Academic journal article Economic Inquiry

Enforcement Costs and the Choice of Policy Instruments for Controlling Pollution

Academic journal article Economic Inquiry

Enforcement Costs and the Choice of Policy Instruments for Controlling Pollution

Article excerpt

I. INTRODUCTION

When evaluating policy instruments for controlling pollution, analysts generally agree that economic incentives are superior to direct controls in terms of minimizing abatement costs. However, when it comes to minimizing enforcement costs, there is no such agreement. Some analysts such as Freeman et al. |1973~ and Anderson et al. |1977~ argue that economic incentives would be much easier to enforce than direct controls, while others such as Drayton |1978~ argue that they would be virtually unenforceable.

The debate typically centers on technical difficulties in continuously monitoring emissions and, to a lesser extent, on political and legal issues related to the assessment of penalties.(1) An issue that has not been examined is whether there are economic reasons for enforcement costs to vary across policy instruments. Although there is now a sizable economic literature on the problem of noncompliance with pollution control policies, there have been no attempts to formally compare enforcement costs across policy instruments.(2)

Accordingly, the purpose of this note is to examine whether there are economic grounds for arguing that enforcement costs would be lower for economic incentives than direct controls.(3) The policy instruments compared are marketable permits (or emissions taxes) and uniform standards. The instruments are compared in a setting where the penalty schedule is previously specified by some judicial or legislative body and the regulator's enforcement policy is limited to the choice of audit frequency. The analysis is based on the premise that for any policy instrument that targets emissions, the regulator will have to periodically monitor emissions and assess penalties for noncompliance. The relevant question, then, is whether less frequent monitoring would be required to ensure compliance with economic incentives. Casual analysis suggests this should be the case. Economic incentives minimize aggregate abatement costs, and lower abatement costs imply lower costs to firms of complying. This should imply, in turn, that less stringent enforcement is needed to achieve compliance. This argument, although intuitively appealing, is flawed. Using a simple model of pollution control with costly enforcement, I show that enforcement costs, narrowly defined, may be higher for economic incentives. For purposes of exposition, the result is established in a setting where the regulator ensures each firm is fully compliant. However, as shown in the appendix, the result generalizes to the more realistic setting where firms are partially compliant.

II. THE MODEL

Consider a group of N risk-neutral firms emitting a single pollutant. For simplicity, the damages from the pollutant are assumed to depend only on total emissions. Each firm's abatement costs are given by a strictly convex function |C.sub.i~(|x.sub.i~) that is decreasing in emissions |x.sub.i~. The firm's maximum emissions level is denoted |Mathematical Expression Omitted~, and is defined by |Mathematical Expression Omitted~. With probability |p.sub.i~, a regulator audits each firm and measures its emissions. If the regulator finds the firm's actual emissions |x.sub.i~ exceed its allowed emissions |s.sub.i~, the firm is assessed a fine of F(|x.sub.i~ - |s.sub.i~). As is common in the literature on enforcement, I assume the fine schedule is previously specified (e.g., by a legislative body).(4) Thus, the regulator can choose the probability with which it audits firms but not the fine it assesses for noncompliance. I assume the fine schedule is such that both the total fine and marginal fine are increasing in the violation size (|x.sub.i~ - |s.sub.i~), F|prime~ |is greater than~ 0 and F|prime~|prime~ |is grater than~.0.

Because the regulator is assumed to ensure full compliance, no violations occur and no fines are collected. Therefore, enforcement costs consist solely of auditing (or monitoring) costs. To simplify the analysis, the cost of conducting an audit, A, is assumed to be the same across firms. …

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