"Distributional Effects of Environmental and Energy Policy: An Introduction"

Is it true that many of the effects of environmental policy are likely regressive? According to this, the answer is yes, but rebates to low-income households can offset the regressive effects. "This makes it important to use emissions taxes or the auction of permits, to raise revenue enough to cover the cost of those rebates":

Distributional Effects of Environmental and Energy Policy: An Introduction, by Don Fullerton, NBER Working Paper No. 14241 August 2008: Public economics has well developed tools for analyzing the incidence and distributional effects of ... taxes. ... Yet most pollution policy does not involve taxation at all. Instead, it employs permits or command and control (CAC) regulations such as technology standards, quotas, and other quantity constraints. ...

CAC environmental restrictions do impose costs, and an important question is who bears those costs. Moreover, those restrictions provide benefits of environmental protection, and another important question is who gets those benefits. Thus, full analysis of environmental policy could address all the same questions as in the tax incidence literature. ...

This introduction discusses some initial literature on distributional effects of environmental and energy policy. ... To identify the major effects around which this introduction is organized, consider a simple requirement that electric generating companies cut a particular pollutant to less than some maximum quota. This type of mandate is a common policy choice, and it has at least the following six distributional effects.

First, it raises the cost of production, so it may raise the equilibrium price of output and affect consumers according to spending on electricity (uses side).

Second, it may reduce production, reduce returns in that industry, and place burdens on workers or investors (sources side).

Third, a quota is likely to generate scarcity rents. Take the simple case with fixed pollution per unit output, so the only "abatement technology" is to reduce output. Then a restriction on the quantity of pollution is essentially a restriction on output. Normally firms want to restrict output but are thwarted by antitrust policy. Yet in this case, environmental policy requires firms to restrict output. It allows firms to raise price, and so they make profits, or rents, from the artificial scarcity of production. Just as tradable permit systems hand out valuable permits, the non-tradable quota also provides scarcity rents – to those given the restricted "rights" to pollute.

Fourth, if it cleans up the air, this policy provides benefits that may accrue to some individuals more than others. The "incidence" of these costs and benefits usually refer to their distribution across groups ranked from rich to poor, but analysts and policymakers may also be interested in the distribution of costs or benefits across groups defined by age, ethnicity, region, or between urban, rural, and suburban households.

Fifth, regardless of a neighborhood's air quality improvement, many individuals could be greatly affected through capitalization effects, especially through land and house prices. Suppose this pollution restriction improves air quality everywhere, but in some locations more than others. If the policy is permanent, then anybody who owns land in the most-improved locations experience capital gains that could equal the present value of all future willingness to pay for cleaner air in that neighborhood. Similar capitalization effects provide windfall gains and losses to those who own corporate stock: capital losses on stockholdings in the company that must pay more for environmental technology, and capital gains on stockholdings in companies that sell a substitute product.

Capitalization effects are pernicious. A large capital gain may be experienced by absentee landlords, because they can charge higher rents in future years. Certain renters with cleaner air might be worse off, if their rent increases by more than their willingness to pay for that improvement. Moreover, the gains may not even accrue to those who breathe the cleaner air! If households move into the cleaner area after the policy change, then they must pay more for the privilege. The entire capital gain goes to those who happen to own property at the time of the change, even if they sell it at the higher price and move out before the air improves. Similarly, new stockholders in the burdened company may be "paying" for abatement technology in name only, with the entire present value of the burden felt by those who did own the stock at the time of enactment, even if they sell that stock before the policy is implemented.

Sixth, strong distributional effects are felt during the transition. If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm. It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs. These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry. If the industry shrinks, those workers suffer a significant loss in the value of that human capital. They must also move their families, acquire new training, and start back at the bottom of the firm hierarchy, with significant psychological costs.

Using these six categories in six sections below, this introduction covers research in economics that has begun to analyze distributional effects of environmental and energy policy. Particular emphasis is given to the twenty-one papers published in economics journals that are reprinted in this book. To set the stage for that discussion, however, the rest of this preliminary section reviews some earlier papers.

