untaxed, applying the
charge only to emissions in excess of this threshold. For example, in Figure 12.2
we might allow the firm e1 units of emissions free of tax and apply the tax rate
of t* to anything over this. In this way the firm would still have the incentive to
reduce emissions to e*, but its total tax payments would be only (c + d). Total
abatement costs, and total damages caused by the e* units of emissions, would
still be the same.
How might the charge be set if regulators did not know the marginal damage
function? Emissions are connected to ambient quality; the lower the emissions,
the lower the ambient concentration of the pollutant, in general. So one strategy
might be to set a tax and then watch carefully to see what this did in terms of
improving ambient quality levels. We would have to wait long enough to give
firms time to respond to the tax. If ambient quality does not improve as much as
desired, increase the charge; if ambient quality improves more than is thought
appropriate, lower the charge. This is a successive approximation process of
finding the correct long-run emissions charge. It is not at all clear whether this
approach would be practicable in the real world. In responding to a charge,
polluters would invest in a variety of pollution-control devices and practices,
many of which would have relatively high up-front costs. This investment pro-
cess could be substantially upset if, shortly afterward, the authorities shift to a
new tax rate. Any agency trying to use this method to find the efficient charge
rate would undoubtedly find itself embroiled in a brisk political battle. Rather
than planning to make successive adjustments in the tax rate, there would be a
strong incentive for policymakers to determine the correct rate at the beginning.
This would put a premium on prior study to get some idea of the shapes of the
aggregate abatement and damage cost curves.
Emission Charges and Cost-Effectiveness

Perhaps the strongest case for a policy of effluent charges is to be made on
grounds of their effects in controlling multiple sources of emissions in a way
that satisfies the equimarginal principle. If the same tax rate is applied to
different sources with different marginal abatement cost functions, and each
source reduces its emissions until its marginal abatement costs equal the tax,
then marginal abatement costs will automatically be equalized across all the
sources.
This is depicted in Figure 12.3.3 We assume here that there are two sources of
a particular type of emission, labeled Source A and Source B. Also assume that
3
We have seen a graph like this several times before, for example, in Figures 11.3 and 5.5.
fie21898_ch12_221-244.indd 227 15/12/15 9:17 am

FIGURE 12.3 Emission Charges and the Equimarginal Rule
Marginal Abatement Costs ($)

Emission Level (tons/month) Source A Source B
20 0.0 0.0
19 1.0 2.1
18 2.1 4.6
17 3.3 9.4
16 4.6 19.3
15 6.0 32.5
14 7.6 54.9
13 9.4 82.9
12 11.5 116.9
11 13.9 156.9
10 16.5 204.9
9 19.3 264.9
8 22.3 332.9
7 25.5 406.9
6 28.9 487.0
5 32.5 577.0
4 36.3 677.2
3 40.5 787.2
2 44.9 907.2
1 49.7 1,037.2
0 54.9 1,187.2
A B
MACA MACB
50 50
40 40
$ 30 $ 30
20 20
c
a
10 10
b d
5 10 15 20 5 10 15 20
Emissions (tons/month) Emissions (tons/month)
fie21898_ch12_221-244.indd 228 15/12/15 9:17 am

these emissions, after they leave the respective sources, are uniformly mixed
together, so that the emissions of the two plants are equally damaging in the
downstream, or downwind, impact area. The marginal abatement costs for the
two sources are the same as those we used in the last chapter. They are shown
in graphical form at the bottom of Figure 12.3. The marginal abatement costs
of Source A increase much less rapidly with reductions in emissions than do
those of Source B. In the real world, differences like this are normally related to
the fact that the firms are using different production technologies. They may be
producing different outputs (e.g., a pulp mill and a food-canning firm), or they
may be plants in the same industry but using different production techniques
(e.g., coal-fired and oil-fired electric power plants). According to the graphs, the
production technology used by Source B makes emission reduction more costly
than it is at Source A. If we impose an effluent charge of $33/ton on each source,
the operators of Source A will reduce their emissions to 5 tons/month; those
at Source B will cut back to 15 tons/month (dealing only with integer values).
After these reductions, the two sources will have the same marginal abatement
costs. The total reduction has been 20 tons per month, which the effluent charge
has automatically distributed between the two firms in accordance with the
equimarginal principle.
Note very carefully that the emission tax has led Source A to reduce its
emissions by 75 percent, whereas Source B has reduced its emissions by only
25 percent. The emissions tax leads to larger proportionate emission reductions
from firms with lower marginal abatement costs. Conversely, firms having
steeper marginal abatement costs will reduce emissions less, in proportionate
terms. Suppose that instead of the charge the authorities had instituted a pro-
portionate cutback on the grounds that “everybody should be treated alike”;
therefore, they require each source to reduce emissions by 50 percent. Our two
sources in Figure 12.3 both reduce emissions to 10 tons/month. At this point
their marginal abatement costs would be different. Furthermore, we can calcu-
late total abatement costs by remembering that total cost is the sum of marginal
costs. Thus, for example, for Source A the total costs of 10 tons of emissions
would be $(1.0 + 2.1 + . . . + 16.5) = $75.90.
The following tabulation compares the compliance costs of the equipropor-
tionate reduction and the effluent charge with equimarginal rules.
Total Compliance Costs ($/month)

