Incentive Based Strategies: Transferable Discharge Permits Lecture 20

While Taxes on emissions is an interaction between polluters and public authorities Transferable Discharge Permit (TDP) works in a more decentralized fashion Working through the interaction of polluters themselves

General Principles Property Rights? TDP: Every permit entitles its holder to emit one unit of pollutant over a period of time Begins by a centralized decision Upper limit on a quantity of effluent TDP are transferable

Current sulfur emissions are 150000 tons/month 100000 tons/month A power plant: 7000 tons/year Permit is for 5000 tons/year Reduce emissions to 5000 tons/year Buy more permits Reduce emissions to 4000 tons/month and sell the excess permits

There are gains from trade for the two polluters in trading a permit Firm A: Sell at $1200 and Firm B: Buy at anything less than $4000 In the trading of permits, and the adjustment of emissions in accordance with their permit holdings, these sources would be led to an outcome that satisfies the EMP

For satisfying equi-marginal principle, the permits shall be traded among different sources This requires a market for permits where tradable prices are publicly known Permits would flow from sources with relatively lower MAC to those with high abatement costs MAC1 = MAC2 = MAC3 = MAC N Subsequent market transactions will redistribute them in accordance with the relative marginal abatement costs of polluters whatever the original distribution may have been

The central authorities don’t need to know the MAC functions Trading of permits doesn’t alter total amount of emissions Make the policy equitable by distributing permits appropriately  Allocation formula Size of the firm Amount of firms present and the aggregate emissions occurring How much effort has already been put in to reduce emissions Careful of perverse incentives Source of revenue for public agencies by auctioning rights

Establish Trading Rules Public agency should establish some clear and simple rules and then allow trading to proceed Who may trade? Only potential traders or any other agencies – such as environmental protection groups at regional or national level Higher the public intervention, greater would the inefficiency in the efficient flow of permits, uncertainty among traders and transaction costs Size of trading areas

Factors that affect the damage functions of each emission point Non Uniform Emissions Factors that affect the damage functions of each emission point Distance MAC functions Different transfer coefficients

Source B is twice as damaging as source A, then former should buy two permits to get one! Zoned system; each zone relatively same damage function Make trading restricted to respective zones or make transfer coefficients for each zone Trading on one-to-one basis is not applicable

TDP and competition problem Markets work best under competitive economic environment Efficient interactions would lead to the right price of permit If the firms are few, trading zones should be set as widely as possible  include large number of buyers and sellers Traders might as well be widely dispersed, but polluters should not be!! Trading areas be restricted or defined broadly? Remember, potential traders are polluters!

TDP and Enforcement Check that sources are not emitting more than the amount of TDP they possess Number of permits Amount of emissions done Administrative agencies could keep a track of market transactions Self reporting of permit buyers Market for permits

TDP and incentives for R&D Reduce emissions by engaging in R&D program and hence save (a + c)

Problems of TDP Benefits Based on the efficiency of markets What is the allocation formula Monitor and enforce compliance Benefits Substantially lower costs of implementation Give incentives to the polluters to reduce level of emissions… Achieving e* is not the aim of polluters but that of policymakers