# Market-Based Environmental Management: Issues in Implementation

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/crs%3A94-213

## Record

- **Collection:** Congressional research report
- **Document type:** CRS Report
- **Published:** March 7, 1994
- **Citation:** 94-213

## Text

94-213

CRS Report for Congress
Received through the CRS Web

Market-Based
Environmental Management:
Issues in Implementation

March 7, 1994

(name redacted) and John E. Blodgett, Coordinators
(name redacted), David E. Gushee, Susan L. Mayer, (name re
dacted), and Larry B. Parker
Environment and Natural Resources Policy Division

Congressional Research Service ˜ The Library of Congress

MARKET-BASED ENVIRONMENTAL MANAGEMENT:
ISSUES IN IMPLEMENTATION
SUMMARY

The acid rain title of the 1990 Clean Air Act Amendments authorizes the first nationwide
system for trading the regional location and method of pollution control. This market-type
mechanism, if successfully implemented, could reduce the cost of compliance of meeting new
limits on sulfur dioxide emissions, the main precursor of acid rain.
Successful passage of the sulfur dioxide trading mechanism has invigorated efforts to add
similar mechanisms to the regulatory regimes for other environmental management areas.
Limitations of current regulatory approaches, complexity of remaining and emerging
environmental problems, and the attack on the Federal budget deficit make greater use of
incentive-type approaches to environmental management an attractive option, in some cases.
While existing regulatory systems have made measurable reductions in common air and
water pollutants, most observers agree that they have been less successful against complex
problems caused by toxics and by transformed or transported pollutants. As supplements to
established regulatory systems, market-based options often offer cost saving potentials, enhanced
flexibility, and increased effectiveness. Options include trading of permitted discharges or other
types of resource constraints or over control credits among sources; pollution taxes, fees, and
charges; deposits and refunds; and liability assignment and information disclosure. Particularly
in situations where total pollution loadings or other resource management objectives rather than
ambient health standards are the issue, greater consideration of regulatory financial burdens may
be warranted. More importantly, many environmental problems are too intertwined with
everyday economic activities to be managed effectively through highly centralized regulatory
systems.
Proposals by the Clinton Administration for market-based environmental protection build
on the earlier efforts of Congress and the Bush Administration. The 103rd Congress is
considering market-based approaches in reauthorization for the Clean Water Act. Some in
Congress also propose market-type mechanisms for dealing with the potential threats of global
warming, for encouraging the recycling of solid waste, and for improving management of some
natural resources.
As attractive as these mechanisms may be in concept, their implementation occurs within
a well established regulatory context involving all three levels of government, international treaty
obligations, agency capabilities, and the private sector. It is the implementation concerns that
will largely shape the debate in Congress and help determine which innovations ultimately
become public policy. For example, the political consensus for taxing pollution rests more on
raising
revenue than on any attempt to charge for the external costs of pollution. Similarly, emission
reduction credit or allowance trading systems may offer politically attractive ways to share the
financial burdens of policy changes while also reducing compliance costs.

CONTRIBUTORS

Coordination and Integration
(name redacted)
John E. Blodgett
Air Quality
Larry B. Parker
Susan L. Mayer
David E. Gushee
Water Quality and Resources
(name redacted)
John E. Blodgett
Solid and Hazardous Waste
Susan L. Mayer
(name redacted)

CONTENTS
INTRODUCTION AND FINDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
AN EMERGING DOUBLE BIND IN ENVIRONMENTAL MANAGEMENT . . . . . . 1
BEGINNINGS OF A CHANGE IN ENVIRONMENTAL REGULATION . . . . . . . . . 1
IMPLEMENTATION AS THE PRIMARY CONCERN IN
REGULATORY INNOVATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
THE OUTLOOK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
REPORT CONTENTS AND FOCUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
FINDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Growing Interest and Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Potentials Versus the Pragmatic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Cases in Point . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Concerns and Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
THE CONTEXT FOR MARKET-BASED APPROACHES . . . . . . . . . . . . . . . . . . . . . . . . . . 9
THE CURRENT SYSTEM: ITS STRENGTHS AND WEAKNESSES . . . . . . . . . . . 10
Strengths . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Weaknesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
PRESSURES FOR GREATER USE OF INCENTIVES . . . . . . . . . . . . . . . . . . . . . . . 11
Cost, Finance, and Management Effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . 12
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Indirect Mechanisms for Complex Environmental Problems . . . . . . . . . . . . . . . 15
International Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
CURRENT AND PROPOSED APPROACHES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Current Examples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Proposals for Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
ADVANTAGES: POTENTIAL COST SAVINGS AND INNOVATION . . . . . . . . . 23
Studies of Cost Saving Potentials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
A Stimulus for Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
CHALLENGES TO IMPLEMENTATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Uncertainty in Meeting Environmental Goals . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Third Party Effects and Local Environmental Compliance . . . . . . . . . . . . . . . . . 30
Moral Opposition to Local Changes in Pollution . . . . . . . . . . . . . . . . . . . . . . . . 30
Measurement and Monitoring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Complexity Of Nonconventional Pollutants . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Institutional Capability and Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Market Imperfections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Regional Definitions and Boundaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Compliance Versus Abatement Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Cross-Media Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
INSTITUTIONAL CONSIDERATIONS IN IMPLEMENTATION . . . . . . . . . . . . . . . . . . 33
THE ROLE FOR MARKET APPROACHES IN A REGULATORY CONTEXT . . . 33
TAXING POLLUTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
The General Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Implementing Pollution Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Other Ways of Using Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

ii
TRADING OF POLLUTION REDUCTION OR OTHER RESOURCE
MANAGEMENT CONSTRAINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
The General Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Implementing Tradeable Pollution or Other Compliance Requirements . . . . . . 38
Ways of Using Tradeable Permits or Other Over
Performance on Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
DEPOSIT/REFUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
The General Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Implementing Deposit Refund Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Ways of Using Deposit-Refund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
OTHER MARKET STRENGTHENING ACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Liability Assignment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Best Management Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
CURRENT U.S. APPROACHES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
ACHIEVING REGIONAL/LOCAL REGULATORY EFFICIENCY . . . . . . . . . . . . . 49
Emissions Trading Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Direct Discharge Permit Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Point-Nonpoint Sources Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
MEETING NATIONAL POLLUTION REDUCTION OR PHASE-OUT
REQUIREMENTS THROUGH TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Lead Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Sulfur Dioxide Allowance Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
INTERNALIZING SOCIAL COSTS THROUGH
NONREGULATORY MEANS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
CFC Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Permit Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Input Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
Wetlands Mitigation Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Information Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
Liability Assignment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Deposit-Refund for Managing Solid and Hazardous Waste . . . . . . . . . . . . . . . . 79
PROPOSALS FOR NEW APPROACHES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
ACHIEVING REGIONAL/LOCAL REGULATORY EFFICIENCY . . . . . . . . . . . . . 81
Marketable Permit Programs In The Los Angeles Area . . . . . . . . . . . . . . . . . . . 81
MEETING POLLUTION REDUCTION OR PHASE-OUT
REQUIREMENTS THROUGH TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Tradeable Permits For Carbon Dioxide Control . . . . . . . . . . . . . . . . . . . . . . . . . 84
Recycling Credits in the Solid Waste Area . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
INTERNALIZING SOCIAL COSTS THROUGH NONREGULATORY
MEANS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Carbon Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Effluent Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
Input Fees - Fertilizer, Pesticide and Animal Feed Tax . . . . . . . . . . . . . . . . . . . 96
User Taxes - Water Use Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
Wetlands Mitigation Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
Assurance Bonding To Reduce Agricultural Nonpoint Source Pollution . . . . . 101
Investment Tax Credits for Recycling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

iii
Other Tax Credits for Recycling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Virgin Materials Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
Unit Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
Deposit/Refund for Batteries and Other Hazardous Substances . . . . . . . . . . . . 109

TABLES
Table 1.
Table 2.
Table 3.
Table 4.
Table 5.
Table 6.
Table 7.
Table 8.
Table 9.

Current Market-Type Mechanisms in Operation . . . . . . . . . . . . . . . . . . . . . . . . . 19
Proposals for Market-Based Environmental Protection . . . . . . . . . . . . . . . . . . . . 25
Summary of Emissions Trading Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Water Pollution Permit Trading (Fox River, Wisconsin) . . . . . . . . . . . . . . . . . . 56
Water Pollution Rights Trading (Dillion Reservoir, Colorado) . . . . . . . . . . . . . . 57
EPA Lead Trading and Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Implementation Costs by Cost Category . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Transactions in Sulfur Dioxide Allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Relative Comparison of Five Basic Options for Controlling
N Fertilizer Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

MARKET-BASED ENVIRONMENTAL MANAGEMENT:
ISSUES IN IMPLEMENTATION
INTRODUCTION AND FINDINGS

AN EMERGING DOUBLE BIND IN ENVIRONMENTAL MANAGEMENT
Increasingly, efforts to protect integral features of the natural environment that are essential
to human well being face a double challenge.
First, the magnitude of some conventional and emerging threats to environmental quality
is growing, despite solid progress in controlling some causes. This is particularly the concern
on a global scale in terms of atmospheric changes and loss of biological diversity.
Second, easily-implemented uniform control methods using feasible technologies or other
direct regulatory approaches are already in place for many pollution and resource management
problems in the United States. Additional progress with so-called command and control policies
can be expensive and disruptive, and thus counter productive to overall economic well being.
This type of dilemma is common where environmental deterioration results from diffuse and
complex causes inherent in technically-advanced high-consumption industrial societies such as
the U.S. Solutions to these types of environmental problems are complicated by the diffuse
benefits which obscures the net gains of additional controls that have concentrated and highly
visible costs.
Given this double bind, many policy analysts and academics have for years advocated more
cost-effective and flexible approaches relying on market forces to further some environmental
management objectives. Although market-based theory and practical environmental policy are
still far apart, the incremental approach to environmental policymaking since the late seventies
has resulted in some market-type innovations within traditional regulatory frameworks at all
levels of government. The most prominent examples are the Environmental Protection Agency's
(EPA) air emissions trading program and the recently enacted sulfur dioxide allowance trading
program under the 1990 Clean Air Act Amendments.

BEGINNINGS OF A CHANGE IN ENVIRONMENTAL REGULATION
In enacting environmental legislation, Congress has continually tried to ensure adequate
regulatory and technical controls on individual sources of air, water, and land pollution in order
to protect public health and ecological values. The cost of these controls, while significant in
some cases, had been small enough in the context of the overall economy that through the late
1980s, no viable consensus emerged for specific refinements or shifts in the various laws and
implementing regulations governing environment and natural resources management. This status
quo began to change in 1989 with the push for Clean Air Act Amendments by the Bush
Administration. The need to project low national costs and market-oriented Administration

CRS-2
policy led to the enactment in 1990 Clean Air Act Amendments (CAAA) of the first nationwide
system for trading the location and method for controlling a pollutant (sulfur dioxide).

IMPLEMENTATION AS THE PRIMARY CONCERN IN REGULATORY
INNOVATION
Some argue that the sulfur dioxide trading mechanism marks a new era in environmental
management. Its successful implementation, however, faces significant challenges at the State
level and in the private sector. Other current and proposed market-type innovations face similar
implementation issues.
Since implementation is often the litmus test in assessing the merits of public policy
innovations, this report focuses primarily on the potentials and institutional challenges facing
market-based mechanisms for environmental management within the Federal system.

