Identifying Cost-Effective Environmental Policies That Address Distributional Concerns

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Some pollution-abatement policies (including typical pollution taxes and auctioned tradeable permits) have the attraction of cost-effectiveness but impose a very large share of the economy-wide cost of regulation on the regulated firms, causing substantial losses of profit in the regulated industries. Other policies (such as systems of grandfathered tradeable permits) manage to avoid imposing such large costs on the regulated firms, but accomplishing this involves a very large sacrifice of cost-effectiveness, that is, a very large increase in the regulatory cost to the economy as a whole. The inability to avoid placing a large economic burden on key industries without significantly increasing the overall economic cost has seriously hampered the broader use of incentive-based and other policies that promise efficiency improvements. This project analyzes and evaluates the efficiency costs of addressing significant distributional concerns in environmental policy. In particular, the project examines the cost of "insulating" producers that have an especially large stake in the economic outcomes of pollution policy, and explores how efficiency costs change as the "insulation net" becomes broader to protect a wider group of industrial stakeholders. It considers a wide range of potential instruments with the aim of identifying relatively cost-effective pollution-control policies that provide a reasonable degree of compensation or insulation to key stakeholders - thus enhancing the prospects for political feasibility. Policies to be considered include those involving inframarginal exemptions to pollution taxes, partial grandfathering of pollution permits, and (in the case of downstream firms) industry-specific corporate tax cuts or tax credits.The research employs both analytically solved and numerical general equilibrium models to delineate the circumstances under which the cost of insulating key sectors is small. It considers the costs of avoiding serious impacts both on "upstream" suppliers of polluting fuels and on "downstream" firms that utilize such fuels intensively. The first major component of the project focuses on C02-abatement policies. The second component generalizes the analysis so that it can be applied to other pollutants such as NO2 and S02. The third component - to be performed in tandem with the first two - involves empirical work to improve key parameters of the theoretical and numerical models and to introduce important "bottom-up" details into the energy system of the numerical model.