The United States Experience with Economic Incentives to Control Environmental Pollution July 1992

This was the first in a series of reports on this subject.  The second report was issued in 1997, including a section on international use of incentives, and the third in 2001.  A report on international use of incentives was issued in 2004.

In the past few years, economic incentives have moved from relative obscurity to a significant role as a tool for managing the environment. Nowhere is this attention to incentives more explicit than in the 1990 Clean Air Act Amendments. That legislation authorizes incentive-based mechanisms for the control of acid rain, for the evelopment of cleaner burning gasoline and less polluting vehicles, for states to use in controlling urban ozone and carbon monoxide, and to facilitate the reduction of toxic air emissions.

Other key environmental statutes, the Clean Water Act and the Resource Conservation and Recovery Act, are now up for reauthorization. Incentive mechanisms promise to be actively debated as these and other environmental legislative proposals make their way through Congress. EPA is currently preparing analyses of numerous possible incentives to support this debate. At the state level, some incentive programs have been implemented, and many other proposals are currently under active consideration.

With current high levels of interest in incentive mechanisms for environmental management, it is useful to examine the record to date. Over the past 20 years, federal, state, and local authorities have enacted a diverse array of environmental incentive mechanisms. How well have these mechanisms performed? What can be learned from the record that will assist in the formulation of new mechanisms? How economically efficient have these mechanisms been in achieving their objectives?

This report examines that record, highlighting applications of emission and effluent fees, charges for solid waste disposal, marketable permit systems for air and water pollution, deposit-refund systems, and information and liability mechanisms. All satisfy the basic requirement that an incentive provide a continuous signal to pollution generators to be aware of and act on opportunities to reduce releases of pollution to the environment.

The report first reviews the available information on the economic efficiency and environmental effects of economic incentives in general. The literature uniformly finds that economic incentives should be much more economically efficient in controlling pollution than the traditional command-and-control approaches. Some studies, however, indicate that the cost savings actually realized have fallen short of those predicted by these studies.

Economic incentives should be particularly efficient when diverse sources of pollution are involved which are most efficiently controlled using little-known technology. In addition, incentives provide a stimulus to innovation and technical change. The evidence on the environmental effects of economic incentives, while much less extensive than that on economic efficiency, suggests that incentives mechanisms are fully compatible with environmental objectives.

The historic record concerning individual incentive programs suggests that although there have been a number of important successes, in some cases incentive programs have failed to live up to their full theoretical promise. This appears to be the result of the particular design features of the programs tried, however, rather than the theoretical promise of the approach.  In most cases, fees and charges have been designed primarily to raise government revenue, and have thus been set too low to have significant effects.  Trading systems have often been constained by complicated regulations, but some new ones which have not as yet been fully implemented hold out considerable promise for being both effective and efficient in reducing pollution.  Beverage container deposits appear to have greatly reduced litter, but there is only limited knowledge of the impact of other deposit-refund systems and virtually no analysis of the costs and benefits of any of the deposit-refund mechanisms.  Some programs providing information appear to be having great impract among fully implemented incentives considered in this report and are likely to be economically efficient as well, but have not been examined with the detailed scrutiny necessary for a fair evaluation of performance.  Liability mechanisms can do act as efective incentives, but structuring liability rules to accurately intrernaize the costs of pollution has proved difficult.

Finally, a review of the use of economic incentives outside the United States suggests a preference for a somewhat different mix of incentive mechanisms but somewhat similar conclusions as to their effectiveness and efficiency as in the United States. The United States uses many more marketable permit systems than European countries, but much less environmental labelling. Although charges and fees are used more widely in Europe, they also tend to be revenue-raising instruments with few incentive impacts, as in the United States. The lack of incentive impact of charges is due primarily to their low magnitude and because a number of the charges are not closely linked to waste generation or product consumption. As in the United States, official interest in economic incentives appears to be increasing in Europe.

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