Grantee Research Project Results
2006 Progress Report: An Experimental Economics Examination of Incentive Mechanisms for Reducing Ambient Water Pollution Levels from Agricultural Non-Point Source Pollution
EPA Grant Number: R830989Title: An Experimental Economics Examination of Incentive Mechanisms for Reducing Ambient Water Pollution Levels from Agricultural Non-Point Source Pollution
Investigators: Poe, Gregory , Schulze, William
Institution: Cornell University
EPA Project Officer: Hahn, Intaek
Project Period: June 1, 2003 through May 31, 2006 (Extended to May 31, 2008)
Project Period Covered by this Report: June 1, 2006 through May 31, 2007
Project Amount: $279,999
RFA: Market Mechanisms and Incentives for Environmental Management (2002) RFA Text | Recipients Lists
Research Category: Environmental Justice
Objective:
The broad objective of this research is to use established experimental economics methods to test the variety of ambient-based incentive programs that have been suggested in the theoretical environmental economics literature on nonpoint source pollution. Such incentive programs may involve fixed penalties for all sources of emissions if ambient pollution levels exceed a specified level. Alternatively taxes (subsidies) may be levied for each unit of pollution exceeding (falling below) the ambient pollution standard. It is also possible to combine the “fixed penalty” and the “marginal” tax/subsidy approaches. Because of stochastic biophysical relationships, the relation between aggregate emissions and ambient pollution levels has a random element.
Within this broad framework, there are four specific components/tasks of this research:
- Examine the efficiency of tax/subsidy/fixed penalty and combined approaches under noncooperative and cooperative settings under conditions in which pollution, damages, and marginal penalties are assumed to be linear functions of output +/- the random element.
- Examine viability of alternative approaches suggested in the literature when damages are not linear, subjects are heterogeneous in terms of size and abatement functions, and sources of nonpoint pollution are able to reduce emissions through reducing output, investing in abatement management options, or both.
- Building on #1 and #2 above, explore the use of voluntary programs with the threat of imposing an ambient tax/subsidy scheme if ambient targets are not met (Segerson and Wu, 2006). Such an approach has desirable policy features and has been demonstrated theoretically to provide efficient outcomes.
- Building on #1, #2, and #3, which involve low stakes experiments with student subjects, evaluate the most efficient outcome under high-stakes farm population settings.
The results of these tasks should be of substantial use to environmental managers because many of the practical issues of implementing a new mechanism in the field can be discovered in the relatively low-cost environment of the experimental economics laboratory.
Progress Summary:
Task #1 is completed and two journal articles have been published (Poe, et al., 2004; Vossler, et al., 2006) in the academic literature along with related conference presentations.
Our research has centered on experiments replicating conditions that policy economists have identified as most conducive to successful implementation of ambient-based pollution control incentive programs: small watersheds with limited numbers of farmers, homogeneous operations, readily monitored water quality, and short time lags between emissions and ambient pollution levels. We examine the efficacy of the various fixed penalty and marginal pollution control incentive mechanisms under conditions in which pollution sources do not act cooperatively (consistent with theoretical presentations) and an alternative policy relevant situation where communication and cooperation are permitted. There are three key policy findings from this task:
- Our research demonstrates that when communication and cooperation are allowed, the results and policy implications are dramatically different than the optimal outcomes of the policy design when communication and cooperation are not assumed. This indicates that, at least for a subset of ambient control mechanisms, pollution control policies can be undermined by varying, unknown levels of communication across watersheds.
- Under conditions where cooperation is possible, policies involving subsidies for achieved levels of pollution below the policy target lead to over abatement. In other words, participants realize that as a group it is more profitable to reduce pollution below target levels because of the positive financial returns associated with marginal subsidies. In contrast, when communication is allowed, mechanisms such as the fixed penalty and the tax-only mechanisms that do not involve subsidies approximate optimal levels. However, the fixed penalty approaches lead to under abatement (excess pollution) when cooperation is not possible. Based on these results, we demonstrate that subsidy-based and fixed penalty approaches are undesirable from a policy perspective because their performance depends upon unknown, and uncontrollable, levels of cooperation.
- Tax-only policies (i.e., those that impose a marginal tax on each unit of pollution exceeding the environmental standard) approximate efficient levels of abatement in both cooperative and noncooperative settings. Hence tax-only, incentive-based ambient pollution policies appear to be the most promising in designing policies that are not dependent upon communication.
