- Understand the general process and difficulties of policymaking.
- Describe how policy levers can help shape business sustainability.
- Discuss effective policy design features.
- Describe specific policy instruments and their features.
Markets are useful for efficiently allocating certain types of goods and services and not as useful on their own for allocating other goods and services that are subject to market failures, such as externalities as discussed previously. A key question for government policymakers is what policies might help achieve desired outcomes. Here we focus on the desired outcome for a more sustainable future and review different types of policies and policy levers that can help to shape effective policy development in this area.
Sustainability Policy Design Features
In the US context and consistent with the nation’s private market principles, most would agree that sustainability policies should strive to achieve desired environmental objectives with the greatest positive economic benefit or at least cost. Another key principle is to strive for fairness and justice—that is, to try to ensure that polices work to reduce inequities or at a minimum do not make current inequities in our society any worse than they currently are. An example of injustice is using low-income neighborhoods or countries as the location for hazardous waste collection to reduce hazardous waste generated in higher-income neighborhoods or nations.
After these principles, most of the pragmatic proponents of sustainability would be supportive of the following policy design features:
- Use an incremental approach. Policy proponents should recognize that there will be supporters of existing policies who will resist change. An incremental approach respects what exists now; however, it should not be an excuse for either inaction or diversion from longer-term desired objectives.
- Be ready to change or adjust policies. Policies must be able to adapt to changed conditions. Policies are evaluated once they are vetted and tested after they are implemented; experience provides opportunities for learning and adjustment. The process of adaptive management should guide policy design and implementation.
- Address problems institutionally on the same scale as the problem. It is desirable to deal with a problem at the smallest domain in which it can be solved. Problems should be addressed by institutions on the same scale as the problem. For example, garbage and recycling collection is mostly a local problem and requires local policies. Garbage disposal and the reuse of recycled materials is a wider area issue and would require multilocal or regional entities to address. Climate stability and energy use are global problems and require global policy instruments and institutions.
- Address uncertainty by erring on the side of reducing risk of environmental damage when dealing with the possibility of significant environmental damage that is irreversible. Policies should leave a margin of error when dealing with the biophysical environment. Ecosystem dynamics involve considerable uncertainties and could involve irrevocable negative changes. Adopting a precautionary approach would establish a safety margin between the demands placed on ecosystems and best estimates of their capacities.
What follows are some of the governmental policy instruments available to address issues related to sustainability.
Taxes (Taxing “Bads”)
Taxes are a powerful, frequently used, policy instument used to collect revenue to support government policies and programs. And they are also used to discourage societal “bads” that can harm individuals and impose costs on society. This includes the use of taxes to discourage smoking and alcohol use.
With regards to environmental and energy issues, taxes, such as a carbon tax (a tax on the carbon content of fossil fuel, e.g., coal, oil, gas) can send market signals that the free market does not send and can improve the efficiency and effectiveness of the market system. Carbon taxes can help to correct for the market failures associated with externalities and the difficulties of establishing property rights with natural resources.
Several nations have established carbon taxes, including Finland, Sweden, and the Netherlands. An informal coalition of economists led by Harvard University professor Greg Mankiw have endorsed a US carbon tax as an efficient economic policy to address concerns about climate change. The proponents of the carbon tax point out that research has demonstrated that people respond to taxes—make the taxes high enough and behavior changes—whether it’s smoking or polluting. So a carbon tax would shift energy consumption from high carbon producing sources to low carbon producing sources, for example, from coal to solar power.
The flip side to taxing is tax credits. Tax credits that reduce tax liabilities can encourage different forms of investment and different types of business activity. Tax credits are a popular policy instrument for sustainable business in the United States.
Federal and state renewable energy and energy efficiency investment tax credits reduce the after-tax cost and encourage businesses and households to invest in renewable energy and energy efficiency. An example is the US federal business energy investment tax credit available for eligible energy systems placed in service on or before December 31, 2016. For solar, small wind turbines, and fuel cells, the credit is equal to 30 percent of expenditures, with no maximum credit. For geothermal systems, microturbines, and combined heat and power, the credit is equal to 10 percent of expenditures, with no maximum credit limit. The original use of the equipment must begin with the taxpayer, or the system must be constructed by the taxpayer. The equipment must also meet any performance and quality standards in effect at the time the equipment is acquired, and the energy property must be operational in the year in which the credit is first taken.