Effluent Charge
Equiproportionate Reduction with Equimarginal Rules
Source A 75.90 204.40
Source B 684.40 67.90
Total 760.30 272.30
Note how much the totals differ. The total compliance cost of an equipropor-
tionate cutback is about 2.8 times the total cost of an emission tax. The simple
reason is that the equiproportionate cutback violates the equimarginal principle;
fie21898_ch12_221-244.indd 229 15/12/15 9:17 am

it requires the same proportionate cutback regardless of the height and shape of
a firm’s marginal abatement costs. The difference in total costs between these
two approaches is quite large with these illustrative numbers. We will see in
later chapters that in the real world of pollution control these differences are
often much larger. The extra amount spent to treat all firms with the same pro-
portionate percentage could have been used to further reduce pollution.
The higher the tax rate, the more emissions will be reduced. In fact, if the
tax rate were increased to something over $55/ton, Firm A would stop emit-
ting this residual entirely. The marginal abatement cost function for Firm B in-
creases so rapidly, however, that an extremely high charge (more than $1,187/
ton) would be required to get this source to reduce emissions to zero. A single
effluent charge, when applied to several firms, will induce a greater reduction
by firms whose marginal abatement costs increase less rapidly with emission
reductions than from firms whose marginal abatement costs increase more rap-
idly. Because the firms are paying the same tax rate, they will have different
total abatement costs and different tax bills. In Figure 12.3, the total abatement
costs are equal to area b for Source A and area d for Source B. On the other hand,
the monthly tax bill sent to Source A would be only a, compared to a bill of c
sent to Source B. Thus, the less steeply the marginal abatement cost of a firm
increases, the larger that firm’s emission reduction will be and the smaller its
tax bill.
It needs to be emphasized that the efficiency results of the emission charge
approach (i.e., that it satisfies the equimarginal principle) are achievable even
though the administering agency knows nothing about the marginal abatement costs of
any of the sources. This is in clear contrast with the standards approach, where
the public agency has to know exactly what these marginal abatement costs are
for each firm in order to have a fully efficient program. In a charge approach the
only requirement is that firms pay the same tax rate and that they are cost mini-
mizers. After each one has adjusted its emissions in accordance with its mar-
ginal abatement costs (which we can expect them to know themselves), they
will all be emitting at the appropriate rates to satisfy the equimarginal principle.
Emission Taxes and Nonuniform Emissions

So far the discussion has proceeded under the assumption that the emissions
of all sources are uniformly mixed together; that is, the emissions from one
source have the same marginal impact on ambient quality levels as those from
other sources. In the real world this is usually not the case. Very often the
situation is something like, although of course more complicated than, that de-
picted in Figure 12.4. Here there are two sources. Source A, however, is about
twice as far away from the center of population as Source B. This means that
emissions from Source A do not produce as much damage in the urban area as
emissions from Source B. If the two sources are emitting some material into a
river that flows toward the city, the emissions of Source A have a longer time
in the water to be broken down and rendered less harmful than do the emis-
sions from Source B. Or if it is an air pollution problem, Source A is much far-
ther upwind than Source B, so there is more time for its emissions to be spread
fie21898_ch12_221-244.indd 230 15/12/15 9:17 am

FIGURE 12.4 Nonuniform Emissions

Direction of environmental flow
distance (A) = 2 x distance (B)
distance (B)
Source A Source B Population center

(Damage)
out and diluted than there is for the emissions from Source B. There could be
other reasons than location differences for the different impacts; for example,
they may emit residuals at different times of the year when wind patterns are
different. Studying the location problem will allow us to examine the general
problem of nonuniform emissions.
In this case a single emission charge applied to both sources would not be
fully efficient. A single charge addresses only the problem of differences in
marginal abatement costs, not differences in damages caused by the emis-
sions from different sources. In Figure 12.4, a one-unit reduction in emissions
from Plant B would improve environmental quality (reduce damages) in the
urban area more than a one-unit reduction in emissions from Plant A, and
this fact must be taken into account in setting emission charge rates. Suppose
emission reductions at Source B are twice as effective at reducing damages
as reductions in emissions at Source A. This means, in effect, that the efflu-
ent tax paid by Source B must be twice as high as the effluent charge paid by
Source A.4 Thus, after adjustment to these tax levels the marginal abatement
cost of Source B would be twice the marginal abatement cost of Source A. But
the damage reduction per dollar spent in reducing emissions would be equalized
across the two sources.
The logic of the preceding discussion would seem to imply the conclusion
that in these cases we would have to charge different emission charges to each
source. To do this, we would have to know the relative importance of the emis-
sions from each source in affecting ambient quality. Exhibit 12.2 discusses
some results showing that for several important air pollutants, damages were
4
The technical concept here is called a “transfer coefficient.” A transfer coefficient is a number
that tells how the emissions from any particular source affect ambient quality at some other point.
In the previous example, suppose 1 ton of SO2 emitted by B would increase SO2 concentration
over the urban area by 0.1 ppm. Then a ton emitted from Source A would increase the ambient
concentration by 0.05 (assuming an effect that is strictly proportional to distance). If the transfer
coefficient for Source B is 1, that for Source A is 0.5, so the tax at A has to be half the tax at B. More
generally, if the transfer coefficient at A is t1, and that of B is t2, then the tax at A should be t1/t2
times the tax at B.
fie21898_ch12_221-244.indd 231 15/12/15 9:17 am

