Efficient Pollution Regulation: Getting the Prices Right

TLDR

The paper argues for efficient environmental regulations that equate marginal pollution damage with marginal abatement costs across space, estimating source‑specific damages and welfare gains from improving the sulfur dioxide allowance trading program for power plants. The authors estimate source‑specific marginal damages of air pollution and compute welfare gains from optimizing the sulfur dioxide allowance trading program for power plants. Using marginal‑damage‑based trading ratios could save $310–$940 million annually, and efficiency gains from setting aggregate emissions and expanding source coverage could be many times larger. JEL codes: H23, Q53, Q58.

Abstract

This paper argues for efficient environmental regulations that equate the marginal damage of pollution to marginal abatement costs across space. The paper estimates the source-specific marginal damages of air pollution and calculates the welfare gain from making the current sulfur dioxide allowance trading program for power plants more efficient. The savings from using trading ratios based on marginal damages are between $310 and $940 million per year. The potential savings from setting aggregate emissions efficiently and from including more sources of air pollution are many times higher. (JEL H23, Q53, Q58)