Transcript Slide 1

Policy for Market Failure:
Market-based strategies
Price Instruments
Jeffrey Ely and Lam Thuy Vo / NPR
Instrument taxonomy
Market-based instruments
• Advantages of MBI’s over C&C (Stavins, 1998):
– cost effectiveness, and
– dynamic incentives for technology innovation
• Encourage behavior change through market
signals rather than with explicit behavioral
requirements.
• Key attribute: MBI’s take advantage of private
information that polluters have
– RE: means and procedures they could use to reduce
pollution
Price-based policy examples
Fees/taxes/charges to disincentivize activity
• User fees (e.g. National Parks)
• Congestion fees, road tolls (e.g. London
congestion charge, 8 £)
• Emissions fees (e.g. GHG tax)
Subsidies to incentivize activity
• Abatement subsidies (reduce “bads”)
– E.g. NC bill to provide $50B to reduce
hog farm waste
• Subsidies to encourage “goods”
– California Million Solar Roofs Initiative
– 2008 Farm Bill
• $14B in subsidies for various crops
• $27B to conserve environmentally
sensitive farmland
• $23B crop insurance
Emissions charge (tax) mechanics
• Suppose: emissions tax
of $120/ton.
–What is the predicted
response, assuming
• polluter is rational
• objective: minimize TCC?
•Define:
TCC = TAC + TEF
total
compliance
cost
total
abatement
cost
total
emissions
fees
Tax has been set
at $120/ton/month
Tax - mechanics
• If the MAC curve
shifts down (e.g.
MAC’)
– does the predicted
level of abatement
go up or down (tax
unchanged)?
MAC’
Arthur Cecil Pigou
“Corresponding to the above investments in which
marginal private net product falls short of marginal social
net product, there are a number of others, in which, owing
to the technical difficulty of enforcing compensation for
incidental disservices, marginal private net product is
greater than marginal social net product.
Thus, incidental uncharged disservices are rendered to
third parties when the game-preserving activities of one
occupier involve the overrunning of a neighbouring
occupier's land by rabbits—unless, indeed, the two
occupiers stand in the relation of landlord and tenant, so
that compensation is given in an adjustment of the rent.
….
Yet again, third parties—this time the public in general—
suffer incidental uncharged disservices from resources
invested in the running of motor cars that wear out the
surface of the roads. The case is similar—the conditions
of public taste being assumed—with resources devoted to
the production and sale of intoxicants.”
Killer Rabbit of Caerbannog
Monty Python and the Holy Grail
The Economics of Welfare, 1921
h/t Krugman
Setting an efficient tax
• If the MD function is known then the tax can
be set to produce the efficient level of
emissions.
• When the tax is set equal to the marginal
damage at the efficient level of emissions we
call it a “Pigovian tax/fee”
Setting an efficient tax
• Questions: Identify…
– Efficient emissions
– Given t*:
– TAC: Total abatement cost
– TEF: Total emissions fees
(“tax bill”)
– TB: Total benefit from
damages averted.
A diversion:
“Roland S*”
• Swiss millionaire (est.
wealth: $20M)
• Ferrari Testarossa
driver (red)
• a repeat traffic
offender
• Caught driving “35 miles an hour faster than the 50-milean-hour limit”
• fined $290,000 for speeding (Swiss court in St. Gallen)
– record-breaking fine
• Price instrument in combination with performance
standards – tailored to the agent
Source:
http://www.blick.ch/news/schweiz/ostschweiz/st-galler-ferrari-raser-ich-bin-diplomat-137378
(Assoc. Press, Jan 7, 2010)
Equimarginal principle
• Major strength of emissions
charges:
– IF same tax rate applied to
different sources with different
MAC functions
(and each reduces it emissions as
predicted such that MAC = tax)
THEN, MAC’s will be equalized
across sources.
Cost effectiveness achieved
***Does the regulator have to
know the MAC functions for
• a tax to be cost-effective?
• a tax to achieve the
socially optimal level of
aggregate abatement?