Emissions from Different

Sources Can Produce
Very Different Damages EXHIBIT 12.2
Different sources with the same type and particulate matter (PM2.5) and sulfur diox-
quantity of emissions may be very differ- ide (SO2). The top four power plants are
ent in terms of the damages they cause. near urban areas and the bottom four are
Two economists estimated source-specific in rural locations.
damages from emissions of major pol- For the urban power plants, note the
lutants from power plants in the United differences for the Con Edison plant in
States. They used a large-scale model New York: it would take 11 tons of PM2.5
that tracks the consequences of emission emitted from the stack to produce the
through air quality changes, exposure same damage as 1 ton emitted at ground
levels, dose-response information, and level. For SO2 it would take 8 tons com-
the valuation of resulting health impacts ing out of the stack to generate the same
on affected populations. Some results are damages as 1 ground-level ton. For the
shown in the following table. Results are rural plants, the results are very different;
in the form of “trading ratios,” which is here the stack and ground-level emissions
the number of tons of pollutant emitted produce the same levels of damage.
from the power-plant stack that causes What these results show is that there
the same amount of damage as would can be very substantial differences be-
1 ton emitted at ground level at the tween sources in terms of damages pro-
same site. The results shown are for fine duced by the same pollutant.
Stack Trading Trading

Ground Source Power Plant Height Ratios Ratios
(city, state) (firm, facility) (feet) PM2.5 SO2
New York, NY Con Edison, 74th Street station 495 11:1 8:1
Washington, D.C. Potomac Power Resources 400 23:1 8:1
Atlanta, GA Georgia Power Co. 835 19:1 5:1
Houston, TX Texas Genco, Inc. W.A. Parish 600 17:1 10:1
Grant Country, WV Dominion, Mount Storm Station 740 1:1 1:1
Rosebud County, MT PPL Montana, Colstrip Steam Elec 690 1:1 1:1
The trading ratio is the number of tons emitted from the stack of a power plant that would cause
the same damage as 1 ton from a ground source at the same site.
Source: Nicholas A. Muller and Robert Mendelsohn, “Efficient Pollution Regulation: Getting the
Prices Right,” American Economic Review, 99(5), 2009, pp. 1714–1739.
substantially different among sources. The best response here might be to in-
stitute what is called a zoned emission charge. Here the administering agency
would divide a territory into separate zones; the actual number of zones would
depend on the circumstances of the case. Within each zone the agency would
charge the same emission charge to all sources, whereas it would charge differ-
ent charges in different zones.
fie21898_ch12_221-244.indd 232 15/12/15 9:17 am

FIGURE 12.5 Zoned Emissions Charge

Urban
Zone 1 Zone 2 Zone 3 Zone 4 area
1 3 5 7 8 10 11
2 4 6 9 12
Key: 1 Emission sources

X Water-quality monitoring station
Naturally, the zones would be identified by grouping together sources

whose emissions have similar effects on ambient quality levels. Figure 12.5, for
example, shows the schematic of a river with a dozen different sources of emis-
sions and one urban area where water quality is measured and water quality
targets are established. The 10 upstream sources are strung along the river at
increasing distances from the urban area. Thus, each has a different impact on
measured water quality at the monitoring station, and a fully cost-effective pro-
gram of emissions reductions would have to account for this fact in addition to
their different marginal abatement costs. But it would be administratively very
costly to apply a different emissions charge to each source. We might, in this
case, fall back on a zoned emission charge.
We first define different zones along the river, then apply the same tax to all
sources within the same zone, but different taxes to sources in different zones.
Each zone would contain sources whose emissions have roughly the same im-
pact on measured water quality. In Figure 12.5, for example, four upstream
zones along the river are sketched out. The three sources in Zone 1 would pay
the same charge, as would the four sources in Zone 2, and so on. Sources 11
and 12 are downstream from the urban area and may not get taxed at all. Of
course, this is a simplified diagram to show the basic idea; in the real world,
there would also very likely be downstream damages. By using a zone system,
we can achieve a certain amount of administrative simplification while recog-
nizing differences in the locations of different groups of sources.
Emissions Charges and Uncertainty

Pollution-control policies have to be carried out in a world of uncertainty.
Administrative agencies often do not know exactly what emissions are being
produced by each source or exactly what the human and ecosystem impacts
are. Another source of uncertainty is the shape of the marginal abatement cost
curve of the sources subject to control; these may be known reasonably well by
the polluters themselves, but administrators usually will be very unsure of how
high they are, how steep they are, how much they differ from source to source,
and so on. It is one of the advantages of emissions charges that they can bring
about cost-effective results even within that state of uncertainty.
fie21898_ch12_221-244.indd 233 15/12/15 9:17 am

