EPA-240-R-01-001

January 2001

The United States Experience

with Economic Incentives

for Protecting the Environment

Office of Policy, Economics, and Innovation

Office of the Administrator

U.S. Environmental Protection Agency

Washington, DC 20460
The U. S. Experience with Economic Incentives for Protecting the Environment

January

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Executive Summary

2001 i

EXECUTIVE SUMMARY

I. Purpose of This Report

Over its 30-year history the predominant tool used by the U.S. Environmental

Protection Agency (EPA) to help achieve the nation’s environmental goals has been

uniform, nationally applicable regulations derived from environmental law. Those

regulations, e.g., source-specific emissions limits, product specifications, and pollutioncontrol guidelines, have been responsible for much of the improvement in air and water

quality that is evident in the country today.

But over the past 20 years, and during the past decade in particular, EPA has begun to

use a much broader array of tools to manage environmental quality. Among these

relatively new tools, several kinds of economic incentives are being applied more and

more widely. Once considered an academic abstraction or a revenue-raising adjunct to

traditional regulatory mechanisms, market-based economic incentives are being used

now as the principal instrument for controlling a growing number of environmental

problems. To varying degrees, federal, state, and local governments are promoting the

use of economic incentives as an environmental management tool because of the

perceived advantages and effectiveness of these incentives.

Because of the wideand growinguse of economic incentives at all levels of

government in the United States, it is important to understand them more clearly. For

example, what kinds of economic incentives are being used today to address what kinds

of problems? Are particular incentives better suited for use at specific levels of

government? Even more important are questions regarding relative effectiveness. How

well have economic incentives performed in terms of improving environmental quality?

How economically efficient and cost-effective have they been? To what extent have

they stimulated technological change and innovation? How can past experience with

economic incentives help improve their use today and in the future?

This report attempts to answer those questions by providing a broad overview and

analysis of the current use of economic incentives as an environmental management

tool in the United States. To that end, it makes use of, and builds on, related reports,

surveys, and research. This report expands and updates the information contained in an

earlier EPA report (1992) and a report to EPA in 1997 that documented the growing

use of economic incentives in the United States and foreign countries. It also notes

related research by the National Academy of Public Administration (NAPA).

At the same time, this report is not exhaustive. It does attempt to identify most of the

incentives currently in use at the federal level for environmental pollution control.

However, it limits its discussion of incentives at other levels of government to a

representative sample of programs. A complete survey and assessment of the large

number of incentives currently in use at the state and local levels would require a much

broader study than this report. Likewise, the report only briefly summarizes a

voluminous theoretical and applied literature on economic incentives.
The U. S. Experience with Economic Incentives for Protecting the Environment

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II. Definition of Economic Incentives

For the purposes of this report, economic incentives are defined broadly as instruments that use

financial means to motivate polluters to reduce the health and environmental risks posed by their

facilities, processes, or products. These incentives provide monetary and near-monetary rewards

for polluting less and impose costs of various types for polluting more, thus supplying the

necessary motivation to polluters. This approach provides an opportunity to address sources of

pollution that are not easily controlled with traditional forms of regulation as well as providing a

reason for polluters to improve upon existing regulatory requirements. Under traditional

regulatory approaches, polluters have little or no incentive to cut emissions further or to make

their products less harmful once they have satisfied the regulatory requirements.

The definition of economic incentives used here is quite broad. As such, a great many

instruments and programs could be included in this review. By necessity the report focuses on

the most significant federal programs and a representative sampling of activities at the state and

local level.

III. Value of Economic Incentives

Economic incentives have a singular advantage over traditional forms of regulation: they harness

the force of the marketplace to reduce environmental and health risks. While this feature does not

make economic incentives applicable to every source of pollution, market forces often can

operate where traditional regulations would be ineffective. Sources of pollution include point

sources such as discharge pipes and stacks; area sources such as factories and storage areas; and

non-point sources such as streets, farms, and forests. In a traditional regulatory system, owners of

many of these sources have an incentive to complyi.e., avoidance of enforcement actionsbut

releasing pollution has no economic cost to the owner. Consequently, owners of these sources of

pollution (hereafter referred to as “sources”) normally have no incentive to do more than the

regulations require, whether it is a limit on emissions or on the use of a specific technology.

With market incentives, sources of pollution can see an economic value in reducing pollution

because doing so saves them money. Consequently, the difference between a traditional

regulatory system and economic incentives can lead to several public health, environmental, and

economic benefits.

First, economic incentives in some circumstances can be structured to achieve larger reductions

in pollution than would result from traditional regulations. For example, a program that allows

trading of pollution reduction obligations among sources may be able to require greater

reductions in pollution than a similar program that does not use trading. Pollution charges or

voluntary pollution prevention programs could encourage sources to reduce emissions below

permitted amounts.

Second, economic incentives often can control pollution at lower costs than can traditional

regulations. By setting standardized emissions, product, or technology requirements, traditional

regulations do not usually take into consideration the different costs of compliance faced by

different sources. But in an incentive system, the marginal costs of controlling pollution play an

essential role. When emission allowances or credits can be bought and sold by the sources, the

sources that have relatively low costs of pollution control will reduce more pollution than

sources that have relatively high costs of pollution control. Thus, when economic incentives are
Executive Summary

2001 iii

used, goals of reducing pollutionwhether applied over a facility, an industry, or the nation as a

wholewill be achieved at the lowest cost as determined by market forces. One study done for

the EPA (Anderson. 1999) estimated that the potential savings from widespread use of economic

incentives at the federal, state, and local level could be almost one-fourth of the approximately

$200 billion per year currently spent on environment pollution control in the United States.

Third, the use of economic incentives, in contrast to that of traditional regulations, can control

the pollution that is caused by a multitude of small and dispersed sources. A traditional

regulatory system, which relies on reporting, inspections, and fines for noncompliance, becomes

very cumbersome and expensive to administer when applied to thousands, or even millions, of

sources. For many serious environmental concerns today, such as surface water quality and

global warming, the sources of the problem can indeed number in the millions. Deposits on leadacid batteries and variable charges for solid waste disposal are two good examples of how

economic incentives can more effectively manage the quantity of pollution that is released from

large numbers of small and dispersed sources.

Fourth, economic incentives can stimulate technological improvements and innovations in

pollution control in situations where traditional regulatory mechanisms may not. In some cases,

traditional regulatory mechanisms can stimulate technological change. For example, challenging

numerical performance standards have prompted the development of cleaner technologies (e.g.,

catalytic converters). Also, when regulations require the use of the best available control

technology (BACT), manufacturers of pollution control equipment have an incentive to improve

the performance of the products they offer for sale. But traditional regulations that specify the

approved pollution control technologies discourage sources from developing better pollution

control technologies. Not only is there uncertainty that an improved pollution control technology

would be approved, but greater pollution control normally is costly. What source would want to

engage in greater control of pollution than is required by existing regulations? Economic

incentives, on the other hand, attach a value to controlling pollution. In some cases the value is

an explicit monetary amount, while in other cases the financial impact is indirect. Therefore,

sources have an incentive to develop technologies that are more effective or less costly,

particularly when pollution reduction obligations can be traded among sources like any other

commodity in the marketplace.

Clearly, economic incentives have several advantages that make them attractive environmental

management tools. When properly designed and used in appropriate circumstances, they can

achieve environmental results beyond those of traditional regulations, they can achieve those

results at lower costs, they often can do a better job of controlling large numbers of small

sources, and they provide a valuable spur to technological innovation.

However, just as economic incentives have advantages, they also have limitations. One of the

most significant disadvantages is that they are often inappropriate for dealing with environmental

issues that revolve around equity concerns. Many types of environmental standards are designed

to protect individuals around the site of a polluting facility; in some cases the specific purpose is

to protect individuals exposed to the highest pollutant concentrations. In general, people are not

willing to accept higher risks to their health because it is “more economical” to reduce risks to

others. There are many such environmental and health standards, including toxicity standards for

air, waste management standards, and cleanup standards. For example, risks cannot be traded

between Superfund sites. To do so would mean that some people would live near an unsafe site
The U. S. Experience with Economic Incentives for Protecting the Environment

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that doesn’t meet federal standards because other people would live near another site that is

twice as safe as required by federal standards.

IV. Types of Economic Incentives

This report examines several types of economic incentives that are currently in use in the United

States at all levels of government, and it assesses their advantages and disadvantages. Although

all these incentives give sources of pollution an impetus to minimize their emissions, the

incentives take widely differing forms. In fact, the variety of economic incentives in use today is

one of the most remarkable developments in environmental management over the past decade.

1. Fees, Charges, and Taxes

From the perspective of sources that are subject to environmental fees, charges, and taxes, these

three terms are largely interchangeable in terms of their effects. They all require that the

generator of a designated type of pollution pay a fee (or charge or tax) for each unit of pollution.

These fees make attractive tools for managing the environment because they attach an explicit

cost to polluting activities and because sources can easily quantify their savings if they reduce

the amount of pollution they emit. One disadvantage is that fees do not guarantee the amount by

which a source would reduce pollution.

Pollution-related fees, charges, and taxes are widely collected at all levels of government, and

they are one of the most prevalent economic incentives in use today. For example, fees linked to

air emissions are imposed in California, Texas, and several other states, while permit fees for

water effluent discharge are based on the volume and toxicity of the discharge in Washington,

New Jersey, and Wisconsin, among others. Per-bag fees on households that dispose of solid

waste are in effect in more than 3,000 communities across the country. Fees that are tied to

resources such as the use of grazing lands, water, and sewage systems are widely levied in the

United States.

Similarly, environmental taxes are usually imposed on landfill operations and the disposal of

hazardous wastes. Product charges are sometimes levied on productse.g., chlorofluorocarbons,

low-efficiency automobiles, fertilizer, motor oil, and packagingthat are believed to have

harmful effects on the environment. Other fees are being charged on activities that are potentially

damaging to the environment, for example, wetlands development and storm water runoff.

Although fees can generate substantial revenues for the government agency that imposes them,

they tend to be set at rates too low to have a significant impact on pollution. Generally speaking,

if pollution fees or taxes were set at rates equal to the incremental damage being caused by the

pollution, or at a level that would force changes in business or personal behavior, they would be

controversial. Concerns about the competitiveness of U.S. businesses would be raised if foreign

companies were not subject to similar fees. Consequently, the rates of most of these

environmental fees and taxes are not set high enough to achieve U.S. environmental goals,

although in some specific cases fees and taxes are working well as a mechanism for controlling

pollution.

2. Deposit-Refund Systems

Deposit-refund systems require a monetary deposit at the time of sale of a product. The deposit is

returned when the item is returned at the end of its useful life. In the United States, deposit-
Executive Summary

2001 v

refund systems have been applied most widely to help control the disposal of lead-acid batteries,

but they also are being applied in some states to products such as aluminum and glass cans,

pesticide containers, and tires. When used products are valuable, as is currently the case for leadacid batteries, the private sector often creates and manages a disposal system. Regardless of who

manages the disposal of such products, the fees charged by this system help subsidize the return

of recyclable products.

Deposit-refund systems appear to be most appropriate for discrete, solid commodities such as

beverage containers, batteries, and car bodies that would cause environmental harm through their

improper disposal. Government-mandated deposit systems for less discrete substances, like air

and water pollutants, have not been attempted. One factor that limits the widespread use of

deposit-refund systems is their high transaction cost. Collecting and refunding deposits on the

sale of individual products such as beverage containers tends to be expensive, and additional

costs are involved in collecting and returning used products for disposal.

3. Marketable Permits

There are two distinct types of trading systems: cap-and-trade systems and credit systems. Capand-trade systems seek a specific environmental result; trading allowances to release pollution is

simply an option to minimize the cost of achieving the emission reductions specified in the

regulatory cap on emissions. In the cap-and-trade approach, allowances for future emissions are

sold or granted to existing sources. Uncapped credit systems, on the other hand, do not establish

any fixed ceiling on total emissions. Total emissions can increase if new sources of pollution

enter the market and as existing sources increase production. In uncapped systems, credits are

earned for controlling pollution beyond a baseline specified in one's permit. Distinctions between

cap-and-trade and credit systems are discussed in much more detail in chapter 6.Two wellknown examples of cap-and-trade systems are EPA’s Acid Rain Trading Program and Southern

California's RECLAIM. A wide variety of other federal, state and local programs feature some

form of emission or effluent trading. For example, some of the high-mountain communities in

Colorado require permits to use wood-burning appliances. Existing homeowners are given

permits reflecting historic use but those who wish to install a new wood stove in a home are

required to retire two existing permits, a rule that helps reduce air pollution. Certain classes of

heavy-duty engines are subject to emissions averaging to meet an average performance standard,

which is just the trading of pollution control obligations within a company, as well as emissions

trading between companies. The rights to burn dry grass are subject to trading in Spokane

County, Washington, and land development rights are traded in a few jurisdictions in Maryland,

New Jersey, and Florida. In some areas, wetland mitigation credits can be created, banked, and

sold to offset the adverse effects of development.

Trading programs have certain features that have made them increasingly popular in the United

States. In a trading program, capital moves between companies involved in trades, and

innovative, entrepreneurial companies can profit from low-cost reductions in emissions. In

addition, cap-and-trade programs can provide great certainty about the magnitude of

environmental improvement that will be achieved.

At the same time, trading programs may have several drawbacks, including the potential for high

transaction costs and inactive markets, especially in credit or open-market systems. High costs

can be attributed to the need to verify each reduction before authorizing the credit. Clearly,

trading programs should not be applied to all environmental problems. The long-term effects of
The U. S. Experience with Economic Incentives for Protecting the Environment

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trading programs on technical innovation vary from program to program. Some have spurred

considerable innovation, such as the acid rain program, while others have not due to high

transaction costs.

4. Subsidies

Subsidies to support reductions in pollution take many forms. Among the many subsidies that are

used at all levels of government to help manage environmental pollution are grants, low-interest

loans, favorable tax treatment, and preferential procurement policies for products believed to

pose relatively low environmental risks. Subsidies are used to support private-sector pollution

prevention and control activities, the cleanup of contaminated industrial sites, farming and land

preservation, consumer product waste management, alternative automobile fuels, clean-running

cars, and municipal wastewater treatment.

Subsidies for environmental management are sometimes criticized because the government

entity providing the subsidyand the taxpayer, ultimatelyis helping to bear the costs that

should be the responsibility of the polluter. Other environmentally related subsidies, such as

federal support for timber harvesting in the national forests, are also criticized because they in

fact have proven harmful to the environment. Nonetheless, subsidies have become a fairly

common tool to manage the environment at every level of government.

5. Liability

Being held legally responsible for health or environmental damages is a potent incentive for

sources to reduce or avoid pollution, since if found liable they can face extraordinarily large and

unpredictable damage claims. The Clean Water Act, for example, requires the cleanup of oil and

petroleum products spilled into the nation’s waters, while the Superfund Act and the Oil

Pollution Act impose liability for environmental damages caused by the release of hazardous

substances and oil, respectively. Since 1990, awards and settlements for damages to natural

resources under these and related state statutes total more than $700 million, with a number of

cases that involve large sums still in varying stages of litigation. Liabilities associated with the

cost of cleanup at Superfund sites total billions of dollars.

With potential costs of this magnitude, sources have a powerful incentive to minimize their legal

exposure. Consequently, expensive technologies that control pollution or aggressive

environmental management systems can seem very reasonable to sources. While liability has

prodded sources to take significant actions to reduce pollution, such as managing hazardous

wastes on site, it is sometimes difficult to quantify the environmental results of those actions or

to establish a causal link between concerns over liability and reductions in pollution.

6. Information Disclosure

The collection and public availability of information on environmental performance has proven

to be a strong incentive for sources to reduce their emissions of pollution. The incentive derives

from a number of factors. For example, when companies collect emissions information, they

learn about the nature and magnitude of their emissions. When such information is made easily

accessible to the public, workers and local communities have a much better idea of the

environmental risks they face, so they are more prone to support or demand actions to reduce

emissions. When a source’s emissions are shown to decline over time, the source often reaps the

benefits of better relationships with its employees and with the local community. Finally, in
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some cases a proven, long-term record of environmental stewardship makes a company’s

products more desirable to consumers.

The disclosure of environmental performance information is much more common today than a

decade ago. Although some information is disclosed voluntarily, other information must be

released to the public as required by statute. The two best-known laws mandating the public

disclosure of environmental information are the Toxics Release Inventory provisions of the

federal Community Right-to-Know Act and California’s Proposition 65. Other forms of

information reporting include environmental impact assessments, product labeling,

environmental performance awards, Securities and Exchange Commission (SEC) environmental

reporting requirements, and disclosure requirements for lead paint and radon when homes are

sold.

Information disclosure has been a powerful tool for reducing pollution. Over the past decade, the

Toxics Release Inventory, for example, shows that sources have substantially reduced the

amount of substances listed in the inventory that they release into the environment. Because the

TRI requires only the reporting of information, actions taken by sources to reduce pollution are

voluntary and in all likelihood relatively low cost.

7. Voluntary Actions

Although government programs that encourage sources to reduce pollution on a voluntary basis

were virtually unheard of 20 years ago, they have become one of the fastest growing

environmental management tools in the country. At present, EPA and state governments have a

variety of programs in place that encourage sources like private companies, schools, hospitals,

and universities to reduce specific kinds of pollution. A 1999 EPA survey identified 54 such

federal partnership programs, up from 28 just three years earlier. More than 7,000 organizations

now participate in EPA’s voluntary programs, and in 1998 those participants conserved 1.8

billion gallons of clean water, 7.8 million tons of solid waste, and prevented the release of air

pollution in an amount equivalent to taking 13 million cars off the road. At t the same time, EPA

estimates these organizations saved roughly $3.3 billion. Literally hundreds of similar programs

are in operation at the state and local levels.

There are a number of reasons why voluntary reductions in pollution are proving more and more

popular with sources, and they are related to the incentives associated with information

disclosure. When sources voluntarily reduce pollution and their employees, neighboring

communities, and customers learn about it, sources gain several benefits. Voluntary actions taken

by sources often reduce employees’ exposure to harmful pollutants, thus lessening sources’

liability and improving their relationship with labor. Sources enjoy better relations with

neighboring communities, and a reputation for good environmental stewardship may attract more

customers for their products. In some cases, sources also save money by taking these actions.

Moreover, sources that join voluntary partnership programs can be eligible for various kinds of

technical assistance from sponsoring government agencies. For example, they can receive free

information on the cost and availability of energy-efficient technologies.
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V. Conclusions

1. Diversity of Economic Incentives at EPA

EPA is well known for its use of emissions trading as a key feature of its program to control acid

rain. However, acid rain emissions trading is only one of the economic incentive programs

managed by EPA.

Emissions trading, averaging, and banking are helping control major air pollution problems such

as stratospheric ozone depletion and ozone-forming nitrogen oxide emissions. They are helping

this country to achieve national goals for cleaner fuels, and they are built into virtually all EPA

rules for motor vehicles and engines. New efforts to implement a Total Maximum Daily Load

(TMDL) program in areas with impaired water quality are expected to substantially increase the

use of water effluent trading in the years ahead.

EPA subsidies are helping to revitalize brownfields across the country. In addition, the Agency is

rapidly expanding the kinds and extent of environmental information that it makes available to

the public and that it requires sources of pollution to disclose to the public. The Toxic Release

Inventory required by Superfund may be the public’s most well known and most widely used

EPA database, but over the past several years it has been augmented by many others. For

example, beginning in 1998 drinking water suppliers have been required to provide households

with information on the quality of their drinking water. Moreover, in 2000 EPA began

publicizing the emission characteristics of motor vehicles to help consumers in their purchasing

decision and to encourage vehicle manufacturers to further reduce emissions.

Voluntary programs have also become a major environmental management tool at EPA over the

past decade. The Agency now manages dozens of such programs, many of which have led to

measurable reductions in pollutant emissions. In some cases EPA’s voluntary programs have

given U.S. companies an incentive to develop less polluting products, like computers and

household appliances, the sale of which reduces pollution in every part of the country.

EPA has incorporated nearly every type of economic incentive currently in use in the United

States into its programs. And the growth of those incentives over the past decade suggests that

the Agency is likely to increase its use of them in the decade ahead.

2. Wide Application at Other Levels of Government

The survey undertaken in this report demonstrates the extent to which economic incentives have

been adopted as an environmental management tool at state and local levels in the United States.

The report discusses dozens of such applications in detail, but there are hundreds more that are

known but not included for analysis here.

Not only are the number of state and local economic incentives growing, but their diversity is

remarkable. In fact, one of the most interesting aspects of economic incentives that are being

tested in different states and communities in the 1990s is their rich variety. Several examples

follow. Communities in California, Washington, Michigan, Wisconsin, Minnesota and many

other states are charging fees to households for collecting and disposing of their solid waste

based on the amount of waste generated. More and more states are imposing taxes on the

generation of hazardous wastes. North Carolina imposed a disposal fee on “white goods” such as

refrigerators and freezers in 1995, the same year that Minnesota levied a tax on the
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“contamination value” of property. As an outgrowth of EPA’s proposed Open Market Trading

Rule, states like Illinois, Michigan, New Jersey, Texas, and Pennsylvania have developed trading

programs for air emissions. In addition to EPA’s subsidies for developing brownfields, states like

New Jersey, Pennsylvania, Delaware, Minnesota, Ohio, Arizona, and Tennessee are offering

similar subsidies. In addition, trading programs for water effluent are in various stages of

development in Long Island Sound, the Boise River, Chesapeake Bay and many other locations.

The sheer numbers and variety of these programs make them a difficult topic for analysis within

a single limited study. However, they do suggest that state and local governments will continue

to be a major developer and user of economic incentives well into the future.

3. Unique Contributions to Environmental Management

In some instances it is difficult to quantify the reductions in pollutants or the improvements in

human health and environmental quality that result from the use of specific economic incentives.

However, there is little doubt that such incentives are providing a new and unique element to

environmental management in the United States. In many cases, incentives are generating health

and environmental benefits beyond what is possible with traditional regulations, and sometimes

they can be applied in situations where regulations might not be possible at all. It is difficult to

imagine, for example, the public supporting a regulatory system that mandated reductions in

household waste, but household wastes are declining significantly in communities that charge for

waste collection based on the amount generated.

The contributions to environmental management made by economic incentives are as varied as

the incentives themselves. Deposit-refund systems are helping change the environmental

behavior of individual consumers in ways that traditional regulations could not. Deposit-refund

systems and taxes on products and outputs are reducing the pollution caused by a multitude of

small and geographically dispersed sources that typically are difficult to control through

traditional regulations.

Many economic incentives give an impetus to technological change and innovative pollution

control because sources can generate profits by finding better, cheaper ways of reducing

emissions. EPA’s voluntary programs are a particularly good example of economic incentives

acting as an incubator for technological improvements. When businesses take initiative on their

own or work collaboratively with government to find ways to reduce pollution, instead of merely

reacting to government regulations, they tend to apply the same inventiveness and cost-cutting

skills used in other parts of the business. In this sense, voluntary programs, as well as other kinds

of economic incentives, unleash the qualities of American entrepreneurs that make U.S.

businesses such strong competitors in the marketplace and encourage these sources to use those

skills to protect the environment.

4. Cost Savings

Economists have long understood that economic incentives have the potential to reduce pollution

at a cost below that imposed by traditional regulations. The national experience of using

economic incentives over the past decade reinforces this point of view. In some cases, it is

difficult to quantify the costs imposed by a particular incentive. In other cases, the hoped-for cost

reductions do not materialize to the extent expected. However, in general, it is clear that

economic incentives do provide the opportunity to achieve any given level of pollution control

with substantial cost savings.
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Evidence supporting the lower costs of economic incentives is both theoretical (derived from

models) and empirical (based on the results of operating programs). At least 40 studies based on

computer modeling of different scenarios for controlling pollution show that economic

incentives should be more cost-effective than traditional regulations. One study (ICF, 1989)

estimated that allowance trading in EPA’s acid rain program could result in savings to affected

utilities of $700 to $800 million per year over the long term. The actual cost savings now are

believed to be at least twice this amount. Other areas also offer potentially large savings. For

example, effluent trading has the potential to save sources as much as $7.5 billion annually. Even

if the cost savings from using market incentives are less than predicted as a result of regulatory,

institutional, transactional, or legal restraints, or some combination of these factors, the actual

savings undoubtedly are still significant.

5. Applicability to Specific Environmental Problems

The nation’s recentand growingexperience with economic incentives has helped improve

our collective understanding of their relative usefulness and applicability to specific

environmental problems. Experience to date suggests that, even though a wide variety of

incentives are available, any particular one may be effective in managing only a fairly narrow

range of problems (see Table ES-1).

Product taxes, for example, have been imposed on such diverse goods as fertilizer, tires, and

chlorofluorocarbons. It is most useful to apply these taxes to products that have many consumers

because administering these taxes is relatively simple and inexpensive. Product taxes have the

added advantage of raising revenue for the taxing authority. For other environmental problems,

however, raising revenue may be a less important, or even inconsequential, consideration.

Subsidies often are politically popular. In contrast to taxes, they transfer funds to specific targets

within the private sector where incentives for conservation, recycling or pollution control

currently are lacking. Consequently, subsidies may be most useful in situations in which targeted

assistance is essential and other policy approaches would be politically unacceptable or

ineffective.

Deposit-refund systems, like input or output taxes, appear to be most useful when applied to

numerous, decentralized sources of pollution. However, these systems tend to have high

administrative costs compared to alternative instruments such as taxes and fees. Clearly, the

relative ability to administer the incentive would be a primary consideration when choosing

among these alternatives.

In short, any government agency interested in using economic incentives has a range of options

from which to choose. The environmental success of the incentive selected depends to a great

extent on the characteristics of the specific environmental problem at hand.
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Table ES-1. Uses of Economic Incentives

Incentive Examples Pros & Cons

Pollution Charges &

Taxes

Emission charges

Effluent charges

Solid waste charges

Sewage charges

Pros: stimulates new technology; useful when damage per unit of

pollution varies little with the quantity of pollution

Cons: potentially large distributional effects; uncertain

environmental effects; generally requires monitoring data

Input or Output

Taxes & Charges

Leaded gasoline tax

Carbon tax

Fertilizer tax

Pesticide tax

Virgin material tax

Water user charges

CFC taxes

Pros: administratively simple; does not require monitoring data;

raises revenue; effective when sources are numerous and damage

per unit of pollution varies little with the quantity of pollution

Cons: often weak link to pollution; uncertain environmental effects

Subsidies

Municipal sewage plants

Land use by farmers

Industrial pollution

Pros: politically popular, targets specific activities

Cons: financial impact on government budgets; may stimulate too

much activity; uncertain effects

DepositRefund Systems

Lead-acid batteries

Beverage containers

Automobile bodies

Pros: deters littering; stimulates recycling

Cons: potentially high transaction costs; product must be reusable

or recyclable

Marketable Permits

Emissions

Effluents

Fisheries access

Pros: provides limits to pollution; effective when damage per unit of

pollution varies with the amount of pollution; provides stimulus to

technological change

Cons: potentially high transaction costs; requires variation in

marginal control costs

Reporting

Requirements

Proposition 65

SARA Title III

Pros: flexible, low cost

Cons: impacts may be hard to predict; applicable only when

damage per unit of pollution does not depend on the quantity of

pollution

Liability

Natural resource damage

assessment

Nuisance, trespass

Pros: provides strong incentive

Cons: assessment and litigation costs can be high; burden of proof

large; few applications

Voluntary Programs

Project XL

33/50

Energy Star

Pros: low cost; flexible; many possible applications; way to test new

approaches

Cons: uncertain participation
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Table of Contents

2001 xiii

Table of Contents

1. Introduction.........................................................................................................................................1

1.1 Purpose of the Report ................................................................................................................1

1.2 Scope of the Report ...................................................................................................................1

1.3 Organization of the Report ........................................................................................................3

2. Government Policy on Economic Incentives ....................................................................................5

2.1 Reports and Strategies ...............................................................................................................5

2.1.1 Project 88 Report..........................................................................................................5

2.1.2 Report of the EPA Economic Incentives Task Force....................................................6

2.1.3 President’s Council on Sustainable Development........................................................6

2.1.4 Economic Report of the President ................................................................................6

2.2 Executive Orders and Initiatives................................................................................................7

2.2.1 Executive Order 12291.................................................................................................7

2.2.2 Executive Order 12866.................................................................................................7

2.2.3 Climate Change Initiative.............................................................................................9

2.2.4 Greening the Government.............................................................................................9

2.2.5 National Performance Review....................................................................................10

2.2.6 Reinventing Environmental Regulations ....................................................................10

2.2.7 National Environmental Technology Strategy............................................................10

2.3 Recent Environmental Management Initiatives.......................................................................11

2.3.1 Performance Track Approach at EPA........................................................................11

2.3.2 EPA Air and Water Policy Initiatives.........................................................................11

2.3.3 EPA Research Activities .............................................................................................11

2.3.4 Promotion of Economic Instruments Abroad .............................................................11

2.4 Legislation: Clean Air Act Amendments of 1990 ...................................................................12

3. The Cost Effectiveness and Environmental Effects of Incentive Systems ...................................13

3.1 Introduction .............................................................................................................................13

3.2 Traditional Regulatory Approaches.........................................................................................14

3.3 Incentive-Based Mechanisms ..................................................................................................16

3.3.1 Pollution Charges, Fees, and Taxes...........................................................................17

3.3.2 Deposit-Refund Systems .............................................................................................19

3.3.3 Marketable Permit Systems ........................................................................................19

3.3.4 Subsidies for Reducing Pollution or Improving the Environment..............................20

3.3.5 Liability for Harm Caused by Pollution .....................................................................21

3.3.6 Information Disclosure...............................................................................................22

3.3.7 Voluntary Pollution Reduction Programs ..................................................................23

3.4 Relative Cost Effectiveness .....................................................................................................23

3.5 Economic Instruments and Technological Change..................................................................27

3.6 Impacts on Environmental Quality..........................................................................................29

3.7 Finding the Right Instrument for the Problem.........................................................................30

4. Pollution Charges, Fees, and Taxes .................................................................................................33

4.1 Introduction .............................................................................................................................33

4.2 Water Fees ...............................................................................................................................34

4.2.1 Indirect Discharge and User Fees..............................................................................34

4.2.2 Direct Discharge Fees................................................................................................35

4.2.3 Some State Effluent Permitting Fees ..........................................................................36

4.2.4 Stormwater Runoff Fees .............................................................................................37

4.3 Air Emission Fees....................................................................................................................37

4.3.1 Permit Fees.................................................................................................................37
The U. S. Experience with Economic Incentives for Protecting the Environment

xiv January

4.3.2 Ozone Non-attainment Area Fees...............................................................................40

4.4 Solid Waste Disposal Fees.......................................................................................................41

4.4.1 Variable Pricing Programs ........................................................................................41

4.4.2 Landfill Taxes .............................................................................................................46

4.4.3 Hazardous Waste Taxes..............................................................................................47

4.5 Product Charges.......................................................................................................................48

4.5.1 Federal Product Charges ...........................................................................................49

4.5.2 State Product Charges................................................................................................50

4.6 Road User Fees........................................................................................................................53

4.7 Wetland Compensation Fees ...................................................................................................54

4.8 Grazing Fees ............................................................................................................................55

4.9 Minnesota Contamination Tax ................................................................................................55

5. Deposit-Refund Systems ...................................................................................................................57

5.1 Introduction .............................................................................................................................57

5.2 Beverage Containers................................................................................................................58

5.2.1 Maine Bottle Deposit System......................................................................................59

5.2.2 California Beverage Container Recycling Program ..................................................62

5.2.3 Summary of Beverage Deposit/Refund Systems..........................................................63

5.3 Lead-Acid Batteries.................................................................................................................64

5.4 Maine Pesticide Container Deposit System.............................................................................64

5.5 Other Products .........................................................................................................................65

5.6 Voluntary Deposit Systems .....................................................................................................66

5.7 Performance Bonds..................................................................................................................66

6. Trading Programs.............................................................................................................................67

6.1 Trading in Clean Air Act Programs: An Overview .................................................................69

6.2 Foundations of Air Emissions Trading....................................................................................71

6.2.1 Offset Program ...........................................................................................................72

6.2.2 Bubble Policy..............................................................................................................72

6.2.3 Banking.......................................................................................................................73

6.2.4 Netting ........................................................................................................................73

6.2.5 Evaluation of Early Emission Trading Activities .......................................................74

6.3 Acid Rain Allowance Trading.................................................................................................76

6.3.1 Allowances..................................................................................................................77

6.3.2 Monitoring and Compliance.......................................................................................78

6.3.3 Allowance Auction......................................................................................................79

6.3.4 Transaction Costs.......................................................................................................79

6.3.5 Results.........................................................................................................................80

6.4 NOx Regional Ozone Programs ...............................................................................................82

6.4.1 OTC NOx Budget Program .........................................................................................83

6.4.2 NOx Budget Trading Program....................................................................................84

6.5 Chlorofluorocarbon (CFC) Production Allowance Trading....................................................85

6.6 Lead Credit Trading.................................................................................................................86

6.7 Gasoline Constituents ..............................................................................................................87

6.8 Tier 2 Emission Standards.......................................................................................................89

6.9 Heavy-Duty Truck Engine Emission Averaging.....................................................................89

6.10 Corporate Average Fuel Economy (CAFE) Standards............................................................90

6.11 Hazardous Air Pollutant (HAP) Early Reduction....................................................................91

6.11.1 The Petroleum Industry NESHAP ..............................................................................92

6.11.2 Hazardous Organic Chemical NESHAP ....................................................................92

6.12 Regional Clean Air Incentives Market (RECLAIM)...............................................................93

6.13 Other State Programs...............................................................................................................96
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2001 xv

6.13.1 Illinois Emission Reduction Market System................................................................96

6.13.2 Michigan Emissions Trading Program ......................................................................97

6.13.3 New Jersey Emission Trading Program .....................................................................97

6.13.4 Texas Emissions Trading Program ............................................................................97

6.13.5 Pennsylvania Emission Trading Program..................................................................98

6.13.6 Wood Stove and Fireplace Permit Trading (Colorado) .............................................98

6.13.7 Grass-Burning Permit Trading (Washington)............................................................99

6.14 Effluent Trading.......................................................................................................................99

6.14.1 Effluent Bubble .........................................................................................................100

6.14.2 Effluent Trading: Point-to-Point ..............................................................................101

6.14.3 Effluent Trading: Point-to-Non-point Sources .........................................................102

6.14.4 Future Prospects for Effluent Trading .....................................................................103

6.15 Wetland Mitigation Banking .................................................................................................106

6.16 Greenhouse Gas Emissions....................................................................................................107

7. Subsidies for Pollution Control......................................................................................................111

7.1 Introduction ...........................................................................................................................111

7.2 Pollution Prevention and Control ..........................................................................................111

7.2.1 Tax Benefits ..............................................................................................................113

7.2.2 Louisiana Environmental Scorecard ........................................................................114

7.2.3 Supplemental Environmental Projects .....................................................................115

7.2.4 Loans and Tax Exempt Bonds...................................................................................115

7.3 Brownfields Programs ...........................................................................................................116

7.3.1 EPA Pilot Grant Projects .........................................................................................117

7.3.2 Tax Incentives and Loans .........................................................................................117

7.4 Farming and Land Preservation.............................................................................................118

7.4.1 Conservation Reserve Program................................................................................119

7.4.2 Conservation Reserve Enhancement Program.........................................................121

7.4.3 Wetlands Reserve Program ......................................................................................122

7.4.4 Compliance Provisions.............................................................................................123

7.4.5 Highly Erodible Land Conservation and Sodbuster Provisions...............................123

7.4.6 Swampbuster Program .............................................................................................124

7.4.7 Subsidies Created Under the 1996 Farm Bill...........................................................125

7.4.8 Impacts of Conservation Programs..........................................................................126

7.4.9 State Initiatives .........................................................................................................126

7.4.10 Purchase of Development Rights Programs.............................................................127

7.5 Consumer Product Waste Management................................................................................128

7.5.1 Advance Disposal Fees.............................................................................................128

7.5.2 Deposit Handling Fees .............................................................................................129

7.5.3 Recycling Loans and Grants.....................................................................................129

7.5.4 Tax Incentives...........................................................................................................131

7.5.5 Preferential Procurement of Recycled Products ......................................................131

7.5.6 Recycled Content Policies ........................................................................................132

7.6 New Jersey’s Information Awards Program..........................................................................133

7.7 Alternative Fuels and Low-Emitting Vehicles ......................................................................133

7.7.1 Federal Subsidies .....................................................................................................134

7.7.2 State Subsidies ..........................................................................................................135

7.7.3 Car Buyback Schemes ..............................................................................................136

7.8 Renewable Energy and Conservation....................................................................................136

7.9 Municipal Sewage Treatment Plant Construction .................................................................137

7.10 Accelerated Review of New Pesticide Formulations ............................................................139

7.11 Subsidies That May Harm the Environment..........................................................................139
The U. S. Experience with Economic Incentives for Protecting the Environment

xvi January

7.11.1 Subsidies for Timber, Minerals, and Water Extraction............................................139

7.11.2 Agriculture................................................................................................................141

7.11.3 Mortgage Interest Tax Deduction.............................................................................142

8. Liability Approaches.......................................................................................................................143

8.1 Introduction ...........................................................................................................................143

8.2 Liability for Cleanup Costs....................................................................................................144

8.3 Liability for Damage to Natural Resources ...........................................................................145

8.4 Civil and Criminal Liability...................................................................................................147

8.4.1 Resource Conservation and Recovery Act (RCRA) ..................................................148

8.4.2 Comprehensive Environmental Response, Compensation, and Liability Act

(CERCLA).................................................................................................................149

8.4.3 Clean Water Act (CWA)............................................................................................149

8.4.4 Clean Air Act (CAA) .................................................................................................150

8.5 Tort Liability..........................................................................................................................150

9. Information Disclosure ...................................................................................................................153

9.1 Background............................................................................................................................154

9.2 National Environmental Policy Act (NEPA).........................................................................155

9.3 Emergency Planning and Community Right-to-Know Act (EPCRA) ..................................155

9.3.1 Trends in Toxics Release Inventory (TRI) Data .......................................................156

9.3.2 Incentive Effect of the Toxics Release Inventory ......................................................158

9.4 State Chemical Reporting Programs......................................................................................159

9.4.1 Massachusetts Toxics Use Reduction Act (TURA) ...................................................159

9.4.2 New Jersey Reporting Requirements........................................................................160

9.5 Drinking Water Consumer Confidence Report .....................................................................161

9.6 EPA Reporting of Environmental Information......................................................................162

9.6.1 Automobile Pollution Rankings ................................................................................162

9.6.2 Envirofacts................................................................................................................162

9.6.3 Sector Facility Indexing (SFI) ..................................................................................162

9.7 Proposition 65........................................................................................................................163

9.8 Hot Spots Act.........................................................................................................................164

9.9 Labeling Schemes..................................................................................................................164

9.9.1 OSHA Warning Labels .............................................................................................165

9.9.2 FTC Guidelines for Environmental Marketing Claims ............................................165

9.9.3 Green Seal and Other Seals of Approval..................................................................166

9.9.4 Single-Attribute Labels .............................................................................................167

9.9.5 Report Cards and Information Disclosure ...............................................................168

9.9.6 Energy Efficiency Labeling.......................................................................................168

9.9.7 Hazard Labels...........................................................................................................170

9.10 Environmental Performance Awards.....................................................................................170

9.11 Securities and Exchange Commission Disclosure Requirements..........................................171

9.12 Summary................................................................................................................................171

10. Voluntary Programs .......................................................................................................................173

10.1 Background............................................................................................................................173

10.2 Federal Initiatives: Climate Change ......................................................................................174

10.2.1 Green Lights .............................................................................................................176

10.2.2 Energy Star Partnership Program............................................................................176

10.2.3 Climate Wise.............................................................................................................178

10.2.4 WasteWise.................................................................................................................178

10.2.5 Methane Reduction Programs ..................................................................................178

10.2.6 Coalbed Methane Outreach Program ......................................................................179

10.2.7 Natural Gas Star Program .......................................................................................179
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2001 xvii

10.2.8 Agstar Program ........................................................................................................179

10.2.9 Assessment of Climate Change Programs................................................................180

10.3 Public Voluntary Initiatives: Pollution Prevention................................................................181

10.3.1 33/50 Program..........................................................................................................181

10.3.2 Design for the Environment (DfE)............................................................................183

10.3.3 Environmental Accounting Project (EAP)................................................................184

10.3.4 Environmental Leadership Program (ELP) .............................................................185

10.3.5 Water Alliances for Voluntary Efficiency (WAVE)...................................................185

10.3.6 Community-Based Environmental Protection (CBEP).............................................186

10.3.7 Voluntary Mobile Source Emission Reduction Program (VMEP) ...........................186

10.3.8 Pesticide Environmental Stewardship Program (PESP)..........................................187

10.3.9 Commuter Choice Leadership Initiative...................................................................187

10.4 Industry Initiatives.................................................................................................................188

10.5 Federal Negotiated Agreements ............................................................................................189

10.5.1 Project XL.................................................................................................................189

10.5.2 Common Sense Initiative (CSI).................................................................................191

10.6 An Assessment of Pollution Prevention Efforts ....................................................................193

10.7 Voluntary Programs Developed by EPA Regions.................................................................193

10.8 State Programs.......................................................................................................................194

10.8.1 Massachusetts Recycled Newsprint Program...........................................................194

10.8.2 Adopt-a-Highway Programs.....................................................................................194

10.8.3 State Voluntary Cleanup Programs..........................................................................195

10.9 Conclusions ...........................................................................................................................195

Index.........................................................................................................................................................197

Bibliography ............................................................................................................................................201

About the Report.....................................................................................................................................223

Endnotes...................................................................................................................................................225

List of Figures

Figure 3-1. Control Options for a Source .................................................................................................15

Figure 3-2. National Long-Term Air Quality Trends, 1979-1998............................................................16

Figure 3-3. Tax Per Unit of Emissions .....................................................................................................17

Figure 3-4. Comparison of Emission Tax and Emission Limit ................................................................28

Figure 4-1. Water and Wastewater Charges (monthly average)...............................................................35

Figure 4-2. Solid Waste Flows in San Jose...............................................................................................43

Figure 5-1. Lead Recovery from Lead Acid Batteries..............................................................................65

Figure 6-1. Internal and External Trading ................................................................................................80

Figure 6-2. Acid Rain Allowance Prices ..................................................................................................81

Figure 7-1. Cumulative SRF Investments (in billions of dollars, 1988−1999) ......................................137

Figure 9-1. Reported TRI Releases.........................................................................................................156

Figure 10-1. Energy Savings in Showcase Buildings...............................................................................177

Figure 10-2. Goals and Accomplishments of EPA’s Climate Change Programs: 1995−2000.................180

Figure 10-3. Releases of TRI Chemicals (1988−1994) ............................................................................183
The U. S. Experience with Economic Incentives for Protecting the Environment

xviii January

List of Tables

Table 3-1. Considerations for Selecting Regulatory Instruments............................................................14

Table 3-2. Potential Savings from Using Economic Incentives to Control Air Pollution.......................25

Table 3-3. Potential Savings from Using Economic Incentives to Control Water Pollution ..................26

Table 3-4. Potential Savings from Using Economic Incentives to Control Solid Waste ........................26

Table 3-5. Potential Savings from Using Economic Incentives for Other Pollution-Related Issues ......27

Table 3-6. Uses of Economic Instruments...............................................................................................31

Table 4-1. Fees, Charges, and Taxes in Environmental Policy...............................................................33

Table 4-2. State Effluent Permit Fee Structures......................................................................................36

Table 4-3. Air Emissions Permit Fees in Maine......................................................................................38

Table 4-4. Emission Fees in SCAQMD ..................................................................................................39

Table 4-5. Air Toxics and Ozone-Depleting Chemicals Emission Fees in SCAQMD ...........................39

Table 4-6. Variable Rate Structures ........................................................................................................42

Table 4-7. Responses to Variable Rate Pricing .......................................................................................45

Table 4-8. Hazardous Waste Landfill Fees in California ........................................................................47

Table 4-9. California Hazardous Waste Generation Fees .......................................................................47

Table 4-10. Federal and State Tire Charges ..............................................................................................51

Table 5-1. State Beverage Container Deposit-Refund Systems ..............................................................59

Table 5-2. Beverage Containers: Estimated Tons Recycled and Costs of Collection in Maine..............61

Table 5-3. States with Mandatory Lead-Acid Battery Deposit Systems .................................................64

Table 6-1. Emission Trading Activity in the Los Angeles Area .............................................................74

Table 6-2. Origin of 1999 Allowable Emissions.....................................................................................77

Table 6-3. OTC’s NOx Budget Program Allocations and Emissions (1999) ..........................................83

Table 6-4. Benefits of Achieving Early Emission Reductions................................................................92

Table 6-5. Reclaim Trading Credit Prices...............................................................................................95

Table 6-6. Open Market Emissions Trading Registry Report (2000) .....................................................97

Table 6-7. Estimated Cost Savings from Iron and Steel Intraplant Trades ...........................................100

Table 6-8. Effluent Trading Projects.....................................................................................................104

Table 6-9. Accepted USIJI Projects ......................................................................................................109

Table 7-1. The Use of Subsidies in Environmental Management .........................................................112

Table 7-2. Points Under Louisiana Scorecard System ..........................................................................114

Table 7-3. Funding for Conservation Subsidy Programs of the U.S. Department of Agriculture (FY

1998) in millions of dollars..................................................................................................118

Table 7-4. Conservation Reserve Acreage and Rental Payments..........................................................120

Table 7-5. Estimated Social Benefits and Costs of CRP.......................................................................120

Table 7-6. Status of Conservation Reserve Enhancement Programs.....................................................121

Table 7-7. Wetland Reserve Program’s First Enrollment (1992)..........................................................123

Table 7-8. Economic Benefits and Costs of Conservation Compliance................................................124

Table 7-9. Impacts of Conservation Programs ......................................................................................126

Table 7-10. Purchase of Development Rights Programs in States ..........................................................128

Table 7-11. State Subsidies for Used Tire Management .........................................................................129

Table 7-12. Financial Assistance Programs in Wisconsin that Promote Recycling (1994−95) ..............130

Table 7-13. State Loan Funds for Recycling Enterprises........................................................................130

Table 7-14. Alternative Fuel and Vehicle Subisdies ...............................................................................134

Table 7-15. Federal Procurement Requirements for Alternative Fuel Vehicles by Model Year ............135

Table 7-16. Alternative Fuel and Vehicle Subsidies in the Ozone Transport Region.............................136

Table 7-17. Water Subsidies of the U.S. Bureau of Reclamation ...........................................................140

Table 8-1. Largest Natural Resource Damage Settlements Brought by the U.S. Government .............146

Table 8-2. Criminal Penalties for Violations of the Clean Water Act...................................................149
Table of Contents

2001 xix

Table 9-1. Classification of Environmental Labeling Schemes ............................................................165

Table 10-1. Federal Voluntary Programs for Greenhouse Gases............................................................175

Table 10-2. Energy Savings from Green Lights/Energy Star Program...................................................176

Table 10-3. Federal Voluntary Pollution Prevention Programs ..............................................................182

Table 10-4. Federal Negotiated Voluntary Programs..............................................................................189

Table 10-5. Economic Benefits for Select Project Sponsors of Project XL............................................191

Table 10-6. Selected Regional Voluntary Programs of EPA ..................................................................193
The U. S. Experience with Economic Incentives for Protecting the Environment

xx January

List of Acronyms

ADF Advance Disposal Fee

AEL Acceptable Exposure Level

AF Alternative Fuel

AFV Alternative Fuel Vehicle

API American Petroleum Institute

AQMP Air Quality Management Plan

ATU Allotment Trading Units

AUM Animal Unit Months

BAAQMD Bay Area Air Quality Management District

BAT Best Available Technology Economically Achievable

BCRP Beverage Container Recycling Program

BLM Bureau of Land Management

BOD Biochemical Oxygen Demand

BPT Best Practicable Control Technology Currently Available

Btu British Thermal Unit

CAA Clean Air Act

CAFE Corporate Average Fuel Economy

CalCAP California Capital Access Program

CARB California Air Resources Board

CBEP Community-Based Environmental Protection

CCAP Climate Change Action Plan

CCTI Climate Change Technology Initiative

CDM Clean Development Mechanism

CEM Continuous Emission Monitoring

CEQ Council on Environmental Quality

CERCLA Comprehensive Environmental Response Compensation and Liability Act

CFC Chlorofluorocarbon

CH4 Methane

CLEAN California Loans for Environmental Assistance Now

CLI Consumer Labeling Initiative

CMA Chemical Manufacturers Association

CNG Compressed Natural Gas

CO2 Carbon Dioxide

CPCFA California Pollution Control Financing Authority

CPTC California Private Transportation Company

CRP Conservation Reserve Program

CRS Congressional Research Service

CSI Common Sense Initiative

CWA Clean Water Act

DACS Department of Agriculture and Community Services (Florida)

DEM Division of Environmental Management

DfE Design for the Environment

DOE Department of Energy

DOT Department of Transportation

EAP Environmental Accounting Project

EBI Environmental Benefits Index

EER Energy Efficiency Rating

EHS Environmental Health and Safety

EIP Economic Incentive Program
List of Acronyms

2001 xxi

ELP Environmental Leadership Program

EO Executive Order

EPA Environmental Protection Agency

EPCA Energy Policy and Conservation Act

EPCRA Emergency Planning and Community Right-to-Know Act

EQIP Environmental Quality Incentive Program

ERC Emission (or Effluent) Reduction Credits

ERMS Emission Reduction Market System

EU European Union

FGD Flue Gas Desulfurization

FTC Federal Trade Commission

FWPCA Federal Water Pollution Control Act

FY Fiscal Year

GEF Global Environment Facility

GHG Greenhouse Gas

GNP Gross National Product

gpm Grams Per Mile

HAP Hazardous Air Pollutant

HEL Highly Erodible Land

HFC Hydrofluorocarbon

HON Hazardous Organic Chemical NESHAP

IET International Emissions Trading

IPTEP Industrial Property Tax Exemption Program

IRR Internal Rate of Return

ISO International Organization for Standardization

JI Joint Implementation

kWh Kilowatt Hour

LAER Lowest Achievable Emission Rate

MACT Maximum Available Control Technology

MMBtu Million Btus

MMTCE Million Metric Tons of Carbon-Equivalent

MOU Memorandum of Understanding

mpg Miles Per Gallon

MSDS Material Safety Data Sheet

N2O Nitrogen Oxide

NEPA National Environmental Policy Act

NESHAP National Emission Standards for Hazardous Air Pollutants

NFRC National Fenestration Rating Council

NGO Nongovernmental Organization

NLEV National Low Emission Vehicle

NMOG Non-Methane Organic Gas

NOAA National Oceanic and Atmospheric Administration

NOx Nitrogen Oxide

NPDES National Pollution Discharge Elimination System

NRDC Natural Resources Defense Council

NSR New Source Review

ODC Ozone-Depleting Chemical

OMB Office of Management and Budget

OPA Oil Pollution Act

OSHA Occupational Safety and Health Administration

OTC Ozone Transport Commission

P2 Pollution Prevention
The U. S. Experience with Economic Incentives for Protecting the Environment

xxii January

P3 Public-Private Partnership

PAH Poly-Nuclear Aromatic Hydrocarbons

PDR Purchase of Development Rights

PET Polyethylene Terephthalate

PFC Perfluorocarbon

POTW Publicly Owned Treatment Work

ppm Parts Per Million

PRIA Public Rangelands Improvement Act

PSD Prevention of Significant Deterioration

RACT Reasonably Available Control Technology

RCRA Resource Conservation and Recovery Act

RECLAIM Regional Clean Air Incentives Market

RIA Regulatory Impact Analysis

RFF Resources for the Future

ROG Reactive Organic Gases

RTC RECLAIM Trading Credits

RVP Reid Vapor Pressure

SARA Superfund Amendments and Reauthorization Act

SCAQMD South Coast Air Quality Management District

SCS Scientific Certification Systems

SEC Securities and Exchange Commission

SEP Supplemental Environmental Project

SF6 Sulfur Hexafluoride

SFI Sustainable Forestry Initiative

SIC Standard Industrial Classification

SIP State Implementation Plan

SMCRA Surface Mining Control and Reclamation Act

SOCMI Synthetic Organic Chemical Manufacturing Industry

SO2 Sulfur Dioxide

SRF State Revolving Fund (Clean Water)

STEP Strategies for Today’s Environmental Partnership (API)

TSCA Toxic Substances Control Act

TDR Transferable Development Rights

TMDL Total Maximum Daily Load

TNRCC Texas Natural Resource Conservation Commission

TRI Toxics Release Inventory

TSP Total Suspended Particulates

UNFCCC United Nations Framework Convention on Climate Change

URVs Unit Risk Values

USAID United States Agency for International Development

USDA United States Department of Agriculture

USIJI United States Initiative on Joint Implementation

VMT Vehicle Miles Traveled

VOCs Volatile Organic Compounds

VOM Volatile Organic Matter

WAVE Water Alliance for Voluntary Efficiency

WRAP Waste Reduction Awards Program

WRP Wetlands Reserve Program

WRI World Resources Institute
Introduction

2001 1

1. Introduction

In recent years, economic instruments have achieved a prominent place among the tools

used by governments to manage the environment. Once mainly an academic

proposition, or a revenue-raising adjunct to traditional regulatory mechanisms, marketbased economic incentives are now being used as the principal instrument of control on

a number of environmental issues. Nowhere is this fact more evident than in the 1990

Clean Air Act Amendments, which created many programs that are underpinned by

market-based mechanisms. The Clean Water Act Amendments of 1992, the Safe

Drinking Water Act, and a host of state and local initiatives also contain important new

incentive-based initiatives.

1.1 Purpose of the Report

This report expands upon and updates two earlier EPA surveys on the use of economic

instruments for managing the environment. A 1992 EPA report documented the

growing use of economic instruments to manage the environment in the United States

and also characterized the experiences of many other countries.1

 A 1997 report to EPA

reviewed many additional programs in the United States and in other nations.2 Since

these reports were issued, many new instruments have been implemented and existing

instruments have been subjected to evaluation by academics and government agencies.

Thus, an update is not only timely but also a good opportunity for offering new insights

and perspectives. This is not the first such update. Particularly noteworthy are survey

articles by Stavins and Hahn and recent research by the National Academy of Public

Administration.3

 While the basic conclusions of the earlier EPA reports are still valid,

the number of instruments that have been reviewed for their efficacy has grown

substantially. A number of subtle and not so subtle differences in perspective also may

be evident to the reader.

This report attempts to go well beyond simply enumerating existing market-based

mechanisms for managing the environment by examining key issues. How well have

these instruments performed? How economically efficient or cost-effective are these

mechanisms in achieving the goals of environmental management? What are their

effects upon the environment? Why are potential gains from economic instruments

seldom observed in practice, and what can be done to improve this record? What can be

learned in these cases that will assist in the formulation of new mechanisms?

1.2 Scope of the Report

For the purposes of this report, the term “economic incentives” will be defined broadly

as instruments that provide continuous inducements, financial or otherwise, to sources

of pollution, to reduce their releases of pollutants or make their products less polluting.

In essence, with incentives, sources view each unit of pollution as having a cost,

whereas under more traditional regulatory approaches pollution may be free or nearly

so once regulations have been satisfied.
The U. S. Experience with Economic Incentives for Protecting the Environment

2 January

To achieve maximum cost effectiveness, each source should control pollution to the point where

the last units of pollution cost the same amount to control at each source. To achieve efficiency,

the situation that maximizes the difference between benefits and costs, pollution should be

controlled until the per-unit costs of controlling pollution that are faced by each source are equal

to the incremental value of damage to health and the environment caused by that pollution. This

latter objective is much more difficult to achieve, so much so that it is of interest primarily as an

academic or theoretical exercise; it does not have great regulatory significance.

The definition of economic incentives used here excludes mechanisms that use explicit or

implicit price signals to control activities that have pollution as a by-product. While sometimes

known as “environmental incentives,” programs that provide ride sharing, bike paths, highoccupancy vehicle lanes, parking surcharges, and the like are beyond the scope of this report.

However, there is a brief discussion of congestion pricing that addresses a problem not unlike

(and quite likely linked directly to) pollution. While of interest because these mechanisms may

lead to a reduction in pollution, they provide neither an explicit nor an implicit price on units of

pollution. Excluding these mechanisms carries no particular implication regarding EPA's

perspective regarding their present or future applications.

Payments per unit of pollution are perhaps the clearest example of an incentive, as the term is

used in this report. Credits and allowances to reduce pollution also provide direct price signals.

As such, sources receive rights that can be sold and used by another source. Subsidies for

pollution control and deposit-refund systems also create continuous financial incentives. Finally,

indirect financial incentives are created through reporting requirements, liability rules, and

voluntary programs. All of these mechanisms provide financial incentives for sources to reduce

their emissions and to make their products more environmentally friendly.

The principal contrast between incentive mechanisms and traditional regulatory approaches is

that the latter do not provide incentives to reduce releases below permitted levels, or to make

their products less harmful to the environment once regulatory requirements are satisfied. Under

traditional regulatory approaches, sources are tempted to view releases within permitted amounts

as having no cost and products that release less pollution than allowed by requirements s as

having no incremental value. Sources operating within the limits of existing regulations have

little reason to act until new regulations are issued.

In fact, if firms reduce pollution below permitted amounts or produce products with superior

environmental performance, they may trigger actions by regulators to impose tougher

requirements based on a source’s past performance. Thus, under traditional forms of regulation

there may be perverse incentives not to innovate and not to improve the technology to control

pollution. Nonetheless, some incentives to exceed regulatory requirements do exist. Releasing

less than permitted amounts of pollution provides a margin of safety to sources in the event of

equipment malfunctioning; it often leads to fewer inspections; and it may trigger a tightening of

regulations that would adversely affect competitors. Vendors of equipment that controls

pollution also may have an incentive to design equipment and processes that exceed regulatory

requirements. If they design technologies that exceed these requirements, EPA might adopt

stricter pollution control requirements, thus creating a market for the vendors’ products.

Although this report attempts to make a careful distinction between traditional and market-based

approaches, these distinctions are often blurred in practice. A range of pollution control measures

does exist. They span the spectrum from such highly prescriptive traditional regulatory measures

as technology requirements to such purely market-oriented measures as deposit-refund systems
Introduction

2001 3

or pay-per-bag methods for municipal waste disposal. Between these extremes exists a broad

range of instruments, with no clear dividing line between traditional regulatory approaches and

methods based on economic incentives. Many approaches to environmental management

embody some features of incentive mechanisms along with a heavy dose of direct regulatory

action. Most of the best known examples of economic incentive approaches, such as the acid rain

trading program and the gasoline lead credit trading program, also have some features that are

found in traditional regulatory approaches such as enforcement for noncompliance.

While many incentive programs are reviewed herein, including all that could be identified at the

federal level, this report makes no pretense of being exhaustive. The literature on economic

incentives is immense. Many levels of government have adopted such programs or are

considering their use. Rather than being comprehensive, an attempt has been made to identify

those mechanisms that are most likely to have significance in the long term. In doing so, many

important initiatives have undoubtedly been omitted because of a lack of information or the need

to create limits on the scope of this report. For example, economic mechanisms for allocating

water are noted only briefly, despite the potential effect of this mechanism on the environment,

because pollution control is not the primary objective of water allocation. Likewise, the brief

discussion on highway pricing and congestion charges merely serves to introduce these

incentives, since the effects of these fees on the environmentalthough they may be potentially

significanthave yet to be documented.

1.3 Organization of the Report

This report is organized into eight additional chapters that are briefly summarized below.

Chapter 2 examines current and past U.S. government policies that incorporate incentive

mechanisms, with an emphasis on policies initiated by the Clinton administration.

Chapter 3 provides an overview of the various types of incentive mechanisms in terms of their

cost effectiveness and environmental effects, both in theory and in practice.

Chapter 4 discusses pollution-based fee, charge, and tax systems in place in the United States,

and fees imposed on the quantity and quality of emissions, or both, that are released into the

environment.

Chapter 5 considers deposit-refund systems to encourage recycling or the proper disposal of the

product.

Chapter 6 covers trading systems, including credits for pollution reductions that have been

achieved (open market programs) as well as emissions cap-and-trade (allowance) programs.

Chapter 7 discusses subsidy systems, including grants, low-interest loans, favorable tax

treatment, and preferential procurement policies for products believed to be environmentally

friendly. The chapter also considers the potential benefits that could be achieved by eliminating

subsidies that harm the environment. Chapter 8 addresses the use of liability as a mechanism for

compensating victims when sources release pollution that causes harm to human health and the

environment and also as a mechanism for encouraging sources to comply with existing

environmental regulations.

Chapter 9 discusses in some detail the potential effects that economic incentives may have on the

information reporting requirements of two laws. They are the Emergency Planning and
The U. S. Experience with Economic Incentives for Protecting the Environment

4 January

Community Right-To-Know Act (EPCRA), which established the Toxics Release Inventory

(TRI) reporting requirements, and California’s Safe Drinking Water and Toxic Enforcement Act,

commonly referred to as Proposition 65. Other forms of information reporting are also reviewed

in this chapter, including environmental impact assessment reporting, product labeling,

environmental performance awards, Securities and Exchange environmental reporting

requirements, and lead paint and radon disclosure requirements.

Chapter 10 looks at programs under which EPA and the states ask companies to voluntarily

participate in activities to reduce pollution and protect the environment.
Government Policy on Economic Incentives

2001 5

2. Government Policy on Economic Incentives

From the early days of the EPA, policy makers have recognized that economic

instruments held the potential to improve the cost effectiveness of environmental

management. The Nixon administration proposed to use emission fees to limit sulfur

dioxide, however this initiative failed in Congress. Gradually, as allowed by its

governing statutes, EPA began to experiment with the use of economic incentives,

introducing emissions trading in the early 1980s. The Clean Air Act Amendments of

1990, a product of the Bush administration, greatly increased the use of economic

incentives in environmental management. The Clinton administration has continued

strong support for the use of economic incentives in environmental management. This

chapter highlights some of the key reports, executive orders, environmental

management innovations, and legislation that demonstrate the growing commitment to

expanding the use of innovative, cost-effective approaches to environmental

management.

2.1 Reports and Strategies

2.1.1 Project 88 Report

Sponsored by Senators Heinz and Wirth, a group of public policy scholars prepared the

Project 88 Report in 1988.4

 It identified 36 proposals for “innovative solutions to major

environmental and natural resource problems.” Among the economic incentives

included in these proposals were

• a national market for CO2 offsets;

• internationally marketable permits for greenhouse gases;

• marketable permits for potential ozone-depleting substances, SO2, NOx, and

point and non-point sources of water pollution;

• a deposit-refund system for hazardous wastes that can be placed in containers;

• taxes on fuel-inefficient vehicles with rebates for fuel-efficient vehicles;

• taxes on certain pesticides; and

• air emissions charges for mobile sources.

Round II of the Project 88 Report evaluates in detail implementation issues regarding

three areas where incentives might be applied: global climate change, solid and

hazardous waste management, and natural resource management. Many of the

initiatives proposed in the Project 88 Report subsequently were enacted: solid waste

management unit pricing, the Gas-Guzzler tax on fuel-inefficient vehicles, and

marketable permits for SO2, NOx, and water effluents. The proposal for an international

market in greenhouse gases that was contained within the Kyoto Protocol also flows

directly from this report.
The U. S. Experience with Economic Incentives for Protecting the Environment

6 January

2.1.2 Report of the EPA Economic Incentives Task Force

The 1991 report by the EPA Economic Incentives Task Force, entitled Economic Incentives:

Options for Environmental Protection studied existing and potential incentive mechanisms for

the purpose of stimulating discussion on the role of such mechanisms in environmental policy.5

The report focused on four areas where incentives might be applied: municipal solid waste

management, global climate change, water resource management, and multi-media concerns. In

the preface to the report, the EPA Administrator stated, “To maintain progress toward our

environmental goals, we must move beyond a prescriptive approach by adding innovative policy

instruments such as economic incentives. Properly employed, economic incentives can be a

powerful force for environmental improvement.”

2.1.3 President’s Council on Sustainable Development

Created in May 1993, the Council on Sustainable Development includes of representatives from

the Cabinet, industry, and environmental groups. The Council has the task of developing a

strategy to achieve long-term economic growth without harming natural resources.

In its March 1996 final report, the Council recommended the use of performance targets in lieu

of technology standards, commending Project XL for allowing companies to develop innovative

methods to control pollution. It also recommended the adoption of incentives and the elimination

of disincentives for environmental protection in a number of areas, as well as more cooperation

between industry and government in controlling pollution. One example of cooperation that was

endorsed by the report was the Common Sense Initiative, under which industry and

environmental groups worked with EPA to study ways to improve environmental regulations

affecting six specified industries.

2.1.4 Economic Report of the President

Under the terms of the Employment Act of 1946, the President’s Council of Economic Advisors

prepares an Economic Report of the President every year. Among the topics discussed in the

1996 report was regulatory reform and its application to environmental policy.

The report offers several ideas for “reinventing regulation,” which it defines as “taking a new

look at regulation and the regulatory process to ensure that regulations meet legitimate social

needs, and where necessary changing both content and process to improve efficiency and

effectiveness.” Efforts to reinvent regulations take several forms, including the “better targeting

of regulatory efforts to where the need is greatest,” “a shift in emphasis from prescribing

methods of compliance to specifying desired outcomes,” and “harnessing economic incentives

through market-based regulatory mechanisms.”

A significant portion of the report is devoted to reinventing regulation of the environment and

natural resources. “The Administration is improving the way we protect the environment,” states

the report, “making government a partner rather than an overseer.” The report cites “cooperation

with States and localities, partnerships with the private sector that engender creative solutions as

well as set standards, and careful assessment of the advantages and disadvantages of alternative

government action” as a means by which “environmental protection can be achieved at an

affordable cost.”

Stating that environmental rules should impose the least possible burden and that their benefits

should justify their costs, the report discusses a number of incentive approaches that have been or
Government Policy on Economic Incentives

2001 7

could be used to protect natural resources. The section entitled “Creating Cost-Effective Policies:

Economic Incentives for Environmental Protection” includes liability for environmental

damages, fees and charges, trading systems, conservation easements, and the provision of

information. Trading systems for water pollution, air pollution, and fishing quotas are discussed

at length. On the subject of water pollution, the report contains Administration estimates that

several hundred million dollars to several billion dollars a year could be saved if effluent trading

programs were expanded.

2.2 Executive Orders and Initiatives

2.2.1 Executive Order 12291

President Reagan’s E.O. 12291 of February 17, 1981, required a Regulatory Impact Analysis

(RIA) for proposed “major rules.” The definition of “major rule” was similar to that of

“significant regulatory action” in E.O. 12866, which replaced E.O. 12291. E.O. 12291 required

that no regulatory action be taken “unless the potential benefits to society for the regulation

outweigh the potential costs to society.” Each RIA was required to contain a “description of

alternative approaches that could substantially achieve the same regulatory goal at lower cost,

together with an analysis of this potential benefit and costs and a brief explanation of the legal

reasons why such alternatives, if proposed, could not be adopted.”

After E.O. 12291 was adopted, EPA developed guidelines for conducting RIAs, according to

which “each RIA should calculate the benefits and costs of a proposed regulation’s full range of

effects and should compare them with those of other regulatory and non-regulatory approaches.”

In the section entitled “Considering Alternative Approaches,” the guidelines called for the

consideration of “market-oriented regulatory alternatives (whether or not they are explicitly

authorized in the Agency’s legislative mandate).” Such alternatives “include using information

or labeling to enable consumers or workers to evaluate hazards themselves and using economic

incentives, such as fees or charges, marketable permits or offsets, changes in insurance

provisions, or changes in property rights.” EPA was required to submit all RIAs and proposed

regulations to OMB for review. EPA’s RIA guidelines were intended to increase the use of

incentive mechanisms in environmental regulation.

E.O. 12291 built on a number of earlier Executive Orders and regulations dating back to

President Nixon’s “Quality of Life” reviews that required an assessment of alternatives and cost

comparisons for proposed regulations. President Ford’s E.O. 11821 of 1974 and E.O. 11949 of

1976 required inflation impact statements for major regulations. President Carter’s E.O. 12044 of

1978 required Regulatory Analyses of the economic consequences of proposed regulations and

alternatives under consideration, and the Executive Order instructed agencies to select the least

burdensome alternative.

2.2.2 Executive Order 12866

A central idea of President Clinton’s Executive Order (E.O.) 12866 of September 30, 1993 is that

regulations should be adopted only after a reasoned determination concludes that quantified and

nonquantified benefits justify the costs of the regulation. Further, E.O. 12866 states that, “in

choosing among alternative regulatory approaches, agencies should select those approaches that

maximize net benefits (including potential economic, environmental, public health and safety,

and other advantages; distributive impacts; and equity), unless a statute requires another
The U. S. Experience with Economic Incentives for Protecting the Environment

8 January

regulatory approach.” This order replaced President Reagan’s E.O. 12291. Under E.O. 12866,

agencies are required to assess the benefits and costs of any “significant regulatory action.”

Actions deemed “significant” include those that “have an annual effect on the economy of $100

million or more or adversely affect in a material way the economy, a sector of the economy,

productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal

governments, or communities” or that meet certain other criteria.

E.O. 12866 also requires that agencies consider the possibility of using incentive-based

approaches for any significant regulatory action. Two specific “Principles of Regulation” in E.O.

12866 refer to incentive-based approaches:

1b3: “Each agency shall identify and assess available alternatives to direct regulation,

including providing economic incentives to encourage the desired behavior, such as user

fees or marketable permits, or providing information upon which choices can be made by

the public.”

1b8: “Each agency shall identify and assess alternative forms of regulation and shall, to

the extent feasible, specify performance objectives, rather than specifying the behavior or

manner of compliance that regulated entities must adopt.”

In January 1996, an interagency group convened by the Office of Management and Budget

(OMB) issued a document entitled Economic Analysis of Federal Regulations that provided

guidelines for performing economic analysis of proposed federal regulations under E.O. 12866.6

Among the topics discussed in these guidelines were the importance of performance-based

standards, alternative compliance methods, information approaches, and economic incentives.

On the first of these topics, the guidelines state, “Performance standards are generally to be

preferred to engineering or design standards because performance standards provide the

regulated parties the flexibility to achieve the regulatory objective in a more cost-effective way.”

“Performance standards,” the guidelines continue, “should be applied with a scope appropriate to

the problem the regulation seeks to address. For example, to create the greatest opportunities for

the regulated parties to achieve cost savings while meeting the regulatory objective, compliance

with air emission standards can be allowed on a plant-wide, firm-wide, or region-wide basis

rather than vent by vent, provided this does not produce unacceptable air quality outcomes (such

as ‘hot spots’ from local pollution concentration).”

On the subject of ensuring compliance, the guidelines state, “When alternative monitoring and

reporting methods vary in their costs and benefits, promising alternatives should be considered in

identifying the regulatory alternative that maximizes net benefits.”

The guidelines mention various “informational measures,” including “government establishment

of a standardized testing and rating system (the use of which could be made mandatory or left

voluntary), mandatory disclosure requirements (e.g., by advertising, labeling, or enclosures), and

government provision of information (e.g., by government publications, telephone hotlines, or

public interest broadcast announcements).”

The guidelines also call for consideration of economic incentives: “In general, alternatives that

provide for more market-oriented approaches, with the use of economic incentives replacing

traditional regulatory requirements, are more cost effective and should be explored.” Incentives

“that may be considered include fees, subsidies, penalties, marketable permits or offsets, changes
Government Policy on Economic Incentives

2001 9

in liabilities or property rights (including policies that alter the incentive of insurers and insured

parties), and required bonds, insurance or warranties.”

In March 2000, OMB issued new Guidelines to Standardize Measures of Costs and Benefits and

the Format of Accounting Statements.7

 OMB explains the relationship between this document

and the Best Practices Manual as follows:

These Guidelines draw from the “Best Practices” document developed in 1994

and 1995 by an interagency group co-chaired by the Department of

Transportation and the Council of Economic Advisers. That “Best Practices”

document in turn revised the “Regulatory Impact Analysis Guidance” published

by OMB in 1990 after a two-year notice and comment period. You should use this

document in estimating and presenting the benefits and costs of regulations.

While it does not represent OMB guidance, you may use the “Best Practices” (Q:

shouldn’t the document title here be surrounded with quotes as shown in other

instances in this paragraph?) document as supplementary material to illustrate

further specific issues or techniques. (page 2)

2.2.3 Climate Change Initiative

The Climate Change Action Plan relies largely on voluntary incentives to achieve reductions in

greenhouse gas emissions. Among its initiatives are Green Lights and Energy Star, Climate

Wise, and at least four voluntary programs to promote methane recovery (Natural Gas Star,

AgStar, Coalbed Methane Outreach, and Landfill Methane Outreach). Several of these programs

are described in more detail in Chapter 10.

