Market-Based Environmental Policies

Some eighty years ago, economists first proposed the use of corrective taxes to internalize environmental and other externalities. Fifty years later, the portfolio of potential economic-incentive instruments was expanded to include quantity-based mechanisms — tradeable permits. Thus, economicincentive approaches to environmental protection are clearly not a new policy idea, and over the past two decades, they have held varying degrees of prominence in environmental policy discussions. This paper summarizes U.S. experiences with such market-based policy instruments, including: pollution charges; deposit-refund systems; tradeable permits; market barrier reductions; and government subsidy reductions. No particular form of government intervention, no individual policy instrument — whether marketbased or conventional — is appropriate for all environmental problems. Which instrument is best in any given situation depends upon a variety of characteristics of the environmental problem, and the social, political, and economic context in which it is being regulated. There is no policy panacea. Indeed, the real challenge for bureaucrats, elected officials, and other participants in the environmental policy process comes in analyzing and then selecting the best instrument for each situation that arises. *Albert Pratt Professor of Business and Government, and Faculty Chair, Environment and Natural Resources Program, John F. Kennedy School of Government, Harvard University, and University Fellow, Resources for the Future. Quindi Franco provided excellent research assistance, and helpful comments on a previous version of the chapter were provided by Dallas Burtraw, Don Fullerton, Robert Hahn, Richard Morgenstern, Richard Porter, Paul Portney, Lynn Scarlett, and Tom Tietenberg. But the author alone is responsible for any errors. While discussion of goals typically precedes examination of alternative means for achieving goals, this is not necessarily the case. For example, both the Bush and Clinton administrations endorsed market-based methods for addressing global climate change before either had committed itself to specific greenhouse policy goals. This section draws, in part, on: Hockenstein, Jeremy B., Robert N. Stavins, and Bradley W. Whitehead. “Creating the Next Generation of Market-Based Environmental Tools.” Environment 39, number 4 (1997), pp. 12-20, 30-33. See, for example: Stavins, Robert N., ed. Project 88 Round II Incentives for Action: Designing Market-Based Environmental Strategies. Sponsored by Senator Timothy E. Wirth, Colorado, and Senator John Heinz, Pennsylvania. Washington, D.C., May 1991; Stavins, Robert N., ed. Project 88: Harnessing Market Forces to Protect Our Environment. Sponsored by Senator Timothy E. Wirth, Colorado, and Senator John Heinz, Pennsylvania. Washington, D.C., December 1988; U.S. Environmental Protection Agency. Economic Incentives, Options for Environmental Protection. Document P-2001. EPA, Washington, D.C. ,1991; Organization for Economic Cooperation and Development. Economic Instruments for Environmental Protection. Paris, 1989; and Organization for Economic Cooperation and Development. Environmental Policy: How to Apply Economic Instruments. Paris, 1991. Another strain of literature — known as “free market environmentalism” — focuses on the role of private property rights in achieving environmental protection. See, for example: Anderson, Terry L. and Donald R. Leal. Free Market Environmentalism. Boulder: Westview Press, 1991. 1 MARKET-BASED ENVIRONMENTAL POLICIES Robert Stavins 1. WHAT ARE MARKET-BASED POLICY INSTRUMENTS? Nearly all environmental policies consist of two components, either explicitly or implicitly: the identification of an overall goal (either general or specific, such as a degree of air quality or an upper limit on emission rates) and some means to achieve that goal. In practice, these two components are often linked within the political process, because both the choice of a goal, and the mechanism for achieving that goal, have important political ramifications. This chapter focuses exclusively on the second component, the means — the “instruments” — of environmental policy, and considers, in particular, economic-incentive or market-based policy instruments.