1. look for
outcomes in
which MACs
are equalized
2. stop when you find
the outcome that
achieves the required
aggregate abatement
Incentives to innovate
Questions:
• Baseline, MAC1: what level of
emissions is chosen and what is
the total compliance cost?
– TCC1 = TACMAC1 + TEF1 = ?
• After innovation (MAC2): what
level of emission is chosen and
what is the TCC?
– TCC2 = TACMAC2 + TEF2 = ?
• What is the firm’s benefit
(incentive) for innovating (cost
savings)?
– TCC2 – TCC1 =?
• Compare to incentive under
performance standard e1
Story: Initially at MAC1. After
costly R&D, develop new method,
move to MAC2. Emissions charge
is constant at t.
Incentives to innovate are greater under
emissions charges than standards
• R&D efforts will lead to a bigger reduction in
compliance costs for firms (abatement plus
taxes) under a tax compared to a standard.
• Under a tax: a firm will automatically reduce its
emissions as it finds ways to shift its MAC
function downward
– Same incentive not present under standards.
Subsidy policies
• Payments to reduce pollution (less of a bad)
• Price supports (e.g. agriculture) (more of a
“good”).
• Deposit-refund systems
– Subsidy is the refund (deposit funds the subsidy
payment).
• Subsidy removal
Subsidies
• Pollution context: polluter paid per unit of
reduction below some benchmark level
– generates an incentive: opportunity cost for polluting
• emitting a given unit of pollution means forgoing the subsidy
payment.
• Subsidies to reduce pollution are not common.
Why?
– Violates “polluter pays” principle
– Can potentially lead to more pollution:
Subsidies decrease firm pollution
 increase industry profits encourage new
entrants  more production  more pollution
Federal energy
subsidies,
2002-2008
Environmental Law Institute, 2009
“Antibiotics Research Subsidies Weighed by U.S.”
(A. Pollack, NYT, 11/5/10)
•
“Worried about an impending
public health crisis,
government officials are
considering offering financial
incentives to the
pharmaceutical industry, like
tax breaks and patent
extensions, to spur the
development of vitally needed
antibiotics.
•
…bacteria (have) steadily
become resistant to virtually all
existing drugs at the same
time that a considerable
number of pharmaceutical
giants have abandoned this
field in search of more
lucrative medicines.”
“Antibiotics Research Subsidies
Weighed by U.S.” (NYT, 11/5/10)
• “While the notion of directly subsidizing drug companies may be
politically unpopular in many quarters, proponents say it is
necessary to bridge the gap between the high value that new
antibiotics have for society and the low returns they provide to drug
companies.
• `There is a market failure,’ said Representative Henry A. Waxman, a
California Democrat and the chairman of the House Energy and
Commerce Committee, who said he was considering introducing
legislation. `We need to look at ways to spur development of this
market.’”
• Alternative approach: Generating Antibiotic Incentives Now bill:
“provide certain antibiotics with five extra years of protection from
generic competition” <What type of approach is that?>
Subsidy removal example:
Below-cost timber sales
• Moving timber from U.S. public lands into the
marketplace frequently costs the Federal government
more than it gets in return  implicit subsidy
– Common form: credits to private lumber companies for road
building
– 1964 Forest Roads and Trails Act
• companies deduct road construction expenses (credits) directly
from the amount they pay the Forest Service for the timber they
extract.
• Removal of these subsidies could foster environmental protection
and save taxpayers up to (an estimated) $1.2 billion over five years.
(Stavins, 1998)
Optional additional material
OECD countries
Ian W.H. Parry. (2011). Reforming the Tax System to Promote Environmental Objectives: An Application to
Mauritius. IMF working paper 11/124.
Enforcement costs
• Non-point-source (NPS) pollution: “a form
of pollution in which neither the source nor
the size of specific emissions can be
observed with sufficient accuracy”
• Most non-point sources of pollution cannot
be regulated through emissions charges
– Too costly to monitor
(Xepapadeas, 2011)
• E.g. pollutants in street runoff, agricultural
runoff.