Pollution Control (Economic Instruments) PDF

1  Main Points ◼ Pollution taxes ◼ Marketable pollution permits ◼ Pollution subsidies 2  Pigouvian Taxes ◼ A.C. Pigou (1938) argued that an externality cannot be mitigated by contractual negotiation between the affected parties. ◼ Pigou argu...

1  Main Points ◼ Pollution taxes ◼ Marketable pollution permits ◼ Pollution subsidies 2  Pigouvian Taxes ◼ A.C. Pigou (1938) argued that an externality cannot be mitigated by contractual negotiation between the affected parties. ◼ Pigou argued that use of taxes should be used against the offending party. ◼ These taxes are referred to as Pigouvian taxes. ◼ A tax or financial penalty imposed on polluters by government authorities. The charge is specified on the basis of dollars or cents per unit of effluent (emission) emitted into the environment. 3  Pigouvian Taxes ◼ The basic principle behind the use of externality taxes is that the tax eliminates the divergence between the Marginal Private Cost (MPC) and the Marginal Social Cost (MSC). 4  Pollution Tax ◼ Pollution Charges or Taxes Pollution charges or pollution taxes confront the producers with the external cost of pollution and provide an incentive to seek technologies that are less polluting. 5 Pollution tax: How does firm react? 6 Pollution tax: How does firm react? ◼ Consider this firm is required to pay an effluent tax in the amount of tk or $20 per unit of waste discharged. ◼ Firm interested in minimizing its cost would discharge 150 units of waste. ◼ Firm will control 250 units of waste (400–150) using its facility to clean the waste. 7 Pollution tax: How does firm react? Suppose the firm decided ◼ to reduce its emission to 100 units. At this level of emission, the MCC>t =$20. ◼ Thus, paying the tax to discharge the waste would be cheaper to the firm than using its facility to clean the waste. ◼ A similar argument can be presented if the firm decides to increase its waste discharge to a level exceeding 150 units. ◼ However, in this case it would be cheaper for the firm to clean the waste using its waste- processing facilities than pay the tax; that is, MCC tax, can reduce costs by increasing pollution and paying lower tax rather than high abatement ◼ Each polluter will choose an emission level at which MAC = tax. 11 Optimal level of Taxes 12  Optimal Level of Taxes ◼ The effluent charge needs to be determined by taking both the damage and control costs into consideration at an aggregate level. ◼ In the short run, government authorities determine effluent charge using a trial-and- error process. 13  Optimal level of Taxes ◼ The optimal effluent charge, te, should be the tax-rate which when implemented would tend to yield the socially optimal level of waste discharge (We). ◼ When this level of waste is emitted, te = MCC = MDC. ◼ Note that te may or may not be equal to tk, the effluent tax imposed on firms at a point in time 14  Optimal Level of taxes ◼ If the aggregate MAC function is known, then achieving a targeted level of pollution is easily accomplished. ◼ If the aggregate MAC function is not known, the appropriate tax level is much harder to determine. 15 In summary: ▪ Pollution taxes are preferable since pollution taxes minimize abatement costs and provide incentives for R&D. ▪ Because of uncertainty ( determining MAC), pollution taxes are less proficient than command and control techniques in achieving a desired level of pollution. 16  Marketable Pollution Permits ◼ Marketable pollution permits are permits which give a firm the right to emit a specific number of units of pollution. ◼ Polluters are free to buy and sell these rights to pollute. ◼ A marketable pollution permit system can both minimize total abatement costs, and achieve the desired level of pollution emissions. 17  Marketable Pollution Permits ◼ A system of marketable pollution permits begins with the determination of the target level of pollution. ◼ The next step is to allocate pollution across polluters. ◼ This allocation can be based on historic pollution levels. ◼ The buying and selling of pollution permits will reallocate the emission rights. ◼ Under the transferable emission permit approach, government authorities basically have two functions: A. Determine the total allowable permits. B. Decide the mechanism to be used to distribute the initial pollution permits among polluters. 