On optimal audit mechanisms for environmental taxes

We consider the auditing problem of an environmental enforcement agency with fixed audit resources: How to decide which firms to audit after having observed the firms' taxable emissions reports. The goal of the agency is to implement the socially efficient emissions level. The audit mechanism is the agency's sole choice variable, while other variables such as the tax rate on emissions and the fine for non-compliance are determined by other governmental actors. The fines and budget of the agency are constrained in such a way that the common random audit mechanism fails to implement socially efficient emissions. Assuming perfect information among the firms, we derive an optimal audit mechanism capable of implementing the socially efficient emissions level. The optimal audit mechanism creates a contest exploiting the strategic interdependencies between the firms, where the probability of winning (not being audited) for each firm depends on costly efforts (their taxable emissions reports).     

Environmental Auditing in Management Systems and Public Policy

New international standards for environmental auditing are now being actively promoted by public authorities and adopted by private firms. One important feature of these standards is their emphasis on managerial systems and incentives that support a wiser use of environmental resources. This paper studies such a system, in which incentive compensation may be based in part on the results of an environmental audit. It is found that optimal wages after an environmental audit is performed should have a greater range than wages paid when no audit has occurred. It is also shown that the decision to conduct an environmental audit and the size of the expected wage in this case depend crucially on whether the agent's prudence (or precautionary motives) dominates his aversion to risk. It is finally found that the insertion of environmental audits within current management systems would certainly induce a manager to care more about the environment; although this may come at the expense of less concern for other activities, we find plausible circumstances in which properly designed environmental audits overcome such a tradeoff and increase the manager's attention tobothenvironmental and traditional tasks. Some implications of the analysis for environmental public policy are also discussed briefly.     

Incentives and prices in an emissions trading scheme with updating

Emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota (or allowance) price. Nevertheless, according to Böhringer and Lange [On the design of optimal grandfathering schemes for emission allowances, Europ. Econ. Rev. 49 (2005) 2041–2055], such allocation schemes are cost-effective if the system is closed and allocation rules are identical across firms. In this paper, we show that the cost-effective solution may be infeasible if marginal abatement costs grow too fast. Moreover, if a price cap or banking/borrowing is introduced, the abatement profile is no longer the same as in the case with an auction (or lump-sum allocation). In addition, we show that with allocation based on updated emissions, the quota price will always exceed marginal abatement costs, possibly misguiding policy makers and investors about abatement costs. Numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs, unless a significant share of allowances is auctioned.     

A political economy model of implementing pollution laws

A model of the implementation process as applied in pollution control is developed. It differs from previous bureaucracy models in that it subjects the control agency to pressures from both firms and procontrol citizen groups. Each of these three actors maximizes utility over environmental quality and some other variable. Environmental quality may be in the actor's preference function or it may represent derived demand. Working through the agency budget and other policy variables, each actor constrains another actor's attempts to move policy in preferred directions. This results in movement toward a concensus environmental quality, not necessarily the efficient quality. Several institutional changes are analyzed to demonstrate the workings of the model.     

Environmental policy à la carte: Letting firms choose their regulation

Under uncertainty, the optimal choice between price and quantity instruments depends on the technology of the regulated firms, which is often private information. We consider an environmental policy that delegates the prices-versus-quantities decision to the firms by offering them the choice between an emissions tax and permit trading. Such an approach is currently used in Swiss climate policy. We provide a detailed characterization of the optimal policy and show that this approach reduces expected social costs compared to a pure tax or permit-trading regime. We demonstrate that an optimal allocation of firms to instruments can be achieved despite substantial informational constraints, and that all firms gain from the introduction of the instrument choice compared to optimally designed single-instrument policies. Furthermore, we discuss the conditions under which this approach is likely to be preferable to a hybrid regulation.     

