Topics in Environmental Economics: Taxes, Emissions Trading, and Other Topics in the Economics of Pollution Guest Lecturer: Hans Zigmund DePaul University PPS 329/359 Special Topics: Applied Urban and Environmental Economics

Purpose

 To provide students with the tools of economic theory for analyzing environmental issues from an economic perspective.

 To that end this lecture will be largely theoretical with relevant applications in the second half of the talk.

Outline

 Macroeconomics (Growth Theory)  Microeconomics Theory  Utopian Capitalist View  Cost Benefit Analysis  Adjustments at the Margin (Taxes, Subsidies, and Markets)  Microeconomics applied to policy  Kyoto Protocol  European Union Emission Trading Scheme (ETS)  Alternative International Agreements  Boulder Carbon Tax

Economic Growth

 Increase GDP/Capita (Economic Output)  Factors of production:  Land (L)  Labor (N)  Capital (K)  Economic output requires the exploitation of natural resources.

Areas of Government Intervention

 Reduce Pollution (Today’s area of focus)  Reduce Depletion of Natural Resources  Manage Public Lands  Compensation from Natural Disasters

Environmental Perspective on GDP

 Focus of economic growth is on increasing GDP/capita.

 Hides negative impact on ecosphere of producing goods and services.

 Pollution related healthcare costs  Exxon Valdez clean up $2.2bn

Environmental Perspective on GDP

 GDP does not account for the degradation of natural resources.

 Erosion  Water Pollution  Exhausting Mineral Resources  Depleting Fisheries (until possibly too late)

Environmental Perspective on GDP

 Hides negative or underestimates some positive effects.

 Energy efficient light bulbs and appliances.

 Fuel efficient cars.

Index of Sustainable Economic Welfare (ISEW) and Genuine Progress Indictor  (GPI) Created by Herman E Daly and John Cobb Jr. (1989) and Philip Lawn (2003)  Adjusts GDP/capita for  Income Distribution  Depletion of natural resources  Loss of wetlands  Loss of farmland from soil erosion and urbanization.

 Cost of air and water pollution  Estimate of long term cost of global warming.

Utopian Capitalist View: Pareto

 Edgeworth Box

Optimality

 Exhausting Gains On Trade  Conditions of Pareto Optimality  You cannot make one party better off without making another worse off.

 Parties involved in exchange bear the full true cost of the transaction.(no externalities)

Cost Benefit Analysis: Pollution Abatement

 Seek out the point that minimizes both the cost of abatement and environmental damage costs (or maximize environmental benefit).

 Total Cost curve is minimized at the point of intersection.

 $1 in abatement cost = $1 in damage cost control or environmental benefit.

Cost Benefit Analysis: Pollution Abatement

TC Damage Cost

Socially optimum amount of pollution abatement

0 Abatement Cost (Environmental Amount of pollution abatement Benefit)

Cost Benefit Analysis: Pollution Abatement

 On the right side, spend too little leads to high environmental costs.

 On the left side, spend too much and it trade offs will have to be made with other social programs such as public health.

Regulatory Approach

 Historically the regulatory approach has been effective.

 Example:  Automobile emissions and MPG standards.

 Leads to reductions in Carbon Monoxide emissions and other pollutants.

 Is the regulatory approach the most efficient?

Regulatory Approach

 Two Firm Model  Marginal Cost/Marginal Benefit and inefficiencies.

 Because hypothetical firm A and firm B to abate the same quantity under different marginal cost structures, firm A may abate in excess of marginal benefit while firm B may abate less than optimal.

Regulatory Approach

MC A MC B

I II 0

Q eA Q R Q eB

Amount of pollution abatement

Damage Per Unit

Regulatory Approach

 Area I represents abatement cost in excess of benefits for firm A.

 Area II represents opportunity cost loss of firm B for stopping abatement while marginal benefits were still greater than marginal costs.

Adjustments at the Margin: Pollution Taxes

 In efficient markets P = MC.

 True only when firms marginal cost equals the real cost of the next unit of production.

 If pollution create costs on society not incurred by business (externality), then an over allocation of resources into production will occur.

 Taxes can correct for this over allocation by internalizing the externality.

TAX P

Adjustments at the Margin: Pollution Taxes

Spillover MC t costs MC P 0 P e

0

Q 0 D Q e Overallocation Corrected

Q

Adjustments at the Margin: Subsidies

 R&D that leads to reduction in pollution has positive societal benefits.

 R&D will only be invested in if profitable.

 Subsidizing R&D can reduce the time it takes to develop new technology.

 R&D doesn’t always generate a outcome on the income statement. The subsidy helps offset the risk of investment.

P

P e

Adjustments at the Margin: Subsidies

MC MC s R&D Subsidy to producers Decreases marginal cost P 0 D Underallocation Corrected

Q 0

Q e Q 0

Adjustments at the Margin: Markets for Pollution Rights

 Politically more palatable to business because it relies on markets rather than taxes for corrections.

 Firms (such as public utilities in the market for SO 2 ) receive a fixed number of pollution allowances.

 These credits can be sold and bought on the CBOT.

 If firms use more pollution than they own credits for they pay a fine.