The classic text in the economic analysis of environmental policy is the book by Baumol and Oates (1988), which devotes a whole chapter to distributional effects. ... A ... challenge in ... Baumol and Oates (1988) is related to the idea that many effects of environmental policy are likely regressive. Consider the six categories just listed. First, it likely raises the price of products that intensively use fossil fuels, such as electricity and transportation. Expenditures on these products make up a high fraction of low income budgets. Second, if abatement technologies are capitalintensive, then any mandate to abate pollution likely induces firms to use new capital as a substitute for polluting inputs. If so, then capital is in more demand relative to labor, depressing the relative wage (which may also impact low-income households). Third, pollution permits handed out to firms bestow scarcity rents on well-off individuals who own those firms. Fourth, low-income individuals may place more value on food and shelter than on incremental improvements in environmental quality. If high-income individuals get the most benefit of pollution abatement, then this effect is regressive as well. Fifth, low-income renters miss out on house price capitalization of air quality benefits. Well-off landlords may reap those gains. Sixth, transition effects are hard to analyze, but could well impact the economy in ways that hurt the unemployed, those already at some disadvantage relative to the rest of us.

That is a potentially incredible list of effects that might all hurt the poor more than the rich. The second challenge for subsequent literature, then, is to determine whether these fears are valid, and whether anything can be done about them – other than to forego environmental improvements! ...

VI. Conclusion: Costs of Transition and Remaining Issues

...Papers in this volume show that environmental protection does likely raise the price of goods such as electricity and transportation that constitute high fractions of low-income budgets. In addition, pollution permits handed out to firms bestow scarcity rents on the well-off individuals who own those firms. Yet some of the papers in this volume show how rebates to low-income households can offset those regressive effects and allow for environmental protection without adverse distributional consequences. This point makes it important to use emissions taxes or the auction of permits, to raise revenue enough to cover the cost of those rebates.

Other papers in this volume estimate whether high income individuals get more benefits from environmental protection, because of higher willingness to pay. Results are mixed. Certainly high income families have more ability to pay, and thus may have higher demand for recreation and other environmental amenities, but the actual valuation by different groups depends on what amenity is being valued. Thus, environmental policies can be designed to provide sufficient protection to low-income neighborhoods. Some of the most pernicious effects of environmental policy, however, are the capitalization effects that provide windfall gains and losses. Those who own land or corporate stock at the time of environmental damage suffer a capital loss, and they may sell that asset before the abatement policy is implemented. It then provides gains to others who did not suffer the loss. Capitalization effects also apply to human capital, with even greater proportional gains and losses to individuals. These effects also are a challenge to the economics profession.

Comments

[save_the_rustbelt]

Allow me to translate:

The US will drive offshore much of our manufacturing, and the jobs will evaporate.

Low income folks will get hosed, the rich will barely notice, the middle will struggle on.

Some attempt will be made to make this look fair.

Conclusion: this little attempt at social and economic engineering could be a giant cluster mess.

[Noni Mausa]

STR, forgive me if I err, but what you describe sounds like what we have now.

Noni

.

[Actually, you shouldn't be allowed]

That's a pretty bad translation.

[Patricia Shannon]

Poor people are more likely to be affected by pollution that causes lung disease, heart disease, cancer, birth defects, neurological problems, and they often can't afford to move to a healthier location or obtain a healthier job, even if they know about the problems. If they own property, it may become worthless.

[Bruce Wilder]

Oh, my. This article makes me feel tired.

Is this kind of sophomoric crap the only alternative to "on the one hand, on the other hand"? Are we really so short of resources to do quality empirical work, that no one knows how to do it? Are the powers of economic reasoning really so atrophied?

"First, it raises the cost of production . . ."

Maybe it does, and then, again, maybe it doesn't. This is why it is an empirical or factual question. It cannot be answered purely by analytic reasoning. At best, analytic reasoning can frame the problem. Which Mr. Fullerton has conspicuously fail to do.

Does a command-and-control requirement to limit emissions of a particular pollutant raise production costs?

I don't know. Details matter.

If we are talking about electrical generation, then management control of the process and scale economies matter a lot, because electricity is mostly generated in a range of increasing returns to scale.

