comparing_cac_econ-incent

comparing_cac_econ-incent - Environmental policies can rely...

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Unformatted text preview: Environmental policies can rely more on direct regulation (the command-and- control or (AC approach) or, alternatively, on economic incentives for environmental protection. A study of their actual use on both sides of the Atlantic belies some of the more simplistic claims that have been made. Most polices, in fact, contain some elements of both approaches. Comparisons of the two approaches in terms of a set of criteria reveal that in practice there are some systematic differences. Economic incentives, for example, have been able to achieve greater cost savings. The good news is that in all the cases studied, there has been significant environmental improvement. . w-sfmgwoma. Economic Incentives versus Command and Control What's the Best Approach for Solving Environmental Problems? Winston Harrington and Richard D. Margenstern Now, decades after the first environmental laws were passed in the United States, policymakers face many choices when seek- ing to solve environmental problems. Will taxing polluters for their discharges be more effective than fining them for not meet- ing certain emission standards? Will a regulatory agency find it less costly to enforce a ban or oversee a system of tradable per- mits? Which strategy will reduce a pollutant the quickest? Clearly, there are no “one—size-fits—all” answers. Many fac- tors enter into the decision to favor either policies that lean more toward economic incentives (EU or toward direct regula- tion, or what is commonly referred to as command-and-control (CAC) policy. Underlying determinants include a country’s gov- ernmental and regulatory infrastructure, along with the nature of the environmental problem itself. Even with these contextual factors to consider, we thought it would be useful to compare EI and CAC policies and their outcomes in a real-world setting. To do this, we looked at six environmental problems that the United States and at least one European country dealt with differently (see box on page 68.) For each problem, one approach was more of an El measure, while the other relied more on CAC. For example, to reduce point—source industrial water pollution, the Netherlands imple— mented a system of fees for organic pollutants (El), while the United States established a system of guidelines and permits (CAC). It turned out, in fact, that most policies had at least some elements of both approaches, but we categorized them as E1 or CAC based on their dominant features. aginally published in Resources, No. 152, Fall/Winter 2004. 66 We then asked researchers who had previously studied these policies on either side of the Atlantic to update or prepare new casestudies. We analyzed the 12 case studies (two for each of the six environ- mental problems) against a list of hypotheses fre— quently made for or against El and CAC, such as which instrument is more effective or imposes less administrative burden. The Evolution of (AC and El Only recently has it been possible to find enough EI policies to carry out a project such as this. Until about 15 years ago the environmental policies actu- ally chosen were heavily dominated by CAC approaches. In the United States, the 19705 saw a great volume of new federal regulation to promote environmental quality, none of which could be characterized as relying heavily upon economic incentives. Since then, however, there has been a remarkable surge of interest in E1 approaches in environmental policy. Since the late 1980s, when- ever new environmental policies are proposed, it is almost inevitable that economic incentive instru- ments will be considered and will receive a respect— ful hearing. The reasons for the newfound popularity of El policies are unclear. Perhaps it is due to the growth in awareness of economic incentive approaches among policymakers and policy analysts the 20 or so years between 1970 and 1990. In the 19705 these approaches were generally unfamiliar to those outside the economics profession. Another possibil— ity is the emergence of tradable emission permits in the late 19705. Before then, the main El alternative to the regulatory policies being implemented was a per-unit tax on pollution (sometimes referred to as an effluent fee). By the 19805 the policy community was generally aware of a “quantity-based” E1 alter- native — tradable emission permits — that seemed to provide the same assuranccs of the achievement of environmental goals that were offered by CAC approaches. A third possible cause is the widespread disap~ pointment with outcomes of the CAC regulations adopted in the 19705. The nearly limitless variety of American industries and industrial processes required the EPA to write very detailed and com- plex regulations, but despite these