THE OUTLOOK
The Federal budget situation and the nature of emerging environmental problems are
becoming the factors that focus attention on more active use of incentive approaches for
environmental protection. Expanding the use of fees to finance environmental protection
programs and greater reliance on trading to shift pollution reduction towards lower cost control
points is already done within EPA and State environmental protection programs. Experience to
date suggests a number of directions for the use of these mechanisms including:
•

Large direct taxes on pollution, while likely to be effective in the longer term, raise
concerns about U.S. international cost competitiveness, the administrative capability
to implement such techniques, and the political difficulties of applying them in a
targeted way.

•

A more modest role for environmental taxes is one in which they serve multiple
purposes such as the proposed Btu tax or the recently-passed gasoline tax. The use
of taxes in these circumstances may serve several objectives not necessarily related
to environmental protection, but may possibly modify behavior sufficiently to
produce some reduction in pollution. Such taxes may raise general or dedicated
revenue, send a signal on level of consumption, possibly be used to offset other
revenue sources, or serve as a way of capturing windfall gains when other regulations
drive up prices.

•

Credit or permit trading is emerging as an acceptable means for easing transitions in
certain situations where strict location of compliance is not a concern. Such systems
can be used to ease the financial burden and opposition to strict local standards for
uniformly distributed environmental problems such as severe ozone nonattainment,
as is the goal in the Los Angeles basin; to lessen economic disruption by allowing
regulated entities to find some other related way to meet a standard or market
constraint as with acid rain control; and to create transitional efficiencies when a
substance or activity is being phased out or substantially reduced in scope, as with
CFCs.

CRS-3
•

Deposit refund approaches are gaining favor in some States for disposal problems
other than beverage containers. The most common target for this approach is lead
acid batteries, with 10 States operating some type of program. More innovative uses
of this technique, such as management of some toxic substances, remains an untested
proposal.

•

Information and other market conditioning policies, while indirect and hard to
evaluate, may be one of the more powerful ways to change consumer and business
behavior regarding environmental quality. Anecdotal evidence suggests that the
toxic chemical disclosure requirements of the 1986 Superfund Amendments (Right-to
Know) are leading many corporations to modify practices in order to avoid adverse
publicity even when no legal violations are present.

REPORT CONTENTS AND FOCUS
This report is a revision and update of an earlier CRS report on the same subject. 1 This
version looks explicitly at issues of implementation for both existing and proposed market-based
mechanisms. As such, the report is divided into several overlapping sections written to the
interests of various readers. Focus of each major section is:
1)

Findings - presents an integration of major points in the report.

2)

Context for Market-Based Approaches - presents the range of actual and proposed
mechanisms, their relation to current regulatory systems, and their general strengths
and weaknesses.

3)

Institutional Considerations in Implementation - discusses how each of the generic
market-based approaches works, its range of applicability, and the challenges to
implementation within the public sector authorities and capabilities.

4)

Current U.S. Approaches - assesses U.S. experience with actual market-based
approaches to-date, focusing on lessons and outcomes relative to expectations.

5)

Proposals for New Approaches - assesses some of the major options that are currently
under debate either in Congress or in various policy communities.

FINDINGS
Growing Interest and Experience
With the passage of the trading system for sulfur dioxide, the interest in market-based
refinements among environmental advocacy groups and within Congress has increased for at
least three reasons.

1

U.S. Library of Congress. Congressional Research Service. Using Incentives for
Environmental Protection: An Overview. 89-360 ENR. Washington, 1989.

CRS-4
•

The country is facing a new round of major pollution control programs -- programs
dealing with possible CO2 reductions, urban ozone reductions, recycling and waste
reduction requirements, nonpoint source water pollution reduction as well as already
enacted efforts to deal with phase out of CFCs and acid rain control. These initiatives
could increase total direct costs of pollution abatement from the historical 2% of the
Gross National Product, where it has remained for nearly 15 years. Facing these
potential cost increases, more efficient control mechanisms begin to look more
attractive. In addition, solutions to some of these problems (such as CO
2,
stratospheric ozone depletion, and acid rain), may be more amenable to cost and
efficiency considerations since total regional, national or even international pollution
loadings are involved rather than local ambient concentrations. These circumstances
seem to loosen potential solutions from strict consideration of uniform restraints,
allowing consideration of differences in incremental benefits and costs among
differing circumstances to shape how pollution reduction is accomplished, while still
protecting human health.

•

Existing regulatory approaches appear inadequate or simply inappropriate for
managing some of the diffuse and more complex pollution problems that are
increasingly apparent -- from toxics and pesticides to global concerns about
stratospheric ozone depletion and climate change. By levying charges or taxes on
pollution, polluting activities or products, or by providing other market incentives,
one may be able to augment existing regulatory and enforcement mechanisms
without resorting to more burdensome and costly methods.

•

Because of the Federal budget deficit, it is difficult for Congress to authorize and
appropriate monies for new programs to address emerging environmental problems.
Some market-based approaches serve both as potential revenue sources as well as
incentives to modify polluting activities.

Options
Incentive or market-based options give the regulated community a financial reason to
reduce pollution or change other behavior, usually without directives as how such changes
should be made. Although proposals vary, most proponents see incentive approaches as
supplemental to or refining existing environmental regulatory structures rather than replacing
them. Major options include:
•

Taxes or charges - levied on either polluting outputs, polluting inputs, or polluting
products at a sufficiently high level to make it financially desirable to reduce or even
eliminate pollution;

•

Fees - levied on pollution discharge permits or other activities and intended generally
to finance regulatory programs;

•

Tradeable Discharge Permits or Pollution Allowances - various arrangements where
permits or allowances for a fixed amount of pollution can be shifted among pollution
sources through the buying and selling of pollution allowances that concentrate
abatement at the points of lowest cost;

CRS-5
•

Tradeable Credits - where businesses which over perform in meeting an industrywide constraint or objective (removing lead from gasoline, increasing recycled paper
content in newsprint, etc.) are allowed to sell the excess produced to businesses who
cannot meet the objective efficiently thereby achieving gains from trade and lower
compliance costs;

•

Other - including deposits and refunds; the explicit provision of information; the
assignment of liability; the levying of noncompliance fines or taxes; guidelines;
zoning; cross compliance; and subsidies and tax concessions.

Potentials Versus the Pragmatic
Case studies of potential savings from possible incentive-based systems, usually tradeable
discharge permits, often generate estimates in the tens of billions of dollars. Such results are
usually predicated on unconstrained shifting of pollution reduction requirements to the lowest
incremental-cost points of abatement. As such, these studies ignore existing regulations based
on broader policy concerns and the fact that industries have already spent considerable amounts
on abatement. Estimates of savings from EPA's air emissions trading program suggest industry
savings of several billions of dollars since the beginning of the program in the mid-seventies.
The EPA estimates that the SO2 allowance trading may save $0.7 to $1.0 billion per year over
the course of the program depending on State public utility regulation and the participation of
utilities.2
Besides direct cost saving potentials, there are at least two more subtle, but equally
important considerations. First, proponents argue that incentive-based systems provide financial
motivation for long run innovations that may go beyond traditional regulatory approaches in
solving environmental problems. Second, even if incentive systems do not produce greater
reductions in pollution or improvements in resource management than traditional approaches,
they offer the advantage of flexibility in timing the decisions and methods for meeting
environmental goals, not an insignificant factor in managing private sector activities.
Cases in Point
The EPA's air emissions and SO2 allowance trading program are the most prominent
examples of market-based mechanisms, but several other programs or plans use incentive-type
approaches.
•

2

For the SO2 allowance trading program under the acid rain control provisions of the
1990 CAAA, it is too soon to tell whether initial expectations on cost savings will be
realized. Phase I which begins in 1995 requires an intermediate level of reduction
in emissions which many utilities may be able to meet through internal changes. The
exchange of allowances in a market context seems more likely for phase II
allowances which cover emissions of SO 2 after the year 2000 and require more
stringent reductions from more sources. Full realization of the potentials of the

Carlin, Alan. The United States Experience with Economic Incentives to Control
Environmental Pollution. United States Environmental Protection Agency. 230-R-92-001 July
1992. p. 5-7.

CRS-6
program will depend, in part, on State public utility commissions' policies, support
from State legislatures, and judicial interpretation of State laws.
•

The 1990 CAAA also contain several provisions that will be implemented in later
years such as fees of $5,000 per ton of excess emissions of volatile organic
compounds; an oxygenated gasoline credit program; and a low emission vehicle
credit program.

•

For air emissions trading under various EPA mechanisms (netting, bubbling, offsets,
and banking) the results have been mixed, due in part to uncertainties and the
reluctance by regulators and industry to apply these techniques. The most active
"markets" are in Southern California, where stringent pollution limitations on new
industry had been in force prior to the 1990 CAAA and there had been strong
industrial growth. Much of this activity, however, had been credits generated from
plant closings (shut down credits). With the passage of the 1990 Clean Air Act
Amendments, trading activity in Southern California and other areas may be
facilitated by the Act's comprehensive permit program and increasing sanctions for
noncompliance by industry.

•

Lead phase-down in gasoline was implemented by EPA using a lead rights trading
program among refiners who had differing technical capabilities to remove lead. The
program was generally viewed as successful in reducing the overall industry costs of
complying with stricter lead standards. Some argue that lower costs for marginal
suppliers resulted in lower gasoline prices and thus lower overall industry profits,
while benefitting consumers.

•

In Colorado, two local governments have established programs for accommodating
future economic growth by allowing water pollution sources with high treatment
costs to "buy" comparable or greater abatement from lower-cost sources, usually
diffuse nonpoint polluters. The program is beginning to be used and is being studied
as a possibility for areas with similar water pollution problems.

•

Wisconsin has established a statewide discharge permit trading program whose sole
application to date is on the Fox River in order to help achieve regional water quality
standards that had not been met even after dischargers had installed required
pollution control equipment. It appears that limitations on what constitutes tradeable
rights, lengthy approval processes, and other restrictions are the reasons that there has
been virtually no trading within this program.

•

North Carolina has set an overall limit on nitrogen and phosphorus effluent for one
basin with charges for pollution sources to meet short term goals. In the long-term,
lower discharge limits will probably be imposed through control of nonpoint sources.
Dischargers can offset their effluents with credits issued by a program that controls
agricultural runoff with the most effective management practices.

•

Most States as well as the Federal government use various forms of permit fees or
taxes to help finance regulatory programs, or in the case of the Federal Superfund to
pay for cleanup of past problems. Such fees are seldom large enough to create an

CRS-7
economic incentive for abatement, though some argue that permit fees for air
emissions in some areas may be high enough to have some incentive effect.
•

Underlying incentive approaches is the role of better information. Both the Federal
government and various States have made disclosure of pollution information an
explicit requirement for certain types of environmental releases. For example, the
1986 Superfund amendments require that manufacturing companies report annually
on releases of specified hazardous chemicals. New Jersey and California also have
enacted strict disclosure requirements for hazardous substances.

