Taxes, subsidies and marketable permits are each cost-effective: they achieve any chosen pollution target at the lowest possible cost. We have already explained why this is so for marketable permits. The reason why it is also true for taxes (and subsidies) is very simple. For any given tax (or subsidy) rate, firms will reduce pollution whenever the cost of doing so is less than the tax they would have to pay (or the subsidy they would lose) on additional units of pollution. The end result is that most pollution abatement is done by firms for whom it is cheap to abate, and least is done by those for whom abatement costs are the highest. Transferable permits, pollution taxes and pollution abatement subsidy are equivalent ways of achieving the same goal, and each attains the goal at the lowest cost. Furthermore, each of these three instruments has desirable incentives. Reducing pollution increases a firm’s income, and so an ever-present incentive exists to develop low-cost methods of reducing pollution.
Economists have two main criticisms of command-and-control instruments. First, they fail to create appropriate incentives. Once a target has been achieved, no incentive exists to search for low cost ways of reducing pollution further. Second, they are not cost-effective. Typically the same degree of control is placed on firms irrespective of how costly it is to reach that target. Cost efficiency is squandered by not focusing control where the costs of doing so are lowest.
In assessing the performance of the marketable emissions permit schemes in the United States in comparison with the older command-and-control approaches, Tom Tietenberg has written
The [marketable emissions permits] programme has unquestionably and substantially reduced the costs of complying with the Clean Air Act. Most estimates place the accumulated capital savings for all components of the programme at over $10 billion. This does not include the recurrent savings in operating costs.
(Tietenberg – Environmental Economics and Policy (5th Edition), 2006, page 269-270 in the Markandya and Richardson reprint).
These cost savings accrue to polluting firms and to the economy as a whole. If firms are to be controlled, it is clearly desirable that the cost is as low as possible. Many kinds of command-and-control regulation give firms little or no flexibility in how they are to be achieve targets. This lack of flexibility tends to result in high costs. Incentive schemes are inherently more flexible. They allow firms to choose how to reach targets and, through trade, how the overall control effort should be allocated.
A consensus is emerging that the degree of environmental regulation will increase in the medium and longer term, and that control will rely increasingly on pollution taxes and marketable permits. The following statement by two eminent American environmental economists, Cropper and Oates, illustrates this expectation:
“ ..effluent charges and marketable permit programs are few in number and often bear only a modest resemblance to the pure programs of economic incentives supported by economists. …….As we move into the 1990’s, the general political and policy setting is one that is genuinely receptive to market approaches to solving our social problems. Not only in the United States but in other countries as well, the prevailing atmosphere is a conservative one with a strong predisposition towards the use of market incentives wherever possible, for the attainment of our social objectives.”
Cropper and Oates 1992, pages 729 and 730.