Green Payment Programs for Nonpoint Source Pollution Control: How Important Is Targeting for Cost-Effectiveness?

Article excerpt

Mechanism design theory is used to examine the case of a cost-minimizing regulator who uses input-reduction subsidies to meet an exogenously imposed ambient standard for nonpoint source pollution. A general result claimed for a welfare-maximizing regulator is clarified to show that an optimal contract scheme may involve a pooling equilibrium. Numerical results suggest the ability to directly target contracts reduces costs significantly for the regulator. But in the absence of this ability, indirect targeting reduces costs only slightly.

Key words: ambient standard, cost minimization, input-reduction subsidy, mechanism design, nonpoint source pollution, targeting

Introduction and Background

Point source pollution of surface and groundwater resources has received the majority of regulatory attention in the past few decades. This emphasis on point source pollution is largely because nonpoint source (NPS) pollution is much more difficult to control. The sources of observed ambient NPS pollution are diffuse, and therefore difficult to identify and monitor. Further, the mechanism by which NPS pollution migrates from its sources into the environment is site-specific and stochastic. It is not surprising, then, that the U.S. Environmental Protection Agency has labeled NPS pollution as the"greatest source of water quality problems in the United States today" (p. 52).

Considerable academic research on NPS pollution control has focused on market-based pollution incentives. Work on ambient taxes and subsidies dates back to Tietenberg's reply to Baumol and Oates' 1971 theorem regarding the efficiency of a uniform pollution tax. In 1988, Segerson contributed a seminal paper which incorporates both taxes and subsidies with a flat penalty, and Xepapadeas (1991, 1992, 1995) has examined various stochastic-dynamic elements of subsidy and penalty schemes. Marketable permits and point-nonpoint trading also continue to receive a significant amount of attention in the literature, with some of the more often-cited works including analyses by Shortle (1987, 1990); Letson; and Malik, Letson, and Crutchfield.

Each of these market-based approaches unfortunately has serious practical problems that limit applicability to NPS pollution control in the field-including significant information costs, the use of Draconian penalties, scarcity of permit traders, and the issue of establishing an appropriate trading ratio. In light of these difficulties, some researchers instead have considered voluntary "green payment" programs which are much more common in practice. Essentially, these programs offer subsidies to polluters who voluntarily choose to adopt less-polluting (but often more expensive, less productive, or higher variability) production practices. Research in this area has focused on either input-reduction subsidies or cost-sharing programs for the installation and maintenance of less-polluting technologies (often called "best management practices").

Malik and Shoemaker were first to examine the problem of designing an economically efficient cost-sharing program to control agricultural NPS pollution. Their model assumes each profit-maximizing agent operates a farm with heterogeneous land quality on which two different technologies may be employed: a "cleaner" technology that is more productive on lower quality land, and a "dirtier" technology that is more productive on higher quality land. The regulator's goal is to choose the ranges of land quality over which each technology may be employed as well as the technology subsidies which maximize net social benefits subject to an ambient pollution standard.

In a different approach to a similar problem, Wu and Babcock use mechanism design theory1 to examine the case of profit-maximizing agents operating heterogeneous farms with homogeneous land quality (i.e., there is a distribution of land quality across farms but not within a single farm). The regulator's problem is to specify a set of incentive-- compatible and individually rational contracts (x^sub i^, s^sub i^) that maximizes net social welfare from agricultural production and pollution. …