Toward a total-cost approach to environmental instrument choice

Publication Date15 August 2002
AuthorDaniel H. Cole,Peter Z. Grossman
Daniel H. Cole and Peter Z. Grossman
Most theories of environmental instrument choice focus exclusively on
differential compliance costs. But compliance costs comprise only part
of the total costs of environmental protection. Administrative costs -
particularly the costs of measuring emissions and monitoring compliance
- can differ significantly between environmental instruments. Those
administrative cost differentials may offset the compliance cost advantages
commonly associated with economic instruments, such as tradeable permits
and effluent taxes. Moreover, measurement and monitoring constraints
may increase ex ante uncertainty over the differential costs and benefits
of alternative regulatory policies. That uncertainty may militate against
selecting regulatory instruments that appear superior from the perspective
of models focusing exclusively on compliance-cost differentials.
Much of
the extensive theoretical literature
on the efficiency of instruments
for environmental regulation
is predicated
on the presumption of ex ante
uncertainty about the ex post
costs and benefits
of policy choice. Beginning
An Introduction to the Law and Economics of Environmental Policy: Issues in Institutional
Design, Volume 20, pages 223-241.
Copyright © 2002 by Elsevier Science Ltd.
All rights of reproduction in any form reserved.
ISBN: 0-7623-0888-5
with Weitzman (1974), the literature has centered on the factors that might lead
regulators to favor a price-based over a quantity-based instrument, or vice versa. ~
Although Weitzman did not prescribe exact types of price or quantity
instruments, many scholars see the issue as a binary choice problem pitting a
price-based effluent tax regime against a quantity-based regime of tradeable
emissions permits. The comparison of only these two alternatives reflects a
normative presumption that only such "economic" instruments have any possi-
bility of producing an efficient outcome. Other potential alternatives, such as
non-tradeable emissions quotas or more general taxation arrangements (such
as input or production taxes) are ruled out as inherently inefficient (Tietenberg,
1985; Stewart, 1996) and even anti-democratic (Ackerman & Stewart, 1985;
Stewart, 1992; Sunstein, 1997).
Moreover, most of the literature relies on an important but unwarranted
assumption: that cost and benefit functions, although they may be subject to
uncertainty, are identical regardless of the regime that is chosen; that is, price
and quota systems are assumed to face the same cost and benefit curves with
the same expected values. Most crucially, the models assume that no regime
will be subject to greater or lesser uncertainty than another. In other words, the
variance is assumed to be invariant with the choice of regulatory regime. Under
these assumptions, virtually all existing economic theories of environmental
policy suggest that instrument choice should be determined simply by the
relative elasticities of the curves.
Environmental instrument choice in the real world is, however, more
complicated than most existing theories suppose because the assumptions on
which those theories are based do not always obtain. In the real world, the costs
of administering - that is, monitoring and enforcing - one regime might be
quite different from the costs of administering another regime. Technological
and institutional factors may make one regime not just more costly but infea-
sible, in which case the most efficient instrument must be some alternative that
appears inferior from the perspective of theories that focus exclusively on differ-
ential compliance costs. These considerations apply not only to comparisons of
effluent tax regimes and tradeable permit programs but also to comparisons
between "economic" instruments generally (including both taxes and tradeable
permits) and command-and-control regulations and general Pigovian taxes.
Though much of the theoretical literature predicts greater efficiency from the
former, the theory is seriously incomplete.
A number of studies suggest that economic instruments may not always
be the most efficient choice. Burrows (1980) notes that "the differential in
information, administration, and enforcement costs tend to favour the regulation
of uniform standards rather than charges." Hahn and Axtell (1995) show that

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