These pages first explain why the appropriate level of environmental quality, or alternatively, the "efficient quantity of pollution", is not a matter that should be left to the free and unregulated private market. More importantly, however, these pages explain why economists insist that having the government establish pollution emissions fees can result in the achievement of the "efficient quantity of pollution' at a lower cost than mandatory quantitative controls. Alternatively, having the government issue a given quantity of "licenses to pollute" that are fully marketable can be Just as effective as pollution emission fees. Since this article was written, the "marketable pollution permit" approach has gained wider application and even has been applied on a small scale in Southern California as well as for sulfur dioxide in the Clean Air Act of 1990.
All this progress would seem to be cause for celebration. But economists are frowning---and not because they do not prize cleaner air and water, but rather because our current polities make environmental protection far too costly. America can achieve its present levels of air and water quality at far lower cost, economists insist. The nation is, in effect, shopping for cleaner air and water in a high-priced store when a discount house is just around the corner. Being natural cheapskates, economists find this extravagance disconcerting. Besides, if we shopped in the discount store, we would probably buy a higher-quality environment than we do now ....
... Nothing in this discussion... implies that the appropriate level of environmental quality is a matter for the free market to determine. On the contrary, the market mechanism is ill suited to the task; if left to its own devices, it will certainly produce excessive environmental degradation. Why? Because users of clean air and water, unlike users of oil and steel, are not normally made to pay for the product.
Consider a power plant that uses coal, labor, and other inputs to produce electricity. It buys all these items on markets, paying market prices. But the plant also spews soot, sulfur dioxide, and a variety of other undesirables into the air. In a real sense, it "uses up" clean air--one of those economic goods which people enjoy--without paying a penny. Naturally, such a plant will be sparing in its use of coal and labor, for which it pays, but extravagant in its use of clean air, which is offered for free.
That, in a nutshell, is why the market fails to safeguard the environment. When items of great value, like clean air and water, are offered free of charge it is unsurprising that they are overused, leaving society with a dirtier and less healthful environment than it should have.
The analysis of why the market fails suggests the remedy that economists have advocated for decades: charge polluters for the value of the clean air or water they now take for free. That will succeed where the market fails because an appropriate fee or tax per unit of emissions will, in effect, put the right price tag on clean air and water--just as the market now puts the right price tag on oil and steel. Once our precious air and water resources are priced correctly, polluters will husband them as carefully as they now husband coal, labor, cement, and steel. Pollution will decline. The environment will become cleaner and more healthful ....
The Efficiency Argument
It is now time to explain why economists insist that emissions fees can clean up the environment at lower cost than mandatory quantitative controls. The secret is the market's unique ability t~ accommodate individual differences---hi this case, differences among polluters.
Suppose society decides that emissions of sulfur dioxide must decline by 2C percent. One obvious approach is to mandate that every source of sulfur dioxide reduce its emissions by 20 percent. Another option is to levy a fee on discharges that Is large enough to reduce emissions by 20 percent. The former is the way our current environmental regulations are often written. The latter is the economist's preferred approach. Both reduce pollution to the same level, but the fee system gets there more cheaply. Why? Because a system of fees assigns most of the job to firms that can reduce emissions easily and cheaply and little to firms that find it onerous and expensive to reduce their emissions.
Let me illustrate how this approach works with a real example. A study in St. Louis found that it cost only $4 for one paper-products factory to cut particulate emissions from its boiler by a ton, but it cost $600 to do the same job at a brewery. If the city fathers instructed both the paper plant and the brewery to cut emissions by thc same amount, pollution abatement cost would be low at the paper factory but astronomical at the brewery'. Imposing a uniform emissions tax is a more cost-conscious strategy. Suppose a $100/tor tax is announced. The paper company will see an opportunity to save $100 in taxes by spending $4 on cleanup, for $96 net profit. Similarly, any other firm whose pollution-abatement costs are less than $100 per ton will find it profitable to cut emissions. But firms like the brewery, where pollution-abatement costs exceed $100 per ton, will prefer to continue polluting and paying the tax. Thus the profit motive will automatically assign the task of pollution abatement to the low-cost rums--something no regulators can do.
