Environmental Economics

Incentives and Impediments to Pollution Prevention

  • Abstract
    The purpose of this project is to build a single analytical general equilibrium model of the U.S. economy for use in comparing alternative polices for source reduction or "green design." The model encompasses the entire life-cycle of a product including design, production, packaging, sale, consumption, and disposal. It also encompasses market clearing at each of these phases, and the possibility of negative externalities from disposal. Thus, if consumers had to pay for the full social cost of disposal of each item, then they would demand goods with less packaging and with recyclable designs. Since consumers generally do not pay a price per bag of curbside garbage disposal, however, any particular item can be discarded for free. Producers then are not induced to sell goods with less packaging or more recyclable designs. The same model can then be used to solve for policies directed at firms that would equivalently reduce packaging and increase recyclability. This model will be extended to a second-best framework, with pre-existing labor taxes and other distortions, to see how these policies for green design can simultaneously address environmental problems and revenue needs. Supplemental Keywords: Scientific Discipline, Sustainable Industry/Business, Economics, Social Science, cleaner production/pollution prevention, analytical general equilibrium model, cost benefit, disposal, green design, incentives and impediments, packaging, product life cycle, recyclable design
  • Metadata
    Principal Investigators:
    Fullerton, Don
    Technical Liaison:
    Research Organization:
    Texas at Austin, University of
    Funding Agency/Program:
    Grant Year:
    Project Period:
    October 1, 1995 – September 30, 1997
    Cost to Funding Agency:
  • Project Reports

    Objective(s) of the Research Project: The project undertook research in three lines of inquiry. First, a simple general equilibrium model was developed and used to analyze and compare the effects of disposal-content fees, subsidies for recyclable designs, unit-pricing of household disposal, deposit-refund systems, and manufacturer "take-back" requirements. These alternative policies for "green design" might induce firms to reduce packaging or make products more recyclable. A second line of inquiry relates to a "two-part instrument." The purpose of this research is to build relatively simple general equilibrium models to demonstrate the general equivalence between a pollution tax and the combination of a presumptive tax (i.e., that imposed which presumes all production uses a dirty technology or all consumption goods become waste) and environmental subsidy. The environmental subsidy is then provided only to the extent that production uses a cleaner technology or that consumption goods are recycled.

    A third line of inquiry is related to the "double-dividend hypothesis" (DDH), which suggests that increased taxes on polluting activities can provide two kinds of benefits: an improvement in the environment, and an improvement in economic efficiency from the use of environmental tax revenues to reduce other taxes, such as income taxes that distort labor supply and saving decisions.

    This research makes four main points. First, the validity of the DDH logically cannot be settled as a general matter. Second, the focus on revenue in this literature is misplaced. Three policies are demonstrated that can have equivalent impacts on the environment and on labor supply, when in reality, revenue is raised from the environmental component of the reform, another loses revenue, and a third has no revenue associated with it. Third, what matters is the creation of privately held scarcity rents. Policies that raise product prices through some restriction on behavior may create scarcity rents. Unless those rents are captured by the government, such policies are less efficient at ameliorating an environmental problem than are policies that do not create rents. Finally, the distinction is made between two types of command and control regulations on the basis of whether they create scarcity rents.

    Summary of Findings: First, if market signals can be corrected through the use of appropriate disposal charges, then it is demonstrated that consumers will induce firms to use less packaging and to design products for easier subsequent recycling. If market signals cannot be corrected in this manner, however, then welfare can be improved by policies directed toward the firm. The solution may involve a subsidy to recycling, or, if that is not possible, a subsidy to recyclability. In the extended model, with disaggregate commodities of differing toxicity, separate output taxes and recycling subsidies are shown to address hazardous and nonhazardous generation of waste.

    Second, desirable incentive effects of a waste-end tax can be matched exactly, without the measurement and enforcement problems, by the use of a "two-part instrument." The deposit- refund system is one such example. To see this, the generation of waste is viewed as an input to production, with its own marginal product such as labor, capital, and materials. Then the tax need not apply directly to the unobservable wastes, because the exact same changes in relative prices can be achieved through a tax on an observable transaction, such as the purchase of the output, in combination with a subsidy to other observable transactions, namely the purchase of all other inputs to production except waste.

    The intuition is fairly simple and follows the idea that the waste-end tax has two intended incentive effects. First, the tax raises production costs and makes the good more expensive, so the "output effect" reduces production and, therefore, consumption of the good. Second, the waste-end tax makes the waste more expensive relative to other inputs, so the "substitution effect" reduces waste per unit. By analogy, the two-part instrument accomplishes the same effects separately. The first part imposes a tax on the output, which reduces production and consumption of the good. This tax on output is equivalent to a tax at the same rate on all inputs to production, including labor, capital, materials, and waste. The second part subsidizes all nonwaste inputs, which makes waste relatively more expensive and reduces waste per unit of output.

    Third, debates about DDH have focused on whether an environmental policy raises revenue that can be used to cut other distorting taxes. Welfare results are derived for alternative policies in a series of analytical general equilibrium models with clean and dirty goods that might be produced using emissions as well as other resources, in the presence of other preexisting distortions such as labor taxes or even monopoly pricing. The same welfare effects of environmental protection can be achieved, without exacerbating the labor distortion, through taxes that raise revenue, certain command and control regulations that raise no revenue, and subsidies that cost revenue. Instead, policies that generate privately retained scarcity rents exacerbate the preexisting labor tax distortion. These rents raise the cost of production, raise equilibrium output prices, and thus reduce the actual net wage. Such policies include both quantity-restricting command and control policies and certain marketable permit policies.

    Environmental Levies and Distortionary Taxation: Comment. Am Econ Rev 1997;87:245-251.

    Fullerton D, Wolverton A. The case for a two-part instrument: presumptive tax and environmental subsidy, In: Panagariya A, Portney P, Schwab R, eds. Environmental and public economics: essays in honor of Wallace E. Oates. Cheltenham, UK: Edward Elgar, 1999.

    Fullerton D, Metcalf G. Environmental taxes and the double-dividend hypothesis: did you really expect something for nothing? Chicago-Kent Law Rev 1998;73(1).

    Fullerton D, Metcalf G. Environmental controls, scarcity rents, and pre-existing distortions. Cambridge, MA: NBER WP#6091, 1997.

    Fullerton D, Wu,W. Policies for Green Design. J Environ Econ Management 1998;36:131-148.

  • Project Status Reports