Regulating Chemical Emissions with Risk-Based Environmental Taxation
Sadler, Thomas R., International Advances in Economic Research
THOMAS R. SADLER [*]
This paper develops a policy of risk-based environmental taxation for chemical emissions. A scoring index of chemical risk values for target pollutants first takes into account potential human health risk and ecological risk. A common tax base called the risk unit, which reflects the risk values from the scoring index, is then identified for individual pollutants. By determining the number of risk units for target emissions and levying a single tax rate on one risk unit, the risk-based tax system assigns a different pollution price to each chemical release. The policy sets rates according to marginal damage and provides target industry with permanent incentive for pollution abatement. By narrowing the gap between the marginal private cost and constrained marginal social cost of the chemical emission externality, the environmental tax system creates efficiency gains. (JEL Q28)
Since 1976, U.S. industries have produced more than 70,000 chemicals, and annual sales of the chemical industry alone top $200 billion [Swanson et al., 1997, p. 372; Macauley et al., 1992, p. 1]. For over 80 percent of the U.S. population, the cancer risk from toxic chemical exposure in the air is significantly higher than that of a decade ago.  The Environmental Protection Agency (EPA) has addressed these problems. Because of the certainty of command-and-control (CAC) regulation, the EPA regulates, with CAC policy, chemical waste streams into the air, water, and earth, which means banning or restricting production and chemical use, setting emission or exposure standards, and mandating product reformulation or specific abatement technology [McKenzie, 1994, p. 95]. From an economic perspective, however, the problem with CAC (direct) regulation concerns excessive policy cost because the regulator must use scarce resources to acquire information that polluters already possess [Carlin, 1992, p. 2-12; Turner e t al., 1993, p. 144]. Since direct control does not equate marginal abatement cost (MAC) across firms at any level of pollution reduction, this type of policy results in higher MAC than is necessary [Kahn, 1998, p. 66]. In addition, two decades of CAC regulation have not sufficiently reduced numerous chemical releases to acceptable levels [Davis et al., 1994, p. 1; U.S. General Accounting Office, (GAO) 1993, p. 15].
By contrast, incentive approaches, such as environmental taxation, economize on scarce abatement cost information of individual firms and provide incentive for cost minimization and technological innovation. The flexibility of incentive policy allows polluters to make choices based on individual MAC. As long as policy authority implements the same tax rate to all polluters, decentralized decision making leads to a least-cost solution [Baumol and Oates, 1988, p. 164]. As an example, the U.S. imposes environmental taxes on certain chemical inputs to production. These taxes come from different industries responsible for contaminated sites and finance trust funds to clean up the sites. However, they do not discourage behaviors that lead to contamination [Fullerton, 1996, p. 35]. To reduce chemical emissions at lower cost while providing greater flexibility for target firms, the EPA could supplement or replace existing CAC regulation with pollution taxation [U.S. GAO, 1993, p. 20]. 
In order to address the chemical emission externality, this paper develops an incentive policy: risk-based environmental taxation.  The focus is on the formulation of environmental tax rates. None of the existing taxes on chemical inputs qualifies as an incentive-based tax designed to discourage the polluting activity itself [Fullerton, 1996, p. 33]. To properly price the spillover cost of target chemical emissions, the risk-based policy formulates, with the use of scoring results from the EPA's waste minimization prioritization tool (WMPT), tax rates that vary according to the economic value of marginal pollution damage. …