FIGURE 12.6 Emission Charges, Uncertainty, and Tax Revenues
MAC1
$ $
MAC2
th
a d
tl
b c e f
e1 e 2 e3 e4
Emissions (lbs/month) Emissions (lbs/month)
Nevertheless, when administrators set taxes at certain levels, they normally

will be uncertain about how much emission reduction will ensue, for that de-
pends on how sources respond to the tax. This is one of the drawbacks of emis-
sion charges. It may be difficult to predict accurately how much total emissions
will decrease because exact knowledge of marginal abatement costs is often
lacking. Observe Figure 12.6. It shows two different marginal abatement cost
functions, a steep one (MAC1) and one that is much less steep (MAC2). Consider
MAC1. If the tax were set at the relatively high rate of th, this source would re-
duce emissions to e1, whereas if it were set at the low rate of tl, it would adjust
emissions to e2. These two emission rates are relatively close together. In other
words, whether the tax is high or low, the emissions rate of this source would
not vary much; we could count on having an emissions rate of something in the
vicinity of e1 and e2.
But for the firm with the less steep marginal abatement costs (MAC2), things
are much more unstable. If the tax were set low, it would change emissions to e4,
whereas with a high tax emissions would go all the way down to e3. In other
words, for given changes in the tax rate, this firm would respond with much larger
changes in emission rates than would the source with the steeper MAC curve.
The upshot of this discussion is that if most firms in a particular pollution
problem have relatively flat MAC functions, regulators may have trouble find-
ing the charge rate that will give us just the amount of reduction in total emis-
sions we want. Because they don’t know exactly where the MAC functions
really are, they don’t know exactly how high to set the tax. If they set it a little
high or a little low, these firms will respond with large changes in their emis-
sions. This is one of the main reasons administrators opt for standards: they
seem to offer a definite control on quantities of emissions produced. In the next
chapter, we will discuss an incentive approach that addresses this problem.
Emission Charges and Tax Revenues

Another important aspect of emission charges is that they lead to tax revenues
accruing to the government. Carrying this line of thought further has suggested
fie21898_ch12_221-244.indd 234 15/12/15 9:17 am

to many people that society could benefit by replacing certain existing taxes
with emission taxes. Many countries tax employment, for example. When firms
hire workers, they must pay employment taxes to cover such things as the pub-
lic costs of unemployment insurance and social security payments. But employ-
ment taxes lead to reduced levels of employment because, in effect, they make
hiring workers more expensive. A government, therefore, might reduce its em-
ployment taxes and increase emission taxes in such a way as to keep its total tax
revenue the same. This action has come to be known as the double-dividend
hypothesis. This refers to the fact that society would gain both from the emis-
sions taxes (through reduced emission damage) and from reduced employment
tax (through increased employment).
But predicting the revenue impacts of emission taxes may be difficult. Sup-
pose, in Figure 12.6, an emission tax was increased from tl to th. If the aggregate
marginal abatement costs of the affected firm is MAC1, total tax revenue will
increase from (b + c) to (a + b). But if the marginal abatement cost is actually
MAC2, raising the emission tax will cause tax revenues to decrease from (e + f)
to (d + e). This is because in the case of MAC2 the tax increase leads to a large
decrease in emissions, while in the case of MAC1 it does not. Thus, if the tax
authorities don’t know much about the shape and location of the relevant mar-
ginal abatement, they may be in for some major surprises in terms of changes
in tax revenues.
Research on the double-dividend idea has also brought out another im-
portant factor. This is the potential impact of increased prices of the goods
and services produced by the sectors subject to emission taxes. This can
have a direct negative effect on the welfare of consumers of these goods and
services. It can also have an indirect effect working through changes in the
labor market.5
Emission Charges and the Incentives to Innovate

In a dynamic world, it is critical that environmental policies encourage tech-
nological change in pollution control. One of the main advantages of emis-
sion charges is that they provide strong incentives for this. This is shown in
Figure 12.7, which shows two marginal abatement cost curves for a single
firm. MAC1 represents the current condition. It shows the costs the firm
would experience in cutting back its emissions with the particular technol-
ogy it currently uses. MAC2, on the other hand, refers to abatement costs that
the firm would experience after engaging in a relatively expensive research
and development (R&D) program to develop a new method of reducing
emissions. Assume the firm has a reasonably good idea of what the results of
the R&D will be, although of course nothing is ever a sure thing. We can use
it to measure the strength of the incentives for this firm to put money into the
R&D program.
5
See Don Fullerton and Gilbert E. Metcalf, “Environmental Taxes and the Double-Dividend
Hypothesis: Did You Really Expect Something for Nothing?” Chicago-Kent Law Review, 73(1), 1998,
pp. 221–256.
fie21898_ch12_221-244.indd 235 15/12/15 9:17 am

