Econ 201 Lecture 10.1d

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

2. Things You Ought to Look At • http://facweb.northseattle.edu/dperry/econ201/Harris_AER_EnvEcon.pdf • http://facweb.northseattle.edu/dperry/econ201/The%20(Tuna)%20Tragedy%20of%20the%20Commons%20-%20Dot%20Earth%20Blog%20-%20NYTimes_com.mht

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)