Question: How does emissions trading promise to correct some inefficiencies brought on by command and control?

The grandfathering of existing sources might be defended on grounds that old plant and equipment could not economically be up-graded to modern stan- dards: either they have to be granted special dispensation. or be written off. But that sad pair of choices is not set in stone; it is the result of having chosen a system of command and control to implement pollution control. Alternatively, it would seem to be possible to make regulation more efficient and even more effective in terms of reducing pollution by changes that make it less rigid. Suggested Improvements Short of adopting some sort of a pricing system, reforms have been suggested that could make command and control more efficient. Take stationary source air pollu tion, for example. Assume that the concept of setting emission targets is retained but that each plant is given a budget instead of a standard and is allowed to decide how best to operate within it-that is, emphasis could be placed on performance rather than method. By operating part-time, old plants (even without modifica. tion) could live up to the same rules as new plants. To make up for resulting pro- duction short-falls, ceteris paribus, new plants would likely be brought on line earlier so that the replacement of old technology with new could be faster without being disruptive. By the same token, operators of new plants could choose to adopt a technology they found cost-effective (or profit-maximizing). The choice of technology would likely differ between firms rather than being uniform as mandated under current law: the ability to choose one's means of satisfying emis- sion targets ought to be more efficient-by opening up the range of choice it should be possible to minimize the cost of meeting air quality goals. Or consider the control of stationary source water pollution, where existing law mandates national, uniform emissions standards and will not take ambient conditions of the local environment into account. But if the ambient water qual- ity-a performance variable-were taken into account in setting parameters for the volume and quality of effluent allowed from a single source, a cost-effective system of pollution control might be devised. Allen Kneese cites a simulation study which compared the costs of applying uniform standards to adapting the least-cost means to control water quality for a small, but heavily populated river basin; the study concludes that uniform treatment costs were virtually three times higher than the least-cost treatments on the average."(It should be noted, how- ever, that any feasible incentive system could not achieve the level of efficiency implied by the simulation study either, so that this really does overstate the magni- tude of inefficiency which can be attributed to command and control.)CRITICISM AND CHANGE IN COMMAND AND CONTROL 425 And consider the regulation of mobile source air pollution by mandating emission standards for new cars. Reform of the present system would mean shift- ing the focus from the manufacturer to the user and shifting responsibility for deciding how to deal with the scarcity of emission constraints from government to the individual. Edwin Mills and Lawrence White provide a detailed reform based upon a system of emission charges to achieve the desired result." Mills and White suggest that manufacturers choose their own designs with a tax levied on the amount of exhaust emissions produced under the manufacturers' design standards. The new car buyer would have a choice between two versions of "optional equip- ment": a pollution tax or a pollution control device. Actually, the buyer might have a range of choice, with the degrees of control and levels of tax varying more or less continuously. Owners of old cars might also have to pay for pollution per- mits: this would establish parity between old and new cars without forcing owners of old cars to adopt technical improvements that might not be feasible, but if such changes were cheaper than the tax, there would be an economic incentive to make them. Mills and White also suggested that in problem locations, such as the nonat- tainment areas, local authorities could levy a secondary emissions tax to further ration emissions where pollution damage is greatest. An adjunct to the Mills-White approach might be locally based quantity rationing in problem areas-overcrowded urban centers with chronic ambient air quality problems-that would apply to all cars, old and new alike. The state might issue a fixed number of permits to limit the total amount of mobile source emissions produced by cars licensed in the metropolitan area. The owner-opera- tor of each licensed auto would have to buy enough permits, the amount varying according to the emission characteristics of the make and model, to register it. An older and/or "dirtier" car would thus cost more to register than a "cleaner" one- both in terms of the pecuniary cost to the owner and in terms of the utilization of the scarce resource (permits). With the total number of permits fixed in supply. there would be real incentives to economize on them: the local population would either have to operate "cleaner" cars or fewer cars in total; there would be an incentive to retire older cars permanently or to ship them off to a less delicate environment. Given the American love for and reliance upon the automobile, some might well regard the regulation of the number of cars as an unacceptable alternative, but it places responsibility for clean air at the source of the problem, and it is far better adapted to what is really a localized congestion problem than is the present policy of direct control of quality-it is virtually certain to be a more cost-effect tive solution than the present system. Singapore, for example, does regulate the number of cars.426 ENVIRONMENTAL PROTECTION Administrative Reforms As indicated in Chapter Thirteen, the administration of pollution control-along with other aspects of social regulation-acted as a moderating process. A series of Executive Orders from the Ford, Carter, and Reagan-Bush administrations mandated economic analysis of rule making: first. the EPA (and the other agen- cies) were ordered to take account of inflationary impacts; later. they were ordered to base their rule-making decisions on least-cost and benefit-cost analysis (where permitted by law). The EPA's response was to alleviate some of the rigidi- ties inherent with command and control that were the cause of some economic inefficiencies. Over a period of years, the EPA developed several variations of emissions trading to augment the practice of assigning pollution rights by fiat, which tended to favor the existing operators over the new and thus, more often than not, the operaters with the most primitive pollution controls, The innovations amounted to a modest relaxation of command and control and the substitution of a market-type process to allocate pollution rights. The principle common to all forms of emis- sions trading is (1) to start with the grant of a well-defined unit of pollution rights, provided under command and control, and (2) to allow for the market reassign- ment of the permit by consent of the grantee. The EPA later adopted its Final Trading Policy, in 1986, which sought to strengthen and clarify its