Concerns and Limitations
While incentive-based approaches may be appealing as a refinement to current regulatory
systems, their application in specific situations raises important concerns:
•

Total pollution control costs could be greater for industry in some cases than
traditional command and control systems, even though abatement expenditures may
be reduced through incentive approaches. This is especially the case where pollution
taxes or auctions of pollution permits would be involved. In this case, industry must
both either pay for all of its pollution or pay for partial cleanup and permits and/or
taxes on the rest. On the other hand, where tradeable permits are grandfathered as
they were with the SO2 allowance trading program, questions of equitable allocations
based on differences in past control have to be addressed. To a large extent, the
working out of an allocation of permits to existing and new sources may involve
complexities and politics as challenging as some aspects of command and control
systems.

•

Government revenue from an incentive approach (say from pollution taxes or
auctioned permits) would not be recycled to polluters under most proposals. For
example, earlier proposals for a Btu tax (partly justified on environmental and energy
security grounds) would have gone for deficit reduction, as does the increase in the
gasoline tax that was part of the final budget package. There are also a number of
proposals for substantial tax increases on various pollution sources or other problems
such as auto-related congestion with some of the revenue going to reduce income
taxes. However, some advocate earmarking revenues for environmental programs
or to subsidize abatement for vulnerable industry segments. This approach seems to
be popular in Europe.

•

Incentive systems -- because they allow greater latitude in how and where reductions
occur -- may increase the need for detailed monitoring and enforcement, either at
government or industry (ultimately consumer) expense.

•

Complexity of both sources and pollutants in the toxics and hazardous waste area
probably confines incentive approaches to areas such as long-run technical change,
recycling, and restraint on quantity used. For example, deposit and refund systems
for some types of toxics have appeal. Information disclosure along with shifting of
the burden of proof may be an effective strategy for motivating non-regulatory
compliance. Taxing polluting inputs may also provide incentives for development

CRS-8
of safer new products or substitution towards less harmful alternatives, as well as
raising product price which reduces the amount demanded.
•

In situations where environmental deterioration is severe, the relative advantages of
incentive approaches may be small. In these circumstances, every feasible means of
technical control may be needed to achieve environmental standards, if major
lifestyle changes are to be avoided.

•

To use market-based approaches assumes that markets will not have major
imperfections. Too few buyers and sellers, hoarding, lack of adequate information,
and uncertainty about security of investments in overcontrol are all concerns that
surround trading proposals.

•

Other potential problems include conflicting objectives between governmental bodies
(e.g., environmental program officials' goals to reduce emissions versus State public
utility commissions' goals on service reliability and cost); and geographic inequities
where different jurisdictions might impose different approaches with different costs;
and potential interstate conflict.

•

In some cases, there may be an inherent conflict between equitable protection of
individual health and the goal of greater latitude in reducing pollutants.

CRS-9

THE CONTEXT FOR MARKET-BASED APPROACHES

As noted in the introduction, the growing emphasis on market-based approaches seems to
be driven by three trends:
•

Rising costs from traditional regulatory approaches;

•

The growing complexity of diffuse sources of environmental deterioration including
nonsustainable pressures on many renewable resources; and

•

The perceived urgency to reduce the Federal deficit, thus increasing the attractiveness
of environmental taxes and fees as a revenue source.3

Whether these forces will accelerate changes in Federal environmental protection and
resource management policy is unclear, but the thrust of the Administration's early proposals is
toward market-based techniques. In many cases, market-based mechanisms can potentially ease
the transition to more sustainable but controversial environmental and resource management
standards.
In any assessment of current market-based approaches or proposals for change, the policy
and regulatory setting within which techniques are or may be implemented is the necessary
starting point. This section develops that context as background for later discussions of specific
market-based mechanisms. The section covers:

3

•

The current regulatory system and its perceived strengths and weaknesses;

•

The pressures for change;

•

Current examples of market-based approaches and proposals for new approaches;

•

The advantages of greater reliance on market-based options;

•

The concerns about market-based approaches.

Some even advocate using pollution taxes as a revenue source to shift tax burdens away
from the income tax while also creating incentives to reduce pollution. See for example: 1)
Oates, Wallace E. Taxing Pollution: An Idea Whose Time has Come? Resources. Spring
1988. Resources For the Future. Washington, D.C. pp 5-7; and 2) Repetto, Robert, et. al.
Green Fees: How a Tax Shift Can Work for the Environment and the Economy. World
Resources Institute. Washington, D.C. November, 1992.

CRS-10
THE CURRENT SYSTEM: ITS STRENGTHS AND WEAKNESSES
Today Federal, State, and local efforts to control environmental deterioration involve a
complex mix of requirements that, taken together, are frequently termed a "command-andcontrol" approach. Typical components of this regulatory structure that was developed mostly
in the 1970s include (1) health- or ecology-based standards that are not supposed to be violated,
(2) technology-based or performance-based standards for discharges to the environment, and (3)
permit approval and enforcement procedures for facilities. Liability assignment and fines can
also be important features.
For example, the Clean Water Act establishes technology-based standards for discharges
to water, provides for water quality standards to ensure that remaining discharges adequately
protect water uses, and provides for permits and enforcement. The Clean Air Act establishes
technology-based or performance-based standards for emissions from new sources, establishes
Federal ambient air quality standards which States must develop plans to meet, and creates
elaborate permitting processes that can result in differential requirements depending on whether
the source is new or old and whether it is located (or would be built) in an area complying with
or violating air quality standards. Various provisions of the 1990 Clean Air Act Amendments,
discussed at several points later in this report, modify the command and control nature of the
Clean Air Act by adding new or expanded market-based policies. The acid rain control title
which authorizes the establishment of a trading system for new limitations on sulfur dioxide
emissions, is the most comprehensive attempt to-date at a market-based solution to a national
environmental problem. In contrast, the Air Toxics title of the 1990 Clean Air Act Amendments
is probably one of the most "command and control" provisions in environmental law calling for
technology standards on almost 200 different toxic chemicals.
For toxic materials, there are some regulatory variations: for hazardous wastes, the Solid
Waste Disposal Act creates a manifest system for tracking wastes from cradle to an approved
grave; for toxic substances generally, the Toxic Substances Control Act establishes procedures
by which EPA can require firms to test chemicals and, depending on the results, EPA can impose
various restrictions on use, handling, disposal, etc.; and for pesticides, the Federal Insecticide,
Fungicide, and Rodenticide Act provides for Federal registration of individual pesticides, with
labels specifying permitted uses and restrictions.
Strengths
The current system of regulations has provided administrators with some assurance that
technically and economically feasible actions are being taken to abate specific pollutants, and
provides a basis for enforcement in cases of noncompliance. Regulation in each of the media
(air, water, and land disposal) attempts to assure that a variety of standards will be met. In some
cases (i.e. water and new stationary air pollution sources), generally uniform technology is
required on a national basis. In other cases (i.e., existing plants for air pollution sources), State
or local requirements must lead to compliance with national environmental quality standards set
by the Federal government.
This mix of technology requirements, performance standards, and ambient standards
provides regulators with a reasonable degree of predictability in how much pollution levels will
be reduced. The regulatory system has also generally protected the competitive positions of
competing facilities by requiring uniform abatement technology across the country for new

CRS-11
facilities (in air), or by industrial class regardless of facility age (in water); for existing plants
emitting air pollution, requirements are related to imperatives imposed by ambient conditions.
Placing strictest controls on new plants has been based on the assumption that it is cheaper
for new sources to incorporate pollution control and that economic growth will result in the
eventual replacement of older, dirtier facilities. Slower growth and structural change in
manufacturing and electric power sectors since the mid-seventies has tended to work against
these initial assumptions. This approach has also increased the incentive to keep old facilities
in operation longer, further weakening the intended environmental benefits of new source
controls.
Current regulatory policies, however, have scored notable successes. Water bodies have
much less organic pollution compared to thirty years ago. Urban air quality in terms of lead,
sulfur dioxide, and particulate matter is much improved today over the late sixties.4
Weaknesses
In spite of notable progress on some fronts, the system enacted during the seventies has
been unable to achieve several mandatory standards and deadlines established in the authorizing
legislation. Nonattainment of ozone and carbon monoxide ambient air quality standards in
dozens of urban areas is a good example and led to substantial new requirements in the Clean Air
Act Amendments of 1990. Similarly, many water bodies still do not approach their mandated
quality objectives. Proponents of change argue that in such cases ambient standards and
deadlines should be tailored to differences in regional conditions. Regardless of the merits of
that argument, critics contend that more flexible market-based approaches could help achieve
statutory goals in a more timely and less costly way.
There are also many emerging problems where traditional command and control
approaches may not be practical at an acceptable cost. Examples include nonpoint source
pollution of surface and ground water; solid waste disposal; and pesticide and toxics buildup in
land, water, and air. Management of some combustion byproducts and other industrial
chemicals affecting global climate change may be the ultimate environmental challenge for
which treatment technologies would be infeasible regardless of the scale of investment and
deployment. A system based on demand restraint (such as taxes) or quantity restraints (credits)
may be more effective and practical for many current environmental management problems than
extending detailed command and control systems.

PRESSURES FOR GREATER USE OF INCENTIVES
Legislators, regulators, industry, and environmental interest groups until the last few years
provided little support for market-based systems as an acceptable option for dealing with the

4

For trend data and references see: Environmental Quality: The Twenty-third Annual
Report of the Council on Environmental Quality. Part II: Environmental Data Trends .
January, 1993. For more specific data see:National Air Quality and Emission Trends Report,
1992. EPA-454/R-93-031. U.S. EPA Office of Air Quality Planning and Standards. October,
1993.

CRS-12
Nation's environmental management problems. In spite of major criticisms, the various interests
involved with environmental protection largely supported the current regulatory system. For
conventional pollutants, at least, it had done an acceptable job of meeting the concerns of equity,
administrative manageability, public sector cost, and enforceability.
Whether the nineties see a dramatic increase in the use of market-based approaches is a
matter of speculation. There are, however, growing forces that may make some types of marketbased techniques more attractive in the context of broader international, national, state, and local
policy needs. Interrelated policy needs that seem to be promoting a convergence of interests
around greater use of market-based alternatives include:
•

Cost, finance, and management effectiveness; i.e. the need to deal with growing
control costs, fiscal pressures, and overuse of some resources and environmental
infrastructure;

•

Indirect mechanisms for complex environmental problems ; i.e.; the need to
find some common ground between strong competing interests in dealing with the
intractability of many environmental problems. (Progress on many environmental
and natural resource problems will require fundamental, equitable, and long term
system and technical changes which may only be possible through indirect changes
in the incentives facing businesses and consumers); and

•

International obligations; i.e. the prominent role the U.S. plays as both an example
of solutions and as a significant contributor to some global environmental threats
placing the U.S. in potentially difficult positions in international treaty and political
negotiations.