The more recent Climate Change Technology Initiative (CCTI) supplements these purely

voluntary programs with targeted subsidies to improve technologies, so fewer greenhouse gases

are produced. Shortly after the Kyoto agreement to reduce greenhouse gas emissions of

December 1997, the Clinton administration proposed the CCTI and asked for congressional

approval of $3.6 billion in tax credits as incentives and $2.7 billion for research and

development.8

 Congress authorized $1.021 billion in R&D and $85 million in tax credits for FY

1999 and $1.095 in R&D for FY 2000. The 2001 budget proposed spending over $1.4 billion for

R&D in FY 2001 and $4 billion in tax credits for the CCTI over the next five years.

2.2.4 Greening the Government

Executive Order 13148, issued by President Clinton on April 22, 2000, instructs the head of each

federal agency to ensure that actions are taken to integrate environmental accountability into

routine agency decision making and long-term planning. Many of the directives of the order

could be classified as economic incentives because they help to provide information, take full

costs into account in decision making, and reduce the use of toxic chemicals where costeffective. Among other things, the order calls for federal agencies to develop and implement

environmental management systems and to ensure compliance with environmental regulations by

implementing audit programs and policies on environmental compliance that emphasize

pollution prevention. The order also directs agency heads to keep the communities in which

federal facilities are located informed as to possible sources of pollution, to make efforts to

reduce the use of toxic chemicals by 10% per year, to engage in pollution prevention efforts, and

to conduct life cycle cost analysis. The order is the latest of several issued by the Administration
The U. S. Experience with Economic Incentives for Protecting the Environment

10 January

on “greening the government,” including E.O. 13101 of September 14, 1998, E.O. 13123 of June

3, 1999, and E.O. 13134 of August 12, 1999.

2.2.5 National Performance Review

Vice President Gore’s National Performance Review released a report in 1993 entitled Creating

a Government That Works Better & Costs Less.

9

 Focused on reinventing government, the report

included a number of recommendations for improving environmental protection, some of which

advocated the use of economic incentives. The document’s authors suggested that EPA work

with Congress to encourage the use of incentives to reduce water pollution, including wastewater

discharge fees. It also recommended that the conditions for accessing federal resources for

activities such as grazing and mining be modified. The purpose of this suggestion was twofold:

first, to ensure that the government obtains a fair return on its land, and, second, to provide

incentives for improving federal land management.

2.2.6 Reinventing Environmental Regulations

On March 16, 1995, the President announced the first government-wide regulatory reforms

designed to improve environmental regulation, so the nation achieves a better environment at

lower cost. The President emphasized economic incentives in these reforms. For example, the

document entitled Reinventing Environmental Regulation provides 10 principles for reinventing

environmental protection. One of these principles is that environmental regulations must be

“performance based” and must allow flexibility while requiring accountability in attaining goals.

Another principle is that “market incentives should be used to achieve environmental goals,

whenever appropriate.” The document also includes “25 High Priority Actions,” a section in

which open-market air emissions, effluent trading in watersheds, and other topics are

discussed.10 (Subsequent initiatives by EPA to implement these recommendations are described

in Chapter 6.)

In addition, the document describes actions that can improve compliance, accountability, and

enforcement. EPA now coordinates these activities through its Environmental Leadership

Program, a voluntary program that focuses on the role of compliance management systems in

enforcement. It also provides incentives for auditing, disclosure, and correction. (This program is

described in Chapter 10.) The document characterizes Project XL (another voluntary program

discussed in Chapter 10) as one of the “Building Blocks for a New System” of environmental

regulation.

2.2.7 National Environmental Technology Strategy

On March 18, 1995, the Vice President announced a National Environmental Technology

Strategy to “create high-wage jobs and exports and stimulate overall economic growth; reduce

the cost of cleaning up past pollution; and help prevent future damage to the environment.” The

strategies advocated the use of economic instruments to promote innovations in pollution control

technologies that enhance the effectiveness of pollution control efforts or reduce cost, or both.
Government Policy on Economic Incentives

2001 11

2.3 Recent Environmental Management Initiatives

2.3.1 Performance Track Approach at EPA

How to obtain more environmental protection more efficiently is the focus of recent EPA

innovations in environmental management.11 Noteworthy among the new innovative approaches

are rewards for superior environmental performance. The current system of environmental

regulation offers little incentive for firms to go beyond compliance. EPA now views this

approach as a missed opportunity to encourage top environmental performers. Through a new

“Performance Track” approach, firms would receive a standard package of incentives such as

public recognition for meeting environmental criteria. Firms that routinely do much more than

meet established requirements would be placed on a smaller second track and receive a higher

level of recognition and incentives more closely tailored to their individual needs. EPA views

this two-tiered reward structure as a significant step toward a more performance-based system

that stimulates superior environmental achievement.

2.3.2 EPA Air and Water Policy Initiatives

Among the many initiatives within EPA that concern economic instruments, one on air quality

and one on water quality are particularly noteworthy. Beginning in the late 1970s, EPA explored

the ways in which flexibility could be integrated into air quality regulation, so cost effectiveness

would be enhanced. These activities, which are described in Chapter 6, culminated in the

Emission Trading Policy Statement and laid the groundwork for the broader use of economic

incentive approaches in the Clean Air Act Amendments of 1990. Since then, EPA has provided

trading opportunities in many air programs and rules to combat a variety of air pollution

problems. In addition, the EPA Office of Water has actively promoted effluent trading as a

means of improving the cost effectiveness of attaining its goals on water quality.

2.3.3 EPA Research Activities

Through the years, the Office of Research and Development (ORD), the EPA policy office, and

several program offices have supported research on economic incentives for environmental

management. Much of that research is available on the Economy and Environment home page at

www.epa.gov/economics. At present, ORD is supporting a program in Market Mechanisms and

Incentives Research.12

2.3.4 Promotion of Economic Instruments Abroad

On April 9, 1999, Vice President Gore and Premier Zhu Rongji announced a cooperative

agreement designed to increase markets for U.S. environmental technology in China. The

agreement will increase opportunities for U.S. investment in the Chinese energy-producing

sector and promote the reduction of greenhouse gas emissions in China through a program to

trade sulfur dioxide (SO2) emissions. “In an agreement that will move China closer to a system

of emissions trading, the EPA and China’s State Environmental Protection Administration signed

a Statement of Intent on development of a Sulfur Dioxide Emissions Trading Feasibility Study.

The agreement calls for developing a study to test the effectiveness of emissions trading in China

as a market-based approach to reducing greenhouse gas emissions.”13
The U. S. Experience with Economic Incentives for Protecting the Environment

12 January

2.4 Legislation: Clean Air Act Amendments of 1990

While other environmental legislation also creates programs based on economic incentives, the

Clean Air Act Amendments of 1990, enacted during the Bush administration, are particularly

noteworthy. With the passage of these amendments, the legislative branch of government

showed strong support for economic incentives and expanded the regulatory toolbox beyond

traditional regulatory requirements, which had dominated air pollution control policy in previous

years. Among the incentive mechanisms authorized in these amendments are the Acid Rain

Trading Program, provisions for offsets and other trading programs in ozone non-attainment

areas, early reduction credits for hazardous pollutants, fees based on pollutant emissions, the

possibility of marketable credits for certain fuel constituents, marketable production allowances

for ozone-depleting substances, and labeling of ozone-depleting substances.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 13

3. The Cost Effectiveness and Environmental Effects of

Incentive Systems

3.1 Introduction

This chapter reviews several of the attributes of incentive-based strategies for managing

the environment. From the perspective of economics, pollution is an output that occurs

outside of normal market transactions. Termed an “externality,” it has little or no cost to

the source but may impose significant costs on other economic actors. How best to get

sources to control their pollution is an issue that has been studied closely by economists

and policy analysts.

One means of control is to rely on private negotiations between those who bear the costs

of pollution and the sources of pollution. If several conditions are satisfied, such

negotiations can lead to an optimal level of pollution control in which the full costs of

pollution are taken into account in the decision process of the source.14 One condition is

that the sources and victims do not engage in strategic behavior. Another condition is

that individuals who are harmed by pollution and sources can negotiate without any

transaction costs (such as personal time or the need for third-party involvement). The

final condition is that sources and victims are fully informed as to risks and harms that

may occur. Although the assumption of no strategic behavior may be reasonable in many

cases, costless transactions may never be a realistic assumption. The more parties who

are harmed and the more geographically dispersed these parties are, the higher the

transaction costs are likely to be. Likewise, it is unrealistic to assume that victims of

pollution are as fully informed about risks as are the sources.

The existence of environmental legislation reflects the fact that negotiations between

victims and sources of pollution cannot be relied upon as a means of control for most

pollution problems. EPA’s governing legislation uses various approaches to set

environmental goals. Under some of the laws, the goal is to adequately protect public

health and the environment without explicitly considering costs. In other cases, the

governing statutes instruct EPA to take costs into account in protecting public health and

the environment or to set goals that balance cost, health and environmental

considerations.

The governing environmental statutes have varying opportunities and limitations with

respect to the mechanisms that are available for achieving environmental goals. In the

traditional regulatory approach, EPA often specifies requirements for different types of

sources (factories, vehicles, fuels, etc). The regulations may impose limitations on the

amount of discharge, the technology used to control pollution, the inputs that may be

used, or characteristics of the outputs that are produced.

Market-based or incentive approaches, by contrast, provide rewards for reducing

pollution (and, conversely, assign penalties for releasing pollution). The rewards may or

may not be financial. In contrast to the traditional regulatory approach, an incentivebased regulatory strategy gives sources great flexibility in selecting both the type and
The U. S. Experience with Economic Incentives for Protecting the Environment

14 January

magnitude of their response and gives them incentives to develop new and cheaper strategies and

technologies to control pollution.

Depending upon the characteristics of the sources of pollution and the damages (see Table 3-1),

some tools of environmental management are likely to be more cost-effective than are others.

Cost-effective tools achieve environmental goals for the least cost. Other criteria such as

fairness, political acceptability, stimulus for innovation and technological improvement, and

enforceability also could be used in place of, or in conjunction with, cost effectiveness.

Table 3-1. Considerations for Selecting Regulatory Instruments

CHARACTERISTICS OF THE SOURCES OF POLLUTION

• Are the costs of control known with certainty? If not, how great is the uncertainty?

• Is the technology of pollution control static, or is it likely to change over time?

• Can the quantity of pollution from each source be measured (or approximated) easily?

• How many sources are there for each pollutant?

• Are incremental control costs similar for different sources, or is there considerable variation?

CHARACTERISTICS OF THE DAMAGE CAUSED BY POLLUTION

• Does a unit of pollution from each source have the same impact on health and the environment, regardless of where it is

released?

• Are the impacts on health and the environment known with certainty? If not, how great is the uncertainty?

• What are the major sources of uncertainty? What is known regarding the effect of pollution on environmental quality,

exposures, physical effects, or the economic valuation of effects?

• How many parties are experiencing damage from pollution?

• Is it critical to control pollution within narrow limits to achieve environmental goals, or is the damage caused by pollution

such that there is a continuum of effects from less serious to more serious, with no obvious unacceptable level and no

obvious safe level of pollution?

The following sections describe alternative means for managing the environment and the

circumstances under which one mechanism is likely to perform better than another tool.

3.2 Traditional Regulatory Approaches

Traditional regulatory approaches normally operate through one of three means: source-specific

emission limits, output specifications, or technology requirements. A brief description of each

alternative illustrates both the strengths and weaknesses of traditional forms of regulation.

The first alternative applies emission (or effluent) limits to specific sources as a means of

achieving health standards or environment-based ambient standards. The total amount of

pollutants that are released could be limited by setting emissions standards for individual

sources, such that total emissions just equaled the sum of the individual contributions from each

source. Other pollution allocation formulas that do not treat new sources more harshly than

existing sources could also be used. One such formula, for example, determines a set weight of

pollution that can be released per unit of output.

Unless the authority responsible for controlling pollution is able to identify which sources have

the lowest incremental costs for controlling pollution and insist that those sources implement

their pollution controls first, this source-specific approach to emissions will not be cost-effective.

As Figure 3-1 depicts, each source will usually have a number of options for controlling
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 15

emissions. The least cost option (#1 in the figure) will control some emissions. Other

successively more expensive measures may be implemented until all emissions are controlled.

It is very difficult in practice to

identify the least cost strategy for

controlling emissions from multiple

sources. If all control measures and

their costs are known, linear

programming or other modeling

techniques could be used to find the

least cost strategy for every level of

emission control for the sources

taken as a whole. However, in most

cases all potentially available

control measures are not known,

and, even if they were, pollution

control laws typically do not allow

an agency to impose strict controls

at one source and relatively lenient

control burdens on another, even if

their control costs are quite

different. Generally, similar sources

must be treated the same. Furthermore, incremental control costs include more than simply the

costs that sources must bear in order to comply with regulations, as noted earlier. It is likely to be

difficult to predict in advance how emission limits would affect production technology, energy

and other input use, and other cost elements. Economic instruments avoid the problems that a

pollution control agency would have in identifying the least cost methods of meeting a pollution

control objective by harnessing market forces to identify cost-effective solutions.

The second alternative specifies certain characteristics of outputs that are destined for the

product market. Some examples include fuel efficiency requirements for automobiles, product

specifications for gasoline, and regulations regarding the ability of products to be recycled and

the recycled material content of consumer products. The regulatory strategy of imposing

limitations on the polluting characteristics of products is affected by the same issues noted above

that make it difficult to regulate emissions in a cost-effective manner. For example, the cost to

individual refineries of meeting a sulfur limit in gasoline is likely to vary significantly. It would

be more efficient to allow trading among sources to meet pollution reduction obligations than to

apply uniform standards to each source.

The third alternative imposes technology requirements that specify the techniques or equipment

that sources must use to control pollution. EPA prefers to use performance-based numerical

limits rather than technology requirements whenever feasible, and, in fact, the Agency’s

programs rely heavily on numerical limits. Some standards that are performance-based demand a

level of emission control that can be met only with one existing technology. Unless pollution

control technologies improve, such performance standards have the same effect as technology

standards. (For example, new source performance standards for SO2 emissions at coal-fired

electric power plants require a 90% reduction in these emissions from their uncontrolled state, a

degree of control that can be met only by scrubbing.)

Figure 3-1. Control Options for a Source
The U. S. Experience with Economic Incentives for Protecting the Environment

16 January

Technology standards (or more accurately de facto technology standards) are likely to be less

cost-effective than emission or effluent standards, since the latter give sources the freedom to

choose the least costly method of compliance. Further, technology standards tend to lock firms

into one accepted method of compliance, which discourages technical change and innovation.

However, when emissions cannot be measured or concerns exist about the feasibility of

enforcing tax or trading systems or both, technology standards provide a practical way to reduce

pollution.

From a dynamic perspective, identifying the strategies that should be implemented to control

pollution at the least cost is more problematic. Technology is not static. Over time, the number of

possible options increases. Most of the options offer improvements over earlier technologies, in

terms of cost, environmental performance or both. A traditional regulatory strategy to identify

and mandate least cost controls can lock firms into technologies that become progressively less

effective, and thus less attractive, over time.

These issues aside, traditional regulatory policies have achieved much in the United States. For

the most part, traditional regulatory policies have resulted in ambient air and water quality that is

demonstrably better now than it was 30 years ago when the EPA was established. The most

recent Emissions Trends Report (EPA, 1998b) reveals that emissions of all criteria pollutants

have declined since 1979: In the case of sulfur dioxide and carbon monoxide, emissions have

been reduced by more than 50% and lead emissions by more than 95%. (See Figure 3-2.) Water

quality is also improving. This achievement is significant given the economic growth and

increasing populations that has occurred over the same period of time.

3.3 Incentive-Based Mechanisms

While incentive-based systems have existed in some form for decades as tools of environmental

management, the federal government has aggressively sought their implementation for only the

past 10 to 15 years. Economic incentives to protect the environment rely on decentralized

Figure 3-2. National Long-Term Air Quality Trends, 1979-1998

0

20

40

60

80

100

120

19791980198119821983198419851986198719881989199019911992199319941995199619971998

Year

Index (1979=100)

CO Pb NO2 Ozone SO2

Source: EPA 1998b
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 17

decision making by economic agents, all acting in their own self interest. In contrast, traditional

regulatory approaches to environmental management are based on the regulations established by

federal, state, or tribal governments that have been given the authority to make pollution control

decisions. Actual compliance is the responsibility of the sources of pollution that are subject to

the regulations. However, the flexibility that sources have to choose technology, as well as the

extent of pollution control, tends to be quite limited under a traditional regulatory approach.

Economic incentive methods generally allow sources to select how much they reduce pollution

and the technology that helps them in this endeavor.

3.3.1 Pollution Charges, Fees, and Taxes

Pollution charges, fees, and taxes are payments required of sources for emitting pollution. (The

three terms are used interchangeably here.) Ideally, sources would pay for each unit of pollution

they emit. A source that is concerned with minimizing costs and is also faced with such a tax will

control those emissions for which control costs are less than the tax and release the remainder.

The source will then pay the tax on each of those units of pollution released into the

environment.

A simplified analysis of charges, fees, and taxes from an economic perspective is illustrated in

Figure 3-3. Prior to regulation, total uncontrolled emissions are equal in magnitude to E0.

Damage to the environment is equal to the area (c+d+e) and the source spends nothing on

pollution control. If an emission fee of magnitude C1 were imposed, cost-minimizing polluters

would reduce total emissions to E1. The total costs of pollution, which is equal to the sum of

pollution control costs and environmental damage (c+d), are minimized with the fee at level C1

Emission fees set at C1 per unit of emissions cause cost-minimizing polluters to pay for all

emissions up to E1, an amount equal to the area (b+c) in Figure 3-3. Polluters subject to the fee

spend an amount equal to area (d) to control emissions beyond E1 and reduce environmental

damage by an amount equal to the area (d+e) relative to uncontrolled emissions.

Emission fees that are high enough to change behavior significantly, like the one shown in this

example, would typically result in large revenue transfers to the government. That is, payments

the government, equal to area (b+c) in Figure 3-3, tend to be large, especially relative to the

environmental damage that is mitigated, area

(d). For this reason, polluters usually oppose

pollution charges, taxes, and fees that would

be high enough to act as an incentive for

them to reduce pollution. They would prefer

that their environmental expenditures be used

to control pollution, not sent to the

government.

From an economic perspective, charges,

taxes and fees are basically interchangeable,

although from a legislative and legal

perspective some differences exist. The

House Ways and Means Committee must

review proposed taxes, since tax revenues are

a part of general federal revenues. Fees and

Figure 3-3. Tax Per Unit of Emissions

Marginal

Control

Cost

Marginal

Damage $

E 1 E 0

e

c d

b

a

Emissions

C1
The U. S. Experience with Economic Incentives for Protecting the Environment

18 January

charges, in contrast, are designed to recover some or all of EPA's administrative costs and need

only be reviewed by environment committees and subcommittees. Fees and charges are imposed

in two ways. First, an environmental statute may specify the activities that are subject to fees and

charges. Second, EPA has additional general authority to collect and assess fees and charges

under the Independent Offices Appropriations Act (31 U.S.C. §9701). Fees and charges assessed

and collected under this Act must be deposited into the General Fund of the Treasury and cannot

be retained by EPA.

Legislation authorizing pollution fees, taxes, and charges typically limits their magnitude to what

is necessary to recover the costs of administering the program in question or related programs.

Worldwide, the vast majority of emission tax, fee, and charge systems collect revenues that

amount to only a few percent of pollution control costs.

Two exceptions are noted. The first is the tax on U.S. chlorofluorocarbon (CFC) production. This

tax was designed to remove windfall profits that would otherwise accrue to CFC producers from

increases in CFC prices due to reductions in the quantities of CFCs allowed in commerce. This

tax is discussed in more detail later in this report. The second exception is the Swedish charge on

NOx emissions, which is set at a high level with the objective of changing behavior. Power plants

pay the NOx charge on emissions of NOx and receive rebates in proportion to their energy output.

The result is a mechanism that raises no revenue for the government yet produces significant

incentives.15 Relatively clean facilities receive rebates in excess of payments while relatively

dirty facilities pay more in charges than they receive in rebates.

Designing pollution taxes that minimize the total costs of pollution (damage costs plus control

costs) is difficult for a variety of reasons, including the lack of data on pollution damages, the

inability to precisely measure emissions, and political opposition to large revenue transfers from

pollution sources (companies) to the authority imposing the tax (government). The relationship

between the quantity of emissions and the cost of the damages caused by those emissions (often

called the “pollution damage function”) depicted in Figure 3-3 is highly simplified and glosses

over a number of difficult measurement issues. In many situations, the function is not well

known, so the ability of an agency to set charges to equate marginal control costs with marginal

damages is questionable. Moreover, the damage function may differ from one localized area to

another depending upon the population at risk, prevailing winds, sunshine, temperature, and

other factors. If marginal control costs or marginal damages differ from one region to another, a

single charge level may be inappropriate. Charges that differ by region may be required in order

to achieve the efficient amount of pollution control. In addition, an emission tax provides the

pollution control agency with limited control over the physical quantity of emissions dispersed

into the environment because sources have the choice of controlling emissions or releasing

emissions and paying the tax. If the magnitude of emissions is very important, as could be the

case with toxic emissions that threaten public health, an emission tax may be viewed as an

inadequate control over the actual quantity of emissions.

The implementation of emission fees, taxes, and charges also depends on the ability to measure

emissions. The precision with which a pollution tax can be levied depends on the precision with

which emissions can be measured. Political concerns may also be an issue in implementing

emission taxes. Environmentalists sometimes oppose emissions fees because they seem to

sanction the release of pollution.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 19

3.3.2 Deposit-Refund Systems

A deposit-refund system operates like a tax on the purchase of a product with a subsidy for

returning the used item to a designated collection site. The purpose of the subsidy or refund is to

encourage individuals and firms to dispose of these items in an environmentally acceptable

manner. The tax or deposit is made on the original purchase and yields sufficient revenue to pay

future refunds. Some or all of the unclaimed deposits may be used to subsidize collection

facilities. While the magnitudes of the deposit and the refund often are the same, there is no

reason that this has to be the case.

Although most deposit-refund systems are created by legislation, deposit-refund systems

sometimes are developed by the private sector when the used product has economic value. Thus,

private-sector deposit-refund systems for beverage containers were widespread in the early part

of the twentieth century before cheaper, non-returnable containers appeared. Mandatory deposit

legislation for lead-acid automotive batteries has been enacted in about a dozen states, while the

private sector has created deposit systems for lead-acid batteries in the remainder of the states,

largely because of the economic value of used batteries. Ten states have enacted beverage

container deposit-refund systems. Deposit systems exist for car bodies in four European nations,

and for a wide variety of containers throughout most European nations. In a few nations of

Europe, deposit systems help assure the recycling of used motor oil.

Administrative costs are an important consideration when determining whether to create deposit

systems. Ackerman et al. (1995) estimate that administrative costs average about 2.3 cents per

containermore than $300 per ton for steel containers and $1,300 per ton for aluminum

cansin states with traditional legislation on beverage container deposit systems. A full

accounting of the desirability of deposit-refund systems would compare administrative costs and

the costs imposed on consumers with the benefits of reduced disposal costs, energy savings,

reduced litter, and other environmental benefits. Deposit-refund systems appear best suited for

products whose disposal is difficult to monitor and potentially harmful to the environment. When

the used product has economic value, the private sector may initiate the program.

3.3.3 Marketable Permit Systems

Two main forms of trading systems are observed: emission (or effluent) reduction credits

(ERCs), and tradable allowances for future pollution. ERCs are earned by sources when they

release less pollution than is authorized in their environmental permits. With either form of

trading system, sources with high marginal control costs will try to buy credits or allowances

from sources with low marginal control costs. Trading ERCs or allowances in such a situation is

mutually beneficial.

For trading systems to function well, several requirements must be satisfied. First, there should

be several potential participants (i.e., sellers and buyers of allowances or ERCs) so that a

functioning market can develop. Exactly how small a universe of potential participants is

sufficient for a functioning market is difficult to say, but simulation experiments suggest that 8 to

10 participants is a reasonable estimate.16 Second, if sources are dispersed geographically,

trading ratios other than one-to-one might have to be imposed to assure no degradation in

environmental quality in particular locations.

Third, pollution control agencies must have the ability to monitor emissions (or measure a

surrogate) reasonably well. The commodity to be traded needs to have constant or near-constant
The U. S. Experience with Economic Incentives for Protecting the Environment

20 January

impacts across the geographic area where trading is allowed. Fourth, the commodity to be traded

must be quantifiable. The process of establishing emission baselines so that credits or allowances

can be quantified is likely to require good historic data on emissions, input use, processes, etc.

Trading systems tend to be more popular with pollution sources than pollution charges because

in many cases sources do not have to pay for emissions that are below permitted amounts. In

fact, the right to emit pollutants up to permitted amounts and not pay for those emissions may

have a considerable value once a trading

system is created.

The literature that is cited later in this

chapter predicts large, potential savings

from trading systems. Available evidence

on actual achievements, however, points to

relatively modest savings from many of the

programs. In searching for the reasons why

such a wide gap exists between the potential

savings and the actual savings, Stavins

(2000) identifies transaction costs as the

primary culprit. For example, the need to

ensure that the credits claimed under the

trading system represent real emissions

reductions is one source of transaction

costs.

With high transaction costs, the prices that

sellers receive for pollution rights is

depressed and the prices that buyers must

pay for these rights remains high, which

makes transactions less attractive for both

buyers and sellers. With transaction costs acting as a barrier to trading, sources find it difficult to

identify potential trading partners and to conclude trades. Transaction costs were especially high

for some of the early emissions and effluent trading programs. Only a tiny fraction of the

potentially beneficial trades actually took place.17 Transaction costs were lower for programs

such as lead credit trading and resulted in a far higher proportion of available credits actually

being traded.

Transaction costs also feature prominently in the choice between making trades between sources

within a firm (internal trades) and between firms (external trades). For all of the trading

programs that have been studied, firms exhibit a strong preference for internal trading when it is

feasible, often even when larger cost savings can be achieved by external trading.18

3.3.4 Subsidies for Reducing Pollution or Improving the Environment

Subsidies are the mirror image of emission taxes. Rather than taxing emissions to encourage

firms to reduce their emissions, the subsidy approach offers cash payments to firms for reducing

emissions. Polluters who release emissions forgo the cash payment. Under a subsidy system,

polluters have an incentive to control all units of pollution whose marginal control cost is less

Price versus Quantity Instruments

The economics literature makes an important distinction

between price and quantity instruments when a regulatory

authority is uncertain regarding control costs and damage

functions (Weitzman, 1974). Quantity instruments, such as cap

and trade systems, provide the pollution control authority strict

control over the quantity of emissions. Price instruments, such

as pollution taxes and fees, provide strict limits on how much a

firm must spend to control pollution but do not limit the release

of emissions.

With uncertainty, the regulatory authority would not be able to

predict costs well if it implements a quantity-based pollution

control mechanism, or the environmental consequences if it

implements a price-based approach. Which type of uncertainty

is likely to be more serious? If important environmental

threshold effects exist, a quantity approach would be preferred.

But few pollutants have that characteristic; most exhibit

relatively stable dose-response relationships. Because of

difficulties in forecasting control technologies, it may be more

important to limit the maximum amount that sources incur to

control pollution. Thus, uncertainty may offer a reason to prefer

price to quantity instruments for many types of pollution.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 21

than the subsidy. Subsidy systems for pollution control are especially popular in two sectors:

farming and municipal government.

Economists point out a major drawback of subsidy systems. Existing firms, farmers, and other

entities that receive pollution control subsidies would have an incentive to reduce their pollution.

However, the subsidies could attract new firms to enter the industry. In some extreme cases,

pollution control subsidies could have the perverse effect of increasing total pollution.

Both federal and state governments have numerous subsidies already written into the tax code, a

number of which are perceived as having harmful environmental consequences. Reducing

environmentally harmful subsidies is another mechanism for improving the environment.

3.3.5 Liability for Harm Caused by Pollution

Another approach for resolving environmental issues is to make polluters liable for the damage

their pollution causes. The purpose is twofold: First, to get polluters to make more careful

decisions about the release of pollution; and second, to compensate victims of pollution. Liability

rules control pollution through the decentralized decisions of polluters to act in their own best

interest.

If polluters are liable (and must pay) for the damage they cause, they will control pollution to the

point where the marginal pollution damage equals the marginal costs of control. At this point,

their total payments for controlling pollution and compensating victims are minimized.

Liability can take two forms: civil law and common law. Civil liability is expressly written into

law. Many environmental statutes worldwide have liability provisions. In the United States, the

most important statutes are the Comprehensive Environmental Response, Compensation, and

Liability Act (CERCLA), which holds responsible parties liable for cleanup costs, and the Oil

Pollution Act (OPA), which holds responsible parties liable for damage to natural resources

caused by releases of hazardous substances and petroleum. Liability under CERCLA applies to

historic as well as contemporary releases of pollutants. The form of liability is strict, joint, and

several, meaning that a single contributor can be held responsible for all of the damage, even

though many contributors caused the damage. Furthermore, liability is retroactive. Therefore, an

individual or company can be held liable for actions that were perfectly legal at the time they

occurred.

In an attempt to improve the incentive effects for cleaning up hazardous waste sites, EPA and the

states have developed numerous so-called "Brownfields" initiatives, which are described in this

report. The initiatives provide limited relief from strict and retroactive liability in exchange for

promises to clean hazardous waste sites and turn them into productive assets. EPA recognized

the need to address some of the concerns raised in the past regarding the fairness of enforcement

in Superfund. As a result, EPA has taken significant steps to reduce litigation, to promote faster

settlements, and to emphasize fairness in the application of Superfund’s liability scheme. By

streamlining the process by which claims are resolved at Superfund sites, EPA is accelerating the

cleanups themselves and increasing the pace at which contaminated properties can be moved

back into viable economic use, which is the critical first step in expediting many brownfields

development projects.

Polluters respond to federal and state pollution liability statutes by taking precautionary actions

that reduce the severity and frequency of spills. Alberini and Austin found this effect with

respect to the imposition of strict liability laws by states.19 The petroleum industry created the
The U. S. Experience with Economic Incentives for Protecting the Environment

22 January

Marine Spill Response Corporation, an emergency spill response effort, following the Exxon

Valdez spill and the 1990 Oil Pollution Act.20

Common law, such as nuisance, trespass, and negligence, can be used to address harm to

individuals and to private property that is caused by pollution. The effectiveness of these

approaches in dealing with pollution is an open question. In selected applications, liability can be

a strong deterrent, but a number of considerations limit the effectiveness of this approach as a

general solution to pollution-related problems. One factor that restricts its widespread use is the

time limit for filing claims, otherwise known as the "statute of limitations." In most jurisdictions,

a case must be filed within two or three years of discovering a harm. In a few jurisdictions, a

case must be filed within a two- or three-year period of when the harm occurred. This distinction

is very important for individuals who develop cancer and other diseases of long latency possibly

as a result of exposure to toxic substances, since observable effects may arise many years or even

decades following the exposure.

A second limiting factor is the burden of proof required by law. The burden of proof required for

a judgment against the defendant is usually the standard of “more likely than not,” which usually

is interpreted as having a probability greater than 50%. Epidemiological studies may suggest that

exposure to a particular toxic substance is but one of many factors that could have caused a

disease. Satisfying the more-likely-than-not standard can be difficult. Even if a substance is

implicated, it may be difficult to determine which polluter is responsible for the harm. For

example, doctors may determine that an auto mechanic’s lung cancer likely was caused by

inhaling dust from brake linings, but assigning responsibility to a particular manufacturer may be

impossible. A few jurisdictions allow the assignment of proportional responsibility for both the

harm-causing substance and for the determination of who is responsible.

A final limiting factor for liability systems are the transaction costs of pursuing a claim. These

costs include the legal costs of obtaining evidence, reaching agreement among plaintiffs on how

to pursue a case, presenting the case, and following up if the case is appealed. Liability works

best when there is one party on each side of the case and an easily demonstrated harm. When the

harm is large in magnitude, liability systems may perform reasonably well when transaction

costs are small in proportion to the amounts awarded and if there are few defendants and clear

causation, even if the number of plaintiffs is large.

3.3.6 Information Disclosure

By information disclosure programs, this report refers to mandatory disclosure requirements,

such as those associated with California’s Proposition 65 and the Emergency Planning and

Community Right-to-Know Act (EPCRA), which also is referred to as Title III of the Superfund

Amendments and Reauthorization Act of 1986. At the time these statutes were enacted, there

was little evidence as to how companies would respond to information disclosure rules, other

than that they strenuously objected to such requirements.

A number of retrospective studies found that EPCRA requirements gave a strong incentive for

firms to identify and act upon opportunities for reducing accidental and routine releases of

hazardous substances.21 Information reporting requirements caused firms to behave as if all

emissions were costly. Emissions that could be controlled relatively cheaply were reduced.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 23

3.3.7 Voluntary Pollution Reduction Programs

At both the state and federal level, an enormous number of voluntary programs attempt to

motivate firms and individuals to reduce pollution, promote conservation, and increase recycling.

There are many reasons why voluntary programs are increasing in popularity. First, although the

statutory authorities for creating programs and regulating sources through traditional regulatory

mechanisms may be fully implemented, many less serious pollution and resource conservation

problems remain. Second, voluntary programs are perceived to have low costs because firms and

individuals undertake the measures on a purely voluntary basis. Unlike traditional regulatory

measures, voluntary programs do not carry the threat of enforcement actions and penalties for

noncompliance. Third, voluntary programs are sometimes used to experiment with new

approaches to pollution control, approaches that may be adopted by law or regulation at a later

date.

What incentive do firms and individuals have to participate in voluntary programs? In some

cases, the reward is limited to the satisfaction of doing a good deed. Many recycling programs

would be characterized as such. Participants in some voluntary programs receive free technical

assistance regarding pollution control options. The permit approval process may be accelerated

for firms that participate in some voluntary programs. Finally, many voluntary programs publicly

acknowledge the participants that have successfully met program criteria. Being publicly

recognized as an environmentally responsible firm could bring benefits such as increased product

sales, improved access to talented workers, and a lower cost of capital to the firm.

3.4 Relative Cost Effectiveness

Economic analysis indicates that incentive mechanisms can often increase the cost effectiveness

of pollution control relative to traditional regulatory approaches. Several reasons exist for this

conclusion. First, some incentive-based mechanisms explicitly allow the trading of pollution

allowances or pollution reduction credits. By trading credits or allowances, sources with high

incremental costs of pollution control can have their obligations satisfied by sources with low

incremental costs of pollution control. Other incentive-based mechanisms levy a charge or tax on

each unit of pollution. Under such an approach sources would control pollution only to the point

at which the incremental cost of control equaled the charge or tax. In an ideal world that did not

have transaction costs and competitive markets, both permit/credit trading and pollution fee,

charge and tax approaches should result in the same marginal cost of controlling pollution at

each source. In such an idealized world of economic incentives, control costs should be lower

than (or, at most, the same as) the costs associated with a traditional regulatory approach.

Being cost-effective, though, does not necessarily guarantee that the net benefits of pollution

control are higher when an incentive-based approach is used. For example, the location of

individual sources can matter. One source may be located upwind of a large population center

while another is downwind. Equating marginal control costs per ton or equating the trading of

allowances or pollution reduction credits among sources may well not maximize net benefits to

society. Imagine the consequences if allowance trading resulted in greater emissions at a source

upwind of a population center and lower emissions at a downwind source.

A number of other incentive-based mechanisms, such as information reporting requirements,

liability rules, and voluntary programs, rely on implicit charges for pollution. The cost

effectiveness of such mechanisms is more difficult to predict because sources are reducing
The U. S. Experience with Economic Incentives for Protecting the Environment

24 January

pollution for reasons that have only an indirect financial consequence. In some cases, a financial

link to incentive-based approaches is very tenuous. The motive for participating in voluntary

programs is largely one of improving corporate image to customers, to employees, and to

regulators, although management’s concern for the environment certainly could be a factor. With

corporate image as the principal goal, the benefit to a firm of reducing emissions is difficult to

express in financial terms. Perhaps the best that could be done is to examine what firms actually

spend to participate in such programs to determine their willingness to pay for pollution

reduction. One might find that firms respond in a systematic fashion to the various indirect

incentives. Across a sample of firms, liability, for example, might generate a higher willingness

to pay for a unit of pollution reduction than an information-reporting requirement, which in turn

might exceed the willingness to pay for strictly voluntary activities.

An emerging literature has examined the impacts of existing taxes on the cost effectiveness of

different approaches to environmental management (the so-called “tax-interaction” effect). If

true, the tax interaction effect would raise the social cost of all environmental programs that

control pollution. It appears that economic instruments fare better under these calculations than

do traditional regulatory approaches. Goulder et al. (1998) used a general equilibrium model to

demonstrate that preexisting taxes would make pollution control about 35% more costly than

what was calculated with conventional methods. Relative to conventional calculations of cost,

the general equilibrium method shows all forms of regulation as being more costly, however

economic instruments maintain their cost advantages. Another observation is that the relative

performance of economic instruments can be enhanced through careful design. For example,

auctioning marketable permits can result in important efficiency gains relative to simply giving

these permits to existing sources (so called ”grandfathering“).

Parry and Bento (1999) extended the results calculated by Goulder et al. with a simple numerical

model that evaluated the effects of tax-favored consumption (e.g., employer- provided health

insurance and the mortgage interest deduction). In this model, some economic instruments

perform much better than traditional regulatory alternatives. In particular, the welfare gain from

using revenue-neutral environmental taxes or the auctioning of emission permits can be greater

than previously thought. Under certain conditions, the welfare costs of an environmental tax can

be negative.

In a reexamination of the Goulder tax-interaction effect, Jaeger (2000) finds evidence of a

double-dividend effect but not the alleged tax-interaction effect.22 With the double-dividend

effect, not only is pollution controlled with a tax or trading program, but revenues are also raised

for other worthwhile programs.

Several studies that compare the theoretical cost effectiveness of incentive mechanisms to

traditional regulatory approaches to managing the environment are summarized in Table 3-2 (air

pollution); Table 3-3 (water pollution); Table 3-4 (solid waste); and Table 3-5 (other pollutionrelated issues). Many of these studies did not specify the precise nature of the market-based

mechanism that would be used. Rather, the assumption was made that either pollution taxes or

marketable permits would yield the least cost outcome that was identified through linear

programming. One observes in every case that the ratio of costs comparing the traditional

regulatory approach with the market-based approach exceeds 1, and sometimes it far exceeds 1.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 25

Table 3-2. Potential Savings from Using Economic Incentives to Control Air

Pollution

Pollutant

Controlled

Study

Year, Source

Geographic

Area

Traditional Regulatory

Approach

Ratio of Costs:

Traditional

Approach vs.

Incentive Approach

Hydrocarbons Maloney & Yandle

(1984) T

DuPont facilities

in United States Uniform percent reduction 4.15

Nitrogen dioxide Seskin et al. (1983) T Chicago

Proposed Reasonably Available

Control Technology (RACT)

regulations

14.4

Nitrogen dioxide Krupnick (1986) O Baltimore Proposed RACT regulations 5.9

Total Suspended

Particulates (TSP)

Atkinson & Lewis

(1974) T St. Louis State Implementation Plan (SIP)

regulation 6.0

Particulates (TSP) McGartland (1984) T Baltimore SIP regulations 4.18

Particulates (TSP) Spofford (1984) T Lower Delaware

Valley Uniform percent reduction 22.0

Particulates (TSP) Oates et al. (1989) O Baltimore Equal proportional treatment 4.0 at 90 ug/m3

Reactive organic

gases and NO2 SCAQMD (1992) O Southern

California

Best Available Control

Technology

1.5 in 1994

1.3 in 1997

Sulfur dioxide Roach et al. (1981) T Four Corners

Area SIP regulation 4.25

Sulfur dioxide Atkinson (1983) A Cleveland

Sulfur dioxide Spofford (1984) T Lower Delaware

Valley Uniform percent reduction 1.78

Sulfur dioxide ICF Resources

(1989) O United States Uniform emission limit 5.0

Sulfates Hahn and Noll (1982) T Los Angeles California emission standards 1.07

Six air pollutants Kohn (1978) A St. Louis

Benzene Nichols et al. (1983) A United States

Chlorofluorocarbons

Palmer et al. (1980);

Shapiro and Warhit

(1983) T

United States Proposed emission standards 1.96

All regulated air

pollutants Bates et al. (1994) O Poland European Community andGerman standards 1.1 to 1.2

Sulfur dioxide Haklos (1994) O Europe Uniform percent reduction 1.42

Ozone Hahn (1995) O United States Vehicle mandate in CA and

Northeastern United States

1.3 (NE only) 2.0

(CA + NE)

NOx Krupnick at al. (2000) O Eastern United

States EPA SIP call provisions 1.83 (utilities)

2.0 (all sources)23

Note: T refers to original citation in Tietenberg (1990), A to original citation in Anderson et al. (1990), and O to original publication

of paper.
The U. S. Experience with Economic Incentives for Protecting the Environment

26 January

Table 3-3. Potential Savings from Using Economic Incentives to Control

Water Pollution

Substance

Controlled

Source

Year, Source Geographic Area Traditional RegulatoryApproach

Ratio of Costs:

Traditional

Approach vs.

Incentive Approach

Biochemical

Oxygen Demand

(BOD)

Johnson (1967) T Delaware Estuary Equal proportional treatment

3.13 at 2 mg/l

1.62 at 3 mg/l

1.43 at 4 mg/l

BOD O’Neil (1980) T Lower Fox River,

WI Equal proportional treatment

2.29 at 2 mg/l

1.71 at 4 mg/l

1.45 at 6.2 mg/l

BOD Eheart et al. (1983) T Willamette River,

OR Equal proportional treatment 1.12 at 4.8 mg/l

1.19 at 7.5 mg/l

BOD Eheart, et al. (1983) T Delaware Estuary Equal proportional treatment 3.00 at 3 mg/l

2.92 at 3.6 mg/l

BOD Eheart et al. (1983) T Upper Hudson

River, NY Equal proportional treatment 1.54 at 5.1 mg/l 1.62

at 5.9 mg/l

BOD Eheart et al. (1983) T Mohawk River, NY Equal proportional treatment 1.22 at 6.8 mg/l

Heavy metals Opaluch & Kashmanian

(1985) O

Rhode Island

jewelry industry Technology-based standards 1.8

Selenium EDF (1994) O Central Valley, CA Best management practices 1.2

Nitrogen Moore (2000) O Long Island Sound Equal treatment 1.46 at 3.5 mg/l

Nitrogen Shabman and

Stephenson (1998) O Long Island Sound Equal treatment 1.56 at 3.5 mg/l

Phosphorus Faeth (2000) O Minnesota River

Valley Equal treatment 2.7 at 1ppm/l

Phosphorus Faeth (2000) O Rock River, WI Equal treatment 1.74 at 1 mg/l

Phosphorus Faeth (2000) O Saginaw Bay, MI Equal treatment 5.9 at 1 mg/l

Note: T refers to original citation in Tietenberg (1990), A to original citation in Anderson, et al. (1990), and O to original

publication of paper.

Table 3-4. Potential Savings from Using Economic Incentives to Control Solid

Waste

Substance

Controlled

Study

Year, Source Geographic Area Traditional RegulatoryApproach

Ratio of Costs:

Traditional Approach

vs. Incentive

Approach

Municipal solid

waste Palmer, et al. (1995) United States Uniform percent reduction of10% 2.0

Of course, these ratios are merely theoretical calculations of potential savings. Actual savings

could be much less if sources face high transaction costs with trading regimes, a scenario that

severs as the basis for comparison in most of the studies. A recent report to EPA (Anderson,

1999) used these studies and other inputs to calculate the potential savings from the widespread

use of economic instruments in environmental management. The estimate is largeon the order

of $45 billion a year, or almost one-fourth of current environmental expenditures of $200 billion

a year at the federal, state, and local levels.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 27

Table 3-5. Potential Savings from Using Economic Incentives for Other

Pollution-Related Issues

Substance

Controlled

Study

Year, Source Geographic Area Traditional RegulatoryApproach

Ratio of Costs:

Traditional Approach

vs. Incentive

Approach

Fuel efficiency Charles River

Associates (1991) United States Corporate Average Fuel

Economy standards 4.5

Agricultural

chemicals

Rendleman et al.

(1995) United States Uniform percent reduction 1.1

Traffic congestion Hau (1990) Hong Kong Car ownership restraint 2.5

Examining the performance of trading systems in particular, one finds that existing applications

fail to achieve anywhere near their theoretical potential cost savings.24 Trades have been fewer

and cost savings smaller, according to this analysis, than indicated by economic modeling. A

number of explanations have been offered for why the predicted savings are not realized.25

Regulatory and legal requirements of the actual programs may limit the trading opportunities to a

greater extent than portrayed in the models, especially where the incentive programs operate in

conjunction with traditional regulatory programs. Various models have not fully reflected all the

aspects of real regulatory programs, including the transaction costs, restrictive trading rules,

monitoring and reporting requirements, and the administrative burden placed on both emission

sources and regulatory agencies.

In addition to the limitations imposed by the regulatory structure, potential participants in trading

systems may be reluctant to trade emissions credits or allowances, preferring instead the greater

certainty of installing pollution control equipment at their facilities. Moreover, pollution credits

have a limited life whereas engineering controls, in principle, last for the life of a facility. In

most trading systems, the vast majority of trades that take place occur within firms, not between

firms. Furthermore, markets for permits that are available for sale tend to be thin, and it may be

difficult to locate potential sellers.26

For tax, charge, and fee systems in the United States, the principal limitation to achieving the

theoretical gains in cost effectiveness has been the generally low level of charges relative to the

levels that would be required to have a significant impact on pollution. Typically, charges are set

to recover the administrative costs of a program, not to affect pollution.

Even if the cost savings of trading systems are less than predicted, the actual savings are still

impressive. In the appropriate circumstances, the wider use of incentive programs that are

feasible in an actual policy setting will result in substantial cost savings while achieving

equivalent environmental goals. In other circumstances, the cost differences between an

incentive program and a well-designed traditional regulatory program will be less, although the

incentive program will provide a stronger stimulus for innovation and technical change.27

3.5 Economic Instruments and Technological Change

Market-based instruments should have significant advantages over traditional regulatory

mechanisms in terms of stimulating technical change and innovation in pollution control. The

reason is that each and every unit of pollution is costly to the source. In contrast, under a
The U. S. Experience with Economic Incentives for Protecting the Environment

28 January

traditional regulatory approach, once a source has satisfied the emission limits, all pollution

within those limits has no cost. Why spend valuable resources instituting further controls when

there is no offsetting cost savings? In fact, there generally is no incentive for a facility to reduce

pollution much below permitted amounts because such an action would invite regulators to

reduce the facility's permit limits. In many parts of the nation, pollution control agencies are

constantly struggling to find ways of meeting ambient environmental quality goals. Facilities that

demonstrate the possibility of making emission reductions below permitted amounts offer an

easy target for obtaining some of the necessary emission reductions. These same innovative

firms may be the catalysts for developing regulations that require other firms in the same

industry to reduce their emissions to the amount shown to be feasible.

Figure 3-4 graphically depicts the difference in incentives produced by an emissions tax and by a

traditional regulatory policy. A firm with marginal control costs (MCC) of MCC1, facing an

emission standard set at E1 will control emissions to that level and incur costs equal to areas

(a+b) for controlling all emissions beyond E1. With an emissions tax set at t, the firm also would

control emissions to E1, but the firm would

not only incur control costs of (a+b) but also

would have to pay the tax on E1 of

emissions equal to (c+d+e).

The incentive for sources to find improved

methods of pollution control are much

stronger under the emissions tax, since total

pollution control costs are much higher. If

the source finds a new, cheaper pollution

control technology (represented by the shift

in marginal control costs to MCC2 in Figure

3-4), total abatement costs under the

emissions standard approach would fall by

an amount equal to area (b). Under the

emissions tax approach, total pollution

control outlays would equal (a+c+e), a

decrease of (b+d).

It should not be surprising that the theoretical and empirical literature concludes that emission

taxes provide the greatest stimulus for technical change and innovation, with marketable permits

offering a lesser stimulus and traditional regulatory approaches the least. Among traditional

regulatory approaches, it is safe to say that performance-based standards should provide a greater

incentive to innovate than would pure technology requirements.

Long-run changes in behavior and technology are among the most difficult economic effects to

document. For that reason, relatively little is known of the effects that take place as a

consequence of different pollution control policies. Yet these effects are thought to be very

important.

Outlays for research and development (R&D) in pollution control are between 2% and 3% of

total pollution control expenditures. This percentage is about the same as the average R&D

expenditure in all of U.S. manufacturing. Pollution control that is based more heavily on

Figure 3-4. Comparison of Emission

Tax and Emission Limit

c

d

b e

a

E1

t

MCC2

MCC1

Cost

Emissions
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 29

economic instruments would be expected to stimulate greater R&D and, in turn, reduce the costs

of improving the environment over the long run.

There is historical evidence that Clean Air Act requirements (some market-based, some not)

have helped to provide impetus and market opportunities for technology innovation and

performance improvements. Innovative companies have responded by producing breakthroughs

such as alternatives to ozone-depleting chemicals and new super-performing catalysts for

automobile emissions. There are many examples of technologies that were not commercially

available a dozen years ago, but that are now important elements of pollution control programs.

These examples include the following:

• Selective Catalytic Reduction (SCR) for NOx emissions from power plants

• Advanced gas reburning technology for NOx

• Scrubbers that achieve 95% SO2 control on utility boilers

• Sophisticated new valve seals and detection equipment to control leaks

• Water-based and powder-based coatings to replace petroleum-based formulations

• Reformulated gasoline

• LEVs (Low-Emitting Vehicles) that are far cleaner than those believed possible in the

late 1980s (an additional 95% reduction over the 1975 controls)

• Reformulated lower VOC paints and consumer products

• Safer, cleaner burning wood stoves

• Dry cleaning equipment that recycles perchlorethylene

• CFC-free air conditioners, refrigerators, and solvents

This pattern of technological progress is continuing today. In the regulatory impact statement for

the 1997 ozone and PM National Ambient Air Quality Standards (NAAQS), EPA identified a

number of emerging technologiesranging from fuel cells to ozone-destroying catalysts to new

coating technologiesthat may hold promise for achieving further air pollution reductions. EPA

can help foster additional demand for clean technologies by promoting strategies that create a

market for the most efficient, best performing technologies.

3.6 Impacts on Environmental Quality

A full understanding of the desirability of incentive programs requires information on the actual

environmental benefits that are achieved relative to command and control alternatives. The

literature focuses almost exclusively on the cost side of the equation as opposed to the

environmental effects because most studies assume that the same environmental goals are being

sought in both approaches to environmental management. When comparing incentive-based

policies with traditional regulatory approaches, or when comparing one incentive-based policy

with another incentive-based policy, there may be impacts on environmental quality that would

be of interest to regulators and other parties.

In general, incentive mechanisms based on trading are designed to produce environmental effects

that closely approximate what would be achieved through a traditional regulatory approach.

Some distinctions exist. For example, a cap-and-trade policy provides control over total

emissions, while an open-market trading approach does not limit overall emissions. In an openmarket approach, credits are generated at the sources’ discretion. Open-market trading could

reduce total emissions, however, if trading ratios of greater than 1:1 were applied. Some trading
The U. S. Experience with Economic Incentives for Protecting the Environment

30 January

programs described in this report have that feature (e.g., fireplace permit trading), but others do

not.

In most cases, emission tax systems have not been designed to produce a specific environmental

impact. Rather, the primary goal has been to raise modest revenues. (See, for example, Arnold

1995, chapter 11.) However, in the few examples for which emission fees have been set at a level

intended to have environmental impacts, the benefits were greater than forecast (e.g., Swedish

NOx and SO2 charges, and U.S. chlorofluorocarbon taxes).

Deposit systems appear to have achieved environmental results greater than could be achieved

with a traditional regulatory approach. However, the refund must be large enough to induce

consumers to bring back the used product. For example, deposits/refunds on automobile bodies

(required in some European countries) function well in assuring the proper disposal of car hulks

when set at a high enough level. A traditional regulatory approach works less well for car hulks.

Thousands of abandoned cars are removed at city expense in New York each year, despite

regulations prohibiting that type of disposal.

Variations in environmental effects can be important in evaluating the overall desirability of

different approaches. Oates et al. provide an example in a comparison of regulatory approaches

for of particulate matter control in the Baltimore, Maryland, region. The traditional regulatory

approach of applying uniform emission limits to sources results in control of particulate matter to

an extent greater than necessary to meet ambient air quality standards in some parts of the city.

In contrast, an incentive-based approach achieves the air quality standard with more uniform

ambient concentrations of particulate matter in all parts of the city. The extra reductions of

particulate matter in some areas under the traditional regulatory approach yield a benefit that

partially offsets the higher costs of the traditional approach.28

3.7 Finding the Right Instrument for the Problem

This chapter has described a wide range of instruments from the perspectives of cost

effectiveness, distributional consequences, environmental effects, and incentives to develop new

technologies to deal with pollution. An ideal tool would maximize the net benefits that accrue to

society (all environmental and other benefits, less compliance costs, administrative costs,

monitoring and enforcement costs) without creating major imbalances in the distribution of costs

or benefits. The evidence accumulated from literally hundreds of applications of economic

instruments that is reviewed in the following chapters suggests that the set of instruments that

can deal effectively with individual classes of environmental problems is fairly narrow. Table 3-

6 identifies the types of incentive-based instruments that have been applied to a variety of

environmental problems. The relative effectiveness of the different mechanisms is also

characterized. The interested reader is referred to Dower (1995) for other perspectives on

selecting the best economic instrument for specific environmental problems.
The Cost Effectiveness and Environmental Effects of Incentive Systems

2001 31

Table 3-6. Uses of Economic Instruments

Instrument Examples Pros & Cons

Pollution Charges & Taxes

Emission charges

Effluent charges

Solid waste charges

Sewage charges

Pros: stimulates new technology; useful when damage per

unit of pollution varies little with the quantity of pollution

Cons: potentially large distributional effects; uncertain

environmental effects; generally requires monitoring data

Input or Output Taxes & Charges

Leaded gasoline tax

Carbon tax

Fertilizer tax

Pesticide tax

Virgin material tax

Water user charges

CFC taxes

Pros: administratively simple; does not require monitoring

data; raises revenue; effective when sources are numerous

and damage per unit of pollution varies little with the quantity

of pollution

Cons: often weak link to pollution; uncertain environmental

effects

Subsidies

Municipal sewage

plants

Land use by farmers

Industrial pollution

Pros: politically popular

Cons: high budgetary cost; may stimulate too much of the

activity; uncertain effects

DepositRefund Systems

Lead-acid batteries

Beverage containers

Automobile bodies

Pros: deters littering; stimulates recycling

Cons: potentially high transaction costs; product must be

reusable or recyclable

Marketable Permits

Emissions

Effluents

Fisheries access

Pros: provides limits to pollution; effective when damage per

unit of pollution varies with the amount of pollution; provides

stimulus to technological change

Cons: potentially high transaction costs; requires variation in

marginal control costs

Reporting Requirements Proposition 65

SARA Title III

Pros: flexible, low cost

Cons: impacts may be hard to predict; applicable only when

damage per unit of pollution does not depend on the

quantity of pollution

Liability

Natural resource

damage assessment

Nuisance, trespass

Pros: strong incentive effect

Cons: assessment and litigation costs can be high; burden

of proof large; few applications

Voluntary Programs

Project XL

33/50

Energy Star

Pros: low cost; flexible; many possible applications; way to

test new approaches

Cons: uncertain effectiveness
The U. S. Experience with Economic Incentives for Protecting the Environment

32 January

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Pollution Charges, Fees, and Taxes

2001 33

4. Pollution Charges, Fees, and Taxes

4.1 Introduction

A pollution charge is a fee based on the quantity of pollutants that are discharged

into the environment. A user charge is a fee paid in exchange for the use of natural

resources or for the collection or disposal of pollutants. A product charge is a fee

imposed on products that are believed to have environmentally harmful effects.

Although the terms “fee,” “charge,” and “tax” are used interchangeably in this

chapter, there are subtle differences. Under federal law, a tax is a purely revenueraising instrument, whereas charges or fees are intended to offset costs to the

government. Thus, tax receipts would be part of general revenues. While many

charges and fees that are collected must be placed in the Treasury General Fund,

some are allowed to be retained and could supplement agency budgets. The different

types of fees, charges, and taxes discussed in this chapter can be classified in various

ways. They are summarized in Table 4-1.

Table 4-1. Fees, Charges, and Taxes in Environmental Policy

Instrument Description Examples

Pollution fee Charge based on the

quantity of pollutants

released into the

environment

Air emissions permit fees in California, Maine, other

states

Effluent permit fees in Louisiana, California,

Wisconsin, other states

Solid waste disposal fees

User fee Fee for the use of

resources

Water use fees

Congestion or time-based highway tolls

Grazing fees

Product charge Charge on a product

believed to have

environmentally harmful

effects

Gas guzzler tax

CFC tax

State taxes on fertilizers

State advance disposal fees on tires, motor oil,

packaging, other goods

Other fees on

environmentally

damaging activities

Various mechanisms Wetland development fees

Stormwater runoff fees

Most environmental taxes are designed primarily to raise revenue, often to fund

environmental protection activities. The economic rationale behind such taxes is that

those who cause pollution should bear the costs. Such costs include both damages to

the environment and the administrative costs incurred by the authorities that regulate

polluters. To be economically efficient, environmental taxes should reflect both of

these costs.

Although some charges, especially product charges, have been imposed at the federal

level, the majority of them have been introduced at the state or local level. In the case

of air and water pollution, the federal government has provided policy guidance on

charges, but the states have developed and implemented a wide variety of charges as

they have seen fit.
The U. S. Experience with Economic Incentives for Protecting the Environment

34 January

Given the multiplicity of environmental taxesespecially at the state and local levelsand the

frequency with which they are adopted or modified, this chapter does not attempt to provide a

comprehensive description of all the environmental taxes in place in the United States. Rather, its

purpose is to describe some of the more important environmental taxes.

4.2 Water Fees

Water fees take various forms, including user fees (e.g., for groundwater, surface water, or

drinking water supplied by waterworks) and fees for direct or indirect water discharges. Indirect

discharges are sent to treatment works. The rationale for water user fees is that water is not a free

resource but rather a scarce commodity that should be priced to avoid inefficient use and related

environmental problems. The rationale for discharge fees follows from the polluter-pays

principle described in the previous section. Most water fees are intended primarily to raise

revenue to recover the costs of providing service rather than to allocate a scarce resource among

competing interests.

4.2.1 Indirect Discharge and User Fees

Fees are imposed on households and businesses for discharges of wastewater into Publicly

Owned Treatment Works (POTWs). Frequently, the water and wastewater utilities that service a

household or business are one and the same. When a single invoice includes both services, users

may be able to distinguish discharge fees from water user fees only by careful attention to line

items. Wastewater discharges are not directly metered in most cases; rather they are assumed to

be equal in volume to water consumption, which is measured. Some discharge fees for larger

businesses are based not only on water use but also on discharge toxicity, which provides them

with a separate incentive to reduce the toxicity of their discharges. Sims found that toxicitybased charges provided an incentive for large industrial facilities to reduce the volume of their

discharge.29

With respect to water user fees, EPA’s 1995 Community Water System Survey estimated that

95% of residential water customers and 98% of nonresidential water customers are metered.

They pay water charges based directly on their usage.30

Whether a water user fee has a greater effect in terms of raising revenue or reducing a potentially

polluting activity depends largely on the elasticity of the demand for water, that is whether

demand is responsive to changes in price. If the demand is inelastic, an increase in user fees will

raise revenue. User fees will not, however, affect consumption behavior in a significant way. If

demand is elastic, however, consumption behavior is likely to be changed by a water fee, but the

revenue-raising prospects are limited. Although water demand is often assumed to be inelastic,

studies that separate water demand by season have found that household water demand is

inelastic in winter but elastic in summer. Others have found that water demand by industrial and

agricultural users is sensitive to price changes.31

To promote water conservation, many have suggested the use of rate schedules that impose

higher rates per 1,000 cubic feet as use increases. Two periodic surveys give an indication as to

the type of rates that water utilities use. The Ernst & Young survey focuses on only the largest

urban utilities, while the EPA Community Water System Survey is a more comprehensive,

random-sample survey that includes smaller utilities. The Ernst & Young survey of residential

rates for about 130 utilities reported that 38% use decreasing rates, 37% use uniform rates, and
Pollution Charges, Fees, and Taxes

2001 35

22% use increasing rates. It also shows two trends over time: a greater use of increasing rates and

a lesser use of decreasing rates. EPA’s Community Water System Survey obtained residential

rates from more than 1,000 systems: 49% use uniform rates, 16% use decreasing rates, and 11%

use increasing rates. Since utilities could report more than one type of rate per class of customer,

the total for all rate types is more than 100%. Taken together, these two surveys suggest that

smaller utilities in general are less likely to use increasing or decreasing rates than larger utilities.

As shown in Figure 4-1, periodic surveys of selected water utilities indicate that water and

wastewater fees have risen significantly since 1986. These price increases have exceeded the rate

of inflation. In addition, EPA’s Community Water System Survey notes the tendency for large

utilities to raise rates more frequently than small utilities. Smaller utilities raise rates by a greater

amount when they do raise rates, but

the differences are less dramatic

when reported in annualized terms.

In addition to water and wastewater

charges, stormwater charges have

been imposed in a number of areas.

Ernst & Young found that the

number of utilities with such charges

increased significantly from 1992 to

1994. Their use varies significantly

across regions: They are used by over

half of all utilities surveyed in the

West but by none surveyed in the

Northeast. In some areas, reduced

storm-water fees are assessed in

return for measures that promote

stormwater management.

Finally, in some states, water user

fees generate revenues for drinking water programs. New Jersey, for example, raises $2.8 million

annually (out of a total drinking water program budget of $5 million) from a water use tax of

$0.01 per 1,000 gallons.32

4.2.2 Direct Discharge Fees

The Federal Water Pollution Control Act of 1972 provides for the regulation of point- source

discharges through a system of national effluent standards that are promulgated by EPA. All

point sources must obtain National Pollution Discharge Elimination System (NPDES) permits in

order to discharge effluent.33 By August 2000, EPA had authorized 43 states to issue NPDES

permits.34 In two states, EPA regional offices issue the permits. As of July 1995, about 59,000

municipal and industrial facilities in the United States had received NPDES permits.35

A 1993 survey revealed that 39 states assessed NPDES permit fees as of December 1993. In 10

of the states, fees varied according to discharge volume and toxicity, while in 18 other states fees

varied according to discharge volume alone (see Table 4-2). Other criteria sometimes used in

setting fees include the purpose of the water use, the characteristics of the receiving water, and

the type of facility releasing the discharge. Some states use point or class systems with various

Figure 4-1. Water and Wastewater

Charges (monthly average)

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

1986 1988 1990 1992 1994

water wastewater

Source: Ernst & Young. 1994. p. 3
The U. S. Experience with Economic Incentives for Protecting the Environment

36 January

criteria to determine the fee levels for different dischargers. Fees for Publicly Owned Treatment

Works (POTWs) are sometimes based on the size of the population that is presumed to be

connected to the local sewage system.

Table 4-2. State Effluent Permit Fee Structures

Fee Structure States

Flat or varies only according to industry or size of

permit holders.

Alabama, Alaska, Delaware, Hawaii, Kentucky, Maine, Massachusetts,

Pennsylvania, Rhode Island, Utah, Virginia

Varies according to discharge volume

Arizona, Arkansas, Colorado, Connecticut, Florida, Kansas, Minnesota,

Missouri, Nevada, New York, North Carolina, Ohio, Oregon, South

Carolina, South Dakota, Tennessee, Vermont, Washington

Varies according to discharge volume and toxicity California, Indiana, Louisiana, Maryland, Montana, New Jersey,

Oklahoma, Texas, West Virginia, Wisconsin

Source: Duhl. 1993, p. 10.

The primary purpose of NPDES permit fees is to raise revenue, especially for the permitting

program. This rationale explains why fees are often based on the complexity of the permit, a

reflection of the administrative effort required to get the permit in place. In a number of states,

fees are set to attain revenue targets.

A secondary purpose is to discourage water pollution. Although the incentive effect of water

effluent fees in the United States has not been studied in a comprehensive way, several factors

limit the likelihood of a strong impact. In some cases, fees are based not on measured discharge

characteristics but rather on more easily measured parameters that are related to discharge

characteristics. Moreover, some fee structures have broad classes for characterizing discharge

volume, toxicity levels, or both. These structures impose the same fee within a given volume or

toxicity class In such cases, polluters have no incentive to limit discharges unless they can move

from one fee class to another. Finally, the charges are often modest relative to control costs. New

Jersey has the highest effluent fees. In 1993, two facilities in New Jersey paid $702,812. In most

states, however, the highest fees are less than $100,000. As a point of comparison, effluent

control costs typically exceed $5 million each year at a large industrial facility.

4.2.3 Some State Effluent Permitting Fees

Although it is beyond the scope of this report to describe water effluent fees for all 50 states,

examples from Louisiana, California, and Wisconsin should illustrate typical characteristics of

these fees. Each of these states has NPDES permit fees (i.e., effluent fees) that vary with both the

volume and toxicity of the discharge.

Louisiana uses water permit fees to fund not only the state permit program but also the activities

of the Office of Water Resources of the Department of Environmental Quality. (The legislature

no longer provides general revenues to the Office.) The annual permit fee is determined by a

worksheet that assigns points on the basis of several factors: (1) facility complexity; (2) flow

volume and type; (3) pollutants released; (4) heat load; (5) potential public health threat; and (6)

the designation of a facility as major or minor, depending upon how many people it employs.

The points are multiplied by a rate factor of $97.50 per point for municipal facilities and $170.63

per point for industrial facilities to determine total annual fees. The minimum annual fee is

$227.50, and the maximum annual fee is $90,000. In addition to annual fees, Louisiana imposes
Pollution Charges, Fees, and Taxes

2001 37

application fees for new, modified, or reissued permits. In most cases, these fees are 20% of the

annual fee.36

In California, NPDES annual fees are based on the threat to water quality and the complexity of

the permit. There are three categories for each characteristic: Categories I, II, and III for the level

of threat to water quality; and Categories a, b, and c for the complexity of the permit. Permit

holders with a I-a rating (the greatest threat to water quality and the most complex permits) pay

the highest fees, $10,000 a year. III-c permit holders pay the lowest fees, $400 a year. These fees

fund State Water Board programs.

In addition to the NPDES permit fees, California charges Bay Protection and Toxic Cleanup

fees. This fee structure is similar to that of the NPDES permits except that it is also applied to

other sources of pollution such as storm drains, boat construction and repair facilities, marinas,

dredging operations, and beach replenishment activities. Another difference is that its revenues

fund the Bay Protection and Toxic Cleanup Program, which is designed to identify hot spots,

develop a water quality database, and help coordinate water policy. The Bay Protection Fee

schedule ranges from $300 for III-c permittees (who pose the least threat to water quality and

have the least complex permits) to $11,000 for I-a permittees. Dredging operations are charged

an annual fee of up to $15,000.

The Wisconsin effluent fee system is believed to have potential incentive effects. The fee rate per

pound of individual pollutants is inversely related to the permit limit in pounds for the pollutant.

Thus, the most harmful pollutants are taxed at the highest rate per pound. Pollutant loadings are

calculated on the basis of flow and concentration information contained in wastewater

monitoring reports. Polluters are thereby encouraged to reduce both the quantity and the toxicity

of pollutant releases.

4.2.4 Stormwater Runoff Fees

It is common practice for counties to impose fees on real estate developments based on surface

area runoff (paved areas and areas under roof). Fee revenues are used for storm-water

management in stream valleys. These fees differ from the utility stormwater fees described in

Section 4.2.1 in that they apply to runoff into surface water.

4.3 Air Emission Fees

As is the case with water pollution, there are no national air emissions fees. However, the Clean

Air Act Amendments of 1990 require that states impose fees for issuing emission permits. The

Amendments also impose fees on VOC emissions that will come into force in 2005 and 2010 in

areas that fall far short of attaining national ambient air quality standards for ozone. States have

been more active in the use of emission fees as an air quality management tool.

4.3.1 Permit Fees

The 1990 Clean Air Act Amendments require that states impose permit fees to recover the

administrative costs of their EPA-approved operating permit programs. The Amendments set the

minimum presumptive level for such fees at $25 per ton of emissions of air toxics and criteria air

pollutants (excluding carbon monoxide). They also specified that this amount should be adjusted

for inflation. Each state is required to set fees that completely cover operating permit program

costs. If the fees are greater than or equal to $25 per ton, adjusted for inflationat present, about
The U. S. Experience with Economic Incentives for Protecting the Environment

38 January

$35 per tonEPA assumes that the fees are adequately high. States with lower fees must present

detailed evidence that fee revenues are sufficient to cover their operating permit program costs.

Several state permit programs have been denied full EPA approval because they have submitted

insufficient information on the adequacy of their fees. These states have received interim

approval, pending their submission of evidence of fee adequacy.

Although states can meet the revenue-raising requirement through flat fees or other types of fees,

most have chosen incremental per-ton fees. Some states base their fees on the pollutant’s

potential harm to the environment. New Mexico, for example, levies fees of $150 per ton for air

toxics but only $10 per ton for criteria pollutants. Fee structures in Maine and California are

discussed here for illustrative purposes.

4.3.1.1 Air Emission Permit Fees in Maine

In November 1993, Maine raised its air emission permit fees. Charges were raised from $2 per

ton to $5 per ton for emissions up to 1,000 tons; from $4 per ton to $10 per ton for emissions

between 1,001 and 4,000 tons; and from $8 per ton to $15 per ton for emissions in excess of

4,000 tons. The minimum charge rose from $100 to $250, and the maximum charge rose from

$100,000 to $150,000. The fees apply to emissions of sulfur oxides (SOx), NOx, VOCs, and

particulate matter. Having since been adjusted for inflation, their fee levels (as of 1997) are

shown in Table 4-3. The fees applied to all permit holders.

Table 4-3. Air Emissions Permit Fees in Maine

Amount Emitted Fee ($/ton)

Up to 1,000 tons 5.28

1,000-4,000 tons 10.57

More than 4,000 tons 15.85

Source: Limouze, Maine Air Quality Bureau.

Maine has also imposed an air quality surcharge based on the toxicity of emissions. The

magnitude of the surcharge is determined on the basis of several criteria. Approximately 85

facilities are subject to the tax, which is capped at $50,000. Before the surcharge was adopted,

the Director of Maine’s Air Quality Bureau said that the state would give polluters an incentive

to identify how they would reduce their emissions of the most toxic substances.37 The same Air

Quality Bureau official indicated that surcharge revenues have fallen and that the surcharge has

had a slight incentive effect. The official also suggested that the impact on the environment is

difficult to isolate from other potential factors, such as the Toxics Release Inventory. Permit fees

produce approximately $1.8 million in revenues each year, and toxicity surcharges net $0.6

million in annual revenues. Revenues are used for the air permit program and other air quality

activities.

4.3.1.2 Emission Permit Fees for South Coast Air Quality Management District

The South Coast Air Quality Management District (SCAQMD), located in Southern California)

levies the highest fees per unit of air emissions in the United States. The fees shown in Tables 4-

4 and 4-5 are adjusted for inflation and budgetary needs of the SCAQMD every May.

Facilities that temporarily exceed their allowable emissions levels must pay excess emissions

fees. For most pollutants, the excess emissions fees are about the same as the regular fees. For
Pollution Charges, Fees, and Taxes

2001 39

carbon monoxide, however, they are approximately twice as high. In addition, SCAQMD

imposes fees for visible emissions and various administrative procedures.38

Table 4-4. Emission Fees in SCAQMD

FY 99−00, $ per ton

Annual Emissions Organic Gases Nitrogen Oxides Carbon Monoxide Sulfur Oxides Particulate Matter

4−25 tons $292.80 $171.30 $203.10 $223.90

25−75 tons 475.40 272.10 328.30 362.80

>75 tons 711.60 409.80 492.90 543.20

>100 tons $3.50

Source: SCAQMD Rule 301.

Fees for some air toxics have escalated rapidly, far faster than the fees for criteria air pollutants.

Between 1996 and 2000, emission fees for asbestos; cadmium; hexavalent chromium;

chlorinated dioxins; 1,3 butadiene; and lead rose by 50% to more than 100%.

Table 4-5. Air Toxics and Ozone-Depleting Chemicals Emission Fees in

SCAQMD

$ Per Pound Pollutant

FY96−97 FY98−99 FY99−00

Asbestos, cadmium 2.17 3.00 3.40

Benzene, carbon tetrachloride, ethylene di-bromide, ethylene

dichloride, ethylene oxide 0.90 1.00 1.13

Methylene chloride 0.05 0.05 0.06

Hexavalent chromium 2.67 4.00 4.53

Chlorinated dioxins and dibenzofurans 3.17 5.00 5.66

Nickel 1.67 2.00 2.26

1,3-Butadiene, inorganic arsenic, beryllium, poly-nuclear

aromatic hydrocarbons (PAH) 1.50 3.00 3.40

Lead, vinyl chloride 0.50 1.00 1.13

1,4-Dioxane 0.11 0.21 0.23

Formaldehyde, perchloroethylene 0.21 0.21 0.23

Chlorofluorocarbons 0.18 0.18 0.20

1,1,1-trichloroethane 0.038 0.04 0.04

Source: SCAQMD Rule 301

Given the presence of traditional forms of regulation and other factors that might influence air

pollutant emissions, the incentive effect of the SCAQMD emissions fees is difficult to determine.

