Question

7.) Externalities, the Environment, and Natural Resources

Contrary to popular belief, some forms of pollution were actually decreasing even before government programs were initiated to protect the environment. In what ways do voluntary efforts, direct controls, taxes on pollution, and tradable emissions permits incentivize emission reductions? Why do economists believe that the monetary incentives approach is the most efficient way to control harmful externalities?

Answer 1

a. Policy-makers have two broad types of instruments available for changing consumption and production habits in society. They can use traditional regulatory approaches (sometimes referred to as command-and-control approaches) that set specific standards across polluters, or they can use economic incentive or market-based policies that rely on market forces to correct for producer and consumer behavior.

Two basic types of traditional regulatory approaches exist. The first, a technology or design standard, mandates specific control technologies or production processes that polluters must use to meet an emissions standard. The second, a performance-based standard, also requires that polluters meet an emissions standard, but allows the polluters to choose any available method to meet that standard. Performance-based standards that are technology-based, for example, do not specify a particular technology, but rather consider what available and affordable technologies can achieve when establishing a limit on emissions. At times, EPA may completely ban or phase out the use or production of a particular product or pollutant, as it has done with chlorofluorocarbons (CFCs) and certain pesticides. Regulations can be uniform or can vary according to size of the polluting entity, production processes, or similar factors. Regulations are often tailored in this manner so that similar regulated entities are treated equally.

Fees, charges, and taxes are widely used incentives which generally place a per unit monetary charge (or fee or tax) on pollution emissions or waste to reduce the overall quantity. The main drawback is that fees, charges and taxes cannot guarantee a specific amount of pollution reduction, only that those who pollute will be penalized. Examples include pollution taxes, water user fees, wastewater discharge fees, and solid waste disposal fees.

Subsidies are forms of financial government support for activities believed to be environmentally friendly. Rather than charging a polluter for emissions, a subsidy rewards a polluter for reducing emissions. Examples of subsidies include grants, low-interest loans, favorable tax treatment, and procurement mandates. Subsidies have been used for a wide variety of purposes, including: brownfield development after a hazardous substance contamination; agricultural grants for erosion control; low-interest loans for small farmers; grants for land conservation; and loans and grants for recycling industrial, commercial and residential products. While subsidies offer incentives to reduce emissions similar to a tax, they also encourage market entry to qualify for the subsidy.

b. While traditional regulatory and voluntary approaches are valuable policy tools for some types of environmental problems, incentive based policies are becoming increasingly popular as tools for addressing a wide range of environmental issues, from acid rain to climate change. Market-based approaches or incentives provide continuous inducements, monetary and near-monetary, to encourage polluting entities to reduce releases of harmful pollutants. As a result, market-based approaches create an incentive for the private sector to incorporate pollution abatement into production or consumption decisions and to innovate in such a way as to continually search for the least costly method of abatement. A criticism of command-and-control policies is that firms are only encouraged to reduce to a regulated level. With market incentives, firms will reduce their emissions as long as it is financially valuable for them to do so, and this generally happens at a point where marginal abatement costs are equated across all regulated firms. Cost savings to firms also often translate into cost savings to customers who purchase products from regulated firms, resulting in lower overall social costs. The main disadvantage associated with economic incentives is that they can be inappropriate for dealing with environmental issues that pose equity concerns. Emissions trading programs, for example, could have the unintended consequence of concentrating pollution in economically-disadvantaged areas.