Question

4 The government sees a cement company polluting the river. They want to internalize the externality of the cleanup costs to get the water safe for recreational use. They have two choices to accomplish their goal. They can either put a tax on a certain level of pollution or create a regulation that limits the amount of pollution allowed. If they use a regulation should they allow for pollution permits? Explain the benefits and detriments of each form of control. What would you recommend and why?

Answer 1

Having regulations on air pollution does not say how they will be achieved . So in addition to regulations, taxes, directives are required to reduce pollution.Market based scheme which reduce pollution are known as pollution permits.They encourage firms to reduce pollution.It is good to reduce pollution through market incentives.

The government imposes tax to make the producers and consumers pay social cost for creating pollution. Eg petrol tax , carbon tax.With the use of tax ,the government can raise sufficient revenue which can be used to finance pollution reduction programs. The firms and consumers switch to less fuel intensive engines as a result of petrol tax. However demand for petrol is inelastic and will not reduce demand much and so will have less impact on pollution.But in the long run people will shift to other mode of transport and pollution might reduce.The cost involved in implementing green tax is costly.People do not like paying taxes even though they know it will reduce pollution in the long run.Many regulations have been created to limit pollution.The advantage is that pollution levels will actually be reduced rather than depending on market demand incentives.These regulations were effective in reducing smog in London IN 1950. Regulation banned houses from using coal .The important drawback is difficulty at implementing.

I would recommend reducing pollution through taxes because they  bring revenue to the government.