If the requirement imposition is timed to coincide with capital investment in improving and expanding the plant -- the typical policy, by the way -- then, it is quite possible that the imposition will be associated with a reduced production cost.

You could make a counterfactual argument, I suppose, that the imposition still raises production costs compared to what they "would have been", but even that argument might not be tenable. If your reasoning is that "firms . . . use new capital as a substitute for polluting inputs", your reasoning is almost certainly faulty. Capital investment typically implements better managerial or technical control of process -- firms invest to improve factor productivity by reducing waste, including pollution.

A lot of pollution control is accomplished simply by improving control of the production process and reducing, or redirecting, the waste. Pollution control is a by-product of improving management and technical control, aka x-efficiency; there's a total factor productivity gain, which reduces total cost. How many ways can I say it?

Let's say the imposition did affect competition in the industry/market, reducing "supply" as the analysis suggests. Doesn't it follow that costs are higher? Not necessarily. Increasing returns, remember? Pollution control could just add to the pressure toward fewer plants on a larger scale; the larger scale of production results in lower marginal unit costs, and lower average costs.

I don't want to go thru all six of his points, or the subsequent reasoning, as poor as it is.

A simple conceptual experiment is rather obvious: what are the distributional implications of pollution?

Does anyone think the externality of pollution falls mostly on the rich? Does that have the sheen of plausibility?

By that standard of comparison, the tendentiousness of Fullerton's analysis is revealed, without the need for more detailed consideration.

The alleged perniciousness of capitalization, however, ought to be addressed. Is this some catch-all device for neo-liberal crap production? Because his reasoning on this point is completely faulty and stupid.

The poor person, who lives a healthier life in a cleaner neighborhood, may, indeed, pay a somewhat higher rent, in some circumstances. Details matter, again. Increasing the supply of clean neighborhoods might actually reduce the rent associated with living in a clean neighborhood.

But, capitalization doesn't obviate living a healthier life in a cleaner neighborhood. The landlord doesn't live the healthier life vicariously, because he gets a slightly higher rent. And, whether poor people, in general, end up paying higher rents in a cleaner world, would depend on whether poor people earned larger incomes.

The poverty of economic reasoning is very discouraging.

[Think, then write. Works better that way]

Speaking of poor reasoning, did you catch the part about this being one chapter of many that reviews 20+ papers on this topic? You read them all and there's no empirical evidence? Wilder - quit tossing out crap you know nothing about, you start with ridiculous assertions and then get worse (speaking of not having time to go through them all!).

[bakho]

Norhaus (NBER Working Paper No. 10950) studied productivity decline in the 1970s and found"the energy shocks were the earthquake, and the industries with the largest slowdown were nearest the epicenter of the tectonic shifts in the economy."

Is this because companies choose to divert resources that would otherwise go into productivity improvements into energy efficiency instead? Should we expect productivity declines to accompany the latest energy shock?

Does the same thing happen with meeting environmental standards?
Obviously, the best environmental solutions are those that increase productivity and cost less, but this is probably not true of many of the changes.

[Patricia Shannon]

If a someone writes something obviously wrong and biased, why in the world should people be expected to continue reading more?

[Bruce Wilder]

Think: "did you catch the part about this being one chapter of many that reviews 20+ papers on this topic?"

Yes, he's framing 20+ papers on this topic. I got that, and it just depressed me more. He could look at 20+ papers and not be any smarter than this? Geez.

[MattY]

Of course, if we had an efficient tort system for pollution there would be no regression whatsoever, assuming transactions costs are low and class actions have nearly the complete set of damaged parties.

In this system, people who do not cause pollution would be getting checks from those who do. Simple match, balanced, damaged party and damaging party.

[Julio]

"First, it raises the cost of production, "

Even without considering the indirect effects of the changes, this is a dubious statement. Sometimes companies get stuck in local minimum, where none can afford to invest in new processes for fear of making their competitive position temporarily worse. Government regulation can get them collectively unstuck.

Of course, as Bruce Wilder points out, once you consider all the surrounding factors, the statement is silly. Does it raise the cost? It depends.

Sounds like a sloppy overview. But the papers might make some interesting reading.