A regulation is a rule or order prescribed by an authority that controls or directs some activity, often in relation to a standard or target. Environmental awareness in the twentieth century led to a large number of regulations to protect people and the environment. Bans, quotas, and standards of various sorts have been ordered by governments, and fines or penalties are generally prescribed for violations.
DDT (Dichlorodiphenyltrichloroethane), a synthetic pesticide, was one of the earliest substances banned; individual paper factories have limits or quotas set for the amount of wastes they can discharge into a river; and emission standards have been prescribed for many industries. Other regulations require the use of prescribed technologies—for example, best available control technologies (BACTs) may be required to reduce pollution—and the type of equipment used to harvest fish may be prescribed to limit habitat destruction.
Regulations can be quite effective at limiting pollution and are helpful in managing renewable resources. But command and control mechanisms are not always the most efficient ways of achieving the desired ends. Regulations have their own limitations as well. There are the issues of administrative costs of microcontrol and threats and potential violations of private property rights. In addition, once regulatory goals are achieved there may be no incentives for additional improvements.
A ban is a regulation that removes a substance from circulation, thereby eliminating throughput of a particular type. A ban is the simplest and best solution when an emitted substance cannot be absorbed or broken down through natural processes; it accumulates in the environment where it causes damage. DDT, leaded gasoline, and CFCs (chlorofluorocarbons; organic compounds that contain carbon) were all found to cause damage to critical ecosystems and all have been banned in the United States and many other developed countries.
Some of the earliest bans can be traced back more than 2,500 years, when hunting certain animals was banned in India. Bans can take many forms: they can be total or partial, they can focus on production or consumption, they can be temporary or permanent, they can be graduated in time or magnitude, or they can be supported by incentives or penalties. Many substances have been banned, and bans are used in a wide variety of situations—from local seasonal bans on hunting and fishing to global treaties imposing bans on specific compounds or activities.
Quotas are partial bans. They are a way to establish the maximum allowable throughput of a substance and could be very effective in ensuring specific substances only enter the economy at a sustainable level. Quotas, such as quotas on fishing, may be preferable to a complete ban if there is evidence that some levels of throughput can be safely absorbed by the ecosystems they affect. This safe level of throughput allows the benefits of the substance to be made available. Quotas should not be used unless there is adequate proof that safe levels are indeed possible; often there are disputes about this issue.
Rationing is similar to quotas. While not used currently in the United States, rationing is a public policy that has been used in the past. It has been used most frequently during times of war in the United States to allocate food and consumer goods in short supply to households and businesses. Rationing was used in a nonwar situation in the 1970s in the United States during the OPEC oil embargo. Gasoline was rationed by designating odd and even days for the purchase of gasoline based on the last digit or letter on license plates. In a context of limited reserves of nonrenewable energy sources, rationing is one tool that may become necessary.
Standards are prescribed levels of performance enforced by law. A wide range of such standards were enacted in the latter part of the twentieth century as a response to growing awareness and concern over environmental pollution. Ambient standards regulate the amount of pollutant present in the surrounding (ambient) environment, such as parts per million (ppm) of dissolved oxygen in a river, sulfur dioxide (SO2) in an air shed, or ground-level ozone levels. Measures are often an average (e.g., over a twenty-four-hour period or per year), as concentrations vary by time of day and by season (e.g., due to weather changes). The level itself cannot be directly enforced; therefore, the sources of the pollution must be found and regulated to be sure that the ambient standard is met. The US Clean Air Act, for example, sets ambient standards for six criteria pollutants in a region. If a region is in violation, they must come up with a plan to attain compliance.