NOTE: Vossler, et al., 2006, received the Economic Inquiry Editor’s Choice Award for 2006.
Task #2 is completed. One paper has been accepted for journal publication (Suter, et al., in press). Another has been presented at a professional conference and is under revision for journal submission.
We have examined the robustness of the of the “best setting” findings described above to examine performance of the tax-only mechanism when damages are both linear and non-linear and subjects are heterogeneous. Based on theoretical issues raised in the mechanism design literature, we also investigated policy setting wherein taxes are levied on levels of pollution below the desired environmental standards. Designed appropriately, such taxes still create incentives to abate to levels consistent with the environmental standards.
With respect to nonlinearity of damages (i.e., the damages of pollution increase dramatically when pollution rises rather than having constant damages for each level of pollution), our findings suggest that, in terms of quantity of emissions, the tax-only mechanism achieves from 80–99% of the economic surplus in both the noncooperative linear and nonlinear settings. However, in cooperative settings, over abatement is demonstrated, much in the same way as the tax-subsidy mechanism investigated under Task #1. Nevertheless, when the tax-only mechanism is designed appropriately such that the tax threshold corresponds with the target level of pollution, high efficiency is achieved in the linear-damages-without-communication (93%), linear-damages-with-communication (100%), non-linear-damages-without-communication (100%), and non-linear-damages-with-communication (100%). Despite these high aggregate emissions efficiency levels, there remain substantial equity issues associated with variation in the levels of individual abatement. Although achieving near-optimal levels of abatement for the group, some firms over abate while others under abate. Building on notions of allocative and technical efficiencies in the production economics literature, we have developed methods of comparing these “equity” inefficiencies to “aggregate emissions” inefficiencies in terms of their overall impact on potential economic surplus. For noncommunication settings, the equity inefficiencies more substantively impact the overall efficiency of the mechanism than the aggregate emissions inefficiencies. For the cooperative settings, both sources of efficiencies are equally high.
The performance of the tax-only policy that has been discussed to this point correspond to settings in which polluting firms are homogenous in terms of size and pollution abatement costs. To examine more realistic conditions, representative firms were created to correspond to three different farm size categories in the NY dairy industry with income levels and abatement cost functions calibrated to dairy farm business summary statistics: small (80 cows, annual net farm income = $30,000); medium (200 cows, annual net farm income = $75,000); large (660 cows, annual net farm income = $180,000). Firms were not allowed to cooperate. The findings from the experiments demonstrate that tax-only mechanisms continue to be relatively efficient in meeting pollution standards under heterogeneous conditions. However, inequity in abatement levels across firms is more pronounced. Notably, efficient aggregate abatement levels are achieved by large farms tending to over abate relative to their optimal abatement level, while small farms under abate. In experiments where larger farms opt not to bear a more than a proportional share of abatement, experimental results indicate that strategic behavior of large farms (which can weather temporary taxes better) can lead to bankruptcies of the small farms.
From a policy perspective, there are two major results from this task. (1) If tax thresholds are appropriately set, tax-only policies continue to be efficient in heterogeneous settings with a distribution of firm sizes. (2) Although effective in achieving desired levels of pollution, equity concerns arise in tax-only policies, especially under conditions of heterogeneous firm sizes.
Task #3 is completed. Papers have been presented at professional conferences and a Ph.D. dissertation chapter on this topic has been completed.
Historically, water quality policy in the United States has not involved taxing nonpoint source polluters. Given the political challenges of implementing taxes at a watershed level, Segerson and Wu (2006) recently designed a voluntary-threat ambient pollution control incentive mechanism. Briefly, such a policy involves two stages. In the first stage, potentially regulated entities are given the opportunity to voluntarily reach a pollution standard and so on. If they achieve the standard then the voluntary policy continues into the next period. If the group fails to achieve a standard, a tax-only policy with a tax threshold below the standard will be put in place. Segerson and Wu (2006) demonstrate theoretically that such a policy threat could lead firms to collectively achieve the environmental standard voluntarily.
Our experimental design under this approach allows for varying levels of incentives. To summarize, we find that this policy can be effective if the threatened tax penalty is substantially large, greatly exceeding the theoretically minimum levels of threat necessary to achieve the environmental standards in noncooperative settings. When communication and cooperation are allowed, environmental targets are achieved on relatively low levels of threatened tax penalty.