FIGURE 12.7 Emission Charges and the Incentive for R&D
MAC1
MAC 2
$
t
c
a d
b
e
0
e2 e1
Suppose the firm is subject to an effluent tax of t/ton of emissions. Initially

it will reduce emissions to e1; at this point its total pollution-related costs will
consist of (d + e) worth of abatement costs and a tax bill of (a + b + c). If it can
lower its marginal abatement cost curve to MAC2 through the R&D activities, it
would then reduce its emissions to e2. At this point it would pay (b + e) in abate-
ment costs and a in taxes. The reduction in total costs has been (c + d). If the firm
had instead been faced with an emissions standard of e1, its cost savings with
the new technology would have been only d, as we saw in the last chapter. Also,
as we saw in the last chapter, if public authorities shift the standard to e2 when
the new technology becomes available (giving the same emissions reduction
as the tax would have), the firm could actually experience an increase in costs
because of its R&D efforts.
Thus, under a policy of emission charges:
r A firm’s R&D efforts will lead to a bigger reduction in its pollution control-
related costs (abatement costs plus tax payments) than under a standards
approach.
r A firm would automatically reduce its emissions as it found ways to shift its
marginal abatement cost function downward, whereas under the standard
no such automatic process would result.
r Polluters must pay for emissions as well as for abatement costs, whereas
with standards they only need to pay abatement costs.
r Potential cost savings from new pollution-control techniques are much larger
under the charge program.
fie21898_ch12_221-244.indd 236 15/12/15 9:17 am

Emission Charges and Enforcement Costs

Charges pose a different type of enforcement problem than standards. Any
charge system requires accurate information on the item to be taxed. If emis-
sions are to be taxed, they must be measurable at reasonable cost. This means
that residuals flowing from a source must be concentrated in a small enough
number of identifiable streams that monitoring is possible. This rules out most
nonpoint-source emissions because they are spread thinly over a wide area in a
way that makes them impossible to measure. It would normally be impossible
to tax the pollutants in city street runoff because the diffuse nature of the “emis-
sions” makes them impossible to measure. This also may rule out certain toxic
chemical emissions, which, in addition to being nonpoint source, often involve
such small quantities that their flow rates are difficult to measure.
With emission charges the taxing authorities would be sending a tax bill to
the polluting firms at the end of each month or year, based on their total quan-
tity of emissions during that period. So the agency would require information
on cumulative emissions from each source. This is more involved than just in-
formation on rate of discharge because cumulative discharge is rate times dura-
tion. There are several ways of getting this information. Perhaps the most ideal
would be to have permanent monitoring equipment that measures emissions
continuously over the time period in question. Lacking such technology, one
could fall back on periodic checking of the rate of emissions, with an estimate of
the duration based on normal business considerations or perhaps self-reporting
by firms. Alternatively, engineering studies might be carried out to determine
prospective emission quantities under specified conditions of operation, inputs
used, and so on.
It is probably fair to say that the monitoring requirements of an emissions
charge policy are more stringent than those for the typical standards program.
Polluters, of course, have incentives to find ways, legal and otherwise, to get
their tax bills reduced. One way to do this is to influence the monitoring process
enough so that reported emissions are smaller. Once they do get their tax bills,
recipients will have every incentive to contest them if they appear to be based
on uncertain data or have other technical weaknesses. The lack of high-quality
monitoring and reporting procedures has undoubtedly contributed to the un-
popularity of effluent charge policies for environmental quality control.
Other Types of Charges

So far we have discussed only one type of charge, an effluent or emissions tax.
Because it is the emission of residuals that leads directly to environmental pol-
lution, charges on emissions presumably have the greatest leverage in terms of
altering the incentives of polluters. But it is often impossible or impractical to
levy charges directly on emissions. In cases where we can’t measure and moni-
tor emissions at reasonable cost, charges, if they are to be used, would obviously
have to be applied to something else. A good case of this is the problem of water
pollution from fertilizer runoff in agriculture. It is impossible to tax the pounds
of nitrogen in the runoff because it is a nonpoint-source pollutant and thus not
directly measurable. The same problem applies to agricultural pesticides. What
fie21898_ch12_221-244.indd 237 15/12/15 9:17 am

