Dynamic Adjustment to Incentive-Based Environmental Policy to Improve Efficiency and PerformanceEPA Grant Number: R830990
Title: Dynamic Adjustment to Incentive-Based Environmental Policy to Improve Efficiency and Performance
Investigators: Burtraw, Dallas , Palmer, Karen
Institution: Resources for the Future
EPA Project Officer: Hahn, Intaek
Project Period: June 1, 2003 through May 31, 2005
Project Amount: $173,684
RFA: Market Mechanisms and Incentives for Environmental Management (2002) RFA Text | Recipients Lists
Research Category: Economics and Decision Sciences
Important environmental policies such as amendments to the Clean Air Act, Clean Water Act, or environmental regulations targeted at other media are made at discrete points in time – typically less often than once per decade – and usually these policies have a limited capability to incorporate new scientific or economic information. Achieving consensus on new scientific information is necessarily slow and may occur on a time line that is roughly synchronized with regulatory or legislative processes. However, the expanded use of market based environmental policies (such as cap and trade programs) integrates an instantaneous means of revealing new economic information through the allowance price signal that reflects the marginal cost of compliance. Currently, cap and trade programs fail to take advantage of this information and, as a result, these policies are not as efficient as they could be.
This research will investigate institutional designs reflected in several current policy proposals and measure the potential gains in economic efficiency and environmental performance from incorporating a decision rule for adjusting the pace of emission reductions when the costs of compliance differ from expectations. Often there is significant uncertainty about costs, as in the case of potential policies to reduce greenhouse gases and, to a lesser extent, the dramatic reductions in SO2, NOx and mercury that may be required in the electricity sector. In these cases a dynamic adjustment to the emission caps provides insurance that such policies will not impose extraordinary harm to the economy. On the other hand if technological change and organizational innovation reduce costs below expected levels, as many environmental advocates claim will occur, then dynamic adjustment can allow for an acceleration in the pace of emission reductions.
This investigation will use algebraic methods to develop a taxonomy of possible designs for incentive-based environmental policies that incorporate dynamic adjustment and to shed light on the incentive properties of these mechanisms. We will use computer simulations to estimate their potential economic and environmental benefits.
The results will provide information of scholarly stature and immediate policy relevance to applications of market mechanisms for environmental protection. Based on the results of this research, policymakers will be able to capture even more of the potential efficiency advantages of market-based policies.