In most cases, these fees are lower than the marginal costs for pollution abatement. The main

purpose of these fees is to recover the administrative costs of SCAQMD’s activities.

4.3.1.3 California “Hot Spots” Fees

The California Air Toxics “Hot Spots” Information and Assessment Act (AB 2588) requires

facilities to report the type and quantity of certain substances they release into the air. The

California Air Resources Board (CARB) administers the program. The law also requires CARB

to develop and adopt fees to cover the administrative costs of the program that are incurred by

CARB and local air districts. Districts can either set their own fees or request that CARB set fees
The U. S. Experience with Economic Incentives for Protecting the Environment

40 January

for them. Each district is responsible for billing and collecting the fees and remitting the district’s

share of state costs to CARB. The information component of this law is discussed in Chapter 9.

The fees are discussed in this chapter.

CARB’s Hot Spots fee structure, which is used in 12 of California’s 34 air pollution control

districts, is no longer based on tonnage of emissions. However, at least two of the 22 districts

that set their own fees base them on the amounts and toxicity of pollutants. One district bases its

fees on amount but not toxicity. The toxicity-based fee structure of the Bay Area Air Quality

Management District (BAAQMD) is described here as an example.

BAAQMD bases fees on Unit Risk Values (URVs) for carcinogen emissions and Acceptable

Exposure Levels (AELs) for other emissions. Fee amounts depend on the quantities of weighted

emissions. For carcinogens, weighted emissions are determined by multiplying the amount of

each substance by 100,000 times its URV. For other toxics, weighted emissions are determined

by multiplying the amount of each substance by the reciprocal of its AEL (in m3

/micro-gram).

The sum of the weighted emissions of all toxics is multiplied by a coefficient to calculate the

fees charged to each source. The coefficient varies from year to year depending on the costs

incurred by CARB and BAAQMD to manage the Hot Spots program.

Facilities with fewer than 50 weighted pounds pay nothing, while facilities with weighted

emissions between 50 and 1,000 pounds pay a flat fee of $125. For gasoline dispensing facilities,

the fee is simply $5 for each dispensing nozzle. For small businesses, which are defined as

having no more than 50 employees and $5 million in annual receipts, fees are capped at $5,000.

Government facilities are also subject to the fees. Although there is no maximum fee for larger

businesses, no source has paid more than $60,000 in annual fees. In 1992, about 1,200 facilities

paid $1.16 million in fees.

A total of 81 toxics are subject to the fees. In most cases, emissions are not measured but rather

estimated on the basis of two factors: data on the use of toxics and emissions factors that depend

on the abatement equipment. Although fee amounts appear relatively small for larger businesses,

BAAQMD officials believe that the fees have contributed to a decrease in toxic emissions.

Facilities have lowered emissions in various ways, including process changes and reductions in

the use of toxics. When toxicity-based fees were adopted in 1992, for example, hospitals and

metal plating facilities emitted relatively large amounts of ethylene oxide and hexavalent

chromium. Since these substances have high URVs, emitting facilities faced high fees. Most of

these facilities installed Best Available Control Technology soon after the BAAQMD fee

structure was adopted.39

However, it is difficult to isolate the effects of these fees from other factors that could influence

toxic emissions, including the information and reductions planning components of the Hot Spots

program and federal Toxic Release Inventory requirements. In addition, refineries have made

large investments to comply with the reformulated fuel and fugitive emissions standards.

4.3.2 Ozone Non-attainment Area Fees

The 1990 Clean Air Act Amendments impose fees on “excess” VOC emissions in ozone nonattainment areas designated as “Severe” or “Extreme.” The fees are set at $5,000 per ton

(adjusted for inflation since 1990) for each ton emitted in excess of 80% of a baseline quantity.

The fees come into effect on the applicable attainment date for the area: 2005 for areas with the

designation Severe and 2010 for areas designated as Extreme. (In 1990, California’s South Coast
Pollution Charges, Fees, and Taxes

2001 41

Air Quality Management District was the only non-attainment area rated as Extreme. At present,

there are no areas that have that classification.)

4.4 Solid Waste Disposal Fees

This section briefly discusses variable rate programs (a relatively new trend in household waste

collection), landfill taxes, and hazardous waste disposal taxes. The purpose of such disposal

taxes is to discourage waste generation and encourage recycling. Unfortunately, they also create

incentives to dispose of waste illegally or to transport waste to other locations where disposal is

cheaper.

4.4.1 Variable Pricing Programs

Communities throughout the United States have traditionally levied fixed collection fees for

household waste, or they have included collection and disposal costs in property taxes. Such

pricing practices are inefficient in that the marginal price of solid waste disposal faced by the

household is zero, whereas the marginal collection and disposal cost is positive.

However, a growing number of communities are now charging for solid waste collection based

on the volume generated by the household. Such variable rate (or “pay-as-you-throw”) programs

have been implemented in more than 4,100 communities in 42 states, reaching an estimated 10%

of the U.S. population. Four states have mandated the use of variable rate programs in some or

all of their municipalities. Washington’s law applies mostly to private collectors that operate in

unincorporated areas of the state, but virtually all municipalities in the state use variable rates.

Iowa and Wisconsin require variable rates only in communities that fail to attain a 25% waste

recycling/diversion goal by certain deadlines. In Minnesota, variable rates are required in all

communities.40 EPA is also encouraging variable rates, and the Agency has held a series of

workshops to explain their advantages and disadvantages and to provide information on how to

implement them.

Variable rate programs can take several forms. Prepaid garbage bags or stickers that affix to bags

can be required for collection, or collection fees can be based on the number of cans, the size of

cans, or both of these characteristics. A small number of communities have weight-based

systems. More common are mixed programs that combine a fixed ratewhich in some programs

entitles households to collect a pre-specified amount of wasteand incremental rates for

amounts in excess of the maximum covered by the flat rate. Such mixed programs are growing in

popularity, perhaps because they are relatively easy and inexpensive to implement, they provide

a stable source of revenue for collection services, they have the potential to reduce illegal

dumping, and they offer a pre-specified level of service at a fixed cost to many customers.41

However, according to one source, collection systems that require periodic billing of customers

are likely to be more expensive to administer than bag or sticker systems.42 On the other hand,

one disadvantage of using bags is that they can tear, especially if handled improperly or opened

by animals. Table 4-6 describes variable rate structures in a number of U.S. communities studied

by Miranda and Aldy and Bauer and Miranda.

Waste collection systems can be open systems or exclusive franchises. In open systems, the city

may provide optional waste collection (e.g., Grand Rapids, Lansing), or it may leave collection

completely in the hands of private firms (e.g., Colorado Springs). In exclusive franchises,

collection can be done either by the city (e.g., Spokane, Tacoma) or by one or more contracted
The U. S. Experience with Economic Incentives for Protecting the Environment

42 January

Table 4-6. Variable Rate Structures

Community Fee Structure

Glendale, CA 65-gallon cart: $6.45/month, 2¢/gallon

100-gallon cart: 10.10/month, 2¢/gallon

Pasadena, CA

60-gallon cart: $10.41/month, 4¢/gallon

100-gallon cart: 16.23/month, 4¢/gallon

2 60-gallon carts: 19.01/month, 4¢/gallon

60-gallon & 100-gallon carts: 22.40/month, 4¢/gallon

2 100-gallon carts: 28.62/month, 3¢/gallon

San Jose, CA

32-gallon cart: $13.95/month, 10¢/gallon

64-gallon cart: 24.95/month, 10¢/gallon

96-gallon cart: 37.50/month, 10¢/gallon

128-gallon cart: 55.80/month, 10¢/gallon

Santa Monica, CA

40-gallon cart: $14.85/month, 9¢/gallon

68-gallon cart: 17.76/month, 7¢/gallon

95-gallon cart: 21.07/month, 6¢/gallon

68-gallon & 95-gallon carts 37.28/month, 5¢/gallon

Oakland, CA

20-gallon can: $10.08/month, 13¢/gallon

1st 32-gallon can: 13.74/month, 11¢/gallon

Each extra 32-gallon can: 16.49/month, 13¢/g

Portland, OR

20-gallon can: $14.60/month, 18¢/gallon

32-gallon can: 17.60/month, 14¢/gallon

35-gallon cart: 19.30/month, 14¢/gallon

60-gallon cart: 24.05/month, 10¢/gallon

90-gallon cart: 27.10/month, 8¢/gallon

Tacoma, WA 60-gallon can: $17/month, 7¢/gallon

90-gallon can: 25.50/month, 7¢/gallon

Spokane, WA

20-gallon can: $8.56/month, 11¢/gallon

1st 30-gallon can: 11.07/month, 9¢/gallon

Each extra 30-gallon can: 6.01/month, 5¢/gallon

Colorado Springs, CO

1 34-gallon can + 1 30-gallon bag: $9.50/month, 4¢/g

2 cans and 2 bags: 11/month, 2¢/gallon

3 cans and 3 bags: 13/month, 2¢/gallon

Downers Grove, IL 30-gallon bag: $1.50, 5¢/gallon

Hoffman Estates, IL 30-gallon bag: $1.45, 5¢/gallon

Woodstock, IL 30-gallon bag: $1.56, 5¢/gallon

Grand Rapids, MI 30-gallon bag: $0.85, 3¢/gallon

30-gallon can: 44.20/year, 3¢/gallon

Grand Rapids, MI 64-gallon cart: $15/month, 6¢/gallon

104-gallon cart: 17/month, 4¢/gallon

Grand Rapids, MI 90-gallon cart: $17.35/month, 5¢/gallon

Lansing, MI 30-gallon bag: $1.50, 5¢/gallon

Lansing, MI 63-gallon cart: $12/month, 5¢/gallon

104-gallon cart: 15/month, 4¢/gallon

Lansing, MI 60-gallon cart: $11/month, 5¢/gallon

90-gallon cart + 3 30g bags: 13.40/month, 2¢/g

Sources: Miranda and Aldy. 1996; Bauer and Miranda. 1996.
Pollution Charges, Fees, and Taxes

2001 43

haulers (e.g., Oakland). In both open and franchise systems, communities can set rules regarding

collection fees. In St. Paul, Minnesota, for example, the city operates no collection program but

requires that collectors charge variable rates, and Portland’s open system has no city program but

sets the collection fees that private haulers charge their customers.

Many communities with variable rates implement public education, curbside recycling, yard

waste, white goods (e.g., refrigerators), and holiday greenery collection programs as well.

Education has been found to be an important element in the success of variable rate programs.

The collection frequency, fees, materials collected, and participation requirements for these

programs, with the exception of public education, vary across communities. These

complementary activities can have an important impact on the success of variable rate programs.

San Jose, California, began its variable rate program in 1993. The city contracts its waste

collection and curbside recycling services to two different firms. One company serves the

approximately 80,000 single-family households in the northern half of the city as well as all

multi-family housing. The other business serves about 105,000 single-family households in the

southern half of the city. A combination cart/sticker system is used to price household waste

collection. Residents subscribe to specific cart sizes and pay the fees shown in Table 4-6 for

weekly collection of the waste in these carts. When these households have too much garbage for

their cart sizes, they can put the excess garbage in 32-gallon plastic bags, provided the bags each

bear a sticker sold for $3.50 at local libraries, supermarkets, and convenience stores. Multifamily dwellings pay flat fees. One potential advantage of the stickers is that they give

households the flexibility to exceed planned waste generation on occasion. San Jose also offers

free curbside collection of recyclables and yard waste and collects white goods for a separate fee

of $18 for up to three items. Figure 4-2 suggests that the variable rate program has significantly

reduced the amount of waste sent to landfills and increased the amount of recycled waste. The

amount of yard waste set aside for

collection and subsequent

composting also increased.

The variable rate systems

described thus far base prices on

waste volumes. Another, less

common price basis is weight.

Communities that have

implemented weight-based pricing

include Seattle, Milwaukee,

Minneapolis, Durham (NC),

Columbia (SC), and Farmington

(MN). Such systems could have a

stronger incentive effect by

charging for every additional unit

of weight and thereby eliminating

the incentive given by volumebased systems to compact trash into containers. Seattle’s weight-based scheme lowered the

weight of garbage collected by 15%. One disadvantage of weight-based systems is that they tend

to be technologically much more complicated, requiring that collection trucks carry specialized

equipment and increasing the time haulers take to collect waste.

Figure 4-2. Solid Waste Flows in San Jose

0

50

100

150

200

250

1993 1994 1995

thousand tons

Landfilling Yard Waste Collected Recycling

Source: Miranda and Aldy. 1996
The U. S. Experience with Economic Incentives for Protecting the Environment

44 January

Seattle, for example, found that collection times were extended by 10% under the city’s weightbased system. If the weight of garbage decreases enough, however, there is the potential to offset

the increased implementation costs.43

In most areas where variable rate programs have been introduced, the amounts of waste collected

have decreased significantly, a result of either increased recycling or decreased waste generation.

• A 1998 study of 114 variable rate cities and 845 traditional fixed rate communities

estimated a 43.8% reduction in waste disposal after those cities and communities began

to charge $1 for every 32-gallon bag.44

• A 1992 survey of 14 cities with variable rate programs found that the amount of waste

destined for disposal decreased by an average of 44% during the first year following

program initiation.45

• A study in Maine found that municipalities with variable rate systems disposed of less

than half as much waste per capita as municipalities without such systems.46

• Surveys in Tompkins County, New York, and Dover, New Hampshire, found that

variable rates led consumers to think of ways to reduce waste generation, including

altering their purchasing habits.

• A 1996 study of four communities in California and five in the Midwest found that they

achieved reductions in waste disposal of 6% to 50% after introducing variable rate

systems. The higher the unit prices, the greater the reductions. Moreover, reductions were

greater in those communities with relatively small minimum container sizes. If the

minimum container size is too large, consumers often have little incentive to alter their

behavior.47

• As shown in Table 4-7, another study found reductions in the tons of waste sent to

landfill, reductions that ranged from 17% to 74% following the adoption of variable rates

in 21 northern cities. The study reached two conclusions. First, the magnitude of the unit

prices was positively correlated with the change in the amount of waste recycled. (That

is, the higher the price per unit of waste, the more waste was recycled). Second, unit

prices were negatively (not the right term) correlated with the change in the amount of

waste landfilled. That is the higher the price per unit of waste, the less waste that was sent

to landfills and the more waste that was recycled.

The recycling increases shown in Table 4-7 were achieved in geographic areas that did

not simultaneously implement recycling programs. In places where the adoption of

variable rate programs has coincided with new public recycling activities, however, it is

difficult to determine how much of the decline in waste disposal is due to the variable

rates and how much is due to the new recycling alternatives. The Dover survey found that

curbside recycling programs alone encouraged recycling but that variable rates provided

additional incentive.48 Another study estimates that a variable rate program will increase

the amount of waste that is recovered under existing recycling programs by 4% to 13%. 49

• Nestor and Podolsky (1998) reported on the results of an experiment in the city of

Marietta, Georgia. In January 1994, the City of Marietta simultaneously introduced a

bag/sticker program and a subscription can program in different parts of the city. After

adjusting for seasonal effects, Nestor and Podolsky estimate that households participating
Pollution Charges, Fees, and Taxes

2001 45

in the bag program reduced their garbage disposal by approximately 23% while

households participating in the subscription can program decreased waste disposal by

only about 8%. The explanation for this difference is that the bag/sticker program offers

households more flexibility on a week-to-week basis regarding the amount of waste they

are required to pay for. Households who are able to set out smaller-than-usual amounts of

waste immediately benefit from it. The bag/sticker program gives households greater

incentive to reduce waste because they are not committed to a specified number of

containers each week.

Table 4-7. Responses to Variable Rate Pricing

Municipality % Reduction in Tons of

Waste Landfilled

% Increase in Tons of Waste

Recycled

Antigo, WI 50 145

Charlemont, MA 37 N/A

Downers Grove, IL 52 N/A

Grundy Center, IA 32 N/A

Hancock, VT 33 N/A

Hartford, VT 17 29

Harvard, IL 33 113

High Bridge, NJ 18 N/A

Huntingburg, IN 74 N/A

Illion, NY 51 141

Ithaca, NY 31 63

Lisle, IL 53 N/A

Mt. Pleasant, IA 49 N/A

Mt. Pleasant, MI 44 141

Perkasie, PA 54 157

Plains, PA 49 88

Quincy, IL 41 45

River Forest, IL 19 N/A

St. Charles, IL 41 456

Weathersfield, VT 36 150

Woodstock, IL 31 N/A

Source: Miranda, as reprinted in Arner and Davis.

Despite the evidence cited in Figure 4-7, variable rate programs have some unresolved problems.

Data on decreases in collection can be misleading if the programs result in significant illegal

disposal of waste or the diversion of waste to cheaper disposal services. Illegal dumping includes

direct discharge to the environment as well as placing waste in someone else’s container or

donating irreparable items to charitable organizations. Direct discharge to the environment is

likely to be of more concern than other types of illegal disposal. The Maine study found that an

increase in backyard burning and a slight increase in roadside dumping and illegal disposal in

commercial containers coincided with variable rate systems. Of the 14 cities surveyed in

Skumatz (1993), “six cities reported no problem with dumping, four reported minor problems,

and four reported notable problems.” Among the measures cited to limit illegal disposal are

creation of viable recycling alternatives, public education, locking commercial dumpsters, high

dumping fines, and flat collection fees that entitle households to a minimum level of service.50
The U. S. Experience with Economic Incentives for Protecting the Environment

46 January

Other problems need to be addressed in designing and managing variable rate programs. They

can be difficult to implement in multi-family housing such as apartments, and they can have a

regressive effect on large families. Variable rates are likely to be regressive because the amount

of waste produced per thousand dollars of income is likely to be higher for a poor household than

for a more affluent household. In addition, variable rate programs can lead to significant

decreases in revenue for municipal waste collectors because households reduce the amount of

solid waste that they generate.

Variable rate programs may not be appropriate for all communities. Analysts assert that variable

rate pricing is unlikely to be successful in communities having the following characteristics: (1)

those with affordable and environmentally acceptable landfills; (2) those with few or no nearby

recycling facilities; (3) those with open spaces located nearby, which makes that land vulnerable

to illegal dumping; and (4) those with consumers who oppose paying variable rates.51 In some

areas, however, variable rate programs appear to be beneficial. According to a World Resources

Institute (WRI) study, “Where landfill costs are high, disposal charges would generate net

economic savings of $0.17 for every dollar of revenue collected, even after the gross costs of

curbside recycling programs were paid.”52

4.4.2 Landfill Taxes

According to the National Recycling Coalition, surcharges on waste delivered to landfills have

been imposed in over 20 states.53 If operators are capable of passing on such taxes to their

customers in their disposal fees, landfill taxes could have effects similar to variable rate

programs.

New Jersey levies three different landfill taxes: a Solid Waste Services Tax of $1.05 per ton, a

Landfill Closure and Contingency Tax of $0.50 per ton, and a Solid Waste Recycling Tax of

$1.50 per ton. For waste in liquid form, rates for the Solid Waste Services Tax and the Landfill

Closure and Contingency Tax are 0.002 cents per gallon, and rates for the Solid Waste Recycling

Tax are 0.00225 cents per gallon.

In Pennsylvania, counties are required to create trust funds to finance the costs associated with

closing landfills and to finance these trust funds with disposal fees. The per ton disposal fee is

calculated by dividing the estimated cost of closing the landfill by the estimated weight of the

garbage that will be sent to the landfill before it is closed.

Texas levies a fee of $1.50 per ton on the disposal of all municipal solid waste. In part, fee

revenues are used to fund the state’s efforts to control solid waste. They are also used to provide

grants to local governments and other organizations for recovering resources, minimizing the

amount of waste, and developing programs that help enhance the efficiency of solid waste

management facilities.54

It is unclear whether these landfill taxes have produced a significant incentive effect. Moreover,

as is the case with variable rate programs, increasing the price of waste disposal creates

incentives to use alternative disposal options. The District of Columbia’s experiences with its

nearby Lorton, Virginia, landfill is a case in point. Of the $64.39 per ton tipping fee at Lorton,

$28.39 per ton was reserved for the District’s residential recycling program. Private trash haulers

have reportedly trucked waste to landfills located elsewhere in Virginia and southern

Pennsylvania, where tipping fees are lower. The resulting loss in revenue from tipping fees led

the District to suspend its recycling program in 1995. It subsequently reestablished the program
Pollution Charges, Fees, and Taxes

2001 47

but with reduced service. Because of the instability of these tipping fee revenues, the District

now relies on general revenues to fund its recycling program.

4.4.3 Hazardous Waste Taxes

A 1998 survey identified 30 states that impose taxes on the generation or management of

hazardous wastes.55 Some of these states have higher tax rates for landfilling than for

incineration, and several states impose no tax on incineration. In some states, taxes vary

according to the type of waste or whether the waste was generated outside the state, or both of

these factors. In addition, on-site disposal of hazardous waste is exempt from taxes in some

states. Vermont and California each levied taxes of more than $100 per ton for land disposal of

hazardous waste, and six other states levied taxes of more than $50 per ton. The mean tax level

for all states, including those with no tax, was $21 per ton. To put these taxes into perspective, in

the late 1980s a middle-of-the-range estimate of the costs associated with the disposal of

hazardous waste was $132 per ton.

California levies fees on both the generation and disposal of hazardous waste. As shown in Table

4-8, California imposes taxes on hazardous waste disposal that range up to $220 per ton.

Generation fees vary by quantity generated, with rates fixed within a given range of tons per

year. (See Table 4-9.)

Table 4-8. Hazardous Waste Landfill Fees in California

Waste Category Rate ($/ton)

Non-RCRA cleanup wastes $7.50

Other non-RCRA wastes 17.94

Ores and minerals 14.30

Extremely hazardous waste 220.00

Restricted hazardous waste 220.00

Hazardous waste (RCRA) 44.44

Source: California Department of Toxic Substances Control.

Table 4-9. California Hazardous Waste Generation Fees

Weight of Waste Generated (tons/year) Fee ($) Middle Range of Rates Charged

($/ton)

Less than 5 $0 $0

5 to 25 169 11.3

25 to 50 1,348 35.9

50 to 250 3,371 22.5

250 to 500 16,855 44.9

500 to 1,000 33,710 44.9

1,000 to 2,000 50,565 33.7

More than 2,000 67,240 <33.7

Source: California Department of Toxic Substances Control.

According to the California Department of Toxic Substances Control, the two fees are intended

to raise revenue and to encourage waste minimization. The tonnage of hazardous waste sent to

landfills has declined in the last 10 years. It is difficult, however, to determine to what extent this
The U. S. Experience with Economic Incentives for Protecting the Environment

48 January

decline is due to the fees, as many other factors could influence generation and disposal

practices.

Hazardous waste is also subject to numerous other administrative fees in California. Efforts are

currently being made to simplify the existing fee structure, which is widely viewed as too

complicated.56

The findings of several studies suggest that taxes on hazardous waste have had an impact on

disposal. Two engineering studies, one by the Congressional Budget Office (1985) and the other

by EPA (1984), concluded that such taxes significantly reduced the disposal of hazardous waste

in landfills. By 1987, 10 states had taxes exceeding the level at which EPA predicted a 60%

reduction in landfill disposal. Another study examined empirical evidence on the effects of a

twofold rise in hazardous waste taxes in New York in 1985. It found that the quantity of

hazardous waste disposed of in the state decreased significantly. Because taxes on incineration

remained constant in this case, the amount of waste incinerated rose, but it did not increase as

much as the amount of waste sent to landfills declined.57

Sigman (1996) studied the impact of landfill and incineration taxes on the generation of four

types of chlorinated solvent wastes from metal cleaning. Using data from the 1987−1990 Toxics

Release Inventories, the study included a cross-section analysis of generation across states and

used a number of independent variables, including disposal taxes in the state of generation and in

neighboring states. It also studied the impact of disposal taxes and other factors on the choice of

disposal method. The study reached two conclusions. First, elasticities of waste generation with

respect to these taxes on disposal were in the range of -7 to -22, meaning that the quantity of

hazardous waste sent to landfills or incinerators was very sensitive to the tax. Second, the taxes

encouraged generators to choose incineration or other treatment options as their waste

management method, instead of landfilling. However, the estimated impact of these taxes was

minor because the fees were low in comparison to the total costs of waste management.

Although “[s]tates’ experience suggests that taxes may provide an alternative to the standardbased policies now used for most hazardous waste regulation,” Sigman found, the design and

implementation of such taxes pose several potential problems, including the determination of tax

levels. To maximize the efficiency of these taxes, they should reflect the social cost of hazardous

waste generation. This cost, however, depends on the type of waste, the method of disposal, the

geographic location, and various other factors that are difficult to assess and incorporate into tax

structures. If, on the other hand, taxes are too high, they could encourage illegal dumping, of

which even a small amount could cause enough environmental damage to offset the increased

efficiency achieved by taxes. “In the presence of illegal dumping,” the study states, “a

deposit/refund program may be substantially less costly than a waste-end tax.”

Because current federal regulations impose high costs on generators of hazardous waste, there

may already exist sufficient incentives to reduce the generation of hazardous waste. If existing

regulatory incentives are sufficient, taxes could raise the costs of waste disposal to a level that is

higher than what is socially desirable.

4.5 Product Charges

Product charges are imposed on either a product or some characteristic of that product.

Economic theory suggests that products whose disposal causes environmental pollution should
Pollution Charges, Fees, and Taxes

2001 49

be taxed to reflect the added social costs they impose. To date, the theoretically ideal product

charge has not been imposed. Although some product charges may be large enough to have a

significant effect on behavior, most of them are intended primarily to raise revenue. Product

charges typically take the form of advance disposal fees (ADFs) or of taxes on a product

designed to fund its proper disposal after use.

A traditional regulatory mechanism that competes with the product charge is termed “extended

producer responsibility;” it relies on take-back requirements placed on the manufacturers of

certain products. Producers bear the responsibility for ensuring the proper disposal of postconsumer waste. Although some states have implemented extended producer responsibility for

selected products, the federal government has never endorsed such an approach.58 Several

European nations have also enacted rules regarding extended producer responsibility.

4.5.1 Federal Product Charges

A number of federal product charges have been imposed, including charges on fuels,

transportation, transport equipment, and chemicals. Most of these taxes are intended to raise

revenue. Consequently, they have minimal effect on incentives. For a list of federal

environmental excise taxes, see Barthold (1994). The following subsections in this chapter

discuss the Superfund taxes, taxes on fuel-inefficient automobiles, and taxes on

chlorofluorocarbons (CFCs).

4.5.1.1 Superfund Taxes

Until the end of 1995, the federal government imposed taxes on oil, chemicals, and business

profits to fund the cleanup of inactive hazardous wastes designated under Superfund. This

activity was financed by taxes on crude oil (9.7 cents per barrel), chemicals ($0.22-$4.87 per

ton), and gross business profits (0.12% of amounts over $2 million).59 Congress did not extend

the tax after its scheduled expiration. The oil and chemical taxes could be regarded as product

charges or raw material input taxes. Their primary purpose, however, was to raise revenue, rather

than to prevent pollution.

4.5.1.2 Taxes on Gas Guzzlers

Introduced in 1978, the gas-guzzler tax is imposed on the sale of new automobiles with a fuel

efficiency of less than 22.5 miles per gallon. Sports utility vehicles (SUVs), minivans, and trucks

are not subject to the tax. The magnitude of the tax ranges from $1,000 to $7,700 per automobile,

depending on fuel efficiency. Revenues, which amounted to $144.2 million in 1992, contribute

to the Highway Trust Fund.60 Most gas-guzzler tax payments have been made by buyers of

foreign luxury cars.

Two measures that could have effects similar to gas-guzzler taxes are fines for the failure to meet

corporate average fuel efficiency (CAFE) standards and taxes on luxury cars. CAFE fines, which

could be regarded as non-compliance fees, are based on the extent to which an auto manufacturer

violates CAFE standards. These fees could provide an incentive for manufacturers to invest in

the design of fuel-efficient cars. Luxury taxes are set at 10% of the sales price of a car in excess

of a base level, which was originally set at $30,000 but has since increased. Since many luxury

cars are relatively fuel-inefficient, luxury car taxes could encourage the use of more fuel-efficient

vehicles.
The U. S. Experience with Economic Incentives for Protecting the Environment

50 January

4.5.1.3 Ozone-Depleting Chemicals

In accordance with the 1987 Montreal Protocol on Substances that Deplete the Ozone Layer and

subsequent amendments, the production of ozone-depleting chemicals (ODCs) such as

chlorofluorocarbons (CFCs) for most uses in the United States was phased out by January 1,

1996. To facilitate the phaseout, the United States imposed a tax on selected ODCs on January 1,

1990; the government expanded that tax to other ODCs the following year. The magnitude of the

tax was determined by multiplying a base rate per pound of ozone-depleting chemicals produced

or imported by an ozone depletion factor that varied according to the type of chemical. Initially

set at $1.37 per pound, the base tax amount increased to $3.35 in 1993, $4.35 per pound in 1994,

and $5.35 in 1995. Since 1996, the annual increase in the base tax amount has been $0.45 per

pound per year. The ozone depletion factors, which are intended to indicate each chemical’s

damage to the ozone layer, were set by the Montreal Protocol.61 For example, methyl chloroform

had a factor of 0.1, whereas Halon-1301 had a factor of 10.0, which meant that methyl

chloroform was taxed at $0.53 per pound in 1995 while Halon-1301 was taxed at $53.50 per

pound that year. The tax was imposed on producers and importers of these chemicals as well as

on the importers of products that contained these chemicals or that used them in their production

processes.

Unlike most product charges, this tax is widely credited with a significant incentive impact. ODC

consumption (expressed in CFC-11 equivalents using the above-mentioned ozone depletion

factors) fell from 318,000 metric tons in 1989 to 200,000 metric tons in 1990, the year the tax

was introduced.62 A Congressional Research Service (CRS) study concluded, “the CFC tax has

clearly accelerated the rate at which CFC uses are being substituted for and the rate at which

CFCs are being recovered for reuse.” CRS adds that the tax was also intended to raise revenue

for the federal government and to capture a portion of the windfall revenues experienced by

ODC producers as a result of the tightened supply of ODCs.63

According to the World Resources Institute (WRI), the tax raised $2.9 billion in its first five

years. WRI adds that the phaseout cost less than EPA’s original projection.64 In 1988, EPA

predicted that the average cost of reducing the use of CFCs by 50% would be $3.50 per kg. In

1992, EPA revised its cost estimate to only $2.45 per kilogram.

The tax is believed to have contributed significantly to the reduction in ODC use. Several other

factors, however, also had an impact, including the establishment of an ODC trading system

(described in Chapter 6); the well-publicized intentions of the federal government to phaseout

ODC use; and EPA’s work with the private sector on ODC recycling and the use of substitutes.

As a result of the multiplicity of these policy measures, it is difficult to isolate the effects of the

CFC tax.

4.5.2 State Product Charges

States have imposed charges on a number of products, including beverage containers, fertilizers,

furniture, motor oil, pesticides, refrigerators, solvents, and tires. Some of these have taken the

form of advance disposal fees (ADFs). Hoerner (1998) identified approximately 400

environmental taxes that are imposed at the state level. Some taxes, such as those on the sale of

tires, are found in well over one-half of the states. Litter taxes, which are imposed on the sale of

products that commonly are found in litter, are found in a handful of states. Many states impose

severance taxes on the removal of minerals from the ground. This section highlights a few of the

charges that states impose on different products.
Pollution Charges, Fees, and Taxes

2001 51

4.5.2.1 Tire Charges

Fees are imposed on automobile tires in at least 34 states. The fees generally range from $0.25 to

$2.00, but Texas has a fee of $3.50 on truck tires. Some of the fees are assessed as a percentage

of the price of the tires. Given the low magnitude of the charge levels relative to the price of tires

and the lack of substitutes for tires, the incentive effect of state tire charges on the buyers of tires

is likely to be minimal; however, the system does encourage the proper disposal of tires. Most

fees were instituted as part of a scrap tire program, which included restrictions or bans on the

disposal of used tires in landfills.65 States use their tire fee revenues to subsidize the development

of markets for end uses of used tires, such as rubberized surfaces, noise barriers, blasting mats,

and rubberized asphalt pavement. Fee revenue also may be used to pay for the cleanup of tire

disposal sites and for the enforcement of laws designed to prevent illegal disposal. The effect is

that tire buyers pay for the proper disposal of used tires through these tax/subsidy schemes.

As shown in Table 4-10, the federal government also imposes product charges on tires, charges

that range from $0.15 to $0.50 per pound. Revenues from these charges are allocated to the

Highway Trust Fund.66

Table 4-10. Federal and State Tire Charges

Taxing Authority Fee Structure Uses of Revenues

Federal Government

Tires 40−70 lbs: $0.15/lb x weight exceeding 40 lbs

Tires 70−90 lbs: $4.50 + $0.30 x weight exceeding 70 lbs

>90 lbs: $10.50 + $0.50 x weight exceeding 90 lbs

Highway Trust Fund

State Governments (34) $0.25 to $2.00 for passenger car tires Tire recycling, tire disposal site

cleanup, other similar activities

Source: Fullerton. 1995, p. A7; Scrap Tire News Legislative Report, pp. 18−19.

4.5.2.2 Fertilizer Charges

At least 46 states impose charges on the sale of fertilizers. Nebraska’s fee of $4 per ton is one of

the highest; most are below $1 per ton. Assuming fertilizer prices of $150−$200 per ton, the

charges are too low to significantly influence the use of fertilizer. The most common use of these

charge revenues is the inspection of fertilizers and fertilizer storage by state agencies.

4.5.2.3 Rhode Island Hard-to-Dispose Material Tax

Rhode Island imposes charges on “hard-to-dispose material,” such as lubricating oil, antifreeze,

organic solvents, and tires. The fees are 5 cents per quart of lubricating oil, 10 cents per gallon of

antifreeze, 0.25 cents per gallon of organic solvents, and 50 cents per tire. Although the incentive

effects are assumed to be minimal, the charge incorporates at least some of the disposal costs of

these various materials into their prices. Charge revenues are deposited in a “hard-to-dispose

material account” that funds educational and technical assistance programs, grants, research, and

collection centers for hard-to-dispose material.

4.5.2.4 Florida Advance Disposal Fee (ADF)

In a two-year experiment with ADFs, on October 1, 1993, Florida instituted a fee of one cent on

a variety of containers. Exempted from the tax were containers made of plastic, plastic-coated

paper, and glass that had average recycling rates of at least 50%; glass containers having 35%

recycled content; and plastic containers having 25% recycled content. Paper and plastic
The U. S. Experience with Economic Incentives for Protecting the Environment

52 January

packaging were also subject to the ADF, with exemption possibilities similar to those for glass

and plastic containers. Since the Florida Department of Environmental Protection determined

that aluminum and steel cans had already fulfilled the 50% recycled content requirement, they

were exempt from the tax.67 To further encourage recycling, the tax was doubled the second year

it was in effect.

Despite the low-fee level, manufacturers reportedly went to considerable trouble to obtain

exemptions. Their efforts appear to have been due more to the public relations value of being

exempted than to the ADF itself.68

One interesting aspect of this ADF is the wide range of options that it gave manufacturers to

obtain exemptions. These options included working with other firms in the same sector to raise

recycling rates, increasing the recycled content of packaging, averaging the amount of recycled

content over various containers, and recycling equivalent amounts of previously discarded waste

into other products. In theory, the variety of options should have allowed each firm to select a

relatively cost-effective way to promote recycling. Most firms sought exemption based on use of

recycled content. However, at least two companies, Piper Plastics and Anheuser-Busch, have

built, or plan to build, recycling facilities. Both companies cited the ADF as the decisive factor in

their decisions to build these facilities in Florida.69

One disadvantage of including various exemption possibilities in the ADF was the potential

administrative burden of assessing requests for exemptions. At least one industry group criticized

the ADF as deceptive, burdensome, and administratively costly.70 The ADF expired in October

1995.

4.5.2.5 North Carolina ADF

North Carolina imposes a fee on “white goods,” such as refrigerators and freezers. Beginning in

1995, the ADF was $10 for products containing CFCs and $5 for those without CFCs. Effective

July 1998, the tax was reduced to a flat $3 per item and extended to July 2001.71

Although the ADF probably does not have a significant incentive effect, it generates revenues to

manage the disposal of white goods. With the introduction of the ADF, county landfills were

required to accept old white goods for disposal, free of charge. Counties received 75% of the

ADF revenue on a per capita basis to fund the removal of CFCs and programs that recycle white

goods and metal products. Additional ADF revenues were available for those counties whose

disposal costs exceeded their per capita allocations of ADF funds from the state. In July 2001,

local governments will be authorized to impose disposal fees for white goods.

4.5.2.6 Texas Clean Fuel Incentive Surcharge

In 1989, Texas introduced a 20-cent-per MMBtu-surcharge on boiler fuel oil. The surcharge

applies only to industrial and utility boilers that are capable of using natural gas, that are in use

between April 15 and October 15 of each year, and that are located in ozone non-attainment

areas having populations of 350,000 or more. As part of a larger state effort to encourage the use

of natural gas, the surcharge specifically addresses ozone problems that occur in the summer

months and that caused by NOx emissions. Used oil and fuels derived from hazardous waste are

exempt from this fee. Surcharge receipts are deposited in the State General Revenue Fund.72

According to one official on the Texas Natural Resource Conservation Commission (TNRCC),

the surcharge has had little if any incentive effect because few facilities used fuel oil before the

surcharge was introduced.
Pollution Charges, Fees, and Taxes

2001 53

4.6 Road User Fees

Tolls are the most common type of road user fee for financing road construction in the United

States. Because these fees are purely revenue-raising mechanisms that are unrelated to

environmental protection, they are not discussed in this report. However, another type of road

user fee, congesting pricingthe tolls that vary by time of day or how heavily the road is being

usedis intended to reflect some of the social costs of traffic congestion. One of these costs is

increased emissions per mile traveled. One study estimated that if the current level of vehicular

traffic in southern California flowed smoothly, emissions from motor vehicles would decrease by

approximately 13%.73 For this reason, congestion pricing is of considerable interest as an

environmental management tool. Moreover, economic analysis indicates that the economic gains

from congestion pricing can be large, much greater than any other traffic management tool.74

Congestion pricing makes users aware of the impact their use of a highway has in terms of

increasing the travel time of others. By making users pay the full social cost of travel and not just

their private cost, highway use declines and traffic flows more smoothly.

In December 1995 in southern California, a congestion-based 4-lane toll road opened in the

median of the existing eight-lane Riverside Freeway (SR-91). The road was built by private

funds from the California Private Transportation Company (CPTC), and the same firm operates

the toll system. CPTC is free to determine toll levels, but it is subject to a cap on the rate of

return on its investment. Five different toll levels range from $0.25 to $2.50 per 10-mile trip,

depending on the time of day. Toll prices are announced in advance, so motorists can plan their

trips accordingly. Windshield-mounted transponders allow motorists to pay for toll-lane use

without stopping at toll booths. High-occupancy vehicles (HOV) having three occupants, public

transit vehicles, zero-emission vehicles, and vehicles with a disabled-person license plate are

exempt from paying the tolls.

By March 1996, over 30,000 transponders were in use, a level the project had not expected to

reach until late June. In interviews with the Los Angeles Times, express lane users have reported

time savings of more than 30 minutes. CPTC adds that the toll lanes have not only reduced travel

times for their users but also diminished congestion on the adjacent freeway.75

As part of its Value Pricing Pilot Program, the Federal Highway Administration is studying the

experiences of SR-91 and is funding several other projects. Some of the pilot projects are

highlighted below.76

• In March 1998, San Diego began a pilot project that charged for the use of lanes in the I15 freeway based on the time of day and the level of congestion. In the first four months

of the project, almost 4,000 transponders had been distributed.

• Houston began a pilot project in January 1998 that allowed a limited number of users of

HOV-2 carpools into HOV-3 carpool lanes for a fee of $2 during peak travel periods.

• Beginning in August 1998, variable pricing is being used to manage traffic flows on two

bridges in Ft. Myers, Florida. The program offers drivers a 50% reduction in the usual

toll if they travel on either side of peak travel periods.
The U. S. Experience with Economic Incentives for Protecting the Environment

54 January

4.7 Wetland Compensation Fees

Wetland compensation fee systems are programs in which a regulatory agency collects fees in

lieu of requiring a developer to compensate for wetland losses through their on-site mitigation or

through their acquiring of credits generated by a mitigation bank. (This system is discussed in

greater detail in Chapter 6.) The fees are used for mitigation projects undertaken by an agency or

non-profit organization. Wetland compensation fees offer the flexibility to mitigate wetland loss

in a cost-effective manner. Instead of doing mitigation at the project site, a developer pays a fee

to another organization to perform mitigation activities in more suitable locations.

Fee-based mitigation mechanisms have been used in Arkansas, Florida, Illinois, Louisiana,

Maryland, Mississippi, Texas, and Virginia. The magnitude of the fees is usually set to cover

costs such as mitigation, land acquisition, project planning, and site management.

Initiated in 1986, Florida’s Mitigation Park Program is the oldest fee-based wetland mitigation

system in the United States. Fees paid by wetlands developers in lieu of on-site mitigation are

deposited in the Florida Game and Fresh Water Fish Commission’s Fish and Wildlife Habitat

Trust Fund. These charges finance the purchase and subsequent management of large,

biologically defensible Mitigation Parks. These parks, which range in size from 400 to 1,500

acres, are publicly owned but may be managed by either government entities or non-profit

organizations.

To participate in the program, developers need approval from the regulatory agency with which

they are working. Fees depend on the amount of wetlands developed, the type of habitat

impacted, and the species present at the site of the development. The developer pays one fee to

finance land acquisition; a second fee (15% of the first fee) to fund site management; and a third

fee (7% of the sum of the first two charges) to their state’s tax department. Interest accrued on

the second fee is used to fund site management. As of 1999, the Mitigation Park Program had

received more than $17 million in deposits and had purchased in excess of 7,000 acres.77

In Maryland, the mitigation fees paid by developers into the Nontidal Wetlands Compensation

Fund depend on the number of acres and type of wetlands impacted and the costs of wetland

restoration and construction. The mitigation ratio (the number of acres that must be enhanced,

restored, or created for every acre impacted) is 1:1, 2:1, or 3:1, depending on the type of wetland

impacted. The 3:1 ratio applies to wetlands of special concern to the state. Land acquisition costs

are assessed on the basis of the prevailing market prices for agriculturally zoned or low-density

land that has little potential for development. Restoration and construction costs are assessed at

$10,000 per acre in low-cost counties and $50,000 per acre in high-cost counties. Counties with a

relatively large amount of farmed hydric soils, which indicates the former presence of wetlands,

are placed in the low-cost category. Losses of less than 5,000 square feet of wetlands do not

require mitigation.

In Louisiana, companies are required to offset their damage to coastal wetlands by performing a

mitigation project on their own property or by contributing mitigation fees to the Louisiana

Wetlands Conservation and Restoration Fund. Mitigation fees range from $1,500 to $12,000 per

acre, depending on the environmental quality of the wetland that is lost to development.

The costs, benefits, and incentive effects of wetlands compensation fees have not been

comprehensively studied, and it would be difficult to determine those effects given the varied

functions that wetlands perform. Some evidence suggests, however, that such fees have been
Pollution Charges, Fees, and Taxes

2001 55

beneficial. Clustering individual mitigation activities into selected areas increases the viability of

the wetlands. Moreover, the fact that developers have participated in fee-based schemes suggests

that paying fees is more economical for them than conducting on-site mitigation activities on

their own.

4.8 Grazing Fees

Federal and state governments charge fees for animal grazing on public lands. Federal fees date

back to 1906 and are currently charged for grazing on about 167 million acres of Bureau of Land

Management (BLM) land and 94 million acres of Forest Service land. About 10% of the

livestock producers in the 16 Western states participate in the program. Grazing on BLM land

accounts for approximately 2% of total beef-cattle feed in the 48 contiguous states. Fees are

charged based on a formula that was established by the 1978 Public Rangelands Improvement

Act (PRIA).78 The PRIA formula is based on private grazing rates, beef cattle prices, and the cost

of livestock production. The fee is expressed in animal unit months (AUM), where one AUM is

the amount of forage required to sustain one cow and her calf, one horse, or five sheep or goats

for a month. The fee in 2000 is a minimum of $1.35 per AUM, the same minimum fee imposed

by President Reagan in 1986.79

The theory behind such fees is that animal owners should pay fair market value for the use of the

land and that they should bear the costs of the damage inflicted by their animals on that land.

However, current fee levels are widely believed to be lower than what would be charged if the

grazing rights were being sold by a private owner. That belief is supported by the fact that

properties with attached federal grazing rates command higher market prices than properties

without such grazing rights. Moreover, the fees may not adequately compensate the federal

government for the environmental destruction caused by the movement of privately owned

animals on public lands. To the extent that the fees are too low, they amount to a form of

subsidization. Therefore, they are included in the discussion of environmentally harmful

subsidies in Chapter 7.

4.9 Minnesota Contamination Tax

The Minnesota Contaminated Property Tax, which entered into effect in fiscal year 1995, is

levied on the “contamination value” of property, i.e., the difference in the value of the property

before and after contamination. Owners of contaminated property who do not have approved

cleanup plans pay this fee at the full property tax rate. The contamination tax is halved for

owners who have filed an approved cleanup plan. Owners who purchase contaminated land

without being notified by the seller of the contamination pay 25% of the full property tax rate

until they file a cleanup plan, after which the tax rate decreases to 12.5%. According to a local

tax official, the tax gives property owners “a strong impetus to clean up.”80
The U. S. Experience with Economic Incentives for Protecting the Environment

56 January

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Deposit-Refund Systems

2001 57

5. Deposit-Refund Systems

5.1 Introduction

Deposit-refund systems (hereafter referred to as “deposit systems”) are a

combination of a product charge (the deposit) and a subsidy for recycling or proper

disposal (the refund). Manufacturers or vendors of products that are subject to

deposits incur additional costs in handling returned products, but these costs are often

partially offset by the interest earned on deposits, unclaimed deposits, and sales of

collected, used products.

One of the objectives of a deposit system is to discourage illegal or improper

disposal. Waste products that are discarded improperly have higher social costs than

those disposed of properly, since such discards can become an eyesore or even an

environmental or health threat. Improperly discarded waste is also quite expensive to

redirect to the legal waste stream. Deposit systems are commonly applied to beverage

containers, in part because these containers make up a large proportion of roadside

litter. Another important objective of a deposit system is to divert recyclable items

from the waste stream.

In addition to being used for beverage containers, deposit systems have also been

used for other products such as pesticide containers, lead-acid batteries, and tires.

Some of these systems are voluntarily implemented by industry, whereas others are

implemented by state or local authorities. While federal legislation on deposits has

been considered, none of these proposals has been enacted.

Several studies have concluded that deposit systems are more cost-effective than

other methods of reducing waste disposal, such as traditional forms of regulations,

recycling subsidies, or advance disposal fees (ADF) alone. A recent study by Palmer

et al. (1995) concluded that a 10% reduction in waste disposal would cost $45 per ton

of waste reduced under a deposit system, compared to $85 per ton under advance

disposal fees and $98 per ton under recycling subsidies. However, the study noted

that the relatively high administrative costs of a deposit system could outweigh these

cost savings.

Administrative costs are an important consideration when determining whether to

create deposit systems. Ackerman et al. (1995) estimate that administrative costs

average about 2.3¢ per containermore than $300 per ton for steel containers and

$1,300 per ton for aluminum cansin states with traditional legislation on beverage

container deposit systems. A full accounting of the desirability of deposit-refund

systems would compare administrative costs and the costs imposed on consumers

with the benefits of reduced disposal costs, energy savings, reduced litter, and other

environmental benefits. Deposit-refund systems appear best suited for products

whose disposal is difficult to monitor and potentially harmful to the environment.

When the used product has economic value, the private sector may initiate the

program.
The U. S. Experience with Economic Incentives for Protecting the Environment

58 January

Fullerton and Kinnaman (1995) conclude that fees for waste collection should be priced as if

disposal and recycling are the only two disposal options. If illicit burning or dumping is also an

option, the optimal policy is “a tax on output plus a rebate on proper disposal,” in other words, a

deposit system. While variable pricing programs for waste collection have the potential to give

waste generators an incentive to improperly dispose of waste, deposit schemes give them an

incentive to return waste for proper disposal or for recycling. For example, with beverage

containers, roadside litter is an important issue, so a deposit system is a good policy choice.

As noted in this chapter, studies have found that deposit systems result in higher recovery rates

of used products and less contamination of recyclables than curbside recycling programs.

However, deposit schemes are also believed to cost more to administer than curbside programs.

5.2 Beverage Containers

Beverage containers have been subject to both voluntary and mandatory deposit schemes. In the

past, the beverage industry made extensive use of voluntary schemes to recover refillable bottles.

However, this practice nearly disappeared following the introduction of cheaper “disposable”

containers.

As shown in Table 5-1, 10 states have passed “bottle bills” that mandate beverage container

deposits ranging from 2.5¢ to 15¢ per container, the most common amount being 5¢ per

container. Beer and soft drink containers are subject to deposits in all 10 states; mineral water

containers in six states; malt containers in four states; and wine coolers, liquor, and carbonated

mineral water containers in three states. Michigan includes containers of canned cocktails, New

York includes containers of soda water, and Maine includes containers of juices and tea. In most

states, deposit requirements apply to the full range of container types, including glass, plastic,

aluminum, and steel. The State of Delaware, however, has exempted aluminum from its

requirement.

Most states require retailers to take back containers that are in their product line, even if the

container was purchased elsewhere. In Maine, however, retailers located within a certain

distance of a certified redemption center are not obligated to take back containers. In addition to

retail outlets, “redemption centers” accept containers in most states. Any organization may

operate such centers, although certification of the center may be required. Some redemption

centers and retailers could earn profits from mandatory handling fees of 1.5¢ to 3¢ per container,

fees that are paid by distributors. As shown in Table 5-1, distributors usually keep unclaimed

deposits.

Not included in this table is a deposit system that has been in effect in Columbia, Missouri, since

1982. Under this system, consumers pay deposits of 5¢ on containers of beer, soft drinks, malt,

and carbonated mineral water. Although retail stores are required to take back containers, no

handling fees are mandated. The overall rate of redemption is estimated to be 85% to 95%.

Although it is beyond the scope of this report to describe in detail every deposit system that is

listed in Table 5-1, systems in Maine and California are discussed below as illustrative examples.
Deposit-Refund Systems

2001 59

Table 5-1. State Beverage Container Deposit-Refund Systems

State Since Containers

Covered

Deposit,

Refund

Amounts

% Returned Redemption

Sites

Unclaimed

Deposits

Handling

Fees

California 1987

Beer, soft drinks,

wine coolers,

mineral water

<24 oz, 2.5¢

>24 oz, 5¢

Aluminum 88%

Glass 76%

PET 50%

Overall 84%

State-certified

centers

Program

administration

grants

Per container

processing

fee

Connecticut 1980

Beer, malt, soft

drinks, mineral

water

Minimum 5¢

Cans 88%

Bottles 94%

Plastic 70-90%

Retail stores

and redemption

centers

Kept by

distributor or

bottler

Beer, 1.5¢;

Soft drinks, 2¢

Delaware 1982

Non-aluminum

beer, malt, soft

drink, mineral

water <2qt

5¢ Insufficient data

Retail stores

and redemption

centers

Kept by

distributor or

bottler

20% of

deposit

Iowa 1979 Beer, soft drinks,

wine, liquor 5¢

Aluminum 95%

Glass 85%

Plastic 70-90%

Retail stores

and redemption

centers

Kept by

distributor or

bottler

1¢

Maine 1978

Beer, soft drinks,

wine, wine coolers,

liquor, juice, water,

tea

Beer, soft

drinks, juice:

5¢. Wine,

liquor: 15¢

Beer, soft drink

92%

Spirits 80%

Wine 80%

Juices, noncarbonated 75%

Retail stores

and redemption

centers

Kept by

distributor or

bottler

3¢

Mass. 1983 Beer, soft drinks,

carbonated water 5¢ Overall 85%

Retail stores

and redemption

centers

State 2.25¢

Michigan 1978

Beer, soft drinks,

canned cocktails,

carbonated and

mineral water

Refillables:

5¢;

Nonrefillables

: 10¢

Overall 93% Retail stores

75%

environmental

programs, 25%

handling fees

25% of

unclaimed

deposits

New York 1983

Beer, soft drinks,

wine coolers,

carbonated

mineral water,

soda water

5¢

Wine cooler 63%

Soft drink 72%

Beer 81%

Retail stores

and redemption

centers

Kept by

distributor or

bottler

1.5¢

Oregon 1972

Beer, malt, soft

drinks, carbonated

mineral water

Standard

refillables: 3¢;

Others: 5¢

Overall 85% Retail stores

Kept by

distributor or

bottler

None

Vermont 1973

Soft drinks, beer,

malt, mineral

water, liquor

Soft drinks,

beer: 5¢

Liquor: 15¢

Overall 85%

Certified

redemption

centers and

retail stores

Kept by

distributor or

bottler

3¢

5.2.1 Maine Bottle Deposit System

Maine introduced a deposit system for beer and soft drink containers on January 1, 1978.81 In

distributing beer and soft drinks to retailers, distributors (or manufacturers) levy a 5¢ deposit.

Retailers in turn include this amount in their sales prices. The customer can obtain a 5¢ refund by

returning the container to any retailer that sells the product or to a redemption center.
The U. S. Experience with Economic Incentives for Protecting the Environment

60 January

Distributors (or manufacturers) return the 5¢ deposit to retailers for every returned container. In

addition, retailers are reimbursed a 3¢ handling fee, which provides a strong incentive for

retailers to promote the return of containers. At times, demand by retailers for used containers is

so high that customers can obtain refunds 10% to 20% higher than the deposit amount. In some

places, reverse vending machines also offer refunds for returned containers.

Distributors typically pick up used containers while distributing new products. Distributors (or

manufacturers) have at least three sources of revenue to offset the costs of handling containers.

First, they can sell the collected containers to processors and keep unclaimed refunds and

handling fees. Second, in the past distributors had to share one-half of their unclaimed refunds

with the state government. Distributors then complained about their costs. As a result of their

efforts, distributors were allowed to retain all unclaimed refunds, effective January 1, 1996.82

Third, distributors earn revenue by the interest earned on deposits and handling fees before

redemption.

The deposit system was expanded to include liquor and wine containers on September 1, 1990,

and bottled water, iced tea, and juice on December 31, 1990. This action resulted in new (and

perhaps less cost-effective) types of deposit-refund arrangements. Unlike soft drinks and beer,

several companies in the same geographic area often distribute juice. Consequently, each one

often has difficulty determining which containers it is responsible for collecting. As a result,

some distributors may pay more in refunds than they receive in deposits, while for others,

deposits may exceed refunds. Because distributors fear that they will lose money in collecting

deposits and paying refunds, manufacturers have had to collect deposits themselves and contract

independent collectors to redeem containers. This method may be less cost-effective than

collection by distributors who already travel to collection sites when they distribute new

products.

Two redemption problems have been identified. One, the in-state distribution of containers can

take place without deposit fees being imposed. Second, the in-state redemption of containers that

were originally purchased outside the state also occurs. These errors have resulted in redemption

rates in excess of 100% for certain products. For example, Coca-Cola reported redemption rates

for Minute Maid Juices and Hi-C of 142% in 1993, 281% in 1994, and 126% in 1995. The

same type of bottle deposit fraud is estimated to cost the state of Michigan more than $16 million

per year.83 Nearly one-third of the cans returned for recycling in southeast Michigan were

purchased outside the state.

Retailers have complained that the deposit system (especially the expanded one) requires more

storage space and more time for recordkeeping, receiving bottles and sorting bottles. In addition,

traces of beverages in containers have attracted pests. The administrative burden probably

became more severe following the expansion of the system because significant variations in the

types of juice containers make them more difficult to sort and store.

The deposit system in Maine is reported to have significantly reduced litter. A 1979 study by the

Maine Department of Transportation found that total litter declined by 10% and that container

litter declined by 56%.84 Since completion of the study, the redemption rate rose. Thus, it is

likely that container litter has decreased further. In addition to reducing the incidence of litter,

the deposit system also gave incentives to scavenge bottle and can litter to obtain refunds. The

deposit also may have increased recycling capacity by creating a reliable supply of recyclable

materials. Three container-processing facilities were established in Maine as a result of the
Deposit-Refund Systems

2001 61

deposit system. These facilities can, in turn, stimulate demand for recyclables that are collected

outside the deposit system.

Criner et al. (1991) estimate that the costs of Maine’s deposit system exceed those of curbside

collection programs, but the system also results in higher collection rates. They surveyed

retailers, redemption centers, distributors, and manufacturers to develop cost estimates for the

deposit system. Using a computerized waste management model, Criner et al. estimated that

retailers incurred costs of 2.4¢ to 3.1¢ per container under the original deposit system and

virtually the same costs under the expanded system. The high end of this range applies to smaller

retailers. Based on these estimates, the handling fee of 3¢ per container appears to be set at a

level that covers retailers’ costs. The handling fee was originally one cent, but it rose to 2¢ in

1980 and to 3¢ in 1990.

Criner et al. estimated the costs incurred by distributors at 5.7¢ per container for beer and soda

and 7.5¢ for juice products. (These estimates do not include the costs incurred by consumers in

returning containers for refunds.) Collection costs, storage facilities, and labor can be more

expensive for containers of juice than for other beverage containers. Two reasons for this

difference are suggested: (1) significant Variations in the types of juice containers make them

more expensive than other containers to sort and store; and (2) manufacturers hire companies

specifically to collect used juice containers, which raises costs.

Table 5-2 presents cost estimates for collecting recyclables under curbside programs and deposit

systems for a hypothetical Maine community of 25,000 inhabitants. The estimates are based on

the assumption that curbside collection is present. They suggest that the costs of deposit systems

are not only significantly higher than curbside programs but that they also raise the costs of

curbside collection when the two activities are implemented at the same time. This latter effect is

probably caused by the diversion of recyclable containers away from curbside programs, which

reduces the economies of scale that were present in these programs.

Table 5-2. Beverage Containers: Estimated Tons Recycled and Costs of

Collection in Maine

Collection Method No Deposit System Original Deposit

System

Expanded Deposit

System

Curbside Programs: tons recycled (cost per ton) 2,538 ($41) 1,917 ($80) 1,378 ($100)

Deposit Schemes: tons recycled (cost per ton) 0 1,138 (567) 2,037 (402)

Total: Tons Recycled (weighted average cost per ton) 2,538 (41) 3,055 (261) 3,413 (280)

Source: Criner et al. 1991, p. 50.

A significant portion of the costs of Maine’s deposit system appears to be passed on to

consumers. Criner et al. compared beverage prices in Maine with those of neighboring New

Hampshire, Rhode Island, and Massachusetts. Prices were very similar for juices, which were

not subject to deposits at the time, but they were higher in Maine for soda and beer. As noted in

Table 5-1, Massachusetts has a 5-cent deposit, as does Maine. Criner et al. speculate that the

deposit system in Massachusetts has not resulted in beverage prices that are higher than those of

New Hampshire and Rhode Island. Two reasons may explain this theory. First, distributors in

Massachusetts face more competition than they do in Maine. Second, the state’s population

density limits the cost of handling and transporting used containers.
The U. S. Experience with Economic Incentives for Protecting the Environment

62 January

Criner et al. also found that the prices of most juices sold at two Maine supermarkets increased

during the fall of 1990 to late February 1991. During the same period, the prices of orange juice

in large plastic containers (64−96 oz.)which was subject to deposit requirementsfell

significantly. These findings suggest that expanding the deposit system to include juice

containers an impact on the prices of these beverages. However, the price increases at the two

stores were not compared with price changes elsewhere.

5.2.2 California Beverage Container Recycling Program

The 1986 California Beverage Container Recycling and Litter Reduction Act (AB2020) led to

the creation of the Beverage Container Recycling Program (BCRP) in 1987. The program was

originally intended to achieve an overall beverage container-recycling rate of 80%.

California’s deposit system removes some of the constraints on vendors associated with other

deposit systems. It introduces flexibility through simplification and leaves intact the incentive to

consumers to return containers for proper disposal or recycling. California’s system differs

significantly from that of other states in two ways. First, retailers in the state are not responsible,

for the most part, for collecting deposits and offering refunds to consumers. Second, used

containers are not returned to their original distributors. Instead, manufacturers of most beverage

containers pay a fee of 2¢ per container to a state recycling fund. When containers are returned,

the fund pays 2.5¢ per container to the individual or organization that collected it. The beauty of

this system is that anyone can be a collector: businesses or consumers. For containers of more

than 24 ounces, the fee is 4¢, and the payment is 5¢. The payment may be passed on to

consumers to entice them to return containers.

This system resembles an advance disposal fee, with fee revenues used to provide collection

incentives. It is the result of compromise between various interests, including grocers (who did

not want to manage used containers in their stores) and environmentalists (who wanted

incentives to stimulate recycling).

Retailers with annual revenues of less than $2 million are not required to accept used containers,

and larger retailers can be exempted if there is a recycling center located within a half-mile

radius of their store. In areas where there are no centers, retailers usually hire a recycling

business to establish a collection site or to install a reverse vending machine.

The state also assesses handling fees each year for each type of container. Manufacturers are

required to either pay these fees or to guarantee a price for recyclable containers that is equal to

the cost of collection. These requirements have increased the prices of recyclable containers in

the state to the point at which incentives are provided to import these containers from other

states. The law bans redemption for such imports.

In 1994 and 1995 the BCRP received about $333 million in revenues. However, this figure fell in

the next few years because reductions in processing fees were required by 1995 legislation and

container redemption increased. Unclaimed deposits and fees finance grants for private, nonprofit programs and public-sector activities that help reduce litter and promote recycling.

Like all other states with deposit systems, California has specific labeling requirements for its

beverage containers. All containers must bear the label “CA Redemption Value” or “California

Redemption Value.” To increase the public’s awareness of the deposit system, the redemption

value must be posted separately on store shelves, in advertising, and on retailer invoices.
Deposit-Refund Systems

2001 63

The BCRP required that a government structure be created to manage the program. Initially, the

program generated relatively low return rates. By the early 1990s, however, after the initial onecent container fee had been more than doubled, the program had achieved return rates

comparable to those of other states with deposit systems. As shown in Table 5-1, the overall

recycling rate for beverage containers has risen to 84%.

Ackerman et al. (1995) observe that California’s redemption system results in lower costs per

redeemed container than systems in which redemption is managed through vendors. Containers

are not sorted by brand and returned to their distributors as in other states. As a result,

administrative costs are estimated at 0.2¢ per container in California and 2.3¢ in other states with

deposit-refund laws.

5.2.3 Summary of Beverage Deposit/Refund Systems

Although data are incomplete, anecdotal evidence suggests that beverage container deposit laws

have significantly reduced litter in several states, as would be expected. Maine reported

decreases in litter following the introduction of its deposit scheme. Oregon reported a 75% to

85% decrease in roadside litter just two years after enacting deposit legislation.

Another probable impact has been an increase in the percentage of containers recycled, although

this is difficult to confirm due to a lack of historical data on recycling. Wellman, Inc. (1994)

estimate that the percentage of PET containers recycled in 1993 was about 80% in states with

deposit systems (excluding California), 70% in California, but only 53% nationally. A 1990

GAO study found that almost two-thirds of the glass recycled in the United States. came from

the deposit states, excluding California, even though these states made up only 18% of the U.S.

population. If California is included, the 10 states accounted for more than 80% of this country’s

recycled glass. All deposit states also report return rates on aluminum cans that exceed the

national average.

A related phenomenon is the relatively high market share for refillable containers in states with

deposit schemes. In the case of beer containers, for example, all nine deposit states (excluding

California) exceed the national average for market share of refillables. McCarthey (1993)

calculated that the unweighted average for these nine states was 15% in 1990, which was three

times the national average.

A comparison of deposit systems and curbside recycling programs by McCarthey (1993) found

that deposits generally resulted in higher percentages of materials returned and less

contamination of collected materials. Among states with large curbside programs but no deposit

systems, the study found that none had attained a recovery rate equal to that of states with

deposit schemes. Moreover, glass collected through curbside programs is much more likely to

break before it can be sorted by color. Such breakage makes it difficult to recycle not only glass

bottles but also other recyclables that may be contaminated with glass. The largest user of

recycled polyethylene terephthalate reported that more than 90% of the PET it purchased came

from states with deposit schemes because of its concerns over contamination.

The costs of deposit systems may be substantial for manufacturers, distributors, vendors,

consumers, and regulatory authorities. One study found California’s system to be more costeffective than those in which retailers accept redeemed containers. Deposit systems could also

divert revenues from, and lower the cost effectiveness of, curbside recycling programs. However,

McCarthey (1993) found evidence suggesting that “local governments would achieve a greater
The U. S. Experience with Economic Incentives for Protecting the Environment

64 January

diversion of solid waste from disposal at a lower cost per ton if both a bottle bill and a curbside

collection program were in place.” One difference between the two approaches is that the costs

of deposits are borne by manufacturers and distributors, who in turn pass on some costs to

consumers, whereas the curbside programs are often funded by general revenues or waste tipping

fees. Lack of information on the costs and benefits of litter reduction and recycling and on the

costs incurred by consumers in returning containers makes it difficult to thoroughly evaluate

beverage container deposit systems.

5.3 Lead-Acid Batteries

Lead-acid batteries are subject to mandatory deposit systems in several states and voluntary

deposit systems in most other areas. The lead in used batteries has positive economic value for

battery makers. Deposit amounts are typically $5 to $10 per battery. Consumers can obtain

refunds by returning a used battery and proof of the deposit to the same retailer, typically within

7 to 30 days after the purchase of a new battery.

Despite the presence of numerous voluntary schemes, 11 states have required deposit systems.

As shown in Table 5-3, state laws have addressed such questions as the refund period and what

portion of unclaimed refunds should go to different parties.

Table 5-3. States with Mandatory Lead-Acid Battery Deposit Systems

State Deposit/Refund ($) Unclaimed Refunds Refund Period (days)

Arizona $5 Retailer 30

Arkansas 10 Retailer 30

Connecticut 5 Retailer 30

Idaho 5 Retailer 30

Maine 10 Retailer 30

Minnesota 5 Retailer 30

New York 5 Retailer 30

Rhode Island 5 State: 80%, Retailer: 20% 7

South Carolina 5 Retailer 30

Washington Minimum of 5 Retailer 30

Source: Weinberg, Bergeson & Neuman. 1996.

As with beverage containers, deposit systems for lead-acid batteries appear likely to have a

significant incentive effect because they offer motorists money in return for a used product. As

shown in Figure 5-1, the percentage of battery lead that has been recycled nationwide has

exceeded 90% since 1988. Lead prices appear to affect the recycling rate to a minor extent; the

dip in the recovery rate in 1992−1993 coincided with a period of low prices for primary and

secondary lead. (Scrap lead prices can be found at several sites on the Internet.85)

5.4 Maine Pesticide Container Deposit System

The discovery of more than 400 illegal disposal sites in Maine led state authorities to initiate a

deposit system for pesticide containers in 1985. The rule applies to all limited-use and restricteduse pesticides sold in glass, metal, or plastic containers, a category that consists mainly of

conventional agricultural and forestry applications. Deposit amounts are $5 for containers with

less than a 30-gallon capacity and $10 for larger containers.
Deposit-Refund Systems

2001 65

Farmers must rinse containers three times before returning them for refunds. Containers found to

have significant traces of pesticides are not accepted for refunds. Collections are made at

designated points once a year according to publicized schedules. Pesticide dealers arrange to

have container-shredding equipment at the collection sites. According to the Maine Board of

Pesticides Control, the deposit system has played a significant role in reducing the incidence of

improper container disposal.86

In 1985, the first year that the deposit system operated in Maine, Board of Pesticides Control

staff inspected all 7,055 containers that were turned in. Had these containers simply been drained

rather than properly rinsed, 429 pounds of active ingredient would have been deposited into

landfills. Since the containers were triple-rinsed and therefore were 99.998% clean, only 0.05

pounds of active ingredient was sent to landfills that year.87 Published reports on the Maine

pesticide container deposit system do not discuss the consequences of transferring pesticide

residues to wastewater systems.

It is possible that pesticide

residues are managed in a more

environmentally sound manner

when they move through

wastewater management systems

than when they are sent to

landfills.

One problem with the deposit

system is that it does not apply to

general-use pesticide containers,

which are far more numerous

than containers for restricted-use

and limited- use pesticides. One

reason why general-use products

are not included in the system is

that inspecting them would

require significantly more

resources than are available at present. For a similar reason, a few larger states have considered a

program similar to Maine’s, but they have concluded that they would not be able to inspect a

large number of containers.

5.5 Other Products

Since 1988, Rhode Island has required $5 deposits on all types of replacement vehicle tires.

Customers can recover their deposits by returning old tires within 10 to 14 days after they

purchase new tires. Their refund payments are limited to one tire for every tire purchased, and

the refunds can be obtained only at the point-of-sale of the new tire. In addition to the deposit,

Rhode Islandalong with most other statesimposes product charges on tires to finance the

cleanup of piles of old tires.

Outside the United States, deposit systems have been applied to car hulks, light bulbs, lubricating

oil, and other products. An earlier EPA report by Anderson and Lohof (1997) describes several

of these systems.

Figure 5-1. Lead Recovery from Lead Acid

Batteries

80

82

84

86

88

90

92

94

96

98

100

1987 1989 1991 1993 1995 1997

Year

Percent Recycled

Source: Smith, Bucklin and Associates.
The U. S. Experience with Economic Incentives for Protecting the Environment

66 January

5.6 Voluntary Deposit Systems

In addition to lead-acid batteries, a few other products are subject to deposit schemes that are

voluntarily operated by industry. Among such products are large paper drums, beer kegs,

propane gas containers, and, in some areas, beer bottles and pesticide containers.

5.7 Performance Bonds

Performance bonds are fees levied upon companies that extract certain natural resources, such as

timber, coal, oil, and gas. Amounts deposited with the performance bond can be refunded when

the payer fulfills certain obligations. In that sense, a performance bond acts like a deposit-refund

system.

An example of an environmental issue that has been addressed with the use of performance

bonds follows. The Surface Mining Control and Reclamation Act (SMCRA) of 1977 requires the

purchase of performance bonds before surface coal mining and reclamation permits can be

obtained.88 The amounts are determined by the regulatory authority, which can be either the state

authority or the U.S. Department of the Interior. The fee amount depends on the reclamation

requirements that are specified in the permit; the anticipated difficulty of reclamation due to

factors such as topography, geology, hydrology; and the revegetation potential of the site.

SMCRA requires that the amount charged be sufficient to finance reclamation by the regulatory

authority in case the company forfeits its deposit. The minimum amount is $10,000 per permit

area. Deposit amounts are adjusted as mined areas increase or decrease and as estimates of

reclamation costs change.

Although such performance bonds give companies an economic incentive to reclaim mining

sites, they are backed up by a regulatory requirement that is specified in a permit. The

reclamation requirement may have more of an incentive effect than the deposit, since a firm’s

ability to obtain leases in the future is dependent in part on satisfying today’s regulatory

requirements.

Federal and state governments also use performance bonds to influence environmental

management by the timber industry and oil and gas operators.
Trading Programs

2001 67

6. Trading Programs

Crocker and Dales generally are credited with first proposing that marketable

emission permits be used as an incentive mechanism for achieving environmental

goals.89 The basic approach outlined by Crocker and Dales and later refined by

Dewees and Harrison is that the environmental authority can issue a fixed number of

marketable permits to release emissions.90 Through trading, low-cost sources will sell

some of their permits and abate more than they would under a traditional regulatory

approach, while high-cost sources will buy permits and abate less. The end result,

according to the academic design, is the same amount of pollution reduction that

would be achieved through traditional regulatory approaches, but it is achieved at

lower cost.

EPA first applied the concept of marketable emission permits in the mid-1970s as a

means for new sources of emissions to locate in non-attainment areas without

causing air quality to worsen. New sources and existing sources that wanted to

expand their facilities were required to offset their emissions by acquiring emission

reduction credits from existing sources. This important but modest beginning was

based on an interpretation of the Clean Air Act, rather than on a specific statutory

authority. EPA’s Offset Policy was included in the 1977 amendments to the Clean

Air Act statute. In 1980, then-Administrator Hawkins signed a memo that allowed

emission averaging between can-coating lines.91

On August 7, 1980, EPA promulgated New Source Review (NSR) and Prevention of

Significant Deterioration (PSD) rules that allowed netting, a means for sources to

avoid PSD and NSR requirements for emission increases due to facility expansion, if

emissions were decreased contemporaneously elsewhere at the facility.92 Under the

PSD mandate, this rule included facilities within a plant as a source of emissions as

well as an entire plant as a source of emissions, in what was termed a “dual-source

definition.” Chevron and others challenged this rule, claiming it made modernization

too difficult. Eventually the U.S. Supreme Court agreed that states did not need to

include the dual-source definition in their non-attainment rules. This opened the door

to many of the emission trading programs that exist today.