Environmental policy with upstream pollution abatement technology firms

This paper examines how the existence of an upstream abatement technology sector affects optimal environmental policy. We explore whether the policy should be especially stringent in order to spur a successful export industry based on abatement technology. Furthermore, we investigate if a stringent policy can be used to increase competition in the upstream sector. Our point of departure is a three-stage game between a government in a country with a polluting downstream industry, and a limited number of upstream firms supplying abatement technologies. The government moves first, and may use its environmental policy strategically to influence the behavior of the upstream technology firms. We find that an especially stringent environmental policy towards the polluting downstream sector may be well founded, as it increases competition between the technology suppliers, leading to lower abatement costs. However, to our surprise, an especially stringent environmental policy is not a particularly good industrial policy with respect to developing successful new export sectors based on abatement technology.     

Self-Reporting and the Design of Policies for Regulating Stochastic Pollution

Existing environmental regulations frequently require firms to self-report their compliance status to regulatory agencies. Using a principal-agent framework, I derive and compare incentive-compatible regulatory policies with and without self-reporting. I find the firm needs to be audited less often when self-reporting is required, but punished more often. The sign and magnitude of the gains from self-reporting depend on the relative size of audit and sanction costs, the accuracy of the regulator′s monitoring technology, and the desired level of abatement effort.     

Optimal environmental policy for waste disposal and recycling when firms are not compliant

We investigate a model that considers disposal and recycling activities after the consumption of products. In the field, the deposit–refund (D–R) policy has been considered as an ideal policy for internalizing disposal costs, which can result in the realization of the first-best policy. However, the possibility of firms' illegal disposal has been neglected. We introduce a monitoring cost to prevent firms from disposing of collected residuals illegally and induce the second-best D–R policy. We find that the relation between the monitoring problem for firms and the price of the recycling market brings about a variation in the optimal level of the refunds (which is typically smaller than the first-best level). Further, we investigate an alternative policy that requires producers to take-back residuals and show how this policy works equivalently to the second-best D–R policy by applying the theory of the tradable rights market.     

An empirical analysis of economic strategies for controlling air pollution

In evaluating current environmental protection policy, economists often note that current regulations are more costly than necessary to meet environmental quality standards. While the a priori case is strong that current regulatory approaches are resulting in higher-than-necessary costs to attain environmental standards, there is relatively little empirical evidence to support this claim. The purpose of this paper is to supply some of the missing evidence by presenting the results of one study that assesses some of the potential savings associated with implementing economic, rather than command-and-control, regulatory approaches to abate one type of air pollution in one region of the country. Specifically, the paper examines the costs of meeting a prospective short-term standard for nitrogen dioxide under a range of alternative emissions control strategies for stationary sources of nitrogen oxide emissions in the Chicago Air Quality Control Region. The alternative strategies that are considered range from those that might result under current regulatory policy to those that economic policy approaches (such as emissions charges or marketable permits) are designed to implement. The analysis shows that the most efficient program of emissions controls may be more than an order of magnitude less costly than current regulatory strategies, and that economic approaches have additional advantages over more conventional regulatory approaches.     

Endogenous Monitoring and Enforcement of a Transferable Emissions Permit System

The literature on noncompliant firms in transferable emissions permit systems offers little guidance to policymakers that must determine how to commit resources to monitor firms and punish violations in such systems. We consider how a budget-constrained enforcement authority that seeks to minimize aggregate noncompliance in a transferable emissions permit system should allocate its monitoring and enforcement efforts among heterogeneous firms. With a conventional model of firm behavior in a transferable permit system, we find that differences in the allocation of monitoring and enforcement effort between any two types of firms should be independent of differences in their exogenous characteristics.     

The economics of enforcing air pollution controls

The goal of this paper is to determine the likely effect on a firm's control actions of alternative implementation and enforcement policies available to the control agency. Three alternatives are studied, legal enforcement through the new source performance standards set forth by EPA, and two effluent fee enforcement alternatives. First, a generalized model of the effects of implementation and enforcement policies on the firm's control action is developed. This model assumes that the firm is an expected cost minimizer. The model is then applied to the case of particulate matter discharges from coal-fired power plants in order to estimate empirically the effect of policy alternatives on the firm's control efforts. Finally, the results of the model and its empirical application are used to develop policy functions which relate control to the values of various policy parameters. These results lead us to several policy recommendations.     

