[Economic Report of the President (2004)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]


 
Chapter 9

Protecting the Environment

Economic growth and environmental improvements go hand-in-hand.
Economic growth can lead to increased demand for environmental
improvements and can provide the resources that make it possible to
address environmental problems. Some policies aimed at promoting
environmental improvements can entail substantial economic costs.
Misguided policies might actually achieve less environmental
progress than alternative policies for the same economic cost. It is
therefore important to weigh the direct benefits of environmental
regulations against their economic costs.

While the free-market system typically promotes efficiency and thus
enhances economic growth, the absence of property rights for
environmental "goods" such as clean air and water can lead to
negative externalities that reduce societal well-being. This can be
addressed by establishing and enforcing property rights that will
lead the affected parties to negotiate mutually-beneficial outcomes
in a market setting. If such negotiations are expensive, however,
the government can design regulations that consider both the
benefits of reducing the environmental externality as well as the
costs the regulations impose on society. Regulations should be
designed to achieve environmental goals at the lowest cost possible,
thus helping to achieve environmental protection and continued
economic growth.

The key points in this chapter are:
 Establishing and enforcing property rights for the
environment can address environmentally-related market
failures. Any needed regulations should consider both
the benefits and the costs.
 Environmental risks should be evaluated using sound
scientific methods to avoid possible distortions of
regulatory priorities.
 Market-based regulations, such as the cap-and-trade
programs promoted by the Administration to reduce
common air pollutants, can achieve environmental goals
at lower cost than inflexible command-and-control
regulations.


The Free Market and the Environment

In a free-market system, only trades that benefit both parties will
take place. Market prices coordinate the activities of buyers and
sellers and convey information about the strength of consumer demand
for a good, as well as how costly it is to supply. In the context of
the environment, a market failure may occur if a voluntary
transaction between parties imposes involuntary costs on a third
party. These involuntary third-party costs are known as negative
externalities (or spillovers), and their existence in a free market
can lead to inefficient outcomes; that is, outcomes that fail to
maximize the net benefits to society. For example, a plant might
produce and sell a good to a consumer to both their advantage, but
the production process may result in emissions of air pollutants
that negatively affect others not involved in the transaction. The
root of the market failure is that there are no clear property
rights for the surrounding air. The interests of the third
party--the people affected by the plant's emissions--are not
represented in the market transaction.

If those affected by the plant's emissions had a right to demand
compensation for the costs imposed on them by the pollution, then
the firm would take these costs into account when making its
production decisions. The plant would produce only up to the point
where the benefit of another unit of production equals the
additional cost of producing the good plus the cost to the people
negatively affected by the pollution. Any additional emissions due
to producing more goods would require compensation that is greater
than the monetary gain the plant gets from selling the additional
goods. Likewise, if the property right belonged to the plant, the
people negatively affected by the emissions could compensate the
plant for reduced emissions. Either way, all three parties
(consumers, the firm, and those affected by the emissions) would
transact voluntarily to everyone's benefit, resulting in an
efficient outcome. If the government were to assign and enforce the
property right, and if it were costless for parties to collectively
agree on compensation, then an efficient use of resources would
result from private bargaining, regardless of which party was
assigned the property right. This insight is known as the Coase
theorem.


The Role of Government in
Regulating the Environment

The existence of property rights does not always guarantee an
efficient outcome. If there are many sources of pollution or there
are many parties affected by the emissions, then it might be
difficult for the parties collectively to agree on the compensation,
and an efficient outcome might therefore not be achieved. This
presents an economic justification for government involvement and
regulation. Government regulation might also be justified in order
to address distributional concerns associated with environmental
problems.

Regulations that address negative externalities can therefore
improve societal welfare. To improve the environment while still
promoting economic growth, sound policies must consider both the
benefits and the costs of regulations. Economic growth itself can
contribute to environmental improvements (Box 9-1). As the economy
grows, the demand for environmental improvements increases and the
greater wealth provides more resources to better address
environmental concerns. It is therefore important to weigh the
direct environmental benefits of regulations against their economic
costs.

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Box 9-1: Economic Growth Can Improve the Environment

Much research has shown that economic growth contributes to
environmental gains. In the early stages of economic development,
environmental degradation may occur because nations place higher
priority on basic needs such as food and shelter. As wealth
increases,  however, so does demand for a cleaner environment, and
greater wealth provides more resources to better address these
environmental concerns. After a certain level of national income is
attained, the balance shifts and environmental degradation is
arrested and then reversed. For several decades in the United
States, many environmental indicators have been improving as the
economy has also grown.

