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Marketable Pollution Permits

2 March, 2015 - 12:11

An alternative to emissions taxes is marketable pollution permits, which allow their owners to emit a certain quantity of pollution during a particular period. The introduction to this chapter dealt with an example of marketable pollution permits; each of the permits to dump a metric ton of greenhouse gases that is purchased results in a reduction in the cost of meeting the goal of reducing the emissions of these gases.

To see how this works, suppose that Firms A and B are again told that they must reduce their emissions to 250 tons of a pollutant per month. This time, however, they are given 250 permits each— one permit allows the emission of one ton per month. They can trade their permits; a firm that emits less than its allotted 250 tons can sell some of its permits to another firm that wants to emit more.

We saw that Firm B can reduce its emissions below 250 tons for a much lower cost than Firm A. For example, it could reduce its emissions to 249 tons for $100. Firm A would be willing to pay $1,000 for the right to emit the 251st ton of emissions. Clearly, a mutually profitable exchange is possible. In fact, as long as their marginal benefits of pollution differ, the firms can profit from exchange. Equilibrium will be achieved at the least-cost solution at which the marginal benefits for both firms are equal.

One virtue of using marketable permits is that this approach represents only a modest departure from traditional command-and-control regulation. Once a polluter has been told to reduce its emissions to a certain quantity, it has a right to emit that quantity. Polluters will exchange rights only if doing so increases their utility or profits—allowing rights to be exchanged can only make them better off. Another benefit, of course, is that such exchanges allow a shift from the inefficient allocation created by command-and-control regulation to an efficient allocation in which pollution is reduced at the lowest possible cost. Finally, each firm will have an incentive to explore ways to reduce its emissions further, either to be able to sell more rights or to require purchasing fewer permits.