Adjustments at the Margin: Markets for Pollution Rights

$2000

D 2007

S = Supply of SO 2 pollution rights $1000

2010

8 9 10 11 12 13 Quantity of SO 2 pollution rights (millions of tons)

Allowance Trading Basics



An emissions "cap":

A limit on the total amount of pollution that can be emitted (released) from all regulated sources (e.g., power plants); the cap is set lower than historical emissions in order to reduce emissions. 

Allowances:

An authorization to emit a fixed amount of a pollutant. 

Measurement:

Accurate tracking of all emissions. Source:http://www.epa.gov/airmarkets/trading/basics.html

Allowance Trading Basics



Flexibility:

Sources can choose how to reduce emissions, including whether to buy additional allowances from other sources that reduce emissions. 

Allowance trading:

Sources can buy or sell allowances on the open market. Because the total number of allowances is limited by the cap, emission reductions are assured. 

Compliance:

At the end of each compliance period, each source must own at least as many allowances as its emissions. Source:http://www.epa.gov/airmarkets/trading/basics.html

Trading the Right to Pollute

 The NO x Budget Trading Program is a market based cap and trade program created to reduce emissions of nitrogen oxides (NO x ) from power plants and other large combustion sources in the eastern United States. Source : http://www.epa.gov/airmarkets/progsregs/nox/sip.html

Trading the Right to Pollute

 Market-based sulfur dioxide (SO 2 ) allowance trading component of the Acid Rain Program  Utilities regulated under the program, decide the most cost-effective way to use available resources to comply with the acid rain requirements of the Clean Air Act.  Purchase pollution allowances.

 Switching to lower sulfur fuel.

 Reduce emissions by employing energy conservation measures Source: http://www.epa.gov/airmarkets/trading/factsheet.html

Success of Acid Rain Program which includes trading pollution allowances  Reduced SO 2 emissions by over 5.5 million tons from 1990 levels, or about 35 percent of total emissions from the power sector. Compared to 1980 levels, SO percent. 2 emissions from power plants have dropped by more than 7 million tons, or about 41  Cut NO x emissions by about 3 million tons from 1990 levels, so that emissions in 2005 were less than half the level anticipated without the program. Other efforts, such as the NO significantly to this reduction. x Budget Trading Program in the eastern United States, also contributed  Led to significant cuts in acid deposition, including reductions in sulfate deposition of about 36 percent in some regions of the United States and improvements in environmental indicators, such as fewer acidic lakes.

Source: http://www.epa.gov/airmarkets/progress/arp05.html

Kyoto Protocol

 Industrialized nations reduce CO 2 5 percent from 1990 levels by 2008-2012 compliance period.

 United States withdrew in 2001.

 China and India are not required to comply because they are developing nations.

 By 2002 Kyoto only covered about 30 percent of global CO 2 emissions.

 Too little too fast.  Not enough change to make a difference.

 Difficult to comply with for countries who experienced substantial growth in the 1990’s.

European Union Emissions

 

Trading Scheme (ETS)

Kyoto with teeth.

Covers half of Europe’s carbon emissions. (8% of global)  Each country creates a national allocation plan for specifying caps on greenhouse gases.

 Businesses can either reduce their emissions or purchase allowances from facilities with an excess of allowances.  Allowances traded in the ETS are not printed but are held in electronic account registries set up by Member States and are overseen by a Central Administrator at the EU.

 Emissions considered a service under EU’s VAT.

Sources: http://ec.europa.eu/environment/climat/emission.htm

and Nordhaus, William D.

The American Economic Review,

Alternative Mechanisms to Control Global Warming” 96(2) May 2006, 31-34 “After Kyoto:

Alternative International Treaty Options  Link treaty to specific environmental objectives rather than a baseline year pollution level. (e.g. temperature, costs, damages) (Nordhaus 2006)  Use an extended time path. Depart gradually from a business as usual pattern becoming more severe over time. (Olmstead and Stavins 2006)  Extend tradable allowances globally. (Olmstead and Stavins 2006)  Extend participation beyond industrialized nations to include the developing world and United States. (Olmstead and Stavins 2006) Nordhaus, William D.

The American Economic Review,

“After Kyoto: Alternative Mechanisms to Control Global Warming” 96(2) May 2006, 31-34 and Olmstead, Sheila M. and Robert N. Stavins. 96(2) May 2006, 31-34 and

The American Economic Review,

“An International Policy Architecture for the Post-Kyoto Era

Boulder Carbon Tax

 Boulder's City Council adopted the goals of the Kyoto Protocol in 2002 to reduce greenhouse gas emissions below 1990 levels by 2012.  On November 14, 2006 with Initiative 202, the Climate Action Plan Tax, the Boulder Colorado city council approved a carbon tax which is applied to residents electric and gas bills.   Average tax for homeowners $1.33/month and Business $3.80/month Estimated energy cost savings from implementing the Climate Action Plan are $63 million over the long term.   Revenue estimated is $6.7 million by 2012, when the goal is to have reduced carbon emissions by 350,000 metric tons.

Source: http://www.ci.boulder.co.us/index.php?option=com_content&task=view&id=6136&Itemid=169 econ.net/2006/11/a_carbon_tax_in.html

and http://www.env-