Mandatory proportional reductions have the seductive appearance of "fairness" and so are frequently adopted. But they provide no incentive to minimize the social costs of environmental clean-up. In fact, when the heavy political hand requires equal percentage reductions by every firm (or perhaps from every smokestack), it pretty much guarantees that the social clean-up will be far more costly than it need be. In the previous example, n one-ton reduction in annual emissions by both the paper factory and the brewery would cost $604 per year. But the same two-ton annual pollution abatement would cost only $8 if the paper factory did the whole job. Only by lucky accident will equiproportionate reductions in discharges be efficient.
Studies that I will cite later... suggest that market-oriented approaches to pollution control can reduce abatement costs by 90 percent in some cases. Why, economists ask, is it more virtuous to make pollution reduction hurt more? They have yet to hear a satisfactory answer and suspect there is none. On the contrary, virtue and efficiency are probably in harmony here. If cleaning up our air and water is made cheaper, it is reasonable to suppose that society will buy more clean-up. We can have a purer environment and pay less, too. The hardheaded economist's crass means may be the surest route to the soft-hearted environmentalist's lofty ends.
The Enforcement Argument
Some critics of emissions fees argue that a system of fees would be hard to enforce, in some cases, they are correct. We obviously cannot use effluent charges to reduce concentrations of the unsightly pollutant glop if engineers have yet to devise an effective and dependable devise for measuring how much glop firms are spewing out. If we think glop is harmful, but are unable to monitor it our only alternative may be to require firms to switch to "cleaner" technologies. Similarly, emissions charges cannot be levied on pollutants that seep unseen --and unmeasured--into groundwater rather than spill out of a pipe.
In many cases, however, those who argue that emissions fees are harder to enforce than direct controls are deceiving themselves, if you cannot measure emissions, you cannot charge a fee, to be sure. But neither can you enforce mandatory standards; you can only delude yourself into thinking you are enforcing them. To a significant extent, that is precisely what the EPA does now. Federal antievolution regulations are poorly policed; the EPA often declares firms in compliance based on nothing more than the firms' self-reporting of their own behavior. When checks are made, noncompliance is frequently uncovered. If emissions can be measured accurately enough to enforce a system of quantitative controls, we need only take more frequent measurements to run a system of pollution fees.
Besides, either permits or taxes are much easier to administer than detailed regulations. Under a system of marketable permits, the government need only conduct periodic auctions. Under a system of emissions taxes, the enforce-merit mechanism is the relentless and anonymous tax collector who basically reads your meter like a gas or electric company. No fuss, no muss, no bother--and no need for a big bureaucracy. Just a bill. The only way to escape the pollution tax is to exploit the glaring loophole that the government deliberately provides: reduce your emissions.
Contrast this situation with the difficulties of enforcing the cumbersome command-and-control system we now operate. First, complicated statutes must be passed; and polluting industries will use their considerable political muscle in state legislatures and in Congress to fight for weaker laws. Next, the regulatory agencies must write detailed regulations defining precise standards and often prescribing the "best available technology" to use in reducing emissions. Here again industry will do battle, arguing for looser interpretations of the statutes and often turning the regulations to their own advantage. They are helped in this effort by the sheer magnitude of the information-processing task that the law foists upon the EPA and state agencies, a task that quickly outstrips the capacities of their small staffs.
Once detailed regulations are promulgated, the real problems begin. State and federal agencies with limited budgets must enforce these regulations on thousands, if not millions, of sources of pollution. The task is overwhelming. As one critic o! the system put it, each polluter argues:
Yet other factors argue for market-based approaches to pollution reduction.
One obvious point is that a system of mandatory standards, or one in which a particular technology is prescribed by law, gives a firm that is in compliance with the law no incentive to curtail its emissions any further. Ur the law says that the firm can emit up to 500 tons of glop per year, it has no reason to spend a penny to reduce its discharges to 499 tons. By contrast, a firm that must pay $100 per ton per year to emit glop can save money by reducing its annual discharges as long as its pollution-abatement costs are less than $100 per ton. The financial incentive to reduce pollution remains.
