Chapter 15: Incentive Based-Regulation: Theory Flashcards
What is the basis of Incentive-Based Regulations?
Basic Concept:
- Make polluting an expensive activity
- Lower costs of pollution control by leaving decisions about how to reduce pollution up to firms
📎 How to do better? CANNOT DO BETTER
Types:
1. Pollution Tax
2. Cap-and-trade System
Types of IB Regulations:
Types:
- Pollution Taxes (Pigovian taxes, emission, or effluent fees)
- Cap-and-Trade System (Marketable or tradeable permit system)
Why is Incentive-Based Regulation better than Command-and-Control Systems?
CAC: Kak … Command system → does not work
IB better:
- Promotes more cost-effective relgulation in the short term
(Cost-Effective: achieve particular goal at the lowest possible cost)
- Provides better incentives for firms seek out new technologies to lower pollution control costs in the long run
Potential Problems:
- Monitoring and enforcement
- Hot spots
What is the Cost-Efficiency Rule?
Cost-Effectiveness achieved iff the MC or reduction is equal for each pollution source
Why?
- Whenever MC of pollution reduction at one source greater than another
- Then, overall costs reduced without changing pollution level by decreasing pollution at low-cost site and increasing at high-cost site
How do Incentive-Based Regulations relate to cost-effectiveness?
📎 Incentive: Choose on own to which you want
- Do in your own best interest
Both tax and permits achieve cost-efficient pollution control automatically (principle)
CAC:
- Govenment regulators could only achieve cost-efffectiveness by knowning coontrol costs at different sources, and setting firm-specific regulatory targets.
- Info not usually avaible
- Info not needed under IB regulations
Why is CAC not always cost-efficient?
CAC:
- Govenment regulators could only achieve cost-efffectiveness by knowning coontrol costs at different sources, and setting firm-specific regulatory targets.
- Info not usually avaible
- Info not needed under IB regulations
IB Regulation
How do firms profit from give-aways?
- Selling excess permits
- From higher product prices
Prices rises same amount regardless of whether permits given away/actioned
- Firms without permits pay same price either case - market prices has to rise to cover cost - Firms low clean-up costs profit from higher energy prices
How to know the correct number of permits?
- Too much? Oversaturate the market ⇒ not worth anything & can’t sell
- Government then revize and take some back
Using Tax or Auction Revenue
Idea #1: “Double Dividend”
Substituting pollution taxes or cap-and-trade auction reveneues for tax on labor (capital) would discourage pollution and encourage work (or investment)
Using Tax or Auction Revenue
Idea #2: “Cap & Dividend”
Rebate revenue directly back on equal basis to all citizens
- Similar Alaska permanent fund
- No “double-dividend” since aren’t cutting taxes on labor
Leads to net benefits for the majority people (progressive policy)
How does imperfect information not impact Incentive based regulation?
IB: Government not need to know → Still need monitor (removes one level of responsibility compared to CAC)
- Firms hate pollution takes and/or Actionated cap-and-trade → Prefer give away (CAC less expensive firms as well)
- “Double dividend” reasons and insure incentive-based appraoches not regressive, economists increasingly favor Cap and Trade auctions (or Pollution Taxes) over permit-giveaways
Government Make Money:
Auction off permits then could, depending on the structure, make the same as with a tax
What is the Coase Theorem Corollary?
Well-functioning permit market, cost-effective outcome will be achieved by marketable permit system regardless of initial ownership of permits
Compare Cap-and-Trade and Pollution Taxes:
Cap & Trade:
Directly control quantity pollution emitted
- “Quantity instrument”
Advantages:
- Always given, lower costs to firms
- More certain pollutant level
- No need adjustment to account for economic growth/inflation
Pollution Taxes:
Regulators only indirectly control quantity of pollution, guessing industry response tax of a certain lelevel
- “Price instrument”
Advantages:
- If revenues used cut income tax, labor market efficiency will be improved (Revenue Neutrality)
- If revenues partially retained by enforcement agencies, enforcement incentives strengthened
- Issue of thin market, market power, and price volatility avoided
IB Regulation and Technological Progress:
- Taxes and permits generate better incentives for long-run technological progress in pollution control than CAC
a. Taxes: Less pollution means lower taxes
b. Permits: Pollution bears an opportunity costs since less pollution frees up permits for sale - Pollution now costly firms, motivate seek out new ways reducing polluiton
Potential Problems IB:
- Need direct monitoring emissions and enforcementEmmisions monitoring GOOD thing → needs n systemCannot work without monitoring
- Hot-spots: High local concentration of pollutants
IB create hot-spots for concentrated and nonuniformly mixed pollutants
What are Hot-Spots?
- Uniformly mixed pollutant:
- Emissions concentrations spread evenly over multiple areas
- Concentrated Pollutant:
- All damage done emisssions of a plant occur in plant’s area
- Nonuniformly mixed pollutant:
- Bulk damage done locally → effects drift other areas
- Taxes higher (or emissions value of permit lower) areas already polluted