The 1990 Clean Air Act Amendments authorized a variety of emission trading

systems. While similar statutory authority to establish effluent permit trading systems

does not exist, EPA believes that the Clean Water Act allows effluent trading.

Programs of this sort have been operational for several years without legal

controversy. Pollution permit trading systems now come in a wide variety of forms,

and they apply to a large and growing number of sources of pollution that affect the

quality of air, water, and land.

Insofar as trading between economic entities is concerned, two main forms of trading

systems are observed: (1) uncapped emission (or effluent) reductions credit (ERC)

systems, and (2) capped allowance systems (also referred to as cap-and-trade

systems). In the case of uncapped systems, pollution limits are rate-based (e.g.,

grams per mile for motor vehicles), and sources earn credits by releasing less

pollution than their legal limit or other defined baseline. Under these systems,
The U. S. Experience with Economic Incentives for Protecting the Environment

68 January

emissions can increase with economic growth. By contrast, with capped systems, total emissions

are limited by an overall ceiling that is designed to achieve health or environmental goals, and

allowances are allocated to sources in quantities consistent with this ceiling. The formula for

making such allocations will vary from one situation to the next.

A number of the programs described in this chapter involve the right to average emission

characteristics of a slate of similar products that are manufactured by one economic entity.

Emission averaging is an important mechanism for improving the cost effectiveness of

environmental regulation. It can be characterized as intra-firm trading across the product lines

where it is allowed.

Trading systems, properly designed and applied in appropriate circumstances, can cut

compliance costs, encourage technological development, and create incentives for achieving

environmental benefits beyond minimum requirements. For trading systems to function well, a

number of requirements must be satisfied. There should be several potential participants in trades

if a functioning market is to be created. Exactly how small a universe of potential participants

there can be and still have a functioning market is difficult to say, but simulation experiments

suggest that 8−10 participants is a reasonable estimate.93 If sources are dispersed geographically,

trading ratios other than one-to-one might have to be imposed to account for wind direction or

the distance between sources to ensure no degradation in environmental quality.

Some pollutants are seasonal in their impact, implying that trades might be allowed only during a

portion of the year. Trading might be limited because of a desire to avoid “hot spots” where

pollution concentrations increase. Trading requires that pollution control agencies have the

ability to monitor emissions (or measure a surrogate to those emissions) reasonably well. The

need to ensure accountability of trades must not pose unacceptably high transaction costs. The

commodity to be traded needs to be defined. In general, a well-defined commodity requires a

baseline from which to calculate the emission reduction credits (or allowances) that may be

traded. Establishing baselines is likely to require good historic data on emissions, input use, etc.

In the case of allowance systems, the political will must exist to achieve an allocation of

allowances among competing interests.

Cap-and-trade systems to date have allocated most or all of the allowable emissions under the

cap to existing sources, providing allowance set-asides for new sources or using auctions as a

safeguard to ensure access to allowances. Initially, environmentalists opposed marketable permit

trading because the existence of trading was evidence that sources could make greater reductions

in pollution than were being achieved. In addition, there has been a lingering concern that trading

could result in localized “hot spots” that had undesirably high levels of pollution. With the

success of the Regional Clean Air Incentives Market (RECLAIM) and the Acid Rain Program

described later in this chapter, marketable permit trading has become more accepted as a costeffective means of achieving many environmental goals.

On the other hand, attempts to establish new trading programs often encounter controversy. For

example, some citizen groups have opposed trading programs for ozone-forming volatile organic

compounds (VOCs). They based their opposition on two basic concerns: (1) the possibility of

localized toxic pollution “hot spots,” or (2) the ability of the source (or EPA for that matter) to

reliably measure emissions to ensure that participants would be held accountable. EPA, in

consultation with environmental justice groups and other stakeholders, is working on guidance

for addressing these environmental justice concerns with trading.
Trading Programs

2001 69

The scope of trading systems is considerable. An emission trading proposal is a centerpiece of

the Kyoto Protocol for controlling greenhouse gas emissions. Certain Colorado communities

have created programs to trade the right to own and operate a wood burning stove or fireplace.

For a number of years, there was an active program under which refiners could trade lead that

was used as an additive in gasoline. Heavy-duty truck manufacturers can meet engine emission

standards by averaging together the emissions performance of all the engines they produce.

Programs to trade effluents are operating in selected locations. These particular programs are

likely to be expanded significantly in coming years as a result of a new EPA initiative to improve

water quality in polluted rivers and lakes. Developers whose activities would cause the loss of

wetlands can satisfy mitigation requirements in some areas by purchasing credits from a wetland

mitigation bank.

These and other trading systems for air, water, and land are described in this chapter. The

discussion begins with a review of trading programs in air emissions, followed by sections on

water effluent trading, land development, and, finally, international trading programs in which

the United States is involved.

A few basic parameters may be used to characterize trading systems:

1. Scope. Is trading restricted to averaging within a single facility, allowed among facilities

owned by the same firm, or allowed among firms or facilities under different ownership?

2. Cap. Is there a limit on total emissions or on effluents?

3. Commodity Being Traded. How will the commodity be defined: As allowances for future

pollution, as credits for quantifiable reductions in pollution, as emission characteristics of

products, as rights to own and operate products themselves, or as some other definition?

4. Distribution of Tradable Permits. Are the tradable certificates auctioned to the highest bidder,

or are they grandfathered to existing sources?

5. Trading Ratio. Is the required trading ratio 1:1 or some greater ratio? Does the trading ratio

depend on the respective location of the sources, season of the year, or other factors?

6. Banking. Can tradable certificates be banked or otherwise reserved for future use?

7. Monitoring. How is credit generation and trading monitored?

8. Environmental Benefit. Is a “set-aside” for the benefit of the environment built into the trading

system? For example, each trade could be debited by 10% to yield an environmental benefit.

6.1 Trading in Clean Air Act Programs: An Overview

Since 1990, EPA has significantly expanded the use of trading in Clean Air Act programs.

Today, emissions trading is a standard tool of EPA’s air quality program. Although not a

panacea for every situation, trading is being used by EPA and states to help solve a variety of air

pollution problems. A broad overview of these programs follows. (Some of these programs are

discussed in detail later in this chapter.)

Acid Rain: Perhaps the best-known example of trading is the Acid Rain Program’s system of

marketable pollution allowances for sulfur dioxide emissions for electric utilities. Enacted as part

of the Clean Air Act Amendments of 1990, this cap-and-trade program has been highly

successful at achieving cost-effective emissions reductions. The first phase of the program,
The U. S. Experience with Economic Incentives for Protecting the Environment

70 January

which took effect in 1995, reduced annual emissions by 4 million tons. Since then,

measurements have shown that rainfall in the eastern United States is as much as 25% less

acidic, some ecosystems in New England are showing signs of recovery, and ambient sulfate

concentrations have been reduced, thus benefiting public health. The second phase of the

program, beginning in 2000, will more than double the annual emissions reductions achieved by

the first phase over time. The annual cost of the program, once it is fully implemented, is

expected now to be approximately $2 billion, which is about one-half the cost that EPA had

originally estimated.

Smog and Other Common Pollutants: EPA is working with states to promote trading and other

market-based approaches to help achieve national air quality standards for smog, particulates,

and other common pollutants that are regulated through national air quality standards. In

addition, EPA has provided trading opportunities in virtually all federal rules that are aimed at

cutting emissions from motor vehicles and fuels. These federal measures are essential to helping

states meet federal air quality goals.

Under the Clean Air Act, states have primary responsibility for devising pollution control

strategies for local areas, so states can meet national air quality standards. EPA has issued

guidance to assist states in designing trading and other economic incentive programs, including

economic incentives rules and guidance in 1994 (which, at present, are being revised); general

guidance on State Implementation Plans (SIPs) in 1992; and the 1986 emissions trading policy

statement. EPA also has assisted states in setting up trading programs, such as California’s

RECLAIM cap-and-trade program for sulfur dioxide and nitrogen oxides and the Ozone

Transport Commission’s (OTC) program for controlling nitrogen oxide emissions among states

in the Northeast. Through a unique partnership, EPA and the OTC states are jointly

implementing this NOx budget system for the Northeast, which draws on the experience of the

acid rain program.

In 1998, EPA issued a rule that established NOx budgets for many states (the “NOx SIP call”) to

combat the problem of transported ozone pollution in the eastern United States on a broader

scale. To encourage an efficient market-based approach to reducing NOx on a regional basis,

EPA simultaneously provided states with a model cap-and-trade rule for utilities and large

industrial sources. The experiences of the acid rain program and the OTC effort show that this

approach holds the potential to achieve regional NOx reductions in an efficient and highly costeffective manner.

In the 1990 Clean Air Act Amendments, Congress called for EPA to help states meet their air

quality goals by issuing federal standards to cut emissions from cars, trucks, buses, many types

of non-road engines, and fuels. These rules cut toxic air pollution as well as reduced the amount

of air pollutants, which were regulated through air quality standards.

EPA has provided trading opportunities in virtually all of these new standards, building on the

early success of trading in the phased reduction of lead in leaded gasoline during the 1980s.

These standards include rules for cleaner burning reformulated gasoline, which now accounts for

approximately 30% of the nation’s gasoline, and the national low-emission vehicle standards for

cars and light-duty trucks that will be met nationwide by 2001. Opportunities for averaging,

trading, and banking also are provided by new national emissions standards for heavy-duty

trucks and buses, locomotives, heavy-duty off-road engines such as bulldozers, and small

gasoline engines (e.g., those used in lawn and garden equipment).
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2001 71

Another recent example is the landmark Tier II/gasoline sulfur rule that President Clinton

announced in December 1999. This rule would provide compliance flexibility to both vehicle

manufacturers and fuel refiners by allowing them to use averaging, banking, and trading. to In

the case of automakers, EPA created different “bins” of emissions levels, rather than require a

single NOx emissions standard for each vehicle model. EPA required automakers to achieve a

fleet average emissions rate of 0.07 grams of NOx per mile (gpm). Automakers whose fleet

average is below 0.07 gpm could generate credits that they could either use in a later model year

or sell to another auto manufacturer. This rule does allow the production of certain higher

polluting vehicles that consumers desire. However, it also provides a strong incentive for the

industry to develop technology well beyond the 0.07 gpm standard, since any higher polluting

vehicle will have to be offset by a lower polluting one.

Industrial Air Toxics: The 1990 Clean Air Act Amendments called on EPA to establish

national emissions standards to control major industrial sources of toxic air pollution. EPA has

used emissions averaging as one of several ways to provide compliance flexibility in these

industry-by-industry standards. For example, emissions averaging is permitted by national air

toxics emissions standards for petroleum refining, synthetic organic chemical manufacturing,

polymers and resins manufacturing, aluminum production, wood furniture manufacturing,

printing and publishing, and a number of other sectors. To avoid shifting risks from one area to

another, toxics averaging is allowed only within individual facilities. With appropriate

safeguards, EPA also has used other methods, including multiple compliance options, to help

provide flexibility in complying with air toxics rules.

Ozone Layer Depletion: In gradually phasing out the production of chemicals that harm the

stratospheric ozone layer, EPA is giving producers and importers the flexibility to trade

allowances. Under the Montreal Protocol, the United States and other developed countries agreed

to stop producing and importing CFCs (chlorofluorocarbons) and other chemicals that are

destructive to the ozone layer. By 1996, production of the most harmful ozone-depleting

chemicals, including CFCs, virtually ceased in the United States and other developed countries.

Additional chemicals are to be phased out in the future. Provided the United States and the world

community maintain their commitment to planned protection efforts, the stratospheric ozone

layer is projected to recover by the middle of the 21st century.

The phase-out of these chemicals is being achieved by using trading rules developed by EPA,

rules that have served as a model for programs in other countries. In part because of the flexible

market-based approach, the phase-out of CFCs was much less expensive than predicted. In 1988,

EPA estimated that a 50% reduction of CFCs by 1998 would cost $3.55 per kilogram. In 1993,

the cost for a 100% phase-out by 1996 was reduced to $2.45 per kilogram.

6.2 Foundations of Air Emissions Trading

The first trading of permitted rights to release any type of pollutant in the United States began in

the 1970s as a mechanism to allow economic development in areas that failed to meet ambient

air quality standards. EPA gradually broadened the offset policy to include emission bubbles,

banking, and netting. These programs are described in the following paragraphs. While many of

the achievements are modest, EPA’s early efforts in emissions trading are important because

they provided a foundation and valuable practical experience for the development of more

effective and cost-effective trading programs such as the Acid Rain Program.
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6.2.1 Offset Program

In the mid-1970s, the EPA proposed the “offset” policy that permitted growth in non-attainment

areas, provided that new sources install air pollution control equipment which met Lowest

Achievable Emission Rate (LAER) standards. These sources also had to offset any excess

emissions by acquiring greater emission reductions from other sources in the area. Through this

process, growth could be accommodated while maintaining progress toward attaining national

ambient air quality standards.

Of more than 10,000 offset trades (a few of which are described later in this section), over 90%

have been in California. Nationwide, about 10% of offset trades are between firms; the

remainder are between sources owned by the same firm. Most offset credits are created as a

result of all or part of a facility being closed.

The offset policy, which was included in the 1977 amendments to the Clean Air Act, spawned

three related programs: bubbles, banking, and netting. The common element in these programs is

the Emission Reduction Credit (ERC), which is generated when sources reduce actual emissions

below their permitted emissions and apply to the state for certification of the reduction. To be

certified as an ERC, the state must determine that the reduction meets the following criteria: (1)

that the reduction is surplus in the sense of not being required by current regulations in the State

Implementation Plan (SIP); (2) that it is enforceable; (3) that it is permanent; and (4) that it is

quantifiable. ERCs are normally denominated in terms of the quantity of pollutant in tons

released over 1 year. By far the most common method of generating ERCs is closing the source

or reducing its production. However, ERCs also can be earned by modifying production

processes and installing pollution control equipment. Trades of ERCs most often involve

stationary sources, although trades involving mobile sources are permitted. States have approved

a variety of activities that sources may use to generate offset credits. The South Coast Air

Quality Management District (SCAQMD) in California, for example, accepts the scrapping of

older vehicles and lawn mowers as a means of generating credits. It then applies a formula to

determine the magnitude of air pollution credits for each old car that is scrapped.94

The offset, banking, and netting programs and bubble policy were subject to numerous revisions

before being incorporated into EPA’s Final Emission Trading Policy Statement, which was

issued in 1986.95 The Policy Statement addresses trading of ERCs for criteria pollutants such as

sulfur dioxide, nitrogen oxides, particulate matter, carbon monoxide, and volatile organic

compounds (VOCs) that contribute to the formation of ground-level ozone. The final policy

statement responded to public comments that pollutant trading could cause environmental

damage unless accompanied by safeguards, such as trading ratios greater than 1:1and the use of

air quality modeling in some cases).

6.2.2 Bubble Policy

The bubble policy, established in 1979, allows sources to meet emission limits by treating

multiple emission points within a facility as if they face a single aggregate emission limit. The

term bubble was used to connote an imaginary bubble over a source such as a refinery or a steel

mill that had several emission points, each with its own emission limit. Within the “bubble,” a

source could propose to meet all of its emission control requirements for a criteria pollutant with

a mix of controls that is different from those mandated by regulationsas long as total emissions

within the bubble met the limit for all sources within the bubble. A bubble can include more than
Trading Programs

2001 73

one facility owned by one firm, or it can include facilities owned by different firms. However, all

of the emission points must be within the same attainment or non-attainment area.

Bubbles must be approved as a revision to an applicable State Implementation Plan (SIP), a

factor that has discouraged their use. Prior to the 1986 final policy, EPA approved or proposed to

approve approximately 50 source-specific bubbles. EPA approved 34 additional bubbles under

EPA-authorized generic bubble rules. The EPA-approved, pre-1986 bubbles were estimated to

save $300 million over conventional control approaches. State-approved, pre-1986 bubbles saved

an estimated $135 million.96 No estimates are reported for the number of, or savings from, post1986 bubbles. By design, bubbles are neutral in terms of environmental impact.

6.2.3 Banking

EPA’s initial offset policy did not allow the banking of emission reduction credits for future use

or sale. EPA contended that banking would be inconsistent with the basic policy of the Clean Air

Act. But without a provision for storing or banking ERCs, the policy encouraged sources to

continue operating dirty facilities until they needed credits for internal use. New and expanding

firms without internal sources of ERCs had to engage in lengthy searches for other firms that

were willing to create and supply credits.

The offset policy in the 1977 amendments to the Clean Air Act included provisions for the

banking of emission reduction credits for future use or sale. Although the EPA approved several

banks, there was limited use of the provision, most likely because of the uncertain nature of the

banked ERC. In 1980, EPA determined that an ERC is not an absolute property right and that

communities must have the option of modifying the use of ERCs, including the debiting of part

or all of the banked ERCs.97 A 1994 report identified 24 emission banks; some limited ERCs to a

life of as little as 5 years.98 Since that date, the number of banks has remained stable. Most of the

banks provided a registry to help buyers of ERCs find potential sellers. Some states debit a

percentage of each ERC deposit for use by the state to attract new industry or to meet anticipated

SIP requirements.

6.2.4 Netting

Netting, the final component of EPA’s 1986 emission trading policy statement, dates from 1980.

Netting allows sources undergoing modification to avoid new source review if they can

demonstrate that plant-wide emissions do not increase significantly. Netting is the most widely

used of these early emission trading programs. Hahn and Hester (1989) estimate that between

5,000 and 12,000 sources have used netting.

In each application, netting is designed to have no significant impacts on environmental quality.

However, with a large number of netting transactions, a modest adverse impact might ensue. The

total savings in control costs from netting are difficult to estimate because the number of

transactions is not known precisely, and the cost savings from individual transactions can be

highly variable.

Cost savings can arise in three ways. First, netting may allow a firm to avoid being classified as a

major source, under which it would be subject to more stringent emission limits. Reductions in

control costs in such a case would depend upon the control costs and emission limits that the

firm must satisfy after netting. One source estimated that netting typically results in savings

between $100,000 and $1 million per application (indicating aggregate savings of $500 million
The U. S. Experience with Economic Incentives for Protecting the Environment

74 January

to as much as $12 billion).99 Second, the aggregate cost savings from avoiding the cost of going

through the major source permitting process could range from $25 million to $300 million.

Third, additional savings could arise from avoiding construction delays that are caused by the

permitting process.

On April 3, 1996, EPA’s Office of Air and Radiation announced a series of proposed revisions to

new source regulations. These revisions were expected to reduce the number of permitting

actions that new sources and sources undergoing changes must take by more than one-half.

Because the proposal shares many of the features of netting, it is described here. The proposed

regulations would allow sources to use plant-wide limits. They would also provide exemptions

for pollution prevention activities and so-called “clean” emission sources in a facility.

Under the proposal, sources making changes could avoid new source review requirements by

establishing a plant-wide cap on emissions. (In general, this cap would be the source’s maximum

potential emissions.) Process changes could be made as long as the changes did not result in an

increase in emissions beyond the cap.

6.2.5 Evaluation of Early Emission Trading Activities

With data from offset transactions in the Los Angeles area, Foster and Hahn (1995) provide the

most comprehensive evaluation of the original emissions trading program. The South Coast Air

Quality Management District (SCAQMD) provided data on trading activity, some of which are

reproduced in Table 6-1. The large increase in offset transactions in 1991 and 1992 reflects

activity at two special funds created by the SCAQMD in 1991: the Community Bank, which

serves small sources producing less than 2 tons per year; and the Priority Reserve, which secures

credits for essential public services.

Table 6-1. Emission Trading Activity in the Los Angeles Area

YEAR OFFSETS NETTING TOTAL

pre-1977 ... 5 5

1977 ... 30 30

1978 ... 34 34

1979 ... 72 72

1980 ... 129 129

1981 ... 238 238

1982 ... 210 210

1983 ... 258 258

1984 ... 256 256

1985 7 235 242

1986 27 432 459

1987 24 329 353

1988 55 358 413

1989 30 352 382

1990 53 394 447

1991 2,208 155 2,363

1992 3,678 77 3,755

Note: Trading activity is based on the number of trades reported to SCAQMD.

Source: Foster and Hahn (1995).
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2001 75

During the period 1985−1992, over 10,000 tons of pollutants were traded in the offset program,

with total expenditure on ERCs estimated to be on the order of $2 billion. (This figure indicates

an average price for traded pollutants of about $200 per ton.) Nearly three-quarters of the trades

involved reactive organic gases (SCAQMD terminology for a subset of volatile organic

compounds), but there also were trades in CO, NOx, PM, and SO2.

AER*X, a broker in the Los Angeles offset market, supplied data for prices for over 40 of the

trades from 1985 to 1992. The minimum price per ton in trades of reactive organic gases (ROG)

fluctuated in the $40-per-ton range over this period, while the minimum value for NOx trades

was about $120 per ton. High prices for ROG increased steadily over the period, from $135 per

ton to $711 per ton; and high NOx prices increased from about $320 per ton to $655 per ton over

the same period.

For a variety of reasons, one would not expect all tons of ROG or NOx to be valued identically.

First, the markets are imperfect, and information on historic trades is not widely disseminated.

Second, credits that have been banked involve additional costs to the selling party. Third, offset

ratios vary with the distance and location of parties to the transaction. The low end of prices

could be determined largely by transaction costs to the seller (thought to be a minimum of

$10,000 per transaction). In a few cases, transaction costs apparently exceeded the market value

of the credits that were exchanged. Although the highest and average prices increased over the

period, most of the change in 1991 can be attributed to a change in SCAQMD rules in the prior

year. None of the observed prices remotely approach the typical incremental control costs for

ROG and NOx in the Los Angeles area over that period: on the order of $5,000 per ton for ROG

and $8,000 per ton for NOx.

ERC emission trading has not lived up to expectations; trades have been fewer and offset prices

lower than many had expected. Several factors seem to have limited the appeal of the emissions

trading policy. In order to assure that air quality did not deteriorate, state environmental

administrators often required expensive air quality modeling prior to accepting proposed trades

between geographically separated parties. Deposits to emission banks typically were “taxed” by

the air quality management authority to meet state SIP requirements or to generate a surplus that

the area could offer to attract new firms. Offset ratios greater than unity further depressed the

value of ERCs. In many areas, it appears that ERCs had an economic value less than the

transaction costs of completing a sale to another party.

In other respects, the emission trading program revealed the myriad possibilities for emission

trading and many of the features that would be necessary to make trading viable. It served as the

foundation for the enormously successful lead credit trading program and for many of the

emission trading features of the 1990 Clean Air Act Amendments. States also have learned from

the experience.

A number of states have redesigned their offset programs as trading programs without emission

caps. (Examples include Delaware, Massachusetts, Michigan, New Jersey, Texas, and

Wisconsin.) The Los Angeles area has developed a much more significant trading initiative

known as “RECLAIM,” with an emissions cap and phased reductions in the allowable emissions

of SO2 and NOx. (The RECLAIM initiative is described in more detail later in this chapter.)

Illinois recently developed a similar program with an emissions cap.
The U. S. Experience with Economic Incentives for Protecting the Environment

76 January

6.3 Acid Rain Allowance Trading100

An early solution to mitigate local air pollution that was caused by sulfur dioxide (SO2) and

nitrogen oxide (NOx) emissions from power plants was to build tall stacks to disperse pollutants

away from populated areas. This strategy led to large increases in regional pollution

concentrations and concerns about potential ecological damage. Coal-burning electric generating

units built after 1970 were limited to 1.2 pounds of SO2 per million Btu (British Thermal Units).

By 1977, new plants were forced to meet a percent-reduction requirement in addition to the 1.2-

pound limit. However, older coal-burning units continued to emit pollutants at much higher

ratesup to 7 pounds of SO2 per million Btus—and to operate far beyond their original design

lives because of the high cost of building new units.

By the 1980s, studies began to demonstrate probable harm to lakes and forests, agricultural

crops, materials, and visibility from the long-range transport of sulfates and nitrates formed from

SO2 and nitrogen oxide emissions. Studies also revealed that the acidification of soils and waters

could release heavy metals and aluminum that were previously bound in soils. Further, increased

atmospheric levels of sulfate and nitrate pose a risk to human health.

In Title IV of the Clean Air Act Amendments of 1990, Congress created the Acid Rain Program

to address both wet and dry acidic deposition by cutting national SO2 emissions from power

plants by approximately 50%. Costs of compliance were estimated in the range of $5 billion per

year. At that time, quantifiable economic benefits were believed to be lowerin the range of $1

billion per year.101 Actual costs have been far less and associated benefits have been far greater,

as further explained in this last paragraph of this subsection.

Title IV also sets allowable limits on NOx emissions from utility boilers by placing limits on

emission rates. An owner of two or more power plants may comply with the NOx requirement by

averaging emissions across all its power plants, a rudimentary form of emissions trading.

The Acid Rain Program set a cap of 8.95 million tons of SO2 per year, to be achieved in two

phases. During Phase I, which ran from 1995 through 1999, the 110 highest emitting coal-fired

power plants (with a total of 263 coal-burning units) were required to reduce emissions to satisfy

a tonnage cap. These so-called “Table 1” units were targeted for the first phase because their

emissions exceeded 2.5 pounds of SO2 per million Btu, and their capacity exceeded 100

megawatts. Between 125 and 182 additional units each year joined Phase I as substitution or

compensating units. Although not required to participate until Phase II, these units elected to

participate early to help fulfill the compliance obligations of a Table 1 unit. Furthermore, several

units not required to participate in the Acid Rain Program opted to join the program during these

years. In the second phase, which began in 2000, all power plants producing more than 25

megawatts and all new facilities must meet a lower emission cap. Phase II reductions will total

an additional 5 million tons and will reach the overall 8.95 million-ton cap.

A major innovation of the program is the acceptance of emissions trading as a means of

achieving compliance. Prior to the drafting of Title IV of the Clean Air Act, a number of studies

had identified potential cost savings of as much as $1 billion per year through emissions trading

due to significant differences among utility sources in the marginal cost of abatement.102 Actual

experiences with emission trading have exceeded expectations. A recent study estimates that

emissions trading reduces the cost of complying with Title IV by 50%, or $2.5 billion

annually.103
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2001 77

6.3.1 Allowances

Emission caps are enforced through a system of tradable emission allowances. Title IV specifies

fixed numbers of allowances, each of which represents a limited authorization to emit one ton of

SO2, to be given each year to each of the affected units. Political considerations dictated that

allowances be given rather than auctioned. SO2 allowances issued in any particular year do not

expire, meaning allowances issued in 1 year may be “banked” for use in subsequent years. The

banking provision has been widely utilized in the Acid Rain Program. Emissions each year have

been well below allocated levels, resulting in an increasing amount of banked allowances that

can be used for compliance in later years. For example, 1999 emissions were almost 30% below

the level allowed. Sources benefit from the flexibility that allows them to conserve allowances

for use in later years.

The basic formula for computing Phase I allowances is 2.5 pounds of SO2 per million Btu,

multiplied by each unit’s average 1985−1987 Btu consumption. For Phase II, 1.2 pounds of SO2

per million Btu are multiplied by each unit’s 1985−1987 Btu consumption. There are a number

of departures from the basic formula, particularly in Phase II. Sources that fail to hold sufficient

allowances to cover their emissions following a compliance period are subject to a penalty for

each ton of excess emissions. Initially set at $2,000 per ton, the penalty is indexed for inflation

and is currently more than $2,600 per ton. The Acid Rain Program has reported 100%

compliance for its first 5 years, primarily because noncompliance carries such a high price.

As in Table 6-2, Table 1 units received 6.9 million allowances in 1999. Several other provisions

of Title IV also create allowances, and the number of allowances created under these other

provisions can vary from year to year. These other provisions varied from year to year during

Table 6-2. Origin of 1999 Allowable Emissions

TYPE OF ALLOWANCE NUMBER OF

ALLOWANCES EXPLANATION OF ALLOCATION

Initial allocation 5,550,820 Granted to units based on baseline Btu output and emission rates, as

specified in the Clean Air Act Amendments of 1990

Phase I extension 171,710 Given to Phase I units that reduce emissions by 90% or reassign

obligations to units that reduce emissions by 90% (i.e., scrubbers)

Substitution allocation 909,455 These are the initial allocations of Phase II units that enter Phase I as

substitution units

Auctions 150,000 Provided in the Clean Air Act Amendments in a Special Allowance

Reserve when initial allocations were made

Compensation allocation 85,138 These are the initial allocations of Phase II units that enter Phase I as

compensating units

Opt-in allowances 97,392 Provided to units that enter the program voluntarily

Small diesel allowances 25,617 Allocated to small diesel refineries that produced desulfurized diesel

fuel in the previous year

Total (1997) 6,990,132

Source: Exhibit 2 at http://www.epa.gov/airmarkets/cmprpt/arp99/index.html#so2compliance

Phase I. Owners of “extension” units that propose to reduce emissions with flue gas

desulfurization (FGD)/scrubbing receive allowances, as do owners of “substitution” and

“compensation” units. The substitution provision allows owners of units to substitute cheaper

reductions from other units for the reductions required of Table 1 units. The compensation
The U. S. Experience with Economic Incentives for Protecting the Environment

78 January

provision lets a utility reduce electricity generation of a Table 1 unit below its baseline level,

provided the source of any compensating generation is designated. If the compensating unit

emits SO2, EPA provides an allocation of allowances to that unit, so the compensating unit in

essence becomes part of Table 1. Phase I initially included 263 units. An additional 125−182

combustion units joined Phase I as compensation or substitution units (the totals varied by year).

Several opt-in sources joined as well, raising the total of Phase I units to between 398 and 445

units.

Beginning January 1, 1995, EPA could allocate up to 300,000 bonus allowances from its

Conservation and Renewable Energy Reserve to utilities that undertake energy efficiency and

renewable energy measures. The full accounting of provisions for allocating 1999 allowances are

identified in Table 6-2 to illustrate the many sources of allowances.

In order to maintain the emissions cap, new sources receive no allowances. Instead, they must

buy them from existing allowance holders or in EPA auctions. New sources are also required to

satisfy New Source Performance Standards.

In March 1995, EPA expanded the Acid Rain Program to include industrial facilities that burn

fossil fuels.104 The rule establishes an “opt-in” program that allows industrial sources and other

sources to participate in the existing SO2 program, which previously included only utilities.

Industrial sources that participate in the program will have an allocation of allowances that they

can use for compliance or for selling or trading to other sources. These provisions allowing

industrial sources to opt-in have been little used, partially due to high transaction costs and

lower-than-expected allowance prices.105 Ten units had joined the program as opt-in units by

1999.

6.3.2 Monitoring and Compliance

Utilities whose units are included in Phase I and Phase II must install continuous emission

monitoring (CEM) systems to verify compliance with emission limits, and they must file

quarterly reports of their hourly emissions data with EPA. Initially, sources mailed these data to

EPA on computer disks, but most sources now transmit the information over the Internet.

Continuous emission monitoring systemsthe accepted industry standard for measuring SO2,

NOx, and CO2provide an accurate accounting of emissions, assuring those buying and selling

allowances that the commodity they are trading is real and assuring EPA that emission limits

have been met.

CEMs for coal-fired electric power plants have an initial capital cost of just over $700,000, and

annual operating costs of just under $50,000. On an annualized basis that spreads the capital

costs over a capital recovery period, the cost of operating a CEM is approximately $125,000

each year. This amount is equivalent to about $0.16 per kilowatt of installed capacity.106

The cost of monitoring with CEMS represents approximately 7% of the observed cost of

compliance. More than 2,100 units are now required to have CEMS for Phase II of the program.

This requirement helps ensure low transaction costs and confidence that each allowance

represents one ton of SO2 emissions, regardless of where or when it is generated. That

confidence is an important underpinning of trading.

At the end of each quarter, EPA receives more than 1,700 reports containing hourly emissions

data and heat input for affected units. More than 90% of this data is received electronically.
Trading Programs

2001 79

Using these data and the allowance record for each unit, EPA tracks compliance. CEMS provide

some of the most accurate and complete data ever collected by EPA. In 1999, SO2 monitors on

sources in the Acid Rain Program achieved a median relative accuracy of 3% and a median

availability of 99.5%.

Under the authority of Title IV, EPA developed an allowance tracking system that serves as the

official record of ownership and transfers. The system currently requires a paper form with the

signature of the seller, but it will allow transactions to be completed on the Internet by the end of

this year. With just two staff members, EPA processes most allowance transactions within one

day of receipt.

6.3.3 Allowance Auction

In addition to private transactions in allowances, Title IV directed EPA to offer allowances at an

annual auction, beginning in 1993. This auction offers the equivalent of roughly 2.8% of total

allowances. Private parties may also offer allowances at the auction. Each offer includes the

quantity for sale and a minimum acceptable price. The auctions helped to provide a price signal

to the allowance market in the early stages of the program and currently provide an additional

source of allowances for utilities. The auctions have only involved allowances that can be used in

the current year and 6 and 7 years into the future. From now on, each auction will involve

current-year and 7-year allowances.

Before discussing the specifics of the auction, it is worth noting that it has largely served its

purpose now that (1) the market under the Acid Rain Program is flourishing and (2) the auction

activity is dwarfed by the allowance exchanges occurring every day all over the country.

Economists have criticized the mechanics of the auction, suggesting that it may also contribute to

lower prices than otherwise would occur.107 The Act requires a discriminating price auction,

which ranks bids from highest to lowest. EPA has interpreted this statement as requiring that

each seller receive the bid price of a specific buyer. The auction first awards allowances offered

by the seller with the lowest asking price to the bidder with the highest bid price. Incrementally,

the allocation mechanism moves up the supply list and moves down the bid list until no bidder is

willing to offer what the remaining sellers are asking. The idea of having a discriminating price

auction came from staff members of the U.S. House of Representatives, who were convinced

that such an auction maximized revenue to sellers.108

This unusual auction mechanism may cause sellers to misrepresent and under-reveal their true

costs of emission control.109 By lowering the reservation price, a seller increases the probability

of sale and the expected price, if buyers are offering different prices. Therefore, sellers would set

lower reservation prices in such a discriminating price auction than in a single-price auction.

Joskow (1998) concludes that EPA auctions became a sideshow to the much larger private

market, after just the first two auctions. (These two auctions provided useful indications early in

the process that allowance prices would be lower than first anticipated.)–The evidence from a

detailed analysis of the auction records is that private sellers in the EPA auction have tended to

set prices above market-clearing levels rather than too low, as initially hypothesized by Cason

and others.

6.3.4 Transaction Costs

Many observers of the Acid Rain Program have noted the low transaction costs of the allowance

market. The allowance market operates on a very narrow bid—to-ask spread. Recently, this
The U. S. Experience with Economic Incentives for Protecting the Environment

80 January

spread has been less than $2 per ton, or about 1% of allowance prices. Most allowance transfers

are processed within 24 hours of receipt, as program requirements eliminate the need for review

of submissions beyond electronic verification that the allowances being transferred are indeed in

the seller’s account. In addition, program design eliminates the need for source-specific emission

limits or reviews of compliance strategies, causing the costs of oversight to drop dramatically.

During the 5 years following the Clean Air Act Amendments, EPA spent $44 million to

implement the Acid Rain Program and allocated an additional $18.9 million to state and local

governments to implement the program. These costs may be compared with the $1.09 billion that

EPA spent to implement the Clean Air Act in the same period and the $833 million EPA

distributed to state and local governments for this purpose.110

6.3.5 Results

From 1995 through 1999, the Acid Rain Program has exceeded expectations, with firms

exceeding the reduction target at less than one-half the forecast cost. These results follow from

the very flexible structure of the program, one key component of which was the trading

provision.111

While there was considerable trading activity from the start, little of that activity initially was

between economically distinct entities. (See Figure 6-1.) In searching for explanations for the

relatively low level of trading

between economically distinct

entities (labeled “external” in

Figure 6-1), analysts have cited

relatively high transaction costs

at first, the behavior of public

utility commissions, and

legislation in some states that

promoted the use of locally

produced coal.

Emissions data compiled by

EPA show at least 9,300

transfers involving 81.5 million

allowances through the end of

1999. About 62% of the

allowances or 50.4 million tons

were transferred within

organizations, and 38% or 31

million tons were transferred

between organizations. Another

40 million tons reflect

movements of allowances from EPA to the market through auctions, Phase I extension

allowances, substitution allowances, and other mechanisms. SO2 emissions control is ahead of

schedule. The excess emissions reductionsunused allowancesin Phase I are being banked by

utilities for use during Phase II, when the performance standard tightens significantly.

Figure 6-1. Internal and External Trading

0

2

4

6

8

10

12

14

16

1994 1995 1996 1997 1998 1999

INTERNAL EXTERNAL

Source: Exhibit 6 at

http://www.epa.gov/airmarkets/cmprpt/arp99/index.html#so2compliance
Trading Programs

2001 81

The price of allowances has been far below initial forecasts, an issue that has attracted

considerable attention. Prior to passage of the Clean Air Act Amendments of 1990, industry

estimates of abatement costs were $1,000 per ton, and EPA forecast allowance prices were in the

$750-per-ton range. As an ultimate backstop for compliance, Congress authorized direct

allowance sales by EPA at a price of $1,500 per ton. The direct sale provisions were eliminated

several years ago when it became clear that allowance prices were far lower than anticipated, and

the direct sale option would not be utilized.

Some early allowance transactions occurred at prices as high as $300 per ton in 1992. By 1993,

the price had fallen to a range of $150 per ton to $200 per ton. Allowance pricesfrom EPA

auctions, transactions through the Emissions Exchange, and through brokersgradually fell to a

low of $66 per ton through mid-1995 and, in general, remained below $120 per ton through

1997. (See Figure 6-2.) In 1998, allowance prices began to increase and exceeded $200 per ton

by early 1999, peaking at $217 per ton

in March. Prices then declined to about

$130 ton by March 2000.112

Lower-than-forecast allowance prices

have several explanations. Prices for

virtually every form of compliance are

well below anticipated levels. The price

of low-sulfur western coal delivered to

Mid-West and Eastern markets has

declined due to productivity

improvements in extraction and

transport, and deregulation of rail rates.

Engineers have found ways to blend

low-sulfur Western coal with highsulfur Eastern coal to meet emission

limits in boilers that had been designed

to burn high-sulfur coal. In addition, innovations in the scrubber market have cut the cost of

scrubbing by approximately one-half. Many utilities committed themselves to scrubbers and

other relatively expensive control measures, based on early engineering cost studies. If utilities

had anticipated SO2 control costs better, fewer scrubbers would have been placed in service. The

consequence of greater-than- expected compliance is downward pressure on allowance prices in

Phase I.

Analysts debate the role that allowance trading plays in stimulating cost effectiveness in SO2

control from power plants. There is no doubt that SO2 control has experienced tremendous

technological and productivity improvement over a very short period of time, leading to

approximately 50% lower costs for controlling emissions than had been anticipated. The issue is

the extent to which allowance trading should be credited with these gains. Burtraw (1995)

reached two conclusions. First, it is the flexible, performance-based design of the program that

has stimulated the development of low-cost compliance measures seen in Phase I. Second, within

that framework, allowance trading played an important, positive role. Ellerman (2000) attributes

all of the cost savings to trading provisions. The difference in the two points of view is

considerable. Ellerman gives credit to emissions trading for a dramatic fall in the cost of

scrubbing emissions and for the growing use of low-sulfur Western coal. In contrast, Burtraw

Figure 6-2. Acid Rain Allowance Prices

$0

$50

$100

$150

$200

$250

Aug-94

Feb-95

Aug-95

Feb-96

Aug-96

Feb-97

Aug-97

Feb-98

Aug-98

Feb-99

Aug-99

Feb-00

Source: Exhibit 5 at

http://www.epa.gov/airmarkets/cmprpt/arp99/index.html#so2compliance
The U. S. Experience with Economic Incentives for Protecting the Environment

82 January

credits performance standards and flexible program design, not emissions trading directly, for

much of the cost savings.

Phase II of the Acid Rain Program is likely to see much greater reliance on allowance trading.

Phase II will involve 700 additional sources, many of which are likely to select scrubbing as their

method of compliance. More scrubbing should result in greater variation in the marginal costs of

control across sources. Consequently, there should be greater incentives to trade allowances to

achieve compliance in Phase II.

A 1995 EPA assessment of the Acid Rain Program put the costs at $1.2 billion annually in Phase

I and $2.2 billion annually in Phase II.113 The same EPA report estimated the mean value of

annual health benefits at $10.6 billion in Phase I and $40 billion in Phase II. These health

benefits are limited to benefits from reduced sulfates; total health benefits would be even higher.

Interestingly, health benefits were not a major concern in the legislative decision to control acid

rain, yet they now appear to be the dominant benefit component, dwarfing earlier estimates of

environmental effects. Recall that early estimates of the costs of controlling acid rain put the

costs at $4.5 billion to $6 billion annually with a traditional regulatory approach and benefits at

$1 billion to $2 billion. An independent assessment reached a similar conclusion: Benefits will

be much greater than costs.114 More recent studies have estimated Phase II costs at $1.0 billion

(Carlson et al., 2000) and $1.4 billion (Ellerman, 2000, p. 282).

To estimate the savings attributable to tradable allowances, Carlson et al. (2000) estimated

marginal abatement cost functions for thermal power plants that were affected by Title IV. For

plants that use low-sulfur coal as a means of compliance, they found that the main sources of

cost reductions are technological improvements and the fall in low-sulfur coal prices, not

allowance trading. Over the long run, the authors estimate that allowance trading could result in

savings of $700 million to $800 million per year, relative to an “enlightened” regulatory

approach with a uniform emission standard.

6.4 NOx Regional Ozone Programs

The federal SO2 control program shows that acid rain poses a number of difficult problems for

policy makers, regulators, environmentalists, and industry. Experiences with the SO2 program

were instrumental in designing and implementing the recent NOx control program.

Along with SO2, NOx contributes to the acid rain problem nationwide. NOx also contributes to

ground-level ozone and fine particulate problems in the East and in certain densely populated

areas elsewhere. With respect to acid rain, both SO2 and NOx have cumulative and long-range

impacts on the environment. With respect to ground-level ozone and fine particulate matter, the

primary concern is ambient concentrations over short periods of time during the summer months.

NOx trading is designed to account for these complex time and space dimensions in the need to

control NOx. Electric power generation peaks in summer months in the Northeast to meet air

conditioning demands. Periods of peak power production are periods of peak NOx emissions and

tend to be periods of time when ambient ground-level ozone concentrations are most likely to

exceed federal standards.
Trading Programs

2001 83

6.4.1 OTC NOx Budget Program

In the 1990 Clean Air Act Amendments, Congress established the Ozone Transport Commission

(OTC), a working group consisting of 12 Northeast states and the District of Columbia. OTC’s

mandate was to develop plans to meet national ambient air quality goals for ozone in the Eastern

United States. With the help of EPA, the OTC developed a NOx Budget Program to address

regional ozone problems. Critical program elements, such as monitoring and reporting

provisions, compliance determination, and penalties, were required to be uniform across states. A

1994 memorandum of understanding with EPA was signed by all of the OTC states, except

Virginia. It put in place a NOx cap-and-trade system within the OTC states. The intent of the

agreement is to institute a cooperative effort to solve a common problem.

The agreement caps NOx emissions at 219,000 tons during the May through September

compliance period for the years 1999−2000 and at 143,000 tons starting in 2003. Both amounts

are less than one-half the 1990 baseline of 490,000 tons. The cap affects 465 sources of NOx in

the participating OTC states, including utilities, industrial plants, and independent power

producers.

The OTC NOx trading program is implemented by states, as are many programs under Title I of

the Clean Air Act. States are free to establish rules of their own choosing, including allocation

provisions. (See Table 6-3.) The OTC made efforts to ensure that the rules were compatible

across states to facilitate regional emissions trading. Some provisions, such as initial emission

allocation formulas, differ across participating states. The program establishes that one

allowance is good for one ton of NOx emissions emitted during the compliance months. EPA

administers the Allowance Tracking System and the Emissions Tracking System, but the states

maintain all responsibility for compliance and enforcement.

Table 6-3. OTC’s NOx Budget Program Allocations and Emissions (1999)

STATE BASELINE EMISSIONS

(in tons)

1999 ALLOCATIONS115

(in tons)

1999 EMISSIONS

(in tons)

Connecticut 11,130 6,312 5,830

Delaware 13,510 6,142 6,160

Massachusetts 41,331 19,680 17,293

New Hampshire 14,589 6,788 3,463

New Jersey 46,963 21,292 15,390

New York 85,632 54,276 47,267

Pennsylvania 203,181 103,668 79,166

Rhode Island 1,099 580 274

TOTAL 417,435 218,738 174,843

Source: 1999 OTC NOx Budget Program Compliance Report.

Unlimited banking of allowances is allowed, but sources are restricted in how they may use them

for compliance. The constraints on banking address seasonal and spatial concerns regarding

ozone formation. Eight states participated in the 1999 OTC NOx Budget Program: Connecticut,

Delaware, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, and Rhode

Island. A total of 912 affected combustion units underwent reconciliation for 1999 to determine

whether they held sufficient allowances to cover their emissions. The affected sources released
The U. S. Experience with Economic Incentives for Protecting the Environment

84 January

emissions at a level nearly 20% below their allocations for 1999, banking the remainder for

future use when emission limits will be stricter.116

The market is showing signs of maturing. Trades for future year allowances have higher prices,

which reflect the anticipated difficulty of meeting a shrinking cap on emissions. Similar price

spreads also exist in the SO2 allowance market.

6.4.2 NOx Budget Trading Program

EPA promulgated the call for State Implementation Plans (SIPs) on NOx, (the NOx SIP call)

pursuant to the requirements of Section 110 of the Clean Air Act (CAA). Section 110 requires a

SIP to contain adequate provisions that prohibit any source or type of source or other types of

emissions within a state from emitting any air pollutants in amounts that will contribute

significantly to non-attainment in, or interfere with maintenance of attainment of a standard by,

any other State with respect to any National Ambient Air Quality Standard (NAAQS). Section

110 authorizes EPA to find that a SIP is substantially inadequate to meet any CAA requirement

when appropriate, and, based on such finding, to then require the state to submit a SIP revision

within a specified time to correct such inadequacies.

The final rule required 22 states and the District of Columbia to submit State Implementation

Plans that address the regional transport of ground-level ozone. The rule will reduce total

summertime emissions of nitrogen oxides by about 28% (1.2 million tons) in the affected states

and the District of Columbia. The final rule includes a model NOx Budget Trading Program that

will allow states to achieve over 90% of the required emissions reductions from large electric

generating sources and large industrial boilers in a highly cost-effective way.

The NOx SIP call was challenged by representatives of both industry and affected states. In May

1999, the U.S. Court of Appeals for the District of Columbia Circuit stayed the submittal

deadline of the NOx SIP call indefinitely. In November 1999, oral arguments were heard and, in

March 2000, the Appeals Court ruled in favor of EPA on all major issues, remanding to EPA

only a few minor issues.

As a result of its ruling, three states were no longer required to comply with the NOx SIP call

(Wisconsin, Georgia, and Missouri), and EPA was required to take further notice and comment

on a portion of its electric generation unit (EGU) definition. Sources in several states will be

subject to this action: Alabama, Connecticut, District of Columbia, Delaware, Illinois, Indiana,

Kentucky, Massachusetts, Maryland, Michigan, North Carolina, New Jersey, New York, Ohio,

Pennsylvania, Rhode Island, South Carolina, Tennessee, Virginia, and West Virginia. In June

2000, the Appeals Court lifted the stay and ruled that affected states must submit SIPs to EPA by

the end of October 2000. In August 2000, the court made another ruling. This ruling moved the

compliance date to submit SIPs to May 31, 2004, from its original date of May 1, 2003. As of

September 2000, EPA had not yet decided whether to appeal this ruling.

The petitioners have asked the Supreme Court to review the Appeals Court’s decision. As of

August 2000, the Supreme Court had not decided to hear the case.

Section 126 of the Clean Air Act allows states that are adversely affected by interstate transport

of pollution to petition EPA to set pollution limits on specific sources of pollution in other states.

In a December 17, 1999 rule, EPA granted petitions filed by Connecticut, Massachusetts, New

York, and Pennsylvania that sought to reduce ozone in these states through the control of NOx
Trading Programs

2001 85

emissions from other states.117 These states had petitioned that they could not attain the federal 1-

hour ozone standard because of the interstate transport of ozone and its precursors.

Under its Section 126 authority, EPA published a final rule that affects 392 electric utilities and

industrial boilers with rated output greater than 25 megawatts or a maximum heat input capacity

greater than 250 MMBtu/hr. The Federal NOx Budget Trading Program establishes emission

limits for affected sources in the form of tradable NOx allowances. One allowance authorizes the

emission of one ton of NOx. Sources in the program are located in Delaware, the District of

Columbia, Indiana, Kentucky, Maryland, Michigan, North Carolina, New Jersey, New York,

Ohio, Pennsylvania, Virginia, and West Virginia. Collectively, they must reduce NOx emissions

by nearly 530,000 tons per year by 2007 from levels had been allowed that year.

Both the NOx SIP call and the Section 126 action require sources to reduce emissions of NOx.

However, the SIP call allows states the flexibility to choose how reductions will be made; under

the 126 action, EPA directly regulates sources. Furthermore, the SIP call covers a larger

geographic area. EPA is continuing to work with the states to determine how to integrate these

two programs.

6.5 Chlorofluorocarbon (CFC) Production Allowance Trading

The Montreal Protocol on Substances that Deplete the Ozone Layer called for a cap on

chlorofluorocarbon (CFC) and halon consumption at 1986 levels, with reductions in the cap

scheduled for 1993 and 1998. At a second meeting in 1990, the parties to the Montreal Protocol

agreed to a full phaseout of the already-regulated CFCs and halons, as well as a phaseout of

“other CFCs,” by 2000.118

The Montreal Protocol defined consumption as production plus imports, minus exports.

Consequently, in implementing the agreement, EPA distributed allowances to companies that

produced or imported CFCs and halons. Based on 1986 market shares, EPA distributed

allowances to 5 CFC producers, 3 halon producers, 14 CFC importers, and 6 halon importers.

The marketable permit system for producers and importers resulted in a number of savings

relative to a program that directly controlled end uses. EPA needed just 4 staffers to oversee the

program, rather than the 33 staffers and $23 million in administrative costs it anticipated would

be required to regulate end uses. Industry estimated that a traditional regulatory approach to end

uses would cost more than $300 million for recordkeeping and reporting, versus only $2.4

million for the allowance trading approach.

Title VI of the Clean Air Act Amendments of 1990 modified the trading system to allow

producers and importers to trade allowances within groups of regulated chemicals that were

segregated by their ozone-depleting potential. As an example, EPA assigned producers and

importers allowances for five types of CFCs (CFC-11, CFC-12, CFC-113, CFC-114, and CFC115). Producers and importers could trade allowances within this group. For example, 14 million

kilograms of CFC-11 and CFC-113 were traded for CFC-12 in 1992 as air conditioner makers

and foam producers reduced their use of these substances. At the same time, CFC-12 users

maintained their demand. By 1994, the quantity of CFC-11 and CFC-113 swapped for CFC-12

grew to 26 million kilograms. EPA rules implementing Title VI specify that, each time a

production allowance is traded, 1% of the allocation is “retired” to assure further improvement in

the environment.
The U. S. Experience with Economic Incentives for Protecting the Environment

86 January

Congress coupled the marketable allowance trading system with excise taxes on CFC

production, which are discussed in Chapter 4, Pollution Charges, Fees, and Taxes. The rationale

for the excise taxes was that the restrictions on the quantity of CFCs and halons could be sold

would lead to rapidly escalating prices. The excise taxes were designed to capture “windfall

profits.” In contrast, the allowance trading system was designed to assure that the production and

import of the CFCs was cost-effective. The excise tax has the effect of making CFCs much more

expensive in the United States than they are in developing countries where production is still

allowed. Smuggling of these chemicals has become a serious problem.

6.6 Lead Credit Trading

As early as the 1920s, tetra-ethyl lead was added to gasoline by refiners to increase octane levels

and reduce premature combustion in engines, which allowed more powerful engines to be built.

Lead additives in gasoline were the least expensive of several ways of raising octane levels. The

additives also prevented premature recession of soft-valve seats, a feature of most automobile

engines that were manufactured prior to 1975 (but not after).

By the 1970s, virtually all gasoline contained lead at an average of almost 2.4 grams per gallon.

EPA acted to curtail lead use in gasoline for two reasons. One, by 1975 new production vehicles

were equipped with exhaust system catalysts, so these vehicles could meet the tailpipe emission

standards for hydrocarbons, carbon monoxide, and nitrogen oxides that were mandated by the

1970 Clean Air Act. Unleaded fuel was required for vehicles manufactured after model year

1975, since exhaust system catalysts would be fouled and not function properly if vehicles were

run on leaded gasoline. As catalyst-equipped vehicles began to dominate the fleet, sales of

unleaded gasoline reached about 80% of all gasoline sales by the mid-1980s.

Two, concerns about the role of airborne lead in adult hypertension and cognitive development

in children motivated EPA to limit the overall use of lead in gasoline. EPA required that the

average lead content of all gasoline sold be reduced from 1.7 grams per gallon after January 1,

1975, to 0.5 grams per gallon by January 1, 1979. Initially, these limits were applicable as

quarterly averages for the production of individual refineries, implicitly allowing trading across

batches of gasoline at individual refineries. Later, EPA broadened definition of averaging to

allow refiners who owned more than one refinery to average or “trade” among refineries to

satisfy their lead limits each quarter.

During the late 1970s, the demand for unleaded gasoline grew steadily as more catalyst-equipped

vehicles were sold. By the early 1980s, the market share of leaded gasoline had shrunk to the

point that EPA’s limits on the average lead content of all gasoline ceased to have an impact on

the lead content in leaded gasoline. Meanwhile, evidence on the magnitude and severity of the

health effects attributable to lead mounted.

EPA acted to curtail sharply the remaining use of lead in gasoline, initially setting a limit of an

average level of 1.1 gm/gal beginning on November 1, 1982. EPA lowered the average to 0.5

gm/gal by July 1, 1985, and then to 0.1 gm/gal by January 1, 1986. To facilitate the phasedown,

EPA allowed two forms of trading: inter-refinery averaging during each quarter and banking for

future use or sale.

Inter-refinery averaging, which operated from November 1, 1982, to December 31, 1985,

allowed refineries to “constructively allocate” lead. To take an example, suppose refiner A

produced 200 million gallons of gasoline in the first quarter of 1983 with an average lead content
Trading Programs

2001 87

of 1.4 gm/gal. Refiner A could buy 60 million grams of lead credits from Refiner B, who

produced an equal quantity of gasoline with lead content of 0.8 gm/gal. In 1985, EPA permitted

refiners to bank credits for use until the end of 1987, which in effect extended the life of lead

credits to that date.

Lead credits were created by refiners, importers, and ethanol blenders (who reduced the lead

content of gasoline by adding ethanol). For example, when the average lead content was limited

to 1.0 gm/gal, a refiner producing 1 million gallons of gasoline with an average lead content 0.5

gm/gal would earn 500,000 lead credits. EPA enforcement relied on reporting requirements and

the random testing of gasoline samples. Reporting rules were simple. Each refiner or importer

was obligated to provide the names of entities with whom it traded, the volumes for each trade,

and the physical transfer of lead additives. The data allowed EPA to compare reported lead

additive purchases and sales for each transaction to assure compliance. Discrepancies in reported

figures could trigger investigations and enforcement actions. Well over 99% of all transactions

were reported accurately; however, several dozen fraudulent transactions occurred.119 In one

quarter alone, the now-defunct Good Hope refinery in Louisiana accounted for over one-half of

all reported lead credits sold during one quarter. Subsequent investigation uncovered the fraud.

Judged by market activity, lead credit trading was quite successful. Lead credit trading as a

percentage of lead use rose above 40% by 1987. Some 20% of refineries participated in trading

early in the program; by the end of the program, 60% participated.120 Early in the program, 60%

of refineries participated in banking, rising to 90% by the end. Trading allowed the EPA to phase

out the use of lead in gasoline much more rapidly than otherwise would have been feasible.

Given that refiners faced very different opportunities for reducing the lead content of gasoline, a

rapid phase-down without trading would have rewarded refiners collectively, since the market

price of gasoline would have been determined by the high-cost producers.

During the period of time when lead credits were traded, the price increased from about 3/4

cent/gm to 4 cents/gm.121 Nearly one-half of all lead traded was between refineries owned by the

same firm.122 With external transactions, refiners revealed a preference to deal with normal

trading partners, even though they could obtain a better price elsewhere. This preference

indicates that trading did not produce the least cost outcomes, even though there was an active

market in lead credits. In part, this result occurred because internal trades have lower transaction

and information costs than inter-refinery trades. However, it also reflects strong preferences in

the industry to avoid revealing potentially valuable information to competitors.

EPA estimated that the banking provisions alone would involve 9.1 billion grams of lead credits

and save refiners $226 million. Subsequently, the amount of lead banked was placed at just over

10 billion grams. Lead credit trading may be viewed in retrospect as a considerable success. The

use of lead in leaded gasoline was sharply reduced over a short period of time, without spikes in

the price of gasoline that otherwise might have occurred. The market in lead credits was quite

active, although, as noted in the previous paragraph, refiners did not maximize their gains from

trade. In addition, some small refiners and ethanol blenders nonetheless sold many more credits

than they had earned, despite seemingly foolproof procedures for catching fraudulent trades.

6.7 Gasoline Constituents

Title II of the Clean Air Act Amendments of 1990 imposes substantially tightened mobile source

emission standards by requiring automobile manufacturers to reduce tailpipe emissions and by
The U. S. Experience with Economic Incentives for Protecting the Environment

88 January

requiring refiners to develop reformulated fuels. The Amendments require reductions in tailpipe

emissions of 35% for hydrocarbons and 60% for NOx, starting with 40% of the vehicles sold in

1994 and increasing to all vehicles sold in 1996. Light-duty trucks are subject to similar

requirements. EPA is required to impose further reductions of 50% below these standards by

2003 if it finds such reductions are necessary, technologically feasible, and cost-effective. EPA

recently issued Tier 2 gasoline sulfur standards that implement this further reduction.

Title II requires that states having CO non-attainment areas with design values of 9.5 parts per

million (ppm) or higher must implement a program to supply oxygenated fuels to motorists in

winter months. (The term “design values” is defined as the second highest ambient reading

measured over the most recent two years.) Gasoline sold in the 41 cities affected by this

requirement must have an oxygen content of 2.7% starting in 1992. To meet the percent oxygen

requirement, states are “strongly encouraged” to create a program for marketable oxygen credits

to provide flexibility to gasoline suppliers.

In October 1992, EPA issued guidance for trading programs in oxygenates under the wintertime

oxygenated gasoline program; however, participation is optional for the affected states.123 In

areas where trading is permitted, credits in oxygenates can be exchanged between parties that the

state has designated as responsible for satisfying fuel requirements, also known as the Control

Area Responsible Party or CAR. Normally the CAR is the party who owns gasoline at a

terminal. The CAR receives data on the volume and oxygen content of all gasoline shipped to the

terminal and assures that the average oxygen content is 2.7% by weight. Where trading is

allowed, the CAR would be free to sell excess oxygenate credits to other CARs or buy oxygenate

credits from a CAR to meet the 2.7% requirement. While trading in oxygenates theoretically

offers a cost-effective means of meeting wintertime oxygenate requirements, in fact, the trading

programs have been moribund. Only the Pennsylvania part of the Philadelphia ozone nonattainment area (which also includes parts of New Jersey) adopted trading rules. Within that area,

no trades have been reported. Other areas have declined to allow trading, citing the costs of

monitoring such a program as prohibitive.

Title II also requires that the 9 worst ozone non-attainment areas offer reformulated gasoline

during the summer months. It also specifies several performance characteristics for reformulated

gasoline as well as certain fuel properties, including a minimum oxygen content of 2% by weight

beginning in 1995. Under so-called “opt in” provisions, an additional 31 areas applied to EPA, so

they could participate in the reformulated gasoline program.

Title II requires that EPA establish trading systems for three constituents of reformulated fuels:

oxygen, aromatics, and benzene. Under a trading system, refiners could meet reformulated

content requirements by producing gasoline that met the specifications or by trading credits in

these constituents with other refiners, so collectively the standards were satisfied. EPA’s rules

for reformulated gasoline set up an averaging-and-trading system as well as an averaging-andtrading system for meeting EPA’s performance standards for VOCs and toxic air chemicals.

There has been considerable trading and averaging of reformulated gasoline requirements,

mainly from the Midwest to the East Coast. That trading has led to some regional failures to

meet oxygenate retail averages, and it has resulted in a tightening of the oxygenate standards for

reformulated gasoline.
Trading Programs

2001 89

6.8 Tier 2 Emission Standards

On February 10, 2000, EPA promulgated new standards for tailpipe emissions of NOx from

passenger cars and light-duty trucks and for the sulfur content of gasoline.124 The tailpipe

emission action was taken under EPA’s authority to set tailpipe emission standards for new

vehicles (Section 202 of the Clean Air Act). The fuel standard action was based on EPA’s

determination that motor vehicle fuels contribute to air pollution and adversely affect the

performance of emission control systems (an authority under Section 211 (c)(1) of the Clean Air

Act).

Manufacturers will be able to average their Tier 2 vehicles to comply with the corporate average

NOx tailpipe standard of 0.07 grams per mile (gpm), which is more than a 75% reduction from

the current 0.30 gpm. standard.125 When a manufacturer’s corporate average NOx emissions fall

below the standard, it will earn credits that may be banked for later use or sold to another

manufacturer. These credits will be very similar to those currently in place for non-methane

organic gas (NMOG) emissions under California and the federal National Low Emission Vehicle

(NLEV) regulations. The NOx credits will have unlimited life. Manufacturers would be permitted

to run a credit deficit for 1 year and carry forward that deficit. If the manufacturer has a credit

deficit in the second year, the manufacturer would be subject to an enforcement action.

Refiners and gasoline importers must satisfy a corporate average gasoline standard of 120 ppm

and a cap of 300 ppm sulfur beginning in 2004. In 2005, this corporate average standard drops to

90 ppm sulfur, with the cap remaining at 300 ppm. The format of the program changes in 2006

from a corporate average to a per-refinery requirement. At that time, the cap will be 80 ppm

sulfur, and most refiners will have to produce gasoline that averages no more than 30 ppm sulfur.

Refiners who produce gasoline with a corporate average sulfur content lower than the standard

will be allowed to bank credits for future use or for sale to other refiners that are unable to meet

the standard. Credits produced under the phase-in years have a limited life. Those credits

produced beginning in 2006 have an unlimited life. The program runs until 2010. However,

refiners will be able to carry forward a deficit for 1 additional year, providing that the average is

below 80 ppm sulfur.

The standards concern hydrocarbon emissions, which was termed “NMOG” in the rulemaking.

Manufacturers would have to satisfy a corporate average standard, but they could meet this

standard through the trading of credits earned by manufacturers that exceeded the corporate

average standard. Banking also would be allowed. Banked credits, however, would be subject to

discounting over time.

6.9 Heavy-Duty Truck Engine Emission Averaging

Title II of the Clean Air Act Amendments of 1990 authorizes EPA to set standards for particulate

matter, NOx, and other emissions from heavy-duty truck engines. The standards must represent

the maximum degree of reductions achievable, taking cost and other factors into consideration.

EPA has interpreted this provision to authorize the use of averaging, banking, and trading as part

of the process of realizing the maximum degree of reductions achievable.

Under this program, there has been a great deal of averaging and banking but only one trade

between firms, a 1996 exchange of rights to 5 tons of particulate matter from Navistar to Detroit

Diesel. The averaging of emissions facilitates compliance, since not every class of engines has to
The U. S. Experience with Economic Incentives for Protecting the Environment

90 January

meet the 75% reduction standard. How much engine manufacturers actually save is unknown.

However, a recent paper examined a similar type of engine performance averaging program that

was proposed in California for light-duty trucks. It concluded that the cost savings of the

program were likely to be modest.126

6.10 Corporate Average Fuel Economy (CAFE) Standards

The Energy Policy and Conservation Act of 1975 established corporate average fuel economy

(CAFE) standards for all manufacturers that sell vehicles in the United States. The standards

were first imposed in 1978 and are now 27.5 miles per gallon (mpg) for production passenger

cars and 20.7 mpg for production light-duty vehicles. (Light-duty vehicles include sport utility

vehicles, minivans, and pickup trucks with gross vehicle weight ratings less than 8500 pounds.)

Corporate average fuel economy and compliance with the CAFE standard is determined as the

harmonic mean of the fuel economy of automobiles produced by each manufacturer.127

Harmonic average fuel economy is more difficult to achieve than is simple averaging. For

example, to achieve a CAFE standard of 27.5 mpg, two 35-mpg vehicles must be sold for every

20-mpg vehicle sold. The penalty for failing to meet the CAFE standard is $5.50 per automobile

for every 0.1-mpg shortfall. Carry back and carry forward provisions akin to banking do exist,

and they allow shortfalls in one year to be met with credits from another year.

CAFE standards have been the primary national policy instrument for improving personal

vehicle fuel economy and for reducing gasoline and oil consumption in the transportation sector.

From the late 1970s through the mid-1980s, CAFE standardsworking in concert with higher

gasoline prices through most of that periodnearly doubled the average fuel economy of new

personal vehicles. Throughout the 1990s, with oil and gasoline prices recording historic lows on

an inflation-adjusted basis, CAFE standards provided a floor for automotive fuel economy. Fuel

economy was higher than it would have been absent the standards. Therefore, compliance with

these standards reduced gasoline consumption.

Since fuel economy is inversely proportional to carbon dioxide emissions, the primary

greenhouse gas from motor vehicles, CAFE has yielded reductions in carbon dioxide emissions

and overall greenhouse gas emissions. (Fuel economy is largely unrelated to emissions of criteria

pollutants such as particulate matter, CO, and NOx). In this regard, CAFE can be viewed as an

intra-firm trading system to meet a de facto standard to reduce the carbon dioxide emissions

from personal vehicles.

As a policy instrument, CAFE has both advantages and disadvantages. Some of CAFE’s

advantages follow.

• CAFE is in place, it has proven to be a workable program, and lessons have been learned

about how it could be improved.

• CAFE has yielded significant reductions in gasoline consumption and carbon dioxide

emissions, which would not have been the case without these standards.

• The general public strongly supports CAFE relative to other alternatives to increase fuel

economy and reduce carbon dioxide emissions, such as higher gasoline taxes.

• CAFE includes many market elements, such as
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2001 91

• sales-weighted averaging (as opposed to a floor that every vehicle must meet),

• a 7-year rolling average for compliance (and credits can be carried back or forward for 3

years), and

• the option of paying monetary fines in lieu of meeting the standard, a choice that is left to

the discretion of the manufacturer. (Several non-U.S. firms pay these fines. All U.S.

automakers have chosen to meet CAFE standards in the past.)

Like any policy instrument, CAFE also has disadvantages. Some of them follow.

• CAFE is inconsistent with low fuel prices. That is, when gasoline prices are relatively

low, there is less demand for high-fuel economy cars, and manufacturers must sell higher

fuel economy than the market demands.128

• CAFE does nothing to reduce vehicle miles traveled (VMT). (Some analysts argue that

CAFE increases VMT and emissions by lowering the cost of driving, i.e., raising the fuel

economy of vehicles means, in theory, that less gasoline is needed to travel a certain

number of miles. Other analysts assert that these effects are negligible.)

• CAFE does have a cost, either in terms of the higher prices of vehicles or the tradeoffs

that must be made with other vehicle attributes such as utility, weight, or acceleration.

• CAFE is strongly opposed by automakers, whose objections include higher vehicle cost

and the potential reduction in safety for passengers in these lighter weight vehicles.

Alternatives to CAFE standards would include higher gasoline taxes and “feebates,” which

would assess fees to the sale of vehicles with low-fuel economy and rebates for the purchase of

high-fuel economy vehicles. Like CAFE, each of these options has advantages and

disadvantages. The relative merits of these options relative to CAFE are debated, as is the

magnitude required for such policies to provide the same benefits as CAFE.

6.11 Hazardous Air Pollutant (HAP) Early Reduction

In December 1992, EPA issued final rules for the early reduction of hazardous air pollutants.129

If a facility qualifies for inclusion in the program by reducing hazardous air pollutants by

90%95% in the case of hazardous particulate emissionsprior to EPA proposing maximum

available control technology (MACT) regulations on the source category, the facility may defer

compliance with the new MACT for as long as 6 years. Because participation in the program is

voluntary, a source must anticipate cost savings, or it would not have an incentive to participate.

Once a source is accepted into the program, it becomes legally obligated to meet the 90% (or

95%) reduction in emissions. Trading exists intertemporally across time in that sources exchange

their early reductions for their later reductions. (The example in the next paragraph illustrates

how this program works.)

EPA has shown that such a program can benefit the environment. Assume a source emits 100

tons per year. Under the early reduction program, it would emit 10 tons per year. Further assume

that MACT would have the source reduce emissions to 2 tons per year in year 5 and thereafter.

The source has reduced emissions by 360 tons in years 1 through—4 in exchange for 48 tons of

emissions in years 5 through10. Total emissions are reduced by 312 tons. Table 6-4 illustrates

the time profile of emissions.
The U. S. Experience with Economic Incentives for Protecting the Environment

92 January

By mid-1993, over 60 chemical plants had asked to participate in the program, so they could

avoid the synthetic organic chemical MACT standard for 6 years. Other types of facilities also

had applied to join the program.130

Table 6-4. Benefits of Achieving Early Emission Reductions

YEAR MACT EMISSIONS (in tons) EARLY REDUCTION EMISSIONS (in tons)

1 100 10

2 100 10

3 100 10

4 100 10

5 2 10

6 2 10

7 2 10

8 2 10

9 2 10

10 2 10

TOTAL 412 100

Source: 57 FR 61970

6.11.1 The Petroleum Industry NESHAP

EPA’s National Emission Standard for Hazardous Air Pollutants (NESHAP) rule, promulgated

on August 18, 1995, establishes Maximum Available Control Technology (MACT) requirements

for process vents, storage vessels, wastewater streams, and equipment leaks at refineries. The

rule specifically includes marine tank vessel-loading activities and gasoline loading racks.

The rule excludes distillation units at pipeline pumping stations and certain process vents that

EPA determined would be subject to future NESHAP rules: catalyst regeneration on cracking

units, vents on sulfur recovery units, and vents on catalytic reforming units.

On September 19, 1995, EPA issued a final NESHAP rule for marine vessel tank-loading

operations. The rule affects new and existing marine bulk loading and unloading facilities that

emit 10 tons or more of a single hazardous air pollutant (HAP) or 25 tons of any aggregate

HAPs. Affected facilities must install a vapor collection system to collect volatile organic

compounds (VOCs) that are displaced from marine tank vessels during loading. The vapor

recovery system must achieve a 95% reduction in emissions, 98% if combustion is used.

Both of these NESHAP rules permit the use of emissions averaging among marine tank vesselloading operations, bulk gasoline terminal or pipeline breakout station storage vessels and bulk

gasoline loading racks, and petroleum refineries. Emissions averaging gives the owner the

opportunity to find the most cost-effective control strategies for a particular situation. The owner

may over-control at some emission points and under-control at others to achieve the overall level

of emissions control that is required.

6.11.2 Hazardous Organic Chemical NESHAP

The Hazardous Organic Chemical NESHAP (or “HON”) affects more than 400 facilities of the

Synthetic Organic Chemical Manufacturing Industry (SOCMI). The final rule requires sources to

limit emissions of organic hazardous air pollutants (HAPs) and to apply “reference control” or
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equivalent maximum available control technology (MACT). In recognition of the high costs of

some MACT controls in this industry, the rule allows emissions averaging. Under this alternative

method of compliance, sources engaging in pollution prevention measures that over-control at

some points earn emissions credits that can be used to offset the debits they accrue when

measures under-control at other points.

6.12 Regional Clean Air Incentives Market (RECLAIM)

Some of the highest ozone levels in the nation are recorded in the Los Angeles area. The South

Coast Air Quality Management District (SCAQMD or District) also fails to meet the particulate

matter and CO NAAQS, although not by such a large margin. Historically, the SCAQMD has

relied on source-specific emissions regulations to limit the emissions of ground-level ozone

precursors (as well as other pollutants).

