The design of marketable permit schemes to control local and regional pollutants

Publication Date15 August 2002
Date15 August 2002
DOIhttps://doi.org/10.1016/S0193-5895(02)20017-2
Pages331-377
AuthorJonathan Remy Nash,Richard L. Revesz
THE DESIGN OF MARKETABLE
PERMIT SCHEMES TO CONTROL
LOCAL AND REGIONAL
POLLUTANTS*
Jonathan Remy Nash and Richard L. Revesz
ABSTRACT
In recent years, there has been a steady rise in the use of marketable
permits in environmental regulation. They have been employed as tools to
control both air and water pollution, and have been implemented on local
regional, and national scales. These trading regimes - based upon a single
market in emission permits - do not control the distribution of emissions
throughout the trading region or prevent the formation of "hot spots" of
pollution. In this chapter, we propose a marketable permit scheme that is
consistent with the attainment of ambient standards and that does not
significantly interfere with the benefits of trading.
INTRODUCTION
The idea of establishing markets in pollution rights is not new. J. H. Dales
(1968) strongly advocated this regulatory technique in the late 1960s Thereafter,
tradeable permit regimes became popular among academic economists. In a
1985 article that had considerable influence on the legal literature, Bruce
* Based upon our article 'Markets and
Geography: Designing
Marketable Permit Schemes to
Control Local and Regional Pollutants',
Ecology Law Quarterly,
28(2001), 569.
An Introduction to the Law and Economics of Environmental Policy: Issues in Institutional
Design, Volume 20, pages 331--377.
© 2002 Published by Elsevier Science Ltd.
ISBN: 0-7623-0888-5
331
332 JONATHAN REMY NASH AND RICHARD L. REVESZ
Ackerman and Richard Stewart (1985) strongly advocated tradeable permits as
an alternative to command-and-control regulation.
In recent years, there has been a steady rise in the use of tradeable permits
in the regulatory process. They have been employed as tools to control both
air and water pollution, and have been implemented on local, regional, and
national scales. While trading regimes have, to date, been used mostly in the
United States, they are attracting increasing attention abroad, and there is now
considerable interest in emissions trading on a global scale to address the
problem of anthropogenic greenhouse gases.
The design of the trading regime most commonly advocated in the academic
literature - based upon a single market in emission permits - is relatively
straightforward. A policy maker determines the total number of emission permits
that will be allocated to a region. These permits are then distributed
among polluters, generally either by means of an initial auction or through
grandfathering. Subsequently permits trade in an open market. Assuming that
a robust market for permits arises, a tradeable emission permit regime reduces
aggregate emissions to the chosen aggregate level at least cost.
Such a trading regime, however, does not control the distribution of those
emissions throughout the region. As a result, it does not ensure that an ambient
standard - specifying a maximum permissible concentration of the pollutant -
would be met throughout the region. For example, to the extent that trades
result in a disproportionate concentration of the pollutant in some portion of
the region, ambient standards could be violated. More generally, a tradeable
emission permit regime does not prevent the formation of "hot spots" of
pollution - that is, location at which the damage caused by pollutants is
particularly severe. Ackerman and Stewart (1985, p. 1350) acknowledge this
shortcoming: "[T]he market system we have described could allow the creation
of relatively high concentrations of particular pollutants in small areas within
the larger pollution control region." They note that "[t]he extensive literature
on marketable permits.., points to a variety of feasible means for dealing with
the hot spot problem," and recommend that "a long-run strategy for institu-
tional reform should strive to take advantage of these more sophisticated market
solutions to the problem of intraregional variation" (Ackerman & Stewart, 1985,
p. 1351).
Over the years, commentators have advocated several alternative design
structures to deal with the problem of ambient standard violations and hot
spots. Each of these alternatives, however, has significant drawbacks, either
providing only an incomplete solution to the problem or introducing
complexity that could stand in the way of the efficient functioning of the
market.
The Design of Marketable Schemes to Control Local and Regional Pollutants
333
In this chapter, we propose an alternative that would avoid the violation of
ambient standards and formation of hot spots without greatly increasing
administrative complexity or introducing excessively high transaction costs. Our
idea is to construct a market in tradeable emission permits under which trading
would be entirely unfettered, with the sole exception that a prospective buyer
and seller would have to receive approval from a website before they could
consummate their trade. The website, administered by the government, would
contain emissions data for all sources in the region. When a proposed trade
was submitted for approval, the website would temporarily update its saved
data to reflect the change in the geographic distribution of emissions that would
result from the proposed trade. The website would then use an atmospheric
dispersion model to predict the impact of the emissions from all the sources in
the region - as modified by the proposed trade - on ambient pollution levels
at various receptor points. The website would reject any trade resulting in the
violation of an applicable ambient standard and would approve all other trades.
Part I of this chapter describes the functioning of the typical regime of
tradeable emission permits. It examines how such a regime can lead to the
violation of ambient standards and the formation of hot spots.
Part II describes the structure of three recent and prominent U.S. regulatory
programs involving tradeable emission permits: the national sulfur dioxide
trading program, regional trading in ozone precursors in the northeast, and
local trading in sulfur and nitrogen oxides emissions in the Los Angeles
metropolitan area. It explains why these programs are poorly suited to ensure
the attainment of ambient standards or the prevention of hot spots. It also
discusses the unsuccessful efforts to correct these shortcomings.
Part HI evaluates three proposals that commentators have advanced as
alternatives to the typical emission trading regime. We first examine a system
in which the emissions market is divided into zones and interzonal trades are
prohibited. Next, we analyze a system of markets in units of environmental
degradation, under which permits do not entitle a holder to emit a fixed amount
of pollutant, but rather to cause a fixed amount of environmental damage at a
certain receptor point. Last, we discuss pollution offset markets, under which
trading in emission permits does not occur on a one-to-one ratio.
Part IV presents our proposal for a tradeable emission permit regime designed
to solve the problem of ambient standard violations. First, we explain its major
elements. Second, we compare its relevant features to those of the three
alternatives examined in Part HI. Third, we highlight our proposal's impacts on
the structure of the permit markets.
Part V discusses how our proposal would deal with a number of important
issues. In particular, we analyze purchases of permits by sources that locate in

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