Enforcement of pollution regulations in a declining industry

A regulatory agency enforcing compliance in a declining industry might recognize that certain plants would close rather than comply, imposing large costs on the local community. Data on EPA enforcement activity in the U.S. steel industry are examined for evidence of this with a two-equation model linking EPA enforcement decisions and firms' plant-closing decisions. The results indicate that the EPA directed fewer enforcement actions toward plants with a high predicted probability of closing and plants that were major employers in their community; also, plants predicted to face relatively heavy enforcement were more likely to close.     

Non-compliance and the quota price in an ITQ fishery

This paper examines the effects of non-compliance on quota demands and the equilibrium quota price in an ITQ fishery. I show that whereas lower quota prices are implied unambiguously by expected penalties which are a function of the absolute violation size, the expectation of penalties based upon relative violations of quota demands can, under certain conditions, produce higher quota prices than in a compliant quota market. If there are both compliant and non-compliant firms in the fishery, the result would then be a shift in quota demand from compliant to non-compliant firms, rather than the reverse. The findings are generally applicable to quota markets in other industries, including pollution permit markets.     

Ambiguity,reasoned determination,and climate-change policy

This paper examines climate-change benefit-cost analysis in the presence of scientific uncertainty in the form of ambiguity. The specific issue addressed is the robustness of benefit-cost analyses of climate-change policy alternatives to relaxation of Savage's original axioms. Two alternatives to subjective expected utility (SEU) are considered: maximin expected utility (MEU) and incomplete expected utility (IEU). Among other results, it is demonstrated that polar opposite recommendations can emerge in an ambiguous decision setting even if all agree on Society's rate of time preference, Society's risk attitudes, the degree of ambiguity faced, and the scientific primitives. We show that, for a simple numerical simulation of our model, an MEU decision maker favors policies which immediately tackle climate change while an IEU decision prefers “business as usual”.“Each agency shall assess the costs and benefits of the intended regulation, and recognizing that some costs and benefits are difficult to quantify, propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its cost.” Executive Order 12866 of the US President.     

Optimal fishery policy with artificial enhancement through stocking: California's white sturgeon as an example

Although optimal fishery policy has been derived from different kinds of economic and biological models, the interaction of fishing policy with artificial stocking policy has not been explicitly considered. We here determine optimal size limits, fishing effort, and stocking rate for three cases of interest: (1) recruitment-limited population, pre-recruitment stocking; (2) adult biomass-limited population, post-recruitment stocking; and (3) adult biomass-limited and recruitment-limited population, post-recruitment stocking. Results show that lower size limits should be set at the size at which the current market value exceeds the total future value of an individual, both to the fishery and to reproduction. Imposition of upper size limits is rarely optimal. Stocking is advisable when the hatchery cost times the relative contribution of stocking to recruitment is less than the contribution to the value of the catch. Optimal policy ranges from infinite effort at a specific size limit with maximum stocking when the cost of stocking is zero, to lower values of size limit and effort as stocking costs increase, the amount of stocking decreases, and more natural reproduction is optimal. Thus, as hatchery costs decline (or value of captured fish increases), optimal stocking/fishery policy varies from an unstocked fishery to a “put and take” fishery. The results are applied to the sturgeon fishery in the San Francisco Bay Estuary as an example. They imply that a reduced lower size limit and greater fishing mortality together with stocking would be optimal, but that current levels are conservative. The stocking decision depends critically on the values of parameters that are currently poorly known, such as: hatchery costs, survival to the fishery and the mechanisms controlling the sturgeon population.     

