The Positive Political Economy of Instrument Choice in Environmental Policy
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Description
The design of environmental policy requires that two central questions be addressed: (1) what is the desired level of environmental protections? and (2) what policy instruments should be used to achieve this level of protection? With respect to the second question, thirty years of positive political reality in the United States have diverged strikingly from the recommendations of normative economic theory. Our purpose in this paper is to explain why. Four gaps between normative theory and positive reality merit particular attention. First, despite the well-known economic advantages of market-based instruments, command-and-control standards have been used much more frequently. Second, when command-and-control standards have been used, the required level of pollution abatement has generally been far more stringent for new sources than for existing sources. This dual system may actually worsen pollution by encouraging firms to keep older, dirtier plants in operation. Third, in the relatively rare instances in which market-based instruments have been adopted, they have nearly always taken the form of tradable permits rather than emission taxes, although economic theory suggests that the optimal choice between the two is dependent upon case-specific factors. Moreover, the initial allocation of such permits has been through ‘grandfathering,’ or free initial distribution based on existing levels of pollution, rather than through auctions, despite the economic superiority of the latter mechanism. There are four alternative market-based instruments available: taxes, revenue-neutral taxes, auctioned permits, and grandfathered permits. Despite the numerous trade-offs that exist in normative economic terms, the US experience has been dominated by one choice—grandfathered permits. A fourth, conceptually different, gap, between prior and current political practice, is also worthy of attention: in recent years, the political process has been more receptive to market-based instruments, even though they continue to be a small part of the overall portfolio of existing environmental laws and regulations. After being largely ignored for so long, why have incentive-based instruments begun to gain acceptance in recent years? Commentators have advanced various explanations for the existence of these four gaps between normative theory and positive reality. Some explanations emerge from formal theories. Others take the form of informal hypotheses: they purport to explain certain aspects of environmental policy, but are not part of a formal theory of political behavior. In this paper, we review, evaluate, and extend these explanations. Moreover, we place these disparate explanations within the framework of an equilibrium model of instrument choice in environmental policy, based upon the metaphor of a political market. The scope of the paper is intentionally limited. Our emphasis is on the control of pollution rather than the management of natural resources. We treat Congress, rather than administrative agencies, as the locus of instrument choice decisions and we view legislators (rather than regulators) as the ‘suppliers’ of regulation. Moreover, we focus exclusively on the choice among the instruments, such as tradable permits, taxes, and standards, used to achieve a given level of environmental protection. We do not explore the related issues of how the level of protection is chosen or enforced. Nor do we address the issue of why Congress chooses to delegate authority to administrative agencies in the first place. Finally, our outlook is positive, not normative: we seek to understand why we have the set of tools we do, rather than which tools are desirable. The next section presents the key features of our market framework. In Part 3, we consider the demand for environmental policy instruments, and in Part 4, we examine the supply side. Part 5 offers concluding remarks.
Source Publication
Environmental and Public Economics: Essays in Honor of Wallace E. Oates
Source Editors/Authors
Arvind Panagariya, Paul R. Portney, Robert M. Schwab
Publication Date
1999
Recommended Citation
Keohane, Nathaniel O.; Revesz, Richard L.; and Stavins, Robert N., "The Positive Political Economy of Instrument Choice in Environmental Policy" (1999). Faculty Chapters. 1937.
https://gretchen.law.nyu.edu/fac-chapt/1937