A second, and possibly very important, virtue of pollution fees is that they create incentives for firms to devise or purchase innovative ways to reduce emissions. Under n system of effluent fees, businesses gain if they can find cheaper ways to control emissions because their savings depend on their pollution abatement, not on how they achieve it. Current regulations, by contrast, often dictate the technology. Firms are expected to obey the regulators, not to search for creative ways to reduce pollution at lower cost.
For this anti other reasons, our current system of regulations is unnecessarily adversarial. Businesses feel the government is out to harass them--and they act accordingly. Environmental protection agencies lock horns with industry in the courts. The whole enterprise takes on the atmosphere of a bullfight rather than that of a joint venture. A market-based approach, which made clear that the government wanted to minimize the costs it imposed on business, would naturally create a more cooperative spirit. That cannot be bad.
Finally, the appearance of fairness when regulations take the form of uniform percentage reductions in emissions, as they frequently do, is illusory. Suppose Clean Jeans, inc. has already spent a considerable sum to reduce the amount of muck it spews into the Stench Rivet. Dirty Jeans, inc., just downriver, has not spent a cent and emits twice as much. Now a law is passed requiring every firm along the Stench to reduce its emissions by 50 Percent. That has the appearance of equity but not the substance. For Dirty Jeans, the regulation may be a minor nuisance. To comply, it need only do what Clean Jeans is already doing voluntarily. But the edict may prove onerous to Clean Jeans, which has already exploited all the cheap ways to cut emissions. In this instance, not only is virtue not its own re-ward--it actually brings a penalty! Such anomalies cannot arise under a system of marketable pollution permits. Clean Jeans would always have to buy fewer permits than Dirty Jeans ....
Despite the many powerful arguments in favor of effluent taxes or marketable emissions permits, many people have an instinctively negative reaction to the whole idea. Some environmentalists, in particular, rebel at economists' advocacy of market-based approaches to pollution control--which they label "licenses to pollute," a term not meant to sound complimentary. Former Senator Muskie's dictum, quoted at the beginning of this chapter, is an example. The question is: Are the objections to "licenses to pollute" based on coherent arguments that should sway policy, or are they knee-jerk reactions best suited to T-shirts?* My own view is that there is little of the former and much of the latter. Let me explain.
Some of the invective heaped upon the idea of selling the privilege to pollute stems from an ideologically based distrust of markets. Someone who does not think the market a particularly desirable way to organize the production of automobiles, shirts, and soybeans is unlikely to trust the market to protect the environment. As one congressional staff aide put it: "The philosophical assumption that proponents of [emissions] charges make is that there is a free-market system that responds to ... relative costs.... I reject that assumption." This remarkably fatuous statement ignores mountains of evidence accumulated over centuries. Fortunately, it is a minority view in America. Were it the majority view, our economic problems would be too severe to leave much time for worry about pollution.
Some of the criticisms of pollution fees are based on ignorance of the arguments or elementary errors in logic. As mentioned earlier, few opponents of market-based approaches can even explain why economists insist that emissions fees will get the job done more cheaply.
One commonly heard objection is that a rich corporation confronted with a pollution tax will pay the tax rather than reduce its pollution. That belief shows an astonishing lack of respect for avarice. Sure, an obstinate but profitable company could pay the fees rather than reduce emissions. But it would do that only if the marginal costs of pollution abatement exceed the fee. Otherwise, its obduracy reduces its profits. Most corporate executives faced with a pollution tax will improve their bottom lines by cutting their emissions, not by flouting the government's intent. To be sure, it is self-interest, not the public interest, that motivates the companies to clean up their acts. But that's exactly the idea behind pollution fees....
One final point should lay the moral issue to rest. Mandatory quantitative standards for emissions are also licenses to pollute--just licenses of a strange sort. They give away, with neither financial charge nor moral condemnation, the right to spew a specified amount of pollution into the air or water. Then they absolutely prohibit any further emissions. Why is such a license morally superior to a uniform tax penalty on all pollution? Why is a business virtuous if it emits 500 tons of glop per year but sinful if it emits 501? Economists make no claim to be arbiters of public morality. But I doubt that these questions have satisfactory answers.