Emissions standards regulate the level of emissions allowed, such as emissions rates (pounds of SO2 per hour), concentration (ppm of biochemical oxygen demand [BOD] in wastewater), total quantity of a pollutant, residuals per unit of output (SO2 per kWh of electricity), residual content per unit of output (sulfur content of coal), or percentage removal of pollutant (90 percent of SO2 scrubbed). Emissions standards do not guarantee a specific ambient level of pollution.
Technology standards require polluters to use certain technologies, practices, or techniques. While emissions standards require polluters to meet a goal for the level of pollution, they give the polluter freedom to choose the technology used. Technology standards require a specific technology. For example, until 1990, electric utilities were required to install scrubbers with 90 percent efficiency ratings. Another example is the United States requiring catalytic converters in autos. The 1972 Water Pollution Control Act Amendments set a goal of zero discharges by 1985 and used technology-based effluent standards (TBES)—this was a combination of a ban and a standard. The Environmental Protection Agency (EPA) determines the “best practicable technology” and sets standards assuming that firms are using that standard. Often, as in the Clean Air Act, the government mandates that the best available control technology (BACT) be used. However, BACT is often not clearly defined.
Banning certain technologies or processes is another way of establishing a standard. Clear cut logging has been banned in certain jurisdictions and long line drift nets have been banned for certain fisheries. The generation of electricity with nuclear fission has been banned in some European countries.
Like the many other policy tools, standards can be very effective at reducing pollution of various types; they are often used in conjunction with other policy instruments such as bans or quotas. There are many flexible approaches to standards, and considerable experience has occurred with regard to their use. One of the potentially negative aspects of standards is that they have often been of a command and control nature; that is, they prescribe not only, or even necessarily, a goal but a specific means of achieving that goal. This “one size fits all” approach is not always the most effective or cost efficient.
Significant financial resources have been used by business and industry to comply with environmental standards by retrofitting existing infrastructures. In addition to resisting the imposed costs these standards require, business and industry have also objected to being told precisely how to achieve the desired goals. If standards can be set in terms of clear, measurable goals, business and industry prefer to have the flexibility of working out the methods for achieving those goals.
Another problem with the command and control standards is that once achieved there is no incentive for exceeding the standard and providing even greater environmental protection even when this is possible. Incentives to exceed standards can be used to this end.
Standards have been used successfully with a range of local and regional environmental problems. However, the level at which standards are set can have dramatic impacts on other levels. For example, setting standards at the national level for vehicle fuel efficiency can lead to increased vehicle use (known as the rebound effect), exacerbating the problems at the regional and global levels through increased levels of throughput.
Cap and Trade
A cap-and-trade system is a public policy tool where the government issues permits allowing firms to emit a certain amount of a pollutant—each permit might allow, say, one ton of carbon dioxide. Regulators then limit the amount of emissions by imposing a cap on the total number of permits.
Acid Rain Cap-and-Trade Program
The first cap-and-trade program in the United States (1995) was the innovative, market-based sulfur dioxide (SO2) allowance trading component of the Acid Rain Program (ARP). Affected utilities were required to install systems that continuously monitored emissions of SO2, nitrogen oxides (NOx), and other related pollutants in order to track progress, ensure compliance, and provide credibility to the trading component of the program. In any year that compliance was not achieved, excess emissions penalties would apply, and sources either would have allowances deducted immediately from their accounts or were required to submit a plan to the EPA that specified how the excess SO2 emissions would be offset. Overall the program has been hailed as successful by the EPA, the industry, economists, and certain environmental groups, such as the Environmental Defense Fund. Estimates are that emissions of sulfur dioxide have been reduced by 8 million tons, nitrous oxide by 2.7 million tons, and mercury by 10 tons (from 52 to 42). However, it is difficult to estimate the emissions, which would have occurred without the ARP. Since the 1990s, SO2 emissions have dropped 40 percent, and according to the Pacific Research Institute, acid rain levels have dropped 65 percent since 1976. The EPA estimates that by 2010, the overall costs of complying with the program for businesses and consumers will be $1 billion to $2 billion a year, only one-fourth of what was originally predicted.