All three needs point in the direction of greater use of market-based policies because such
policies tend to be less intrusive economically than reliance on direct regulation.
Cost, Finance, and Management Effectiveness
Given the double bind facing environmental management - the growing complexity of
many environmental problems and rising control costs - the cost-effectiveness with which
programs can be implemented will help determine how much "environmental protection" can be
had for a given level of public and private expenditures. Also, tying environmental management
and protection costs more explicitly to the beneficiaries using environmental resources can both
serve to cover public sector management costs and act as a signal to users to economize on use.
Cost
While improving environmental quality produces both monetary benefits -such as reduced
corrosion of materials - and nonmonetary benefits - such as healthier ecosystems, the only
comprehensive economic accounting of the effects of environmental protection efforts is the
measurement of control expenditures as part of GNP. The Environmental Protection Agency
estimates that in 1990 the Nation spent just over 2% of its GNP on all forms of environmental

CRS-13
protection.5 There is no corresponding national measure of the value of benefits produced from
such expenditures, since many are nonmonetary, extremely difficult to quantify, or masked in
other areas of GNP accounting. Thus the fraction and rate of growth of "nonproductive"
environmental protection expenditures becomes a source of concern to those focusing on the
costs of production and distribution. The EPA projects that these costs could rise close to 3%
of GNP by the year 2000.
Expenditures on environmental protection ultimately affect product prices, wage rates, and
returns on capital. Costs of products and services have gone up as a result of pollution abatement
requirements, and environmental control costs have also contributed to decisions to close
marginal plants, especially during business slumps.6
Direct increases in the cost of doing business are not the only concern, however. By
increasing private sector uncertainty and delay, some regulatory approaches may also contribute
to slower economic growth. It has been argued that regulatory requirements for multiple permits
and the additional delays caused by judicial appeals may slow the introduction of new
technologies and reduce flexibility to adapt to changing business conditions.7
Thus, major extensions of the existing environmental regulatory approach may raise
increasing objections because of the perception of unnecessary costs it may impose. The
challenge is its practicality for managing the environmental quality needs of a technically
complex and growing economy and population.8
Finance
Beyond the question of escalating control costs under traditional regulatory approaches,
persistent Federal and State budget concerns elevate the environmental area as a revenue source.9

5

Environmental Protection Agency. Environmental Investments: The Cost of a Clean
Environment, Report of the Administrator of the EPA to Congress of the U.S. [EPA-230-11-90083] (Washington, D.C.: 1990), Tables 8-18.
6

For a comprehensive discussion of the potential economic effects of various Federal
environmental regulations, see: Rusin, Michael et. al. Managing the Environment: A Review
of Present Programs and Their Goals and Methods . Discussion Paper #057. American
Petroleum Institute. Washington, D.C. February 1989.
7

Denison, Edward F. Explanations of Declining Productivity Growth. Survey of Current
Business. V. 59. August, 1979. p. 10.
8

For a discussion of the tension between environmental and economic policy objectives, see:
Blodgett, John E. U.S. Library of Congress. Congressional Research Service. Economic and
Environmental Policymaking: Two-Stepping to a Waltz. Report No. 93-264ENR.
Washington, D.C., 1993.
9

Oates, Wallace E. Taxing Pollution: An Idea Whose Time has Come. Loc. Cit . and
Repetto, Robert et. al. Green Fees: How a Tax Shift Can Work for the Environment and the
Economy. Loc. Cit.

CRS-14
Two revenue options are possible. One is the fees currently used by States and Federal
agencies to fund environmental programs; i.e., fee for service. The other is the explicit use of
taxes on pollutants or polluting activities. This latter option is discussed in the next chapter. The
concern here is the legal status of fees and taxes in terms of their potential use.10
Fees. Federal and State agencies assess a variety of fees associated with pollution
discharge permits, harmful inputs, or with some waste volumes. Such fees are largely designed
to raise revenue to cover environmental regulation, research, or other related activities such as
restoration. These fees are usually set at levels that do not create incentives for polluters to
modify their operations; in other words, the fees are significantly less than the cost of any actions
the business or consumer can take to avoid paying the assessment.
A 1986 partial survey of States by the Congressional Budget Office found that for air,
water, and hazardous waste permits, only seven States did not use some form of environmental
fee in their regulatory programs.11 States use a wide variety of permit-fee structures including:
uniform fees; fees that vary by size of output of the polluting facility; fees that vary by the type
of facility; fees that vary by the type of permit; fees that vary by the volume of pollution
emissions; fees that vary by the toxicity of the discharge or the type of pollutant; and fees that
vary with the destination of discharge.
At the Federal level, certain types of fees may be set by an administrative agency to cover
regulatory or program costs.12 The legislative authority for agency fees comes from one of
several sources: 1) specific provisions in an authorizing statute; 2) authorization provided in
appropriations legislation; and 3) fee collection authority derived from the Independent Offices
Appropriation Act of 1951. In the latter case, fees cannot in reality be a tax; e.g., they must be
proportional to value or service obtained from the groups subject to the fees. Also, receipts go
to the general fund unless Congress specifies otherwise in authorizations or appropriations
language. These and other restrictions in the 1951 Act are intended to preserve the exclusive
power of Congress to levy taxes and to oversee and limit agency growth not authorized by
Congress.
Taxes. An alternative to fees is taxation of polluting activities or substances. Using
taxation as opposed to fees allows greater flexibility in selecting bases and rates and in using the
tax to raise large amounts of revenue. Taxes, if high enough, will also potentially affect polluting
behavior.

10

One other fiscal option affecting resource and environmental management is below-cost
pricing policies for some publicly-owned resources. While change in these policies has both
environmental and fiscal implications, this report focuses only on the direct use of market-type
mechanisms rather than long standing public sector policies which use resource pricing to foster
economic development or maintain community stability in rural areas.
11

12

U.S. Congressional Budget Office. Environmental Charges. August 1987.

U.S. Congressional Budget Office. The Growth of Federal User Charges. Washington,
D.C. August, 1993.

CRS-15
There are two other important contrasts between environmental taxes and program fees.
First, the only restrictions on environmentally oriented taxes are constitutional considerations of
due process and equal protection. However, the constitutional requirement that Federal taxes be
uniform throughout the United States may have implications for some types of incentive-based
approaches. Another distinction noted by CBO is the basing of taxes on market values (sales,
income, or assets), whereas fees are based on non market actions such as licenses, permits, and
government services.
Management Effectiveness
In some cases, rates of use of certain renewable natural resources may exceed the long term
carrying capacity of the resource base under current authorities, institutional arrangements, and
behavior of vested interests. In other cases, an environmental objective may be very costly to
reach through across-the-board requirements on all actors.
Under these general circumstances, trading of the location or method of compliance often
allows the private sector to respond more quickly at less cost to the economy as a whole. The
mechanism involves public intervention to establish a total constraint on total pollution, resource
use, or on other characteristics. Regulated entities are then allowed to trade the location and
method of compliance to their own economic advantage.
Indirect Mechanisms for Complex Environmental Problems
Increasingly, the environmental degradation affecting air, water, and land are the result of
pervasive activities for which traditional "end of the pipe" technologies or command and control
regulations may be neither affordable nor practical. Toxic substances, CO 2, pesticides, and
nonpoint source water pollution are examples typically cited. These types of degradation are
often linked with growing material standards of living; growing population; and the technology
of everyday agricultural, industrial, transportation, and consumer products and processes.
Although conventional pollutants are also associated with economic and population growth, their
emissions levels can still be further reduced with reasonably available technologies.
The seeming intractability of dealing with toxics and pesticide pollution problems arises
from the sheer number of substances, their volumes and diffusion, and the resources and time
demands for evaluating the safety of each one.13 Evaluation difficulties arise for several reasons:
these substances may be biologically active at extremely low concentrations; some of them may
magnify in the food chain; they may cause diverse, subtle, and delayed effects in the form of
cancer or neurological and gene damage; and they may have the potential for accumulation,
cycling in the food chain, and transformation to more harmful substances in the environment.
Congress has passed several major acts directed at toxic substances and pesticides.
Requirements of these acts include testing and evaluation of relative risks and benefits,
registration, application requirements, and substance tracking. Specific requirements for toxics

13

In contrast to the limited number of conventional pollutants, more than 60,000 chemical
products and 1,200 active pesticide ingredients used in over 35,000 formulations give rise to
potential human and ecological hazards.

CRS-16
include regulations on discharge and disposal methods, liability assignment, and fee-supported
cleanup and insurance funds.
Given the complexity and consequences of toxic and other hazardous substances, few
dispute the need for strengthening and improving regulatory approaches. In spite of progress in
dealing with toxics and pesticides, however, the sheer volume and complexity of these
substances present EPA with an enormous information and management burden, and are
considered possible causes in the major delays in meeting various statutory goals. In total, the
EPA estimates that there are over 650,000 generators of hazardous wastes, a figure which does
not include the pesticides used on over two million farms. Annual disposal of toxic wastes in all
media may be as much as one billion tons.14
The fact that so many businesses and individuals use and dispose of hazardous and toxic
substances suggests that future progress in dealing with this problem may require greater use of
flexible and decentralized approaches. In this context, proponents argue that supplemental
market-oriented approaches, such as taxes or deposits and refunds, may be worth considering.
These would provide incentives to reduce the volumes of hazardous products, to encourage
recycling and proper disposal, or ultimately to design less harmful products.
Nonpoint source contamination of surface and groundwater presents similar problems.
Diffuse urban and rural sources of organics, sediment, toxic chemicals, pesticides, and other
contaminants contribute an estimated fifty percent of remaining surface water pollution loadings;
and the dispersed land disposal of wastes and use of agrichemicals pose problems of groundwater
contamination as well. Education on best management practices can help reduce these problems,
but the practicality of technical controls is limited and extending strict regulatory approaches
would present enormous enforcement costs, and problems of political acceptability. Often the
polluting activity or substance is a small part of operational cost but yields large financial returns.
Cases in point include nitrogen fertilizers and many pesticides used in agriculture. Liberal
application of these substances may seem wasteful and is ultimately harmful to the environment,
but to use them more precisely seldom makes sense financially to individuals and businesses.
At current prices and with current technology, wiser use, in an environmental sense, may require
too much management, labor, and information. Again in this context, proponents of new
directions often propose fees or taxes on these substances to help modify individual business and
consumer behavior.
Perhaps the most complex environmental challenge is the role combustion byproducts and
other man-made substances may be playing in global climate modification. Although this topic
is fraught with major uncertainties, proponents of accelerating government actions typically call
for a range of incentive-oriented approaches, including both taxes and trading of the location of
controls
International Obligations
The United States along with other members of the international community have created
or are creating treaty mechanisms to begin efforts to cope with perceived global environmental

14

Office of Technology Assessment. From Pollution to Prevention: A Progress Report
on Waste Reduction. Washington, D.C. U.S. Government Printing Office. 1987. p. 19

CRS-17
threats. These threats to long term environmental quality include loss of species diversity and
habitat, loss of forested areas, atmospheric changes (greenhouse gas buildup and stratospheric
ozone depletion), and growing depletion of ocean and terrestrial wildlife resources shared among
nations.
Part of this growing international imperative is an increasing emphasis on the concept of
"sustainable development." Though ill-defined, it symbolizes the longer term norms proponents
of change seek in technology, institutions, and economic systems in order to move toward a
complementary relationship between human use of the environment on the one hand and
maintenance of life support systems and biological richness on the other.
Given this international context, the U.S. is in a somewhat unique and difficult diplomatic
position. As a world leader, we have often been on the forefront of environmental treaties to
protect the common world interest, the case in point being stratospheric ozone protection. On
the other hand, we are also a significant contributor to some of the long term negative
environmental trends because of the relative size of our economy and our extensive use of fossil
fuels. Thus our stake in the methods proposed for long term changes is indeed large. For that
reason, market-based options which typically provide flexibility and decentralized response, are
often proposed as a less intrusive way to meet potential obligations to future international
agreements.