[Bruce Wilder]

bakho: "Is this because companies choose to divert resources that would otherwise go into productivity improvements into energy efficiency instead? Should we expect productivity declines to accompany the latest energy shock?"

There really should not be any mystery, here.

If you want to increase productivity, you can either apply technical knowledge and management to improve control and reduce error and waste, or you can use more energy input to amplify the work done.

Roughly, in the period, 1950-1972 in the U.S., increases in labor productivity were half-and-half. A 10% improvement in productivity required a 5% increase in associated energy consumption.

In the abstract, pollution can be regarded as the inevitable by-product of using energy in production processes. Ceteris paribus, pollution is proportional to energy consumption, because it "is" energy consumption -- energy consumption and pollution are two aspects of one thing, physical entropy.

We can manipulate and design the control regime to reduce, or manage, energy use and pollution. Actually "tighter" control should result in less energy consumption and pollution, and higher factor productivity overall. But, the inability to amplify or augment factor productivity with the application of energy could, necessarily, constrain the gains in productivity in some production technologies.

This should surprise no one. But, it probably will.

[Bruce Wilder]

MattY: "In this system, people who do not cause pollution would be getting checks from those who do."

Oddly, perhaps, what you describe would not be efficient.

Say, the electric utility paid people living downwind compensation for the pollution suffered. It would be equivalent to a subsidy for living in a dirty neighborhood, and would result in more people living there. Not something one would want to subsidize.

[save_the_rustbelt]

Noni:

When the government takes control of the entire energy market via ultra-complex environmental controls today's problems will look like a Sunday School picnic.

Some of you are old enough to remember the origins of the environmental Super Fund. Not a bad idea, but if memory serves me correctly in the first decade 70% of the funds went to lawyers. I might be a little off on the number. It was a mess.

Utilities in the midwest are already talking electric rate increases in the neighborhoods of 15% - 45% over probably 5 years. Since we can't build nukes and the feds want to punish coal, we could have a much larger Applalachia, say all the way to the UP of Michigan.

[piglet]

str, I have to agree with "Actually, you shouldn't be allowed". You are writing such an incoherent nonsense today that it gives me pain.

"When the government takes control of the entire energy market via ultra-complex environmental controls today's problems will look like a Sunday School picnic."

You should become a speech writer for McCain. You have the qualification.

[Lafayette]

Simpletons

Article: Sixth, strong distributional effects are felt during the transition. If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm. It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs. These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry. If the industry shrinks, those workers suffer a significant loss in the value of that human capital. They must also move their families, acquire new training, and start back at the bottom of the firm hierarchy, with significant psychological costs.

This is just not true and if true is rich with exaggeration.

Carbon taxes have been introduced in the EU for a while now. There is no such evidence of the above sort of drama happening.

The above may be fodder for a Hollywood scenario, but it does not jibe with reality in places where carbon taxes are being introduced. The taxes are not so onerous as to produce the effects as stated above.

The above cited takes the people who devise such taxation for simpletons.

[Lafayette]

MattY: In this system, people who do not cause pollution would be getting checks from those who do. Simple match, balanced, damaged party and damaging party.

It is not as simple as you portray.

Rather, "companies that pollute less get checks from people who pollute more". The intent is to incentivize companies back to an average level of pollution , and to diminish the average where possible.

Tradeable carbon taxes do reduce pollution in as much as they cap its increase. That is goodness, but it is not the total solution - just partly the answer.

Note that it is perfectly reasonable to assume that some polluting companies will pay the cost of purchasing pollution emissions and carry on very well (since they are able to pass the additional costs on to consumers because market conditions permit them to do so). The above argumentation, that additional emission taxation will "cripple" industries (thereby creating unemployment) is madness.

Besides, diminishing permanently carbon emissions will take a lot more than just tradable permits (to pollute). We must look to unhooking ourselves definitively from the carbon molecule in terms of energy usage in residential usage, transportation and industrial usages.

This can only be accomplished by developing/implementing both renewable energy sources and nuclear energy (for backbone supplies of grid-supplied electricity).

[save_the_rustbelt]

"The above cited takes the people who devise such taxation for simpletons."

Yes, like the US Congress and the Department of Treasury / IRS.

