Efficiency Costs of Meeting Industry-Distributional Constraints under Environmental Permits and Taxes

Many pollution-related industries wield strong political influence and can e.ectively veto policy initiatives that would harm their profits.A politically realistic approach to environmental policy therefore seems to require the alleviation of significant profitlosses to these industries.The regulatory authority can do this by freely allocating some emissions permits or by exempting some inframarginal emissions from a pollution tax.However, such policies compel the government to forego an e.cient potential revenue source and to rely more heavily on ordinary distortionary taxes.As a result, achieving distributional objectives comes at a cost in terms of e.ciency.Using analytically and numerically solved equilibrium models, we analyze the e.- ciency costs implied by the distributional constraint that adverse impacts on profits in particular industries must be avoided.Both models indicate that the e.ciency cost implied by this constraint dwarfs the other e.ciency costs when the required amount of abatement is very small.When the abatement requirement becomes more extensive, however, the cost of this constraint diminishes relative to the other e.ciency costs of pollution-control.We also calculate the compensation ratio: the share of potential policy revenue that the government must forego to protect the industries in question.We show how this ratio is a.ected by the extent of abatement, supply and demand elasticities, and the potential for end-of-pipe treatment.One definition of this ratio corresponds to the share of pollution permits that must be freely allocated to prevent profit-losses in the targeted industries.Numerical simulations of sulfur dioxide pollution-control suggest that the Bush Administration s Clear Skies Initiative would exceed this ratio, freely allocating more permits than necessary to preserve profits.Our models also highlight significant di.erences between gross and net policy revenues: when abatement is extensive, a large fraction of the revenue collected from emissions permits or taxes is o.set by the revenue-loss from erosion of the base of existing factor taxes.efficiency;costs;environmental tax;pollution;environmental policy

Efficiency Costs of Meeting Industry-Distributional Constraints under Environmental Permits and Taxes

Many pollution-related industries wield strong political influence and can e.ectively veto policy initiatives that would harm their profits.A politically realistic approach to environmental policy therefore seems to require the alleviation of significant profitlosses to these industries.The regulatory authority can do this by freely allocating some emissions permits or by exempting some inframarginal emissions from a pollution tax.However, such policies compel the government to forego an e.cient potential revenue source and to rely more heavily on ordinary distortionary taxes.As a result, achieving distributional objectives comes at a cost in terms of e.ciency.Using analytically and numerically solved equilibrium models, we analyze the e.- ciency costs implied by the distributional constraint that adverse impacts on profits in particular industries must be avoided.Both models indicate that the e.ciency cost implied by this constraint dwarfs the other e.ciency costs when the required amount of abatement is very small.When the abatement requirement becomes more extensive, however, the cost of this constraint diminishes relative to the other e.ciency costs of pollution-control.We also calculate the compensation ratio: the share of potential policy revenue that the government must forego to protect the industries in question.We show how this ratio is a.ected by the extent of abatement, supply and demand elasticities, and the potential for end-of-pipe treatment.One definition of this ratio corresponds to the share of pollution permits that must be freely allocated to prevent profit-losses in the targeted industries.Numerical simulations of sulfur dioxide pollution-control suggest that the Bush Administration s Clear Skies Initiative would exceed this ratio, freely allocating more permits than necessary to preserve profits.Our models also highlight significant di.erences between gross and net policy revenues: when abatement is extensive, a large fraction of the revenue collected from emissions permits or taxes is o.set by the revenue-loss from erosion of the base of existing factor taxes

Costs of Alternative Environmental Policy Instruments in the Presence of Industry Compensation Requirements

This paper explores how the costs of meeting given aggregate targets for pollution emissions change with the imposition of the requirement that key pollution-related industries be compensated for potential losses of profit from the pollution regulation.Using analytically and numerically solved equilibrium models, we compare the incidence and costs of emissions taxes, fuel (intermediate input) taxes, performance standards and mandated technologies in the absence and presence of this compensation requirement.Compensation is provided either through industry tax credits or industry-specific cuts in capital tax rates.We decompose the added costs from the compensation requirement into (1) an increase in "intrinsic abatement cost," reflecting a lowered efficiency of pollution abatement, and (2) a "lump-sum compensation cost" that captures the efficiency costs of financing the compensation.The compensation requirement affects these components differently, depending on the policy instrument involved and the required extent of pollution abatement.As a result, it can change the cost-rankings of the different instruments.In particular, when compensation is provided through tax credits, the lump-sum compensation cost is higher under the emissions tax than under the command-andcontrol policies (performance standards and mandated technologies) - a reflection of the higher compensation requirements under the emissions tax.When the required pollution reduction is modest, imposing the compensation requirement causes the emissions tax to lose its status as the least costly instrument and to become more costly than command and control policies.In contrast, when required abatement is extensive, the emissions tax again becomes the most-cost effective instrument because of its advantages in terms of lower intrinsic abatement cost