efforts, the Agency faced a raft of legal challenges. Regulatory complexity combined with litigiousness delayed the implementation of most regulations far beyond the schedules envisioned by Congress. In other words, much of the enthusiasm for El could be attributed to disenchantment with CAC. The Two Sides of the Pond Initially, it is worth underscoring some differences between the United States and Europe that serve as a backdrop to policy decisions and implementation. First, of course, we are comparing a single fed- eral system in the United States with the many countries of the European Union (EU). Beginning in the late 19605, environmental policymaking became centralized'in the United States. In Eumpe, each country has adopted policies according to its own timetable, generally beginning in the late 19605 in the wealthiest nations and sweeping south and east to the former Soviet empire by the 19905. Environmental policy in Europe is now a mix of country-specific and EU-wide measures, which these cases reflect. . Second, there are major differences between the United States and Europe in the extent of pre- regulatory studies undertaken. Because of the U.S. requirement on the Environmental Protection Agency and others to conduct a Regulatory Impact Analysis before taking action, substantially more information was available about the hoped-for benefits of US. policies. A further issue concerns the greater reliance on taxes for regulatory pur- poses in EurOpe compared to the United States. A number of European nations use such taxes— sometimes combined with incentive compatible rebate schemes—to achieve environmental objec- tives. In the United States, environmental taxes are virtually nonexistent. Overall, however, and despite these various differences in approaches, we were not able to dis- cern clear differences in regulatory outcomes across the Atlantic: in some cases one or more European The Six Environmental Problems We Studied In our analysis, we selected six environmental problems to serve as a “control” in order to compare El and CAC approaches in trying to solve each one, which are summarized below. We paired a policy from the US. with one implemented in one or more European countries. For clarity’s sake, although almost all contain some blend of El and CAC elements, those that are more closely associated with El instruments are listed first: 1. 502 emissions from utility boilers: Permit market (US) vs. sulfiir emission standards (Germany) 2. NOX emissions from utility boilers: Emission taxes (Sweden and France) vs. NOx New Source Performance Standards (US) 3. Industrial water pollution: Efiluent fees (Netherlands) vs. Efiluent Guidelines and National Pollutant Discharge Elimination System permits (U. S.) 4. Leaded gasoline: Marketable permits for leaded fuel production (US) vs. mandatory lead phase-outs plus differential taxes to prevent misfueling (most European countries) 5. Chlorofluorocarbons (CFC): Permit market (US) vs. mandatory phase—outs (other industrial countries) 6. Chlorinated solvents: Source regulation (US) vs. three distinct policy approaches (Germany, Sweden, Norway) nations acted sooner or more aggressively to address environmental problems while in other cases the United States acted sooner or more aggressively Testing the Hypotheses Since the 19705, when western countries began forming comprehensive environmental policies, there has been a good deal of speculation and dis— putation over the differences between E1 and CAC instruments in practice. These discussions boil down to assertions or hypotheses about compara- tive advantages of each instrument. We compiled a list of the 12 most commonly stated hypotheses, recognizing that different observers might develop very different lists. Below we discuss the five hypothescs that we consider most important in evaluating a policy instrument. For each, ‘we state the hypothesis, review the original rationale in making it, and then test whether the hypothesis holds up in light of one or more of our case studies. El instruments are more efficient than CAC instruments: that is, they result in a lower unit cost at abatement. RATIONAIE It is commonly believed that EI instru- ments have an efficiency advantage over CAC instruments, although the case is not airtight. El instruments are more cost- effective at achieving a given emission reduction. But to get from cost- effectiveness to efficiency requires additional assumptions, including that the system is one of perfect competition and that the emissions are not location-specific. A theoretical counter to this hypothesis is that a CAC instrument can be as effi— cient if the emission standard for each plant is cho- sen so that the marginal costs of abatement equal the marginal social costs of pollutant damage. PERFORMANCE: The cases we analyzed show that EI is generally more efficient. For example, in looking at the