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Economic Incentives for Pollution Control

In the past several years, economic incentives have assumed a prominent position among the tools for environmental management. Nowhere is this role more explicit than in the 1990 Clean Air Act Amendments. That legislation authorizes incentive-based mechanisms for the control of acid rain, for the development of cleaner burning gasoline and less polluting vehicles, for states to use in controlling urban ozone and carbon monoxide, and to facilitate the reduction of toxic air emissions.

As other key environmental statutes such as the Clean Water Act and the Resource Conservation and Recovery Act come up for reauthorization, potential applications of incentive mechanisms may be actively debated. EPA is currently evaluating a variety of incentives to support these debates as well as working to implement other mechanisms under existing statutory authority. At the state level, a wide variety of incentive programs have been implemented, and many other proposals are currently under active consideration. Outside the United States a diverse group of nations are extending the frontiers for applying incentives.

With current high levels of interest in incentive mechanisms for environmental management, it is useful to examine the record to date. Over the past 20 years, federal, state, and local authorities as well as many foreign nations have enacted a diverse array of environmental incentive mechanisms. How well have these mechanisms performed? What can be learned from the record that will assist in the formulation of new mechanisms? How economically efficient have these mechanisms been in achieving their objectives?

This report updates and extends a 1992 EPA review (EPA, July 1992) (See Web siteThe United States Experience with Economic Incentives to Control Environmental Pollution )of that record, highlighting applications of emission and effluent fees, charges for solid waste disposal, marketable permit systems for air and water pollution, deposit-refund systems, and information and liability mechanisms. The mechanisms described in this report all satisfy the basic requirement that a continuous signal be provided to pollution generators to be aware of and act on opportu-nities to reduce releases of pollution to the environment.

The report first reviews the available information on the economic efficiency and environmental effects of economic incentives in general. The literature uniformly finds that economic incentives should be much more economically efficient in controlling pollution than the traditional command-and-control approaches. Some studies, however, indicate that the cost savings actually realized have fallen short of those predicted by these studies. Economic incentives should be particularly efficient when diverse sources of pollution are involved which are most efficiently controlled using little-known or yet-to-be developed technologies. The evidence on the environmental effects of economic incentives, while much less extensive than that on economic efficiency, suggests that incentives mechanisms are fully compatible with environmental objectives.

The historic record concerning individual incentive programs suggests that although there have been a number of important successes, in some cases incentive programs have failed to live up to their full theoretical promise. This appears to be the result of the particular design features of the programs tried, however, rather than the theoretical promise of the approach. In most cases, fees and charges have been designed primarily to raise government revenue, and have thus been set too low to have significant incentive effects. Trading systems have often been constrained by complicated regulations, but some new ones which have not as yet been fully implemented hold out considerable promise for being both effective and efficient in reducing pollution. Beverage container deposits appear to have greatly reduced litter, but there is only limited knowledge of the impact of other deposit-refund systems and virtually no analysis of the costs and benefits of any of the deposit-refund mechanisms. Some programs providing information appear to be having great impact among fully implemented incentives considered in this report and are likely to be economically efficient as well, but have not been examined with the detailed scrutiny necessary for a fair evaluation of performance. Liability mechanisms can and do act as effective incentives, but structuring liability rules to accurately internalize the costs of pollution has proved difficult.

Finally, a review of the use of economic incentives outside the United States suggests a preference for a somewhat different mix of incentive mechanisms but somewhat similar conclusions as to their effectiveness and efficiency as in the United States. The United States uses many more marketable permit systems than European countries, but much less environmental labeling. Also, a wider range of commodities are subject to deposit systems outside the United States. Although charges and fees are used more widely in Europe, they also tend to be revenue-raising instruments with few incentive impacts, as in the United States. The lack of incentive impact of charges is due primarily to their low magnitude and because a number of the charges are not closely linked to waste generation or product consumption. As in the United States, official interest in economic incentives appears to be increasing in Europe, Australia, South Korea, Chile, many parts of the former Soviet Union and elsewhere.

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