The choice between direct controls and effluent fees, then, is not a moral issue. It is an efficiency issue. About that, economists know a thing or two.
Having made my pitch, I must confess that there are circumstances under which market-based solutions are inappropriate and quantitative standards are better. One obvious instance is the case of a deadly poison. If the socially desirable level of a toxin is zero, there is no point in imposing an emission fee. An outright ban makes more sense.
Another case is a sudden health emergency. When, for example, a summertime air inversion raises air pollution in Los Angeles or New York to hazardous levels, it makes perfect sense for the mayor: of those cities to place legal limits on driving, on industrial discharges, or on both There is simply no time to install a system of pollution permits.
A final obvious case Is when m adequate monitoring device exists, as is the case of runoff from soil pollution Then a system of emissions fees is out of the question. But so also is a system o direct quantitative controls on emissions The only viable way to control auto pollution may be to mandate that cleaner technologies be used.
But each of these is a minor, and well-recognized, exception to an overwhelming presumption in the opposite direction. No sane person has ever proposed selling permits to spill arsenic into water supplies. None has suggested that the mayor of New York set the effluent tam on carbon monoxide anew after hearing the weather forecast each morning. Ant no one has insisted that we must meter what cannot be measured. Each of these objections is a debater's point, not a serious challenge to the basic case for market-oriented approaches to environmental protection ....
There are signs, however, that environ mental policy may be changing for the better. The EPA seems to be drifting slowly, and not always surely, away from technology-driven direct controls toward more market-oriented approaches. But not because the agency has been convinced by the logic of economists' arguments. Rather, it was driven into a corner by the inexorable illogic of its own procedures. Necessity proved to be the midwife of common sense.
The story begins in the 1970s, when it became apparent that many regions of the country could not meet the air quality standards prescribed by the Clean Air Act. Under the law, the prospective penalty for violating of the standards was Draconian: no new sources of pollution would be permitted in these regions and existing sources would not be allowed to increase their emissions, implying a virtual halt to local economic growth. The EPA avoided the impending clash between the economy and the environment by creating its "emissions-offsets" program in 1976. Under the new rules, companies were allowed to create new sources of pollution in areas with substandard air quality as long as they reduced their pollution elsewhere by greater amounts. Thus was emissions trading born.
The next important step was Invention of the "bubble" concept in 1979. Under this concept, all sources of pollution from a single plant or firm are imagined to be encased in a mythical bubble. The EPA then tells the company that it cares only about total emissions into the bubble. How these emissions are parceled out among the many sources of pollution under the bubble is no concern of the EPA. But it is vital to the firm, which can save money by cutting emissions in the least costly way. A striking example occurred in 1981 when a DuPont plant in New Jersey was ordered to reduce its emissions from 119 sources by 85 percent. Operating under a state bubble program, company engineers proposed instead that emissions from seven large stacks be reduced by 99 percent. The result? Pollution reduction exceeded the state's requirement by 2,300 tons per year and DuPont saved $12 million in capital costs and $3 million per year in operating costs.
Partly because it was hampered by the courts, the bubble concept was little used at first. But bubbles have been growing rapidly since a crucial 1984 judicial decision. By October 1984, about seventy-five bubbles had been approved by the EPA and state authorities and hundreds more were under review or in various stages of development. The EPA estimated the cost savings from all these bubbles to be about $800 million per year. That may seem a small sum compared to the more than $70 billion we now spend on environmental protection. But remember that the whole program was still in the experimental stage, and these bubbles covered only a tiny fraction of the thousands of industrial plants in the United Slates.
The bubble program was made permanent only when EPA pronounced the experiment a success and issued final guidelines in November 1986. Economists greeted this announcement with joy. Environmentalist David Doniger... complained that, "The bubble concept is one of the most destructive impediments to the cleanup of unhealthy air." By now, many more bubbles have been approved or are in the works. Time will tell who was right.
