Vertical Targeting: Issues in Implementing Upstream versus Downstream Regulation

Regulators face a choice of where in a vertical chain to set environmental regulation.1 Regulation that targets upstream sources of greenhouse gases focuses on firms producing (or importing) coal, natural gas, oil, and refined petroleum products. Downstream regulation may directly regulate pollution sources (e.g., motor vehicles, farms, and power plants) or perhaps focus further downstream by regulating consumer goods (e.g., retail electricity). This paper reviews why direct regulation can minimize regulatory costs. I discuss how transactions costs, offset programs, and international trade affect the optimal choice of where to vertically target environmental regulation.