U.S. program of marketable permits to lower 50; emissions, realized costs are only about one- half what was expected back in 1990 and about one-quarter of the estimated cost of various CAC standards. EI also achieved substantial cost savings in the elimination of CFCs and lead in gasoline, in part because of cost heterogeneities that could be exploited during the phase-down period. However, .;mr)‘)§?:flw;‘; any v _ ._ I71; @u‘fi'h‘fiktfi' iii-i. in instances where the regulations are so stringent that practically all-available abatement measures must be taken, there is little scope for choosing the most cost~effective ones, and El instruments do not achieve significant cost savings over CAC. EI also enjoys little advantage if all plants face similar abatement costs. Both these conditions limited, for example, the efficiency losses of using CAC to reduce German SO; emissions. The real advantages of El instruments are generally real- iletl overtime, because they provide a continual incentive to reduce emissions, thus promoting new technology, and permit maximum flexibility in achieving emission reduc- tions. RATIONALE: The effects of CAC on technology are potentially complex. On the one hand, costly regur lations provide a spur to find less costly ways of compliance. On the other, the requirement to install a specific technology conceivably discour- ages research, since discovering new ways to reduce emissions can lead to more stringent regulations. More stringent performance standards for new plants have the stated objective of promoting tech— nology, but they can also have the pernicious effect of postponing retirements of older, dirtier plants and discouraging entry by outside firms. PERFORMANCE: E1 provides greater incentives than CAC for continuing innovation over time in most, but nor all, cases studied. For example, the Swedish NOx tax induced experimentation in boiler opera— tions that led to substantial reductions in N07, emis- sions. Because NOx emissions from boilers are idio- syncratic, it was unknown beforehand what would work in each boiler. Therefore, achieving these reductions from CAC would not have been possi- ble. Similarly, the US. 50; trading policy induced many nonpatentable boiler-specific innovations on utility boilers. Elsewhere, the Netherlands became a world leader in water purification technologies and its industries adopted more advanced, process— integrated measures to reduce pollutants. Innovation also occurs under CAC, but the results are often different. For example, the lead phase down induced emissions reductions in all plants during the period when a CAC policy was employed, but when the policy allowed permit trading and banking, the reductions were concen- trated in newer plants with longer expected life- times, where the improvements were most cost- effective. In the USS 502 policy, examination of patents suggests that in a CAC regime only cost- reducing innOVations are encouraged, while under E1 both cost-reducing and emission-reducing inno- vations are encouraged. CAC policies achieve their obiectives quicker and with greater certainty than El policies. RATIONALE: In the early 19705, CAC was seen as the way to expedite compliance, even if the approach was not the least costly. It appeared then that El instruments, particularly emission fees, would not achieve the same objectives. PERFORMANCE: The evidence from the cases is mixed. Supporting the relative effectiveness of CAC is the US effort to phase out the solvent trichloroethylene (ICE), in which EPA ultimately mandated limits. The EI aspects of the rule did not attract significant industry participation. In phasing out leaded gasoline in Europe, progress would have significantly slowed without mandating catalytic converters and maximum lead coutent in addition to tax differentials. At the same time, several cases argue that E1 policies are more effective. In the Dutch water case, for example, the influence of effluent fees on organic waste load reductions was prompt and large. Similarly, by eliciting industry cooperation, the trading and banking program probably achieved a much more rapid phase-down of lead in gasoline than would have been possible with a CAC program that industry would have opposed. A fmal point on effectiveness is that two cases show that both approaches can result in significant environmental gains, but without careful design, can yield undesirable longer-term side effects. In the United States, NOx emissions from coal-fired power plants were reduced, but the standards, which only affected new plants, caused firms to extend the life of older, more polluting plants to avoid the costs associated with newer-ones. In Sweden, TCE users persuaded the public and authorities that complete implementation of a ban would cause them undue harm. They received numerous waivers and exceptions, thus undermin— ing the authority of the