Karl Schlegel April 1 st, 2008

Some Basics Use market mechanisms to change behavior. Alternative to direct social regulation. Used on behaviors society disapproves of.

Relation to Key Tool Features Coerciveness: Low Relies on legal authority to implement. Only creates financial incentives for behavior. Directness: Low Government directly implements the system. Does not dictate or mandate behavior.

Relation to Key Tool Features Visibility: High Need to be explicitly approved by legislatures. Changes require discussion and debate. Automaticity: Moderately High Structures for collection must be created. Incentives automatically created by system.

Design Features – Corrective Taxes Some issues are common to all taxes: What to tax. How much to tax. How to tax. But, what is the objective? Raise Revenue. Behavioral Deterrence.

Design Features – Corrective Taxes Collection of the tax Administrators seek to minimize number of taxpayers. Collect from whatever side of the market is easier to administer and police: consumers or sellers. Incentive for change in behavior the same on either side.

Design Features – Corrective Taxes Compliance and enforcement Monitoring typically done through financial audits. Create financial incentives for illegal evasion. Countermeasures often already in place through other taxes.

Design Features – Corrective Fees Most considerations are similar to those of taxes. Collected outside the established system New administrative structures often required. Often receive different budgetary treatment More likely to be dedicated to specific use.

Examples: Corrective Taxes and Fees Alcohol and tobacco taxes. Environmental taxes and fees. Bottle Deposits. Gasoline taxes. Congestion Pricing.

Design Features – Permit Trading Not a tool for reducing overall behavior levels Standards of performance and the enforcement of those standards set through direct government regulation. Not utilized to raise government revenue. Allocate the burden for complying with a mandated reduction in behavior. Allow for emergence of markets with supply and demand

Design Features – Permit Trading Companies individually given a certain number of allowances to pollute annually “Licenses to Pollute.” Companies may “bank” allowances from year to year. Companies may also sell surplus allowances or purchase additional allowances Purchased from a company selling surplus allowances or government auctions.

Examples: Tradable Permits Clear Air Act Amendments of 1990 Mandated used of tradable permits for environmental regulation. Has not been utilized widely outside the United States.

Advantages: Corrective Charges and Taxes Flexible and efficient So long as behavior is sensitive to price. The “Double Dividend” Government raises revenue while serving a greater purpose Complements other regulatory tools

Disadvantages: Corrective Charges and Taxes Uncertainty No certain way to know how behavior will react to price. Direct regulation provides more certain outcome. Financial burdens Additional financial burden compared to direct regulation.

Advantages: Tradable Permits Overall emissions are at a set level Direct regulation provides ceiling. Utilize market forces to provide incentive to pollute less. Lower cost of achieving mandated levels Companies can make money and government doesn’t need to spend any.

Disadvantages: Tradable Permits Deals with overall levels of pollution Presumption that more pollution in one area may be offset by less in another Not necessarily true over large geographic areas. Creates the dangerous potential for “hot spots.”

Political Considerations Corrective Taxes and Charges Generally very popular politically. “Do good while doing well for the treasury…” General opposition if tax or fee is considered “too high.” Tradable Permits Opposition to giving companies “Licenses to pollute.” Flexible reforms have been slow without increased direct regulation. Those who want flexible reforms oppose more direct regulation.