6.5 Solutions: property rights, regulations, and incentive policies  (Page 6/14)

Tradable permit policies have been used in several environmental and natural resource policies. The U.S. used tradable permits (where the annual cap declined to zero over a fixed number of years) in two separate policy applications to reduce the total cost to society of (a) phasing out the use of lead in gasoline and (b) eliminating production of ozone-depleting chlorofluorocarbons. The Clean Air Act amendments of 1990 put in place a nationwide tradable permit program for emissions of acid-rain precursor sulfur dioxide from electric power plants. The European Union used a tradable permit market as part of its policy to reduce carbon dioxide emissions under the Kyoto protocol. Individual tradable quotas for fish in fisheries of Alaska and New Zealand have been used to rationalize fishing activity and keep total catches down to efficient and sustainable levels (see Case Study: Marine Fisheries ).

Tradable permits have been adopted more widely than externality taxes. Two factors may contribute to that difference. First, tradable permit policies can have different distributional effects from taxes depending on how the permits are given out. If the government auctions the permits to participants in a competitive marketplace, then the tradable permit scheme is the same as the tax; the industry pays the government an amount equal to the number of permits multiplied by the permit price. However, policy makers more commonly design policies where the permits are initially given for free to participants in the market, and then participants sell the permits to each other. This eliminates the transfer of wealth from the regulated sector (the electric utilities, the fishing boats, etc.) to the government, a feature that has been popular with industry. Second, taxes and tradable permits behave differently in the face of uncertainty. A tax policy fixes the marginal cost to the industry, but might yield more or less of the harmful activity than expected if market conditions fluctuate. A cap and trade program fixes the total amount of the harmful activity, but can yield costs to industry that are wildly variable. Environmentalists have liked the outcome certainty of tradable permits.

Liability

A third type of environmental policy was not designed by economists, but still functions to give agents incentives to take efficient actions to reduce environmental degradation: liability    . Liability provisions can make people or firms pay for the damages caused by their actions. If the expected payment is equal to the total externality cost, then liability makes the agent internalize the externality and take efficient precautions to avoid harming the environment.

Two kinds of liability exist in the U.S.: statutory and common law. Common law derives from a long tradition of legal history in the U.S.—people have sued companies for damages from pollution under tort law under doctrines such as nuisance, negligence, or trespass. This approach has been highly problematic for a number of reasons. For example, tort law places a high burden of proof on the plaintiff to show that damages resulted directly from actions taken by the defendant. Plaintiffs have often struggled with that burden because pollution problems are often caused by many sources, and the harm caused by pollution can display large lags in space and time. If the defendant expects with high probability not to be held responsible by the courts, then liability does not function effectively to make agents internalize the externality costs of their actions.

Frustration with common law has led to several strong statutory liability laws in the U.S. which make explicit provisions for holding firms liable for damages from pollution with much more manageable burdens of proof. The Oil Pollution Act of 1990 holds companies like Exxon and British Petroleum strictly liable for the damages caused by oil spills from accidents such as the Valdez grounding in Prince William Sound or the Deepwater Horizon explosion in the Gulf of Mexico. Under a rule of strict liability, a party is liable for harm if the harm occurred as a result of their actions regardless of the presence (or absence) of negligence or intent. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, or "Superfund") holds companies strictly liable for damages from toxic waste "Superfund" sites.

These laws have surely increased the extent to which oil and chemical companies take precautions to avoid spills and other releases of hazardous materials into the environment. However, enforcement of these provisions is very costly. The legal proceedings for a big case like Deepwater Horizon entail court, lawyer, and expert witness activity (and high fees) for many years. The transaction costs are so burdensome to society that liability may not be a viable approach for all environmental problems.

Review questions

References

Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics, 3 , 1-44.