Regulatory Options & Efficiency

Goal: Generate regulatory tools to fix environmental problems

Why regulate?

 Does free market efficiently provide goods and services?  Market failure (externalities, public goods, etc.)  Market power (monopolies inefficiently restrict production to raise prices)  Information problems (damages uncertain, food safety, env quality)

Types of questions in regulation

1.

2.

3.

What is the “optimal” amount of pollution? To reduce by X%, who should reduce and by how much?

What regulatory instrument(s) should be used to achieve that level?

Problem

 EPA has regulations to control biological oxygen demand (BOD). EPA would like your advice on how to improve water quality (lower BOD) without increasing costs.

 What is your advice?

BOD Removal, Costs of US Regulations Industry Poultry Meat Packing Cane Sugar Leather tanning Paper Poultry Raw Sugar Processing Paper Poultry Subcategory Duck-small plants Simple Slaughterhouse Crystalline Refining Hair previously removed Unbleached Kraft Chicken – small plants Louisiana NSSC – Sodium Process Chicken —large plants Source: Magat et al (1986); units: dollars per kilogram BOD removed Marginal Cost $3.15

$2.19

$1.40

$1.40

$0.86

$0.25

$0.21

$0.12

$0.10

Principle of efficiency

 Most common approach: uniform burden (eg, everyone cuts pollution by x%)  Two possible results  Too much pollution for the total amount of pollution control costs  Too much cost for a fixed level of pollution reduction  Burden of pollution control should fall most heavily on firms with low costs of pollution control

$/unit More Generally: The “efficient” amount of pollution Marginal Control Cost Marginal Damage Cost Total Damage Cost Q* Total Control Cost Units of pollution

Recall example from 1

st

week

 60 firms, each pollute 100 tons  30 low abatement cost ($100/ton)  30 high abatement cost ($1000/ton)  Everyone reduces 1 ton: Cost=$33,000  Total reduction = 60 tons.

 For same cost how many tons could we have reduced?

With mixed high and low cost firms abating, we could

Either:  Reduce more pollution for the same amount of money…or  Reduce the same amount of pollution for less money.

So we always want low-cost firm to shoulder abatement.

Abatement Cost ($/unit)

If costs aren’t constant: two firms (eg, NOx emissions)

MC A Who should abate the 1 st unit of NOx?

MC B NOx Reduction

$ (A)

How much abatement from each?

Loss from equal reduction MC A $ (B) A: B: 0 80 25 55 40 40 MC B 80 0

How did he do that?

2.

3.

4.

5.

6.

1.

Determine how much total abatement you want (e.g. 80) Draw axis from 0 to 80 (A), 80 to 0 (B) Sum of abatements always equals 80.

Draw MC A as usual, flip MC B Lines cross at equilibrium Price is MC

for A and for B

.

The “equimarginal principle”

 Not an accident that the marginal abatement costs are equal at the most efficient point.

 Equimarginal Principle:

Efficiency for a homogeneous pollutant requires equating the marginal costs of control across all sources.

Control costs

 Should include all other costs of control  monitoring & enforcement  administrative  Equipment   Regulatory uncertainty increases costs.

 If you are a polluter, what would be your response to uncertainty in what you have to do?

 Does this increase your costs? Would like to design regulations that provide an incentive to innovate

Common Instruments for regulation   Command and Control: Centralized determination of which firms reduce by how much.

Taxes: charge $X per unit emitted. This increases the cost of production.

Forces firms to internalize externality

.

  Quotas/standards: uniform standard (all firms can emit Y) or non-uniform.

Tradable permits: All firms get Y permits to pollute, can buy & sell on market. Other initial dist’n mechanisms.

Weitzman on carbon taxes

 “One can only wish that US political leaders might have the insight to understand and the courage to act upon the breathtakingly simple market-friendly idea that the right carbon tax could do

way

more to unleash the power of decentralized American inventive genius on the problem of developing economically-feasible non carbon-intensive alternative technologies than all of the command-and-control schemes and patchwork subsidies making the rounds in Washington these days.”

Example 1: Taxes in China

 China: extremely high air pollution – causes significant health damage.

 Instituted wide-ranging system of environmental taxation  2 tiers  World Bank report estimates that MC of abatement << MB of abatement.

A creative quota: bubble policy

  Multiple emissions sources in different locations.

Contained in an imaginary “bubble”.

 Regulation only governs amount that leaves the bubble.

 May apply to emissions points within same plant or emissions points in plants owned by other firms.

Example 2: Bubble policy in RI

 Narraganset Electric Company:  2 generation facilities in Providence, RI.

 Required to use < 2.2% sulfur in oil.

 Under bubble policy:  Used higher sulfur in one plant, burned natural gas at other plant  Savings:  $3 million/year

Example 3: SO

2

Allowances

 1990 CAAA sought to reduce SO 2 emissions from 20 million tons/yr to 10 million tons/yr  Set up market in emission allowances  97% of 10 million tons allocated to polluters  Rest auctioned at CBOT – anyone can buy: see http://www.epa.gov/airmarkets/forms

SO2 Allowance Prices, 1994- 2004 Source: http://www.epa.gov/airmarkets/trading/so2market/alprices.html

How big the tax or how many permits?

 We know:  Optimal level of pollution is Q*  Marginal Social Cost at the optimum is P*   Marginal Private Cost at optimum is P p.

Optimal tax exactly internalizes externality:   t* = P* - P p Effectively raises MC of production

$/unit Basic Setup: Env Costs, Private Costs, Social Costs MSC MPC P* MEC P p Q* Q c D Dirty Good

$/unit P* P p Q* Q c MSC MPC (with tax) t* MPC (no tax) D Q (pollution)

Problem: How to reduce VOC emissions in LA without increasing costs?

   Where do VOC’s come from?

 Painting, cleaning in manufac, cars Current regime: command and control   NSPS: “Control Technology Guidelines” (new source performance standards) SIP’s: firm by firm rules (state implementation plan)  Example: automobiles • • • Technology requirements Emission limits per mile How could this be done differently?

Alternatives    #1: emmission fees, $1/lb. of VOC #2: marketable permit – issue permits for 500 tons Get equimarginal principal in either case (Why?)

Problem: Too many houses being built in SB; want to

 

slow growth. How?

Current regime: command-and-control tools      Zoning Lengthy permit requirements Goldplated regulations (add’l requirements: code) Infrastructure fees Limit critical inputs (e.g., water) Alternative approaches    Fees • • • Increased property tax Building permits: $1000/square foot Land conversion fee Marketable permits • • • Issue 100 permits per year (or 200,000 sq. ft.) Auction permits Give away permits – what is effect?

What are differences with between fees and marketable permits?