Environmental and Natural Resource Economics 2nd ed. Jonathan M. Harris Updates for 2012 Chapter 16: Pollution Analysis and Policy Copyright © 2012 Jonathan M. Harris

Figure 16.1: Marginal Costs of Pollution Damage and Control The economic approach to pollution is to balance the marginal costs of pollution against the marginal costs of control. Since marginal damage costs typically rise with greater pollution, and marginal control costs also rise as stricter pollution control targets are adopted, there should be some optimum point, in between maximum pollution (the level that would exist with no controls) and zero pollution (a possibly unattainable goal). Since marginal cost curves are generally not directly observable, it is necessary to use a variety of policies to attempt to achieve the “optimum” pollution control level.

Figure 16.2: A Per-Unit Charge for Pollution Emissions Economists often advocate a pollution tax, or per-unit emissions charge. At any given tax level, it is profitable for business to clean up pollution rather than the pay the tax, so long as the marginal cost of cleanup is lower than the tax. In the graph, tax T1 leads to pollution reduction to level Q1, while a higher tax of T2 lead to more cleanup, to pollution level Q2. At tax T1, firms that clean up to level Q1 pay area E in cleanup costs rather than E+F in tax, saving area F. They still pay areas B+D in tax on the pollution that they continue to emit. At T2, firms will be willing to pay an extra cleanup cost equal to areas C+D in order to reduce their tax bill to areas A+B.

Figure 16.3: A Transferable Pollution Permit System An alternative to a pollution tax is a system of transferable (tradable) permits. In this example, two firms that are originally emitting 50 units of pollution each are issued 30 pollution permits each. Without trade, each will have to clean up 20 units, for a total control cost of $8,000. With trade, Firm 1, which has lower marginal control costs, can clean up 30 units, and sell 10 permits to Firm 2. Firm 2, having purchased an extra 10 permits, only has to clean up 10 units. The total cost is now only $6,000 for the same cleanup of 40 units total. This cost efficiency is one reason why economists often favor transferable permit systems. The best-known example of a successfully tradable permit system is the sulfur and nitrogen oxide cleanup mandated in the U.S. Clean Air Act Amendments of 1990.

Figure 16.4: Linear and Nonlinear Pollution Damage Effects A complicating issue in pollution control is the shape of the marginal pollution damage curve. If this curve is linear or near-linear, determination of an “optimum” control level is easier. But if the curve is non-linear or has threshold effects, a small error in pollution control policy can lead to a large increase in damages. For some pollutants, such as heavy metals like mercury, the pollution tax or transferable permit approaches may be inappropriate, since high local concentrations of heavy metal pollution could lead to severe damage.

Figure 16.5: Pollution Control with Steep Marginal Damage Costs In general, the choice of pollution control policy should be governed by what is known about the shape of the marginal damage and marginal control cost curves. If the marginal damage costs rise steeply, as shown above, while the marginal control costs are fairly stable, the use of a pollution tax policy can lead to large errors. In the graph above, if the tax is even slightly too low (T1 rather than T0), pollution damage rises dramatically as firms choose to pay the tax rather than clean up. In this case, a quantity control mechanism such as permit allocation or direct regulation would be more likely to achieve the desired result.

Figure 16.6: Pollution Control with Steep Marginal Control Costs If marginal control costs rise steeply while the marginal damage curve is fairly flat, a tax policy is effective, with variations in the tax (between T1 and T2) leading to relatively small changes in cleanup levels (Q2 or Q3). On the other hand, an excessively strict quantity control (at Q1) can lead to soaring costs in return for relatively small benefits. Industries often argue that this situation prevails, putting them at risk of bankruptcy if regulations are too strict – but the experience of successful (and low-cost) policies such as the sulfur and nitrogen dioxide cleanup in the U.S. suggests that very high marginal control costs are the exception rather than the rule.

Figure 16.7: The Impact of Technological Change Different policies have different effect over time, as technological progress reduced the costs of pollution cleanup. In the case of a pollution tax (T0), a reduction in marginal control costs to MC*C leads firms to do more cleanup, since the marginal cost of cleaning up from Q0 to Q1 is now less than the tax. But if a transferable permit system requires cleanup to Q0 at a permit price of P0, a technologically-driven reduction in cleanup costs will have the effect of reducing the permit price to P1. This could have the perverse effect of encouraging some firms to emit more pollution since they can buy permits for it at a lower price. In this case, regulators would need to “tighten up” the system by reducing the total number of permits available, in order for the technological advance to result in less pollution rather than merely in lower costs to firms.

Figure 16.8: Emissions and Accumulation of a Stock Pollutant The case of a stock, or cumulative pollutant, is more difficult to deal with. Rather than balancing marginal costs of damage and control, it is necessary to try to limit total damage, which is based on long-term accumulation of the pollutant rather than on emission levels. As shown above, a linearly increasing emissions level (years 0-20) leads to a more rapidly increasing accumulation, and emissions control at a certain level (Emax, years 20-40) does not limit damage, since accumulations continue to rise. Even with steadily declining emissions (years 40-60), accumulations and damage continue to increase, though at a slower rate. In order to prevent greater damage, it is necessary to reduce emissions of the stock pollutant to zero. This determination has been made for cumulative pollutants such as DDT, PCBs, CFCs, and other ozone depleters, and may also be appropriate for atmospheric carbon (as discussed in Chapter 18).