From 1975 to 2002, concentrations of five of the six common air
pollutants (the pollutants for which there are reliable data)
decreased by an average of 60 percent (Chart 9-1), as real gross
domestic product (GDP) increased by about 130 percent, energy
consumption increased by 35 percent, and the population increased
by 34 percent.  While the Nation's air quality has improved
substantially since passage of the Clean Air Act of 1970, air
quality was improving prior to 1970, perhaps due to
market-induced technological advancements (such as improvements in
energy efficiency) that accompany economic growth.  The limited
air-quality monitoring data available before 1970 indicate that
average annual concentrations of particulate matter in urban air
dropped 16 percent from 1957 to 1970 and these total suspended
particulates (liquid or solid particles in the air) across the
country fell by about six percent from 1958 to 1970 (Chart 9-2).

As the Nation's productive output has increased and environmental
quality has improved, so too has the health and well-being of
Americans.  In the last century, life expectancy at birth increased
from 48 to 80 years for women and from 46 to 74 years for men.
Infant mortality dropped to the lowest level ever recorded in the
United States.  The death rates for heart disease, cancer, and
stroke are also decreasing.  This well-documented correlation
between wealth and health extends across time and nations.
More-developed countries have higher life expectancy, and globally,
life expectancy has increased as per capita wealth has increased.
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Misplaced Reasons for Government Intervention

In making environmental policies, it must be recognized that
government measures themselves might create further inefficiencies.
When it is difficult to determine the extent of an environmental
externality, an attempt to rectify it might end up making matters
worse by imposing unintended costs on third parties without
achieving an efficient outcome.

This inefficiency can arise even from well-intentioned environmental
regulations. Two fallacious arguments are frequently used to justify
inefficient regulations. One such misplaced rationale is that
regulations improve the economy and spur job growth. The reasoning
goes as follows: environmental regulations lead firms to install
pollution-control technologies, which they must purchase from other
firms. These technologies are built, delivered, installed, and
operated by workers who otherwise would not be doing this work.
Similarly, the regulations may promote environmentally-friendly
industries that hire people who would not be hired otherwise. For
these reasons, the regulations are said to "spur" the economy and
job growth. By this reasoning, throwing a rock through a window also
improves the economy, because it necessitates the hiring of someone
to repair the window. What this ignores is that the resources spent
to comply with an unnecessary or inefficient regulation are diverted
from other uses. The money and people involved could have been used
instead to produce more goods for consumers or to build new
factories or machinery. The jobs associated with complying with
environmental regulations are a cost of regulation, not a benefit.

Another misplaced view of environmental regulation is that the goal
of regulations should be to eliminate or substantially reduce risks
without considering costs. This approach is embodied in some
well-intentioned laws. The 1970 Clean Air Act, for example, directs
the Environmental Protection Agency (EPA) Administrator to set
national ambient air quality standards (NAAQS) that achieve "an
adequate margin of safety," and the Supreme Court has ruled that
"the Clean Air Actï¿½unambiguously bars cost considerations in the
NAAQS setting process." Similarly, the stated goal of the
Occupational Safety and Health Act of 1970 is "to assure so far as
possible every working man and woman in the Nation safe and
healthful working conditions," without considering the costs of
doing so. While the goals of these laws are noble, they do not
recognize the inevitable trade-offs involved. Not all environmental
laws preclude cost considerations. For example, the Safe Drinking
Water Act Amendments of 1996 explicitly acknowledge the importance
of benefit-cost analysis when considering the appropriate level of
regulation for contaminants in drinking water.


Regulations Impose Benefits and Costs

The failure to consider costs inhibits the goal of making
regulations that maximize the difference between benefits and
costs. Furthermore, the failure to consider costs can lead to a
misallocation of resources, because a regulation that is made
without considering costs might receive more resources than other
regulations that warrant greater attention. While the benefits of
many regulations include both health and non-health related
benefits, many regulations primarily address fatality risks, and
there is a wide range of cost per expected life saved across such
regulations. For example, one survey of cost per life saved across
regulations found that the regulation for childproof cigarette
lighters costs approximately $100,000 per life saved (in 2003
dollars) whereas the formaldehyde regulation costs approximately
$80 billion per life saved (in 2003 dollars). Shifting resources
from regulations where the cost per expected life saved is high
(for example, formaldehyde regulation) to regulations where it is
low (for example, childproof lighter regulation) would result in
more lives saved for the same cost to society. Many of the
differences in cost per life saved occur because legislative
mandates only sometimes allow agencies to consider costs when
crafting regulations.

Stringent regulations may appear to be good for society because
they save lives. However, because the Nation's ability to bear costs
is limited, the wide range of costs per life saved across
regulations implies that more lives could be saved at the same cost
by shifting resources to the regulations with lower costs per
expected life saved. One study found that society could save twice
as many lives with the same budget if it designed regulations in a
way that maximized lives saved. Some of the more costly health-based
regulations might actually lead to a net increase in fatality risk
because their high costs diminish the resources available for
improving other health and environmental outcomes.