environmental agency and perhaps emboldening other firms to Oppose other regulations. ~ Regulated firms are more likely to oppose El regulations than CAC because they fear they will lose higher costs, despite the greater efficiency of El instruments. RATIONALE: Although EI instruments may have lower social costs overall, firms pay higher costs under El than CAC. Under CAC, the argument goes, the polluting firm pays to abate pollution; under many EI instruments, the firm pays the cost of abatement plus a charge for the remaining pollu- tion it discharges. The firm is better off only if the abatement cost is lower by an amount at least as great as the charge for the remaining emissions. PERFORMANCE: Experience on both sides of the Atlantic suggests that no government has put this hypothesis to the test, which, in a way, is strong support for it. In nearly all cases, governments eliminate the burden of E1 instruments by returning the revenues to the firms. For example, in France, revenues collected through NOx discharge fees sub- sidized the firms’ abatement investments, while in Sweden the charges were returned to the firms on the basis of the energy they produced. In the United States, where the El instrument of choice is a trad- able permit, the permits have always been given away rather than auctioned off. (AC policies have higher administrative costs. RATIONALE: Administrative costs are determined by the amount of interaction between the regulator and regulated source. Supporters of this hypothesis note tha’l’ the complexity of setting and enforcing specific requirements is higher than implementing fee-based El policies. In addition, fees for increased emissions tend to rise gradually, whereas with CAC, a line separates compliance from violation. The potentially high incremental cost at the point of violation gives regulated sources an incentive to defend themselves legally rather than accept sanc— tions, thus adding to the regulators' burden. PERFORMANCE: The cases show noclear pattern. While the CAC-oriented Effluent Guidelines pro— gram in the United States imposed high administra- tive costs on EPA, so did the El instruments of the lead phase-down program. Looking at 50; reduc- tion, the EI-oriented U.S. trading program gained a reputation for low administrative costs, but the 502 reduction program in Germany does not show evi- dence of higher administrative costs than a compa- rable Ei program. Overall, because the evidence on this hypothesis is mixed, we could not form a firm conclusion about whether policy outcomes sup- ported or refuted it. Apples and Oranges? Questions of effectiveness and efficiency were at the core of the initial selection of policy instruments in the 19705 and 19805. As these cases show, El instruments appear to produce cost savings in pol- lution abatement, as well as innovations that reduce the overall cost. The concern that E1 instruments are not as effective is not borne out in our analysis. However, the finding about El’s economic efficiency is tempered by evidence that polluting firms prefer a CAC instrument because of its perceived lower costs to them. In all but one of the case studies, the actual or potential revenues raised by' El instru— ments had to be reimbursed in some way to the firms. This, of course, means the revenues cannot be used for other purposes. In the 19705, almost all environmental poli- cies relied on direct regulation, with very rare instances of E1 instruments. Since the late 19805, whenever a new policy is proposed, policymakers at least consider, and often select, an El instru- ment. That said, almost all the policies that we studied are a blend of both, beginning as a CAC policy and then having EI elements added or sub stituted. In the 12 cases we studied, in fact, only a few (reduction of 502 emissions in Germany; TCE in Germany and Sweden) had no EI elements in their design. Moreover, we can report significant environmental results from the cases we studied. Averaged across all twelve, emissions fell by about tum—thirds when compared to baseline estimates. ‘ . BID. pro— :tra- ‘ the iuc- ed a SO; evi- ipa- : on mn up- ant out [65. Most outcomes either met or exceeded policymak- ers’ original expectations. This is encouraging news for those seeking environmental improvements in the future. Suggested Reading Harrington, W, R. Morgenstem, and T. Sterner (eds). 2004. Choosing Environmental Policy: Comparing Instruments and Outcomes in the United States and Europe. Washington, DC: Resources for the Future. ...
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This note was uploaded on 06/09/2011 for the course ECON 330 taught by Professor Marble during the Spring '11 term at University of Texas.

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comparing_cac_econ-incent - Environmental policies can rely...

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