5.2  Pollution control

Regulators seek to reduce pollution either directly through controls on emissions, or indirectly through controls on inputs. The latter leaves less flexibility for changes in process or emission control technology.

A CAC approach could involve a limit on the level of inputs or emissions, or on the type of technology used, while an MBI approach would classically either impose a tax per unit, or issue a fixed quantity of transferable permits (see Table 9).[28]

The purpose of using MBI in pollution control is either to reduce emissions by a set amount at the minimum cost (eg, through issuing a set quantity of permits) or to achieve the maximum emission reductions possible below a certain cost per unit (eg, through a flat rate tax). MBIs also can also have positive fiscal effects through tax or charge revenue or from reductions in subsidies.

5.2.1  Pollution permits

Transferable permits have been suggested, and implemented overseas, for controlling pollution as an alternative to CAC regulation. This allows emission reductions to be made by those able to do so most efficiently, and allows those unable to achieve reductions to buy emission rights from others, to mutual benefit. It also creates an incentive to find more efficient means of reducing emissions (Cole, 1999) and is more flexible to changes in technology and other external factors; eg, in Chile firms were able to buy permits “instead of making irreversible investments that would have proved uneconomical ex post facto, that is, after the arrival of natural gas” (Montero and Sanchez, 2002, p269).

Such systems do, however, place a premium on accurate measurement of the initial problem, and of how it changes over time, since adjustments can be costly either in terms of compensation or through undermining the property right (such permits are property rights although they fall short of fee-simple title). The effectiveness of permits can also be affected by factors such as the liquidity of the market, the quality of the property right, and the existence of market power.

Whether initial allocations of permits are auctioned or grand-fathered can also have equity effects which can impact on the acceptability of the proposal.[29] It will not, however, affect the marginal incentives on firms once the permits are in place, since even firms which get permits for free will face an opportunity cost equal to their market value.

The formalisation of rights to emit can also be seen as a license to pollute which may not be socially acceptable.[30] While valuing adverse environmental impacts may be controversial, however, the acceptable cost of preventing such impacts is actually implicit in any regulatory decision.

5.2.2  Pollution taxes

A tax approach is more flexible than permits as the rate of the tax can be adjusted till the right incentive is created, although again certainty regarding future tax rates is a factor in the nature of the response.[31] The compliance costs for taxes are also lower than for permits. Taxes, however, are less certain to achieve a quantity target than permits. Road transport is an example of where the transaction costs of trading may make taxes more viable than permits in many circumstances (Johansson-Stenman, 1999).[32] Environmental taxes have been applied in areas such as water pollution, emissions (sulphur, NO_x, CO₂), waste (general, batteries, other toxic waste), energy use (petrol) and fertiliser.

Taxes also raise the possibility of a double dividend from using revenues from environmental taxes, which produce the first environmental dividend, to reduce other distortionary taxes through revenue recycling, producing the second tax efficiency dividend. The UK government for example has a specific policy to “reform the tax system to increase incentives to reduce environmental damage. That will shift the burden of tax from ‘goods’ to ‘bads’; encourage innovation …. To the benefit of everyone” (HM Treasury, 2002, p5).

The strong form of the double dividend argues that the burden of the tax system can be reduced even if the environmental benefits are completely ignored. The environmental benefits are therefore free. The weak form suggests simply that revenue recycling is superior to revenue retention or distributing the revenue through lump-sum transfers.[33] Therefore the tax scheme will be more attractive if the revenues are considered than if they are ignored (Park and Pezzey, 1999). The weak form is more generally accepted than the strong form, and the latter does depend on the efficiency of the underlying tax system.

The level of revenue involved with a tax can itself be an issue. When revenue is significant in budgetary terms the opportunities for reducing less efficient taxes or recycling revenue into environmentally positive programmes are maximised, but the budgetary cost of successfully reducing pollution also rises. This conflict is less of a factor for smaller taxes.