We also developed and investigated a novel voluntary threat mechanism that has some theoretical advantages over the Segerson-Wu mechanism. In the Segerson-Wu mechanism, the level of the threat is determined exogenously (i.e., the specific per-unit tax and the level of the tax threshold is specified prior to the voluntary period). In the new mechanism, the per-unit tax is specified, but the threshold is made a function of the degree of violation of the water quality standard in the voluntary period. We demonstrate that this policy does reduce the incidence of strategic behaviors in noncooperative settings, both theoretically and in practice, and is effective in cooperative settings. However, like the Segerson-Wu mechanism, the level of the threat has to greatly exceed the minimum theoretical level to induce the desired level of abatement.
From a policy perspective, our results under this task suggest the following: unless cooperation can be assumed, the level of the threatened policy has to greatly exceed the theoretical minimum, obviating some of the political palatability of the voluntary-threat mechanism.
Task #4: Underway, to be completed this final year of the extended project.
Based on the results from the first three tasks, we have decided that, at this point in time, the tax-only mechanism with a tax threshold slightly below the environmental standard is the most promising ambient-based pollution control incentive mechanism. We have already conducted a baseline study of such a mechanism using students in the laboratory under homogenous and heterogeneous conditions and relatively low stake conditions. To complete this task we intend to conduct high stakes experiments with NY farmers.
Future Activities:
Based on the results from the first three tasks, we have decided that, at this point in time, the tax-only mechanism with a tax threshold slightly below the environmental standard is the most promising ambient-based pollution control incentive mechanism. We have already conducted a baseline study of such a mechanism using students in the laboratory under homogenous and heterogeneous conditions and relatively low stake conditions. To complete this task we intend to conduct high stakes experiments with NY farmers.
In addition to these four tasks, we intend to develop a Web platform so as to make the tax-only experiments available to a broader audience for replication and teaching purposes.
References:
Segerson K, Wu J. Nonpoint pollution control: inducing first-best outcomes through the use of threats. Journal of Environmental Economics and Management 2006;51(2):165-184.
Journal Articles on this Report : 3 Displayed | Download in RIS Format
Other project views: | All 16 publications | 4 publications in selected types | All 4 journal articles |
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Poe GL, Schulze WD, Segerson K, Suter JF, Vossler CA. Exploring the performance of ambient-based policy instruments when nonpoint source polluters can cooperate. American Journal of Agricultural Economics 2004;86(5):1203-1210. |
R830989 (2003) R830989 (2006) R830989 (Final) |
Exit |
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Suter JF, Vossler CA, Poe GL, Segerson K. Experiments on damage-based ambient taxes for nonpoint source polluters. American Journal of Agricultural Economics 2008;90(1):86-102. |
R830989 (2006) R830989 (Final) |
Exit |
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Vossler CA, Poe GL, Schulze WD, Segerson K. Communication and incentive mechanisms based on group performance: an experimental study of nonpoint pollution control. Economic Inquiry 2006;44(4):599-613. (Awarded Editor's Choice Article-Economic Inquiry 2006). |
R830989 (2003) R830989 (2006) R830989 (Final) |
Exit |
Supplemental Keywords:
public policy, decision making, non-point source pollution prevention, water, agriculture, experimental economics.Environmental Protection Agency, Economic, Social, & Behavioral Science Research Program, RFA, Scientific Discipline, Ecology and Ecosystems, Economics, Economics & Decision Making, Reinvention, Social Science, decision-making, Clean Water Act, agriculture, economic incentives, economic research, environmental policy, incentives, nonpoint source pollution, NPSP, policy incentives, policy making, water quality model,, RFA, ENVIRONMENTAL PROTECTION AGENCY, Economic, Social, & Behavioral Science Research Program, Scientific Discipline, Reinvention, Economics, decision-making, Ecological Risk Assessment, Ecology and Ecosystems, Market mechanisms, Social Science, Economics & Decision Making, compliance behavior, effects of policy instruments, market-based mechanisms, nonpoint source pollution trading, nonpoint source pollution, impact of federal policy instruments, policy making, economic research, policy incentives, watershed, decision making, Clean Water Act, incentives, economic incentives, environmental Compliance, environmental policy, water pollution, agriculture, nonpoint source pollution (NPSP), voluntary programsProgress and Final Reports:
Original AbstractThe perspectives, information and conclusions conveyed in research project abstracts, progress reports, final reports, journal abstracts and journal publications convey the viewpoints of the principal investigator and may not represent the views and policies of ORD and EPA. Conclusions drawn by the principal investigators have not been reviewed by the Agency.