CURRENT AND PROPOSED APPROACHES
In the mid-seventies, Federal and State agencies began using some incentive-type
strategies, primarily as mechanisms to support the basic "command-and-control" requirements.
Though limited in scope, these strategies typically involve trading of allowed air emissions
among sources through offsets, netting, or bubble arrangements. Other examples include the
noncompliance penalties in the Clean Air Act. The sulfur dioxide allowance trading system in
the 1990 Clean Air Act Amendments builds on this earlier experience.
Legislative proposals in the current and recent Congresses for incentive or market-based
policy tools are outgrowths of these earlier refinements to environmental regulations. Proposals,
in reauthorization efforts for the Clean Water Act and the Resource Conservation and Recovery
Act, for pollution charges or tradeable recycled materials credits are examples. A number of bills
directed at committing the United States to actions to slow emissions of greenhouse gases have
included market-based approaches such as a carbon tax or various forms of carbon dioxide
emissions trading.
Current Examples
At the Federal level, statutory authorities and regulatory implementation in a few areas now
incorporate market-based approaches. Table 1 based on a recent EPA report summarizes the

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variety of mechanisms currently operational or authorized by recent changes in the law.15 EPA
groups current examples under the following headings:
•
•
•
•
•

Fees, Charges, and Taxes;
Deposit-Refund Systems;
Trading Systems;
Emissions Averaging;
Others such as information provision and liability assignment.

States and the Federal government rely to varying degrees on permit and other fees as a
revenue source for environmental programs and related activities. While these fees typically
have not been sufficiently large to provide incentives to modify polluting activities, their use
raises the possibilities of future extension to more incentive-oriented environmental charges.
Indeed, the Clean Air Act Amendments include authorization in cases of future noncompliance
for permit fees that may exceed the incremental cost of abatement. A few examples of fees at
the State level include New York's fee system for hazardous waste disposal, Iowa's nonpoint
source fee on pesticides, fees under the State and Federal Superfunds, and State oil spill funds.
Other innovations at the State/local level include making the incremental cost of environmental
services more explicit to the user. Charging on a per-bag basis for municipal trash collection is
one example. Volume or time-differentiated water or sewer charges are another.
Refundable deposits for beverage containers and for lead acid batteries are now being used
in several States to reduce litter and disposal problems. Deposit-refund systems have also been
proposed for certain toxic and hazardous substances management.
Trading systems have become a feature of environmental policy at all levels of government.
For example, the 1990 Amendments to the Clean Air Act addressed the

15

Carlin, Alan. The United States Experience with Economic Incentives to Control
Environmental Pollution. United States Environmental Protection Agency. 230-R-92-OO1.
Washington, D.C. July, 1992.

CRS-19

TABLE 1. CURRENT MARKET-TYPE MECHANISMS IN OPERATION
FEES, CHARGES AND TAXES
Permit Fees
•

National Pollution Discharge Elimination System -- State permit system for water pollution discharges under
the 1972 Federal Water Pollution Control Act. Some States differentiate fees based on volume and toxicity
of effluent.

•

Publicly-Owned Sewage Treatment Plant User fees -- Charges on industrial facilities and households
discharging into their systems. Fees may have some effect on large industrial dischargers.

•

Municipal Solid Waste Disposal Charges -- At least 2,000 jurisdictions base charges on volume. In addition,
most private collectors impose volume-based charges.

•

Air Emission Fees ---

State permit fees for administrative costs with California highest in the Nation at $300-$600 per ton of
pollutant. Even these rates are below incremental control costs.

--

Federal Nonattainment Area Fees under the Clean Air Act Amendments. Some provisions allow
recovery of administrative costs over a 20 year period. Failure to achieve reduction of excess emissions
in extreme ozone nonattainment areas will subject stationary sources to a $5,000 per ton (adjusted for
inflation) annual fee for each ton of volatile organic compound emitted. Fees in the form of highway
tolls are also allowed to reduce pollution and congestion.

•

•

•

Industrial Solid and Hazardous Waste Charges -- Private waste disposal firms charge based on the
number of containers emptied and content.
Product Charges ---

Fertilizer taxes by States to help pay for programs for environmental protection and research.

--

Automobile Tire Taxes -- State and county taxes with revenue marked for used tire recycling and
disposal.

--

Motor Oil Taxes -- Rhode Island imposes a fee earmarked for used oil collection costs.

--

Superfund Feedstock Taxes on domestic crude oil production, crude oil and petroleum product imports,
and petrochemical feedstocks to finance in part program costs.

--

Chlorofluorocarbon taxes under the Budget Reconciliation Act of 1989 to accelerate reduction in the use
of ozone-depleting chemicals.

Wetland Compensation Fees -- Maryland and New Jersey allow payments for unavoidable wetlands loss with
proceeds available for wetland enhancement and restoration.

CRS-20

TABLE I (continued)
DEPOSIT-REFUND SYSTEMS
•

Beverage Container Deposits in 10 States resulting in sharp reduction in litter.

•

Battery Deposits required in at least 10 States. A $5 to $10 deposit at point of sale is required and deposits
are refundable if an old battery is returned within a specified period. In addition, retailers increasingly are
using deposits to insure that used batteries are returned in jurisdictions without formal deposit legislation.

•

Pesticide container deposits required by Maine to promote triple rinsing and return of commercial containers.

TRADING SYSTEMS
Inter-Firm Non-Approval Trading
•

Acid Rain Allowance Trading under Title IV of the 1990 Clean Air Act Amendments -- Allowing coal
burning utilities to trade the location and method of SO2 reductions mandated by the law.

•

Oxygenated Gasoline Credit Program under Title II of the Clean Air Act Amendments -- Requires gasoline
in certain cities to contain 2% oxygen and allows refiners, blenders or importers who produce greater than 2%
oxygenated gasoline to sell credits to refiners who are unable to meet the 2% requirement. Only the
Philadelphia region has established a trading program, and activity has been minimal to date.

•

Low Emission Vehicle Credit Program under the 1990 CAAA -- Authorizes California to offer marketable
credits to auto manufacturers that sell more low emission vehicles than are required under the pilot test
program for clean-fuel vehicles and alternative fuels.

•

Chlorofluorocarbon Production Allowance Trading -- In response to the 1988 Montreal Protocol and the 1990
CAAA on phaseout of CFCs, EPA established rules apportioning baseline allowances, providing for gradual
reduction in allowances and permitting the transfer of allowances among firms.

•

Lead trading as part of the last part of lead phaseout in gasoline -- Refiners that removed greater amounts of
lead than were required could trade credits to those who were above the limit.

•

Transferable Development Rights -- Whereby local jurisdictions downzone environmentally sensitive areas
and then require areas of higher land use density to purchase development rights from the downzoned area.
Examples include Montgomery and Talbot Counties, Maryland and the Pinelands, New Jersey.

•

Fireplace and Wood Stove Permit Trading -- To reduce particulate matter and carbon monoxide. This
program to reduce local air pollution in Teluride, Colorado uses a combination of performance standards for
existing stoves, a time-limited $750 rebate for conversion to natural gas, and a ban on fireplaces in new
construction unless the developer bought two permits surrendered by existing users.

CRS-21

TABLE I (continued)
Inter-Firm Approval Trading
Air Emission Rights
•

Trading of Air Emissions Rights (EPA) -- Bubbles allowing firms to treat multiple emission points as one
source for control purposes.

•

Offsets (EPA) -- Allowing new plants locating in an area that violates air quality standards to buy reduction
in emissions to insure that air quality does not deteriorate.

•

Banking (EPA) -- Allows saving or banking of emission reduction credits for later use or sale.

•

Netting (EPA) -- Allows plant expansion that avoids stricter, new source standards so long as plant wide
emissions do not increase significantly.

Water Effluent Reduction Trading
•

Wisconsin -- Allowing industrial plants that reduce biological oxygen demand below the standards to trade
the excess reductions to other sources.

•

Dillon Reservoir, Colorado -- Allowing high cost point sources of nutrients discharge to the reservoir to buy
lower cost reductions from nonpoint sources.

•

Cherry Creek Reservoir, Colorado -- Allows publicly-owned wastewater treatment plants to earn reduction
credits by purchasing control of nonpoint phosphorous discharges after these sources have made reduction
of 50% on their own.

•

Tar Pemlico Basin, North Carolina -- The State sets an overall limit on nitrogen and phosphorous effluent with
the possibility of charges for failure by effluent sources to meet short-term goals. In the long-term, lower
discharge limits will probably be imposed through control of nonpoint sources. Dischargers are creating a
fund to pay for nonpoint source control.

•

Steel Industry Effluent Bubble (EPA) -- Allowing steel plants to treat multiple sources in one treatment
system.

•

Wetland Mitigation Banking (U.S. Fish and Wildlife Service) -- Involving creation of new wetlands and
mitigation credits available to developers to meet State-imposed mitigation requirements.

EMISSIONS AVERAGING
This is equivalent to emissions trading within a plant or firm and is used to meet Reasonably Available Control
Technology (RACT) standards. Examples include RACT requirements, Heavy Duty Truck Engine Emissions, California
Motor Fuel Characteristics, and Hazardous Air Pollutants Early Reduction Program.
OTHER METHODS
Several other methods using incentives and other market conditioning techniques have been implemented in recent
years. These include traditional inducements to change behavior or operations such as tax concessions or subsidies;
assignment of liability for prescribed categories of damages or negligence; and the provision of information on risks,
product characteristics, or other operational or site data that facilitates or improves business and consumer decision
making.
Source: U.S. Environmental Protection Agency. The United States Experience with Economic Incentives to Control
Environmental Pollution. 230-R-92-001. July 1992.

CRS-22
acid rain problem by giving new authority to EPA to use a market-based approach for achieving
targeted reductions in sulfur dioxide emissions. The Amendments authorized EPA to establish
a nationwide system for trading the location of sulfur dioxide (SO2) reductions among emission
sources with differing reduction costs. This innovation may have the effect of lowering the long
run compliance costs of electric utilities in meeting legislated targets for reductions in SO2. At
the regulatory level, EPA has since the late seventies allowed various forms of air emission
trading for stationary sources within narrowly prescribed circumstances. EPA also implemented
a credit trading program to ease the transitional costs for refiners in phasing out lead in gasoline
during the 1980s. The goal in all of these cases has been to help reduce the cost to industry of
meeting environmental standards.
State and regional-level innovations have often been within implementation responsibilities
under Federal environmental statutes such as the Clean Air Act. For example, the South Coast
Air Quality Management District in California used a negotiated rule-making process to
introduce emission trading between facilities as a cost-effective way to reduce the costs of
meeting strict health-based ozone standards. In other examples, States have implemented plans
and trading programs, but limited trading has occurred to date. These include two watersheds
in Colorado to reduce future nonpoint source problems and Wisconsin's Fox River waste load
allocation program to attain regional water quality goals. North Carolina also has a similar
mechanism in place for one river system. Locally, communities have applied trading as a way
to reduce pollution from excessive fireplace use in Colorado, for example.
As indicated in the table, other mechanisms include emissions averaging, plants or firms
can average overall emissions to meet a standard; liability assignment in which findings of
damages to third parties carry specified financial compensation; the provision of various types
of information to improve knowledge of risks, both for consumer and business decision making;
and the use of subsidies or tax concessions to induce changes in operation or behavior deemed
to be in the public interest.
Some other types of incentive programs in operation also bear on environmental quality.
For example, at the Federal level, the schedule of fees imposed on continued ocean dumping
after 1991 and the economic-based noncompliance penalties under the Clean Air Act both serve
as incentives to meet environmental standards.
Proposals for Change
While academic economists have long been the major proponents of market-oriented
changes in environmental regulation, these concepts are now actively debated by many in the
policy arena. For example, Table 2 presents some of the types of recent proposals including
those based mainly on two projects sponsored by Senator Wirth and the late Senator Heinz which

CRS-23
have been a focal point for further studies and debate.16 Generic and specific examples of the
various mechanisms in Table 2 are discussed in subsequent sections.
As the table suggests, many of the proposals for greater use of market-based mechanisms
focus on tradeable overcontrol or overperformance on some form of management objective. The
other recurring theme is the more direct use of taxes on polluting activities or products, such as
the Btu tax initially included in the Administration's plan for reducing the Federal budget deficit.

