Environmental Policies: Principles and Instruments. 1. Environmental taxes and standards - Optimal pollution level - The Pigouvian tax - Taxes vs. Standards 2. Natural resource management and intertemporal or intergenerational choices
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1. Environmental taxes and standards
- Optimal pollution level
- The Pigouvian tax
- Taxes vs. Standards
2. Natural resource management and intertemporal or intergenerational choices
- Next generations and the problem of the discounted value
- Optimal extraction (exploitation) rate
Recall that: the optimal allocation of the environmental resources can be restored by assigning exclusive property rights and allowing for free transactions on them (Coase Theorem)
The achievement of this social optimum still being the objective, environmental policies are designed to efficiently pursue this objective any time voluntary negotiations and trade do not occur or become too costly or favour speculative strategic behaviour (free-riding, for instance).
We analyse now some classical environmental policy instruments that aim at restoring optimal use by affecting the voluntary behaviour of agents (mostly, of those who use the environmental goods, the “polluters”): :
E. payments (or subsidies or incentives)
E. negotiable rights (permissions)
We discuss these instruments in terms of ability to achieve the optimal pollution level (the optimal combination between social benefits and costs) but also in terms of distributional effects (who is going to pay the costs, who is going to receive the benefits)
Let’s go back to our simple “model”: the polluter vs. the polluted; the private good (Q) vs. the public good (E). In general terms, starting from zero-pollution we can think about 3 different levels of pollution:
OPTIMAL NEGATIVE EXTERNALITY (POLLUTION)
NON-OPTIMAL NEGATIVE EXTERNALITY (POLLUTION)
(Pareto relevant: regulation)
Pollution level that does not imply costs (reduction of welfare) ( zero pollution)
In the case of “polluter vs. polluted”, even when the negotiation a lá Coase does not work, it remains possible to restore the optimal pollution level (QS) through a direct intervention of the “State” (“Government”) that eliminates the Pareto-relevant negative externality
The solution relies on the internalization of the social cost, that is, on making social cost be part of the private (polluter) cost in producing Q. This can be achieved by introducing a tax on production of Q.
A tax on the polluting good (Q) that equalizes private costs and (relevant) social costs is also called Pigouvian tax (A.C. Pigou)
In many applications, environmental (or pollution) taxes behave as Pigouvian taxes.
Let’s see, conceptually, how such tax is expected to work
Bm(Q)t = Bm(Q) - t
(Bm(Q)t + t) = Bm(Q) – t + t = Bm(Q)
If the standard has also an economic (allocative) purpose (achieving the social optimum) it should be fixed at QS and the minimum (and efficient) sanction at MS. The sanction acts as the Pigouvian tax in allocative terms, while it has no distributional implications (no polluter pays principle, no over-taxation)
As for the environmental tax, the sanction is a cost for the polluter. Therefore, a standard exclusively satisfying a “technical” objective Q* implies a minimum sanction of M*.
It must be taken into account, however, that the sanction is not certain any time the standard is exceeded (violated). It depends on how difficult and costly controlling activities are. The polluter will thus behave on the base of the expected sanction (or the actual sanction), that is, MP = p MS, where p is the probability of being sanctioned upon violation of the standard. If p = 0.5, the actual sanction is 1/2 MS and the standard will be not respected (QP)unless the sanction is raised to 2MS
PROS (+) and CONS (-)
C&C = Command and Control
So far, the problem of optimal allocation of an environmental good E (i.e., of pursuing the maximum net social benefit) has been worked out by comparing CURRENT costs and benefits associated to the use of this good.
This static representation, however, does not fit the actual concerns related to the use of many natural resources where costs and benefits differently occur anddistribute over time
We need to make explicit that these resources behave as stock that can be used either in the current period or in next periods. Therefore, choices about resource use have an inherent dynamic (intertemporal) dimension.Such dimensionconcerns two different aspects:
How future generations will use/demand this resource
How the resource stock evolves over time
The allocation problem thus becomes to find TODAY the optimal exploitation/extraction rate. Such optimal resource exploitation substantially differs for the two different kind of natural resources:
NON-RENEWABLE (EXHAUSTIBLE) RESOURCES: fossil energy, mineral resources, etc.
RENEWABLE RESOURCES: forestry resources, fishery resources, water resources etc.
In principle, the idea of optimality can be maintained: maximization of the Net Social Benefit. Now, however, the “society” is the aggregation of current and next generations and its net benefit is the difference between the flow of benefits B(E)tand of costs C(E)t over time:
Algebraic summation of such benefits and costs, however, incur the problem of comparing monetary values over different periods of time. This problem is tackled by comparing the current value of benefits and costs, therefore by discounting all values at the discount rate r.
Therefore, the maximization of the current (discounted) intertemporal net social benefit (SB0) (thus achieving the optimal allocation of E across generations/periods) is expressed as:
This is evident in the case of exhaustible resources:
Any generation will obtain a net benefit B(Q)t from resource extraction. Due to absolute scarcity, quantity used by time t generation is definitively missed for time (t+n) generations. Therefore, B(Q) t+n becomes an opportunity cost associated to B(Q)t; in other words, it is the option value of the resource itself.
Without an intergenerational coordination, in any period t there will be tendency to over-utilize the resource to the level Q* for which Bm(Q*)t = 0.
At such exploitation rate, however, there will correspond an opportunity cost for the following periods whose discounted value is B(Q*)t+1/(1+r). A generation that is not aware of this implicit cost implicitly assumes a very high discount rate that makes this opportunity cost negligible. Therefore, the discount rate in such context is somehow a measure of the degree of “egoism” of present generations with respect to future generations.
Let’s consider this problem of intergenerational coordination in an oversimplified situation (model): one good (E) and only two generations (t = 1, 2)
Optimal intertemporal extraction of exhaustible natural resources - 1
Optimal intertemporal extraction of exhaustible natural resources - 2
QT - Q1 = Q2 (expresses the extraction of second generation)
We can better appreciate this result graphically :
Optimal intergenerational allocation of stock QT under a non-null discount rate. The higher is r, the larger is the use of current generation (Q1), the lower the amount left to generation 2 (Q2)
Optimal intergenerational allocation of stock QT only when the discount rate is null (r = 0; no intertemporal preference).
Optimal use of current generation (Q1) under an infinite discount rate (r=∞) expressing the lack of intergenerational coordination
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