18 How Marketable Pollution Permits work? 19  How Marketable Pollution Permits work? ◼ Suppose that government agencies of some hypothetical place issue a total of 300 permits for a period of one year. ◼ Each permit entitles the holder to emit a ton of sulfur dioxide. There are only two firms (Firm 1 and Firm 2) emitting sulfur dioxide ◼ Government authorities issue an equal number of permits to both firms. That is, the maximum that each firm can emit into the air is 150 tons of sulfur dioxide per year. ▪ Suppose that in the absence of government regulation each firm would have emitted 300 tons of sulfur dioxide. ▪ Thus, by issuing a total of 300 permits, the ultimate objective of the government policy is to reduce the current level of total sulfur emission in the region by half (300 tons). 20  How Marketable Pollution Permits work? ◼ In this figure the marginal control costs for these two firms are assumed to be different. Specifically, it is assumed that Firm 1 uses a more efficient waste processing technology than Firm 2. ◼ Two firms can engage in some form of mutually beneficial negotiations. ◼ Firm 1 is operating at point R of its MCC. At this point it is controlling 150 units of its sulfur emission. For this firm, the marginal control cost for the last unit of the SO2 is $500. ◼ Firm 2 is operating at point S of its MCC, and it is controlling 150 units of its waste and releasing the other 150 units into the environment. At this level of operation, point S, the marginal control cost of Firm 2, is $2,500. 21  How Marketable Pollution Permits work? ◼ Since permits to pollute are freely tradable commodities, it would be in the best interest of Firm 2 to buy a permit from Firm 1 provided its price is less than $2,500. ◼ Similarly, Firm 1 will be willing to sell a permit provided its price is greater than $500. ◼ This kind of mutually beneficial exchange of permits will continue to persist as long as, at each stage of the negotiation between the two parties, MCC2 >MCC1. ◼ This relationship will cease to occur when the marginal control cost of the two firms attain equality—that is, MCC2=MCC1 22  How Marketable Pollution Permits work? ◼ At this equilibrium point, Firm 1 is emitting 100 tons of sulfur (or controlling 200 tons of sulfur). This means that Firm 1 is emitting 50 tons of sulfur less than its maximum allowable permits. ◼ Firm 2 is emitting 200 tons of sulfur, 50 tons more than its maximum allowable pollution permits. ◼ However, Firm 2 is able to fill this deficit by purchasing 50 tons worth of pollution permits from Firm 1. ◼ At equilibrium the total amount of sulfur emitted by these two firms is 300 tons, which is exactly equal to the total pollution permits issued by government authorities. 23  Marketable Pollution Permits ◼ Marketable pollution permits equate marginal abatement costs across polluters. ◼ Each polluter compares his/her marginal abatement costs with the price of a permit. ◼ If the marginal abatement costs are higher than the price, they have an incentive to buy. ◼ If the marginal abatement costs are lower, they have an incentive to sell. ◼ Buying and selling will continue until the equilibrium price is reached which equates marginal abatement costs across all firms. 24  Other Types of Economic Incentives: Pollution subsidies ◼ A system of pollution subsidies would pay each polluter a fixed amount of money for each unit of pollution reduced. ◼ The polluter would reduce pollution to the point where the subsidy is equal to the marginal cost of abatement. ◼ The subsidy could potentially attract more polluters into the industry. 25 Problem 1 Suppose that a firm producing paper has MDC=100-E MAC= 10+2E ◼ What is the optimal tax the gov. can impose on this firm? 26  Problem2 ◼ Assume that society is composed of two polluters, with the marginal abatement costs of polluters 1 and 2, respectively, equal to MAC1 = 18 – E1 MAC2 = 12 – 2E2 Then, i. What is the unregulated level of pollution for each polluter? ii. Determine the total level of emissions that would be generated if a per-unit pollution tax of $4 were imposed. 27 Problem 3 ◼ Given the same two marginal abatement cost functions in Problem 2, find the marginal abatement cost of each firm if both were to reduce its pollution levels by 50 percent from the unregulated levels of emissions. 28 Problem 4 ◼ Given the same two marginal abatement cost functions in Problem 2, find the emissions emitted by each firm if pollution is limited to 18 units through the issuance of marketable pollution permits. 29