may be feasible instead is to put charges on these materials as they are bought
by farmers—that is, say, a charge per ton of fertilizer or per 100 pounds of pesti-
cide purchased. The charge is to reflect the fact that a certain proportion of these
materials ends up in nearby streams and lakes. Because they are paying higher
prices for these items, farmers would have the incentive to use them in smaller
quantities. Higher prices also create an incentive to use the fertilizer in ways
that involve less wastage, for example, by reducing the amounts that run off.
Placing a charge on something other than emissions is usually a “second-
best” course of action made necessary because direct emissions can’t be closely
monitored. In cases such as this we have to watch out for distortions that can
come about as people respond to the charge, distortions that can substantially
alleviate the effects of the tax or can sometimes make related problems worse.
We mentioned in Chapter 1 the move by many U.S. communities to tax house-
hold trash. One technique is to sell stickers to the residents and require that
each bag of trash has a sticker on it. The rate of tax is determined by the price of
the stickers, and it is relatively easy to monitor and enforce the system through
the curbside pickup operations. But the per-bag tax will produce an incentive to
pack more into each bag, so the reduction in total quantity of trash may be less
than the reduction in the number of bags collected.
On Carbon Taxes
We have now realized that reducing global emissions of GHGs is a critically
important activity to pursue. An obvious idea would be to tax emissions of
GHGs, especially carbon dioxide. CO2 emissions result whenever fossil fuels,
that is, fuels containing carbon, are burned to produce energy. A CO2 emission
tax could be placed directly on emissions, assuming they could be accurately
measured.
Another approach is to place a tax on fuel used, since this is strictly propor-
tional to carbon dioxide released.
r The carbon footprint of an item (a physical good, or a service) is the to-
tal emissions of GHGs occurring in the production and consumption of the
item, usually expressed in equivalent tons of CO2 (one ton of CO2 is equiva-
lent to 0.27 tons of carbon).
This tax could fall on commercial establishments. Perhaps a better approach
would be to levy a tax “upstream,” where fossil fuels are first extracted. The tax
would then filter through the system, affecting more heavily the prices of those
goods and services that have large carbon footprints and less heavily on prices
of those with low or negligible footprints, as is depicted in Figure 12.8.
Distributional Impacts of Emission Charges

There are two primary impacts of emission charges on the distribution of in-
come and wealth:
1. Impacts on prices and output of goods and services affected by the charges,
and
2. Effects from the expenditure of tax funds generated by the charges.
fie21898_ch12_221-244.indd 238 15/12/15 9:17 am

FIGURE 12.8 A Tax on Carbon

An “upstream” tax on the carbon content of:
Coal Natural gas Petroleum
Input markets
Output markets
Large Intermediate Small

Carbon footprint Carbon footprint Carbon footprint
(e.g., cars, fossil (e.g., furniture, (e.g., insurance,
fuels, snowmobiles) clothing, local food) hiking, wind energy)
Large price Moderate price Low, or no, price

increase increase increase
Businesses subject to a charge will experience an increase in costs because

of both the abatement costs and the tax payments. From the firm’s standpoint,
these constitute increases in production cost, which the firm will presumably
pass on to consumers just as with any cost of production. Whether and how
much the firm can do this depends on competitive conditions and the condi-
tions of demand. If the charge is applied to a single firm or small group of firms
within a competitive industry, it will not be able to push its price up above the
industry price, and so will have to absorb the cost increase. In this case the im-
pacts will be felt entirely by owners of the firm and the people who work there.
Many firms fear, or pretend to fear, being in precisely this situation and base
their public objections to taxes on this outcome. If the charge is applied to an
entire industry, prices will go up and consumers will bear part of the burden.
How much prices go up depends on demand conditions.6 For taxes applied di-
rectly to consumer goods, such as gasoline or heating oil, market prices would
respond according to the supply and demand characteristics of the markets.
Price increases often are thought of as regressive because, for any given item,
an increase in its price would affect poor people proportionately more than
higher-income people. For something that both poor and well-off people con-
sume, such as electricity, this conclusion is straightforward. For price increases
in goods consumed disproportionately by more well-to-do people (e.g., airline
travel), however, the burden would be mostly on them.7
6
This was discussed in greater detail in Chapter 8.
7
Sterner, Thomas, Fuel Taxes and the Poor: The Distributional Effects of Gasoline Taxation and Their
Implications for Climate Policy, London, Routledge, 2011.
fie21898_ch12_221-244.indd 239 15/12/15 9:17 am

The burden on workers is tied closely to what happens to the rate of output
of the affected firms. Here again, the extent of the output effect depends on
competitive conditions and the nature of the demand for the good. If the emis-
sion tax program is applied to a single firm in a competitive industry or if the
demand for the output of an industry is very responsive to price, output adjust-
ments will be relatively large and workers could be displaced. The long-run
burden is then a matter of whether good alternative sources of employment are
available.
Although burdens because of price and output changes may be real, we have
to remember that, on the other side, the charge program is creating substantial
benefits in the form of reduced environmental damages. To know how a pro-
gram affects any particular group, we would have to account also for how these
benefits are distributed.
Effluent charges also could involve substantial sums going from consumers
of the goods produced by the taxed industry to the beneficiaries, whomever
they may be, of the funds collected by the taxing authorities. These funds could
be used for any number of purposes; how they are used would determine their
impacts. They might, for example, be distributed to lower-income people to
offset the effects of price increases. They even might be returned in part to the
firms paying the effluent taxes. This is done in some European countries to
help finance the purchase of pollution-control technology. As long as the return
payments do not make the marginal emissions tax rate effectively lower, the in-
centive effects of the charge are not affected. Alternatively, they might be used
to pay for other environmental initiatives in places where direct public action
is called for. They even might be used to reduce overall budget deficits, with
benefits flowing to general taxpayers.
Abatement Subsidies
An emission charge works by placing a price on the environmental asset into
which emissions are occurring. Essentially, the same incentive effects would re-
sult if, instead of a charge, we instituted a subsidy on emission reductions. Here
a public authority would pay a polluter a certain amount per ton of emissions
for every ton it reduced, starting from some benchmark level. The subsidy acts
as a reward for reducing emissions. More formally, it acts as an opportunity
cost; when a polluter chooses to emit a unit of effluent, it is in effect forgoing
the subsidy payment it could have had if it had chosen to withhold that unit of
effluent instead. Table 12.1, using the same numbers as in the preceding discus-
sion on emission charges, shows how this works in principle. The firm’s base
level is set at its current emissions rate: 10 tons/month. It receives $120 per ton
for every ton it cuts back from this base. The fourth column shows its total sub-
sidy revenues, and the last column shows total subsidies minus total abatement
costs. This net revenue peaks at 4 tons/month, the same emissions level the
firm would choose with the $120 tax. In other words, the incentive for the firm
is the same as for the tax.
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TABLE 12.1 An Abatement Subsidy