Substantial progress has been made over the past three decades in improving the air quality in the

Los Angeles Basin. However, it was apparent to SCAQMD officials that further progress toward

attaining federal standards would be prohibitively expensive if they used traditional regulatory

methods. By 1990, the marginal costs of NOx control in the District had reached $10,000 per ton

to $25,000 per ton at electric power plants, versus $500 per ton to $2000 per ton elsewhere in the

United States. Proposed SOx controls on catalytic cracking units at refineries would have cost

$32,000 per ton, versus the national costs of less than $500 per ton for other methods of

controlling SO2 emissions. (See Section 6.3, Acid Rain Allowance Trading. Consequently, the

District began to investigate the feasibility of creating a marketable permit in reactive organic

gases (ROG) and NOx as well as SOxthe latter for its role in the formation of small particulate

matteras a means of accomplishing air quality goals at lower cost.

The District initially proposed a marketable permits program termed “RECLAIM” (for Regional

Clean Air Incentives Market). The program would include about 2,000 sources of reactive

organic gases (sources that represent about 85% of permitted stationary source emissions); 700

NOx sources (sources that represent 95% of permitted NOx emissions); and about 50 sources of

SOx (sources that represent about two-thirds of permitted stationary source emissions). Each

market would start with an allocation of emissions to sources equal to the 1994 emissions target

in the District’s Air Quality Management Plan (AQMP). Each marketable permit program would

be designed to reduce emissions annually by the amounts necessary to achieve the AQMP

targets: Meeting air quality standards for SOx and NOx emissions by 2003 and meeting the goals

for reducing ROG emissions by 2010.

For the NOx and SOx programs, emissions originated at combustion sources with well-defined

exit points to the environment. Emission monitoring would be based on stack gas measurement

using continuous emission monitors (CEM). For ROG, the market was based largely on

evaporative emissions, which are inherently more difficult to measure. Prospective ROG trading

also was complicated by the fact that ROG are not homogeneous; some react much more readily

to form ozone than others do. Furthermore, some ROG are classified as toxic pollutants and

regulated separately. After about 1 year of analysis and discussion, RECLAIM officials decided

to defer including ROG in its program and to concentrate on the program’s design for NOx and

SOx.

A basic issue for both programs was which facilities would be included. Despite the prospect for

lower control costs that would accompany participation in a marketable permit program, a
The U. S. Experience with Economic Incentives for Protecting the Environment

94 January

number of sources argued for exemptions. These sources were concerned about the future price

and availability of marketable permits. District officials eventually exempted sewage treatment

plants, landfills, and three small municipally owned power plants.

Baseline emission allocations proved contentious. According to the basic design features for

RECLAIM, emission allocations would be based on the 1994 emission target for each source.

This target was computed in the AQMP by taking reported 1987 emissions and deducting

projected reductions that were mandated by air quality regulations. Due to a recession in the

early 1990s, emissions in 1991, 1992, and 1993 were lower for many sources than what the

AQMP required. Many interest groups, including the affected sources, argued that baseline

allocations should be based on the AQMP. Environmental groups argued that actual 1993

emissions should serve as the baseline for emission allocations, not the AQMP. The compromise

that was struck defines the emission cap for each source as the highest year of reported emissions

between 1989 and 1991, less any reductions required by regulations that were implemented

through 1993.

Monitoring and reporting issues also proved controversial, with lengthy debates over how

emissions would be measured and how often reports would be filed. Industry sought to file one

report per year, while public health agencies and environmentalists wanted daily or weekly

reporting. The EPA sought assurance that the hourly NOx standard would not be violated.

In an attempt to allay industry concerns that frequent monitoring would be too expensive, the

AQMD developed a central computer that would accept data directly from the facilities

participating in RECLAIM. Sources installed continuous emission monitors, or CEMS, which

cost $100,000 to $150,000 each, on every boiler emitting 10 tons annually or more. These CEMs

recorded pollutant readings minute by minute and sent the readings to a remote terminal that

averaged the readings over 15-minute periods. The remote terminal then forwarded the number

to the AQMD central computer. An artificial intelligence system analyzed the data and verified

compliance by each boiler. When the system detected a potential problem, inspectors were

dispatched to investigate further.

The District projected that the one-time costs of installing monitoring equipment would be

approximately $13 million, with negligible annual operating costs. The District projected that

annual savings in compliance costs relative to traditional forms of regulation would be an

average of $58 million annually for each of the next 10 years. These calculations effectively

muted the industry’s complaints about the costs of monitoring equipment.

The actual trading works as follows. Each source has a declining allocation of RECLAIM

Trading Credits (RTC) for each year from 1994 to 2003. After 2003, the balance remains

constant. The RTC are denominated in pounds: one RTC equals one pound of emissions. Sources

are free to trade RTC for the current year or for future years; however, all RTC are good only for

the year for which they are issued. Trades in RTC are limited by geographical factors; for a

potential buyer, the number of credits required to offset a pound of emissions varies with the

location of the seller. The District maintains records of all transactions in RTC and shares that

information with market participants.

Under RECLAIM rules, the District may impose penalties for net emissions (including trades) in

excess of the permitted amounts. One such penalty would reduce next year’s emission allocation

by the amount that emissions exceeded the allowable limit. Other possible actions include civil

penalties and the loss of the facility’s operating permit.
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2001 95

In 1994, the NOx and SOx markets began with 370 sources and 40 sources, respectively. Both

markets represented approximately 70% of stationary source emissions. Analysis shows that the

program should reduce NOx emissions by an average of 8.3% per year, which amounts to a

cumulative reduction of 80 tons per day by 2003. It should also reduce SOx emissions by 6.8%

per year, which amounts to a cumulative reduction of 15 tons per day by 2003. The District

projects that RECLAIM will lower compliance costs by $57.9 million a year when compared to a

traditional regulatory approach: $80.8 million versus $138.7 million.

As a means of jump-starting the market, the SCAQMD held an auction of RTC on July 29, 1994.

Utilities, which had by then installed new emission control equipment and did not need their full

allocation, were large sellers of NOx credits. A total of 114,676 NOx credits and 9,400 SOx

credits changed hands at the auction. Prices for RTC were low for near years and much higher

for more distant years. In all cases, though, the cost for a ton of credits was far lower than the

marginal control costs incurred from recently enacted or proposed regulations. The per-ton price

ranged from less than $20 to $2000, depending upon the credit’s year of validity, prices that are

very much in line with the 1994 auction. (See Table 6-5 for the prices of these credits.)

Table 6-5. Reclaim Trading Credit Prices

NOx ($ per ton)** SOx ($ per ton)** VINTAGE* 1994 1997 1994 1997

1994 2

1995 334 1,500

1996 574 1,900

1997 227 64

1998

1999 1,480

2000 1,580

2001 1,700

2002 1,830

2003 2,090 2,393

2010 1,880 2,385

Notes: * The term “Vintage” refers to the year in which the credit could be used. ** These figures are based on prices at a July

1994 auction and 1997 market prices.

Source: BNA Daily Environment Report, Aug. 10, 1994; SCAQMD 1998.

In June 1995, the SCAQMD proposed adding VOC emissions to RECLAIM; the initiative

included almost 1,000 facilities in 14 industrial categories that generated 4 tons or more of VOC

annually. In contrast to the NOx and SO2 programs that were scheduled to last for 7 years, the

VOC program would last 14 years. Officials estimated that the program would reduce emissions

from these sources from 53 tons a day, the projected level for 1996, to 15 tons a day by 2010.

The proposal to include the trading of VOCs within RECLAIM met with fierce opposition from

environmentalists. They charged that the 1989 baseline selected for emissions by SCAQMD

could result in a huge increase in emissions over 1993 levels when the program is fully

implemented. Regulators sought the 1989 baseline to avoid locking industry into emission levels

that were associated with the recessionary conditions that occurred in 1991, 1992, and 1993.

Industry representatives note that the AQMP has a schedule for orderly reductions over time

toward the 2010 goals. In their view, emissions increases that occur from 1993 to 1996 as the
The U. S. Experience with Economic Incentives for Protecting the Environment

96 January

economy pulls out of a recession are not relevant so long as emissions remain below the target

levels in the AQMP.

Unable to resolve the baseline issue, the 12-member governing board of SCAQMD set aside the

proposed rule to include trading of VOCs within RECLAIM in January 1996. The board then

directed its staff to develop a program to trade VOC emissions separately. Due to strong

opposition in some quarters and to difficulties in accurately measuring these emissions, a

subsequent VOC initiative ultimately was shelved.

RECLAIM has won praise for its progress to date. A state-mandated performance review found

that the District has a state-of-the-art air quality program that is performing efficiently and

effectively. According to the report, RECLAIM demonstration projects have helped stimulate

technological development. Furthermore, its outreach and compliance programs have helped

save or create more than 10,000 jobs, while, at the same time, these programs have improved air

quality.

Trading in the program has been active, expanding from $2.1 million worth of credits in 1994 to

$21 million worth of credits in 1997.131 The largest buyers of credits have been large refineries

and utilities, while the sellers were smaller refiners, glass container manufacturers and facilities

that ceased operations. Of the sources that went out of business or left the area, only a handful

cited environmental regulations as a factor in their decision.

RECLAIM credit prices have remained far below the prices that were projected at the time of

program adoption. The average price in 1997 for NOx credits of the same vintage was just $227

per ton, while 2010 vintage credits were $1,880 per ton. Average 1997 prices for SOx credits

were as low as $64 for 1997 vintage credits and as much as $2,393 per ton for 2003 vintage

credits. According to Cantor Fitzgerald, a broker in emission reduction credits, the average price

for SOx RTC in early 2000 was about $1500 per ton for 2000 vintage credits and $2,300 per ton

for 2005 to 2010 vintage credits.132

6.13 Other State Programs

In addition to RECLAIM, emission-trading programs are in various stages of development in

several states. This section reviews activities in Illinois, Michigan, New Jersey, Texas,

Pennsylvania, Colorado, and Washington. The state programs are an outgrowth of EPA’s

proposed 1995 Open Market Trading Rule.133 While the 1995 proposal was never finalized, it

was incorporated into Draft Economic Incentive Program (EIP) Guidelines in September 1999.

The Open Market Trading Rule and the subsequent EIP Guidelines provided guidance for states

that wish to institute emissions trading as part of their State Implementation Plans (SIP). As is

the case with all draft guidance documents, the guidelines are subject to change. The advantage

of EPA’s generic emission trading rules over offsets, bubbles, netting, and banking is that

individual trades do not require a SIP revision or EPA review. By following the generic rules, the

transaction costs of emission trading can be reduced substantially.

6.13.1 Illinois Emission Reduction Market System

The Illinois Emission Reduction Market System (ERMS) allows the trading of VOC emission

credits between firms in the Chicago non-attainment area. Like RECLAIM and the Acid Rain

Program, the Illinois ERMS is an allowance program designed with an overall emissions cap and

phased reductions to meet air quality goals. By 2007, when the market is scheduled to end, the
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2001 97

Chicago area must be in attainment for the national ambient air quality standard for ozone. Air

quality modeling revealed that controlling emissions of volatile organic matter would be far

more effective in reducing ozone than controlling NOx emissions.

The ERMS is applicable to sources in the Chicago ozone non-attainment area that emit more

than 10 tons per year of volatile organic matter (VOM) during the ozone season and that are

subject to the Clean Air Act Permit Program. Sources receive an allocation of allotment trading

units (ATU), each of which represents the right to release 200 pounds of VOM during the May

1-to-September 30 allotment period. Sources may receive a program exemption if they accept a

15-ton per season cap on emissions or if they agree to limit emissions to 82% of baseline

emissions. Sources in the program receive an allocation that is 12% lower than their baseline

emissions, defined as the two highest emission years during the 1994−1996 period.

6.13.2 Michigan Emissions Trading Program

The Michigan Air Emission Trading Program began in 1996.134 It provides for the banking and

trading of emission reduction credits (ERCs) in NOx, VOCs, and all criteria pollutants except

ozone. ERCs, which are denominated in tons per year, may be generated in the following ways:

(1) through a facility shutdown; (2) through a permanent reduction in operations that results in

reduced emissions; (3) through the use of new technologies, equipment, or inputs that result in

reduced emissions; and (4) through the installation of pollution control equipment that decreases

actual emissions. Various methods may be used to measure emissions: CEM; stack gas sampling;

measuring surrogates (e.g., some VOC, but not all VOC); inputs; process conditions; etc. In

general, credits obtained through a facility shutdown cannot be traded within a non-attainment

area to satisfy a source’s obligations.

6.13.3 New Jersey Emission Trading Program

The New Jersey Emission Trading Program is similar to Michigan’s program, except that it

applies only to NOx and VOC.135 The New Jersey Department of Environmental Protection

maintains a registry of discrete emission reduction (DER) credits that are transferred. Average

prices for 2000 are reported in Table 6-6.

Table 6-6. Open Market Emissions Trading Registry Report (2000)

POLLUTANT OZONE SEASON YEAR-TO-DATE

AVERAGE PRICE PER DER

NOx No $43.91

NOx Yes 48.40

VOC No 127.50

VOC Yes 127.50

Source: http://www.omet.com/scripts/omet/OMET_Report_Month_Selector.idc

6.13.4 Texas Emissions Trading Program

The Texas Natural Resource Conservation Commission (TNRCC) Emission Credit Banking and

Trading Program provides a market-based framework for trading emission reductions of volatile

organic compounds (VOC), nitrogen oxides (NOx), and certain other criteria pollutants from

stationary, area, and mobile sources. The program was designed to provide additional flexibility

for complying with the Texas Clean Air Act while creating a net reduction in total air emissions
The U. S. Experience with Economic Incentives for Protecting the Environment

98 January

with each transaction. At present, the TNRCC is developing a NOx cap-and-trade for certain

ozone non-attainment areas.

6.13.5 Pennsylvania Emission Trading Program

The Pennsylvania program is similar to the Michigan program, with some exceptions. ERCs may

be generated only for VOCs and NOx. ERCs can be transferred from dirtier areasthe five

Philadelphia countiesto cleaner areas, but not from the cleaner areas to the dirtier ones.136

ERCs may be transferred within the five-county Philadelphia area with some limitations. The

Pennsylvania Department of Environmental Protection (DEP) maintains a registry of ERCs that

are available for trade or future use. Buyers and sellers of ERCs are encouraged to contact DEP

for assistance.

6.13.6 Wood Stove and Fireplace Permit Trading (Colorado)

During the 1970s and 1980s, a number of mountain communities in Colorado experienced

unacceptably high levels of particulate pollution during winter months due to the use of woodburning stoves and fireplaces. The growing popularity of skiing and other winter activities has

exacerbated the problem in some of these areas.

Telluride tried to combat the problem through traditional forms of regulation. In 1977, the city

passed an ordinance limiting new residential construction to one stove or fireplace per unit. This

rule might have slowed the deterioration in air quality. However, new construction continued,

which virtually guaranteed that air quality would continue to worsen, which it did into the 1980s.

In 1987, the city adopted a program that was part traditional and part modeled on air pollution

offsets that would guarantee improvements in air quality. Owners of existing wood stoves and

fireplaces were grandfathered with operating permits, but they were required to meet stringent

performance standards within 3 years: 6 grams of particulate matter and 200 grams of CO per

hour. During the first 2 years of the program, those individuals who converted their fireplaces

and wood stoves to natural gas could earn a rebate of $750, which would partially defray their

costs. For new construction, no new permits would be issued for wood-burning stoves or

fireplaces. To install such an appliance in a newly constructed building, the owner must produce

permits to operate two fireplaces or stoves. These permits could only be acquired from existing

permit owners.

In a matter of months, a lively market in second-hand permits developed, with potential buyers

and sellers making contact through classified advertisements. By the mid-1990s, permit prices

were in the $2,000 range. In the years after Telluride adopted the program, it has reported no

violations of the ambient air quality standard for particulate matter.

Other communities in Colorado soon implemented similar programs, which combined

performance-based standards that encouraged the retirement of older inefficient fireplaces and

wood stoves. All these programs focused on reducing the burning of wood, but some offered no

rebates for converting these fireplaces and stoves to natural gas. From the available evidence, the

programs appear to have been a success, achieving air quality goals quickly and at a relatively

modest cost. A project for future research would compare and contrast the approaches taken by

different communities in limiting the use of heavily polluting wood stoves and fireplaces, as well

as assess the effectiveness of the programs.
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2001 99

6.13.7 Grass-Burning Permit Trading (Washington)

The City of Spokane, Washington, is nestled in the Spokane River Basin about 400 feet below

the surrounding Columbia River Plateau. The basin forms a natural trap for air pollution during

temperature inversions. The area exceeds the federal 24-hour standard for particulate matter

several times each year, due to a combination of unpaved roads, wind-blown dust, grass burning,

and wood-burning stoves.

Spokane is a major growing region for turf grass seed, with between 15,000 and 30,000 acres

planted for seed production each year. After harvest each year, the fields are burned in August or

September to control weeds and pests and to stimulate the grass to produce seed rather than

concentrate its energy on vegetative growth. In 1990, air pollution authorities in Spokane County

implemented an innovative program to reduce grass burning as a source of particulate matter.137

Grass burning had been subject to permitting for years. The program superimposes a countywide

cap of 35,000 acres that may be burned each year onto the existing permit process. Growers are

allocated permits to burn grass based on burning permits they held during the base period, 1985

to 1989. The overall cap does not appear to be binding; it exceeds the actual acreage burned in

every year since 1971. However, some grass growers found themselves short of desired permits

because they had planted other crops during the base period or because they had rented their land

to tenants (who held the permits) during the base period.

The program allows transfers of grass-burning permits in three situations: permanent land

transfers; temporary land transfers by lease; and transfer through an auction held by the Air

Pollution District. When permits are transferred through the auction, 10% of the burnable

acreage is deducted from the buyer’s account, resulting in a small decrease over time in the total

number of burnable acres. The auction mechanism is patterned after the acid rain allowance

auction. Parties submit sealed bids and offers prior to the auction. The party with the highest bid

is matched with the party with the lowest offer, with the actual transaction occurring at a price

midway between the bid and offer. If the entire quantity offered was not purchased by that

bidder, the bidder with the next lower price is then matched with the remaining offer. The

process continues until all potential transactions are completed.

6.14 Effluent Trading

Despite many academic studies showing the potential benefit of effluent trading and considerable

effort by EPA and the states to implement the concept, effluent trading has yet to live up to its

full promise. While conceptually very similar to emission trading (which deals with emissions to

the air), effluent discharge and its regulation also differ significantly from emission trading

because effluent trading deals with emissions to the water.

Water pollution is caused by both point and non-point sources. Point sources discharge

pollutants into surface waters through a conveyance such as a pipe or ditch. Primary point

sources include publicly owned treatment works (POTWs) and industries. Non-point sources add

pollutants from diffuse locations such as surface agricultural runoff or unchannelized urban

runoff. The most important non-point source of water pollution is agriculture. The differences

between emission trading and effluent trading have made it difficult to design practical programs

that can capture the potential benefits of effluent trading. New efforts by EPA to implement its

Total Maximum Daily Load (TMDL) program in areas with impaired water quality are expected
The U. S. Experience with Economic Incentives for Protecting the Environment

100 January

to vastly increase the use of effluent trading. For current EPA efforts to promote effluent trading,

see http://www.epa.gov/owow/watershed/trading.htm.

6.14.1 Effluent Bubble

In concept, a water effluent bubble operates identically to the air emission bubble described in

Section 6.2.2, Bubble Policy. A facility with multiple discharge points is wrapped in an

imaginary bubble, with a facility-wide discharge limit rather than separate limits at the individual

points of discharge. In contrast to the 100-some bubbles approved under the air emission trading

program, only a handful of facilities within the iron and steel industry have received the authority

to bubble effluents. The historical development of that program is described in the following

paragraphs.

Asked by EPA to evaluate the potential for water effluent bubbling, a contractor ventured in

1981 that bubbling would not produce cost savings for most industrial facilities.138 The reasons

include the fact that most industrial facilities already have centralized wastewater treatment

plants with a single point of discharge, trades between outfalls may be circumscribed due to

water quality concerns, and some facilities already operated under permits that allowed all

technologically feasible tradeoffs to be made.

Despite the acknowledged limitations, a subsequent study identified four plants in the iron and

steel industry that would, potentially, benefit from water bubbling as they went from BPT (best

practicable control technology currently available) to BAT (best available technology

economically achievable).139 The projected savings were less than $1 million annually. A

retrospective study estimated the savings from effluent bubbles in the iron and steel industry

were far larger: in excess of $122 million, as shown in Table 6-7.

Table 6-7. Estimated Cost Savings from Iron and Steel Intraplant Trades

FACILITY OUTFALLS

IN TRADE

TRADING PERIOD

FOR ANALYSIS

PRESENT VALUE OF

REDUCED CAPITAL

COSTS (in millions of

1993 dollars)

PRESENT VALUE OF

REDUCED OPERATING &

MAINTENANCE COSTS

(in millions of 1993 dollars)

PRESENT VALUE OF

ALL REDUCED COSTS

(in millions of

1993 dollars

A 5 1987−1993 $3.9 $2.4 $6.3

B 2 1983−1986 No Data No Data No Data

C 2 1985−1993 2.4 2.5 4.9

D 3 1984−1993 2.1 1.2 3.3

E 4 1986−1993 No Data No Data No Data

F 2 1983−1988 10.3 3.9 14.2

G 2 1984−1993 5.5 3.1 8.6

H 2 1984−1989 8.9 6.8 15.7

I 3 1983−1985 57.7 12.1 69.8

J 3 1984−mid-1980s No Data No Data No Data

TOTALS $90.8 $32.0 $122.8

Source: Kashmanian et al. 1995.

EPA’s implementation of the effluent bubble for the iron and steel industry was dictated by a

1983 settlement agreement among EPA, the Natural Resources Defense Council (NRDC), and

the American Iron and Steel Institute. The agreement supports the use of bubbling under the
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2001 101

Clean Water Act, but it imposes constraints on the approach. Bubbling of effluents from iron and

steel plants is acceptable, provided that net reductions are achieved in each pollutant that is

bubbled. Relative to the BAT limits that are in effect, bubbling must involve a reduction of at

least 15% of the amount of both suspended solids and oil and grease and 10% of the amount of

other pollutants. The NRDC reserved the right to challenge bubbles that might be proposed for

other industries.

Complying with the steel effluent bubble has produced considerable cost savings for the

industry. According to a former EPA employee who is now a consultant to the industry,

however, the bubble has not resulted in any pollution control innovations.140 EPA will soon

propose revisions to the iron and steel regulations that would make the effluent bubble

unnecessary.

6.14.2 Effluent Trading: Point-to-Point

Effluent trading dates to the early 1980s. At that time, the State of Wisconsin created a statewide program to give sources such as wastewater treatment plants and pulp and paper mills

added flexibility to meet the state’s water quality standards through the trading of effluent rights.

The first application of this authority was on the heavily industrialized lower Fox River.

The Fox River program applies to the last 35miles of the river, allowing trading between point

sources with permits to discharge wastes that increase biochemical oxygen demand (BOD).

Sources that control more waste than their discharge permit requires can sell those incremental

rights to sources that control less waste than is required. Strict conditions are imposed on wouldbe buyers of rights: Trading of rights is allowed only if the buyer is a new facility, is increasing

production, or is unable to meet required discharge limits despite optimal operation of its

treatment facilities. Traded rights must have a life of at least 1 year, but they may not run past the

expiration date of the seller’s discharge permit, which is, at most, a 5-year period. Since effluent

discharge limits may change with each permit renewal, there can be no guarantee that rights that

were traded-in during one permit period would be available during subsequent permit periods.

Analysis predicted that the potential gains from effluent trading among sources on the lower Fox

River was significant: $7 million annually or roughly one-half of anticipated compliance costs

for BOD regulations.141

Later, the state initiated BOD trading programs on 500 miles of the Wisconsin River. For

administrative reasons, the Fox River was divided into three segments and the Wisconsin River

into five segments. The Fox River program included 21 parties: five mills and two towns in each

of the three administrative segments. Twenty-six parties are included in the Wisconsin River

program. To date, trading under these programs has been disappointing, involving a single trade

on the Fox River between a municipal wastewater plant and a paper mill. One reason for the

limited activity is that dischargers developed a variety of compliance alternatives not

contemplated when the regulations were drafted. Second, there were questions about the

vulnerability of the program to legal challenge, and these questions remain since the Clean Water

Act does not explicitly authorize trading. Furthermore, there is a requirement that all facilities

meet minimum technology-based effluent limits. Finally, as noted in a previous paragraph, the

state imposed severe restrictions on the ability of sources to trade.
The U. S. Experience with Economic Incentives for Protecting the Environment

102 January

6.14.3 Effluent Trading: Point-to-Non-point Sources

A number of programs allow the trading of nutrient discharges between point and non-point

sources. Three such programs are described here; others are included in Table 6-8.

6.14.3.1 Dillon Reservoir

Dillon Reservoir, which supplies Denver with more than one-half of its water supply, is situated

in the midst of a popular recreational area. Four municipal wastewater treatment plants discharge

into the reservoir: the Frisco Sanitation District, Copper Mountain, the Breckenridge Sanitation

District, and the Snake River treatment plant of the Keystone area.

Due to concerns that future population growth in the region could lead to eutrophic conditions in

Dillon Reservoir, as well as the discovery that Copper Mountain was exceeding its discharge

limits, EPA launched a study of the Dillon Reservoir in 1982 under its Clean Lakes program.

The study indicated that phosphorus discharges would have to be reduced to maintain water

quality and accommodate future growth. Point source controls alone were unlikely to be

sufficient; runoff from lawns and streets and seepage from septic tanks also would have to be

reduced.

A coalition of government and private interests developed a plan to reduce phosphorus releases

to the reservoir. The plan established a cap on total phosphorus loadings, allocated loadings to

the four wastewater treatment plants, and provided for the first-ever trading of phosphorus

loadings with non-point sources.

The plan relies on 1982 phosphorus discharges as the baseline; that year represented a near

worst-case scenario due to high rainfall and water levels that led to high non-point loadings.

Discharges from new non-point sources are restricted through regulations that require developers

to show a 50% reduction of phosphorus from pre-1984 norms. New non-point sources must

offset all of their discharges by using a trading ratio of 1:1 with existing non-point sources. For

point sources, the plan established a trading ratio of 2:1, whereby point sources that are above

their allocation must obtain credits from point or non-point sources for twice the amount of the

excess from sources that are below their allocation. The system would be monitored through

existing NPDES (National Pollution Discharge Elimination System) permits for point sources.

Trading has been very slow. Not only has the region experienced a recession for a number of

years that limited population growth, but the wastewater treatment plants have found cheaper

means of controlling phosphorus than were previously envisioned. In the future, though,

opportunities for further control at the wastewater treatment plants are thought to be limited.

Population growth is once again evident, leading to the conclusion that more trading activity is

likely.

6.14.3.2 Cherry Creek Reservoir

Like the Dillon Reservoir, Cherry Creek Reservoir also is a source of water for the Denver

region and an important recreation area. The 800-acre reservoir attracts more than 1.5 million

visitors annually. To protect recreational and water supply uses, the Cherry Creek Basin

Authority developed a total phosphorus standard to limit algae concentrations and assigned

wasteload allocations to the 12 wastewater treatment facilities in the watershed (a total maximum

daily load for the reservoir). Source trading between point sources and non-point sources is

authorized as an option for addressing the fact that 80% of the phosphorus load originates with

non-point sources. To date, there has been no compelling need to trade at Cherry Creek since
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2001 103

phosphorus effluent at municipal wastewater treatment facilities remain below the limits set by

the Colorado Water Quality Commission. The Cherry Creek Basin Authority has designed a

number of non-point pollution control projects that will generate phosphorus reduction credits.

When regional economic growth compels wastewater treatment facilities to achieve greater

phosphorus reductions, the credits will be available.

6.14.3.3 Tar Pamlico Basin

The North Carolina Environmental Management Commission designated the Tar-Pamlico Basin

as nutrient-sensitive waters in 1989, in response to findings that algae blooms and low-dissolved

oxygen threatened fisheries in the estuary. Upon designating an area as nutrient-sensitive, North

Carolina law requires that the Division of Environmental Management (DEM) must identify the

nutrient sources, set nutrient limitation objectives, and develop a nutrient control plan.

DEM prepared analysis showing that most of the nutrient loadings (nitrogen as the limiting

factor but also phosphorus) came from non-point sources, principally agricultural runoff. Other

identified sources included municipal wastewater treatment plants and industrial and mining

operations. DEM proposed a solution to control both nitrogen and phosphorus discharge from

wastewater treatment plants: nitrogen at 4 mg/l in the summer and 8 mg/l in the winter and

phosphorus at 2 mg/l year-round.

Concerned about the potential costs of this regulation, municipal wastewater dischargers worked

with state agencies and the North Carolina Environmental Defense Fund to design an alternative

approach. Ultimately accepted by the DEM, the plan requires the parties to the accord to develop

a model of the estuary, identify engineering control options, and implement a trading program

for nutrient reductions. The trading program allows each of the 12 point source dischargers the

opportunity to offset any discharges above their permitted limits. They may trade with feedlot

operators on a 2:1 basis or with cropland managers on a 3:1 basis. To date, point source

dischargers have found ways to meet new and stricter discharge limits without resorting to

trading. In the future, trading may become more attractive as a compliance option. Hoag and

Hughes-Popp (1997) provide a useful discussion of the program.

6.14.3.4 Other Effluent Trading Initiatives

EPA and the states are actively involved in a number of other effluent trading projects. These

projects are summarized in Table 6-8 and in more detail in a recent EPA report entitled “A

Summary of U.S. Effluent Trading and Offset Projects.”142 Many of these projects also are

discussed on the Nutrientnet web site: http://www.nutrientnet.org.

6.14.4 Future Prospects for Effluent Trading

The Federal Water Pollution Control Act (FWPCA) of 1972 developed the basic framework for

federal water pollution control. After amendments in 1977, the FWPCA has been known as the

Clean Water Act (CWA). The FWPCA controls water pollution by regulating discharges of

pollutants from point sourcessuch as industrial facilities, sewage treatment plants, and

concentrated animal feeding operationswith a system of national effluent standards and

permits for each class of point source discharge (the NPDES system). EPA sets effluent

discharge standards based on the cost of control and the availability of control technology. By

using this basic approach, many of the nation’s streams and rivers are demonstrably cleaner than

they were in 1972.
The U. S. Experience with Economic Incentives for Protecting the Environment

104 January

Table 6-8. Effluent Trading Projects

PROJECT WATER BODY STATE ACTIVITY

DESCRIPTION STAGE

TRADES/

OFFSETS

APPROVED?

SAVINGS

ESTIMATE

AVAILABLE?

Grassland Area

Tradable Loads

San Joaquin

River CA Watershed

trading program Implementation Y N

San Francisco Bay

Mercury Offset

San Francisco

Bay CA Regional offset

program

Under

development N N

Bear Creek Trading

Program

Bear Creek

Reservoir CO Watershed

trading program Approved N N

Boulder Creek

Trading Program Boulder Creek CO Watershed

trading program Implementation Y Y

Chatfield Reservoir

Trading Program

Chatfield

Reservoir CO Watershed

trading program Approved N N

Cherry Creek Basin

Trading Program

Cherry Creek

Reservoir CO Watershed

trading program Implementation Y N

Dillon Reservoir

Trading Program Dillon Reservoir CO Watershed

trading program Implementation Y N

Long Island Sound

Trading Program

Long Island

Sound CT Large watershed

trading program

Under

development N Y

Blue Plains WWTP

Credit Creation Chesapeake Bay DC Single trade Under

development N N

Tampa Bay

Cooperative

Nitrogen

Management

Tampa Bay FL Regional

cooperation Implementation Y N

Cargill and

Ajinomoto Plants

Permit Flexibility

Des Moines IA NPDES permit

flexibility Implementation Y N

Lower Boise River

Effluent Trading

Demonstration

Project

Boise River ID Watershed

trading program

Under

development N Y

Specialty Minerals

Inc. Hoosic River MA Offset for one

discharger Implementation N Some

Town of Acton

POTW Assabet River MA Offset for one

discharger

Under

development N Some

Wayland Business

Center Treatment

Plant Permit

Sudbury River MA Offset for one

discharger Implementation Y Y

Maryland Nutrient

Trading Policy

Chesapeake

Bay, other MD

waters

MD Statewide trading

program

Under

development N N

Kalamazoo River

Water Quality

Trading

Demonstration

Kalamazoo

River, Lake

Allegan

MI Watershed pilot

program Implementation Y N

Michigan Water

Quality Trade Rule

Development

MI Waters MI Statewide trading

program

Nearing

completion N Y
Trading Programs

2001 105

PROJECT WATER BODY STATE ACTIVITY

DESCRIPTION STAGE

TRADES/

OFFSETS

APPROVED?

SAVINGS

ESTIMATE

AVAILABLE?

Minnesota River

Nutrient Trading

Study

Minnesota River MN Watershed

trading study Completed N/A Y

Rahr Malting Plant Minnesota River MN Offset for one

discharger Implementation Y N

Southern Minnesota

Beet Sugar Plant Minnesota River MN Offset for onedischarger Implementation Y N

Chesapeake Bay

Nutrient Trading Chesapeake Bay multi Large watershedtrading program

Under

development N N

Neuse River Nutrient

Strategy

Neuse River

Estuary NC Watershedtrading program Approved N Y

Tar Pamlico Nutrient

Program

Pamlico River

Estuary NC Watershedtrading program Implementation Y Y

Passaic Valley

Sewerage Com.

Effluent Trading

Hudson River NJ Pretreatment

program Implementation Y N

Truckee River Water

Rights and Offset

Program

Truckee River NV Offset for one

discharger Implementation Y N

New York

Watershed

Phosphorus Offset

Pilot Programs

Hudson River NY Offset pilot

programs Implementation Y N

Claremont County

Project

Little Miami

River, Harsha

Reservoir

OH Potential regional

trading project

Under

development N N

Delaware River

Basin Trading

Simulation

Delaware River PA Watershed pilot

program

Early

discussion N N

Henry Co. Public

Service Auth. and

City of Martinsville

Smith River VA Single trade Implementation Y N

Virginia Water

Quality Improvement

Act and Tributary

Strategy

Chesapeake

Bay, other VA

waters

VA Statewide trading

program Approved N N

Wisconsin Effluent

Trading Rule

Development

WI waters WI Statewide trading

program

Pilots active N N

Fox-Wolf Basin

Watershed Pilot Green Bay WI Watershed pilot

program Approved N Y

Red Cedar River

Pilot Trading

Program

Tainter Lake WI Watershed pilot

program Approved N Y

Rock River Basin

Pilot Trading

Program

Rock River Basin WI Watershed pilot

program

Under

development N N

Source: EPA. Reinvention Activity Fact Sheets. Effluent Trading in Watersheds
The U. S. Experience with Economic Incentives for Protecting the Environment

106 January

According to data submitted by states in 1998, about 40% of the nation’s streams and rivers do

not meet the water quality goals set forth by states, Indian tribes, and territories.143 For these

water bodies, a little-known provision in Section 303 of the Clean Water Act will soon be used to

achieve further improvements in water quality. Recently, EPA published final rules, which have

not yet taken effect, concerning the Total Maximum Daily Load (TMDL) Program.

A TMDL is a calculation of the maximum quantity of pollution that a water body can accept and

still meet designated water quality standards. The TMDL is then allocated to point and non-point

sources. Effluent trading will be encouraged as a means of lowering compliance costs for

affected sources.

Of concern is the CWA requirement that existing, expanding, and new facilitiesincluding

publicly owned treatment works, industrial dischargers, stormwater programs, and coastal zone

measuresmeet all applicable technology-based requirements. This requirement appears to

represent a severe obstacle to trading.

The potential cost savings from effluent trading are impressive. Analysis by EPA suggests that

trading among indirect dischargers could produce compliance cost savings of $658 million to

$7.5 billion. Trading just among point sources could achieve cost savings of $8.4 million to $1.9

billion, while trading among point and non-point sources could yield compliance cost savings of

$611 million to $5.6 billion.144

6.15 Wetland Mitigation Banking

Wetlands (also sometimes termed “swamps,” “bogs,” or “floodplain”) were long considered

unproductive wastelands. Over time, hundreds of thousands of acres of wetlands were drained by

farmers, filled by developers, and otherwise converted to “productive” uses. From the 1780 to

1980, the contiguous 48 states lost over one-half of their original wetland acreage. 145

In recent years, scientists pointed out the ecological importance of wetlands. Government

policies at the federal, state, and local level have since come to emphasize wetland preservation,

not development. Developers whose proposed actions would destroy wetlands are increasingly

being forced to minimize damage to wetlands and to offset what damage occurs through wetland

protection or enhancement offsite. Sometimes, the offset takes the form of compensation. That

approach is described more fully in Chapter 4, Pollution Charges, Fees, and Taxes. This section

describes wetland mitigation banking, a procedure for offsetting the adverse impacts of

development on wetlands.

Wetland mitigation banks are created through a memorandum of understanding (MOU) among

federal and state officials and a bank administrator. In most cases, the MOU would describe the

responsibilities of each party, the physical boundaries of the bank, how mitigation credits will be

calculated, and who is responsible for long-term management of the bank. Credits, which are

usually denominated in terms of acres of habitat values, may only be used to mitigate

development within the same watershed. State regulations would cover issues such as where

mitigation credits can be used (e.g., statewide or within a watershed) and the compensation ratios

that would be required for various types of development. Existing banks vary from a few acres to

over 7,000 acres.

Among established wetland mitigation banks, most MOUs allow the bank operator to sell credits

only after the bank has actually accomplished wetland enhancement or preservation. A few states
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2001 107

allow the bank operator to sell credits concurrently as preservation or enhancement actions are

undertaken.

The land for a mitigation bank could have any number of origins. Some of the more common

sources of mitigation bank lands include existing natural wetland areas, enhanced natural

wetland areas, pits created by the removal of landfill material, and lands that previously had been

drained for agricultural use. State highway departments established approximately one-half of

existing wetland mitigation banks to provide a means for mitigating losses due to highway

construction. Conservation organizations and for-profit entities have set up mitigation banks that

offer mitigation credits for sale.

Mitigation banking offers several advantages over more traditional on-site mitigation activities.

• Environmental values are better protected in large-scale developments.

• Economies of scale in wetland preservation and enhancement can be realized.

• The cost of wetland mitigation actions can be made known to developers very early in the

development process.

• Mitigation banking offers greater assurance of long-term management of the protected

area.

About 100 wetland mitigation banks in at least 34 states are currently in operation, and more are

in advanced stages of planning. Wetland mitigation banking was featured in the 1996 Farm Bill

as part of the Wetlands Reserve Program. Wetland mitigation banking has been endorsed by

EPA, the Army Corps of Engineers (which oversees most development in wetlands under

Section 404 of the Clean Water Act), and by the authors of leading legislative initiatives to

reauthorize the Clean Water Act. All of these facts suggest that wetland mitigation banking will

grow in importance as a means of protecting and enhancing the nation’s wetlands.

6.16 Greenhouse Gas Emissions

The Kyoto Protocol to the United Nations Framework Convention on Climate Change

(UNFCCC) establishes quantified emission limitations and reduction targets for greenhouse

gases (GHG) that are to be achieved by the end of the first commitment period (2008−2012). On

average, these commitments call for a 5.2% reduction from 1990 emission levels. (However,

these commitments vary from one Party to the Convention to another.) To date, the Protocol has

been signed by 38 industrialized countries and the European Community—the so-called Annex I

Parties—but it has not been ratified by a sufficient number of Parties to come into effect.

Among other things, the Protocol includes basic provisions for the monitoring, reporting, and

verification of greenhouse gas emissions (Articles 5, 7, and 8), and it outlines the need for

effective procedures and mechanisms to address non-compliance (Article 18). Most remarkably,

the Kyoto Protocol allows for the use of economic-incentive mechanisms, the so-called “flexible

mechanisms,” that enable the emission reduction targets to be met at least cost. These

mechanisms, described in the following paragraphs, consist of Joint Implementation (Art. 6); the

Clean Development Mechanism (Art. 12); and International Emissions Trading (Art. 17). They

also include the use of Article 4 (the “bubble”) by a group of Parties to fulfill their commitments

jointly. At present, many of the rules and guidelines related to these provisions are in the process

of being negotiated. How the issues are resolved will have an effect on the number of countries
The U. S. Experience with Economic Incentives for Protecting the Environment

108 January

that will ratify the Kyoto Protocol and the cost of achieving these emission reduction targets. In

November 2000, delegates met in The Hague, The Netherlands but were unable to resolve many

of the issues concerning GHG trading. They have scheduled a resumed session for May 2001 in

Bonn.146

Joint Implementation (JI): JI allows Annex I Parties to transfer and acquire “Emission Reduction

Units” that are generated from project-level activities that reduce emissions by sources or that

enhance removals by sinks in other Annex I countries. That is, a country or designated legal

entity within a country can invest in a greenhouse gas (GHG) reduction project in another Annex

I country and receive credits for the emissions reductions that the project generates. Project

participants must show that the emissions reductions or removals are real, measurable, and

additional to what would have occurred in the absence of the project activity.

Clean Development Mechanism (CDM): The CDM enables Annex I Parties or legal entities

within these countries to invest in GHG emission reduction or removal projects in non-Annex I

countries (i.e., developing countries), in exchange for “certified emissions reduction” units. The

CDM would promote sustainable development in developing countries and help Annex I

countries meet their GHG targets. Similar to JI, project participants must show that the emissions

reductions or removals are real, long-term, measurable, and additional to what would have

occurred in the absence of the project activity.

International Emissions Trading (IET): Under Article 17, Annex I Parties are able to participate

in international emissions trading to meet their GHG targets. That is, countries with high costs of

emissions abatement can provide funding for additional reductions in other Annex I countries

that have low costs of emissions abatement, in exchange for the acquisition of assigned amount

units. This ruling, in effect, enables Annex I Parties to reach their emission reduction targets at

minimum cost.

The Article 4 Joint Fulfillment: Article 4 would allow a group of Parties in Annex I to choose to

satisfy their emission reduction commitments jointly and to reallocate the commitments among

the Parties within the group. The provision was designed to allow the European Union (EU) to

change the distribution of reduction and limitation commitments set out in Annex B of the Kyoto

Protocol for its members, with the absolute EU target remaining unchanged. The provision also

enables other groups of Annex I Parties to enter into such an agreement, if they choose.

Activities Implemented Jointly (AIJ): At the first conference of the Parties to the UN Framework

Convention on Climate Change, which was held at the 1990 Rio Earth Summit, the Parties

agreed to a pilot program called “Activities Implemented Jointly.” Under this program,

government entities in one country could jointly undertake projects with similar entities in

another country.

The United States Initiative on Joint Implementation (USIJI) was the first national program to

adopt a formal set of criteria and an evaluation process for activities that could be implemented

jointly (AIJ). An Evaluation Panel with representatives from U.S. government agencies

determined the acceptability of proposed projects. The first United States AIJ projects were

accepted in January 1995, and others followed soon thereafter. Central America hosted most of

the early U.S. projects, but Russia and other nations also hosted AIJ projects. Projects involved

energy end uses; energy production; biomass, geothermal, hydroelectric, and wind energy

technologies; and forestry management. Through the end of July 1998, the USIJI panel had
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2001 109

approved 32 projects out of 110 that had been submitted. (See Table 6-9.) The other projects

were withdrawn or rejected.

Table 6-9. Accepted USIJI Projects

(As of October 25, 2000)

 PROJECT NAME COUNTRY PROJECT TYPE

CAPEX, SA Electric Generation Project Argentina Energy production

Landfill Gas Management in Greater Buenos Aires Argentina Energy production

Rio Bermejo Carbon Sequestration Project Argentina GHG sink

Bel/Maya Biomass Power Generation Project Belize Energy production

Rio Bravo Conservation and Forest Management Belize GHG sink

Noel Kempff M. Climate Action Project Bolivia GHG sink

Rural Solar Electrification Project Bolivia Energy production

The Taquesi River Hydroelectric Power Project Bolivia Energy production

SIF Carbon Sequestration Project Chile GHG sink

The Rio Condor Carbon Sequestration Project Chile GHG sink

Wind Energy Project Chile Energy production

La Sierra Electricity Efficiency in Colombia Colombia Energy end use

Aeroenergia S.A. Wind Facility Costa Rica Energy production

Consolidation of National Parks & Biological Reserves as Carbon Deposit Costa Rica GHG sink

Dona Julia Hydroelectric Project Costa Rica Energy production

ECOLOAND: Piedras Blancas National Park Costa Rica GHG sink

Esquinas National Park Costa Rica GHG sink

Klinki Forestry Project Costa Rica GHG sink

Plantas Eolicas S.R.L. Wind Facility Costa Rica Energy production

Territorial and Financial Consolidation of Costa Rican National Parks and Biological

Reserves Costa Rica GHG sink

Tierras Morenas Windfarm Project Costa Rica Energy production

City of Cecin: Fuel Switching, District Heating System Czech Rep. Energy end use

Bilsa Biological Reserve Ecuador GHG sink

Cemento de El Salvador, S.A. de C.V. El Salvador Energy end use

Matanzas Hydroelectric Project Guatemala Energy production

Rio Hondo II Hydroelectric Project Guatemala Energy production

Santa Teresa Hydroelectric Project Guatemala Energy production

Bio-Gen Biomass Power Generation Project, Phase I Honduras Energy production

Bio-Gen Biomass Power Generation Project, Phase II Honduras Energy production

Solar-Based Rural Electrification Honduras Energy production

The Bagepalli Project: Community-Based Fruit Tree Orchards for CO2 Sequestration India GHG sink

Reduced Impact Logging for Carbon Sequestration in East Kalimantan Indonesia GHG sink

Energy Centers for Mali Mali Energy production

Solar Electric Generation for the Island of Rodrigues Mauritius Energy production

APS/CRD Renewable Energy Mini-Grid Project Mexico Energy production

Community Silviculture in the Siera Norte of Oaxaca Mexico GHG sink

Project Salicornia: Halophyte Cultivation in Sonora Mexico GHG sink

Scolel Té: Carbon Sequestration and Sustainable Forest Management in Chiapas Mexico GHG sink

El Hoyo-Monte Galan Geothermal Project Nicaragua Energy production

Continued on the next page
The U. S. Experience with Economic Incentives for Protecting the Environment

110 January

 PROJECT NAME COUNTRY PROJECT TYPE

Commercial Reforestation in the Chiriqui Province Panama GHG sink

The Central Selva Climate Action Project Peru GHG sink

Energy Efficient Street Lighting Project in the Philippines Philippines Energy end use

District Heating Renovation in Lytkarino Russian Fed. Energy end use

Improving District Heating Efficiency in Metallurguichesky District of Cheliabinsk Russian Fed. Energy end use

Reforestation in Vologda Russian Fed. GHG sink

RUSAFOR--Saratov Afforestation Project Russian Fed. GHG sink

RUSAGAS: Fugitive Gas Capture Project Russian Fed. Energy end use

Zelenagrad District Heating System Improvements Russian Fed. Energy end use

Guguletu Eco-Homes Project South Africa Energy end use

SELCO—Sri Lanka Rural Solar Electrification Project Sri Lanka Energy production

Energy Center for Uganda Uganda Energy end use

Solar Light for the Churches of Africa Uganda Energy end use

Source: USIJI Secretariat, 2000.

Financing remains a major obstacle; just 13 of the 32 projects that were approved through July

1998 had obtained funding by sponsors. Participants in these projects assert that they faced large

transaction costs in dealing with host governments and experienced significant delays in getting

project approvals from the USIJI Evaluation Board and from host governments. Sponsors

identified development of new contacts in the host country, early entry into a potentially

profitable business, the possibility of influencing future AIJ criteria, and favorable publicity as

motivating factors.

The record of the early AIJ projects offers important lessons regarding the CDM and how it

should be structured. After-the-fact assessments of a large number of U.S. AIJ projects reveal

difficulties in determining whether project activities truly are additional to activities that would

have been undertaken without the AIJ program. Furthermore, monitoring progress and

measuring the success of JI activities in reducing GHG emissions have proven to be a challenge,

particularly for projects designed to create or enhance carbon sinks. Since pre-Kyoto AIJ was

largely an experimental activity, the consequences of a shortfall were not large. If credits had

been sold or traded to other parties, the consequences would have been more serious.

Implementation of the Kyoto Protocol will have major financial implications. EPA-sponsored

studies by Koomey et al. (1998) and Laitner et al. (1999) suggest that market-based policies,

including expanding EPA’s own voluntary programs, could reduce domestic energy-related

carbon emissions by as much as 300 million metric tons at a net positive benefit to the economy

by 2010. Estimates of the potential savings from the use of trading to satisfy U.S. obligations,

versus traditional alternatives, are as high as $100 billion per year.147 Clearly, details regarding

how the program will be designed and implemented are likely to have considerable financial

implications.
Subsidies for Pollution Control

2001 111

7. Subsidies for Pollution Control

7.1 Introduction

For the purposes of this report, subsidies of interest involve financial support by the

government of activities believed to be environmentally friendly. The types of

subsidies described in this report include grants, low-interest loans, favorable tax

treatment, and procurement mandates for products believed to have environmental

advantages. Research and development, information dissemination, and other

services provided by the government that are below their true cost could also be

considered subsidies. However, such services are too varied and numerous to be

included in this report.

Subsidies are often funded by the fees charged on environmentally harmful products

or activities. Advance disposal fees, for example, provide revenues to subsidize the

proper disposal of products after their use. Although it could be argued that such

disposal activities are not truly subsidized by the government if they are funded

entirely by the fees on the product that are paid by industry or consumers, this

chapter includes such mechanisms for the purposes of discussion.

Given the variety of subsidies used in environmental management at all levels of

government, this chapter does not attempt to cover the topic in a comprehensive way.

Its purpose is, instead, to provide an overview, with illustrative examples of the types

of subsidies and how they have been used to address specific environmental

problems.

The following areas are considered: pollution prevention and control, cleanup of

contaminated industrial sites, farming and land preservation, consumer product waste

management, citizen monitoring of environmental regulations, alternative fuels and

low-emitting vehicles, and municipal wastewater treatment. The chapter concludes

with a discussion of subsidies that have had the unintended effect of promoting

environmentally harmful activities.

Table 7-1 summarizes various subsidy instruments, most of which are discussed in

this chapter. Column 2 shows who pays for the various subsidies. The issue of

whether the costs of subsidies are passed on to other businesses or consumers in

some way is not addressed. Information on funding sources other than general

revenues is also included in parentheses, where available. Column 3 lists the

recipients of these subsidies. Whether these parties pass on the benefits of subsidies

to their customers or others is also not assessed.

7.2 Pollution Prevention and Control

This section discusses the use of tax benefits and loans to promote pollution

prevention and control. It also discusses an EPA program under which fines for

environmental violations are reduced in exchange for pollution prevention and

control activities.
The U. S. Experience with Economic Incentives for Protecting the Environment

112 January

Table 7-1. The Use of Subsidies in Environmental Management

SUBSIDY INSTRUMENT WHO PAYS? RECIPIENTS

Grants

Brownfields development grants EPA, states Communities, property owners

Cost sharing for land conservation Federal government Property owners

Conservation easements Federal, state, and local governments

(Land transfer taxes) Property owners

Environmental violation reporting rewards States of New Jersey, California Individuals and organizations

Waste management and recycling grants

Federal, state, and local governments

(advance disposal fees (ADFs), waste

taxes)

Public and private organizations

Unit-based waste collection or reuse

payments State governments (ADFs, waste taxes) Businesses

Unit-based payments for the use of

alternative fuel vehicles (AFVs) Federal government Public bus systems and small

businesses

Municipal sewage treatment plant

construction grants (replaced by loans) Federal and state governments Communities

Loans

Pollution control loans State governments Small businesses

Brownfields development loans State governments (waste taxes) Property owners

Recycling business loans State governments (ADFs, waste taxes) Businesses

Municipal sewage treatment plant

construction loans (replaced previous grant

program)

Federal and state governments Communities

Tax Benefits

Pollution control property State governments Private organizations

Louisiana environmental score-card

deduction State of Louisiana Businesses

Brownfields development State governments Property owners

Land use credits State governments Property owners

Recycling benefits State governments Businesses

Credits for ethanol and compressed natural

gas Federal and state governments Alternative fuel vehicle

manufacturers

Credits for alternative fuel vehicles and

equipment Federal and state governments Alternative fuel vehicle

purchasers

Renewable electricity generation credits Federal government Businesses

Electric vehicle credits Federal government Businesses or organizations

Interest exemption of pollution control

investment debt Federal government Businesses or organizations

Procurement Mandates

Public procurement of recycled products Federal, state, and local governments Recycled products

manufacturers

Public procurement of alternative fuel

vehicles Federal, state, and local governments Alternative fuel vehicle

manufacturers

Recycled content requirements Private organizations Recycled products

manufacturers

Mandates for the use of alternative fuel

vehicles Private organizations Alternative fuel vehicle

manufacturers
Subsidies for Pollution Control

2001 113

SUBSIDY INSTRUMENT WHO PAYS? RECIPIENTS

Miscellaneous

Reduced fines in return for supplemental

environmental projects Federal and state governments Businesses

Accelerated review of applications for new

pesticides Federal government Pesticide manufacturers

Relaxed regulatory requirements (e.g.,

ethanol Ried Vapor Pressure (RVP) waiver) Federal, state, and local governments Various organizations

Research & development; public education

(technical assistance to participants in

voluntary programs)

Federal, state, and local governments Various organizations

7.2.1 Tax Benefits

Numerous states offer favorable tax treatment for the construction and installation of pollution

control equipment. In most states that have such tax incentives, the equipment must have

pollution control as its primary purpose. In some states, equipment with other purposes receives

tax benefits on a prorated basis. Some states also require environmental regulators to certify

equipment that is eligible for tax breaks.

The benefits usually apply to property or sales/use taxes but can apply to income tax in a smaller

number of states. Air and water pollution equipment is commonly given tax benefits. However,

New York offers a property tax exemption for industrial waste treatment facilities, and Ohio

offers benefits for noise abatement equipment. Tax exemptions for production machinery and

products used directly in manufacturing also apply to pollution control equipment in many

cases.148

In Texas, for example, a constitutional amendment approved by voters in 1993 provided for

exemptions of certain pollution control property from property taxes. The purpose of the

amendment was to ensure that investments made to comply with environmental mandates did not

raise the property tax payments of businesses. The exemptions applied only to “devices,

equipment, methods, or land used to prevent, monitor, control, or reduce air, water, or land

pollution” purchased in 1994 to “meet or exceed state, federal, or local laws, rules, and

regulations.” The vast majority of exemption requests were made for equipment that was used to

comply with Clean Air Act requirements. The total value of the property for which businesses

applied for exemptions was $1.2 billion. A state official estimated that the applications would

lead to a loss of $26.6 million in tax revenue.149

One problem with such tax benefits is that they can erode state or local tax bases. In Texas, for

example, the $26.6-million revenue shortfall is expected to affect mainly school districts, but

also cities and counties. One tax district appraiser predicted that homeowners would make up the

shortfall.150

The incentive effect of such preferential tax treatment is difficult to assess, in part because of the

simultaneous presence of other policies that affect behavior. If the benefits are offered merely to

subsidize compliance with regulations, the regulations themselves probably have a stronger

incentive effect than the benefits. However, the favorable tax treatment could provide an

incentive to exceed requirements.
The U. S. Experience with Economic Incentives for Protecting the Environment

114 January

7.2.2 Louisiana Environmental Scorecard

Louisiana’s environmental scorecard program, which was in effect from October 1990 to

January 1992, linked tax exemptions for companies to their environmental performance. The

state’s Departments of Economic Development and Environmental Quality built the scoring

system into an existing 10-Year Industrial Property Tax Exemption Program (IPTEP). In contrast

to the previous practice of awarding 100% exemptions for 20 years from local property taxes for

new equipment and other capital expenditures, the scoring system determined that companies

would receive a base exemption of 50% and then rated their environmental behavior to

determine how much of the remaining 50% they could obtain.

Companies earned points based on their environmental violation record and the amount of

emissions they generated per employee. Table 7-2 shows how these factors influenced point

totals. Points for environmental violation records were calculated by adjusting the values in

Column 2 of Table 7-2 for the age of the violation, i.e., how many years ago the violation

occurred. Next, the number of years was multiplied by coefficients ranging from 1 for violations

in the past year to 0 for violations 6 years or older. The results were then subtracted from 25.

Points for emissions per employee were calculated by dividing total payroll by $25,000; then

points were awarded as shown in Column 4. After the Department of Environmental Quality had

assigned a preliminary score to an exemption request, a company that received fewer than 100

points could raise its score by developing an emissions reduction plan. Other criteria, such as

recycling activities and creating jobs for high unemployment areas, could also increase point

totals.

Table 7-2. Points Under Louisiana Scorecard System

VIOLATION FINE

POINTS AWARDED

(25 minus the value in this column,

adjusted for the age of the violation)

POUNDS OF EMISSIONS

PER EMPLOYEE

POINTS

AWARDED

$0−$3,000 1 0−500 25

$3,001−$10,000 5 501−1,000 20

$10,001−$25,000 10 1,001−2,500 15

Over $25,000 15 2,501−5,000 10

Criminal or felony violations 20 5,001−10,000 5

Source: Environmental Law Institute. 1993a, p. 119.

Data suggest that this program had a significant incentive effect. Final scores during the 15-

month program averaged 94.9, which was significantly higher than preliminary scores. Twelve

companies submitted emission reduction plans for bonus points worth $7,030,249 in tax

exemptions. This amount is slightly greater than the $5.2 million of exemptions recovered by the

state through the scorecard system. Since the system was built into an existing exemption,

administrative costs were reasonably low. It also gave the state the opportunity to use the

exemption “carrot” to promote not only economic but also environmental health.

Industry, however, opposed the program, perhaps in part because it attached conditions to what

had previously been an unconditional tax exemption (the IPTEP). It was industry’s opposition

that led the Governor of Louisiana to terminate the program in 1992.
Subsidies for Pollution Control

2001 115

7.2.3 Supplemental Environmental Projects

Supplemental environmental projects (SEPs) are “settlements negotiated by EPA and an

environmental law violator in which the company agrees to do an alternative environmental

project in return for an agency agreement to lower the proposed penalty.” Although such projects

have existed since the early 1980s, their numbers have increased in the 1990s and they are now

included in as many as 1-in-10 enforcement actions. More than 200 were approved in 1992. In

the first six months of 1992, one EPA official estimated that EPA negotiated 164 SEPs worth

approximately $23 million. In 1995, EPA negotiated 348 SEPs valued at $104 million.

Most SEPs have been pollution prevention activities that involve violations in the Toxic

Substances Control Act (TCSA) or in the Emergency Planning and Community Right-To-Know

Act (EPCRA). However, SEPs have also been negotiated for violations of other laws. In New

England, for example, a sand blasting and paint company had its EPCRA fines reduced from

$50,000 to $14,000 by agreeing to hire an environmental auditor and launch a five-year pollution

reduction program. In Nebraska, a $5,000 fine for supplying restricted-use pesticide to an

uncertified user in violation of the Federal Insecticide, Fungicide, and Rodenticide Act was

reduced to $2,000 when the violating company agreed to install concrete containment dikes

around its pesticide storage tanks and a shower/eye wash. The measures under the SEP were

estimated to cost this company $7,496.

In a RCRA case involving the improper characterization of waste streams, leakage of hazardous

wastes from a sewer, and operation of an unpermitted incinerator, Eastman Kodak had its penalty

reduced by approximately $3 million in return for investing $12 million in six SEPs. These SEPs

were expected to reduce hazardous wastes at its Kodak Park facility by 2.3 million pounds by the

year 2001. In a Clean Water Act (CWA) case, the City and County of Honolulu agreed to spend

$30 million on SEPs to treat and reuse wastewater and sludge. The Kodak and Honolulu SEPs

are described in an EPA report.151 Fines have also been reduced in cases in which businesses

complied with existing environmental laws soon after being charged with a violation.

The advantage of SEPs for EPA is twofold: First, fines that would be paid to the Treasury are

instead used for environmental protection activities; and second, the cost of these activities

usually exceeds the negotiated reduction in the fine. Estimates place the cost of the SEP at onehalf to one-sixth of the reduction in the fine. At the state level, on the other hand, SEPs have

proven much less popular, in part because many states rely on the revenues from these fines to

fund environmental activities.

Despite the high SEP-to-fine reduction ratio, SEPs can offer violators a number of potential

advantages that are associated with improved environmental performance, including positive

publicity, reductions in waste management costs, and early preparedness for increasingly

stringent regulations. Another advantage is that, unlike fines, SEPs involve business expenditures

that lower taxes. Since all SEPs represent voluntary agreements made by violators, the SEP

mechanism appears to have a significant incentive effect.

7.2.4 Loans and Tax Exempt Bonds

The federal government exempts from taxation the interest on debt that is issued by state or local

governments to finance pollution control or waste disposal facilities. This exemption cost the

government an estimated $625 million in 1995.152
The U. S. Experience with Economic Incentives for Protecting the Environment

116 January

Although it is beyond the scope of this report to describe all state financing programs, several

mechanisms used in California are discussed here. The California Pollution Control Financing

Authority (CPCFA) issues tax-exempt bonds to provide low-interest loans of $1 million to $20

million to small businesses for pollution control and solid waste recovery projects. Loans in

excess of $20 million are provided under a similar program for larger businesses. Repayment

periods are usually longer than those of conventional bank loans. Proceeds from bonds issued by

CPCFA on behalf of businesses are deposited into a fund held by the bond trustee. The borrower

uses these funds for the project, making periodic repayments according to the terms of the loan

agreement.

For example, about $1 million in tax-exempt bonds were issued to finance a dry ash waste

recovery investment at an electricity generating facility at the Eel River Sawmills. The

equipment purchased through this financing arrangement reprocesses ash waste through the

electrical generating facility. This reprocessing reduces the amount of ash waste sent to landfills

by 60%, from 24 tons per day to 10 tons per day.

In addition to these tax-exempt bond programs, CPCFA offered loans for pollution control

investments under the California Loans for Environmental Assistance Now (CLEAN) program.

Under this program, CPCFA issued bonds and lent proceeds at interest rates that were roughly

2% higher than bond rates. CPCFA hoped to repackage and sell these loans to raise more capital

but was unable to do so. In three years, 38 loans ranging from $30,000 to $500,000 were issued,

totaling approximately $3 million. Since CLEAN’s subsidized interest rates attracted a number

of businesses that could have obtained loans from commercial banks, it ended up financing many

pollution control investments that would have been made without the CLEAN program.

Moreover, CPCFA’s loan disbursing process was slow, its loan marketing poor, and its

administrative costs high. The program cost about $1.40 for every $1 lent.153

To address these problems, CLEAN was replaced by the California Capital Access Program

(CalCAP), under which CPCFA sets up loan portfolio “insurance” to encourage banks to lend to

small businesses. CPCFA matches the sum of premiums that are paid by the borrower and the

lender and then puts that money into a loss reserve account for the lender. In case of default, the

CPCFA account covers losses. The maximum individual loan is $2.5 million. As a result of

improved marketing and loan disbursing procedures and the leveraging of reserve funds under

CalCAP, $160 million has been lent in two years, as compared with only $3 million in 3 years

under CLEAN. Under CalCAP, every dollar contributed by CPCFA has resulted in $23 in

lending.

7.3 Brownfields Programs

Various measures have been taken to subsidize the development of brownfields, which are

contaminated industrial sites that pose a relatively low risk to the environment as compared to

the most heavily polluted Superfund sites. The number of brownfields programs has grown at the

federal and state level because they deal successfully with an unintended consequence of

hazardous waste cleanup laws, that is, laws that discourage developers from reusing

contaminated property. Brownfields programs have included a variety of incentives, including

grants, loans, and tax benefits. Liability incentives are another important aspect of brownfields

programs; they are discussed in Chapter 8.
Subsidies for Pollution Control

2001 117

7.3.1 EPA Pilot Grant Projects

Under the Brownfields Initiative, EPA has funded several types of pilot projects to states, tribes,

and local governments to encourage the assessment, cleanup, and reuse of brownfields. EPA has

awarded 362 grants of as much as $200,000 each to assist communities in assessing

contamination at brownfields; 104 grants of up to $500,000 to establish revolving loan funds for

cleanup; and 37 grants of as much as $200,000 each to train local workers to assess and clean up

brownfields. Through the Brownfields Initiative, communities report assessing almost 2,000

properties, leveraging more than $2.3 billion in economic development funds and generating

more than 7,000 jobs. For more information on the Brownfields Initiative, see EPA’s

brownfields Internet site at www.epa.gov/brownfields.

7.3.2 Tax Incentives and Loans

New Jersey offers both tax benefits and loans to encourage brownfields development. Under the

Environmental Opportunity Zone Act, which became effective in January 1996, developers of

contaminated sites could receive a 10-year property tax exemption if they remediate the site in

accordance with state standards and return it to commercial or industrial use. In 1998, the period

of tax exemption was extended to 15 years. Loans for cleanups are funded by a dedicated 5%

portion of the state’s Hazardous Discharge Site Remediation Fund.

To qualify for tax benefits and loans, the contaminated land must be on the state’s list of

hazardous discharge sites, be vacant or underused, and need cleanup because of an actual or

potential pollution discharge. The sites must also be located in environmental opportunity zones

designated by state municipalities. The property tax exemption gradually decreases from 100%

in the first year of development to 0% in the tenth year.154

Pennsylvania’s Land Recycling and Environmental Remediation Standards Act established an

Industrial Sites Cleanup Fund of up to $15 million to provide low-interest loans to help property

owners clean up pollution that they did not cause.155 Grants are available to finance activities by

local governments and economic development agencies. These funds can cover up to 75% of

cleanup costs. The Industrial Sites Environmental Assessment Act allows the U.S. Department of

Commerce to make grants to municipalities and other local authorities, nonprofit economic

development agencies, and similar organizations to fund environmental assessments of industrial

sites in distressed communities. Up to $2 million is provided annually for such funding.156 A key

feature of the program is its reliance on risk assessments to dictate remediation strategies at

individual sites.

A January 2000 legislative report assessed the program’s effectiveness.157 After approximately

$20 million in expenditures, more than 650 sites have been cleaned up and over 300 additional

sites are in the process of being cleaned. The program has received an award from the Ford

Foundation as one of the 10 most innovative programs in government.

In 1995, Delaware added credits for brownfields development to its Blue Collar Jobs Tax Credit

program.158 Minnesota and Ohio offer loans to fund cleanups, and Ohio also provides tax

incentives. Arizona and Tennessee pay for the cleanup of wastes that cannot be identified as to

source or for which sources are no longer financially able to shoulder the cleanup cost burden.159

The Brownfields Tax Incentive was passed as part of the U.S. Taxpayer Relief Act of 1997. This

federal tax incentive encourages the cleanup and redevelopment of brownfields by allowing the

cleanup costs in certain areas to be fully deductible in the year expended, rather than capitalized
The U. S. Experience with Economic Incentives for Protecting the Environment

118 January

over time. The U.S. Treasury Department estimates that the $1.5-billion incentive will leverage

as much as $6 billion in private investment and return as many as 14,000 brownfields to

productive use.

7.4 Farming and Land Preservation

Subsidies used in farming and land preservation include grants, loans, and tax benefits that are

offered in exchange for improved conservation practices. Multi-year contracts pay landowners to

either take land out of cultivation or to manage it in a certain way. In addition, benefits that

support farm programs have, since 1985, been linked to environmental performance in a program

called “Conservation Compliance.” Table 7-3 shows the federal subsidy programs and the

respective funding levels implemented expressly for conservation purposes. The conservation

provisions achieved through cross-compliance are also described.

Table 7-3. Funding for Conservation Subsidy Programs of the U.S.

Department of Agriculture (FY 1998) in millions of dollars

PROGRAM

AGENCY

WITHIN

USDA

CONSERVATION WATER

RESOURCES

RECREATIONAL

RESOURCES

POLLUTION

CONTROL

TOTAL NATURAL

RESOURCES AND

ENVIRONMENT

Conservation

Reserve FSA 2,096 2,096

Agricultural

Conservation FSA 44 44

Conservation

Operations NRCS 644 644

Wetlands Reserve NRCS 38 38

Resource

Conservation NRCS 33 33

Water Bank NRCS 8 8

Wildlife Habitat

Incentives NRCS 8 8

Forestry Incentives NRCS 6 6

Colorado River

Salinity NRCS 4 4

Great Plains

Conservation NRCS 4 4

Resource

Conservation NRCS 1 1

Rural Clean Water NRCS 279 1 280

Watershed and Flood NRCS 57 57

Conservation

Operations NRCS 11 11

State and Private

Forestry FS 59 59

Other USDA 2,462 125 20 2,607

TOTAL 5,407 347 126 20 5,900

Source: USDA. 2000. FSA is the Farm Service Agency, NRCS is the Natural Resources Conservation Service, and FS is the

Forest Service.
Subsidies for Pollution Control

2001 119

This section concludes with a discussion of selected state subsidy schemes, including programs

that allow the purchase of development rights to prevent the conversion of agricultural lands to

alternative uses.

7.4.1 Conservation Reserve Program

The Conservation Reserve Program (CRP) was established by the U.S. Food Security Act of

1985 (also known as the “1985 Farm Bill”) and modified by the 1990 and 1996 Farm Bills. The

CRP seeks to protect soil and water resources and wildlife habitat by taking land out of

cultivation. Participating farmers receive annual payments of as much as $50,000 per person to

put land in the Conservation Reserve for 10 to 15 years. Applications to participate in this

program must include conservation plans, which usually require the planting of grass cover). The

federal government pays not only annual rents, so the land is not cultivated, but also one-half the

cost of the required conservation measures.

Since landowners have offered more acres than the CRP can afford, they bid for enrollment. For

the first nine opportunities to enroll through August 1989, bids had to be at or below the

“maximum acceptable rental rate” for a given area. However, this approach did not actively

target environmentally sensitive cropland. Consequently, farmers gradually increased their

awareness of maximum rates and set their bids accordingly, often resulting in rental payments

that were in excess of market value.160

The 1990 and 1990 Farm Bills shifted the emphasis of the CRP to protecting lands that were not

only highly erodible but also important to water quality and wildlife habitat. The bidding system,

as a result, has been changed several times, beginning with the 10th signup in May 1991. An

Environmental Benefits Index (EBI) is used to evaluate bids at or below the market rental rate

for comparable land. The EBI includes numerous factors relating to soil erosion, water quality,

and the value of the land for wildlife habitat. Lands located in special Conservation Priority

Areas are given additional preference, particularly if structural or land management practices

proposed for the lands maximize environmental benefits per dollar expended. The EBI is

compared with the bid amount to determine whether the parcel should be enrolled in the CRP.

Since August 1992, some 36.4 million acres, the maximum acreage allowed under the program,

had been placed in the CRP. This figure is nearly 10% of the total U.S. cropland, an estimated

395 million acres. (See Table 7-4.) The first nine enrollments consisted mostly of land located in

the Great Plains and Mountains states. Changing the program’s emphasis to water quality and

wildlife goals has led to increased concentrations of land in the Midwest and Great Lakes regions

being enrolled in the program.

In 1990, when 33.9 million acres were enrolled, USDA estimated the net social benefits of CRP

at $4.2 billion−$9.0 billion over the life of the program. Table 7-5 shows the estimated dollar

value of different types of social costs and benefits.

Statistics on the first nine enrollments indicate annual reductions in soil erosion of 700,000 tons,

an average of 19 tons per acre. This figure represents a 22% reduction in cropland erosion since

the program was established.
The U. S. Experience with Economic Incentives for Protecting the Environment

120 January

Table 7-4. Conservation Reserve Acreage and Rental Payments

REGION NUMBER OF ACRES ANNUAL RENTAL PAYMENTS

(in millions of dollars)

RENTAL PAYMENTS

PER ACRE ($)

Appalachia 1,158,124 $62.5 $53.97

Corn Belt 5,603,333 416.1 74.26

Delta 1,248,403 55.3 44.31

Great Lakes 3,008,337 176.5 58.68

Mountain 6,687,264 265.3 39.67

Northeast 226,411 13.4 59.29

Northern Plains 9,664,110 444.5 46.00

Pacific 1,791,182 88.8 42.71

Southeast 1,692,580 72.3 42.71

Southern Plains 5,342,989 214.7 40.18

TOTAL 36,422,733 $1,809.4 $49.70 on average

Source: GAO. 1995b, p. 13.

The CRP could be more cost-effective by concentrating enrollment on land that is more

environmentally sensitive, some critics claim. By concentrating on enrolling buffer zones

alongside streams, rivers and lakes instead of entire fields, a GAO study claimed, only about 6

million acres would need to be enrolled in order to protect surface water, groundwater, air, and

soil. However, protecting wildlife habitat would require significantly more acreage.161 The

buffers along streams can reduce sediment loadings by 50%162 and nitrate concentrations163 and

herbicide concentrations164 by 90%.