[bakho]

If one looks at the short term effects of banning some CFCs, there is a higher cost and transition costs to different equipment. Some of those costs were ameliorated by SEER standards that lower energy costs. DuPont, which held many of the patents on the CFC replacements was a big winner because they were positioned to take advantage on the changing market. Environmental regulations remove some options and favor others. Without the regulations, there was and is little incentive to transition from old technology with large external costs.

[save_the_rustbelt]

piglet:

Spend some time studying the history of the environmental superfund, then get back to me about what a terrific job the federal government could do with this issue. :)

[Patricia Shannon]

The reason that much of the cost of the superfund went to legal fees wasn't because of the government. It was because private industry chose to spend money fighting the law, instead of using that money to clean up the toxic waste they dumped into our environment.

[Dickeylee]

Rusty, Patricia is right. I worked at a Superfund sight for 12 years, for DuP---, and DuP--- fought the EPA in court for 9 of those years, before any site work could start.

[piglet]

"If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm. It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs. These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry."

This is exactly what happens all the time under the rubric of trade liberalization, off-shoring, globalization. Funny that these "disruptions" are ok with almost all economists when they are the result of (Hallelujah!) "Free" Trade but in the context of saving the planet, they are suddenly painted on the wall as a huge threat. And Lafayette is right of course, that description is hyperbolic. Can you think of any examples of environmental legislation wiping out whole industries?

[reason]

piglet...
Yep. Repeat after me, COST OF ADJUSTMENT, COST OF ADJUSTMENT ....
Somehow, it is always missing in models.

bakho ...
I argued this on another site. Consider a highly competitive market with profit maximising firms and a new technology that will possably lower marginal costs. (Nobody wants to be on the bleeding edge however, the costs are higher for early adopters.) Because the firms are profit maximising however, they are not actually interested in lowering their costs as such, because their competitors will follow suit (i.e. it gives them no profit advantage). Nothing will happen unless some external force (government regulation for instance) pushes them. And then the whole society not only ends up with a cleaner environment BUT also lower costs.

[reason]

Notice the argument above depends on UNCERTAINTY and costs of adjustment as barriers stopping transition. I can remember when public service acted as trial ground (for new software) and entry level training ground for private enterprise. In competitive markets, nobody will provide this service because of UNCERTAINTY and costs of adjustments and productivity growth for the whole economy can as a result be adversely affected. (It is one argument for oligopolistic markets, by the way.)

[reason]

I find the argument put forward by prolific Amazon reviewer Michael Emmet Brady that Adam Smith and J.M. Keynes were well aware of the importance of uncertainty, but that the Chicago school lost the awareness of it by equating risk and uncertainty, interesting. The Austrian school sort of understood, but never had a proper formal model for it (like Keynes did). The Chicago school model is a extreme limiting case of the more general Keynesian model (where uncertainty disappears).

[Walt]

“Suppose the pollution restriction [on electric utilities] improves air quality everywhere, but in some locations more than others.”

From this seemingly plausible idea, Fullerton segues to an imaginary “cleaner area,” into or from which households might move, and within which landlords might receive windfall capital gains.

However, in reality such a “cleaner area” would be no less than the whole of eastern North America. Aerosol research has shown that, across that area, sulfur dioxide emissions -- chiefly from electric utilities -- creates a vast blanket of acidic particles that is more or less uniform, moves with major weather systems, and degrades rural and urban visibilities alike.

Suppose utility emissions ceased altogether. Dramatic visual effects would include a five-fold or greater increase in summertime visual range. But even then, Fullerton’s “pernicious” windfalls would be unlikely because few householders see poor visibility as pollution. Reinforced by a half-century of misleading weather reports, most perceive the ubiquitous “summer haze” as a natural obscuration. (Some may even actively enjoy the dramatic red disk of a setting sun seen through polluted air.)

Fullerton’s “cleaner area” recalls the bogus “airshed” concept advanced by industry in the early 1960s. Its codification as “Air Quality Control Regions” is one of many examples of industry’s domination of regulators. From an historical perspective, Fullerton’s tired “command and control” epithet better describes the action of industry on regulators than vice versa.

- posted by an airline pilot