policy on emissions trading. The Final Trading Policy specifies that emission reduction credits (or ERCs) represent property rights and are the units that may be exchanged by the firm which holds a lawful permit and which reduces emissions of a specific criteria pollutant below the amount allowed for under its permit, provided that the reduction is permanent and verifiable. Without sacrificing the primary social objective of reducing pollution. regu- lators found it to be possible to achieve equal (or better) results at lower costs to the polluters (and to society as a whole) by promoting the trade in ERCS. (For example, Hahn and Hester estimated that the practice of nerting had saved between $25 and $500 million in the total costs of processing permits and between $500 million and $12 billion in the total costs of emission controls Eventually, the lessons learned from administrative tinkering with regulation would lead to legislative reform; the Clean Air Amendments of 1990 are evidence that Congress has moved from a more rigid approach to the assignment of emis- sions licenses to a more flexible one and has authorized use of tradeable permits for sulphur oxide emissions generated by coal-fired power plants. Netting Netting is a form of an internal transaction by which a firm might be allowed to better utilize its permit on emissions. It is a practice introduced by the EPA in 1974," subject to approval of the appropriate state regulatory authority. SupposeCRITICISM AND CHANGE IN COMMAND AND CONTROL 427 that the firm wished to expand, but by doing so would have to obtain authority to operate a new source of pollution. And suppose that the new source is more effi- cient than the old-that is, it could produce more net income for the firm (and for society) than the old for each unit of emissions produced. The EPA understood the value of a trade that would enhance productivity and would allow the firm to sat- isfy the authority for a new source by reducing emissions from other sources within the plant. rather than having to apply for a new license to pollute-and per- haps having to sacrifice its priority for a license which it enjoys by simply being an existing source. By allowing this trade-off, netting contributes to pollution con- trol: it reduces pressures that a state air pollution authority might otherwise face from advocates for economic development when a local firm seeks to expand its operations. Offsets Offsets represent another form of trading, a form which was mandated under the 1977 Clean Air Amendments for permits issued to new or modified sources in nonattainment areas. When an airshed had exceeded its emission limits, having failed to meet the primary air quality standards on ambient emissions, a new source of emissions could be licensed only if (1) its production were offset by reducing emissions from one or more existing sources who held legal permits to pollute and (2) these reductions were greater than the amount to be produced by the new source. The offsets program-like the netting program which preceded it-provided some degree of much needed flexibility in a system which was inherently rigid. If a new source could overcompensate an old source for its per- mit, it was reasonable to assume that efficiency and resource productivity would be enhanced. In effect, the law that obviously was adopted for environmental pur- poses-to clean up the air in nonattainment areas-had the indirect effect of help- ing to improve economic use of the environment by creating a market in pollution rights. After emission trading was first introduced in the form of an offsets pro- gram, it has since been adapted to other uses. In 1981, with the approval of the EPA, the state of Wisconsin implemented a program of issuing marketable dis- charge permits for use on the Fox River. The major sources of industrial dis- charges that affected the biological oxygen demand (BOD) could trade permits which would allow them to time their production more efficiently. Heavy use of BOD on the Fox River was really confined to a single industry, pulp and paper. Despite optimistic estimates that predicted substantial cost savings would result from the trades, the Fox River experiment has proven to be rather disappoint- ing. 28 And when it was decided to eliminate lead in gasoline, the EPA set a time schedule for the phaseout of lead additives, including a schedule of declining lead production credits. Lead credits were assigned to refiners on a strict pro rata basisENVIRONMENTAL PROTECTION of gasoline output. but they were permitted to trade lead credits among them selves. It resulted in the situation where some refiners rapidly converted to the production of lead-free gasoline while others did so slowly but continued to oper- ate on credits purchased from the former. By most accounts, the lead-trading pro- gram was an extremely successful use of tradeable permits." Similarly, when the Clean Air Amendments of 1990 established stricter limits on sulphur oxide emissions from major electricity generating plants to be met by 1995, the law included provisions for the trading of permits allowed under the new limits. Bubbles The EPA adopted a bubble policy in 1979 to allow for another form of trade-off applying to existing sources. The idea of bubbles is to permit polluters to select their emission reduction strategy, rather than to heed strictly the technological mandates of the EPA or the state pollution control authority. As the name suggests, an imaginary bubble is defined for the area around a plant subject to regulation, The implication is that an area would be treated as if it were a single point source and that a permit would authorize the holder to release a given total amount of emissions from its bubble so that some operations could exceed the EPA standards for a stand-alone plant as long as others would sufficiently offset them. What really counted was not the use of an approved technology to control pollution but rather the performance of the whole package-that is, the amount of emissions released from the bubble. One added aspect of bubbles was that the emissions per- mits under the bubble could be traded to others in the bubble area. The EPA regarded its bubble policy as a major innovation. It was intended to allow firms additional freedom in finding a least-cost means to satisfy air quality requirements. Initially, the EPA had to approve each bubble as an amendment to a state SIP, but with a policy change in 1981, the EPA authorized a generic rule, and New Jersey was the first state allowed to license bubble permits on its own authority. Banking In 1979, the EPA also introduced banking. Banking is just another facet of the transformation of emission permits into rights that can be used or traded. If the firm were to underutilize its emission budget, it could save up and reserve emis- sion reductions as rights to be traded in the future. Banking gives firms a luxury of timing their pollution control efforts-they do not have to use it or lose it. From the perspective of pollution control, banking has the advantage of encouraging immediate reductions in emissions, rather than encouraging the firm to delay reduction to a time when the right to pollute might become a more marketable commodity, and, from the perspective of economic efficiency, it enhances emis- sions trading to use scarce resources more productively