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Economic Incentives for Pollution Control

At least 100 different economic incentive mechanisms are currently being used in the United States, up from approximately 40 in 1992 when EPA’s first survey was conducted. Outside the United States several hundred more such mechnisms are in active use. Economic incentives are being used at many levels of government from individual towns to state and federal governments. Some of them have multiple applications in different cities, states and nations. Although it would be desirable to be able to summarize the cost savings from the use of each of these instruments, the financial consequences to individual economic sectors, the impacts on technical change and innovation in pollution control, and the environmental effects of each of these mechanisms, few have been studied in such detail.

Approximately 30 quantitative comparative studies now exist, all of which indicate that economic incentives should be more economically efficient than command-and-control approaches for controlling environmental pollution. The predicted efficiency gains can quite large, but it must be kept in mind that retrospective studies have found that the savings actually realized fall well short of the potential, particularly so for many of the trading mechanisms. There is relatively little information available on the environmental effects of economic incentives. Although incentives are being increasingly used, they have not always been implemented in the ways advocated by economists. Not surprisingly, therefore, the results have sometimes fallen short of what economists hoped for. A review of the principal types of incentives suggest several reasons for this result.

Fees and charges, with few exceptions, have not been set equal to marginal treatment cost, let alone the theoretically more defensible and generally higher values determined by the marginal damages the pollution causes. Rather, revenue goals have been the principal drving force behind many of the charge-based incentive mechanisms and fees and charges generally have been too low to have a true incentive effect. In situations where fees and charges approximate marginal treatment cost, such as the Swedish NOx charge and water pollution charges in the Netherlands, the impacts on technical change and innovation are large, as is the measured environmental improvement. Additional study of the impact of pollution taxes and charges that approximate marginal abatement costs is likely to be instructive; potential subject areas include (1) the impact of publicly-owned treatment works (POTW) user fees on industrial users' discharge, (2) the impact of existing pricing mechanisms for commercial and industrial generators of solid and hazardous waste, and (3) further studies on unit pricing of household waste disposal.

Among the market-based trading systems with which there is experience, only the lead phase down, wood stove permit and acid rain examples can be termed a full success and even in these programs there are numerous instances where potentially profitable trades were not completed. Other emission and effluent trading systems are subject to severe regulatory constraints that have raised barriers to trading. In nearly every case, actual cost savings have fallen far short of originally projected amounts. If, as seems likely, the United States will want to expand the opportunities for market-based trading of pollution reduction credits or allowances, it is important that unnecessary constraints not be imposed in future applications and that transactions costs be minimized.

Deposit-refund systems are used for several products at the state level and in Europe. Beverage container deposits appear to be effective in reducing litter. With the exception of beverage container deposits, however, there is only limited knowl-edge of impact and virtually no analysis of costs and benefits. Lead-acid battery deposits are largely a private sector initiative, though some states also require deposits. The near-universal application of this incentive, whether private or public, and the very high rates of recycling that it achieves, make it worthy of further examination. What special features allow it to thrive where other deposit systems engender controversy and high cost?

Several programs that act solely to provide information appear to be having great impact. Many firms have made public announcements of a corporate commitment to reduce pollution voluntarily in response to reports filed under SARA Title III. One attractive feature of information requirements is that response is highly flexible; corporations are free to do nothing or to seek pollution reductions as they see fit. Where pollution reduction can be achieved at reasonable cost, many corporations see it in their self interest to make those efforts.

Liability mechanisms can and do act as incentives. Structuring liability rules to internalize the cost of pollution, without deviating from this objective by a wide margin, may be difficult to accomplish, if the experience with hazardous waste cleanup and natural resource damage assessment are any guide.

Subsidies have both positive and negative effects on the environment. Economists generally do not favor subsidies, believing that there are superior mechanisms to improve the environment. Economists would favor elimination of environmentally-unfriendly subsidies.

Voluntary programs have a mixed record, with several not meeting initial expectations. The lack of a statutory basis for the programs, different expectations on the part of EPA and program participants, and in some cases mistrust, have slowed progress with many programs.

Finally, a review of the use of economic incentives outside the United States suggests a somewhat different mix of incentive mechanisms but generally 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. 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, however, official interest in economic incentives appears to be increasing in Europe and indeed throughout much of the world.

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