Marginal Total Total Subsidy Total Subsidy Minus
Emissions Abatement Abatement at Total
(tons/month) Cost Cost $120/Ton Abatement Costs
10 0 0 0 0
9 15 15 120 105
8 30 45 240 195
7 50 95 360 265
6 70 165 480 315
5 95 260 600 340
4 120 375 720 345
3 150 525 840 315
2 185 710 960 250
1 230 940 1,080 140
0 290 1,230 1,200 –30
Although an abatement subsidy like this would have the same incentive for
each individual source, total emissions may actually increase. To understand
why, note the difference in the financial position of this firm when it emits 4
tons of pollutant under the two programs: With the tax it has total costs of $855
(see Figure 12.1), whereas with the subsidy it has a total revenue of $345. Thus,
the financial position of the firm is much different. In effect, it will be earning
higher profits after the imposition of the subsidy, and this can have the effect
of making this industry more attractive for potential new firms. There is the
possibility, in other words, of having the emissions per firm go down while
the number of firms in the industry increases, and therefore total emissions
increase. This feature is a major drawback of simple subsidies like this.
Although subsidies linked directly to emission reductions have never be-
come particularly popular, governments around the world have frequently
resorted to many other types of subsidies to further the goals of pollution re-
duction. A few of these are listed in Exhibit 12.3.
Deposit-Refund Systems
One place where subsidies may be more practical is in deposit-refund systems.
A deposit-refund system is essentially the combination of a tax and a subsidy.
For example, a subsidy (the refund) is paid to consumers when they return an
item to a designated collection point. The purpose of the subsidy is to provide
the incentive for people to refrain from disposing of these items in environmen-
tally damaging ways. The funds for paying the subsidy are raised by levying
taxes (the deposit) on these items when they are purchased. In this case, the
purpose of the tax is not necessarily so much to get people to reduce the con-
sumption of the item, but to raise money to pay the subsidy. The tax is called a
deposit and the subsidy a refund, but the principle is clear.
Deposit-refund systems are particularly well suited to situations where a
product is widely dispersed when purchased and used, and where disposal is
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Types of Environmentally
Related Subsidies EXHIBIT 12.3
Subsidies in the Form of Example(s)
Tax benefits Tax exemptions for pollution-control
equipment or recycling equipment
Exemptions of ethanol-blended gas
from federal taxes
Reduced environmental fines Reductions in normal fines if firms
undertake extensive pollution-control
plans
Public grants to encourage environmental EPA grants to communities to fund
programs “brownfields” programs1
Grants to farmers to adopt
conservation practices
Grants to businesses or communities
to establish recycling programs
Development rights purchase programs Public purchases of agricultural
development rights to maintain land
in agriculture or open space
Public support of environmental market Public rules on procurement of
development products made from recycled
materials
Cash payments for people who turn
in old, high-emitting automobiles
Cost-sharing grants Grants made to localities to cover a
portion of the cost of building
wastewater treatment facilities
1
Brownfields are contaminated industrial sites that pose relatively low risks, but may be avoided
by private developers because of potential liability problems.
difficult or impossible for authorities to monitor. In the United States, a number