ADVANTAGES: POTENTIAL COST SAVINGS AND INNOVATION
Proponents of decentralized or market-based policies cite the potential cost savings and
efficiency of these alternatives. The general argument is that systems of environmental
regulation which allow flexible responses, or abatement trading among sources with differing
reduction costs, save money. Proponents see such alternatives as both a supplement to traditional
regulatory approaches and as a cost-effective way of attacking emerging problems.
Although proponents talk about market or incentive approaches to environmental
protection, this does not imply markets in the form of daily price quotes and frequent exchanges
of products or property. Rather, proposed approaches would act to increase the flexibility of
meeting environmental or resource management objectives (usually limitations on total pollution
over some broader geographic area) through greater latitude in when, where, and how
adjustments in technology, fuel, materials, or rates of resource use are implemented.
The hoped for objective is less costly management of environmental quality and natural
resources than can be done by trying to extend traditional regulatory methods. In essence, these
types of mechanisms help to focus decision making by making the cost of environmental
management more explicit to both businesses and consumers. This in turn creates reasons to be
innovative to make the cost of compliance as low as possible, thus rationing the absorptive
capacity of the environment similar to the way markets serve to ration any scarce good or service
through the price mechanism.
For the major market-based tools, taxes and tradeable overcontrol of pollution or other
standards, cost savings to society may result for two related reasons. First, flexibility in method,
location, degree of abatement, and contracting arrangements within the regulated community can
lead to less resources expended to meet environmental management objectives. Control is
concentrated at the most cost-effective locations as a result of self-interested trading among the
regulated community, assuming that local environmental standards are met. Second, with both
taxes and tradeable overcontrol, a continuing motivation exists to innovate to avoid the taxes or
create overcontrol that can be sold. If this type of incentive remains a constant and predictable
part of the business or consumer environment, and there are few, if any restraints on how

16

Project 88 -- Round II, Incentives for Action: Designing Market-Based Environmental
Strategies. A Public Policy Study sponsored by Senator Timothy E. Wirth, Colorado and
Senator John Heinz, Pennsylvania. Washington, D.C. May 1991. See also the earlier version
of this report sponsored by the same Senators - Project 88, Harnessing Market Forces to
Protect our Environment: Initiatives for the New President. A Public Policy Study. John F.
Kennedy School of Government, Harvard University. Cambridge, MA. December, 1988.

CRS-24
compliance is achieved, then, proponents argue, longer term cost savings are likely through
innovation and substitution compared to the stereotypical command and control system.
While total cost to society for meeting environmental standards can be less in theory, under
some market-based options total industry compliance costs can be much higher, since regulated
entities must not only pay to use the waste disposal capacity of the environment (through
purchased permits or pollution taxes), but also pay for any abatement they undertake to avoid
taxes or the need to buy overcontrol from somebody else. While expenditures on taxes or
overcontrol are considered transfers within society not affecting the real resource cost of
compliance, they raise the direct compliance cost to industry. Opposition by industry to such
mechanisms, is in part, based on this type of concern.

CRS-25

TABLE 2. PROPOSALS FOR MARKET-BASED ENVIRONMENTAL PROTECTION
ENVIRONMENTAL PROBLEM

MARKET-TYPE PROPOSALS

Air Pollution
Major Stationary Urban Sources

Mobile Sources

Radon(indoor air pollution)

Comprehensive Tradable Permits
•
requires baseline inventory
•
special credit for previous reductions
•
progressive reduction in permit amounts
•
fines exceeding market value of permits
Taxes and Emissions Charges
•
taxes on low-mileage cars
•
charges for automobile use
•
tax on gasoline
Mandatory Information
•
require certification of radon "free" status of house to
qualify for FHA financing

Water
Point Source

Watershed Limitations
•
tradable permits -- similar to air programs

Nonpoint Source
Surface

Groundwater

Pesticides

Point-Nonpoint Source Swaps
•
Point sources buy reductions in nonpoint sources in
order to meet water quality goals (two for one exchange
to assure actual reductions)
•
directed toward nitrogen and phosphorus loadings
Broaden Conservation Reserve Program
Conservation Easements
•
swap farm debt for use restrictions
Taxes on most damaging products

CRS-26

TABLE 2 (continued)
ENVIRONMENTAL PROBLEM

MARKET-TYPE PROPOSALS

Municipal Wastes
Recycling Targets and Tradeable Credits
•
Establish recycling content regulations and allow purchase
or sale of over compliance/under compliance between firms.
Unit Pricing
•
Charge by volume of residential waste
Retail Disposal Charges
•
Surcharges on sale of goods to reflect disposal costs
Virgin Materials Charges
•
Charges on virgin materials to reflect eventual disposal costs
and stimulate use of secondary (recycled) materials
Hazardous Substances
Toxics

Deposit and Refund System on
Containerizable Hazardous Wastes

Greenhouse Effect
New-Major C02 Sources

Offset Policy where New Sources Buy Comparable reductions in CO2
•
from energy conservation
•
from plant retirement
•
from mass transit investments
•
from reforestation joint ventures
Taxes on Major Sources of Carbon Emissions
•
Carbon tax
•
Btu tax
•
Gasoline tax

Deforestation Mitigation

•

from Conservation Reserve Program
•
from international forest for debt swaps

CRS-27
Studies of Cost Saving Potentials
Several earlier studies have looked at this theoretical potential for less costly abatement
approaches through market-based approaches, mainly permit trading.17,18,19 In almost all cases,
these estimates are achieved from simulation models in which current regulations and past
abatement expenditures are not considered. As such, these types of studies will overstate what
might actually be saved from the use of permit trading starting from conditions and regulations
as they currently exist. For example, an earlier survey of several region-specific case studies
suggests that the cost of attaining air quality standards might have been reduced in the range of
fifty percent between 1981 and 1990 if least-cost control had been achieved through
unconstrained emissions trading. 20 This would have amounted to tens of billions in savings.
Hester and Hahn, on the other hand, suggest that savings from the current air emissions trading
program have been a few billion.21
In looking at theoretical or simulation type studies, the extent to which regulatory
constraints on local environmental quality have been excluded from the analysis must also be
considered when evaluating potential savings from emissions trading; that is, if dirty high-cost
facilities would not be allowed to violate local quality standards even if total regional pollution
could be reduced more cheaply through some form of trade, then theoretical savings will be
diminished. In addition, the regulatory approaches may promote values other than costeffectiveness, such as equity and energy policy considerations, among others.
This potential for major cost savings underlying most of the modelling studies is due to the
often large differences in pollution control costs among sources. These potential cost variations
among similar sources are the result of differences in scale, age, technology, cost and ease of
substituting inputs, management practices, and location, among other factors. For example,
studies show that average cost effectiveness across control measures for volatile organic
compounds (VOCs) may range from about $500 per ton for limits on fuel volatility to about

17

United States General Accounting Office. A Market Approach to Air Pollution Control
Could Reduce Compliance Costs Without Jeopardizing Clean Air Goals. PAD-82-15.
March, 1982.
18

ICF Resources Incorporated. Economic, Environmental, and Coal Market Impacts of
SO2 Emissions Trading Under Alternative Acid Rain Control Proposals. Prepared for the
U.S. Environmental Protection Agency and the U.S. Department of the Interior by ICF Resources
Inc. March, 1989.
19

Hahn, Robert W. and Hester, Gordon L. Where Did All the Markets Go? An Analysis of
EPA's Emissions Trading Program . Yale Journal on Regulation. Vol. 6, Winter 1989.
pp.109-153
20

Tietenberg, T. Emissions Trading: An Exercise in Reforming Public Policy. Resources
for the Future. Washington, D.C. pp. 42-43.
21

Hahn and Hester. Loc. Cit. p. 63.

CRS-28
$39,000 per ton for using methanol.22 Typical control costs for VOCs are in the range of $1,000
to $7,000 per ton. Other types of pollutants may have less extreme, but none the less significant,
differences in incremental reduction costs. For example, a series of water pollution control
studies suggested potential saving with least-cost approaches of 20 to 70 percent compared to
equal-proportional treatment of pollution sources.23
Even though major cost variations may hold promise for more cost-effective pollution
control, realizing the savings may not always be practical using extensions of the current system.
For example, most large, low cost sources of pollution abatement are already making pollution
reductions under current regulations. Many of the remaining sources with low incremental
reduction costs may be small individual contributors. Such small activities probably cannot bear
the cost of expensive control technology, but could reduce emissions through changes in
management practices or other operational adjustments. Applying market-based approaches to
these types of problems, however, may involve approaches that are not likely to be
administratively practical, such as taxing inputs or complex polluting byproducts. The latter
implies a very high degree of monitoring or self reporting, both of which have drawbacks.
Another consideration is the stringency of control necessary to achieve environmental
standards. In an area with significant violations of environmental standards (e.g., air in Los
Angeles), virtually every significant pollution source of ozone precursors and of carbon
monoxide may require maximum feasible reductions if ambient standards are to be approached.
Under these circumstances, market-based approaches may reduce inefficiencies in timing and
location of controls, facilitating the implementation of strict standards and reducing indirect
costs, but not appreciably affect total costs.24
A Stimulus for Innovation
Incentive-based approaches may promote lower cost abatement where existing sources of
environmental degradation are required to make major changes. However, a more subtle, but
equally relevant point is the stimulus that market signals can provide for long-term innovations
that might change entire pollution generating products and activities. Incentive systems also
offer important flexibility in timing, important to private sector investment decision-making.
While it has not been demonstrated that current regulatory systems inhibit innovation and
technical advance in environmental protection, proponents argue that incentive systems reduce
the risk that such inhibition will occur. For example, most current environmental regulation is
directed to the removal or transformation of pollutants from industrial, municipal, and mobile
sources or to the control of harmful products entering the environment such as pesticides and
toxics. Solutions to environmental management problems consequently tend to focus on "end
of the pipe" treatment technologies and on disposal practices.25

22

Office of Technology Assessment. Urban Ozone and the Clean Air Act: Problems and
Proposals for Change. April 1989. Washington, D.C. pp. 106-108.
23

Tietenberg, T.H. Op. Cit., p. 46.

24

Tietenberg, T.H. Op. Cit., pp. 45-47.

25

Although the use of "best available control technology" and new source performance
(continued...)