The final step in the logical progression toward the economist's approach would be to make these "licenses to pollute" fully marketable so that firms best able to reduce emissions could sell their excess abatement to firms for which pollution abatement is too expensive. Little trading has taken place to date, though the EPA's November 1986 guidelines may encourage it. But at least one innovative state program is worth mentioning.
The state of Wisconsin found itself unable to achieve EPA-mandated levels of water quality along the polluted Fox and Wisconsin Rivers, even when it employed the prescribed technology. A team of engineers and economists then devised a sophisticated system of transferable discharge permits. Firms were issued an initial allocation of pollution permits (at no charge), based on historical levels of discharges. In total, these permits allow no more pollution than is consistent with EPA standards for water quality. But firms are allowed to trade pollution permits freely in the open market. Thus, in stark contrast to the standard regulatory approach, the Wisconsin system lets the firms along the rivet--not the regulators--decide how to reduce discharges. Little emissions trading has taken place to date because the entire scheme has been tied up in litigation. But one study estimated that pollution-control costs might eventually tall by as much as 80 percent compared to the alternative of ordering all firms along the river to reduce their discharges by a uniform percentage.
The state of Wisconsin thus came to the conclusion that economists have maintained all along: that applying a little economic horse sense makes it possible to clean up polluted rivers and reduce costs et the same time-a good bargain. That same bargain is available to the nation for the asking....
Economists who specialize in environmental policy must occasionally harbor self-doubt. They find themselves lined up almost unanimously in favor of market-based approaches to pollution control with seemingly everyone else lined up on the other side. Are economists crazy or is everyone else wrong?
... I have argued the seemingly implausible proposition that environmental economists are right and everyone else really is wrong. I have tried to convey a sense of the frustration economists feel when they see obviously superior policies routinely spurned. By replacing our current command-and-control system with either marketable pollution permits or taxes on emissions, our environment can be made cleaner while the burden on industry is reduced. That is about as close to a free lunch as we are likely to encounter. And yet economists' recommendations are overwhelmed by an unholy alliance of ignorance, ideology, and self-interest.
This is a familiar story. The one novel aspect in the sphere of environmental policy is that the usual heavy hitter of this triumvirate self-interest--is less powerful here than in many other contexts. To be sure, self-interested business lobbies oppose pollution fees. But, as I pointed out, they can be bought off by allowing some pollution free of charge. Doing so may outrage environmental purists, but it is precisely what we do now.
It is the possibility of finessing vested financial Interests that holds out the hope that good environmental policy might one day drive out the bad. For we need only overcome ignorance and ideology, not avarice.
Ignorance is normally beaten by knowledge. Few Americans now realize that practical reforms of our environmental policies can reduce the national cleanup bill from more than $70 billion per year to less than $50 billion, and probably to much less. Even fewer understand the reasons why. If the case for market-based policies were better known, more and more people might ask the obvious question: Why is it better to pay more for something we can get for less? Environmental policy may be one area where William Blake's optimistic dictum --"Truth can never be told so as to be understood and not believed"--is germane.
Ideology is less easily rooted out, for it rarely succumbs to rational argument. Some environmentalists support the economist's case. Others understand it well and yet oppose it for what they perceive as moral reasons. I have argued at length that here, as elsewhere, thinking with the heart is less effective than thinking with the head; that the economist's case does not occupy the moral low ground; and that the environment is likely to be cleaner if we offer society clean-up at more reasonable cost. As more environmentalists come to realize that T-shirt slogans are retarding, not hastening, progress toward their goals, their objections may melt away.
The economist's approach to environmental protection is no panacea. It requires an investment in monitoring equipment that society has not yet made. It cannot work in cases where the sources of pollution are not readily identifiable, such as seepage into groundwater. And it will remain an imperfect antidote for environmental hazards until we know a great deal more than we do now about the diffusion of pollutants and the harm they cause.
But perfection is hardly the appropriate standard. As things stand now,
our environmental policy may be a bigger mess than our environment. Market-based
approaches that join the hard head of the accountant to the soft heart
of the environmentalist offer the prospect of genuine improvement: more
clean-up for less money, it is an offer society should not refuse.