The general cap-and-trade system can allow firms to “bank” permits, borrow permits, and buy and sell permits from each other, creating a new form of property rights, basically the right to pollute a certain amount. Some companies might find that they could operate using less than their allotment of permits, leaving those firms with extras to sell. Other companies, in contrast, might produce more pollution than would be allowed by their allotment of permits and have to buy additional permits from those companies with extras to sell.
The economic logic of cap and trade is that the firms that can most cost effectively reduce their pollution (e.g., reduce a given level of pollution at the lowest cost) would do so and then sell their pollution permits or rights to firms that had relatively high cost of reducing pollution. The efficient pollution reducing firms would keep ratcheting down their pollution in an effort to free up more permits to sell, and inefficient ones would buy their permits. For businesses, if it were less costly for them to install abatement technologies than buy permits, they would do that. But if that was more costly, they would purchase permits.
Over time, the government could reduce the number of permits allocated and thus cut the total amount of pollution. As that would occur, the market value of the permits would rise creating an even greater incentive to reduce emissions. A cap-and-trade system can potentially harness the private incentives of the market to motivate innovation in pollution abatement technology and reduce pollution over the long term at the least amount of cost.
Cap-and-trade programs are more flexible than other pollution control instruments as they do not put any type of limit on emissions for individual polluters. Regulated sources can design their own compliance strategies to obtain all the allowances they require. These strategies include sales or purchases of allowances, installation of mitigating technologies, fuel switching, and efficiency measures. A cap-and-trade program provides a system for regulated sources to choose the lowest cost approach to managing their emissions. This allows pollution to be reduced at a lower overall cost than more traditional command-and-control approaches.
While cap and trade has been promoted as an effective market based solution to pollution reduction, taxing pollution instead may require less bureaucracy than a cap-and-trade system. Cap and trade requires someone to issue permits, oversee their exchange, and monitor emissions. After all, the United States already has a significant tax collector in the Internal Revenue Service. Finally, by setting a specific price for carbon pollution, a tax would make it easier for firms to plan for the future.
In a cap-and-trade system, the price of permits fluctuates with demand and supply, just like stock prices do. A tax, in contrast, sets a single explicit price. Carbon trading creates new financial markets, with intermediaries like brokers who would assist in the exchange of permits.
Renewable Portfolio Standard
A renewable portfolio standard (RPS) is a public policy designed to help influence the amount of electricity generated from renewable energy resources. RPS policies are meant to encourage the development of new renewable energy resources and to help maintain existing renewable energy resources. An RPS is a “pull” type mechanism because it provides an incentive for the development of renewable energy facilities.
Renewable energy facilities, such as wind turbines and solar panels, are issued separate tradable credits, called renewable energy credits (RECs), for each megawatt hour (MWh) of electricity they generate. Businesses can either voluntarily purchase these credits to “green” the electricity they use or, in an RPS, utilities are required to purchase a specific amount of these credits each year based on a percentage of overall customer electricity use. For example, an RPS may require that the utility provide 5 percent of energy from renewable sources, and the RECS are the accounting system to track compliance with that requirement.
Dissemination of information by a government body is an example of a policy instrument that is often relatively simple and does not impose high cost on businesses. The US government provides information on food and drugs through the US Department of Agriculture and the Food and Drug Administration (FDA). This information can help consumers choose the food and drugs they consume on an informed basis and can use the private market to regulate the quality of beef and other food products. Information dissemination by government and nongovernmental organizations (NGOs) and by private businesses related to carbon emissions, toxic waste disposal, and other environmental factors can influence consumer choices and business practices in similar ways, see more on this in Chapter 4.
- Efforts to establish new policies that address environmental concerns must take into account the resistance that will occur.
- There are benefits with environmental policies that adapt to changing conditions and that take action to prevent activities that have significant risk of harming the environment in ways that cannot be reversed.
- There are a range of policies that can address concerns about the environment, from outright bans of chemicals to market pricing (e.g., with the imposition of taxes) of activities that cause social harms.
Why is it beneficial for government to encourage business innovation to address environmental concerns? What are the different ways government policies can encourage innovation?
What are some of the benefits and problems of using market-based systems, such as cap and trade, to reduce pollutants?