CRS-29
This is not to say that current regulatory systems do not create pressures for cleaning-up
as well as avoiding polluting activities. Adjustments in internal combustion engine technology
along with installation of catalytic converters is a case in point.
The costs of meeting permit conditions, engaging in possible litigation, or paying fines do
provide indirect incentives to engage in avoidance strategies that may reduce pollution.
However, these types of adjustments to regulatory requirements are often in the form of delay,
uncertainty, transactions costs, shutdowns, and decisions that may later prove to be inadequate
or misguided. Where avoidance of regulatory burdens takes a positive form, it may be through
adjusting production processes, changing product lines or inputs, or taking other pollution
reducing activities.
Proponents of incentive systems argue that cost signals should be more explicitly focused
on the polluting substance or activity if we want to do a better job of long-run environmental
management. They argue that there may be any number of ways of reducing the level of
pollutants ultimately reaching environmental media. Having the incentives and flexibility to be
able to choose how and where to make changes can reduce the need for costly removal
technologies. For example, if the impacts on employment in vulnerable segments of the highsulfur coal industry were ignored, an unrestrained incentive-based system would likely lead to
large scale shifting to low sulfur coal. This would be a market-based outcome, since using lowsulfur coal is generally a much less expensive option than installing scrubbers.26 In passing the
acid rain portion of the 1990 Clean Air Act Amendments, however, Congress chose to design
the sulfur dioxide allowance trading system in way that gives some incentives to use scrubbers
that may give some protection to high sulfur coal miners, while still creating the most potentially
comprehensive market-based approach to date.

CHALLENGES TO IMPLEMENTATION
The preceding alludes to some of the institutional challenges in implementing market-based
systems. General concerns include political acceptability, geographical equity, and practicability.
In particular, affected parties may be very reluctant to accept incentive approaches. There are,
moreover, several specific and interrelated policy concerns that accompany proposals for
incentive-oriented policies.
Specific problems include lack of certainty in attaining environmental goals; third party and
local environmental compliance; measurement and monitoring costs; boundary inequities;
institutional capability and authority; market imperfections; compliance versus abatement costs;
complexity in pollution sources; and cross-media effects.

25

(...continued)
standards were supposed to encourage and even "force" new technology.
26

See for example: 1) Streets, David G. and Veselka, Thomas D. Economic Incentives for
the Reduction of Sulfur Dioxide Emissions. Energy Systems and Policy. Vol. 11, pp. 39-59,
1987. 2) Harrington, Winston. Breaking the Deadlock on Acid Rain Control. Resources. Fall,
1988. Resources for the Future. Washington, D.C.

CRS-30
The various incentive approaches discussed in the next chapter are subject in varying
degrees to these specific policy problems. Also, the current command and control system
confronts many of the same concerns.
Uncertainty in Meeting Environmental Goals
Raising the cost of polluting activities or products through charges or taxes can be expected
to lead to reduced pollution levels over some difficult to predict time period. This will happen
so long as the costs of reduction for some businesses or consumers are less than the charges
associated with the polluting activity. However, in a complex economy, it is difficult to predict
accurately how much reduction will occur, how fast it will occur, and what combination of short
and long run alternatives the private sector may use to make reductions.
Thus, if regulators were to add incentive-oriented modifications to current regulatory
systems, the resulting pace of improvement toward environmental goals or standards might or
might not be considered acceptable. Proponents believe that charge adjustments could fine tune
these systems based on initial response. However, frequent changes to adjust the incentive
structure would doubtless lead to criticisms similar to those made of the current system where
numerous changes make private sector response more difficult and inefficient. A further
complication arises if incentive fees also serve to finance the regulatory program. If successful
in reducing the polluting activity, the financing base would be reduced.
Tradeable permits may offer regulators an incentive option with less uncertainty than taxes
or fees. Since permits are for a fixed amount of pollution or other compliance goal, enforcing
compliance with the permit terms should, in total, meet specified standards.
Uncertainty would also affect the private sector's response. If permit conditions and
amounts were not firm or were subject to future change, trading and markets would be retarded.
Similarly, lengthy processes, hearings, intervention points, and possibilities of lawsuits typically
retard or eliminate potentials for cost-saving exchanges.
Third Party Effects and Local Environmental Compliance
Any market-based approach that would result in the shifting of pollution location or in the
potential introduction of unpredictability in regional environmental conditions would require
explicit safeguards. That is, for example, if waste water discharges were transferred between two
different locations as part of permit trading, safeguards would be needed to protect the interests
of persons living along or using the water affected. If various types of interregional emissions
trading are allowed, safeguards would be needed to assure that applicable local environmental
standards continued to be met. Hence, even a market-based system requires a regulatory
framework in order to function and thus is supplemental to such command and control
requirements.
Moral Opposition to Local Changes in Pollution
Closely related to the above, some environmental groups have opposed market approaches
on the grounds that any potentially damaging emissions should be eliminated. Thus there
shouldn't be a "right" to pollute which can be bought or sold. They argue that if it is possible to
reduce emissions at a given source, the source should not be allowed to buy emission rights from
some other source located in a different area, since the local area would continue to bear

CRS-31
avoidable pollution. On the other hand, regulations give one the "right" to pollute also by
meeting the given standard.
Measurement and Monitoring
A major technical and cost challenge for greater reliance on incentives is monitoring of
compliance, particularly for the cases of tradeable permits and less so for taxes on effluents or
emissions. By focusing on performance rather than on what hardware a company has installed,
enforcement difficulties increase.
Systems of monitoring are both necessary and likely to be more complex and expensive
than for a performance- or technology-based approach. With the latter, regulators know
approximately what abatement levels are being achieved and where. To actually measure
pollution levels from specific sources in order to impose charges requires regular monitoring or
self-reporting with periodic verification. For air emissions, for example, most sources do not
have continuous emissions monitoring, nor are all potentially controlled pollutants monitored.
Such monitoring is only required on new sources and coal burning utilities for sulfur dioxide
control purposes. For existing sources, compliance is generally determined by ambient
concentrations as measured by ground monitors. Individual stack monitors would be imperative
to comprehensively monitor compliance with an emissions tax or for systems of potentially
widely-traded emissions. For the SO 2 allowance trading system under the Clean Air Act
Amendments, continuous emissions monitoring is a requirement.
On the other hand, taxes on inputs (such as carbon content of coal) do not require any
extensive monitoring or administrative systems.
Complexity Of Nonconventional Pollutants
The complexity of nonconventional pollutants (i.e., toxics, pesticides, etc.) as well as the
complexity of their sources likely renders tax or charge systems for other than revenue purposes
an extreme challenge in most situations, since authorities would have to set charges for and
monitor a vast number of pollutants and sources. Taxing substances on the input side presents
fewer problems, particularly since companies would normally have transaction data on which
to base charges. For example, proposals for reauthorization of the Clean Water Act include
charges on certain types of toxic chemicals based on a rating of their degree of toxicity.
Institutional Capability and Authority
As stated above, the Federal government has the potential legal authority to use taxes as
a policy tool for influencing private-sector behavior. Some environmental statutes, specifically
the recently amended Clean Air Act, and less so the Clean Water Act, also contain varying
degrees of encouragement or limitations on use of market-type approaches. Beyond the legal
question, Federal, State, and local governments would likely require additional resources,
experience, and capabilities to structure, manage, and enforce certain types of market-based
approaches.
Specifically, capabilities would be needed to structure and facilitate market-type
transactions while avoiding the chilling effect of excessive regulations, oversight, and third party
intervention. Monitoring systems, inter jurisdictional coordination, enforcement authority and
capability, technical analytic staffs, among other resources would be important in supporting less
centralized, market-oriented management systems.

CRS-32
Market Imperfections
The potential for trading overcontrol of pollution or credits to facilitate environmental
management requires well organized markets for trading. If buyers and sellers are few,
information is limited, property rights are not well-defined, transaction rules are cumbersome and
time-consuming, if the public can intervene at multiple points in the decision process, or a few
large organizations can manipulate availability and price of permits, then the potential for trading
is unlikely to be realized or to improve environmental management.
Thus, for pollution or credit trading programs, information and exchange mechanisms
(public or private) would need to evolve quickly to help bring interested parties together. In
many situations, responsible agencies would have to have the capability to monitor market
development and to deal with possible problems of market dominance by very large
organizations or other serious noncompetitive actions.
Regional Definitions and Boundaries
A difficult problem for many of the incentive options is inequities at jurisdictional
boundaries, though this problem also holds for many current environmental regulations. For
example, if input taxes on polluting substances were used, strong incentives exist for avoiding
the cost by doing business in neighboring jurisdictions not using similar programs. Differences
in administrative and legal requirements across jurisdictional lines may also reduce the appeal
and potentials of some of these approaches.
Compliance Versus Abatement Costs
One of the major concerns with some of these approaches is the cost burden on companies.
Systems that involve government auctioning of tradeable permits or payment of effluent charges
particularly raise this problem.
While auction of permits or pollution taxes theoretically achieve the least cost allocation
of pollution abatement expenditures, companies would also pay for the market costs of permits
or pay pollution charges on unabated pollution. This money is paid to the government and is
considered a transfer within society from a social or economic perspective. However, for
companies the combination of spending on pollution abatement as well as permits or effluent
taxes is usually more costly than meeting the requirements for uniform treatment
Understandably, options having this result are vigorously opposed by industry.
Cross-Media Effects
Raising the cost of one means of waste disposal or disposal of one particular pollutant can
often result in diversion of pollutants to other untaxed or uncontrolled environmental media. As
with current regulatory systems, anything less than a comprehensive approach, particularly with
toxic or hazardous substances, invites diversion to other media or even illegal dumping.

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INSTITUTIONAL CONSIDERATIONS IN IMPLEMENTATION

The beginning of market-based approaches to environmental protection in the United States
is accompanied by a growing number of proposals for greater use of these types of policy tools.
Such options are now solidly on the environmental agenda, even though they face significant
institutional and practical obstacles to early or easy application. The challenge to adoption of
such techniques is the extent to which these mechanisms can be at odds with other important
imperatives, authorities, jurisdictions, and practical implementation and management needs.

THE ROLE FOR MARKET APPROACHES IN A REGULATORY CONTEXT
The extent to which market-based mechanisms might ultimately become a major feature
of environmental management policy is subject to a wide range of debate. Such mechanisms do,
however, offer a pragmatic vehicle for accomplishing several things effectively, either as a
supplement to prescriptive regulatory systems or as freestanding systems. These systems offer
at least the following general features which can allow for incremental refinements in existing
environment and resource management systems:
•

Regulatory Efficiencies - Introduction of flexibility in meeting some facility emission
standards or regional ambient quality standards resulting in lower direct compliance
costs or lower indirect costs due to a less cumbersome compliance process;

•

Phase out or Phase Down Mechanisms - Introduction of flexibility and cost savings
in meeting a national or regional pollution constraint where trading of emission
sources does not create local violation of health-based standards;

•

A Way for Internalizing External Costs - Signalling a societal desire for reduction in
the overall consumption of environmentally damaging substances or activities by
raising their costs to the user in situations where other forms of environmental control
are impractical, too costly, less effective, or counter to other values such as individual
freedoms. Taxing cigarettes or alcohol are cases in point at a personal level. Part of
the motivation for a gasoline tax seems to fall in this category.
Not unrelated to these features is the potential for revenue to pay for environmental
protection efforts or to serve other fiscal needs.
The possibilities for less costly or more effective environmental management from adopting
these types of innovations are widely argued and illustrated in academic and other policy
literature. What is less often examined are the issues for implementation within both the
legislative process and the institutional constraints of the Federal system. This section looks at
general implementation issues for three generic approaches and their variations. It also briefly
reviews other market- conditioning mechanisms such as information requirements, liability
assignment, best management practices, and pricing polices.
The approaches include:
1)

Taxing pollution, polluting activities, or polluting inputs;

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2)

Allowing businesses to trade a set amount of pollution or other constraint on business
activity (a fixed amount of sulfur dioxide emissions, recycled paper content in
newsprint, etc.) among themselves in order to achieve gains from trade and thus
achieve lower compliance costs;

3)

Using a deposit-refund mechanism to create incentives to recycle or properly dispose
of containers, and some hazardous substances or contaminated equipment;

4)

Changing how individuals and businesses approach market transactions that may
affect the environment by increasing available information, by internalizing risks
through liability assignment, by pricing policies, and by means such as contracts or
other types of agreements.