The environmental effects of trade within and across sectors

This paper presents a model that combines within and across sector channels through which trade affects our environment by embedding heterogeneous firms and fixed costs into a two-sector framework with an endogenous response to environmental policy. In contrast to existing literature that tends to examine these channels separately, the combined framework developed here shows how cross-sector comparative advantage and within-sector responses to trade and environmental policy or factor endowments interact to affect our environment through three channels: changes in output, cross-sector market share, and emissions intensity. In contrast to a single-sector model with neutral productivity, consideration of two sectors allows for trade liberalization to affect the allocation of inputs in each sector and thereby affect total pollution output. The additional consideration of heterogeneous firm responses to falling trade costs will generate endogenous increases in productivity that increase output, reduce aggregate emissions intensity, and moderate the cross-sector resource adjustment, relative to a representative-firm model. Simulation results show how the combined framework can replicate existing empirical outcomes, and provide concise ceteris paribus insights regarding the potential role of trade and environmental policy changes and factor expansion in driving observed outcomes and their contribution to each of the three channels.     

Analysis of the current situation of environmental policy of China and establishment of distributed environmental policy framework

In this study, China’s current macro-environmental policies as well as their implementation and management tools are analyzed. By using the basic economic methodology, detailed studies are conducted focusing on the implementation effect of contemporary China’s typical environmental policy of the total pollutant discharge quantity control type, and also the two types of environmental management tools are compared from the perspective of implementation costs and policy uncertainty. By introduction of distributed management tools into the implementation of environmental policies, market-oriented means and the methods of economic analysis are introduced into environmental policy decision-making mechanisms, which could afford a new method for changing the current relatively low efficiency of environmental policy, solving the problem of “government failure” in environmental policy implementation, and providing a new way to make environmental policy system more flexible and more efficient. It is of great practical significance to solve China's current structural, complex and accumulative environmental problems.     

Generating spatially optimized habitat in a trade‐off between social optimality and budget efficiency

Auctions have been proposed as alternatives to payments for environmental services when spatial interactions and costs are better known to landowners than to the conservation agency (asymmetric information). Recently, an auction scheme was proposed that delivers optimal conservation in the sense that social welfare is maximized. I examined the social welfare and the budget efficiency delivered by this scheme, where social welfare represents the difference between the monetized ecological benefit and the conservation cost incurred to the landowners and budget efficiency is defined as maximizing the ecological benefit for a given conservation budget. For the analysis, I considered a stylized landscape with land patches that can be used for agriculture or conservation. The ecological benefit was measured by an objective function that increases with increasing number and spatial aggregation of conserved land patches. I compared the social welfare and the budget efficiency of the auction scheme with an agglomeration payment, a policy scheme that considers spatial interactions and that was proposed recently. The auction delivered a higher level of social welfare than the agglomeration payment. However, the agglomeration payment was more efficient budgetarily than the auction, so the comparative performances of the 2 schemes depended on the chosen policy criterion–social welfare or budget efficiency. Both policy criteria are relevant for conservation. Which one should be chosen depends on the problem at hand, for example, whether social preferences should be taken into account in the decision of how much money to invest in conservation or whether the available conservation budget is strictly limited.     

Emissions trading systems with cap adjustments

Emissions Trading Systems (ETSs) with fixed caps lack provisions to address systematic imbalances in the supply and demand of permits due to changes in the state of the regulated economy. We propose a mechanism which adjusts the allocation of permits based on the current bank of permits. The mechanism spans the spectrum between a pure quantity instrument and a pure price instrument. We solve the firms׳ emissions control problem and obtain an explicit dependency between the key policy stringency parameter—the adjustment rate—and the firms׳ abatement and trading strategies. We present an analytical tool for selecting the optimal adjustment rate under both risk-neutrality and risk-aversion, which provides an analytical basis for the regulator׳s choice of a responsive ETS policy.     

On marketable air-pollution permits: The case for a system of pollution offsets

After examining the properties of several alternative forms of marketable permit systems for the control of air pollution, this paper proposes a system of pollution offsets as the most promising approach. Under the pollution-offset scheme, sources of emissions are free to trade emissions permits subject to the constraint of no violations of the predetermined air-quality standard at any receptor point. The paper shows that the pollution-offset system has the capacity to achieve the predetermined standards of air quality at the minimum aggregate abatement cost, while making comparatively modest demands both on the sources and on the administering agency.