Table 7-5. Estimated Social Benefits and Costs of CRP

SOCIAL BENEFITS RANGE OF VALUES ($billion)

Increases in net farm income $2.1−6.3

Value of future timber 3.3

Preservation of soil productivity 0.6−1.7

Improved surface water quality 1.3−4.2

Lower damages caused by windblown dust 0.3−0.9

Wildlife enhancements 1.9−3.1

TOTAL BENEFITS $9.5−19.5

SOCIAL COSTS

Higher food costs for consumers $2.9−7.8

Existence of vegetative cover on CRP land 2.4

USDA technical assistance 0.1

TOTAL COSTS $5.4−10.3

NET BENEFIT $4.1−9.2

Source: USDA.1994a, pp. 180-1.

The 1996 Farm Bill and subsequent rules developed by USDA addressed this criticism in

reauthorizing the CRP through 2002. While maintaining the maximum number of acres to be

enrolled at 36.4 million, the new bill also allows contract holders to terminate contracts entered

into prior to 1995, provided the contract has been in effect for at least 5 years and the land in

question is not of high environmental value. The USDA Secretary was given the authority to
Subsidies for Pollution Control

2001 121

agree to future early terminations. The possibility that such terminations may be invoked will

give USDA the opportunity to refocus enrollment in the program on land that is more

environmentally sensitive.

Substantial bonus payments—including a 20% rental bonus, a $100 per acre up-front payment,

and other incentives—now encourage the enrollment of these stream buffers as well as certain

other practices that are of high priority. More than a million acres of these buffer areas have been

enrolled since farmers were offered the new incentives for buffer zones.

7.4.2 Conservation Reserve Enhancement Program

Part of the 1996 Farm Bill, the Conservation Reserve Enhancement Program is an enhancement

of the Conservation Reserve Program that creates federal−state partnerships for conserving

environmentally sensitive farmland. This program uses financial incentives to encourage farmers

and ranchers to participate in removing lands from agricultural production for periods of 10 to 15

years. The status of this program in each state is shown in Table 7-6.

Payments in the Conservation Reserve Program average about $50 per acre per year. The amount

that farmers will be paid to participate in CREP is quite variable because it is tied closely to the

rental rates of local land. The formula for calculating the amount to be paid to farmers includes

base rental rates, the cost of installing conservation practices, annual maintenance costs, and any

special incentives.

Table 7-6. Status of Conservation Reserve Enhancement Programs

STATE STATUS ACRES

TOTAL COST

(in millions of

dollars)

INCENTIVES EASEMENT

TERM

TARGET

AREA ENVIRONMENTAL OBJECTIVE

IL

Agreement

signed

March 30,

1998.

100,000 $250

30% for buffers,

wetland

restoration,

wildlife food

plots, & shallow

water areas; 20%

all other practices

100,000

acres,

15 yr. or

permanent

Middle

Illinois River

Reduction of sedimentation and

soil erosion –

85,000 acres riparian buffers,

wetland restoration, emphasis on

native species;

15,000 acres Highly Erodible

Land (HEL).

MD

Agreement

signed

October

20, 1997.

100,000 195

70% for riparian

buffers;

50% for filter

strips and HEL

25,000 acres,

permanent

Chesapeake

Bay

Reduction of nutrient loading --

70,000 acres riparian buffers;

20,000 acres HEL;

10,000 acres wetland restoration

MN

Agreement

signed

February

19, 1998.

100,000 223 20% for all

practices

100,000

acres,

>20 yr. To

perpetuity

Minnesota

River

Water quality benefits from

sediment and nutrient reduction

and mitigation of flood damage.

Native grasses and hardwoods,

wetland restoration, and filter

strips.

NY

Agreement

signed

August 26,

1998.

5,000 10 150% N/A

New York

City

watershed/

Catskill/

Delaware

system

Risk reduction of nutrient,

pathogen, and sediment inputs to

streams/reservoirs that supply

drinking water to NYC –

riparian buffers, filter strips, and

erosion control on HEL

Continued on the next page.
The U. S. Experience with Economic Incentives for Protecting the Environment

122 January

STATE STATUS ACRES

TOTAL COST

(in millions of

dollars)

INCENTIVES EASEMENT

TERM

TARGET

AREA ENVIRONMENTAL OBJECTIVE

OR

Agreement

signed

October

17, 1998.

100,000 250

25% for

filterstrips;

35% for riparian

buffers;

50% for wetland

restoration;

Cumulative

impact bonus

equal to four

times base rental

rate

N/A

Streams

providing

habitat for

endangered

salmon and

trout

statewide

Restoration of salmon habitat

through enhancement of riparian

areas and wetland restoration.

WA

Agreement

signed

October

19, 1998.

100,000 250

50%, plus an

additional 10% if

designated under

State growth

management law

N/A

Salmon

spawning

streams

statewide

Restore habitat for native

anadromous fish species using

riparian buffer conservation

practice.

NC

Agreement

signed

March 1,

1999

.. . . . .

DE

Agreement

signed

June 2,

1999

.. . . . .

WY,ID

WI,KY

MO,ND

Proposals

received

Source: USDA/FAS. CRP State CREP Information.

Maryland recently sweetened its CREP program by adding a one-time signing bonus of $250 per

acre in an attempt to increase enrollments to the program’s goal of 100,000 acres. Under the

Maryland program, participating farmers would plant trees and grasses along Maryland

waterways to act as natural filters that absorb nutrients and chemicals before they entered the

waters. When the Maryland program was launched in 1997, it was the first in the nation. In three

years of operation, the program had enrolled only 20,000 acres, largely because farmers

considered the rules complex and the reimbursement rate too low.165

7.4.3 Wetlands Reserve Program

Under the Wetlands Reserve Program (WRP), which was created by the 1990 Food, Agriculture,

Conservation and Trade Act (a.k.a. the 1990 Farm Bill), farmed wetlands and agricultural land

converted from wetlands as well as buffer zones and some riparian areas are eligible for 30-year

easements or permanent easements. Participants in this program are required to implement

conservation plans approved by the Natural Resources Conservation Service and the Fish and

Wildlife Service. Agricultural activities on enrolled land must be compatible with wetlands

protection. Participants receive a lump sum for permanent easements or 10 equal payments for

30-year easements. Payment amounts are limited to the loss of market value of the land as a

result of the easement. In addition to paying for the easements, the government shares in the cost

of approved conservation measures.
Subsidies for Pollution Control

2001 123

As shown in Table 7-7, the number of acres for which bids were made was roughly five times

the acreage enrolled in WRP during its first enrollment. In 1994, WRP was expanded to several

other states.

Table 7-7. Wetland Reserve Program’s First Enrollment (1992)

STATE BID OFFERS

(in 1,000 acres)

ENROLLED LAND

(in 1,000 acres)

TOTAL COST

(in thousands of

dollars)

COST PER ACRE ($)

California 34.3 6.0 10,768 1,787

Iowa 27.9 5.1 5,951 1,168

Louisiana 69.9 14.1 9,882 702

Minnesota 13.1 0.7 764 1,082

Mississippi 65.0 14.9 10,764 723

Missouri 14.6 2.7 2,753 1,032

New York 0.5 0.1 212 2,934

North Carolina 15.3 4.7 3,675 780

Wisconsin 8.5 1.6 1,287 782

TOTAL 249.1 49.9 46,056 923

Source: USDA. 1994a, p. 194.

The 1996 Federal Agriculture Improvement and Reform Act (a.k.a. the 1996 Farm Bill)

reauthorized WRP through 2002 while capping total enrollment at 975,000 acres. Beginning

October 1996, land enrolled in this program was to be divided in the following way: one-third

(33%) will be given permanent easements; one-third, 30-year easements or less; and one-third,

wetland restoration agreements with cost sharing. Seventy-five thousand acres of land in lessthan-permanent easements must be placed in the program before additional permanent easements

are placed. The Act provides cost-sharing assistance to landowners of 75%−100% for permanent

easements and 50%−75% for 30-year easements and restoration cost-share agreements.

7.4.4 Compliance Provisions

Under the 1985 Farm Bill, farmers must adhere to two compliance provisions before they

become eligible for farm support programs such as price support loans and technical assistance.

First, they must implement approved conservation plans on highly erodible land (HEL). Second,

they must refrain from draining wetlands. Considering the large amounts of financial support at

stake—some $24 billion in support payments in 1999—compliance provisions have had a strong

incentive effect.

7.4.5 Highly Erodible Land Conservation and Sodbuster Provisions

To ensure farmers’ eligibility for receiving support under the highly erodible land conservation

compliance provision, farmers are required to develop and implement approved conservation

plans for designated “highly erodible” land that was farmed between 1981 and 1985. The plans

typically entail adjustments in farming practices and rotations and could include measures such

as the maintenance of crop residues on fields in winter, contour plowing, minimum tillage, and

shelterbelts. The sodbuster provision is similar to the highly erodible land conservation

compliance provision, except in two respects. One, it applies to highly erodible land that was not

farmed between 1981 and 1985. Two, it is more stringent in that it requires the adoption of a
The U. S. Experience with Economic Incentives for Protecting the Environment

124 January

conservation system that reduces erosion to a level above which long-term soil productivity may

be depleted.166

This cross-compliance rule appears to have a strong incentive effect. Implementation costs for

the conservation compliance provisions are estimated at $7−$17 per acre depending on the

region, whereas a loss in farm support benefits would cost farmers between $37 and $62 per

acre.167

As shown in Table 7-8, the estimated net benefit of the conservation compliance provision varies

substantially across regions. The air quality benefits listed in the table are limited to household

wind damage. Although the estimates show costs exceeding benefits in the Northern Plains, the

benefits might exceed costs if air quality benefits were more broadly defined.

Table 7-8. Economic Benefits and Costs of Conservation Compliance

PER-ACRE BENEFIT (in $) FROM: PER-ACRE COST (in $) TO:

REGION Water

Quality Air Quality Productivity Producers FederalGovernment

NET

ECONOMIC

BENEFITS

(in $)

BENEFIT/

COST

RATIO

Northeast 35.63 0 0.16 3.57 3.43 28.80 5.12

Lake States 21.99 0 0.12 0.32 3.43 18.37 5.90

Corn Belt 15.61 0 0.25 8.90 3.43 3.53 1.29

Northern Plains 3.47 3.00 0.19 3.35 3.43 -0.11 0.96

Appalachia 23.58 0 0.24 3.51 3.43 16.89 3.43

Southeast 25.63 0 0.12 8.18 3.43 14.15 2.22

Delta 35.50 0 0.12 1.97 3.43 30.22 6.60

Southern Plains 5.26 4.63 0.33 2.34 3.43 4.45 1.77

Mountain 5.10 4.01 0.15 0.20 3.43 5.63 2.55

Pacific 31.83 1.09 0.14 2.23 3.43 27.40 5.85

Entire

United States 13.81 1.93 0.21 3.78 3.43 8.74 2.21

Source: USDA. 1994a. p. 186.

7.4.6 Swampbuster Program

Under the Swampbuster Program, program benefits are denied to farmers who plant crops on

wetlands that were converted after 1985 or who drain or otherwise convert designated wetlands.

Conversion is allowed if its impact on the hydrological and biological value of the wetland is

limited or if the farmer restores wetlands of equivalent value.

The 1996 Farm Bill made several changes to provisions in the Swampbuster Program. According

to USDA, these modifications “will give farmers more flexibility in complying with wetland

conservation requirements while protecting natural resources.”168 The bill expands wetland

mitigation areas and options, allowing mitigation through restoration, enhancement, or creation,

provided that wetland functions and values are maintained. In addition, the bill also stipulates

that conversion activities authorized by a Clean Water Act permit will be accepted for Farm Bill

purposes if the conversions are adequately mitigated. The bill also establishes a pilot program for

mitigation banking. (See Chapter 6 for information on mitigation banking.)
Subsidies for Pollution Control

2001 125

7.4.7 Subsidies Created Under the 1996 Farm Bill

In addition to modifying several existing programs in ways that USDA believes will simplify

them and enhance their efficiency and flexibility, the 1996 Farm Bill created a number of new

programs. The largest of these programs in terms of funding is the Environmental Quality

Incentives Program. Others include the Farmland Protection Program, the Conservation Farm

Option, and the Wildlife Habitat Incentives Program.

As shown in Table 7-3, Conservation Subsidy Programs of the U.S. Department of Agriculture

(FY 1998), USDA has implemented a large number of conservation programs. A 1995 GAO

study stressed the need to consolidate these programs, stating that “they frequently promote

identical resource conservation purposes, use similar financial incentives, serve the same

population, and finance the application of the same set of technical practices.” The study asserted

that program overlap made it more difficult for farmers to identify and apply for financial and

technical assistance and increased the administrative burden on USDA.169

Environmental Quality Incentive Program (EQIP): This program replaced several programs,

all of which were phased out in 1996: the Agricultural Conservation Program, the Colorado

River Basin Salinity Control Program, the Water Quality Incentives Program, and the Great

Plains Conservation Program. EQIP assists farmers and livestock producers with making

environmental and conservation improvements. Participating landowners agree to establish

conservation plans and implement them for periods of 5 to 10 years. In doing so, they receive

cost-share or incentive payments for as much as 75% of their costs for adopting these

conservation practices. Payments are limited to $10,000 per person per year or a total of $50,000

for any multi-year agreement.

The legislation and rules developed by USDA requires the Department to select projects that

maximize the environmental benefits per dollar spent under EQIP. Priority areas must be

targeted. Plans must be developed that identify both the main problems being addressed and the

practices capable of solving these problems with available resources. These provisions

effectively make watershed planning a major activity for the Natural Resource Conservation

Service.

EQIP has placed added emphasis on livestock as a pollution problem. One-half of the program’s

funding is reserved for livestock-related conservation problems, and one-half for other

conservation problems. The program was funded at $130 million in FY 1996 and $200 million

annually from 1997 to 2002, although Congress subsequently reduced funding levels to $170

million a year. Most farmers attempting to enter the EQIP program are turned away due to the

targeting process described in the previous paragraph and current budgetary limitations.

Farmland Protection Program: Under this $35 million program, USDA will work with state

and local governments to purchase conservation easements on 170,000 to 340,000 acres of

farmland of special interest. To be included in this program, land must be subject to a pending

offer from a state or local government for the purpose of protecting topsoil by limiting

nonagricultural uses.

Conservation Farm Option: Under this pilot program for producers of cotton, rice, feed grains,

and wheat, producers may consolidate payments from three programs— CRP, WRP, and

EQIP—into one annual payment. They can do so only in exchange for entering into 10-year

contracts and implementing conservation plans that address water, soil and related resources as
The U. S. Experience with Economic Incentives for Protecting the Environment

126 January

well as wildlife habitat. The incentive effect of being able to consolidate program payments is

unknown. A total of $197.5 million will be provided for this program through 2002.

Wildlife Habitat Incentives Program: This program is intended to offer cost-sharing assistance

to landowners to encourage them to plan and adopt approved management practices that

ameliorate wildlife habitat. Total funding from FY 1996 to FY 2002 is $50 million.

7.4.8 Impacts of Conservation Programs

Table 7-9 presents some of the effects of USDA conservation programs. Activities of the Water

Quality Program consist mostly of educational and technical assistance, but they also include

some financial assistance. Monetary values of some of these impacts have been estimated. For

example, the benefits of reducing salt loads under the Colorado River Salinity Control Program

have been estimated at $61 per ton a year.170

Table 7-9. Impacts of Conservation Programs

IMPACTS PROGRAM AND IMPACTS 1988 1989 1990 1991 1992 1993 1994 1995

Reductions of Erosion (in 1,000,000 tons)

Conservation Reserve Program 514 596 644 654 672 692 692 692

Conservation Compliance Provisions 0 0 0 NA 236 458 465 527

Agricultural Conservation Program 40 34 33 34 30 29 9 18

Conservation Technical Assistance and Great

Plains Conservation Program 463 353 353 282 298 321 325 284

Annual Acreage Reduction Program 107 62 55 60 39 46 29 40

Reductions (in 1,000,000 pounds)

Water Quality Program: Reduction in Nitrogen

Application NA NA NA 10.7 53.3 NA NA NA

Water Quality Program: Reduction in

Phosphorus Application NA NA NA 6.1 70.5 NA NA NA

Reductions of Active Ingredients (in 1,000 pounds)

Water Quality Program: Reduction in

Pesticide Load NA NA NA 239 528 NA NA NA

Reductions (in 1,000 Tons)

Colorado River Salinity Control Program:

Reduction in Salt Load 62 75 92 105 127 163 191 212

Source: USDA, ERS: Agricultural Resources and Environmental Indicators, Ch. 6.1

7.4.9 State Initiatives

In addition to the federal programs described in this chapter, various types of subsidies have been

used to promote land preservation on the state level. A 1994 USDA report found that, as of 1990,

25 states had cost-sharing programs, 6 offered tax credits, and 5 offered low-interest loans to

encourage the preservation of land.171

In Lake Okeechobee, Florida, phosphorus contained in the waste of dairy cattle has posed a

threat to water quality. The “Dairy Rule” that entered into effect in June 1987 required Florida

dairy farmers to use specific techniques to prevent discharges from barn wash water. The Florida

State Legislature provided the Florida Department of Agriculture and Consumer Services
Subsidies for Pollution Control

2001 127

(DACS) with cost-share funds to facilitate the implementation of this policy. Of the 49 dairy

operations in the state that were affected by the Dairy Rule, 18 chose to participate in a buyout

program under which they received $602 for every cow they permanently removed from the

basin. The buyout program took 14,039 cows out of the basin.

A survey of wildlife management programs in the 20-state region of the Northeast found that 5

states had cost-sharing programs, 5 offered equipment loans, 4 offered property tax incentives, 1

offered state income tax benefits, and 8 had tie-ins with federal programs. In Indiana, the

Wildlife Habitat Cost-Share Project pays up to 90% of the cost of establishing permanent

wildlife habitat, windbreaks, brush piles, vegetation management, and wetland improvement.

Property tax assessments are lowered for landowners who adopt measures that enhance or

preserve existing wildlife habitat.172

Minnesota has a property tax exemption for undisturbed wetlands and ungrazed prairie.173 The

state also has a Pheasant Habitat Improvement Program under which landowners can receiving

cost-sharing assistance of up to 75% of their costs as well as technical assistance in return for

improvements such as food plots, nesting cover, and woody cover.174 In Texas, the Galveston

Bay Comprehensive Conservation and Management Plan approved by the EPA in April 1995

called for economic incentives, such as tax breaks, for private landowners. The tax incentives are

intended to encourage owners to preserve wetlands.175

In November 1995, voters in Texas approved a constitutional amendment to allow open-space

land that is used for wildlife management to be taxed in the same manner as open-space

agricultural land. Consequently, taxes will be based on the land’s productive capacity rather than

its higher market value. The Sierra Club lauded the measure, which it said “will allow

landowners to take lands out of traditional agricultural production without penalizing them for

protecting their property for wildlife.”176

7.4.10 Purchase of Development Rights Programs

A number of states (11 as of April 1996) and several counties and local governments have

purchase of development rights (PDR) programs in place under which landowners are paid not to

convert farmland to commercial or residential uses. (Such rights are also known as “conservation

easements.”) As shown in Table 7-10, such programs are especially common in the Northeast

and have covered more than 400,000 acres at a cost of almost $730 million. In addition to

objectives of food security and agricultural production, PDR programs have several

environmental objectives, including the maintenance of habitat and resting places for wildlife

and the aesthetic value of open space. Among the advantages of PDRs are their voluntary nature,

which helps avoid the legal conflicts that can arise from zoning laws, and the low cost of this

form of land protection for state and local governments as compared to outright land purchase.

The funding mechanisms for PDR programs vary from state to state and include general

revenues, land transfer taxes, property taxes, and bonds. Criteria used to select the land parcels

that are to be purchased include cost, threat of conversion, and location. Many programs prefer to

purchase development rights on parcels that are near each other.
The U. S. Experience with Economic Incentives for Protecting the Environment

128 January

Table 7-10. Purchase of Development Rights Programs in States

STATE YEAR

STARTED

NO. OF FARMS

IN PROGRAM

NO. OF

ACRES

AFFECTED

STATE FUNDS SPENT

(in thousands of dollars)

STATE FUNDS

AVAILABLE

(in thousands of dollars)

California* 1980 72 47,992 $46,515 $23,100

Connecticut 1978 164 25,042 73,430 8,800

Colorado* 1986 6 1,904 3,254 2,800

Delaware 1995 31 8,561 12,000 0

Maine 1990 1 307 380 0

Maryland 1977 809 117,319 125,099 8,100

Massachusetts 1977 398 35,907 86,109 6,000

Michigan 1993 2 79 709 10,000

New Hampshire 1979 57 9,148 no data 0

New Jersey 1981 189 27,924 88,463 107,000

New York* 1976 154 6,941 46,000 4,950

North Carolina* 1987 21 1,255 1,785 0

Pennsylvania 1989 596 74,500 148,000 31,000

Rhode Island 1982 30 2,428 14,000 0

Vermont 1987 140 45,511 26,304 2,000

Washington* 1979 187 12,600 58,000 1,500

TOTAL 417,418 730,048 205,250

*Denotes county or other local programs

Source: American Farmland Trust.

7.5 Consumer Product Waste Management

Managing the waste from consumer products is one area in which traditional regulatory

measures may be less likely than incentives to protect the environment. It is difficult, if not

impossible, to monitor the behavior of millions of consumers. For example, bans on the disposal

of used motor oil or containers in landfills are hard to enforce. Consumers are more likely to

respond positively to factors such as more convenient collection service—which subsidies make

possible—or refunds.

Various types of subsidies, including grants, loans, payments, and tax incentives, have been used

extensively in consumer product waste management. Also included in the following discussion

are preferential procurement and recycled content policies, both of which encourage recycling by

stimulating demand for recycled products. Most of these measures have been implemented at

state and local levels. Table 7-11 identifies the various state subsidies that help manage the

disposal of one consumer product, used tires.

7.5.1 Advance Disposal Fees

As noted in Chapter 4, advance disposal fees (ADFs) on consumer products generate revenues

that subsidize the otherwise unprofitable activity of disposing of specific products after they have

been used. In Rhode Island, for example, fees on “hard-to-dispose material,” such as motor oil,

tires, antifreeze, and solvents, are used to fund centers that collect these products after their use

as well as research and public education on the disposal and reuse of these products.
Subsidies for Pollution Control

2001 129

Table 7-11. State Subsidies for Used Tire Management

TYPE OF SUBSIDY NUMBER OF STATES

Tax benefits 13

Payments based on the number of tires recycled 7

Public procurement 28

Grants and loans 34

Source: Scrap Tire News, January 1996, p. 18.

In Virginia, an ADF of $0.50 per tire that has been in effect since January 1990 generates

revenues for the state’s Waste Tire Trust Fund. The fund finances several efforts: cleanup of

used tire disposal sites, activities in several regions that manage the current flow of used tires,

and subsidies of $22.50 per ton for the conversion of waste tires to other end uses such as

blasting mats, fuel and rubberized surfaces. By 2000, the program had processed about 27

million tires at a cost of $11.6 million.177 Similar programs are in effect in several other states.

7.5.2 Deposit Handling Fees

In most states that have mandatory bottle deposits, distributors are required to pay handling fees

to retail outlets and other used bottle collection centers. In California and Maine, for example,

handling fees are 3 cents per bottle. Such handling fees have encouraged the collection of used

bottles to such a degree that many redemption centers have been created voluntarily by the

private sector to earn profits. Chapter 5 has further details on deposit-refund systems in

California, Maine, and other parts of the United States.

7.5.3 Recycling Loans and Grants

At least 24 states have grant or loan programs that promote the recycling industry.178 Under

Washington State’s Model Litter Control and Recycling Act, grants are awarded to individuals

who develop recycling programs. Under a state Litter Control and Recycling Act, Rhode Island

provides grants to communities and organizations for creating litter and recycling initiatives.179

As shown in Table 7-12, Wisconsin offers both loans and grants to promote recycling. The

largest program provides grants to municipalities and counties to fund various recycling

activities. Recycling rebates can be of two types. One, they can be general rebates that are

offered for as long as five years in order to offset the increased cost of making or processing

recyclable materials that are generated in the state. Two, they can be property rebates that cover

5%−25% of the cost of qualified property. In 1993−94, 17 qualified property rebates worth

$1,136,805 and 10 general rebates worth $4,599,334 were awarded.

Under the Waste Tire Reimbursement Grant Program, Wisconsin businesses receive payments of

$20 per ton for using waste tires in any of the following ways: in energy recovery, including the

production of combustible byproducts; as road base in highway improvement projects; in

recycling to make a new product; and in other uses that are approved by the state’s Department

of Natural Resources (DNR). Other uses must be approved in advance by DNR. Businesses

receive payments that are based on documented tire use over the course of a given calendar year.

Wisconsin’s expenditures under this program for 1990−94 totaled approximately $5.5 million.180
The U. S. Experience with Economic Incentives for Protecting the Environment

130 January

Table 7-12. Financial Assistance Programs in Wisconsin that Promote

Recycling (1994−95)

STATE PROGRAMS REBATES

(in thousands of dollars)

Municipal and County Recycling Grants $29,200

Waste Reduction and Recycling Demonstration Grants 1,750

Recycling Loans 2,519

Minority Business Recycling Grants and Loans 400

Recycling Rebates 5,100

Recycling Market Development Board Assistance 2,892

Waste Tire Reimbursement Grants 750

Waste Tire Management or Recovery Grants 250

TOTAL $42,861

Source: Bonderud and Shanovich, p. 11.

As shown in Table 7-13, at least 16 states had loan funds in 1995 for businesses that recycle used

products. In Iowa, for example, loans have included $485,000 for a project that converts waste

gypsum into new wallboard; $145,000 for efforts to convert used electrical wire into padding for

use in the dairy cattle industry; and $245,000 for a project to make rubber mats from used tires.

Table 7-13. State Loan Funds for Recycling Enterprises

STATE MAXIMUM LOAN

AMOUNT (in $) INTEREST RATE FUND SIZE (in $) FUNDING SOURCE

California $1 million 5.8% $25 million by 1996 Landfill tipping fees

Colorado 150,000 initially Prime Rate 1-1.5 million per year 1 tire fee

Florida Unknown <Prime Rate 3.5 million ADFs

Illinois 750,000 5% 1-3 million per year Landfill tipping fees

Indiana 500,000 <Prime Rate 3-4 million per year Landfill tipping fees

Iowa 2 million 0% 4 million per year Landfill tipping fees

Kentucky None for cities 3.4% 4 million General revenues

Louisiana 600,000 Unknown 2 million Tire fees

Maine 100,000 4%-8% About 100,000 per year Brown goods disposal fee

Michigan 500,000 0% 4 million Landfill tipping fees

Minnesota 500,000 2% below

Prime Rate 4 million General revenues

Mississippi 200,000 2% below

Prime Rate Unknown Unknown

New Jersey 500,000 3% below

Prime Rate 21 million Landfill tipping fees

New York 500,000 <Prime Rate 5 million Petroleum overcharge funds

Pennsylvania 300,000 3% 5 million Landfill tipping fees

Vermont To be determined To be determined To be determined To be determined

Wisconsin 750,000 4% 5.6 million Business tax

Sources: Trombly. 1995, p. 38; Louisiana Department of Environmental Quality; California Environmental Protection Agency.

The California Integrated Waste Management Board offers loans to organizations located in the

state’s 40 Recycling Market Development Zones. Zones range in size from a portion of a city to
Subsidies for Pollution Control

2001 131

areas encompassing several counties. Loans are repayable within 10 years with a 5.8% interest

rate and can be used to cover as much as 50% of the cost of a project, up to $1 million. In the

three years leading up to March 1996, 67 loans totaling $28 million were approved, of which 42

totaling over $16 million have closed. The California Environmental Protection Agency has

stated that these 42 loans have diverted nearly 1.4 million tons of waste from landfills annually.

Recent loans include $1 million to finance the production of custom packaging out of shipping

boxes and $475,000 to finance equipment for producing fire logs out of paraffin-saturated

cardboard from grocery stores and sawdust from a local sawmill.181

Louisiana’s used tire subsidy program combines a loan program with rebate payments that are

based on the number of tires recycled. Loans of up to $600,000 are available for efforts to

process waste tires. Each loan is limited to 25% of the value of the processing facility. The loan

is repayable to the state, with interest, at a rate of $0.15 per tire processed. The state also offers

rebates of $0.85 per tire processed.

7.5.4 Tax Incentives

Twenty-eight states have offered tax incentives for businesses that recycle used products. Idaho,

for example, enacted a tax credit in 1994 for the purchase of equipment needed to manufacture

post-consumer paper.182 “An Act Concerning Solid Waste Management” in Kansas allows “up to

$100,000 of income tax deductions determined at a rate of 20% of purchase price of new

equipment that uses recycled materials to produce products or energy and expands the taxpayer’s

ability to use recycled goods.”183

7.5.5 Preferential Procurement of Recycled Products

One type of policy measure that could be considered a subsidy is the preferential procurement of

recycled products. By stimulating demand for recycled products, such policies are intended to

promote recycling. This section of the chapter considers only government procurement practices

as opposed to private-sector procurement practices. Mandates governing the private-sector use of

recycled materials are discussed in the next section, Section 7.5.6, Recycled Content Policies.

Preferential procurement can take one of at least two forms: one, price preferences and two, setasides and goals. In this context, price preferences refer to the public sector’s willingness to pay

a higher price for recycled products. Set-asides and goals refer to the rules or targets established

by the public sector regarding the total percentage of products they purchase that must contain

recycled materials.

Paper is the product most commonly subject to procurement policies on recycled goods. A 1993

survey conducted by the Northeast Maryland Waste Disposal Authority found that all 50 states

and the District of Columbia (DC) favored recycled products, compared to only 13 states in

1986.

In the 38 states (including DC) that had price preference policies, 15 states were willing to pay

5% more for products that had recycled content than for comparable products that did not

contain recycled materials, and 20 states had preferences that were 10%. Oregon had a

preference of 12%, and two other states had preferences between 5% and 10%. In 21 of these

states, the preferences applied not only to paper but also to other recyclable products. Vermont

used life-cycle costing in deciding what to purchase, buying recycled products “where the added
The U. S. Experience with Economic Incentives for Protecting the Environment

132 January

cost of using waste materials rather than virgin materials is less than the cost avoided by not

having (that waste) in the waste stream.”

The same survey found that 30 states had set-asides or goals, mostly for paper. Iowa, Montana,

and Nebraska had the most stringent set-asides. By January 1, 2000, 90% of the printing and

writing paper purchased by Iowa’s public sector had to have recycled content, and two years

later all the tissue paper products it purchased had to have recycled content. Montana had a setaside of 95% by 1996. Nebraska bought only recycled paper and was considering similar

purchasing policies for plastic bags, motor oil, and carpets. North Carolina required the use of

recycled paper for all state government reports, memoranda, and other documents, unless written

authorization was obtained from the head of the agency.

The 1993 survey also identified 186 local governments that favored recycled products, with

some cities adopting price preferences as high as 20% and some having set-asides. The City of

Newark, New Jersey, required its agencies to use recycled products if available, regardless of

price.

In Florida, for example, prison industries reprocess tires for sale to state, county, and local

governments, and state grants to counties are used to purchase products made from waste tires.

The Florida State Department of Transportation uses 10,000 tons of crumb rubber (made from

two million waste tires) annually in rubber-modified asphalt for roads. As a result of these

initiatives and other market development activities, the percentage of tires dumped in Florida

landfills has decreased since 1989.

7.5.6 Recycled Content Policies

Recycled content policies as defined here refer only to requirements that private-sector

organizations use a percentage of recycled products. Recycled content rules applied to

government purchases, such as the aforementioned executive order on paper purchases, have

been placed under the heading of public procurement policies. Consequently, they have been

discussed in the previous section, Section 7.5.5, Preferential Procurement of Recycled Products.

Although there is a large element of traditional regulation in policies that require a minimum

recycled content for certain products or containers, such policies also create incentive effects by

stimulating demand for recycled products. If manufacturers are forced to use a certain amount of

recycled product, they or their suppliers are more likely to offer consumers better access to

recycling services.

At least 13 states have passed laws mandating the use of recycled content in newspapers, and 15

states have created voluntary agreements for the same. (The voluntary agreement in

Massachusetts is described in Chapter 10.) A typical example is the 1990 Wisconsin Recycling

Law, which requires newspapers to use recycled content in newsprint. The minimum content

requirements increased from 10% in 1992 to 45% in 2000. Publishers failing to meet these

requirements are subject to fees that are based on the extent of non-compliance. In this respect,

the law could be considered to act as a product charge on non-recycled newsprint. However, the

Wisconsin Department of Natural Resources sometimes exempts publishers from these fees if

they can show that they could not obtain recycled newsprint at a reasonable cost.

In 1992 and 1993, more than 90% of the 78 newspaper publishers in Wisconsin exceeded the

state’s minimum content requirement of 10%. Only one failed to meet the requirement. In 1994,
Subsidies for Pollution Control

2001 133

however, when the minimum content standard was increased to 25%, 14 of the publishers in the

state failed to meet the standard. Five of them paid the fee and the others were exempted.

7.6 New Jersey’s Information Awards Program

Under this program, which became effective in 1990, New Jersey citizens who report illegal

dumping to environmental authorities receive 10% of any civil penalty or $250, whichever

amount is larger. Information leading to criminal convictions is rewarded by 50% of the

collected penalty. The identity of those seeking rewards is protected.

Four other New Jersey statutes also contain provisions for monetary awards that are given to

individuals who report violations.

1. The Major Hazardous Waste Facilities Siting Act awards 50% of any criminal penalty

collected for the illegal treatment, storage, or disposal of hazardous waste.

2. The Regional Low Level Radioactive Waste Disposal Facility Siting Commission awards 50%

of any penalty collected for the illegal treatment, storage, or disposal of low-level radioactive

waste.

3. The Comprehensive Regulated Medical Waste Management Act awards 10% of any civil or

criminal penalty collected for violations or $250, whichever amount is larger.

4. The Ocean Dumping Enforcement Act awards 10% of any criminal penalty collected for

violations.

This scheme differs from most subsidies and other incentive mechanisms featured in this report.

These programs seek to affect the behavior of citizens and businesses by making monetary

awards to those individuals or organizations that notify authorities of acts of noncompliance, thus

allowing those who report violations to benefit from the successful efforts of law enforcement.

As of May 1996, three penalties had been collected as a result of information provided by

citizens. One payment of $50,000 and two payments of $250 were awarded in these three cases.

(The payments equaled 10% of the penalties collected in each case.) Other rewards are

pending.184

A similar source of monetary support for environmental organizations is the fees awarded to

attorneys who have won citizen suits against environmental violators. As noted in Chapter 8,

these fees appear to create stronger incentives for private parties to initiate lawsuits under

California’s Proposition 65 than the so-called “bounty hunter provision.” Under the bounty

hunter provision, the person who brought the lawsuit can receive 25% of any fines collected.

It is possible for citizens or organizations to obtain rewards for reporting potential environmental

violations or initiating lawsuits under other state and federal laws. However, it is beyond the

scope of this report to determine their extent or their effects on environmental behavior.

7.7 Alternative Fuels and Low-Emitting Vehicles

Various levels of government subsidize alternative fuels (AF) and alternative fuel vehicles

(AFV) through measures such as tax incentives, rebates, and preferential procurement. The

annual costs of federal programs alone have been estimated at more than $1 billion. Some of

these subsidies result in environmental improvements, but, as noted in the following section,

alternative fuels are also subsidized for other reasons.
The U. S. Experience with Economic Incentives for Protecting the Environment

134 January

7.7.1 Federal Subsidies

As shown in Table 7-14, the largest subsidy in the area of cleaner fuels is the exemption of

ethanol blends from $0.054 of the $0.184-per-gallon gasoline tax. Since ethanol blends of 10%

receive this deduction, the exemption for ethanol is the equivalent of $0.54 per gallon.

The category of “other direct subsidies” shown in Table 7-14 includes preferential taxation of

compressed natural gas (CNG) and payments to subsidize purchases of AFVs and AFV

infrastructure. The CNG tax deduction is equivalent to $0.128 per gallon. Although this subsidy

is small compared to ethanol tax deductions, it is expected to increase in importance by the year

2000 as the number of CNG vehicles increases. The federal government also subsidizes the

purchase of alternative fuel mass transit buses and school buses, state AFV planning, and the

purchase of alternative fuel vehicles by small businesses.

Table 7-14. Alternative Fuel and Vehicle Subisdies

TYPE OF SUBSIDY 1994

(in millions of dollars)

2000 (PROJECTED)

(in millions of 1994 dollars)

Research & Development $348 $350

Ethanol credit 573 914

Other direct subsidies 53 76

Preferential procurement 6 614

Tax credits for AFVs and equipment 20 100

Reid vapor pressure waiver for ethanol blends 95 120

TOTAL $1,095 2,174

Source: Anderson. 1994, pp. 18-21.

At present, tax credits for AFVs and refueling stations amount to roughly $20 million each year.

However, they are predicted to rise to $100 million annually by the year 2000. The federal

government also subsidizes a number of research and development activities.

The RVP (Reid vapor pressure) waiver entitles ethanol blends to an extra pound of vapor

pressure beyond the limits imposed on conventional gasoline. (Adding ethanol to gasoline raises

vapor pressure about 1 lb. in a 10% ethanol blend.) This waiver is worth approximately $0.09 per

gallon of ethanol, based on the additional costs incurred by refiners to produce an ethanol blend

stock with lower vapor pressure.

Table 7-14 also shows that another type of subsidy, preferential procurement, is expected to rise

significantly in value by the year 2000. This trend is due to the fact that many procurement

requirements are only now entering into effect, and they are scheduled to become more stringent

over time. Table 7-15 shows these requirements, many of which will eventually be applied to

privately owned fleets of vehicles.

The federal government also provides income tax deductions of $2,000 to $50,000 to businesses,

organizations, and citizens who purchase clean-fuel vehicles. Electric vehicle purchases are

eligible for income tax credits of 10%, or up to $4,000. The cost to the government in 1995 of

the electric vehicle credits has been estimated at $65 million. 185
Subsidies for Pollution Control

2001 135

Table 7-15. Federal Procurement Requirements for Alternative Fuel Vehicles

by Model Year

(percent of all vehicle purchases, except as noted)

MODEL YEAR FEDERAL AGENCIES STATE AGENCIES SUPPLIERS OF

ALTERNATIVE FUELS

OWNERS OF

PRIVATE FLEETS

1993 5,000 vehicles

1994 7,500 vehicles

1995 10,000 vehicles

1996 25% 10% 30%

1997 33% 15% 50%

1998 50% 25% 70%

1999 75% 50% 90%

2000 75% 75% 90%

2001 75% 75% 90%

2002 75% 75% 90% 20%

2003 75% 75% 90% 40%

2004 75% 75% 90% 60%

2005 75% 75% 90% 70%

2006 and beyond 75% 75% 90% 70%

Source: Anderson. 1994, p. 10.

7.7.2 State Subsidies

In addition to the federal purchasing requirements for AFVs that are imposed on state

governments—shown in Table 7-15—several states, including New York and Massachusetts,

have their own vehicle purchasing requirements. Furthermore, most states offer tax benefits or

grants for AF or the purchase of AFVs.186

In Connecticut, for example, vehicles powered by natural gas, propane, or electricity; vehicle

conversion equipment; and equipment for AF refueling stations are exempt from the state’s 6%

sales and use taxes. In addition, businesses are entitled to 50% tax credits for the investments

they make in vehicle conversions and refueling stations. Companies that derive at least 75% of

their income from alternative energy sources are exempt from income tax, and natural gas sales

are exempt from gross earnings taxes of 4%−5%.

The California Air Resources Board (CARB) requires that vehicle sales by the seven largest

vehicle manufacturers in the state include at least 5% alternative fuel vehicles in 2001 and 10%

in 2003. The direct incremental and infrastructure costs of this mandate have been projected at

$19.5 billion through 2010. This figure accounts for almost 80% of the expected costs of all the

state’s activities to promote the purchase and use of alternative fuel.187

A number of cities use AFVs in their mass transit systems. In Los Angeles, for example, the

Board of Directors of the Metropolitan Transit Area has adopted a policy that requires all buses

purchased by the transit agency in the future to be AFVs.

Table 7-16 focuses on the Ozone Transport Region (OTR), which consists of 12 Mid-Atlantic

and Northeastern states as well as the District of Columbia. The table shows that state subsidies

for AF and AFVs are expected to rise significantly over the next 15 years.
The U. S. Experience with Economic Incentives for Protecting the Environment

136 January

Table 7-16. Alternative Fuel and Vehicle Subsidies in the Ozone Transport

Region

TYPE OF SUBSIDY

(excluding federal mandates)

1995

(in millions of dollars)

2000

(in millions of dollars)

2005

(in millions of dollars)

AFV procurement requirements $0 $153.3-930.5 $719.0-5,875.5

State and local tax incentives 4.3-4.8 (44.8)-12.0 Unknown

Other state and local incentives 2.9-10.5 0.0-4.0 Unknown

TOTAL $7.2-15.3 $108.5-946.5 $719.0-5,875.5

Source: Perkins. September 1995, p. 9.

Some of the subsidies actually involve net costs. State and local tax incentives could range from

a net cost of $44.8 million in 2000 to a positive subsidy of $12.0 million. The incentive effect of

some of the AF and AFV subsidies is likely to be significant. Preferential tax treatment has

played a large role in the rise in ethanol production in recent years. A 1995 GAO report found

that without the partial excise tax exemption for ethanol, its use would fall by 50%-90%.188 The

purchase of AFVs has also stimulated demand for methanol and CNG.

The environmental impact of such incentive effects is unclear. Some alternative fuels are cleaner

than gasoline. Alternative fuels are promoted for several reasons: to improve the environment, to

help increase U.S. energy security, and (in the case of ethanol) to provide a market for part of the

country’s large agricultural surpluses.

7.7.3 Car Buyback Schemes

In a number of states, programs have been implemented that offer cash payments to motorists if

they turn in old, high-emitting automobiles. In the RECLAIM program described in Chapter 6,

the South Coast Air Quality Management District (SCAQMD) allows emission reduction credits

to be generated if citizens scrap old vehicles and lawnmowers, both of which are blamed for

significant quantities of air pollution.

In 1990, Unocal Corporation in Los Angeles purchased and scrapped 8,376 vehicles that were

manufactured before 1971 for $700 per vehicle. SCAQMD estimated the per-ton cost of the

combined reductions in oxides of nitrogen (NOx) and reactive organic gas (ROG) emissions at

$4,900 through the scrapping of pre-1972 vehicles. This figure is much less than the $10,000 to

$20,000 per-ton cost for traditional control methods. The SCAQMD concluded that its vehiclescrapping program was relatively cost-effective.189

7.8 Renewable Energy and Conservation

Renewable energy and conservation are subsidized by tax benefits. Renewable electricity

generation earns income tax credits of 1.5 cents per kWh, adjusted for inflation. For 1995, the

credit was 1.6 cents per kWh. It applies to closed-loop biomass and wind energy sources. The

estimated cost of these credits to the government was approximately $970 million in 1995.

Conservation subsidies paid by utilities are also partly or fully excluded from income tax. Since

1992, subsidies to residential consumers have been fully deductible, and 65% of subsidies to

non-residential consumers have been deductible. The annual cost to the government of this

exclusion has been estimated at approximately $100 million.
Subsidies for Pollution Control

2001 137

In cooperation with the U.S. Department of Energy, the U.S. Department of Housing and Urban

Development created the Energy Efficient Mortgages (EEM) Program to help homebuyers and

homeowners finance new homes or the cost of adding energy-efficiency features to an existing

home as part of their Federal Housing Administration-insured home purchase.190 EEM makes

mortgage credit available to borrowers who otherwise would not qualify for conventional loans

or for affordable loan terms and to residents of disadvantaged neighborhoods. In FY 1996, 3,500

loans were approved under this program. In FY 1997, 4,700 additional loans were approved.

7.9 Municipal Sewage Treatment Plant Construction

The federal government has subsidized the construction of municipal sewage treatment plants

since the 1956 Water Pollution Control Act Amendments. The subsidies took the form of costsharing grants in which the federal government’s contribution was limited to 55% in 1956, raised

to 75% by the Federal Water Pollution Control Act of 1972, then decreased back to 55% by the

1981 Municipal Wastewater Treatment Construction Grant Amendments.

During the 1970s and 1980s, the Construction Grants Program provided more than $60 billion

for the construction of public wastewater treatment projects: sewage treatment plants, pumping

stations, and collection and intercept sewers; rehabilitation of sewer systems; and the control of

combined sewer overflows.191

The 1987 Water Quality Act (commonly referred to as the “Clean Water Act”) established 1990

as the last year for appropriating construction grant funds. With the phaseout of the Construction

Grants Program and the initiation of the State Revolving Fund (SRF), Congress significantly

reduced the amounts of funding available. They also provided for a transition from grants to

loans.192

The grants undoubtedly encouraged construction activities that increased public access to sewage

treatment. However, these grants have been criticized for giving municipalities “only weak

incentives to hold the line on capital costs by seeking cost-effective design and technologies or

by matching more carefully the designed capacity of the plant to projected need.” This effect was

compounded by state grants that covered part of the non-federal share, which effectively lowered

communities’ share of construction costs to 10%−25%.193

Under the Clean Water Act, grants were phased out by 1991 and replaced by federal

contributions to state-managed revolving loan funds in what is known as the Clean Water State

Revolving Fund (SRF) program.194 SRFs in all 50 states and in Puerto Rico are capitalized by

federal government grants. States are

required to provide 20% matching funds

for all federal grants, effectively making

the state share 16.6% and the federal share

83.3%. By 1998, the SRF program was

capitalized at approximately $30

billion.195 (See Figure 7-1.) When loans

are paid back, additional funds become

available for new lending. FY 2000

appropriations for the SRF amount to

$1.325 billion.

Figure 7-1. Cumulative SRF Investments

(in billions of dollars, 1988−1999)

$3.2

$11.6 

$15.4

Federal grants

State share

Leveraged funds

Source: EPA. 1999a.
The U. S. Experience with Economic Incentives for Protecting the Environment

138 January

States are responsible for fund management. Interest rates vary from 0% to a market rate, the

average being about 3%. Repayment periods are as long as 20 years, with reimbursement

beginning one year after project start-up.

Data collected by the State of Ohio indicate that as of June 30, 1995, states collectively had lent

$14.6 billion, or 77%, of the $18.9 billion available to them. The percentages of funds that were

loaned varied significantly from state to state, with 8 states having loaned more than 90% of their

funds; 11 states, less than 60%; and 3 states, less than 40%.

A GAO (1996c) study found that various obstacles had limited states’ lending, including the lack

of states’ experience in managing revolving loan funds. In addition, the requirement that loans be

repaid has discouraged applications from some small communities with a limited number of

ratepayers to support project costs. In at least two states, the possibility of obtaining grants from

other federal programs appears to have discouraged loan applications for SRF.

Eight federal agencies manage 17 different programs that may be used by rural areas for the

construction, expansion, or repair of water and wastewater facilities. Some states report that

larger communities with solid credit ratings may be able to borrow money at more favorable

conditions from private-sector sources than from the SRF program.

Unlike the Construction Grant Program it replaced, the SRF program funds a number of

initiatives other than municipal wastewater treatment, including projects that address stormwater;

combined (sanitary and storm) sewer overflows; and agricultural runoff. Over 150 loans worth

more than $1 billion have financed investments to control combined sewer overflow. In addition,

approximately 100 loans worth about $100 million have financed measures to control

agricultural and urban runoff.

Although it is beyond the scope of this report to provide an evaluation of the grant and SRF

programs, the population served by modern sewage treatment has doubled over the past 30 years.

EPA has stated that “the SRF is probably the most efficient program of its kind in the federal

government.”196

In addition to the SRF program, a number of other initiatives support the construction of sewage

treatment works and related activities. A sampling of these initiatives follows.

• EPA’s Public-Private Partnerships (P3) initiative tries to identify opportunities for

municipalities to cooperate with the private sector to finance public wastewater treatment

operations.

• The Hardship Grants Program for Rural Communities helps small, disadvantaged rural

communities deal with their wastewater treatment needs. EPA provides funding for either

the planning, design, and construction of wastewater treatment facilities or technical

assistance on the operation and maintenance of such facilities. To qualify for this

program, communities must meet the following criteria, among others:

1. It must be located in a rural area.

2. It must have a population of fewer than 3,000.

3. It must have no centralized wastewater treatment facilities.

4. It must have a per capita income that is 80% or less than the national average.

5. It must have an unemployment rate that is at least 1% above the national average.
Subsidies for Pollution Control

2001 139

• Section 106 Water Pollution Control Program Grants help establish and implement

ongoing water pollution control programs, including permitting, pollution control

activities, surveillance, monitoring, enforcement, advice and assistance to local agencies,

and the provision of training and public information. These grants provide federal

assistance to states, territories, the District of Columbia, Native American Indian Tribes,

and interstate agencies. Increasingly, Section 106 grants are focusing on basin-wide

approaches to water quality management.

• Section 104(b)(3) Water Quality Cooperative Agreements are grants that promote the

coordination of environmentally beneficial activities, including stormwater control,

sludge management, and pretreatment. These grants provide federal assistance to state

agencies that seek to control water pollution; interstate agencies; and other nonprofit

institutions, organizations, and individuals.

7.10 Accelerated Review of New Pesticide Formulations

When a pesticide manufacturer makes application to EPA to register a new pesticide, that

pesticide may move closer to the front of the queue if the new pesticide can be demonstrated to

substantially reduce risk to human health and the environment relative to the pesticide that is

currently available. EPA articulated this policy in the 1994 Annual Report of the Office of

Pesticide Programs.

197 OPP further clarified the policy on reduced risk in the staff paper that is

part of the OPP public participation process. In that document, OPP described how registration

actions are ranked in the queue.198 Accelerated review for lower risk formulations is an important

benefit to the manufacturer of the new product for two reasons. First, pesticide registration can

take a number of years. Second, the patent protection clock generally is running during the

period when the registration application is being evaluated by EPA. This open policy has

incentives that are clear and recognized by all parties. It has been successful in communicating

the benefits of generating new research on safer pesticides to pesticide registrants.

7.11 Subsidies That May Harm the Environment

Some subsidies are widely believed to have the unintended effect of encouraging

environmentally harmful activities. In many cases, such subsidies were not designed as

environmental policy instruments, but they have had adverse environmental consequences. This

section briefly discusses a few examples of such subsidies.

7.11.1 Subsidies for Timber, Minerals, and Water Extraction

It has been widely asserted that timber, minerals, water, and public grazing land have been priced

below their true social cost and, in many cases, even below their private cost. For all of these

resources, user fees such as those described in Chapter 4 have been assessed. However, to the

extent that these fees are lower than the private cost of the resources or services on which they

are charged, such resources and services are actually being subsidized to the detriment of

environmental protection.

As mentioned in Chapter 4, for example, livestock grazing fees on federal lands that are imposed

according to a formula established by the 1978 Public Rangelands Improvement Act (PRIA) are

widely believed to be below market value. Fees have been between $1.35 and $1.98 per animal

unit month (AUM) since 1986. However, the Bureau of Land Management (BLM) and the
The U. S. Experience with Economic Incentives for Protecting the Environment

140 January

Forest Service estimated that fair market values in 1992 were $4.75 per AUM for sheep.

Furthermore, they estimated that these market values varied across regions and ranged from

$4.68 to $10.26 per AUM for cattle and horses. The costs of the grazing programs were $2.40 to

$3.24 per AUM for the Forest Service and $2.18 to $3.21 per AUM for BLM.

The low end of the cost range applies only if the funding directly linked to the livestock grazing

program is considered, while the high end considers all range management funding. Moreover,

state and private fees are significantly higher than PRIA fees. Data from the National

Agricultural Statistics Service indicate that, in 1993, private fees in 17 Western states averaged

$9.80 and state government fees averaged $4.58. The PRIA fee that year was $1.86.

Table 7-17 shows that estimated irrigation water subsidies provided by the U.S. Bureau of

Reclamation in selected areas ranged from 57% to 97% of the Bureau’s full cost for water

delivery. Excessive irrigation has been associated with a number of environmental problems,

including water shortages and the contamination of water with natural pollutants and agricultural

inputs.

Table 7-17. Water Subsidies of the U.S. Bureau of Reclamation

IRRIGATION DISTRICT IRRIGABLE ACRES SUBSIDY PER ACRE

(in dollars)

SUBSIDY AS %

OF FULL COST

Oroville-Tonasket 9,500 $417 82

Black Canyon #2 53,200 762 89

East Columbia Basin 134,500 1,619 97

Cachuma Project 38,700 1,378 81

Truckee-Carson 73,000 931 83

Glen 152,300 101 91

San Luis Unit 571,900 1,422 85

Coachella Valley 78,500 1,000 70

Wellton-Mohawk 65,800 1,787 89

Imperial Valley 519,500 149 74

Moon Lake 75,300 58 57

Grand Valley 23,300 1,623 85

Elephant Butte 102,100 363 64

Lugert-Altus 47,100 675 90

Malta 42,400 812 92

Lower Yellowstone #1 34,500 507 73

Farwell 50,100 1,446 93

Goshen 52,500 416 74

Source: U.S. Department of Interior, Acreage Limitation, Interim Report, Government Printing Office, Washington, DC, March

1980, pp. 38-41, as cited in Kanazawa (1994), p. 114.

Historically, the mining industries—which include the oil and gas industries—and timber

industries have benefited from preferential taxation of their income. The effect of subsidizing

mineral and timber production through the tax code is to favor virgin material use over

secondary (recycled) materials. Two types of adverse environmental effects may result from

such subsidies: (1) the destruction of natural areas as minerals and timber are harvested; and (2)

the excessive disposal of materials that otherwise might be recycled.
Subsidies for Pollution Control

2001 141

Percentage depletion allowances for petroleum and other minerals, for example, allow

companies to write off arbitrary percentage reductions in mineral deposits that result from their

operations as expenses. The value of these allowances for the oil and gas industries was

estimated at more than $2 billion annually from 1980 to 1982. Its value has since decreased to

insignificant levels. One reason for the decrease is that only independent oil and gas companies

(which account for about 30% of total U.S. oil and gas consumption) are now entitled to

allowances. Moreover, only 25%−40% of these independent companies pay the standard tax

(rather than the alternative minimum tax) required to maintain their eligibility for percent

depletion allowance claims, Many of these companies are excluded from claiming percent

depletion by other criteria under the tax code.

Percentage depletion allowances for other minerals were worth over $500 million annually for

much of the early 1980s. These allowances, however, fell in value after the 1986 Tax Reform

Act. Oil, gas, and other mineral extraction companies also have the advantage of being able to

expense (rather than capitalize) exploration and development costs.

In the past, timber companies were allowed to consider certain income from timber as capital

gains, which are subject to lower tax rates. This practice, worth about $800 million a year in the

first half of the 1980s, was eliminated by the 1986 Tax Reform Act. However, the elimination of

this practice led timber companies to increase their use of other previously underused tax

advantages: (1) provisions that allowed timber management and reforestation costs to be

expensed rather than capitalized; and (2) tax credits and accelerated amortization for

reforestation activities. The federal government’s construction of roads to facilitate the

harvesting of timber is another form of subsidy for this industry.

7.11.2 Agriculture

The effect of the price support program for sugar on the Florida Everglades is frequently cited as

an example of an environmentally harmful subsidy. The federal government subsidizes the sugar

industry by guaranteeing a floor price of $0.18 per pound, which is almost twice the price on

world markets. This U.S. policy is further supported by tariffs of $0.16 per pound on imported

sugar that is in excess of quota levels. In 1992, this support program resulted in $161.5 million in

benefits for sugarcane farmers and $107.7 million for processors.

The increases the amount of water diverted to sugarcane fields as well as the amount of runoff.

The diversion and the runoff, which is contaminated with pesticides and fertilizers that sugarcane

growers apply to maximize production, damage the ecosystem of the Everglades. Agricultural

subsidies appear to be having similar adverse effects elsewhere in the United States. A

Competitive Enterprise Institute study found that the use of pesticides and fertilizers in several

Midwestern states was higher on subsidized fields than elsewhere. The study concluded that “the

complete elimination of subsidies could result in a 35% reduction in chemical use per acre and a

29% reduction in fertilizer use per acre.”

USDA’s peanut subsidy program has also been accused of promoting environmental

degradation. It requires farmers to grow peanuts on the same land so they can retain their

production quotas. Thus, critics charge, the program results in the increased use of pesticides in

order to counteract the negative effects of the lack of crop rotation.199
The U. S. Experience with Economic Incentives for Protecting the Environment

142 January

7.11.3 Mortgage Interest Tax Deduction

Although most interest deductions from personal income tax were eliminated by the 1986 Tax

Reform Act, the deduction of mortgage interest remained in place. This deduction in effect

subsidizes the construction and purchase of large homes. To the extent that larger homes use

more building materials, take up more space, and require more energy, the deduction has a

negative impact on the environment.
Liability Approaches

2001 143

8. Liability Approaches

The purpose of liability mechanisms in environmental management is twofold: first,

to give polluters an economic incentive to make more careful decisions; and second,

to compensate the victims of pollution. The incentive effect is clear, since

environmental values in effect become part of the overall cost of doing business.

Avoiding harm to the environment is a good practice for companies when it reduces

the overall cost of doing business.

Liability for harm to the environment acts as a financial incentive, much like a fee on

emissions, with at least two important exceptions. One, liability for harm creates

much greater uncertainty as to the magnitude of the payment that will be due for a

given release of pollutants. Two, liability for harm can generate relatively large costs

in terms of assessing environmental damage and the amounts due. These concerns

aside, liability is an important incentive mechanism, one that is seeing increasing use

in environmental policy.

8.1 Introduction

Two federal environmental statutes, the Comprehensive Environmental Response,

Compensation, and Liability Act (CERCLA) and the Oil Pollution Act of 1990

(OPA), provide liability for the cleanup of releases of hazardous substances and

petroleum, respectively, that pose a threat to human health and the environment. The

statutes also provide for compensation for the lost use of polluted natural resources

and for the restoration of the environment.

Several of the federal environmental statutes provide for civil and criminal liability

for failure to comply with environmental regulations. The incentive effect of civil

and criminal liability is to encourage individuals to comply with what are largely

traditional forms of regulation. Such an incentive is qualitatively different from the

subject matter contained in this report: incentives that put a price on pollution that

harms health, the environment, or natural resources.

No study has attempted to address whether the existing combination of liability,

penalties, and enforcement produce the correct incentive effect, which would

encourage an optimal level of investment in pollution control. Excessive investment

in pollution control is possible if entities seek to avoid penalties that are too harsh. It

is also possible that firms will expend too little effort at pollution control if penalties

are low and enforcement is lax. One recent study found that some types of chemical

spills are more numerous in states that have imposed strict liability, an unexpected

finding that calls into question many of the assumptions that policy makers have

made regarding the effects of liability mechanisms as a tool of environmental

management.200

In addition to liability for cleanup, and civil and criminal liability for violating

environmental laws, individuals may use tort law to seek compensation from

polluters for harm to their property or person. The difficulty of proving harm caused

by pollution, particularly chronic health effects, creates a severe barrier to such cases.
The U. S. Experience with Economic Incentives for Protecting the Environment

144 January

Consequently, tort law has serious deficiencies as a mechanism to make polluters pay for the

harms they cause. In fact, it was largely the failure of tort law to address many types of

environmental harm that led to the passage of the principal environmental statutes.

8.2 Liability for Cleanup Costs

The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) of

1980 responded to an issue without precedent: the legacy of sites contaminated with hazardous

wastes. Love Canal in New York was the most celebrated case, although others such as Times

Beach, Missouri, also attracted national media attention. CERCLA established a trust fund (the

Superfund) that was financed primarily by three mechanisms: (1) a tax on corporate income; (2)

a tax on crude oil and certain chemicals; and (3) general appropriations. (The taxing authority

expired in the 1990s, leaving the Superfund reliant on annual Congressional appropriations, cost

recoveries, and interest on the existing fund.) EPA uses the fund to pay for cleanup and

restoration activities at sites where no solvent responsible party can be identified or at sites

where an immediate response is deemed necessary.

Section 107(a) of CERCLA provides for liability for anyone who caused, or threatened to cause,

a release of a hazardous substance or for anyone who has threatened to cause a release that

creates a need for cleanup actions. The courts have interpreted this section of the law as requiring

strict, joint and several liability for parties that have been deemed responsible for disposing

ofor generators that arranged for the disposal ofhazardous wastes that pose risks to human

health and the environment. The term “joint and several liability” means that if the government

can identify just one party out of many that contributed wastes to a site, then that one party can

be held responsible, potentially, for all cleanup costs. In turn, any potentially responsible parties

that have been identified by the government may seek to involve other potentially responsible

parties. The term “strict liability” is a standard that holds parties responsible, regardless of the

circumstances of their action, e.g., without regard to whether the party acted negligently.

The most important feature of CERCLA centers on the cleanup of hazardous waste sites that

pose a threat to human health and the environment. CERCLA is unique among the principal

environmental statutes in that it looks backward, seeking to remedy problems stemming from

past actions, rather than forward by trying to prevent damage from current or future activities.

Cleanup costs paid by the private sector under CERCLA could amount to several tens of billions

of dollars. The incentive effects of being held responsible for cleanup must lie outside of the

actual costs of cleanup, since the actions that precipitated the need for cleanup are historical, not

contemporaneous. But the mere prospect of CERCLA cleanup liability is affecting current and

future decisions regarding the disposal of hazardous waste.201 Large firms are managing most of

their hazardous wastes on-site so as not to commingle their wastes with others and face the

possibility of strict, joint and several cleanup liabilities for wastes from other generators. At

present, minimizing wastes and preventing pollution are definitely more attractive strategies for

businesses than risking liability under CERCLA.

The Resource Conservation and Recovery Act (RCRA) creates cradle-to-grave responsibility for

managing hazardous wastes. Generators, transporters, and disposal facilities face strict, joint and

several liability for the ultimate disposition of hazardous waste into a federally permitted facility.

Each shipment of hazardous waste must be accompanied by a manifest to facilitate enforcement.

The system creates powerful incentives for each actor in the hazardous waste management chain
Liability Approaches

2001 145

to know the other parties and to be satisfied that they are acting responsibly. With this approach,

Congress effectively multiplied the enforcement capabilities of EPA.

8.3 Liability for Damage to Natural Resources

Until 1990, damage to natural resources resulting from oil spills was within the scope of

CERCLA. Where responsible parties can be identified, CERCLA provides for compensation to

the public by the responsible party for the loss of services from natural resources. These socalled “interim lost uses” persist after a release of pollution until restoration is complete.

Residual damages may exist if restoration is not complete.202 CERCLA designates federal and

state authorities as trustees for natural resources.

Trustees, in conjunction with the U.S. Justice Department, pursue damage assessments of natural

resources. At the federal level, the U.S. Department of the Interior is the trustee for freshwater

anadromous fish, migratory birds and waterfowl, and endangered species. The National Oceanic

and Atmospheric Administration (NOAA) is trustee for the coastal and marine environment,

including commercial and recreational fisheries, marine mammals, and anadromous fish in salt

water.203

The Oil Pollution Act of 1990 (OPA), was enacted following the 1989 Exxon Valdez spill in

Prince William Sound, Alaska. This Act created an independent statute separate from CERCLA

for addressing damages resulting from oil spills. In Section 1006(e)(1), OPA directed NOAA, a

part of the U.S. Department of Commerce, to promulgate regulations for assessing natural

resource damages. On January 5, 1996, NOAA issued final regulations on natural resource

damage assessment (NRDA) that was conducted under OPA. Later in 1996, the U.S. Department

of the Interior issued regulations governing NRDA under CERCLA. These regulations were

patterned closely after NOAA’s approach.204

The OPA and NOAA regulations have two goals. First, they seek to restore the natural resources

and services to their baseline condition. Second, they seek to compensate the victims of pollution

for the interim lost use of natural resources and services through restoration, rehabilitation, or

replacement, and through the acquisition of comparable resources, comparable services, or both.

Damage assessments conducted by trustees in conformance with the NOAA regulations are

accorded the status of a rebuttable presumption. This term, “rebuttable presumption,” means that

the parties responsible for the damage bear the burden of showing that damage claims presented

by trustees are inappropriate.

The two components of a natural resource damage assessment ensure that the public is made

whole following an oil spill: The resource and its services are restored, and the public is

compensated for any lost use of the resource and resource services. OPA gives potentially

responsible parties a financial incentive not to spill oil. Enforcement of the Act ensures that the

responsible parties will pay the amounts necessary to restore the natural resource and

compensate the public for lost use.

By 1996, under provisions of CERCLA, OPA, and the Clean Water Act, federal agencies had

settled more than 100 natural resource damage cases. Awards for total damages reached well

over $700 million. By that date, state agencies acting as trustees also had settled several cases on

their own, with their awards totaling at least another $20 million.
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146 January

In comparison, cleanup settlements by that date under CERCLA alone totaled at least $10

billion, approximately 10 times the magnitude of the natural resource damage settlements. If no

settlement agreement can be reached with the responsible party, OPA authorizes the trustee to

file a civil action for the damages in federal district court or to seek funds from the Oil Spill

Liability Trust Fund administered by the Coast Guard.205 The fund was financed by a fee of five

cents per barrel on imported and domestic petroleum. Collection of the fee ceased at the end of

1994 as the trust fund had reached its funding limit. Because it is far easier to file a claim against

the fund than to identify and pursue those responsible for “mystery” spills, this mechanism may

reduce incentives for states to pursue those parties that are responsible for large numbers of small

spills.

A number of large NRDA cases are still pending, at least three of which could amount to at least

$500 million in awards. In addition, several important cases involving the federal government as

a responsible party are outstanding. Table 8-1 summarizes the largest cases reported as settled

(or partially settled) by 1996. The list excludes both the Exxon Valdez and the Shell Oil spill at

Martinez, California. NOAA does not list the $620 million (present value) award in the Exxon

Valdez case because it was settled before the NOAA Damage Assessment Center was

established. The Martinez case is not listed because it was brought by the State of California, not

by the U.S. government.

Table 8-1. Largest Natural Resource Damage Settlements Brought by the U.S.

Government

CASE NAME LOCATION OF DAMAGE AMOUNT OF AWARD (in dollars)

Southern California Palos Verdes Shelf, CA $54,200,000

City of Seattle Elliott Bay, WA 24,250,000

AVX New Bedford, MA 21,127,000

Southern Pacific Cantara Loop Derailment, CA 14,000,000

Simpson/Port of Tacoma Commencement Bay, WA 13,035,000

Exxon Bayway Arthur Kill, NY 11,113,000

Blackbird Mine Salmon, ID 7,200,000

Apex Houston San Francisco, CA 5,416,000

Tenyo Maru Olympic Peninsula, WA 5,160,000

Eagle Pitcher Industries Tri-State Site: MO, KS, OK 4,734,000

Nautilus Kill Van Kull, NY/NJ 3,300,000

Sharon Steel Corp. Midvale Tailing Site, UT 2,600,000

Schlumberger Crab Orchard Wildlife Refuge, IL 2,500,000

New York Trap Rock Co. Portland Cement Site, UT 2,207,510

Presidente Rivera Delaware River, PA 2,141,000

Greenhill Timbalier Bay, LA 1,878,000

Elepis Florida Keys National Marine Sanctuary, FL 1,660,000

Charles George Trucking Co. Charles George Reclamation Trust Landfill, IL 1,378,350

Sources: Guerrero. 1995; NOAA. 1996.

It is clear that liability for natural resources is having an effect on corporate behavior. Shortly

after the Exxon Valdez incident and about the same time as the passage of OPA, the petroleum

industry announced the creation of the $600 million, industry-funded Marine Spill Response

Corporation, an organization that would develop response capabilities specifically for large
Liability Approaches

2001 147

spills. Another sign of change is the care taken when tankers transit congested waterways and

load or offload petroleum. In the Arthur Kill and Kill Van Kull waterways of New York and

New Jersey, tug escorts now accompany tankers, and offloading tankers are surrounded by

booms.

One largely unresolved issue concerns oil spills and releases that are too small to justify a natural

resource damage assessment under either CERCLA or OPA. For example, the Coast Guard has

record of between 5,000 and 10,000 oil spills occurring per year, but fewer than 20 are followed

by an assessment of natural resource damage. While the expected damage from many of the

smaller spills may not justify the costs of a traditional damage assessment, some natural resource

damage may nonetheless exist. Not charging for natural resource damage gives incorrect price

signals to potential polluters, since pollution is free rather than costing the responsible source an

amount equal to the damage that is caused.

The petroleum industry has argued that the magnitude of the fines assessed in all assessments,

including those for small spills, should closely match the actual damage to the environment. The

reason they take this position probably has more to do with their attempts to avoid damage

assessments that are calculated according to a formula than with their quarrel over the incentive

effect of such a formula. The correct economic incentive for a given spill is provided to potential

polluters if the calculated value of the assessment equals the average harm done by such a spill.

Alaska, Washington, Florida, and Texas have enacted compensation formulas or tables that

assess charges based on the volume spilled, the nature of the receiving waters, and other factors.

In 1995, NOAA proposed a similar approach for small spills. NOAA later withdrew the initiative

for further study when it was pointed out that the proposed method resulted in unrealistically

large assessments in some cases.

8.4 Civil and Criminal Liability

Congress first decreed pollution of the environment to be a federal crime in the Refuse Act of

1899. This Act made it a misdemeanor to “throw, discharge, or deposit” refuse of any kind other

than runoff from streets and discharge from sewers into navigable waters of the United States.

Violators convicted of violating the Act could be punished by fines not less than $500 and not

more than $2,500, or by imprisonment for not less than 30 days nor more than one year. The

court had the discretion to reward persons who provided information leading to the conviction of

responsible parties with one-half of the fine.

More recently, the 1970 Amendments to the Clean Air Act punished violations of the Act as a

misdemeanor. The 1970 Amendments to the Federal Water Pollution Control Act established

misdemeanor penalties for “negligent or willful” release of pollutants into navigable waters

without a permit or in violation of a permit. The Resource Conservation and Recovery Act of

1976, as amended by the Solid Waste Disposal Act Amendments of 1980, provides felony

penalties for treatment, storage, or disposal of hazardous waste without a permit.

Continuing through the 1980s, Congress further refined the scope of environmental crimes, as

well as the maximum fines and terms of imprisonment, in the Hazardous and Solid Waste

Amendments of 1984, the Superfund Amendments and Reauthorization Act of 1986, and the

Water Quality Act of 1990. In the Clean Air Act Amendments of 1990, Congress included

felony provisions in the Act for the first time.
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148 January

By 1995, the Justice Department had indictments against 443 corporations and 1,068 individuals,

and it had recovered $297 million in criminal penalties. Sentences for individuals totaled 561

person-years of prison for those convicted.

State and local prosecutors also can pursue environmental crimes. In fact, they are required to

demonstrate such a capacity in order to obtain EPA authorization to locally administer programs

of the Clean Air Act, the Clean Water Act, and the Resource Conservation and Recovery Act.

While most states are not actively pursuing environmental crimes, there are a number of

important exceptions. New Jersey, Ohio, Pennsylvania, and California are active in their

prosecution of environmental crimes. Los Angeles maintains its own team of investigators and

prosecutes these cases.

An important sanction in addition to fines and prison sentences is the mandatory “blacklisting”

of contractors under the Clean Air Act and the Clean Water Act. Both statutes prohibit the

federal government from entering into new contracts with, or issuing grants to, any organization

convicted of environmental crimes under these laws. Federal agencies and all states also have the

authority to temporarily disqualify contractors from new work, pending receipt of further

information, when a contractor violates a permit and is suspected of harming the environment.

Consequently, environmental violations can adversely affect a firm or individual even if no

criminal conviction is imposed.

The remainder of this section describes the principal civil and criminal penalties available under

the nation’s environmental laws.

8.4.1 Resource Conservation and Recovery Act (RCRA)

The purpose of RCRA is to establish a legal framework for a national system that oversees the

management of hazardous waste. Congress included within the RCRA statute several

enforcement authorities and penalty provisions. EPA relies on four types of compliance orders as

its primary enforcement tools.

1. EPA may issue an order requiring compliance within a set time frame (usually 30 days) to

facilities in violation of a regulatory requirement of Subtitle C. Such EPA orders include

penalties for any noncompliance period.

2. EPA may require monitoring, testing, analysis, and reporting for facilities that present a

substantial threat to human health or the environment.

3. EPA may issue corrective action orders requiring corrective action of other measures to

interim status facilities (those without full RCRA permits) to protect human health and the

environment.

4. EPA may sue any person who contributes or contributed to solid waste management practices

that pose an imminent and substantial threat to human health or the environment.

Beyond forcing compliance with RCRA and making owners of facilities take actions to protect

public health and the environment, compliance orders may also assess a civil penalty for past and

current violations. Civil penalties can be as large as $25,000 per day for each RCRA violation.

Criminal penalties of up to $50,000 per day of violation or imprisonment for as long as 5 years

may be meted out to any responsible person who knowingly

• transports hazardous waste to a facility not permitted under RCRA;
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2001 149

• treats, stores, or disposes of hazardous waste without a permit;

• makes a false statement or representation in an application, label, manifest, record, or

other document used for compliance with RCRA;

• generates, treats, or disposes of hazardous waste and intentionally destroys records or

other documents required for compliance with RCRA;

• transports hazardous waste without a manifest; or

• exports hazardous waste without the consent of, or in violation of, procedures of the

receiving county.