of individual states8 have enacted deposit-refund systems for beverage contain-
ers, both to reduce litter and to encourage recycling. This approach also has
been widely used in Europe. But many other products could be handled effec-
tively with this type of system.
Germany instituted a deposit-refund on waste lubricating oil. Each year very
large quantities of waste oil are disposed of improperly, putting many air, wa-
ter, and land resources under threat. In the German system, new lubricating oil
8
As of 2015 these were California, Connecticut, Hawaii, Iowa, Maine, Massachusetts, Michigan,
New York, Oregon, and Vermont, plus Guam.
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is subject to a tax (a deposit), the proceeds of which go into a special fund. This
fund is then used to subsidize (the refund side) a waste oil recovery and repro-
cessing system. The terms of the subsidy are set so as to encourage competition
in the recovery/reprocessing system and to provide an incentive for users to
reduce the extent to which oil is contaminated during use.
In Sweden and Norway, deposit-refund systems have been instituted for
cars. New-car buyers pay a deposit at the time of purchase, which will be re-
funded when and if the car is turned over to an authorized junk dealer. Experi-
ence with these systems shows that success depends on more than just the size
of the deposit-refund. For example, it is essential that the collection system be
designed to be reasonably convenient for consumers.
Other items for which deposit-refund systems might be appropriate are con-
sumer products containing hazardous substances, such as batteries containing
cadmium, and car batteries.9 Automobile tires also might be handled this way.
The deposit-refund system also might be adaptable to conventional industrial
pollutants. For example, users of fossil fuels might pay deposits on the quanti-
ties of sulfur contained in the fuels they purchase; they would then get refunds
on the sulfur recovered from the exhaust gas. Thus, they would lose their de-
posit only on the sulfur that went up the stacks.
Summary
Emission charges attack the pollution problem at its source, by putting a price
on something that has been free and, therefore, overused. The main advan-
tage of emission charges is their efficiency aspects: if all sources are subject to
the same charge, they will adjust their emission rates so that the equimarginal
rule is satisfied. Administrators do not have to know the individual source
marginal abatement cost functions for this to happen; it is enough that firms
are faced with the charge and then left free to make their own adjustments. A
second major advantage of emission charges is that they produce a strong in-
centive to innovate, to discover cheaper ways of reducing emissions.
The apparent indirect character of emission charges may tend to work against
their acceptance by policymakers. Standards have the appearance of placing di-
rect control on the thing that is at issue, namely, emissions. Emission charges,
on the other hand, place no direct restrictions on emissions but rely on the self-
interested behavior of firms to adjust their own emission rates in response to
the tax. This may make some policymakers uneasy because firms apparently
are still allowed to control their own emission rates. It may seem paradoxical
that this “indirect” character of effluent taxes can sometimes provide a stronger
inducement to emission reductions than seemingly more direct approaches.
But emission charges require effective monitoring. They cannot be enforced
simply by checking to see if sources have installed certain types of pollution-
control equipment. If emission charges are to have the appropriate incentive
effects, they must be based closely on cumulative emissions.
9
As of 2015, 13 U.S. states had deposit-refund systems for car batteries.
fie21898_ch12_221-244.indd 243 15/12/15 9:17 am

An advantage of emission charges is that they provide a source of revenue

for public authorities. Many have recommended that tax systems be changed to
rely less on taxes that have distorting economic effects and more on emissions
charges. Efforts to combat global climate change have led many to recommend
carbon taxes; these have become quite popular in Europe.
Emissions subsidies would have the same incentive effect on individual pol-
luters, but they could lead to increases in total emission levels. One place where
subsidies have been used effectively is in deposit-refund systems, which are
essentially tax and subsidy systems in combination.
Questions for Further Discussion

1. How might an emission charge program be designed to reduce automobile
emissions?
2. Explain how emission charges solve the equimarginal problem.
3. Opponents of emission tax policies sometimes assert that they are simply a
way of letting firms buy the right to pollute. Is this a reasonable criticism?
4. When emission charges are put into effect, who ultimately ends up paying
for them? Is this fair?
5. Emission charges are sometimes seen as creating a “double burden”: Firms
must pay the costs of reducing emissions and also pay the government for
polluting discharges. How might a charge system be designed to reduce this
double burden?
6. Refer to Figure 12.1. Suppose the emissions tax is $95/ton/month. Find the
efficient level of emissions for the firm. Explain why the firm would not re-
duce its emissions to 1 ton/month.
For additional readings and Web sites pertaining to the material in this chapter,
see www.mhhe.com/field7e.
fie21898_ch12_221-244.indd 244 15/12/15 9:17 am

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Chapter

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FIGURE 11.1 Emission Standards

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Snowmobiling is a major wintertime ac- in 24,300 miles of driving. Snowmobiles

Emission Standards Applicable Carbon Monoxide Hydrocarbons

Yellowstone Entry Standards Number of Snowmobiles Allowed (vehicles/day)

Noise Standards for Yellowstone Decibels

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applicable in this case to snowmobiles. The carbon monoxide, hydrocarbon,

Standards Used in Combination

The Economics of Standards

Setting the Level of the Standard

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FIGURE 11.2 Regional Variation in Efficiency Levels

Standards and the Equimarginal Principle

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FIGURE 11.3 Marginal Abatement Costs for Two Sources

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TABLE 11.1 Illustrative Values for Polluters Shown in Figure 11.3

The essential numbers are summarized in Table 11.1. Uncontrolled emis-

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Standards and Incentives

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FIGURE 11.4 Cost Savings from Technological Change:

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Political-Economic Aspects of Standards

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In this case, standard setting can work against long-run improvements in

The Economics of Enforcement

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FIGURE 11.5 The Economics of Enforcement

issues related to enforcement, discussing these particularly in their relation

Enforcing Emission Standards

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Enforcing Technology Standards

The Enforcing Agency

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Questions for Further Discussion

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4. Consider the example of Figure 11.3. Suppose we define as fair a cutback in

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Environmental Taxes in Europe EXHIBIT 12.1

Charge or Tax Description

Europe. In this chapter we examine the economics of emission charges and

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Emission Charges or Taxes1

The Economics of an Emission Tax

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FIGURE 12.1 An Emissions Charge

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The Level of the Charge

FIGURE 12.2 An Efficient Emission Charge