TAXING POLLUTION
The concept of taxing pollution is simple. The political and management reality of "pure"
pollution taxes, however, is far from simple. Indeed, the pragmatic side of pollution taxes
suggests only limited circumstances where convergent interests, policy needs, and institutional
capability may make some variation of this approach a part of environmental management. 27
As discussed below, it is the variations on the theme that may hold more policy interest than the
conceptual case proposed by some.
The General Case
Pollution damages important human values (health, aesthetics, materials, or the functioning
of ecosystems indirectly necessary for human welfare). Thus, not all of the costs (both monetary
and nonmonetary) of polluting activities are reflected in the prices of the respective goods or
service. This means that damages to other values could be reduced or avoided if less of the good
or service were produced, the production or consumption involved more benign technology, or
defensive efforts were made to counter the pollution.
In these circumstances, economists recommend a tax on the pollution from the activity or
product which causes damages to other values so that price signals the full social cost to the user
(private cost of production plus monetary value of external damages). The level of the tax is set
so that enough economic units (producers or consumers) modify their various behavior
(consumption, fuel choice, technology, chemical use or design, etc.) to just balance the
incremental value of the reduction in external damages from pollution with the incremental costs
of reduction. In this scheme, those who find it cheaper to reduce pollution than pay taxes do so.
They pay taxes on any remaining pollution their activity causes. Those who find it more
expensive to make changes than pay the tax do so and thus continue polluting.
In theory, a tax set at the proper level will result in a reduction in pollution where costs of
reduction are balanced with the benefits of such reductions, that is, where incremental costs of
reduction and incremental benefits of reduction are just equal. Such an arrangement implies a
great deal of information on polluting activities, the damages such activities may cause, and how

27

For example, see: U.S. General Accounting Office.
Environmental Protection:
Implications of Using Pollution taxes for Supplement Regulation . GAO/RCED-93-13.
Washington, D.C., 1993.

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individuals value those damages. Such information would be used by public authorities to
structure and administer pollution taxes.
Implementing Pollution Taxes
While some countries have used variations of pollution taxes to help manage water quality
for some river systems, no pollution tax conceived as a method of balancing incremental control
costs with incremental social benefits has been attempted to date. There are good reasons for this
and include the following considerations:
Credibility of Information
Estimates of monetary benefits necessary to justify tax levels cannot be developed in a
practical and systematically defendable way. Economists have methods for estimating
willingness to pay to reduce pollution, but such methods are experimental at best and not
operational in terms of governmental obligations for protecting public health and other
environmental values. Thus, there is no publicly acceptable way to measure the monetary
benefits of most forms of pollution reduction that would allow defendable methods for setting
a tax. Instead, where taxes have been proposed as an alternative to direct regulation, it has been
more along the lines of how high should a tax be to induce incremental expenditures by
industries in order to achieve a desired reduction in pollution with the tax.
Limited Applicability
The type of pollutants for which optimal taxes are usually proposed tend to be those that
do not have long term or irreversible human or environmental consequences. The standard case
is organic forms of water pollution which can be assimilated and broken down by normal
bacterial processes. The more complex pollution problems, however, relate to certain toxics and
pesticides which are long lasting, bioaccumulate and cycle in the environment. These pollutants
have diffuse and often hard to understand consequences, which often show up first in aquatic and
related ecosystems. Using optimal taxes to manage the myriad compounds that are potentially
damaging presupposes immense analytical, monitoring and enforcement capability which is not
currently the case.
Use of Tax Revenues
The disposition of revenues from taxes on pollution raises several difficult practical issues.
If pollution is taxed in some way (pollutants, inputs, activity) to bring about its overall reduction,
three questions arise. First, who receives the revenue? Second, what happens as revenue from
the tax declines as pollution declines?; i.e., what happens to the revenue base? Third, how are
taxes adjusted for inflation to keep the economic incentive constant in real terms? While these
questions can be easily answered in concept, answers within the Federal system pose significant
problems. Interests affected by taxes typically like to see benefits from such taxes, for example
the highway gasoline tax going for highway construction. Answers also affect the
macroeconomic impacts of such taxes.
Data Availability
Taxing pollution assumes the availability of comprehensive and precise monitoring systems
which do not currently exist and would be expensive to install, maintain, and verify. Unless self
reporting is used or more readily measurable entities such as inputs (for example, high sulfur coal

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rather than sulfur emissions) are taxed, taxes would require expensive monitoring in order to
ensure accurate reporting.
Other Ways of Using Taxes
Accepting the practical difficulties of using taxes to precisely manage environmental
quality on a location specific-basis, there are other roles that taxes, charges, or fees can play.
Fees already serve as a basis for partial or complete financing of some environmental
protection programs. Fees are levied on regulated entities to recover some or all of the costs of
administering Federal, State, or local environmental protection programs. The level of fees must
reflect the cost of administrative services performed meaning that fees seldom will provide any
strong incentive for reducing pollution beyond the regulatory requirements.
Between the financing of environmental protection programs with fees and the precise
taxing of pollution to achieve an essentially unknowable optimal reduction probably lies a more
pragmatic role for taxes in implementing already determined social goals. This role evolves from
using taxes to implement a policy for which a consensus on achieving a specific reduction target
has been obtained. For example, the acid rain control program could have had a tax imposed that
achieved a 10 million ton reduction in SO2, but a permit program was chosen instead.
The use of taxes in these circumstances may have several purposes not necessarily related
to environmental protection but possibly modifying behavior sufficiently to produce some
reduction in polluting activity. Such taxes may raise general or dedicated revenue, send a signal
on level of consumption, possibly be used to offset other revenue sources, or serve other
purposes such as capture of windfall gains where other environmental regulations are driving up
product prices.
The tax on chlorofluorocarbons (CFCs) and proposals for an increase in the Federal
gasoline tax are primary examples of how taxes are or could be applied as part of broader policy
packages. In the case of CFCs, the tax adds incentive to find substitutes and speed phase-out,
but most observers see its imposition as much as a way to capture some of the price runup due
to phase-out and to raise revenue. Proposals for large increases in the gasoline tax are packaged
with any number of motivations including deficit reduction; increased energy security through
reduced consumption of oil and long run incentives to increase equipment efficiency; as a general
premium to signal the social costs of auto use including air pollution, congestion, and accidents;
and as an incentive to shift toward alternative fuels, among others.
A tax on carbon dioxide or more precisely, a tax on carbon content of fuel, has also been
proposed as one possible response to forthcoming treaty commitments by the United States on
global climate change. The level of such a tax would not be set based on an unknowable value
of marginal damages from future climate change. Rather, a target for reduction would need to
be related to incremental costs of reduction and the tax set at the incremental reduction cost. A
large amount of revenue would be raised which opens the possibility of offsetting other taxes or
spending areas so as to minimize the immediate economic impact. The Clinton Administration
and the Rio Declaration at the 1992 Earth Summit have committed the country to stabilization
of greenhouse gases at 1990 levels by the year 2000. A carbon equivalent tax could be set at the
marginal cost of achieving that policy goal. Other possibilities for energy-based taxes related
to climate change include a tax on Btu content of fuel, which shifts the initial costs away from
fuels such as coal and may spread the distributional consequences.

CRS-37
In contrast to a precise pollution tax based on balancing regional environmental benefits
and control costs, a broad based tax serving multiple objectives is likely to have widespread and
highly visible equity or distributional consequences. To the extent that such taxes have
environmental purposes, the objective is to affect levels of consumption and possibly long run
technology or product design and function. In most cases, making consumption more expensive
will disproportionately burden lower income individuals. Opposition to a generalized gasoline
tax is partially along these lines. As with all taxes, some relief to lower income individuals can
be realized through refundable credits or means tests, though the administrative burden increases.
Proposed gasoline taxes fall into this category. Impacts from a carbon tax would be more
concentrated initially on coal producing regions, rail transportation, and coal using utilities in
terms of income and employment loss. The tax would also quickly be reflected in the rates of
coal-consuming electricity utilities, currently about sixty percent of total electric generation.

TRADING OF POLLUTION REDUCTION OR OTHER RESOURCE
MANAGEMENT CONSTRAINTS
Another way to potentially reduce the costs of achieving environmental standards or other
resource management constraints is to allow regulated sources to trade the location and nature
of compliance among themselves. This is already done to some degree through EPA's air
emissions trading program and is a central feature of the acid rain control provisions of the 1990
Clean Air Act Amendments.
This type of mechanism is usually applicable only where the pollutant mixes uniformly and
is damaging over a broad geographical area. Under those circumstances, the point of control is
less important than is putting a limit on the total amount of pollution. As long as local healthbased standards are met, where in the region pollution is reduced is not important to overall
regional environmental quality.
The General Case
As with taxes, the economic logic of tradeable over control of pollution (or other
compliance obligations like recycled material content) within a binding limit on total emissions
is compelling. If reductions can be concentrated at those sources with the lowest costs, the total
economic cost will be less than if sources with differing costs are required to achieve equal
reductions. This least cost outcome is possible if each source is required to control damaging
activity at the specified rate of reduction, but then allowed to sell over control to or buy over
control from other enterprises. For those with low (incremental) costs of reduction, it pays to
over control and sell the excess reduction to enterprises that have high (incremental) costs, who
then are allowed to continue emitting pollutants. The end result is control at the required total
level of reduction. If site specific shifts in the source of damaging activity is not an issue, this
type of mechanism can be a cost-effective way to meet a variety of environmental and natural
resource management goals.

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Implementing Tradeable Pollution or Other Compliance Requirements
Implementing any tradeable pollution system requires consideration of several important
institutional needs. These include:
Protecting Private Transactions
For there to be a market for pollution or other compliance over control, there has to be
security of underlying private obligations. This leads to two very strong necessary conditions
for development of a trading system. First, over control is essentially an investment and as such
must be viewed as "property" that belongs to the investing enterprise if there is to be any
reasonable incentive for trading. Government recognition and protection of that property is
essential for markets to develop. Second, government can facilitate market development by
minimizing the transactions costs of trading. The less encumbered with oversight and potential
vetoes by government authorities or other parties, the more likely that trading and cost saving
potentials will be realized.28
Meeting Public Purposes
On the other side of the coin, there also has to be accountability for the public purpose
being served. Thus, most "op

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/crs%3A94-213. Public record. Not legal advice.