8.4.2 Comprehensive Environmental Response, Compensation, and Liability

Act (CERCLA)

Any person in charge of a vessel or a facility who knows of a release of hazardous substances

from a vessel (other than a federally permitted release) must notify the National Response

Center. Anyone who fails to provide notification “immediately,” or who knowingly supplies

false or misleading information, may be imprisoned for not more than 3 years (5 years in the case

of a subsequent conviction) and fined in accordance with Title 18 of the Act. In addition, the

Emergency Planning and Community Right-to-Know Act (EPCRA) requires that the person

notify state and local emergency response officials.

8.4.3 Clean Water Act (CWA)

EPA can begin civil actions against violators of CWA permits and seek appropriate relief, which

includes the use of permanent or temporary injunctions. EPA can seek criminal penalties

including fines, imprisonment, or both, as shown in Table 8-2. After a person’s first conviction,

the fines and prison terms for subsequent convictions can be doubled.

Table 8-2. Criminal Penalties for Violations of the Clean Water Act

SEVERITY OF VIOLATION FINE IMPRISONMENT

Parties who negligently violate permit conditions

and limitations

Not less than $2,500 per day of violation

nor more than $25,000 per day of violation Not more than 1 year

Parties who knowingly violate permit conditions

and limitations

Not less than $5,000 per day of violation

nor more than $50,000 per day of violation Not more than 3 years

Parties who violate permit conditions and

limitations and knowingly place another person in

danger of death or serious bodily injury

Not more than $250,000 Not more than 15 years

Organizations that violate permit conditions and

limitations and knowingly endanger human health Not more than $1,000,000 Not applicable

Source: Clean Water Act

The CWA also provides for civil penalties for offenses other than permit violations, offenses that

include making false statements on records, reports, and other documents filed under the CWA

and wrongfully introducing pollutants into public sewage treatment facilities.
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150 January

8.4.4 Clean Air Act (CAA)

The Administrator of EPA can seek a permanent or temporary injunction and civil penalties of

not more than $25,000 per day for permit violations by major stationary sources (in general,

those emitting more than 100 tons per year of a regulated pollutant). Criminal penalties that

include both fines and imprisonment for up to 2 years may be sought for any person who

knowingly violates permit terms and conditions through such actions as making material false

statements or omitting material information. Convicted second-time violators can have their fines

and sentences doubled.

Parties who negligently place another human in imminent danger of death or serious bodily

injury are liable, upon conviction, for fines and prison sentences of up to 1 year. Parties who

knowingly endanger human health may, upon conviction, receive fines, prison sentences of up to

15 years, or both. Finally, organizations can be liable for fines of up to $1,000,000 for knowingly

committing permit violations and similarly endangering human health.

8.5 Tort Liability

Litigation concerning claims of personal injury from chronic exposures to toxic agents in the

environment is a relatively recent phenomenon. It is, for the most part, the domain of asbestos

workers. Workplace-related injury claims are not within the scope of this paper. However, a few

cases involve alleged exposure to toxic substances in ambient air and water supplies.

The law under which these tort actions are brought has undergone considerable evolution in

recent years. These modifications are due to several factors, which include the following: (1) the

need to accommodate improved scientific information on the effects of human exposure to toxic

agents; (2) the recognition of the potentially long latency periods between exposure and onset of

a disease; and (3) a growing desire by the courts to hold defendants to a standard of strict

liability. Despite the evolution of tort law in favor of plaintiffs, relatively few cases that claim

harm from pollution in the environment have been filed. Of these cases, very few that involve the

effects of pollution on human health have been decided in favor of plaintiffs.

The statute of limitations is an important barrier to litigation in a few states. However, most

states have struck down this once-important obstacle by allowing plaintiffs to file a case from 1

to 3 years after the discovery of an injury, rather than starting the clock at the date of initial

exposure.

In many situations of environmental harm, plaintiffs find it difficult to identify the party

responsible for the harm. Identifying the source of contamination in well water would be a

challenge for most households. Even if the contamination could be traced to a waste disposal

facility, it might be very hard to identify whose wastes caused the contamination. For toxic

pollutants in the air, identifying the parties responsible for such releases is even more difficult.

Demonstrating causation represents a major challenge because most diseases that have been

linked to toxic substance exposure can be caused by multiple factors. In general, tort law requires

plaintiffs to demonstrate that the harm they experienced was “more likely than not” caused by

the defendant. Courts usually interpret this phrase to mean that the probability that the defendant

caused the harm was at least 50%. Imagine a situation in which a polluter increased the risk of

cancer by 20% in a nearby residential area. Rather than 100 people dying of cancer each year,

120 die. None of the 120 cases would receive compensation under the “more likely than not”
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2001 151

criterion. Two other issues should be noted: (1) that statistical data regarding causation are not

likely to be accepted by courts, no matter what the standard of proof; and (2) that epidemiology

is limited in its ability to detect elevated incidence of a disease, the smallest detectable rate of

excess incidence being on the order of 30%.

In sum, the legal norms under which tort actions for harms caused by exposure to pollution are

such that few cases can satisfy the burdens of identifying the responsible party and proving

causation.
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Information Disclosure

2001 153

9. Information Disclosure

For the purposes of this chapter, information approaches to environmental protection

may be defined as policy instruments that influence the behavior of firms and

individuals through the dissemination of information on inputs, production processes,

and the environmental consequences of final products. Some information approaches

rely purely on voluntary reporting, while others have mandatory reporting.

The environmental information embodied in these approaches has economic value to

consumers, individuals, scientists, academics, and state and local government

officials even in the absence of any changes in emissions by firms. For example,

information on the use of hazardous materials may reduce the uncertainty faced by

local officials in planning for emergency preparedness. Regulators can use the

information to monitor the progress of voluntary efforts to control pollution.

Consumers may gain utility from assurances that products are manufactured in ways

approved by the federal government. Individuals can make more informed decisions

about where to live and work. And scientists and academics gain new sources of data

that can be used in research on health, business management, and the environment.

Information disclosure rules may have ancillary economic effects that stem from the

incentives they create for change in producer or consumer behavior. For example,

information disclosure approaches are an increasingly popular method of

encouraging companies to voluntarily prevent pollution. In contrast to end-of-pipe

traditional approaches or technological mandates, pollution prevention can be

achieved through a much wider array of actions: changes in input use, technologies,

processes, management, and other parameters. Because the full range of these

parameters and possibilities cannot be well-known to regulatory agencies,

governments try to stimulate firms to engage in pollution prevention by mobilizing

workers, financial markets, and the community through the provision of information.

When a rule is promulgated, ancillary changes are hard to specify. The economic

analyses of information rules often ignore these changes and consider the benefits

and costs of environmental information as a good itself, one with independent

production and consumption considerations. This chapter complements the partial

equilibrium analysis of information embodied in many economic analyses by

considering the incentives created by disclosure and the subsequent use of that

information.

This chapter reviews many of the United States’ unique experiences with information

disclosure methods. Available evidence, some of it conjectural in nature, suggests

that at least two factors are important in evaluating the incentive structure of

information disclosure rules. First, the information should be accurate and credible.

Perhaps the best information would be based on measured data and standardized

criteria and provided or verified by an independent source, but few programs meet

these ideals. Second, the information must be made available to the right people, at

the right time, and in a format accessible to participants in an economic transaction.

Unfortunately, not all information policies take note of these considerations.
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154 January

9.1 Background

The earliest attempts at pollution control used approaches such as emissions standards, mandated

reductions in emissions, or requirements that sources adopt particular control measures or

technologies. After the most obvious and easily remedied pollution problems had been

addressed, it became evident that the traditional regulatory approaches to pollution control would

be excessively costly, incapable of achieving all environmental objectives, or both.

A second approach to pollution control responded to these limitations of traditional regulatory

approaches by harnessing the forces of the market. These mechanisms included tradable permits,

emission fees, deposit-refund systems, subsidies, and performance bonds. In most cases, they

have complemented traditional regulatory remedies, but in some instances they are developed as

stand-alone measures.

Although market-based approaches have helped improve the cost effectiveness of environmental

regulation, the problems of pollution regulation have not been fully solved. Environmental

regulators are burdened by the vast number of harmful substances that need to be controlled if

environmental goals are to be achieved. Furthermore, they find that market-based mechanisms

have limits in terms of the sheer numbers of substances that can be controlled and the modes of

behavior that can be encouraged.

In response to these difficulties, pollution control policy evolved to provide information as a

mechanism for making employees, shareholders, and customers of businesses active participants

in the regulatory process. Information disclosure strategies are timely for at least three reasons.

First, environmental regulators need more regulatory tools (as noted in the previous paragraph).

Second, the means by which information is collected, processed, and disseminated are rapidly

falling in cost. Third, with rising incomes and better education, the demand for environmental

information by workers, shareholders, and consumers is increasing.

In the product market, consumers may react to environmental labels by buying

“environmentally-friendly” products, even when they cost more. Some export markets for

products may be effectively closed to firms until they achieve ISO (International Organization

for Standardization) certification. Purchasers of intermediate products increasingly are concerned

about a host of issues regarding their manufacture, such the raw materials used (e.g., virgin

timber, recycled materials) and the environmental performance of the supplier. In the labor

market, firms with better environmental records may be viewed as more attractive places to

work, making it possible for them to hire more talented or productive employees. In the capital

market, shareholders and lending institutions increasingly are concerned about the prospect of

future environmental liability for pollution harms caused by a firm. Hence, firms with better

environmental records may be rewarded with better access to, and a lower cost of, capital.

Information approaches have been used in environmental protection on both the state and federal

levels. This chapter begins with a discussion of the National Environmental Policy Act, the first

disclosure-type program. Following is a review of the Federal Emergency Planning and

Community Right-to-Know Act (EPCRA) and two similar state programs. The chapter then

discusses California’s Proposition 65 and reporting requirements for the release of air toxics,

reporting requirements for environmental impact assessments, product labeling, environmental

performance awards, the Securities and Exchange Commission’s (SEC) environmental reporting

requirements, and disclosure requirements for radon and lead paint. Other voluntary programs in
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2001 155

which industry is encouraged to reduce pollution below permitted amounts are described in

Chapter 10.

9.2 National Environmental Policy Act (NEPA)

The 1969 National Environmental Policy Act of 1969 (NEPA) is the basic environmental law of

the United States.206 The Act requires that environmental impact statements (EIS) be prepared

for federal activities that significantly affect the environment. An EIS provides for a full, fair,

public discussion of environmental impacts and an examination of reasonable alternatives that

will minimize adverse impacts. Implementing regulations issued by the Council on

Environmental Quality (CEQ) establish procedures to ensure that high-quality environmental

information is available to public officials and citizens before decisions are made and actions are

taken.207 In numerous instances, the mere fact that potential adverse environmental impacts were

anticipated and would have to be disclosed motivated project designers to alter their plans to

reduce impacts.

9.3 Emergency Planning and Community Right-to-Know Act (EPCRA)

Enacted in 1986 as Title III of the Superfund Amendments and Reauthorization Act, the

Emergency Planning and Community Right-To-Know Act (EPCRA) requires emergency

planning and disclosure of information on the releases and transfers of hazardous chemicals to

disposal facilities. Section 313 of EPCRA requires certain businesses to report each year on the

amounts of toxic chemicals that their facilities release into the environment and transfer to

treatment, storage, and disposal facilities. As a result of the 1990 Pollution Prevention Act,

reporting requirements were expanded beginning in 1991 to include source reduction and

recycling information. Data for a given year must be submitted by July 1 of the following year.

EPA then compiles the information and makes it available to the public as the Toxics Release

Inventory (TRI).

Through 1998, TRI reporting was required of all manufacturing facilities that met the three

following criteria: (1)they had at least 10 employees;(2) they operated in Standard Industrial

Classification (SIC) codes 20 through 39; and (3) they manufactured, processed, or otherwise

used one or more of the chemicals listed in the TRI in quantities that exceeded certain threshold

amounts. Threshold amounts are 25,000 pounds per year for manufacturing and processing, and

10,000 pounds per year for other uses of any listed chemical during the calendar year. In 1998,

seven additional industries were added. (See text box entitled “Industrial Sectors Subject to TRI

Reporting in 1998.”) Federal facilities were required to submit their first TRI reports by July 1,

1995, for the 1994 calendar year. Data for 1998 were available in May 2000.208

Individuals and organizations can petition EPA to add or remove chemicals from the list. The

number of listed chemicals was originally set at 320, but it has since increased. (A few chemicals

have also been deleted from the list.) A significant expansion took place in 1994. That year, EPA

added 286 new chemicals and chemical categories to the list, bringing the number to 654. These

additions were in effect for the 1995 calendar year. In October 1999, EPA lowered the reporting

thresholds for many persistent bioaccumulative toxic chemicals, and added several other such

chemicals to the list.

Facilities that have a total annual reportable amount209 of 500 pounds or less of a TRI chemical

and that manufacture, process, or use 1 million pounds or less of a TRI chemical can now submit
The U. S. Experience with Economic Incentives for Protecting the Environment

156 January

a shorter, annual certification statement in lieu of the longer Form R. These streamlined

requirements became effective for the 1995 calendar year. The rule attempts to strike a

reasonable balance between maintaining the community’s right-to-know about toxic chemical

releases and the economic costs to EPA and industry of collecting the information. EPA

estimated that simplifying the reporting process for some facilities would result in annual cost

savings of about $18.4 million for industry and $700,000 for federal, state, and local

governments.210

EPA makes TRI information available to industry, environmental groups, and the general public,

so they can know about the toxic releases and other waste management activities of facilities.

This information is available via several media, including printed reports, CD-ROM, and the

Internet. The emergency-planning component of EPCRA calls for the creation of state and local

emergency response bodies that will develop emergency response plans.

This part of EPCRA also requires facilities to perform the following three tasks.

1. Facilities must inform these emergency-response bodies that certain hazardous substances are

located on their premises.

2. They must give immediate notice of accidental releases to emergency response bodies.

3. They must develop response plans that can be implemented in the event of the accidental

releases of hazardous substances.

Information provided by facilities is available to the public.

Governments use TRI data to establish baselines, measure progress, set priorities, and identify

targets of special concern. The general public uses TRI information to identify potential

problems in their local environment and to take part in national and local debates concerning

regulations that could affect their health and welfare. Corporations and investors use TRI data to

gauge the performance of a corporation and individual facilities relative to their peers.

9.3.1 Trends in Toxics Release Inventory (TRI) Data

As shown in Figure 9-1, reported TRI releases have decreased 45.3% in the 10 years since 1988.

Although the data suggest significant reductions in toxic releases, there are several reasons why

these reported decreases may not be equal to actual decreases in releases. EPA points out that

TRI increases and decreases can be “real

changes” or “paper changes.” The latter

result from errors, changes in facilities’

estimation or calculation techniques,

changes in reporting guidance and

facilities’ interpretation of that guidance,

and facilities’ use of exemptions. In

general, companies determine their TRI

release amounts through an estimation

process rather than through monitoring.

EPA guidance has not been issued for all

aspects of TRI reporting, and companies

can sometimes lower reported releases

by using different estimation techniques.

Figure 9-1. Reported TRI Releases

0

0.5

1

1.5

2

2.5

3

3.5

4

1988 1995 1996 1997 1998

Year

Billions of lbs.

Source: www.epa.gov/tri/tri98
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2001 157

EPA indicates that estimation errors are more likely to occur for releases such as fugitive air

emissions and complex wastewater effluent, releases for which little monitoring data are

available. However, EPA audits have found companies’ estimation techniques to be reasonably

accurate. For example, EPA’s review of TRI data quality for 1996 surveyed 60 industrial

facilities: 27 in the primary metal industry, 14 in the electrical equipment industry, and 19 in the

transportation equipment industry. The survey found that facilities were able to calculate

thresholds for reporting correctly 95% of the time. For chemicals that exceeded the threshold,

these facilities correctly identified the threshold 88% of the time. Reports by facilities concerning

their releases agreed closely with an auditor’s assessment in the transportation equipment

industry. However, these reports differed significantly in the primary metals and electrical

equipment industries. The differences were attributed to confusion over the definitions of the

terms “recycling” and “reuse.”211

Another potential problem is that most chemicals have not been subject to TRI requirements. A

1994 GAO study stated that over 70,000 chemicals are used commercially in the United States,

of which only 320 had been included in the TRI. “Consequently,” the study added, “the

companies may maintain or even increase their usage of toxic chemicals while concurrently

reducing the chemicals that are reported to EPA.”212 The original list focused on the most

important toxics, and, as noted in a previous paragraph, EPA included another 286 chemicals in

TRI requirements effective 1995. However, some highly toxic chemicals still have not been

added to the list because they are generated in amounts that are too small to meet criteria for

inclusion.

At present, facilities with fewer than 10 full-time equivalents employees in listed SIC codes are

excluded from TRI reporting. Furthermore, all sources of releases outside that code range are

also excluded. It is not known what percentage of releases is currently exempt from reporting.

Releases are not weighted according to the type of disposal method, the magnitude of potential

population exposure to these toxic substances or the potential effects of these releases on human

health and the environment. Moreover, the TRI data do not include information on the quantity

of toxic chemicals in products leaving the facility. Such products themselves can eventually be

released into the environment.

Although a reduction in releases is, for the most part, desirable, another important question is

how the reduction is achieved. Methods include controlled disposal, recycling, conversion to

energy, and source reduction. The 1990 Pollution Prevention Act set source reduction as the

preferred method of reducing releases, but transfer data show no clear trend toward using this

method. Since recycling and conversion to energy were not reported as transfers until 1991 (as

required under the 1990 Pollution Prevention Act), 1988 total transfers are difficult to compare

with total transfers in the subsequent period.

The assessment of achievements in source reduction is complicated by the lack of TRI data on

the quantities of waste decreased by source reduction measures. Only the practices used to

reduce waste not their resultsare included in the TRI. Changes in waste generation that are

reported in the TRI could be due to factors other than source reduction, including estimation

errors or changes in the production levels of specific products.

The trend of decreases in releases and transfers is more pronounced under the voluntary 33/50

program. (This program is discussed further in Chapter 10.) Total releases and transfers under
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158 January

this voluntary program have decreased every year from 1988 to 1994, with a total reduction of

51% during that period.

9.3.2 Incentive Effect of the Toxics Release Inventory

The incentive effect of the TRI program on polluters cannot be assessed solely on the basis of

reported decreases in releases. A number of factors, including traditional regulations and other

economic incentive mechanisms discussed in this report, have affected releases. Pollution

prevention is also influenced by a number of factors unrelated to the TRI program.

Nonetheless, the TRI program is widely believed to have a significant impact on polluters.213

EPA has called it “one of the most powerful tools in this country for environmental protection”

and “one of the most successful policy instruments ever created for improving environmental

performance.”214 Vice President Gore called the annual TRI publication “the single most

effective common-sense tool” to promote environmental protection.215

Shortly after the first TRI data were released in 1989, citizens groups placed a full-page

advertisement in the New York Times that listed “the corporate top ten” land, water, and air

polluters. Several of these polluters subsequently promised EPA that they would improve their

environmental performance, effectively beginning the 33/50 voluntary releases reduction

program. 216 Monsanto, for example, promised 90% reductions of 1987 air emission releases by

1992. AT&T said it would halt all TRI air emissions by 2000. Dow announced it planned to

reduce overall emissions by 50% by 1995, and Dupont promised to cut air emissions by 60% by

1993 and cancer-causing components by 90% by the year 2000. In Minnesota, public outcry over

revelations that an electronic circuits manufacturer was emitting methylene chloride led the

facility to promise 90% reductions in emissions by 1993. After 1987 TRI data found an IBM

facility in California to be the state’s largest emitter of chlorofluorocarbons (CFCs), a public

interest group organized a campaign. IBM subsequently promised to end the use of CFCs at the

plant by 1993.217 TRI data also appear to influence investors. Some of the investor interest may

be attributed not so much to socially responsible investing but rather to the belief that companies

with relatively high emissions might face mounting environmental costs in the future.

Hamilton (1995) found that the 1988 TRI performance of companies (as reported in June 1989)

was of interest to journalists and investors. The higher a firm’s TRI pollution figures, the study

found, the more likely journalists were to write about the firm’s toxic releases, especially those

firms that were less associated with pollution. Companies that reported TRI releases underperformed the stock market for five days after the data were released. The more chemicals for

which a company submitted data, the greater was the extent of under-performance by the

company. The under-performance was less significant, however, for companies previously

associated with pollution.

The Investor Responsibility Research Center has analyzed TRI data to provide clients with

environmental profiles of companies. The Clean Yield Investment Portfolio Management Group

compares companies’ TRI data with industry-wide averages of releases per unit of sales. Fortune

magazine has used TRI data in its “green index” of American manufacturers, assigning scores of

0 to 10 in 20 performance categories, including toxic emissions per unit of sales.

The regulated community uses TRI data as well. Wolf (1986) examined the effects of the

program on regulatory agencies, legislatures, public interest groups, and affected firms. He found

that major corporations issue environmental progress reports to counter the publicity generated
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by their TRI reports. Often the progress reports specify baselines and milestones, so others can

evaluate their progress. Pine (1997) suggested that TRI data are helping companies develop

waste reduction strategies. Konar and Cohen (1997) studied the response of firms to large drops

in their stock prices following the release of TRI data. The authors concluded that firms

experiencing large, adverse impacts on the price of their stock reduced their TRI emissions more

in subsequent reporting periods than the average firm in their industry. This action suggests that

TRI reports do affect corporate behavior. EPA’s economic analysis of the proposed rule to

modify reporting requirements on persistent bioaccumulative toxic chemicals contains additional

information on the beneficial effects of the TRI program.218

Although EPCRA’s emergency-planning element has received less attention as an incentive

mechanism than the TRI, EPCRA also could have a significant effect on polluters’ behavior.

Firms might reduce the amounts of hazardous substances on their premises if they are forced to

disclose these amounts to local emergency response bodies and (indirectly) to the public. They

might also manage hazardous substances more safely if they are required to plan for, and give

immediate notice of, accidental releases.

9.4 State Chemical Reporting Programs

At least two states have toxic release reporting programs similar to the federal TRI program, but

they have different reporting requirements. The requirements may cover additional chemicals,

industries, or reporting elements; use of toxic substances and pollution prevention plans. The

General Accounting Office (GAO) (Q: add to acronyms list) (1997b) conducted a survey of

efforts to pass similar laws in other states, finding that initiatives had failed in California,

Colorado, Florida, Hawaii, Maryland, and Michigan.

Programs in Massachusetts and New Jersey, for example, differ from their federal counterpart in

that they require companies to use materials balance accounting to plan pollution prevention

actions, to report their goals and progress on pollution prevention, and to examine whether

material inputs to production are accounted for fully by the total of all outputs and pollution

releases.

One advantage of requirements such as those in Massachusetts and New Jersey is that they offer

more information on toxics use and wastes that could be of interest to companies, regulators, and

the general public than do the TRI requirements. One disadvantage of these requirements appears

to be the potential administrative burden they impose on polluters and regulators. If the state

attempts to lessen its program costs by taxing the polluters, it adds to the polluters’ burden. EPA

has studied these programs in the context of its Phase III expansion, so the Agency can better

understand how the federal EPCRA might be improved.

9.4.1 Massachusetts Toxics Use Reduction Act (TURA)

Enacted in 1989, the Massachusetts TURA requires the users of large quantities of toxic

materials, including those in several SIC codes not covered by the federal EPCRA, to (1) submit

an annual Toxic Use Report to the State Department of Environmental Protection, and (2)

develop plans for using toxic chemicals and reducing waste. Facilities that are subject to these

two requirements must report annually on their inputs and outputs of materials and on their waste

generation and management methods.
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Additional data must be reported every two years on actual and projected changes in chemical

use and wastes compared to both planned and base-year amounts. Summaries of the chemical

use and waste reduction plans also must be submitted biennially, but the detailed plans remain at

the facilities to ensure confidentiality. These plans must be endorsed by state-certified Toxics

Use Reduction Planners.

TURA also created two agencies to provide technical assistance to users of toxic substances and

to conduct training and research on TURA and on techniques that reduce the use of toxic

substances. The operations of these agencies and other program costs are covered by toxics use

fees that are based on the number of employees at a facility and the number of chemicals it uses.

These fees are limited to $31,450 per facility annually. They are not closely linked to the

quantities or toxicities of the chemicals used. These fees generate roughly $5 million a year in

revenues.

TURA also contains provisions for citizen involvement. Citizens may assist in monitoring the

use of toxic substances, and they can access the TURA information on toxics use that is reported

to Massachusetts’ Department of Environmental Protection. The Department is required to act on

petitions to inspect a facility’s plans and data if the petitions are filed by 10 or more residents

living within 10 miles of the facility.

The information collected through TURA has also proven helpful to the subject facilities. By

making facilities aware of the quantities of toxics used during production, released to the

environment, and transformed into products, the reporting requirements allow them to identify

improvements in their efficiency and cost-cutting opportunities relative to chemical use.

TURA set a waste reduction goal of 50% over 10 years, using 1987 as a baseline. Reporting

began in 1991 for 1990 data. Between 1990 and 1997, toxics material use fell by 201 million

pounds, toxic byproducts fell by 43.8 million pounds, and the on-site release of toxic materials

fell by 16.2 million pounds. In 1999, the TURA program received an award for “Innovations in

American Government.”219

9.4.2 New Jersey Reporting Requirements

New Jersey’s Worker and Community Right-to-Know Act was enacted in 1984, before the

federal EPCRA. Since 1987, the state has collected data on inputs and outputs of materials and

on the amounts of waste reduced through source reduction activities.220

TURA FORMULA

For every production unit, facilities must also report on their use of chemicals and on use reduction techniques (within SIC range codes

to protect confidential business information). Facilities must also indicate a Byproduct Reduction Index (BRI) and an Emission

Reduction Index (ERI). (“Byproduct” can be considered “waste” in this context, although a byproduct may be reusable.) These two

indices are determined in the following manner:

BRI = (A−B) x 100 and ERI = (C−D) x 100, where

A = Byproduct quantity in base year divided by the number of units of product produced in base year.

B = Byproduct quantity in reporting year divided by the number of units of product produced in reporting year.

C = Emissions quantity in base year divided by the number of units of product produced in base year.

D = Emissions quantity in reporting year divided by the number of units of product produced in reporting year.

Source : http://www.turi.org/turadata/WhatIsTURA/
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The 1991 New Jersey Pollution Prevention Act required facilities to undertake pollution

prevention planning. Like the Massachusetts law discussed in previous paragraphs, New Jersey

set a goal of 50% reduction in waste output by 1997, with 1987 as a baseline. Plan Summaries

must be submitted to the state’s Department of Environmental Protection every 5 years.

Like Massachusetts, New Jersey requires the use of performance indices. Instead of focusing on

waste generation and emissions, however, New Jersey has indices for waste generation and use

of toxics. New Jersey requires that facilities making TRI reports provide additional information

beyond the federal requirements. The additional information includes the quantities of each

chemical brought on-site, produced on-site, used in the manufacturing process, and sent off-site

in products or as waste. Such data, along with the federally required data on releases and

transfers allows regulators to construct a materials balance for each chemical.

The New Jersey Department of Environmental Protection has conducted surveys showing that its

reporting requirements have been beneficial to companies because the data helps them assess

their options to minimize waste. Department officials also claim that the data allow companies to

better manage their activities, including the implementation of the facility-wide permitting

scheme described in Chapter 6.

9.5 Drinking Water Consumer Confidence Report

In an August 19, 1998, notice in the Federal Register, EPA required the suppliers of drinking

water to provide households with information on the quality of their drinking water, beginning in

1999.221 The reports must contain the following information:

• the lake, river, aquifer, or other source of the water;

• a brief summary of the susceptibility of the local drinking water source to contamination;

• how citizens can obtain a copy of the complete water system assessment from the

supplier;

• the level (or range of levels) of any contaminants as well as EPA’s health-based standards

for the contaminants;

• the likely source of any contaminants;

• the potential health effects of any contaminants;

• the water system’s compliance with other drinking water-related rules;

• an educational statement for vulnerable populations about how to avoid

Cryptosporidium;

• educational information on nitrate, arsenic, or lead in areas where they are detected in

quantities e that are more than 50% higher than EPA’s standard; and

• the telephone numbers for additional sources of information.

EPA encourages water supply systems to post water-quality information online, and the Agency

maintains links to this information on the Internet.222
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9.6 EPA Reporting of Environmental Information

Several recent initiatives by EPA focus on two activities: (1) the aggregation or processing of

environmental data that are submitted under existing programs; and (2) the reporting of this data

in a form that is designed to be more useful to consumers, homeowners, and firms. This section

describes three such initiatives.

9.6.1 Automobile Pollution Rankings

In 2000, the EPA launched a web site that uses emission certification data submitted by

manufacturers to rank automobiles and light-duty trucks on the basis of their tailpipe emissions

of hydrocarbons and NOx.

223 Rather than report actual emission certification data, the site ranks

emissions on a scale from 1 (worst) to 10 (best). The information can be used by consumers to

make more informed choices. It also may indirectly pressure manufacturers to improve the

emissions performance of their vehicles.

9.6.2 Envirofacts

EPA's Envirofacts database provides users with a single point of access to select EPA

environmental data sets, as well as a mapping function that finds the geographic location for data

of interest.224 Envirofacts allows the user to retrieve environmental information on air emissions

from sources and information on

• individual chemicals,

• facilities,

• hazardous waste generators and transporters,

• risk management plans for facilities,

• EPA’s Superfund sites,

• toxic releases,

• water discharge permits,

• suppliers of drinking water, and

• microbes and disinfectants in drinking water.

9.6.3 Sector Facility Indexing (SFI)

Sector facility indexing is a pilot effort by EPA to integrate environmental data in each of five

industrial sectors: petroleum refining, iron and steel, primary non-ferrous metals, pulp and paper,

and automobile manufacture.225 SFI combines data from TRI and EPA's national enforcement

databases and provides information on releases, the number of inspections, compliance history,

and enforcement actions. Users can review data on releases from, and the compliance history of,

individual facilities and then compare these data with other facilities in the same industry. EPA

recently announced that the program would be expanded to include certain federal facilities.226
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9.7 Proposition 65

California’s Safe Drinking Water and Toxic Enforcement Act, commonly referred to as

“Proposition 65,” was adopted by voter referendum in 1986. It requires polluters to issue

warnings if they expose people to significant levels of carcinogens or reproductive toxicants that

are included in a list maintained by the Office of Health Hazard Assessment. 227 As of August

2000, the list contained 461 carcinogens, 241 reproductive toxicants, 35 female reproductive

toxicants, and 46 male reproductive toxicants.228

If a substance is listed as a carcinogen, businesses may not discharge it into drinking water

unless the quantities discharged pose “no significant risk.” State regulation sets the levels of

“significant risk” for most of the most toxic and high volume chemicals on the list, but they can

be superseded by more stringent exposure levels that are mandated by other environmental laws.

The defendant bears the burden of proof that the exposure is below the level of significant risk.

Drinking water utilities, government agencies, and organizations employing fewer than 10

people are exempt from the rule.

Citizens have the right to initiate lawsuits under Proposition 65 if authorities do not respond to

their requests to pursue potential violators. Under the “bounty hunter provision,” the person who

brought the suit can receive 25% of any fines collected. Fines can be as high as $2,500 a day.

Data obtained from the State Attorney General’s office indicate that several environmental

groupsincluding the Environmental Defense Fund and As You Sowand individuals have

been compensated for initiating lawsuits under Proposition 65.229

In some cases, businesses in California have avoided issuing clear warnings. They have been

sued for providing warnings deemed too vague or inconspicuous. For example, the food, drug,

and cosmetics industries established a toll-free product information number in lieu of placing

hazard labels on their products. In another case, warnings for air emissions of ethylene oxide

were published as advertisements in the classified section of a local newspaper. In both of these

cases, the warnings were found by the courts to be insufficient.230

Process modifications, chemical substitution, and the use of pollution control devices have all

been attributed to Proposition 65. Some products have been reformulated to avoid negative

labeling. For example, solvents were removed from correction fluids and lead from foil and other

products. The lead content of tableware was also reduced. However, products such as tobacco

and alcohol have to bear warning labels. Businesses appear much more likely to take measures to

avoid issuing warnings for products that consumers in general believe are safe, such as

tableware, and for products that have unlabeled substitutes than they are for products that

consumers know can be dangerous, such as spray paint.

At least one study found that consumers were indifferent to some warnings because they had

become so prevalent. “Overuse of labeling may therefore result in a reduction of

effectiveness.”231 Another study suggested that firms might collude to label in excess, thereby

minimizing the impact of these warning labels.232

Proposition 65 gives polluters incentives not only to identify ways of reducing or eliminating

toxic discharges but also to study the effects of toxics to determine safe exposure levels.

Anecdotal evidence suggests that businesses devoted significant resources to assessing the risks

of exposure to toxics after this law had been passed.233 Business groups had asserted that

compliance with the law would be very costly. However, they failed to provide evidence that
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significant costs actually were incurred when they were given the opportunity to do so by the

State of California during a retrospective analysis of the law.

9.8 Hot Spots Act

Adopted in 1987, California’s Air Toxics Hot Spots Information and Assessment Act (AB 2588)

requires stationary sources to report releases of certain substances into the air. According to the

California Air Resources Board (CARB), the goals of the Hot Spots Act are “to collect emission

data, to identify facilities having localized impacts, to ascertain health risks, and to notify nearby

residents of significant risks.”234 The Act uses at least two potential incentive mechanisms to

reduce toxic air emissions: public notification requirements and unit-based fees. The latter

mechanism, which is also intended to cover all of the administrative costs associated with the

Act, is discussed in Chapter 4. The former mechanism, public notification requirements, is

discussed here.

Facilities are required to submit an air toxics emission inventory plan and a subsequent inventory

to their respective air pollution control district. Certain high-priority facilities must also submit a

health risk assessment. If air quality managers in the district determine that a facility’s emissions

pose a potentially significant health risk, the facility operator must notify all persons who have

been exposed.

The Hot Spots Act originally relied on the information requirement and fees to discourage risky

toxic emissions. In 1992, however, it was amended to require facilities to reduce emissions

below the significant risk level within 5 years or a period not to exceed 10 years, as determined

by the district. This amendment introduced a considerable element of traditional regulatory

policy to what previously had been an incentive-based instrument. However, emissions data and

health risk assessments remain accessible to the public, and they could give polluters incentives

to reduce their emissions more substantially and quickly than they would if this data were not in

the public domain.

According to CARB, the Hot Spots inventory requirements have increased facilities’ awareness

of their toxic emissions, leading to reductions in emissions. Surveys have revealed voluntary

reductions of over 1.9 million pounds per year of air toxics from 21 facilities. Potentially reduced

costs, concern for worker health, improved community relations, and anticipation of future

regulations are some of the motives for these reductions.

9.9 Labeling Schemes

Labeling products according to their effects on the environment is another type of information

approach to environmental management. Consumers can use the information provided by such

labels in making purchasing decisions. If consumers, investors, and others prefer companies and

products they believe are environmentally friendly, businesses have an incentive to improve their

environmental performance to receive a favorable label or to avoid a negative one.

Table 9-1 shows the classification scheme for environmental labeling programs that were

proposed by a 1994 EPA study.235 Programs can be either voluntary or mandatory. Moreover, the

information provided by labeling may be characterized in general as negative, positive, or

neutral.
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Table 9-1. Classification of Environmental Labeling Schemes

PROGRAM TYPE POSITIVE NEUTRAL NEGATIVE VOLUNTARY MANDATORY

Seal of Approval X X

Single attribute X X

Report card X X

Information disclosure X X

Hazard warnings X X

Source: EPA (1994a), p. 9.

Seals of approval are given to products that have been deemed less harmful to the environment,

and single attribute programs certify that a product has a certain positive environmental attribute.

Report cards and information disclosure schemes inform customers of the various impacts of

products on the environment. Hazard labels warn customers of the harmful effects of a particular

product.

Experience with labeling schemes indicates that they are more likely to influence behavior if

they are accompanied by promotional activities that target retailers and consumers. In many

cases, the label itself is only one element of a larger effort to promote the use of environmentally

friendly products. As a result, it is often difficult to isolate the incentive effect of a label from

that of related promotional activities.236

Although the United States does not have a national, government-initiated environmental

labeling program like many other industrialized countries, it does have a few labeling programs

that have been created by the public- and private-sectors. The Consumer Labeling Initiative

(CLI), a pilot program of the U.S. EPA, began in March 1996. Its goal is to foster pollution

prevention, inform consumer choice, and encourage the safe use of household and consumer

products.237 In the pilot phases, the CLI is exploring issues such as how consumers react to

different types of labels and the best ways to present information. This program could evolve

into a national labeling program.

9.9.1 OSHA Warning Labels

The Occupational Safety and Health Administration (OSHA) promulgated hazard

communication standards (29 CFR 1910.1200) in 1983 to assure that the hazards of chemicals in

the workplace are evaluated and that hazard data subsequently are transmitted to employees and

employers.238 These standards require Material Safety Data Sheets (MSDS), container labeling,

and employee training, as appropriate. Under a Presidential Directive, the Hazard

Communication Workgroup began an evaluation of the program in 1995 and presented its report

in September 1996.239 The workgroup report determined that the standard was good and should

not be reopened for comment. The workgroup also noted that MSDS tended to be overly lengthy

and could be simplified to better communicate necessary information to workers and employers.

9.9.2 FTC Guidelines for Environmental Marketing Claims

The Federal Trade Commission’s (FTC) Guidelines for Environmental Marketing Claims or

“Green Guides” were issued in 1992 and, at the time of this writing, were under review for

possible revisions. These guidelines do not constitute a labeling system as such, but they are

designed to have an effect on labeling. They are intended to prevent false or misleading use of

advertising claims such as “environmentally friendly,” “degradable,” and “recyclable.”
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Confusion over the meaning of such terms has affected not only consumers but also companies,

who were concerned about lawsuits over their environmental claims.

The guidelines outline four general principles for environmental claims: (1) qualifications and

disclosures should be sufficiently clear and conspicuous to prevent deception; (2) claims should

make clear whether they apply to the product, packaging, or just a component of either the

product or packaging; (3) claims should not overstate environmental benefits; and (4)

comparative claims should be presented in such a way that the basis for comparison is clear. The

guidelines also address claims about environmental friendliness, degradability, compostability,

recyclability, recycled content, source reduction, refillability, and ozone friendliness.240

9.9.3 Green Seal and Other Seals of Approval

Founded in 1989, Green Seal is the nonprofit organization that awards the Green Seal of

Approval to products that it finds less harmful to the environment.241 The organization develops

a set of standards for each product category it studies. Categories are chosen according to the

significance of their associated environmental impact and their range of products. Products

within a category are then studied to determine their impacts on the environment in their various

stages of production, use, and disposal. After public review and comment, Green Seal adopts a

standard.

Standard criteria vary across categories but may include the reduction of toxic chemical

pollution, improved energy efficiency, the protection of water resources, the minimization of

impacts on fish and wildlife and their habitats, the efficient use of natural resources, the

protection of the ozone layer, and the prevention of global warming. Products are not subjected

to a complete life-cycle analysis. Instead, products are judged according to those aspects of their

life cycle that have the most significant environmental impact. Standards are reviewed at least

once every 3 years.

Manufacturers pay product evaluation fees to apply for the Green Seal mark, and accepted

products are also subject to annual monitoring fees. The fees vary according to the product

category and size and the number of manufacturing facilities. The Green Seal mark for approved

products appears with an explanation of the basis for certification.

The organization has published environmental standards or criteria for about 35 types of

products. Its list of certified products contains central air conditioning systems (1 brand);

architectural coatings (2 brands); cleaning products (1 brand); compact fluorescent lamps (5

brands); recycled paper (5 brands); recycled newsprint (1 brand); re-refined engine oil (3

brands); reusable utility bags (3 models); showerheads (four models); toilets (2 brands); watering

hoses (several models); one manufacturer’s line of windows and doors; and one brand each of

unbleached coffee filters, baking cups, and parchment. Readers interested in the specifications

for these and other products may visit the Green Seal web page: www.greenseal.org/stanlist.htm.

Besides labeling, Green Seal helps market environmentally friendly products in several ways. A

list of certified products is included in a catalog with product information and the addresses and

the telephone numbers of product vendors. Documents entitled Choose Green Reports are

available on topics such as “Environmentally Preferable Printing” and energy-efficient lighting,

computers, and other office equipment. Organizations that agree to purchase environmentally

friendly products, reduce waste, and increase recycling are eligible for the Green Seal

Environmental Partners mark. This mark can be placed on reports, letterhead, and store signs.
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In a Green Seal survey, 4 out of 5 consumers said that they would be more likely to purchase a

Green Seal-certified product than other products of equal quality and price.242 However, the

incentive effects of Green Seal’s activities do not appear to have been studied in any detail.

Some retailers have adopted labeling schemes for products they find environmentally friendly. In

1989, for example, Wal-Mart created a program under which shelves were labeled to indicate

that certain products were environmentally friendly. Wal-Mart ended this program in 1992. Store

officials had difficulty in determining the criteria for environmental friendliness and in assessing

manufacturers’ environmental claims.

Wal-Mart’s experience illustrates one of the main problems encountered by environmental sealof-approval schemes: the lack of agreed-upon criteria for assessing environmental friendliness.

While seals of approval may be relatively easy for consumers to understand, they risk not only

lacking agreed-upon standards but also oversimplifying complex environmental issues. Menell

(1995) cites a number of cases in which the assessments of environmental friendliness that are

necessary for labeling are difficult. For example, a study of the environmental impacts of

disposable cups found that wax-coated paperboard was preferable to polystyrene in terms of

reduced volumes of solid waste generation, but inferior in the areas of energy consumption, air

emissions, water pollution, and weight of solid waste generation. Disposable diapers generate

more solid waste than cloth diapers, but they also use less water and result in less water

pollution. Another study cited by Menell found that the environmental impacts of washing

machines depend less on the model of the machine than on how it is used.

9.9.4 Single-Attribute Labels

The problems of lack of criteria and oversimplification are likely to be less serious for labeling

programs that are based on a single product attribute. EPA’s office equipment label, Energy Star,

is reserved for computers, printers, photocopiers, and typewriters that are relatively energyefficient. This label is part of a voluntary initiative designed to promote the purchase and use of

energy-efficient office equipment. (This program is described in Chapter 10.)

The Flipper Seal of Approval was created in 1992 and licensed by Earthtrust, a non-profit

organization based in Hawaii. It is awarded to companies that harvest tuna in a manner that

minimizes the number of dolphins killed. The seal has been awarded to tuna companies in the

United States and abroad.

From 1986 to 1991, the Bonneville Power Administration, which supplies electric power in

Oregon and Washington, managed a Blue Ribbon Award Campaign that promoted the use of

energy-efficient refrigerators and freezers. Under this program, refrigerators and freezers in the

top 15% of their size and function category were awarded blue magnetic ribbons.243 A retailer’s

survey conducted early in the program estimated that about 22% of its customers had been

“influenced” in their purchasing decisions by the presence or absence of these ribbons.244

Scientific Certification Systems (SCS), a for-profit business, has two single-attribute seal-ofapproval programs. The first program, the SCS Forest Conservation Program, uses a 100-point

index to evaluate the management of forest tracts by timber operations. A separate score is given

for each of the following categories: the sustainability of timber resources, forest ecosystem

maintenance, and the socio-economic benefits to the surrounding community. Scores over 60 are

required in each category before timber companies can be awarded the “Well-Managed Forest”

label. Operations scoring in the top 10% are further labeled as “State-of-the-Art.”245 In the
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second program, SCS can use chain-of-custody certification to verify that wood products sold to

consumers come from well-managed forests. About 10 forestry operations in South, Central, and

North America have been scored by SCS.

SCS has also certified more than 500 environmental claims by manufacturers concerning

recycled content, recycling rates, energy efficiency, water efficiency, biodegradability, and the

lack of smog-producing ingredients. Some claims concern materials, whereas others concern

final products and packages. Certified products are allowed to bear an authorized certification

emblem.

According to SCS, anecdotal evidence indicates that its labels are valued by businesses and

individuals, with consumers willing to pay a premium for products identified as environmentally

friendly. Glidden Company, for example, found that a label designating its paints as free of

volatile organic compounds (VOCs) is valued by institutional customers such as hospitals.

9.9.5 Report Cards and Information Disclosure

SCS also issues environmental “report cards” that rate products according to various criteria.

(The company refers to these report cards as “eco-profiles.”) These profiles are based on a

cradle-to-grave assessment of the environmental burdens associated with the raw material

extraction, manufacture, transportation, use, and disposal of a product. These environmental

burdens include resource depletion, energy use, air and water emissions, and solid wastes. Bar

graphs for each of approximately 20 types of environmental impacts are included on the label.

Eco-profiles have been done for Holiday Fair (handbags, accessories, and travel ware); North

American Plastics (plastic bags); Plasti-kote (paints); Wellman, Inc. (polyester fiber); and Zeta

Consumer Products (plastic bags). Some companies request eco-profiles for internal use rather

than for marketing purposes.

The advantage of such an eco-profile is that it provides more information than simple seals of

approval. Among the disadvantages are that the information on the card can be difficult to obtain

and understand and that the report card may be misinterpreted by consumers as a product

endorsement. Since the SCS report cards are voluntary and appear only on a limited number of

products, they have led many consumers to believe that the card itself implies the environmental

superiority of a product.246

9.9.6 Energy Efficiency Labeling

Two energy-efficiency disclosure programs are managed by the federal government. The first

such program is EPA's Fuel Economy Information Program. It requires new cars to have labels

in their windows that list their mileage-per-gallon for city and highway driving, the estimated

annual fuel cost associated with their operation, and the fuel economy of comparable models.

This program was voluntary at its inception in 1974 but was made mandatory by the Energy

Policy and Conservation Act (EPCA) as of March 1976. Car dealers were also required to have

the Gas Mileage Guide of car fuel efficiency available to customers.

A 1976 study found that more than one-half of new car buyers had seen the fuel economy label

and that those aware of the label bought cars with higher fuel efficiency than other car buyers

did. The program was credited with reducing fuel consumption for 1976 model cars by 893

million gallons. However, the influence of the labeling program decreased as a result of

reductions in gasoline prices after the mid-1970s. Moreover, 64% of buyers did not believe the
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2001 169

mileage estimates. Consumers believed that fuel efficiency was not assessed in realistic driving

conditions and that mileage was therefore overstated. A 1981 DOE survey found that this

skepticism was the main reason why more consumers did not rely on the fuel economy label. In

1985, EPA changed the procedure by which fuel efficiency was assessed to make it more

realistic.247

The second energy efficiency disclosure program managed by the federal government is that for

Energy Guide labels on household appliances. In 1975, EPCA required that these Energy Guide

labels be placed on refrigerators, freezers, water heaters, washing machines, dishwashers,

furnaces, air conditioners, and heat pumps. The content of the labels varies, depending on the

type of appliance. At that time, however, all the labels included information on the manufacturer,

appliance model number, and capacity as well as an energy-efficiency rating (EER) or estimated

annual operating cost, the EER or annual operating cost of the most and least efficient

comparable appliances, and a table showing the annual estimated costs of various patterns of

usage for different energy prices. The 1992 Energy Policy Act expanded these requirements to

include the labeling of fluorescent lamps, showerheads, faucets, water closets, and urinals.

The Federal Trade Commission changed the labels in 1994, so refrigerators, freezers,

dishwashers, clothes washers, and water heaters now include the number of kilowatt hours

(kWh) of energy used by the labeled appliance and a list of the most energy-efficient and least

energy-efficient comparable appliances. Climate control appliances are labeled not according to

kWh of energy use but rather to fuel efficiency indices such as EER, seasonal EER, annual fuel

utilization efficiency, or heating seasonal performance factor. The energy cost table has been

replaced by a single estimate of energy costs for products with kWh energy-use ratings and for

room air conditioners. Other products must have operating cost information available either on

fact sheets or in industry product directories. In a press release on the new labeling requirements,

FTC stated that they would “make the labels easier to read and more useful to consumers in

comparing the energy efficiencies of the appliances.” 248

An in-store survey of appliance buyers conducted for DOE showed that 90% of buyers had

noticed the Energy Guide label and that three-fourths described it as “somewhat” or “very”

helpful in comparison shopping. The same survey revealed that consumers found the labels

confusing and believed that labels should emphasize one or two pieces of information, such as

energy costs.249 Studies have shown that the labels raise consumers’ energy awareness without

necessarily influencing their purchases. The energy efficiency of appliances has risen

significantly since the adoption of EPCA, but this increase appears to be due more to traditional

regulatory requirements than to the Energy Guide.250

FTC has also adopted labeling requirements for the resistance-to-heat flow in insulation

materials, the emissions characteristics of alternative fuel vehicles, and the minimum content of

alternative fuels.

The National Fenestration Rating Council (NFRC), which is an industry initiative, rates the

energy efficiency of windows. More than 120 manufacturers have submitted over 25,000

window products for NFRC ratings. According to NFRC, building energy codes and utility

programs rely increasingly on these ratings. In addition, manufacturers try to improve energy

efficiency to avoid being listed in the NFRC directory as a company with poor ratings. 251
The U. S. Experience with Economic Incentives for Protecting the Environment

170 January

9.9.7 Hazard Labels

Hazard labels inform consumers of the environmental risks associated with particular products.

Proposition 65, which was discussed in Section 9.7 of this chapter, requires manufacturers to

disclose information on the environmental hazards that could be caused by their products. This

mandate frequently results in product labeling, and products have been altered to avoid a

negative label. However, Proposition 65 warnings frequently take forms other than labels.

Ozone-depleting substances are subject to warning labels under the Clean Air Act. The incentive

effect of this label might have been diminished by announcements that such substances would be

phased out earlier than originally expected.

A variety of toxics, including polychlorinated biphenyls (PCBs) and asbestos, have been required

to bear warning labels under authority granted to EPA by the Toxic Substances Control Act.

Pesticides are subject to detailed labeling requirements under the Federal Insecticide, Fungicide,

and Rodenticide Act.

Since 1991, retailers in Vermont have been required to identify household products that contain

hazardous constituents with warning labels. These labels must be placed either on the shelves

stocked with these products or near the subject products. The goal of this law is to discourage

consumers from purchasing such products. Among the types of products subject to the

requirement are cleaning agents, auto and machine maintenance products, hobby and repair

products, shoe polish, aerosols, and butane lighters. The state’s label bears the text: “REDUCE

TOXICS USE. These products contain HAZARDOUS INGREDIENTS.” Green exemption

labels can be attached to shelves displaying products that have been included in the warning

program but contain none of the 24 ingredients listed in the Vermont Community Right-to-Know

list of hazardous chemicals. Vermont has a parallel warning program for pesticides and

commercial fertilizers.

9.10 Environmental Performance Awards

EPA and numerous state and local governments periodically issue awards for environmental

behavior they deem to be exemplary. To the extent that such awards generate positive publicity,

they could encourage environmentally friendly behavior.

In California, for example, 305 businesses won awards under the Waste Reduction Awards

Program (WRAP) in 1995. The Target department store chain won awards at 2 distribution

centers and 90 stores for recycling and their efforts to minimize waste, activities that have

resulted in a 75% reduction in garbage. Winners received certificates of recognition from the

Integrated Waste Management Board as well as the right to use the WRAP logo to publicize their

waste reduction achievements.

The California EPA announces winners each year. The 1999 winners include Autrey Museum of

Western Heritage, Cagwin & Dorward Landscape Contractors, Investec, Kraft Foods Inc.

Visalia, Memorial Hospitals Association, Pebble Beach Company, Straus Family Creamery,

Swinerton & Walberg Company, Trips for Kids/Re-Cyclery, and Unisys Corp.252

In Texas, Governor’s Awards for Environmental Excellence are issued for the following

categories: large business; large technical business; non-technical, small business; government,

civic, and non-profit organizations; education; youth organization; media; agriculture; individual;

and special.253 These awards are part of the Clean Texas initiative under the Waste Reduction
Information Disclosure

2001 171

Act of 1991. In the large technical business category, Lockheed Martin Tactical Aircraft Systems

was the 1995 winner. The company has also received awards from EPA for reducing emissions

of ozone-depleting chemicals and VOCs. It has also received the EPA Regional Administrator’s

Environmental Excellence Award for Excellence in Hazardous Waste Minimization Program

Development.254

9.11 Securities and Exchange Commission Disclosure Requirements

Section 14(a) of the Securities Exchange Act of 1934 empowers the Securities and Exchange

Commission (SEC) to require disclosure by publicly owned companies “as necessary or

appropriate in the public interest or for the protection of investors.”255 To date, the SEC has

interpreted this statement to require the reporting of information that would be deemed important

by investors.

The SEC requires disclosure of environmental liabilities that could have a “material” impact on

the company’s financial or competitive position, information that would be important to

investors. Companies also must report individual environmental enforcement proceedings that

are expected to cost more than $100,000 as well as environmental litigation that might have

significant financial impact on the company. SEC access to information submitted by companies

to EPA enables it to verify company disclosures on Superfund sites, RCRA sites, and federal

enforcement actions. The SEC is authorized to require companies to revise their filings in case of

inaccuracies. In the past, the Commission has written to companies to inquire why the companies

did not disclose certain environmental information in their filings.

The number of large companies disclosing environmental information in SEC Form 10-Ks is

increasing. Among Standard & Poor’s 500 companies, 322 submitted environmental information

in 1990 as compared to 217 companies in 1988. The incentive effect of these disclosure

requirements is not known. However, evidence presented elsewhere in this chapter indicates that

information on the environmental performance of companies is of interest to investors.256

9.12 Summary

Information programs have the potential for creating incentives for environmental change if they

are credible and present data in a usable form. The best known of the information programs is the

TRI. While changes in reported releases have been large following the establishment of the TRI

program, its actual impact is difficult to assess quantitatively because the data are not measured

or verified and no assessment of relative risks accompanies the reports. Information from the

TRI program is widely distributed, well-used, and likely to be affecting environmental

performance at many companies.

State information programs tend to base data on materials accounting and thus partially address

the concern of data reliability. The New Jersey and Massachusetts programs seem to be wellregarded and well-used. Proposition 65 places the burden of proof on industry, which has

incentive effects on firms similar to that of requiring more reliable data. Data collected as the

result of Proposition 65 are well-used

Experience with labeling schemes indicates that they are more likely to influence behavior if

they are accompanied by promotional activities that target retailers and consumers. In many

cases, the label itself is only one element of a larger effort to promote the use of environmentally
The U. S. Experience with Economic Incentives for Protecting the Environment

172 January

friendly products. As a result, it may be difficult to isolate the incentive effect of a label from

that of related promotional activities.257 One of the main problems encountered by environmental

seal-of-approval schemes is the lack of agreed-upon criteria for assessing environmental

friendliness. While seals of approval may be relatively easy for consumers to understand, they

risk not only lacking agreed-upon standards but also oversimplifying complex environmental

issues.

OSHA MSDS sheets have been criticized as overly lengthy and complicated. FTC Guidelines for

Environmental Marketing are intended to prevent false or misleading use of advertising claims

such as “environmentally friendly,” “degradable,” and “recyclable.”

Experience with energy-efficiency labeling demonstrates the limitations of information that is

perceived to be unrealistic, such as the fuel economy labels on automobiles before the 1985

revisions, or confusing, such as the Energy Guide labels on appliances.

SEC-mandated environmental disclosures by firms increasingly are used by investors as

indicators of proactive management, legal liability, or risk at particular firms.
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2001 173

10. Voluntary Programs

An important new trend in environmental management is the use of voluntary

programs to accomplish the goals of environmental protection. This trend involves

implementing methods to cut waste, conserve materials, and improve efficiency—

outcomes that increase the value added by business, improve competitiveness, and

reduce pollution. Voluntary programs are an important addition to the more marketbased incentive measures discussed elsewhere in this report. While the market-based

programs offer financial and other closely related incentives to encourage firms and

individuals to reduce pollution, voluntary programs offer less tangible rewards such

as public recognition and access to information on ways to reduce pollution at low or

no cost. Governments promote voluntary initiatives for a variety of reasons,

including the pilot testing of new approaches and the absence of legislative authority

to establish mandatory programs. As such, many voluntary programs offer unique

approaches to environmental management.

Two major federal initiatives are responsible for many of the federal voluntary

programs. One is pollution prevention, particularly as articulated in the Pollution

Prevention Act of 1990.258 The second is the reduction of greenhouse gas emissions

called for in the Clinton administration’s 1993 Climate Change Action Plan

(CCAP).259 A variety of private-sector and state-led initiatives also are noteworthy.

Without other legislative authorities, the objectives of pollution prevention in the

United States are pursued largely through voluntary actions by firms or agreements

negotiated between government agencies and individual firms. The objective of

pollution prevention is to reduce the pollution intensity of production through

changes in input use, technologies, processes, management, and other parameters.

Because the full range and effectiveness of these parameters cannot be well-known to

regulatory agencies, governments pursue the goals of pollution prevention by

providing information to firms and encouraging the firms to use production methods

that are less pollution-intensive. Similarly, the Climate Change Action Plan relies on

a series of voluntary initiatives that are supplemented by modest subsidy programs to

induce meaningful reductions in greenhouse gas emissions.

10.1 Background

Because voluntary programs are relatively new and involve intangibles that are

difficult to quantify (e.g., what would have been done anyway without the program),

they are difficult to evaluate quantitatively. However, the Oak Ridge National

Laboratory recently completed an initial assessment of about a dozen energy-related

programs for EPA’s Office of Atmospheric Programs (OAP). This assessment was

conducted to support a forthcoming DOE study entitled Scenarios for a Clean

Energy Future.

260 In addition, the proceedings from the American Council for an

Energy Efficient Economy (ACEEE) have a number of peer-reviewed papers that

review and evaluate a wide variety of voluntary energy conservation programs.

These papers can be found in ACEEE’s Energy Efficiency Summer Studies (1994,

1996, 1998, 2000).
The U. S. Experience with Economic Incentives for Protecting the Environment

174 January

One incentive for businesses to take part in these voluntary programs appears to be favorable

public relations (PR). Favorable PR could result in less public pressure to regulate participants,

better relations with employees and the community, and increased market share at the expense of

competitors perceived to be less environmentally friendly. For example, polls have shown that

consumers are willing to pay a premium for products that have environmental advantages.261

Henriques and Sadorsky (1996) found that pressure from shareholders and customers

significantly influenced Canadian firms’ decisions to formulate environmental plans. In this

respect, voluntary programs could have effects similar to the information approaches discussed

in Chapter 9.

Another reason for corporate participation in voluntary programs is that the sponsoring

regulatory authority may provide technical assistance to participants. Such assistance could be

regarded as a subsidy, as discussed in Chapter 8. As noted in subsequent paragraphs, several

companies have saved money by implementing the activities associated with voluntary programs

such as Green Lights and WasteWise.

Moreover, voluntary programs sometimes are structured to limit potentially high litigation,

monitoring, and enforcement costs that otherwise could be incurred by regulators and businesses.

Some voluntary programs offer participating companies the opportunity to identify and address

environmental problems in the present, problems that could subject them to regulatory sanctions

in the near future. On occasion, these programs also give companies the flexibility to improve

their environmental performance at less cost.

A Resources for the Future (RFF) study of EPA’s 33/50 program cited several reasons other than

publicity benefits and added flexibility to explain why firms might voluntarily exceed the

standards set in environmental regulations. (The 33/50 program is discussed in 10.3.1, 33/50

Program.) In some industries, firms might improve their performance in the hope of leading the

government to make such performance mandatory, thereby creating barriers to the entry of

potential competitors. It has also been suggested that firms over-comply to forestall additional

mandatory regulation. Another possibility is that the “lumpiness” of pollution abatement

investments means that large investments offer significantly more abatement per dollar than a

series of small investments made to comply with progressively tighter restrictions.262

Most voluntary environmental programs in the United States have been designed and

implemented by the U.S. EPA. Industry also is involved in the oversight of a number of

voluntary programs. The programs that have been created and managed solely by the federal

government are classified as “public voluntary” programs. Acting independently or with other

federal agencies, EPA oversees programs directed at climate change and pollution prevention.

Programs developed by industry trade organizations for their member companies are termed

“unilateral” programs in this report. Finally, there are voluntary programs that involve significant

negotiation between government regulators and participants. These programs are called

“negotiated agreements.” The following sections review many of these programs.

10.2 Federal Initiatives: Climate Change

The great majority of voluntary programs are concerned with reducing the emissions of

greenhouse gases: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), perfluorocarbons

(PFC), hydrofluorocarbons (HFC), and sulfur hexafluoride (SF6). The 1993 Climate Change

Action Plan responded to the 1992 Earth Summit’s call for reducing greenhouse gas emissions
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2001 175

by developing innovative public- and private-sector voluntary initiatives. Partnerships between

the Environmental Protection Agency (EPA); the Departments of Energy (DOE), Agriculture

(USDA), and Transportation (DOT); state and local governments; industry; farmers; nonprofit

organizations; trade associations; and professional societies have focused on the low-cost and

profitable opportunities for reducing greenhouse emissions. This collaboration has resulted in the

development of more than 40 programs. The principal climate change programs are summarized

in Table 10-1 and described in more detail in the following sections.

Table 10-1. Federal Voluntary Programs for Greenhouse Gases

 PARTNERSHIP PROGRAMS

(year program launched) ENVIRONMENTAL GOAL

Green Lights (1991)

www.epa.gov/energystar

Reduce energy consumption of lighting through cost-effective, energy-efficient lighting

technologies.

WasteWise (1992)

www.epa.gov/wastewise

Reduce municipal solid waste through waste prevention and the purchase/manufacture

of products with recycled content. at business, government, and institutional partners

AgStar (1993)

www.epa.gov/agstar

Promote cost-effective methods for reducing methane emissions at dairy and swine

operations through improved manure management.

Climate Wise (1993)

www.epa.gov/climatewise

Reduce industrial greenhouse gas emissions and energy costs through comprehensive

pollution prevention and energy efficiency programs.

Commuter Choice (1993)

www.epa.gov/ooaujeag/livability/com

_choi.htm

Promote employer-provided commuting options designed to reduce traffic congestion,

improve air quality, and allow employers to tailor transportation benefits to the needs of

individual employees.

Natural Gas Star (1993)

www.epa.gov/gasstar

Encourage natural gas industries to reduce methane emissions through cost-effective

technologies and best management practices.

Ruminant Livestock Efficiency (1993)

www.epa.gov/rlep

Reduce methane emissions from ruminant livestock operations.

Seasonal Gas Use to Control NOx

(1993)

Promote seasonal switching toward the use of low-carbon natural gas, particularly in the

summer, in utility coal and oil plants and in industrial facilities.

State and Local Outreach (1993)

www.epa.gov/globalwarming

Reduce greenhouse gas emissions from states and local communities by empowering

officials with information and technical assistance.

The U.S. Initiative/Joint

Implementation (1993) www.ij.org

Encourage private-sector investment and innovation in developing and disseminating

technologies to reduce greenhouse gas emissions.

Environmental Leadership (1994)

es.epa.gov/elp

Recognize and provide incentives to facilities that are willing to develop and demonstrate

accountability for compliance with existing laws.

Energy Star (1994)

www.epa.gov/energystar

Maximize energy efficiency in commercial, industrial, and residential settings by

promoting new building and product design and practices.

Environmental Stewardship (1994) Limit emissions of perfluorocarbons and hydrofluorocarbons in three industrial

applications: electrical transmission and distribution systems, magnesium casting, and

semiconductor production.

Coalbed Methane Outreach Program

(1994) yosemite.epa.gov/methane/

cmophome.nsf

Identify and remove obstacles to investment in coalbed methane recovery projects,

which increases awareness of investment opportunities.

Landfill Methane Outreach Program

(1994) www.epa.gov/lmop

Encourage profitable recovery of methane released from landfills by identifying viable

technologies, markets, and financing sources.

Transportation Partners (1995)

www.epa.gov/tp

Reduce the growth in vehicular travel through the voluntary adoption of local and

regional transportation strategies that provide better, cheaper, transportation choices for

citizens. Program was discontinued due to funding reductions at the U.S. DOT.

Voluntary Aluminum Industrial

Partnership (1995) www.epa.gov/vaip

Reduce perfluorocarbon gas emissions from aluminum smelting.
The U. S. Experience with Economic Incentives for Protecting the Environment

176 January

10.2.1 Green Lights

One of the early voluntary partnerships between EPA and industry was the Green Lights

Program. The primary purpose of the program was to encourage the use of energy-efficient

lighting to prevent air emissions (CO2, SO2, and NOx) and other emissions from the generation

of electricity. By December 1994, Green Lights investments in energy-efficient lighting had

resulted in annual energy savings of 1 billion kWh, translating into annual energy cost savings of

about $92 million. By May 1996, the program had 1,316 Partners (corporations, industry groups,

nonprofit organizations, hospitals, governments, and universities); 585 Allies (electric utilities,

lighting manufacturers and distributors, and lighting management companies); and 286

Endorsers (professional and trade associations). In 1997, EPA consolidated Green Lights

activities within the Energy Star Buildings program to encourage a more comprehensive

approach to energy-efficiency investments.

Table 10-2 illustrates the energy savings achieved by three companiesStaples, the Atlanta

Journal-Constitution (Cox Newspapers), and Mobil Corpas a result of their participation in the

Green Lights Program. More information on these and other success stories is available at the

EPA Energy Star web site.263

Table 10-2. Energy Savings from Green Lights/Energy Star Program

PROJECT INFORMATION STAPLES ATLANTA JOURNALCONSTITUTION MOBIL

Project costs ($)

• Total expenditures

• Costs per sq. ft.

$3.1 million

$0.91 $1.007 million

$0.53

$1.182 million

$3.95

Cost savings ($)

• Annual savings

• $ saved/sq. ft.

$985,425

$0.29

$447,564

$0.53

$224,500

$0.75

Internal rate of return 29.3% 51% 19%

kWh savings 6.3 million 6.8 million 7.2 million

CO2 savings (lbs.) 6.37 million 11.9 million 103 million

Source: http://www.epa.gov/buildings/esbhome

10.2.2 Energy Star Partnership Program

The Energy Star Partnership Program is designed to raise the level of public consciousness and

action regarding energy conservation. Programs focus on fostering energy efficiency and

reducing transaction costs for consumers and businesses. Three Energy Star programs discussed

in this subsection have been especially successful in reducing annual carbon-equivalent pollution

while maximizing energy cost savings.264

10.2.2.1 Energy Star Buildings

EPA asks participants in the Energy Star Buildings program to perform energy-efficiency

upgrades in buildings where profitable. After installing energy-efficient lighting, participants

tune up building systems, invest in upgrades to reduce heating and cooling loads, improve fans

and air handling systems, and improve the heating and cooling plant. This five-stage upgrade

process is part of an integrated approach to whole-building energy efficiency. Participants that

follow this approach are often able to reduce their energy use by 30% while achieving an internal
Voluntary Programs

2001 177

rate of return (IRR) of 20% or greater on their investment. As shown in Figure 10-1, EPA

predicted that energy costs at Energy Star Showcase Buildings could fall by nearly 50%.265

In 1999, EPA began

providing an effective means

of monitoring the progress of

energy-efficiency upgrades

to buildings; the mechanism

was EPA’s Energy Star

Benchmarking Tool.

Combining the values of

building energy consumption

and their relative impact on

total energy consumption,

performance levels can now

be benchmarked against the

top 25% of all similar-use

buildings. Such information

provides Partners with the

opportunity to save energy

and money and prevent pollution. It provides valuable input into business transactions involving

the buying, selling, appraising, leasing, and insuring of the building as well as the contracting for

energy, operations, and maintenance services.

Energy Star Buildings and Green Lights have over 5,500 participants. Partners have

cumulatively invested more than $3.6 billion on energy-efficiency improvements. From 1995 to

1999, these upgrades have resulted in an estimated reduction in energy use of more than 108

billion kilowatt hours (kWh), with a corresponding reduction of over 23 million metric tons of

carbon-equivalent (MMTCE). (See Table 10-2.)

10.2.2.2 Energy Star Products

Working with equipment manufacturers, the U.S. Department of Energy (DOE) and EPA are

using Energy Star labels to promote highly energy-efficient products. Collaborations formed

with DOE are also facilitating the development of initial markets for advanced technologies, for

example, by encouraging large-volume purchases. These purchases help reduce manufacturing

costs through economies of scale in initial production. More than 1,200 manufacturers now offer

Energy Star products in over 30 commercial and residential product categories such as air

conditioners, heating systems, and exit lights. These products are featured in over 4,000 retail

stores. In 1999 alone, consumers purchased more than 100 million EPA-labeled Energy Star

products, saving over 25 billion kWh of energy.266

10.2.2.3 Energy Star Homes

Jointly sponsored by DOE and EPA, Energy Star Homes promotes voluntary partnerships with

homebuilders to construct homes that are 30% more energy- efficient than the guidelines of the

Model Energy Code. (The Model Energy Code is a model national standard for residential

construction.) The program also encourages lenders to provide Energy-Efficient Mortgages,

which offer lower interest rates than conventional home loans, lower closing costs, up to a 4%

extension of the maximum debt-to-income ratio, and a free home energy rating. (For more

Figure 10-1. Energy Savings in Showcase Buildings

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

Baseline Stage 1 Stage 2 Stage 3 Stage 4 Stage 5

Energy Cost per sq. ft. per Year

Source: EPA. 1994h.
The U. S. Experience with Economic Incentives for Protecting the Environment

178 January

information on Energy-Efficient Mortgages, see Chapter 7, Section 7.8) Fannie Mae and Freddie

Mac encourage lenders to offer energy-efficient mortgages by providing incentives and specific

criteria for the purchase of such mortgages.

10.2.3 Climate Wise

Climate Wise is helping companies realize environmental and economic benefits through costeffective industrial energy-efficiency and pollution-prevention actions. Designed to reduce

greenhouse gas emissions across all sectors, Climate Wise challenges participants to devise and

implement innovative ways of limiting, reducing, or mitigating greenhouse gases. Methods

include process modifications, use of alternative raw materials, carbon sequestration, and other

measures that abate emissions.

The program is a partnership between EPA and the DOE. Collaborative initiatives with industry

include AT&T, British Petroleum, DuPont, General Motors, and Weyerhaeuser, as well as 30

states and local governments. Partnerships number more than 550 and represent more than 13%

of U.S. industrial energy use.

Most recently, EPA has partnered with the United States Agency for International Development

(USAID). This partnership will now extend technical assistance to local municipalities and

companies who seek energy savings and emission reductions in Brazil, Central America, India,

Mexico, and the Philippines.

10.2.4 WasteWise

Created in 1994, WasteWise is a voluntary program intended to reduce the solid waste generated

by businesses. The program’s source-reduction and recycling efforts are intended to reduce

greenhouse gas emissions by (1) reducing methane emissions from the decay of waste in

landfills, (2) increasing carbon sequestered by forests, and (3) reducing emissions resulting from

extracting and processing virgin materials and manufacturing products. There are many

additional benefits of WasteWise, including the following: reduced extraction and processing of

virgin materials; reduced waste disposal; reduction in air, water, noise, and other pollution

associated with waste disposal and manufacturing; reduced costs of managing municipal solid

waste; and new jobs and income created by new recycling enterprises.

To participate, partners are required to implement three significant waste prevention activities,

improve collection programs for recyclables on company premises, and increase either their

purchases of recycled products or the recycled content of the products they manufacture. In the

first year of the program alone, participating companies conserved over 240,000 tons of solid

waste, mostly transportation packaging. They also recycled about 1 million tons of waste and

purchased 20 different kinds of recycled-content products.

With more than 1,000 participating companies, members have saved a significant amount of

money through the program. WasteWise partners reduced a total of 7.8 millions tons of solid

waste in 1998. The cost savings they achieved by not having to dispose of these wastes increased

from $38 million in 1994 to $280 million in 1998.267

10.2.5 Methane Reduction Programs

Methane, a potent greenhouse gas, can be recovered for energy use. To promote methane

recovery, EPA has launched at least three voluntary programs: the Coalbed Methane Outreach
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2001 179

Program, the Landfill Methane Outreach Program, and Natural Gas Star. In addition, joint efforts

of EPA and the U.S. Department of Agriculture (USDA) have encouraged the profitable

collection and reuse of methane in two agriculture-based programs. These programs are the

AgStar Program and the Ruminant Livestock Efficiency Program.

10.2.6 Coalbed Methane Outreach Program

In 1990, methane emissions associated with coal mining operations accounted for approximately

18% of human-related U.S. methane emissions. Launched in spring 1994, the Coalbed Methane

Outreach Program disseminates information that addresses a number of obstacles to mine

methane recovery and development, including the lack of information on recovery technology,

difficulties in obtaining financing for recovery investments, the lack of markets for recovered

methane, and the uncertainty concerning ownership of mine methane. EPA has also developed

guides for state, local, and federal assistance programs that pinpoint sources of loans, grants, and

technical assistance for profitable coal mine methane projects as well as a comprehensive guide

for private-sector financing of coal mine methane projects.

