1. Taxes, Standards and Tradable Permits 6-09-2009
Econ 201 Lecture 10.1d
Taxes, Standards
and Tradable Permits

2. Things You Ought to Look At

3. Negative Externality Marginal Private Costs < Marginal Social Costs
Ideal
Actual Pi Pa

4. Remedies for Negative Externalities
Standards
Permissible level of emissions for each factory in an industry (each industry gets same target), or
Targets how much emissions must be reduced by each factory (again, same target for all)
Taxes
Direct tax on emissions
Indirect on input/output if there is a direct correlation between input/output and pollution
E.g., tax on gasoline, coal based on sulfur content
Tradable permits
Gives each firm the “right” to pollute to a certain level
Firms are allowed to trade/sell permits

5. Negative Externalities & Taxes
How to Set the Optimal tax
Set at point where MBen = MCost of Pollution
Tax: equals difference between MSC and MPC and
“internalizes” it into the consumption decision
Firm’s cost = price*quantity of inputs plus tax*emissions/output
Tax

6. Coase’s Theorem
If property rights exist and transaction (bargaining) and information costs are low
Then parties will be able to bargain among themselves (without government intervention) to obtain an efficient outcome

7. Comparison of Approaches
Standards
Can also produce optimal level of pollution
But set same standard for all firms (and are not productively efficient, e.g. min cost)
To set individual quotas: requires knowledge of each firm’s costs
But have higher administrative costs
Not only have to monitor emissions
Enforcement costs: legal proceedings (time delays and expense)
Not very flexible: regulatory process for changing standards
Provide no incentive for firms to reduce pollution below current “authorized” levels

8. Comparison of Approaches
Standards
Are most useful when:
Problem is short-lived (“burn” bans for high pollution days)
Optimal level is zero

9. Comparison of Approaches
Taxes
Can produce “optimal” amount of pollution at minimum costs and lower administrative costs
Kneese (1977): comparing taxes versus standards found that desired quality costs half as much using taxes
Automatically allocates pollution levels among firms based on their costs
Provides incentive for firms to reduce pollution levels through technological innovation
Easy to adjust/”tune”
Tax revenues can be used finance admin costs

10. And They Are Endorsed by the Sierra Club!
Sierra Club Conservation Policies
Pollution Taxes
make it less expensive for a polluter to adopt alternative processes or invest in additional equipment to curtail releases to the environment
Taxes would supplement, and not replace, standards on maximum permissible emissions.
Taxes should be imposed when the following conditions are found to prevail generally:
for competitive or other reasons, cost-minimizing behavior tends to exist in the company or industry;
the cost of abatement is significant,
the quantity of the pollutant released can be determined with reasonable accuracy,
cost of monitoring should be small in relation to the tax revenue expected in the absence of abatement.
Adopted by the Board of Directors, February 13-14, 1997

11. Comparison of Approaches
Tradable Permits
Cost efficient
Firms will purchase permits from more efficient firms if permit cost < abatement (technology) costs
Technological incentive to reduce pollution
Marginal cost of abatement = permit cost
Similar to taxes
Administratively simpler
Require less information about the firms’ cost
Better able to handle “spatial” variation in pollution
Fewer permits auctioned in bad areas
Adjust “automatically” for changes in inflation and growth
If auctioned -> revenues for admin costs

12. Text’s Taxonomy Distinguishing between private and public goods
Non-excludability: no way to prevent consumers from deriving benefits from provided good (e.g., national defense, parks?)
Non-rival consumption: my consumption of the good does not reduce the amount available to another

13. Positive Externality
Private Marginal Benefits < Social Marginal Benefits

14. What’s the Regulatory Solution?
Problem is:
Since SMB > PMB
Underproduction of the good
“Free-rider” problem
Traditional Solution
Increase production by subsidizing production of the good (i.e., reducing its costs of production)
In this case: subsidy does not lead to inefficiency
Use of income taxes, license fees -> not linked directly to consumption of the good
Tax reductions – reduce taxes on good (e.g. low income housing, green buildings)