Under this program and as a result of the Energy Policy Act of 1992, methane recovery by the

coal industry has more than doubled since 1993. Partners increased the quantity of methane

recovered to nearly 2.0 million tons of carbon equivalent (MMCTE), which is equivalent to

eliminating the emissions from about 1.5 million cars per year.268

10.2.7 Natural Gas Star Program

Initiated in March 1993, the Natural Gas Star Program encourages natural gas companies to

adopt cost-effective technologies and practices that reduce emissions of methane from natural

gas transmission and distribution systems. Methane emissions can be decreased by up to onethird by improving inspection and maintenance practices to reduce fugitive emissions, replacing

equipment that normally vents gas with low-emission technologies, and repairing or replacing

leaking service lines.

More than 70 natural gas transmission and distribution companies have joined the program since

it was expanded in the summer of 1995 to include gas producers. By working with the natural

gas industry, the program has identified more than 50 cost-effective best management practices

for methane-reduction.

10.2.8 Agstar Program

The AgStar Program was launched in the summer of 1993. Under the program, EPA works with

the Departments of Energy and Agriculture to encourage swine and dairy producers to recover

methane from their animal waste management systems. Participants commit themselves to

conducting three activities: (1) surveying their facilities, (2) installing AgStar-selected

technology wherever profitable, and (3) appointing managers to oversee their participation in the

program. EPA helps partners optimize systems and recoup some of their investments through

energy recovery. More than 500 farms are currently AgStar Partners. The program also has 50

Allies, which represent system and equipment manufacturers, educational institutions, and state

and local governments.
The U. S. Experience with Economic Incentives for Protecting the Environment

180 January

10.2.9 Assessment of Climate Change Programs

EPA reported to the U.S. Senate Appropriations Committee in February 2000 that the Agency’s

climate change programs have continued to meet their greenhouse gas reduction goal since 1995,

as shown in Figure 10-2. Cumulatively, greenhouse gas emissions have been reduced by 118.2

MMTCE from 1995 to 1999, with 88.1 MMTCE of the reductions coming from the industrial

sector. Within the industrial sector, carbon dioxide (CO2) emissions have been reduced by 20.8

MMTCE; methane (CH4) by 23.7 MMTCE; and perfluorocarbon (PFC), hydrofluorocarbon

(HFC), and sulfur hexaflouride (SF6) by 43.6 MMTCE. The baseline for evaluating program

performance through 1999 has been a forecast of U.S. greenhouse gas emissions in the absence

of the Climate Change Action Plan programs. This baseline was developed and updated as part

of an interagency evaluation of the Climate Change Action Plan in 1997, which built on a similar

baseline forecast that was developed in 1993 for the Climate Change Action Plan.

EPA’s own evaluation of climate change activities recognizes the difficulties of measuring

effectiveness.

Prior studies have focused on estimating the localized energy savings that could

be attributed to products and services that were purchased by eligible utility

customers, with the incentives of rebates and subsidies. Participant micro data

specifically, customer billing data and customer measure installation data, were

used to estimate changes in customer energy consumption due to participation in

the program.

Recently, the market transformation programs operated by the federal

government have shifted program emphasis away from energy savings and

towards promoting market growth for energy-efficient products and services. This

shift in program paradigms requires a parallel shift in program evaluation

designs. Energy-efficiency program evaluation concepts such as free riders and

Figure 10-2. Goals and Accomplishments of EPA’s Climate Change

Programs: 1995−2000



























































































 



















































































0

10

20

30

40

50

60

MMTCE Reduced



 State and Local

 Transportation

 Buildings

 Industry

 CO2

 CH4

 PFCs, SF6, HFCs

 1998

 Goal Attained

1995

Attained

1996

Attained

 1999

 Goal Attained

2000

Goal

 1997

 Goal Attained

Source: EPA. 2000c Note: 1999 attained values are estimated.
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2001 181

free drivers have only indirect use for evaluating whether, and to which degree, a

program has quickened the overall pace of market movement. For these reasons,

the paradigm for evaluating market transformation programs cannot center on

estimating changes in participant energy use and inferring participant intentions.

Rather, it must focus on the dynamics and the determinants of market outcomes.

EPA is now moving to new methods of program evaluation that are more

appropriate for the types of programs that EPA operates. These evaluations will

assess the market transformation impacts success in promoting market growth for

energy-efficient products and services, as well as the reductions in greenhouse

gas emissions and energy consumption. With the programs now producing sizable

results in the market place, EPA can use market-based assessments to evaluate its

programs, as opposed to requiring an analysis of program participant micro data

as a means of inferring market impact.269

10.3 Public Voluntary Initiatives: Pollution Prevention

EPA’s first major voluntary program, 33/50, was designed to promote pollution prevention. Most

prevention programs seek to reduce a subset of toxic chemicals released and transferred by

manufacturers. Before the 33/50 Program ended in 1995, it encouraged manufacturers to

voluntarily reduce emissions of 17 target chemicals by 50%. Other prevention programs, such as

Design for the Environment and Green Chemistry, are designed to promote the development of

cleaner products and industrial processes. This section reviews several of the public voluntary

programs for pollution prevention identified in Table 10-3. Information on other programs not

discussed here can be found on the web site of EPA’s Office of Policy, Economy and Innovation

and in various EPA publications.270

10.3.1 33/50 Program

The 33/50 Program, introduced by EPA Administrator Riley in 1991, encouraged industry

participation through a challenge to the more than 16,000 facilities releasing any of 17 priority

toxic chemicals. The challenge: Reduce your emissions (reported as TRI releases and transfers)

by 33% by 1992 and by 50% by 1995, relative to a 1988 baseline for the facility.

EPA first issued invitations to take part in the 33/50 Program in February 1991, focusing initially

on 555 primarily large companies that had the highest releases of the 17 chemicals targeted by

the 33/50 Program. As of March 1994, EPA had invited more than 8,000 companies to join, and

almost 1,200 had said they would participate.

Of the largest 600 emitters, approximately 60% agreed, ultimately, to participate. In the

aggregate, the actual emissions reduced by these companies exceeded EPA’s expectations and

occurred ahead of schedule. From those perspectives, the program may be viewed as a

considerable success. Zatz and Harbour (1999) cite six factors as key to the success of the 33/50

Program:

• voluntary participation

• flexibility in the goals and the methods used to reduce emissions

• no additional reporting requirements
The U. S. Experience with Economic Incentives for Protecting the Environment

182 January

• public recognition for participants and their successes

• finite life of program

• an economic benefit for companies

Table 10-3. Federal Voluntary Pollution Prevention Programs

 FEDERAL VOLUNTARY PROGRAMS

(year program launched) ENVIRONMENTAL GOAL

33/50 Program (1991) Reduce total releases and transfers of 17 priority chemicals by 33%

by 1992 and by 50% by 1995, relative to a 1988 baseline. Program

ended in 1995.

Environmental Accounting (1992)

www.epa.gov/oppintr/acctr

Increase corporate understanding of environmental costs and how to

incorporate these costs into routine business operations.

Design for the Environment (1992)

www.epa.gov/dfe

Help business incorporate environmental considerations into the

design of products, processes, and technical systems.

Green Chemistry (1992)

www.epa.gov/dfe/greenchem

Promote the design of chemical products and processes that reduce

or eliminate the generation of hazardous substances.

Water Alliances for Voluntary Efficiency (1992)

www.epa.gov/owm/genwave

Promote water efficiency in hotels, schools, universities, and office

buildings.

Pesticide Environmental Stewardship (1993)

www.pesp.org

Promote integrated pest management and pesticide risk reduction in

agricultural and nonagricultural settings.

Waste Minimization National Plan (1994)

www.epa.gov/wastemin

Reduce the presence of persistent, bioaccumulative, and toxic

chemicals in hazardous waste.

Indoor Air Quality (1995)

www.epa.gov/iaq

Promote simple, low-cost methods for reducing risks to indoor air

quality.

Community-Based Environmental Protection (1998)

www.epa.gov/ecocommunity

Integrate environmental management with human needs, consider

long-term ecosystem health, and highlight the positive correlation

between economic prosperity and environmental well-being.

Adopt Your Watershed (1994)

www.epa.gov/adopt

Encourage and facilitate citizen involvement in local watershed

protection activities.

Environmental Technology Verification (1995)

www.epa.gov/etv

Verify the performance of innovative technologies to accelerate their

entrance into the marketplace.

Voluntary Mobile Source Emission Reduction Program

(1997)

www.epa.gov/oms/transp/traqvolm.htm

Provide flexibility to states in meeting federal air quality goals.

Pesticide Environmental Stewardship Program (1994)

www.epa.gov/oppbppd1/PESP

Reduce risk from pesticides through improved pesticide stewardship.

Commuter Choice Leadership Initiative (2000) Promote the reshaping of employee benefits packages to include

commuting benefits.

EPA data, shown in Figure 10-3, demonstrate that the program goals for 33/50 were achieved 1

year ahead of schedule and that the reductions were greater than anticipated. While some have

criticized the methods by which EPA made these calculations, the program clearly seems to have

been a success.

Aurora and Cason (1995) found that the 33/50 Program had a significant incentive effect.

Although the willingness to participate varied greatly across industries and firms, and a relatively

small percentage of any industry’s firms participated, those that did participate were responsible

for most of the toxic emissions within their respective industries. In the case of petroleum and

chemicals, for example, participating companies were responsible for over 80% of their
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2001 183

industries’ total emissions. The participation of large polluters allowed the program to be

effective in targeting the main sources of pollution.

Aurora and Cason also found that participation rates were higher for industries that were less

concentrated (those having many firms) and that participants in Green Lights were significantly

more likely to participate in 33/50 as well. This “suggests that ‘environmentally conscious’ firms

seek to improve their

reputation by participating

in several voluntary

pollution reduction

programs at the same

time.”

Some reviewers assert that

the proclaimed benefits

have been overstated. The

baseline data and the date

the program was initiated

allowed participants who

had already achieved the

reductions to join the

program after the fact.

Indeed, some participants

had achieved more than a

50% reduction before they

joined 33/50 in 1991. Aurora and Cason (1995) found that one of the main determinants of

participation in the program was a desire by the firm to achieve favorable publicity. Overall, the

program achieved real reductions. GAO (1997b) estimated them to be on the order of 20%, and

participants, in general, realized cost savings. Khanna and Damon estimated that participation in

the program also resulted in a reduction of 28% in future TRI releases.271

10.3.2 Design for the Environment (DfE)

EPA’s Design for the Environment (DfE) Program helps businesses incorporate environmental

considerations into the design and redesign of products, processes, and technical and

management systems. Initiated by EPA’s Office of Pollution Prevention and Toxics (OPPT) in

1992, DfE forms voluntary partnerships with industry, universities, research institutions, public

interest groups, and other government agencies.

Activities of Project Partners include broad institutional efforts aimed at changing general

business practices as well as cooperative projects with trade associations and businesses in

specific industries. The DfE Program ensures that the information developed through this

voluntary effort reaches the people who make decisions—from managers to industrial design

engineers to those who specify materials to buyers. By disseminating the information to these

individuals, the program encourages its Partners to incorporate environmental considerations into

their traditional decision-making process.

DfE works with entire industrial sectors, typically through trade associations and industry

leaders. Several of the current DfE partnerships are highlighted below.

Figure 10-3. Releases of TRI Chemicals (1988−1994)

0

200

400

600

800

1000

1200

1400

1600

1988 1989 1990 1991 1992 1993 1994

Years

Millions of lbs.

1995 Goal

1992 Goal

Source: EPA. 1996c.
The U. S. Experience with Economic Incentives for Protecting the Environment

184 January

• The Printing Sector: DfE works with the screen printing, lithography, and flexography

sectors to improve their environmental performance, principally through solvent use and

reclamation technologies.

• The Printed Wire Board Sector: Traditional methods for making printed wire boards require

the use of substantial amounts of water, energy, and certain toxic chemicals. DfE has

collaborated with this sector to evaluate alternative methods and processes.

• The Computer Manufacturing Sector: DfE is collaborating with this sector to perform lifecycle cost assessments of cathode ray tubes and flat panel displays in computers, assessments

that include environmental impacts.

• Garment and Textile Industries: DfE is working with this sector to reduce the public’s

exposure to perchloroethylene, a chemical used in dry cleaning. DfE is also exploring

alternatives in the dyes and finishes used in textile processing or in clothing design (or in

both) to reduce the need for dry cleaning.

• Industrial Cleaning Sector: Through partnerships with detergent formulators, DfE is trying to

encourage the development and adoption of safer, more cost-effective effective industrial

cleaning agents.

• Auto Refinishing Sector: DfE is working with auto refinishers to identify and adopt cleaner,

safer, and more cost-effective practices that reduce the use of harmful chemicals and

solvents.

• Manufacturers of foam Furniture and Bedding Adhesives: The adhesives used in these

products can contain chlorinated and flammable solvents, and these solvents are increasingly

coming under environmental regulation. DfE is working with manufacturers to develop

adhesives that are more environmentally friendly.

10.3.3 Environmental Accounting Project (EAP)

EPA initiated the Environmental Accounting Project (EAP) in 1992 out of concern that pollution

prevention would not be used to manage the environment until managerial accounting practices

were modified to account for environmental costs. In cooperation with the Institute for

Management Accountants, the American Institute for Certified Public Accountants, the U.S.

Chamber of Commerce, the Business Roundtable, and the American Association of Cost

Engineers, EPA developed agendas for 10 different stakeholder groups. The goal of the EAP is

to help business understand the full range of environmental costs they incur and how to

incorporate these costs into their decision-making.

The EAP encourages businesses to focus on energy costs, capital and operating costs of

equipment that controls pollution, remediation efforts, salaries of environmental managers,

public relations outlays, and other costs associated with the environment. Closer tracking of

these costs enables businesses to identify opportunities to reduce or eliminate various elements

of these costs. Companies can improve their environmental performance, gain a competitive

advantage, and achieve cost savings or increased revenues.

EPA maintains a network of over 800 members of the EAP who share information and ideas.

EAP has prepared several guidebooks for implementing these concepts, and it has developed a
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2001 185

number of case studies that illustrate the gains that can be achieved. Much of this information is

available on EPA’s web site.

10.3.4 Environmental Leadership Program (ELP)

ELP uses innovative approaches to environmental protection by focusing on flexible laws and

regulations. In addition, ELP seeks ways in which to use the greater availability of environmental

information to empower citizens and communities. EPA launched the pilot phase of ELP in June

1994. In April 1995, ELP formally selected 12 projects from a pool of 40 proposals. The

projects, which included 10 companies and two federal facilities, centered on compliance

management systems, verification procedures, management accountability systems, and

community access and participation in compliance. EPA indicated that participants would be

allowed a limited period of time in which to correct minor violations that were discovered in

their audits, without the application of penalties. Two conditions, however, were attached to this

offer: The violations could not be criminal in nature; and they must not present an imminent and

substantial risk to public health or the environment. Participants receive public recognition for

their efforts.

One ELP participant, Gillette Co., is working with EPA and state authorities on auditing and

certifying their environmental management system. The company’s ELP project involves the

following four steps: (1) developing criteria for compliance audits; (2) preparing detailed

instructions for conducting such audits; (3) preparing guidelines for third-arty verification of

these audits; and (4) using the guidelines when auditing three company facilities.

Gillette officials have cited several reasons for participating in the program. It prepares them for

compliance with ISO 14000 environmental management certification standards, which are

expected to become important in the years to come. The program also gives the company the

chance to monitor itself, which will help the firm to avoid excessive monitoring by EPA.

It is not clear to what extent the results of audits conducted under ELP will be made available to

the public. Public interest groups believe that they are entitled to access such information.

Businesses, however, maintain that much of the data contained in audits should be kept

confidential.

10.3.5 Water Alliances for Voluntary Efficiency (WAVE)

Another EPA initiative, Water Alliances for Voluntary Efficiency (WAVE), encourages

businesses and institutionsprimarily in the lodging sectorto reduce water use while

increasing efficiency, profitability, and competitiveness. EPA says that the program “is designed

to focus attention on the value of water and the need for efficient use of this important natural

resource.”272

WAVE participants include partners, supporters, and endorsers. Program Partners agree to equip

new facilities with water-efficient equipment and to install such equipment in existing facilities

wherever profitable. In exchange, they receive technical support and EPA assistance in

publicizing their water efficiency initiatives. Program Supporters publicize the benefits of water

use efficiency and assist partners in their conservation efforts. Supporters are also supposed to

implement water efficiency measures. Endorsers include “conservation-minded environmental

groups, trade and professional associations” who “are invited to review and endorse the WAVE

program.”273
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186 January

As of April 2000, there were 40 WAVE industry partners, all of which were in the lodging

sector. Several of the partners were large chains such as Westin, Hyatt, and Sheraton, with

multiple facilities participating in the program. In addition, two hospitals and two educational

institutions are counted as Partners. The list of Supporters consisted of more than 50 consulting

firms, equipment distributors, manufacturing companies, utilities, and water management

companies. The American Hotel & Motel Association, the American Water Works Association,

Green Seal, and three other institutions were WAVE Endorsers as well.

EPA has stated that WAVE’s measures can result in significant decreases in energy, water, and

wastewater management costs. Through the program, the lodging industry potentially could save

32 billion gallons of water and more than 1 trillion Btu per year of related energy use. According

to an EPA official, the main incentive for businesses to participate in WAVE is cost savings, but

positive publicity is also a factor. Although the program has resulted in water and energy

savings, it has not been without problems. The development of water management software has

taken longer and has cost more than originally expected. In addition, marketing the program to

hotels and motels has been slowed by a reluctance of the lodging industry to embrace change and

by significant variations in the ownership and management structures of hotel branches.

10.3.6 Community-Based Environmental Protection (CBEP)

Initiated in 1997, this program integrates environmental management with human needs,

considers ecosystem benefits, and emphasizes relationships between economic well-being and

environmentally sustainable development. As its name implies, CBEP works with communities

to protect and improve their local environment.

EPA has established several core principles for implementing CBEP.

• Focus on a definable geographic area.

• Interact with stakeholders through a range of partnership mechanisms.

• Determine overall environmental conditions in the area.

• Integrate environmental, economic, and social objectives and encourage local

stewardship.

• Rely on appropriate public-sector, private-sector, regulatory, and non-regulatory tools.

• Monitor results and adjust programs in light of the results that are observed.

EPA's role in CBEP varies from one situation to another. In communities that cross state

boundaries or are nationally important, EPA takes the lead role. In other cases EPA helps to

define goals and methods, and provides environmental information, monitoring and scientific

analysis to community organizers and stakeholders. Because individual projects are expected to

take many years to achieve full success, the agency uses measures of performance that reflect

incremental progress toward the goals.

10.3.7 Voluntary Mobile Source Emission Reduction Program (VMEP)

In the area of mobile sources, EPA has developed the Voluntary Mobile Source Emission

Reduction Program (VMEP). This policy was initiated on October 23 1997, with the purpose of

providing flexibility to states in meeting their federal air quality goals through State

Implementation Plans (SIPs). Through this policy, EPA makes it easier for states to obtain SIP
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2001 187

credits for voluntary activities, and it seeks to further encourage innovation and investment in

effective programs and actions. Thus, the policy provides an incentive for states, localities, and

the public to voluntarily reduce air pollution in their communities.

To obtain these SIP credits, a voluntary program under VMEP must be quantifiable; surplus (i.e.,

yield reductions in addition to those credited in other parts of the SIP); enforceable, and

permanent. The most distinctive difference between a VMEP control measure and a regular SIP

control measure is that the VMEP is enforceable against the state for the emission reductions

only, as opposed to the regular SIP control measure that is enforceable against the regulated

parties for specified actions to reduce emissions.274 This provision encourages industry,

community groups, and third parties to voluntarily agree to emission reductions. The state then

estimates the reduction in emissions it expects will result from the agreements, and includes this

as a control program in their SIP. VMEP submissions are limited to 3% of the emission

reductions needed to obtain the National Ambient Air Quality Standards (NAAQS) in the nonattainment area.

The cities of Dallas, Houston, Chicago, Atlanta, and Las Vegas are including, or are planning to

include, VMEP programs in their SIP. Programs include ozone action-day programs, technology

retrofits, lawnmower buybacks, alternative fuel programs, commuter choice programs, and land

use measures as well as many other programs. Support for the policy, in terms of technical and

programmatic support, has been conducted through the Regional and State Programs Division of

the Office of Transportation and Air Quality.

10.3.8 Pesticide Environmental Stewardship Program (PESP)

Under the Pesticide Environmental Stewardship Program (PESP), EPA works with many

different organizations to promote environmentally responsible pesticide stewardship.

Membership in PESP requires that organizations develop and adhere to well-defined goals for

improving pesticide stewardship. Only those organizations that meet these goals are allowed to

publicize their membership in the program in their promotional materials.275

10.3.9 Commuter Choice Leadership Initiative

On October 17, 2000, EPA and several leading U.S. employers launched the Commuter Choice

Leadership Initiative. Under a Commuter Choice Leadership agreement, employers commit to

working with EPA to develop new commuting benefits and services for their employees.

(Employers who have joined this initiative are also known as “Commuter Choice Leaders.”) This

initiative is part of an effort to redefine the “comprehensive employee benefits package” to

include commuting benefits alongside other standard employee benefits, such as health plans and

retirement packages. New Commuter Choice benefits will help American employees get to and

from work in ways that cut air pollution and greenhouse gas emissions, improve public health,

increase worker productivity, and cut taxes and other expenses for employers and employees.

This initiative is the first step in a national effort to provide employers across the country with

the opportunity to partner with EPA in providing new commuting choices and services to their

employees. If one-half of all U.S. employers offered the same commuting benefits as those

promised by Commuter Choice Leaders, air pollution in the United States would be cut by the

equivalent of about 15 million cars.
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188 January

The commuting options promoted through the Commuter Choice Leader Initiative include the

following: parking cashout (allowing employees to trade their free parking space for cash),

transit fare subsidies, telecommuting, compressed work schedules, flexible work schedules,

carpools, vanpools, bicycling to work, walking to work, environmentally-friendly vehicles, and

others.

Because of recent changes in the U.S. tax code, employees frequently enjoy a reduced tax burden

when taking advantage of these commuting options. Likewise, U.S. employers enjoy a reduced

tax burden when providing commuting benefits that encourage these commuting options. The

initial Commuter Choice Leaders include The Calvert Group, GEICO DIRECT, Intel, Kaiser

Permanente, Nike, Pitney Bowes, and The Walt Disney Company.

EPA has committed itself to helping Commuter Choice Leaders and their employees in several

ways: (1) by providing public recognition to Commuter Choice Leaders; (2) by providing

technical assistance on commuting options and services; (3) by providing communications and

analytical tools; (4) by helping employers and employees identify federal, state, and local

commuting options, benefits, and services; and (5) by providing a forum for exchanging ideas

and experiences with other leading employers.

10.4 Industry Initiatives

In contrast to EPA programs, which primarily seek to reduce pollution, unilateral industry-led

strategies are designed first and foremost to improve public opinion. They are also designed,

however, to accomplish a broad range of worthy objectives. Responsible Care, which began as

an initiative of the Chemical Manufacturers Association (CMA), a 190-member industry trade

association in the United States, has grown to be truly international in scope. This initiative

includes firms in at least 40 nations, firms that represent more than 85% of the global chemicals

industry.276 CMA provides its members with general guidance documents that explain how

companies may adopt management codes in six areas:

• community awareness and emergency response

• pollution prevention

• process safety

• distribution

• employee health and safety

• product stewardship

For the most part, other industry-sponsored efforts in the United States could be characterized as

extending the Responsible Care initiative to other industries. Examples include the American

Petroleum Institute’s (API) STEP program, “Strategies for Today’s Environmental Partnership,”

and the American Forest and Paper Association’s “Sustainable Forestry Initiative.” The National

Association of Chemical Recyclers has developed a “Responsible Recycling Code,” which

extends Responsible Care principles to chemical recycling. The Synthetic Organic Chemical

Manufacturers Association has adopted the pollution prevention management codes of

Responsible Care. The Great Printers Project is a hybrid effort developed by the Printing
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2001 189

Industries of America, the Environmental Defense Fund, and the governors from four states in

the Great Lakes Region.

10.5 Federal Negotiated Agreements

Negotiated agreements are voluntary in the sense that firms are free to participate, or not, as they

see fit. However, once a firm has signed a negotiated agreement, the firm is committed to

fulfilling its part of the agreement. If the firm fails to deliver on agreed-upon actions or fails to

achieve the results specified in the agreement, the firm risks adverse publicity and increased

scrutiny by EPA. The goals of two negotiated voluntary programs are shown in Table 10-4.

Table 10-4. Federal Negotiated Voluntary Programs

 PROGRAMS

(year program launched) ENVIRONMENTAL GOALS

Project XL (1995)

www.epa.gov/ProjectXL

Develops innovative strategies to test better and more cost- effective ways of

protecting the environment and public health.

Common Sense Initiative (1994)

www.epa.gov/commonsense

Addresses environmental management by industrial sector rather than by

environmental medium (air, water, land). Now an EPA Sector Program.

A primary goal of negotiated strategies is to improve efficiency by reducing regulatory burden.

In practice, most Project XL and CSI (Common Sense Initiative) projects attempt to reduce the

administrative costs associated with reporting, monitoring, and permitting.

10.5.1 Project XL

In 1995, EPA launched a portfolio of high-priority initiatives that sought new ways to protect the

environment and public health, while demonstrating how EPA, the regulated community, and the

public together can improve environmental management to address complex environmental

issues. Since then, businesses, communities, and other federal agencies have responded to this

challenge by participating in these initiatives, including Project XL (which stands for eXcellence

and Leadership). Project XL was developed to accelerate environmental progress through

collaboration on environmental problem solving, to modify certain constraints, and to reduce

some costs that could be associated with environmental regulations.

Project XL solicits ideas from EPA’s partners: private-sector and public-sector facilities, other

government agencies, trade associations, and communities. The project then assesses those ideas

that propose solutions to difficult regulatory or technical problems and that explore new

approaches to protecting public health and the environment, usually at a lower cost or lessened

regulatory burden for the project sponsor. The basic tenet of Project XL can be explained in

terms of its three elements: Through prudent experimentation and regulatory flexibility, EPA and

its partners can (1) find economic gains for businesses and government, (2) more effectively

engage the public in decisions that affect their local environments, and (3) achieve a cleaner

environment.

Project XL is providing a forum for companies to test new technologies and alternative

regulatory approaches that eventually might be used more widely to boost energy efficiency and

achieve greater environmental protection. One criticism of federal efforts to protect the

environment is that EPA’s regulatory requirements can be too prescriptive. For years, EPA has

heard: “Give us environmental goals to meet, but don’t tell us how to meet them.” For the past
The U. S. Experience with Economic Incentives for Protecting the Environment

190 January

decade, EPA has been building greater flexibility into regulatory programs through the trading of

emission “allowances” and other approaches. Through Project XL, EPA is providing companies

and other project sponsors with additional opportunities to demonstrate their abilities to find

innovative approaches to environmental protection. EPA is finding that a little flexibility can go

a long way toward getting better results.

The experiments being conducted under Project XL are in various stages. As of November 2000,

16 projects have been underway for a year or more, and 34 projects have been in progress for

less than 1 year. Early evaluation results show benefits to the environment, project sponsors, and

the communities. Data from several projects indicate the potential that innovative approaches

have for significantly improving current methods for

managing the environment.

In fact, Project XL’s greatest opportunity, and its greatest

challenge, is taking successful ideas from individual pilot

projects and moving these ideas into system-wide practice and

into EPA’s everyday way of doing business. Through

experimentation and evaluation, Project XL can add to an

ever diversifying set of tools for environmental protection by

identifying new approaches, discovering the keys to their

effective use, and better enabling EPA to match the right tool

to the right problem.

Under Project XL, project sponsors have gained operational flexibility, such as expediting or

consolidating permitting, reducing the amount and frequency of recordkeeping and reporting,

creating facility-wide emission caps, and supporting innovative technology. As a result of

operational flexibility, project sponsors, in turn, gain additional benefits from improved

administrative or technological efficiencies, industry recognition and leadership, better

leveraging of employee expertise, better community and stakeholder relations, and improved

relationships with regulators. EPA encourages firms to view the flexibility provided by Project

XL as an opportunity to create real incentives for environmental improvement, whether they are

financial, competitive, technological, community-related, or otherwise.

For example, Intel Corporation has announced that it will take advantage of some these concepts

in their business planning. Early this year, Intel announced that it will build its first 300-

millimeter, high-volume semiconductor manufacturing facility in Chandler, Arizona. Intel will

be able to expand the Chandler facility under an existing air emissions cap that was established

under Project XL in 1996. Table 10-5 provides examples of the actual and anticipated economic

gains that have been reported by project sponsors.

EPA currently faces important questions regarding the Project XL challenge. As the information

on project results expands exponentially, what are the best methods for transforming results into

knowledge? As EPA evaluates and learns how these new tools work, how does it match the right

tools to the right problems? How does the Agency increase its rate and scale of adopting new

ideas into appropriate system-wide practice? How does EPA translate its innovation experience

into improved processes that will enhance its ability to test new concepts?

Features of Project XL

• Superior Environmental Protection

• Cost Savings and Reduced

Paperwork

• Stakeholder Involvement

• Innovative Pollution Prevention

• Transferability

• Feasibility

• Monitoring, Reporting, and

Evaluation

• No Shifting of Risk Burden
Voluntary Programs

2001 191

Table 10-5. Economic Benefits for Select Project Sponsors of Project XL

• Crompton Corporation’s Sistersville plant (formerly known as Witco) saved $58,000 from waste minimization and

pollution prevention (WM/PP) activities in 1998 ($42,000 in one-time activities and $16,000 in savings from recurring air

emissions reductions and methanol recycling). As of July 2000, 67 WM/PP initiatives have been implemented at the

Sistersville plant, resulting in a total cost savings of an additional $1,010,000 during 1997-1999 and the first half of 2000.

Crompton expects future savings of $800,000 over 5 years as a result of a negotiated deferral under the rules of the

Resource Conservation and Recovery Act (RCRA). The company also identified potential, recurring cost savings of

$620,000 per year that will be achieved through WM/PP activities.

• Department of Defense Elmendorf Air Force Base (Elmendorf AFB) aims to streamline the application,

implementation, management, and renewal process for Elmendorf AFB’s Title V permit through reduced monitoring and

recordkeeping. EAFB estimates that total monitoring, recordkeeping, reporting, and overall permit management costs

will decrease by about 80%, yielding about $1.5 million in savings over 6 years.

• Department of Defense Vandenberg Air Force Base (Vandenberg AFB) negotiated a protocol for source testing and

validation with the Santa Barbara County Air Pollution District that is $2,400 cheaper than the standard EPA test ($600

per test rather than $3,000 per test). This protocol complies with administrative requirements to upgrade its

infrastructure, pollution prevention programs, innovative technologies, and other approaches that will cost effectively

reduce air emissions below mandated levels.

• HADCO Corporation has achieved some cost savings by reducing the number of sludge shipments it requires, an

action that results from its voluntary installation of a sludge dryer. HADCO expects to see cost savings when it sends its

sludge directly to a recycler instead of shipping it to an intermediate processor.

• Intel Corporation has avoided millions of dollars in production delays in the competitive quick-to-market semiconductor

industry by eliminating 30 to 50 reviews per year. The company operates under a facility-wide permit that allows for

equipment changes, process changes, and new construction at the site as long as the site’s overall air quality limits are

met. Early this year, Intel announced that it will build its first 300-millimeter, high-volume production manufacturing

facility in Chandler, Arizona. Intel will be able to expand an existing facility under an air emissions cap that was

established under Project XL in 1996.

• Weyerhaeuser Company achieved an estimated savings of $176,000 in reporting costs during the first year of

operation as a result of the successful revision and reissue of the facility’s air quality and wastewater discharge permits.

The company is now saving $200,000 a year by recovering lime muds and reusing this solid waste in lieu of purchasing

new lime for use in the mill’s production. (It did incur a one-time cost of $150,000 in 1998 on related sampling collection

and analysis.) Weyerhaeuser foresees avoiding $10 million in future capital spending. While it expects to spend $10

million on new water equipment, it will subsequently save $20 million that would otherwise have been spent on air

pollution equipment.

Source: Project XL 1999 Comprehensive Report, and Project XL 2000 Comprehensive Report.

http://www.epa.gov/projectxl/guidexl.htm

10.5.2 Common Sense Initiative (CSI)

EPA designed the Common Sense Initiative (CSI) to take environmental protection beyond the

command-and-control, pollutant-specific, and media-specific approaches. CSI used a sector

approach, which focused on a particular business, service, or industrial sector, to achieve more

efficient, effective, and timely environmental results. EPA believes that when industry works

collaboratively with government and other stakeholders to consider releases to all environmental

media concurrently rather in piecemeal fashion, industry sees more clearly the environmental

and economic value of preventing pollution at the source. Furthermore, incentives can be tailored

to meet the specific needs of an industry sector.

CSI was a 4-year (1994−98) pilot program for six large and small industry sectors. EPA worked

with industry-sector representatives and other stakeholders in a consensus-based, federal

advisory committee forum to find innovative ways to achieve “'cleaner, cheaper, smarter”
The U. S. Experience with Economic Incentives for Protecting the Environment

192 January

environmental performance. The sectors involved in CSI were metal finishing, petroleum

refining, printing, auto manufacturing, computers and electronics, and iron and steel. This effort

produced more than 40 sector projects and one sector-wide stewardship initiative, the Metal

Finishing Strategic Goals Program (SGP).

Among the 44 CSI projects, 23 addressed regulations, 20 promoted pollution prevention, 7

sought to reduce recordkeeping and reporting, 9 addressed compliance and enforcement, 6

addressed permitting, and 9 attempted to stimulate new environmental technology. True to its

experimental nature, CSI produced expected and unexpected results. Some results are tangible,

such as the implementation of many formal recommendations to the EPA Administrator, while

others are intangible. It provided learning opportunities on a variety of environmental, economic,

and social issues. For example, CSI significantly improved working relationships among

stakeholders, many of whom had only interacted as adversaries in the past. In fact, the printing,

petroleum, and metal finishing sectors are continuing to address issues in a multi-stakeholder,

federal advisory committee forum.

SGP was adopted by the metal finishing industry in October 1997, and the program is still very

active. While voluntary in nature, this stakeholder-driven program has led to regulatory and nonregulatory incentives, tools, and actions to improve performance by facilities within this sector.

The agreement contains commitments on the part of EPA to change regulations that affect the

industry, such as industry-wide goals for full compliance, improved economic payback, and

reduced emissions from facilities. The agreement also includes a comprehensive action plan for

state and local regulators and other stakeholders. As an indicator of the incentive nature of SGP,

more than 400 companies, 21 states, and over 75 municipalities are participating.

With SGP as a model, EPA is developing similar, targeted programs to achieve better

environmental performance and lower regulatory burden in the meat processing,

shipbuilding/repair, specialty-batch chemical, and metal casting sectors. These programs also

benefit from strong industry support. One of many EPA projects is a joint effort with the metal

casting sector to produce information for states that will help them to permit safe uses for spent

sand from foundries. This action will give the metal casting industry the economic incentive to

re-use, rather than dispose of, the spent sand. Hence, millions of tons less waste will be sent to

landfills each year, saving millions of dollars in waste disposal expenses for the industry.

With the growing knowledge of how to use sector approaches to tackle tough problems, in 1998

EPA began a process to integrate sector work into the Agency’s core functions. Sector Action

Plans were developed for FY1999 and FY2000 to guide this effort. EPA’s program offices have

been encouraged to consider, where appropriate, an integrated cross-Agency, multi-media sector

approach as a way of conducting their everyday business. The draft EPA Sector Program Plan

2001−2005, which is being reviewed by stakeholders, provides a vision for environmental

excellence by U.S. industries. The plan affirms the validity of using all types of sector tools and

approaches to protect the environment, whether these tools and approaches are voluntary or

regulatory, single-media or multi-media, issue-specific or industry-wide. The sector approach is

also being extended to include related economic entities through the supplier-producer-customer

chain and other networks that directly impact an industry sector.

Sector approaches are increasingly common. Through the shared experiences of CSI and other

sector programs, leaders from government, industry, and other stakeholder groups have become
Voluntary Programs

2001 193

more willing to sit down together to search for solutions to today's environmental challenges in a

non-adversarial way.

10.6 An Assessment of Pollution Prevention Efforts

A 1998 EPA review of all of its Partners for the Environment efforts concluded that the results to

date have been impressive. Environmental benefits achieved by EPA’s Partners totaled

• 5.2 billion fewer tons of solid waste generated,

• 199 trillion fewer Btus of energy used,

• 24.7 million fewer tons of greenhouse gases emitted, and

• 1.2 billion fewer gallons of water used.

At the same time, these Partners saved $852 million in 1996.

10.7 Voluntary Programs Developed by EPA Regions

The regional offices of EPA have been active in the development and promotion of voluntary

programs. Table 10-6 identifies many of these programs.

Table 10-6. Selected Regional Voluntary Programs of EPA

EPA PROGRAM EPA

REGION EPA PROGRAM EPA

REGION

Agricultural Initiative 9 Metal Finishing Partnership 9

Air Quality Initiative 8 Osage Nation, Oklahoma, CBEP 6

American Heritage Rivers 8 Pollution Prevention (P2) Awards for Excellence 7

Bay Area Green Business Program 9 P2 Roundtable 7

Beneficial Landscaping 5 Pacific Northwest P2 Research Center 10

Brownfields Initiatives 1-10 Partners for Change 1

Business for the Chesapeake Bay 3 Partnership to Help Foundries Achieve Compliance 6

Center for Industry and Technology 1 PCB Used Oil Sweep 5

Chemical Safety Audit Program 3 Problem Oil Pit Initiatives 8

Chemical Safety Audit Program 4 Small Business Assistance Center 3

Chlor-Alkali Mercury Reduction 5 Southern Application Mountain Initiative 4

Clean Star Texas City 6 StarTrack 1

Community-Based Environmental Protection 8 StarTrack 3

Compliance Leadership 1 Sustainable Challenge Grants 4

Environmental Merit Awards 1 Texas City, Texas, CBEP 6

Evergreen Award 10 U. S. Auto P2 Project 5

Great Printers Project 5 Urban Initiatives 4

Greater Chicago P2 Alliance 5 Urban Initiatives for Sustainable Communities 4

Green Communities 3 Urban Livability 8

Headwaters Waste Mining Initiative 8 Utah 2002 Olympics 8

Henryetta, Oklahoma, CBEP 6 Voluntary Initiative for P2 3

Indoor Quality Initiatives 5 Waste Minimization Assessment 5

Merit Partnership 9
The U. S. Experience with Economic Incentives for Protecting the Environment

194 January

10.8 State Programs

A comprehensive treatment of the hundreds of state and community voluntary programs for

environmental protection is beyond the scope of this paper. However, a few programs are

reported in the following paragraphs to illustrate the nature and scope of these activities.

10.8.1 Massachusetts Recycled Newsprint Program

Massachusetts has developed a voluntary newsprint recycling program. (This program can be

contrasted to Wisconsin’s program, which has recycled content requirements on newspaper

publishers, and fees levied on those failing to meet the requirements. See Chapter 6.) Under the

terms of a 1992 memorandum of understanding between the Commonwealth of Massachusetts

and the Massachusetts Newspaper Publishers Association, the Commonwealth agreed to develop

newsprint collection and processing programs within the state, and the Association agreed to

increase its use of recycled content. The following targets for increasing the recycled content of

newsprint were set: 13% of recycled content by December 1993, 23% by December 1995, 31%

by December 1997, and 40% by December 2000.

The publishers agreed to give preference to purchasing newsprint that was recycled within the

state. They are exempt from the targets described in the previous paragraph if high-quality

recycled newsprint cannot be obtained at prices comparable to those of virgin newsprint.

In return for the publishers’ efforts, the Commonwealth agreed to promote de-inking and

processing facilities in an attempt to increase the supply of recycled-content newsprint that was

available to the publishers. The state also agreed to oppose recycled-content mandates or

penalties for the use of virgin newsprint and to facilitate private-sector investment in the

publishing industry.

10.8.2 Adopt-a-Highway Programs

In Adopt-a-Highway Programs, volunteers agree to periodically clean up selected stretches of

roadside. Although these programs vary from state to state, they typically involve agreements by

organizations to clean up a stretch of roadside that is approximately two miles long and to do so

two to seven times a year, for 1 to 3 years. The state usually offers trash bags, safety vests, and

other gear. Perhaps most important for businesses that participate, the state usually provides at

least one sign to be placed on the adopted roadside that indicates the name of the adopting

organization. However, a 1994 survey revealed that 10 states did not allow businesses to adopt

highways, and 33 states did not allow adopting organizations to contract others to perform the

cleanup.

Adopt-a-Highway programs offer advantages both to states and to adopting organizations. They

allow states to maintain roadsides at lower state expense, and they generate positive publicity for

businesses and other adopting organizations.

Although there is no federal Adopt-a-Highway Program, state programs have spread rapidly

since Texas created the first one in 1985. The number of states with programs increased to 41 by

1990. The aforementioned 1994 survey revealed that all states except Maine and Vermont had

these programs. According to the same survey, 121,700 adopting groups composed of 1.3

million volunteers were participating in the programs, and over 200,000 miles of roadside had

been adopted.
Voluntary Programs

2001 195

10.8.3 State Voluntary Cleanup Programs

More than 40 states have voluntary cleanup programs that offer a wide range of incentives for

cleaning up and reusing brownfields. The voluntary programs vary by funding levels, types of

activities funded, and the eligibility of entities. State incentives can include financial support,

regulatory streamlining, and liability relief. EPA provides about $10 million annually to support

state voluntary cleanup programs. In addition, 14 state voluntary cleanup programs have signed

memoranda of agreement with EPA that clarify state and federal responsibilities and strengthen

the role of the state programs.

10.9 Conclusions

Voluntary programs in the United States combine the features of unilateral, negotiated, and

public voluntary approaches employed in the European Union (EU). In the United States,

voluntary agreements have been crafted under the aegis of the Pollution Prevention Act, through

the Climate Change Action Plan, by industry associations, and by state and local governments.

Most U.S. voluntary efforts would be characterized as cooperative, non-mandatory strategies.

Several authors have claimed that existing legislation impedes the implementation of industryled voluntary agreements and public-sector projects that employ negotiation (Davies and

Mazurek 1996; Kappas 1999; Boyd, Krupnick, and Mazurek 1998). The consequence is that

voluntary approaches serve as a supplement to the main thrust of federally mandated air, water,

waste, and toxic control programs.

In most of the U.S. voluntary programs, the task of evaluating program effectiveness is

hampered by unique program features as well as limited data and monitoring relative to baseline

conditions. While there are some data illustrating the administrative costs of developing certain

types of voluntary agreements and the environmental effectiveness of a few of the energy

conservation measures, a comprehensive cost-effectiveness assessment has not been performed

for any of the voluntary programs.

EPA reports and other literature mention a number of desirable effects besides environmental

improvement that result from these programs. Participants in Responsible Care, 33/50, CSI, and

Project XL all cite enhanced public opinion or goodwill with regulators as significant benefits. In

fact, a motivating factor for several Project XL participants was to improve relations with the

community (Boyd, Krupnick, and Mazurek 1998). The Chemical Manufacturers Association

(CMA) advocated Responsible Care primarily as a means of improving public opinion. CMA

convinced its membership that the future of the chemical industry depended on their reversing

the negative public perception of the industry. To facilitate the adoption of its program, CMA

patterned Responsible Care on its members’ ongoing environmental, health, and safety (EHS)

programs.

Voluntary agreements appear to contribute to constructive dialogue among groups that normally

act as adversaries. Voluntary agreements also provide for more opportunity for stakeholder

participation than the status quo does. With improvements in administrative, monitoring, and

participatory procedures, voluntary agreements could become an important element of the U.S.

strategy for improving the cost effectiveness of environmental management.

Unilateral, industry-led voluntary agreements can suffer from what is termed the "free rider"

problem. Such agreements provide benefits in the form of publicity and goodwill for all

members. Members of an industry association may join a voluntary agreement, yet take minimal
The U. S. Experience with Economic Incentives for Protecting the Environment

196 January

actions to comply. Members can also choose not to join the voluntary agreement, but they can

still benefit from the actions of those who have joined. Understandably, an association would be

reluctant to eject members, since it depends on dues from them to survive. Thus, free-riding may

be a significant problem from the point of view of truly motivating participants to join unilateral

agreements. This problem was evident in the STEP program of the American Petroleum Institute

(API). In this case, several API members joined STEP, yet they failed to follow through with all

of its provisions.

Implementation of negotiated agreements is slowed because Congress did not give EPA the

authority to offer firms relief from existing laws and regulations (Davies and Mazurek 1996).

Two consequences follow. The first issue relates to procedure. Whenever government or trade

associations have less than strong legal authority for their initiatives, they act through consensusbuilding processes. This approach gives individual participants potential veto power over such

initiatives, and it may result in large transaction costs. Second, reliance on consensus-based

methods also tends to result in goals that reflect the basic common denominator on which all

parties agree.

While there were difficulties in the initial implementation of CSI, the experiment has

demonstrated the value of collaborative, sector-based approaches to environmental protection.

Many of the 300 participants in CSI have built positive relationships with former adversaries that

have outlasted the program itself. Based on its experiences with CSI, EPA has expanded

opportunities for involving stakeholders in the Agency’s decision-making processes. EPA is

using voluntary collaboration to improve traditional EPA functions such as regulation,

permitting, and compliance assistance. By applying the many lessons learned from this unique

program, EPA attempts to ensure that the next generation of initiatives for environmental

protection is based on common sense and cost effectiveness.

The first few XL projects posed many challenges. EPA had never attempted this type of

experiment. As a regulatory agency, EPA was cautious in the early stages. EPA and others had

concerns about how to test new approaches and yet still maintain the same level of protection

that the current regulatory system provides. The Agency had to learn as Project XL progressed.

Project sponsors, regulators, and citizens alike invested significant resources and time in XL’s

creative and complex experiments. After gaining experience, the Agency had a better idea of

what information was important for industry to include in their proposals and how decisions

should be made. In 1998, EPA and its partners worked hard to streamline Project XL, so

negotiations would go more smoothly, quickly, and predictably. This new process now yields

agreements for most projects in six months to a year, compared to 24 months or longer under the

old process. For example, the Atlantic Steel project, in Atlanta, Georgia, has already shown

results by producing a signed project agreement for Phase One, just eight months after initial preproposal discussions with EPA.

The Agency’s rapidly growing partnership programs continue to show promise for effecting

improved stewardship.277 These programs typically improve efficiency, cut waste, and conserve

resources, thus lowering costs and yielding environmental benefits. As such, EPA has used

partnership programs to address a variety of issues, including climate change, solid waste,

pesticide risks, and to advance new environmental technologies and practices. These experiences

have shown that voluntary approaches can be a strong complement to the traditional regulatory

system and a tangible means for getting better environmental results.
Index

2001 197

Index

3

33/50 Program, 181–83

A

Acid rain, 69, 71, 76–79

Advance disposal fees, 49, 50, 57, 111, 128

Agstar Program, 179

Air

Charges, fees, and taxes, 37–41

Emissions data, 162

Emissions trading, 69–85

acid rain program, 76–79

banking, 73

bubble policy, 72

evaluation of, 74

netting, 73

NOx emissions trading, 82–85

offset program, 72

state programs, 98

Industrial air toxics, 71

Liability under the Clean Air Act, 147

Motor vehicle emissions, 133–36

Reporting under California "Hot Spots" Act,

164

Smog and other common pollutants, 70

Subsidies, 113

Traditional regulatory approaches, 16

Trends in air quality, 16

Voluntary programs, 186, 187

Alternative fuels, alternative fuel vehicles, 111,

112, 133, 134, 135, 136, 169, 187

C

Cap and trade, 29, 68, 83, 98

CFCs. See Ozone depleting chemicals

Clean Air Act, 12, 37, 67, 72, 73, 76, 77, 80, 83,

84, 85, 86, 87, 89, 97, 147, 148, 150, 170

Clean Water Act, 1, 67, 101, 103, 106, 107, 124,

137, 145, 148, 149

Climate change, 6, 9, 107–10, 180

Voluntary programs, 174–81

Climate Wise, 178

Coalbed Methane Outreach Program, 179

Common Sense Initiative (CSI), 191–93

Community-Based Environmental Protection

(CBEP), 186

Commuter Choice Leadership Initiative, 187

Comprehensive Environmental Response,

Compensation, and Liability Act (CERCLA),

21, 49, 116, 143, 144, 145, 146, 147, 149

Congestion pricing, 2, 3, 53

Conservation Farm Option, 125

Cost effectiveness, 2, 16, 23, 24, 27, 30, 57, 68,

81, 154, 195

D

Design for the Environment (DfE), 183

E

Efficiency (economic), 2, 6, 15, 18, 24, 33, 41,

48, 96, 173, 189

Elasticities

Demand for water, 34

Waste generation with respect to disposal

taxes, 48

Emergency Planning and Community Right-ToKnow Act (EPCRA), 22, 115, 149, 155, 156,

158, 159

Emission reduction credits, 67, 72

Energy Star Buildings, 176

Energy Star Homes, 177

Energy Star Partnership Program, 176

Energy Star Products, 177

Envirofacts, 162

Environmental Accounting Project (EAP), 184

Environmental Leadership Program (ELP), 185

Environmental Quality Incentive Program

(EQIP), 125

F

Farm Bill (1996), 107, 119, 120, 121, 123, 124,

125

Farmland Protection Program, 125

Federal Agencies

Bureau of Land Management, 55, 139

U.S. Bureau of Reclamation, 140

U.S. Department of Agriculture, 119, 120,

124, 125, 126, 141, 175, 179

U.S. Department of Energy, 169, 173, 177,

178
The U. S. Experience with Economic Incentives for Protecting the Environment

198 January

U.S. Office of Management and Budget, 7, 8,

9

G

Gas Guzzler Tax, 49

Green Lights, 176

Green Seal, 166

Greenhouse Gas Emissions. See Climate change

H

Hazardous/Toxic air pollutants

Intertemporal trading, 91

Liability, obsticles to use, 150

Permit fees, 37

Reporting releases, 157, 164

I

Innovation, 2, 14, 16, 27, 28, 29, 81, 101

Intertemporal trading, 91

J

Joint implementation, 108, 175

M

Montreal Protocol, 50, 85

N

National Pollution Discharge Elimination

System (NPDES), 35, 36, 103

Natural Gas Star Program, 179

Newspaper recycling, 132

O

Oil Pollution Act of 1990, 21, 143, 145

Open market trading, 29, 96, 97

Ozone depleting chemicals

Charges, fees, and taxes, 50

Trading program, 71, 85

P

Pesticide Environmental Stewardship Program

(PESP), 187

Pollution prevention, 9, 74, 93, 111, 115, 158,

161, 173, 181, 182, 193

Project XL, 189–91

R

Recycling, 15, 23, 41, 43, 44, 45, 46, 50, 51, 52,

57, 58, 60, 61, 62, 63, 64, 114, 129, 130, 131,

132, 155, 165, 168, 178, 194

Reporting requirements, 22, 87, 155, 159, 160,

161

Resource Conservation and Recovery Act

(RCRA), 115, 148

Responsible Care, 188

S

Sector Facility Indexing (SFI), 162

Sodbuster, 123

Solid and hazardous waste

Charges, fees, and taxes, 41–48

Deposite-refund systems. See Chapter 5, p. 61

Liability, 148–49

Product charges, 51, 52

Subsidies, 128–33

Voluntary programs, 178, 194

State programs

California

AVF requirment, 135

Bay Protection and Toxic Cleanup fees, 37

Beverage container recycling program, 62

Emission permit fees, 38

Hazardous waste landfill fees, 47

Hot Spots, 39, 164

NPDES annual fees, 37

Proposition 65, 133, 163, 170, 171

Recycling Market Development Zones, 130

Recycling subsidies, 130

Regional Clean Air Incentives Market

(RECLAIM), 68, 93–96, 136

Riverside Freeway congestion-based toll,

53

Solid waste disposal fee, 42, 43, 44

Variable rate disposal fees, 43

Wetland reserve program, 123

Colorado

Cherry Creek Reservoir effluent trading,

102

Dillon Reservoir effluent trading, 102

Recycling subsidies, 130

Solid waste disposal fee, 42

Wood Stove and Fireplace Permit Trading,

98

Connecticut

Tax exemption for AVFs, 135
Index

2001 199

Deleware

Conservation Reserve Enhancement

Programs, 122

District of Columbia

Solid waste disposal fees, 46

Florida

Advance Disposal Fee (ADF), 51

Dairy Rule, 126

Mitigation Park Program, 54

Recycling subsidies, 130

Georgia

Marietta variable waste disposal fees, 44

Illinois

Conservation Reserve Enhancement

Programs, 121

Emission Reduction Market System, 96

Recycling subsidies, 130

Solid waste disposal fee, 42

Indiana

Recycling subsidies, 130

Iowa

Recycling subsidies, 130

Wetland reserve program, 123

Kentucky

Recycling subsidies, 130

Louisiana

Environmental Scorecard, 114

Recycling subsidies, 130

Used tire subsidy program, 131

Water permit fees, 36

Wetland reserve program, 123

Wetlands Conservation and Restoration

Fund, 54

Maine

Air emission permit fees, 38

Bottle Deposit System, 62

Pesticide Container Deposit System, 64

Recycling subsidies, 130

Maryland

Conservation Reserve Enhancement

Programs, 121

Nontidal Wetlands Compensation Fund, 54

Massachusetts

Recycled newsprint program, 194

Toxics Use Reduction Act (TURA), 159

Michigan

Emissions Trading Program, 97

Recycling subsidies, 130

Solid waste disposal fee, 42

Minnesota

Conservation Reserve Enhancement

Programs, 121

Contaminated Property Tax, 55

Property tax exemption for undisturbed

wetlands and ungrazed prairie, 127

Recycling subsidies, 130

Variable rate disposal fees, 41

Wetland reserve program, 123

Mississippi

Recycling subsidies, 130

Wetland reserve program, 123

Missouri

Wetland reserve program, 123

New Jersey

Emission Trading Program, 97

Information Awards Program, 133

Recycling subsidies, 130

Solid waste disposal fees, 46

Subsidies to encourage brownfields

development, 117

Worker and Community Right-to-Know

Act, 160

New York

Conservation Reserve Enhancement

Programs, 121

Recycling subsidies, 130

Wetland reserve program, 123

North Carolina

Advanced disposal fees, 52

Cherry Creek Reservoir effluent trading,

103

Conservation Reserve Enhancement

Programs, 122

Wetland reserve program, 123

Oregon

Conservation Reserve Enhancement

Programs, 122

Solid waste disposal fee, 42

Pennsylvania

Emission Trading Program, 98

Industrial Sites Cleanup Fund, 117

Recycling subsidies, 130

Rhode Island

Deposits on replacement vehicle tires, 65

Hard-to-Dispose Material Tax, 51

Texas

Adopt-a-highway, 194

Clean Fuel Incentive Surcharge, 52

Emissions trading program, 97

Governor's Awards for Environmental

Excellence, 170
The U. S. Experience with Economic Incentives for Protecting the Environment

200 January

Liability for natural resource damages, 147

Property tax exemption for pollution

control, 113

Solid waste disposal fees, 46, 51

Tax Exemptions for land preservation, 127

Texas City voluntary programs, 193

Wetland compensation fee, 54

Vermont

Recycling subsidies, 130

Washington

Conservation Reserve Enhancement

Programs, 122

Grass-Burning Permit Trading, 99

Seattle weight-based disposal fees, 44

Solid waste disposal fee, 42

Wisconsin

Effluent fees, 37

Effluent trading, 101

Recycling Law, 132

Recycling subsidies, 130

Solid waste collection fee, 41

Waste Tire Reimbursement Grant Program,

129

Wetland reserve program, 123

Superfund. See Comprehensive Environmental

Response, Compensation, and Liability Act

(CERCLA)

Surface Mining Control and Reclamation Act

(SMCRA) of 1977, 66

Swampbuster Program, 124

T

Toxic Substances Control Act (TSCA), 115, 170

Toxics Release Inventory (TRI). See Emergency

Planning and Community Right-To-Know

Act (EPCRA)

V

Voluntary Mobile Source Emission Reduction

Program (VMEP), 186

W

WasteWise, 178

Water

Charges, fees, and taxes, 34–37

Cost savings from economic incentives, 26

Effluent trading, 99–106

Labeling products for water efficiency, 168

Liability for damage to, 147

Liability under Clean Water Act, 149

Reporting on drinking water quality, 161

Reporting releases to, 157

Reporting under California Proposition 65,

163

Subsidies

land conservation, 118, 119, 120, 124, 126

municipal sewage treatment, 137

negative effects of subsidized water, 140

negative effects of sugar subsidies, 141

Traditional regulatory approaches, 16

Voluntary programs

Adopt Your Watershed, 182

Water Alliances for Voluntary Efficiency

(WAVE), 185

Water Alliances for Voluntary Efficiency

(WAVE), 185

Wildlife Habitat Incentives Program, 126
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2001 201

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Wolf, S. 1986. “Fear and Loathing About the Public Right to Know: The Surprising Success of the

Emergency Planning and Community Right-to-Know Act.” Journal of Land Use & Environmental

Law. 11 Spring.

World Bank. 1992. World Development Report 1992: Development and the Environment.

Yellen, Janet. 1998. “The Economic Impact of Kyoto.” Testimony given before the House of

Representatives Commerce Committee. March 4.

Young, C. Edwin and C. Tim Osborn. 1990. The Conservation Reserve Program: An Economic

Assessment. USDA Economic Research Service AER-626. February.

Young, Terry F. and Chelsea H. Congdon. 1994. Plowing New Ground: Using Economic Incentives to

Control Water Pollution from Agriculture. Oakland CA: Environmental Defense Fund.
The U. S. Experience with Economic Incentives for Protecting the Environment

222 January

Zatz, Michael and Shana Harbour. 1999. “The United State’s Environmental Protection Agency’s 33/50

Program: the anatomy of a successful voluntary pollution reduction program.” Journal of Cleaner

Production. 7:17-26.
About the Report

2001 223

About the Report

This report has been prepared by the National Center for Environmental Economics in the EPA

Office of Policy, Economics, and Innovation, which is a part of the Office of the Administrator.

It builds on two previous reports (Carlin, 1992, and Anderson and Lohof, 1997) with similar

titles. This report both updates and substantially expands on the United States portions of these

earlier reports and was authored by Robert C. Anderson. The report has been extensively revised

as a result of reviews by many EPA staff both inside and outside NCEE for both policy and

technical accuracy. Comments were received from the following EPA offices, among others:

Office of the Administrator:

Office of Policy, Economics, and Innovation

Office of Communications, Education, and Media Relations

Office of Air and Radiation

Office of Enforcement and Compliance Assurance

Office of General Counsel

Office of Prevention, Pesticides and Toxic Substances

Office of Research and Development

Office of Solid Waste and Emergency Response

Office of Water

Region 10

Graphical, editorial, and typographical assistance was obtained under Work Assignment WA4-

24 under EPA Contract 68-W6-0029.

Because of the desirability of making possible future reports in this series as comprehensive as

possible, readers who are aware of interesting applications of incentive mechanisms that they

believe should be included in subsequent reports are encouraged to send that information to Alan

Carlin (Carlin.alan@epa.gov) at EPA Mailcode 1809, Washington, DC 20460, who served as the

principal coordinator for this report.
The U. S. Experience with Economic Incentives for Protecting the Environment

224 January

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Endnotes

2001 225

Endnotes

Chapter 1

1 Carlin. 1992.

2

 Anderson and Lohof. 1997.

3

 Stavins, Robert. 2000; Hahn, Robert. 2000; NAPA. 2000.

Chapter 2

4

 Project 88.

5

 EPA. 1991.

6

 OMB. 1996.

7

 OMB. 2000.

8

 More detail regarding the tax credits is in Congressional Research Service. 1998.

9 http://www.npr.gov/library/nprrpt/annrpt/wrkcst94/create.html

10 President Bill Clinton and Vice President Al Gore. 1995.

11 EPA. 2000a.

12 http://es.epa.gov/ncerqa/rfa/ 13 Vice President Gore. 1999.

Chapter 3

14 Coase. 1960. 15 Sterner and Hoglund. 2000.

16 Hahn and Noll. 1982. 17 Hahn. 1989.

18 Burtraw. 1995; Kerr and Mare. 1995.

19 Alberini and Austin. 1999. 20 Marine Spill Response Corporation.

21 Riley et al. 1994.; Konar and Cohen. 1997. 22 Jaeger. 2000.

23 EPA calculated ratio from costs estimated in Krupnick study.

24 Atkinson and Tietenberg. 1991.

25 See Atkinson and Tietenberg. 1991; Dudek and Palmisano. 1998; Hahn. 1989; Hahn and Hester. 1989; Liroff.

1986; Tietenberg. 1985; and Tietenberg. 1990. 26 Hahn and Noll. 1982.

27 Oates, et al. 1989. 28 Oates, et al. 1989.

Chapter 4

29 Sims. 1977.

30 EPA. 1997b, p. 15.

31 Gibbons. 1986, pp. 10-11; EPA.. 1991, p. 4-5.

32 Morandi, et al. 1995.

33 http://www.epa.gov/owm/npdes.htm 34 http://www.epa.gov/owm/wm05000.htm#state 35 GAO. 1996a. pp. 1-4.

36 Duhl. 1993.

37 Limouze. 1996.

38 SCAQMD Rule 303.

39 Environmental Law Institute. 1993b. p. 22-23.

40 Skumatz. 1996. p. 1.

41 Skumatz.1996. p. 2.

42 Miranda and Aldy. 1996. p. 16.
The U. S. Experience with Economic Incentives for Protecting the Environment

226 January

43 Miranda, Bauer, and Aldy. 1995.

44 Kinnaman and Fullerton. 1998.

45 Skumatz. 1993.

46 Warmer Bulletin. February 1996. 47 Miranda and Aldy. 1996. p. 19.

48 Skumatz. 1993.

49 Skumatz. 1996.

50 Repetto, et al. 1992.

51 Skumatz. 1996.

52 Repetto, et al. 1992.

53 Miller. Undated.

54 GAO. 1995a. p. 23.

55 Hoerner. 1998.

56 Larson. 1996.

57 Deyle and Bretschneider. 1990

58 Hickle. 2000.

59 Barthold. 1994. p. 146-147.

60 Fullerton. 1995.

61 http://www.unep.ch/ozone/mp-text.htm 62 Cook. 1996.

63 CRA. 1994. p. 72-75.

64 Cook. 1996. p. 5.

65 Brown, et al. 2000.

66 Fullerton. 1995. A7.

67 DEN. October 5, 1993.

68 Ackerman. 1994.

69 Hoerner. 1995.

70 Grocery Manufacturers of America. 1995.

71 North Carolina State Law 1998-24.

72 Environmental Law Institute. 1993b.

73 Cameron. 1991.

74 Parry. 2000.

75 Brooks. 1996.

76 http://www.fhwa.dot.gov/policy/13-hmpg.htm. 77 http://www.fcn.state.fl.us/gfc/viewing/mitigation/mit_intro.html. 78 Congressional Research Service. 1996.

79 Executive Order 12548.

80 Hoerner. 1995.

Chapter 5

81 Criner, Jacobs, and Peavey. 1991.

82 White. 1996.

83 Cain. 1998.

84 Cited in Criner, Jacobs, and Peavey. 1991.

85 See for example: http://www.economagic.com/em-cgi/data.exe/bci97/lsm023. 86 Batteese. 1996.

87 As calculated by Batteese. 1996.

88 Surface Mining Control and Reclamation Act of 1977.

Chapter 6

89 Crocker. 1966; Dales. 1968.

90 Dewees. 1983; Harrison. 1983.

91 45 FR 80824. Dec. 8, 1980.

92 45 FR 52676.
Endnotes

2001 227

93 Hahn and Noll. 1982.

94 South Coast Air Quality Management District Rule 1610.

95 EPA. 1986.

96 Hahn and Hester. 1989.

97 EPA. 1980.

98 Crookshank. 1994.

99 Hahn and Hester. 1989.

100 EPA. Acid Rain Program web page: http://www.epa.gov/acidrain 101 Portney. 1990. 102 ICF Resources Inc. 1989. 103 Ellerman. 2000. p. 296 104 EPA. 1995b. 105 Atkeson. 1997. 106 Ellerman. 1997. 107 Cason. 1995. 108 Hausker. 1992. 109 Cason. 1995. 110 McLean. 1996. p.12. 111 Ellerman. 2000. 112 EPA. Acid Rain Program. Monthly Average Price of Sulfur Dioxide Allowances Under the Acid Rain Program. 113 EPA. 1995b. 114 Burtraw. 1998. 115 The 1999 allocations include one-time early reduction credits (24,635) in addition to annual allocations. 116 Ozone Transport Commission. 2000. 117 EPA. 1999b. 118 www.unep.ch/ozone/mp-text.htm 119 Loeb. 1996. 120 Hahn and Hester. 1989. 121 Anderson, Rusin, and Hoffman. 1990. 122 Kerr. 1993. 123 EPA. 1992a. 124 EPA. 2000b. 125 Tier 1 and Tier 2 emission standards are specified in the Clean Air Act Amendments of 1990 and implemented

through EPA regulations. Tier 2 standards will be phased in during the period 2004-2009. 126 Rubin and Kling. 1993. 127 The harmonic mean is computed as the mean obtained by taking the reciprocal of the arithmetic mean of the

reciprocals. 128 Green.1990. 129 EPA. 1992b. 130 Novello and Martineau. 1993. 131 South Coast Air Quality Management District. 1998. 132 Cantor Fitzgerald. 133 EPA. 1995g. 134 Michigan Air Emission Trading Program. 135 New Jersey Emission Trading Program. 136 Pennsylvania Department of Environmental Protection. Emission Reduction Credit Registry System. 137 Skelton. 1994. 138 Putnam, Hayes & Bartlett. 1981. 139 Temple, Barker & Sloane. 1981. 140 Amendola, Gary. 141 O’Neil. 1983. 142 http://www.epa.gov/owow/watershed/trading/traenvrn.pdf 143 EPA. Office of Water. Total Maximum Daily Load Program. 144 EPA. Reinvention Activity Fact Sheets. Effluent Trading in Watersheds.
The U. S. Experience with Economic Incentives for Protecting the Environment

228 January

145 Dahl. 1979. 146 http://cop6.unfccc.int/modules/none.asp?pageid=16 147 Yellen. 1998.

Chapter 7

148 Goldhammer, et al. 1995. p.1-5. 149 DEN. March 24, 1995. B1-2. 150 DEN. March 24, 1995. 151 EPA. 1995c. p. 2-14. 152 Whitehouse. 1996. p. 74. 153 Goldstone. 1996. 154 DEN. January 16, 1996. p. A10. 155 Pennsylvania DEP. Pennsylvania’s Land Recycling Program. 156 Pennsylvania DEP. Fact Sheet: Overview Of The Land Recycling Program. 157 Pennsylvania DEP. 2000. 158 DEN, July 18, 1995. p. B2. 159 Environmental Law Institute. 1995. p. 76. 160 GAO. 1995c. p. 13. 161 GAO. 1995b. 162 National Research Council. 1993. 163 Jacobs and Gilliam. 1985. 164 Haycock and Pinay. 1993. 165 Huslin. 2000. 166 USDA. 1994a. p. 182. 167 Rolfe. 1993. p. 21. 168 USDA. 1996b. 169 GAO. 1995c. p. 17-18. 170 USDA. 1994a. p. 166. 171 USDA. 1994a. p. 175. 172 Sendak. 1995. p.5. 173 DEN. July 14, 1995. 174 Sendak. 1995. 175 DEN. May 2, 1995. B1. 176 DEN. November 14, 1995. B5. 177 Virginia Department of Environmental Quality. Waste Tire Management Program. 178 Steuteville. 1995. 179 Beverage World Databank. 180 Bonderud and Shanovich. 1995. p. 11-32. 181 California EPA. 1996b. 182 Steuteville. 1995. 183 Beverage World Databank. 184 Hendricksen. 1996. 185 Whitehouse. 1996. p. 74. 186 DOE. 1996. 187 Sierra Research. 1995. 188 DEN. September 26, 1995, p. 25. 189 Environmental Law Institute. 1993b. 190 http://www.hud.gov/progdesc/energy-r.html 191 EPA. The Clean Water State Revolving Fund (SRF) Program. 192 Freeman. 1990. p. 100-101. 193 Freeman. 1990, p. 138. 194 EPA. 1995a. 195 EPA. 1999a. 196 EPA. 1995a.
Endnotes

2001 229

197 http://www.epa.gov/oppfead1/annual/1994/94annual.pdf 198 http://www.epa.gov/oppfead1/trac/tracpps3.htm 199 Tolman. 1995.

Chapter 8

200 Alberini and Austin. 1999b. 201 Some firms cite expected future liability for clean-up costs as one of the costs of hazardous waste disposal. For

example, see EPA. June 1994a. 202 U.S. Department of the Interior. CERCLA Natural Resource Damage Assessment Regulations. 203 NOAA. 1996. 204 U.S. Department of the Interior. 1996. 205 U.S. Coast Guard.

Chapter 9

206 National Environmental Policy Act (NEPA) of 1969. 207 Council on Environmental Quality. 208 EPA. 2000d. 209 The annual reportable amount is equal to the combined total quantities recycled, combusted for energy recovery,

treated, or released. 210 59 FR 61501. November 30, 1994. 211 www.epa.gov/tri/dq.htm. 212 GAO. 1994a. p. 14. 213 Khanna et al. 1998. 214 EPA. 1995c. p. 3. 215 Wall Street Journal. June 27, 1996. p. B12. 216 Aurora and Cason. 1995. p. 9. 217 EPA. 1996c. p. 2. 218 EPA. 1998a. 219 Innovations in American Government. 1999. 220 New Jersey Department of Health and Senior Services. 1984. 221 65 FR 4451, August 19, 1998. See also http://www.epa.gov/safewater/ccr1.html 222 http://www.yosemite.epa.gov/ogwdw/ccr.nsf/America?OpenView 223 http://www.epa.gov/autoemissions 224 http://www.epa.gov/enviro/index_java.html 225 http://es.epa.gov/oeca/sfi/ 226 http://es.epa.gov/oeca/sfi/frjun00.htm 227 California. 1986. 228 California EPA. 2000. 229 California Attorney General’s Office. 1996. 230 Helfand. 1994. p. 289. 231 EPA. 1994a. p. 29. 232 Helfand. 1994. p. 291. 233 Helfand. 1994. p. 293. 234 California Air Resources Board. Air Toxics “Hot Spots” (AB 2588) Program. 235 EPA. 1994a. p. 9. 236 EPA. 1994a. p. 49. 237 EPA. 1996b. 238 OSHA. 1983. 239 OSHA. September 1996. 240 DEN. October 23, 1995. p. A3. 241 Green Seal: www.greenseal.org/ 242 Harris and Casey-McCabe. p. 8. 243 EPA. 1994a. p. 13. 244 Harris and Casey-McCabe. p. 8.
The U. S. Experience with Economic Incentives for Protecting the Environment

230 January

245 EPA. 1993a. p. 118. 246 EPA. 1993a. p. 145-146. 247 The studies cited in this paragraph are discussed in EPA (1994a). 248 Harris and Casey-McCabe. p. 11. 249 Harris and Casey-McCabe. p. 9. 250 EPA. 1994a. p. 27-28. 251 Harris and Casey-McCabe. p. 10. 252 California. Waste Reduction Awards Program. 253 TNRCC. 2000. 254 Quinn. 1996. p. 25. 255 Williams. 1999. 256 Investor Responsibility Research Center. p. 11, 61-62. Also: http://www.irrc.org/ 257 Investor Responsibility Research Center. p. 49.

Chapter 10

258 Pollution Prevention Act of 1990. 259 White House. October 1993. 260 Interlaboratory Working Group on Energy-Efficient and Low-Carbon Technologies. 2000. 261 Aurora and Cason. 1995. 262 Aurora and Cason. 1995. p. 3-4. 263 EPA. Energy Star Buildings. Partner Success Stories. 264 EPA. 2000e. 265 Energy cost savings are calculated for an upgrade of a 7-story 196,000 square foot office building in Washington

DC. 266 EPA. 2000e. p. 6. 267 EPA. 1999c. 268 EPA. 2000c. p. 25. 269 EPA. 2000c. 270 EPA. 1998b. 271 Khanna and Damon. 1999. 272 DEN. June 23, 1995. p. E11. 273 EPA. Water Alliances for Voluntary Efficiency (WAVE). 274 http://www.epa.gov/oms/transp/trancont/vmep-gud.pdf 275 http://www.epa.gov/oppbppd1/PESP/ 276 Chemical Manufacturers Association. 277 USEPA. 1999d.