Using Science to Help Set Regulatory Priorities

Sound regulatory policy must be based on scientific assessments of
environmental and health risks. Scientific assessments involve a
careful examination of the risks involved and of the expected
health outcomes for the people exposed to the risk at hand. This
allows for an unbiased evaluation of environmental and health
threats in which to target regulatory actions. Unfortunately,
regulatory risk assessments at times overestimate some threats,
or overemphasize risks to "hypothetical" (rather than real) people.
These practices can lead to a distortion of regulatory priorities.


Overestimating the Risks: The Problem with
"Cascading Conservatism"

In a well-intentioned attempt to be prudent, regulatory agencies
sometimes rely on scientific assessments of environmental and health
risks based on assumptions that overstate actual risks. When
estimating chemical toxicity, for example, risk assessors have at
times relied on high-end default assumptions that are likely to
overestimate the actual risk of a chemical. Toxicity testing is
evolving to use information that permits assessors to move away
from assumptions that lead to overstated risks. When more data are
available, regulatory risk assessors do not need to rely on high-end
default assumptions and can instead attempt to estimate more
accurately the expected level of risk. Because the EPA's primary
goal is public health protection, however, it still relies on
high-end default assumptions when there is uncertainty about
scientific data.

Similarly, regulatory agencies sometimes use high-end estimates of
the likelihood of people being exposed to a certain risk. These
exposure estimates are then combined with toxicity estimates that
are themselves likely to overstate risk. The multiplicative impact
of combining several high-end component estimates is known as
cascading conservatism. This practice can lead to risk estimates
that greatly overstate the threat of environmental problems and thus
overstate the benefits of regulating those risks. One study found
that in a sample of hazardous waste sites, over 40 percent of the
sites requiring cleanup under the Superfund program would shift into
the discretionary cleanup range if not for the overestimation of
risks resulting from cascading conservatism.

Such high-end risk estimates can lead to several types of problems.
First, the practice overstates the risk of all environmental health
problems relative to other types of hazards. This overstatement can
cause too many resources to be allocated to addressing low-priority
concerns. An example of such a distortion is the commonly-held view
that synthetic chemical pollutants such as insecticides are a
leading contributor to cancer. In reality, the evidence suggests
that such chemicals account for a low percentage of human cancers.
The main contributors to human cancer appear to be smoking and poor
diet--each of which accounts for about one-third of cancers. The
result is that regulatory efforts are directed at addressing the
risks of synthetic chemicals that may well pose lower risks of
causing cancer than many common natural chemicals.

A second problem with the high-end risk estimates caused by
cascading conservatism is that they can distort the allocation of
resources among different environmental health concerns. If each
uncertain component that goes into a risk assessment overstates the
risk, then the multiplicative impact of cascading conservatism will
result in higher risk estimates for threats that have more uncertain
components. For example, if there are two equally effective
pesticides, with one posing a higher threat to the population than
the other, the safer pesticide might be assessed as more of a threat
if there are more uncertain components involved in its risk
assessment. This assessment could result in the safer pesticide
receiving stronger regulatory emphasis by the government. It is
better to target regulatory dollars to the risks expected to be
higher in a reasonable scenario or range of scenarios than to the
risks that might be higher in a worst-case scenario.


Population-Weighted Risk Assessments

Regulatory efforts can also be distorted when risk assessments
ignore the number of real people potentially exposed to an
environmental risk. For example, an environmental hazard at one
location might pose a greater risk to any person exposed to the
hazard than an environmental hazard at a second location. However,
if no one lives near the first location and many people live near
the second location, the expected risk to society is higher at the
second location.

The case of United States v. Ottati & Goss offers one example of
such misplaced regulatory priorities. In this case, a company
litigated for relief of an EPA-required cleanup that would have cost
the company $9.3 million to remove small amounts of contaminants
from a site that was already mostly decontaminated. The company had
already spent $2.6 million to clean the site so that small children
playing on the site could eat small amounts of dirt daily for 70
days each year for three and a half years without significant harm.
The additional $9.3 million would be used to burn the soil, which
would allow children to eat a small amount of dirt each day for 245
days per year without significant harm. However, there was little
chance that children would ever be exposed to this site because it
was located in a swamp. The courts ruled in favor of the private
party and refused to enforce the proposed remediation goal.


Objective Versus Perceived Risk

Regulatory decisions should be based on scientific assessments of
risks rather than perceived risks. This approach would help properly
order priorities for regulatory decisions. Perceived risks often
differ from expert assessments of risk because laypeople have
difficulty assessing the frequency of low-probability events. Chart
9-3 compares survey respondents' perceived risks of dying from
various hazards to the objectively measured risks of dying. In this
chart, the dashed line represents where the perceived risk equals
the actual risk; if all the points on the chart fell on this line,
it would indicate that survey participants precisely estimated the
risk of dying from various hazards. All points to the left of the
dashed line represent hazards for which the



perceived risk of dying is higher than the actual risk, and all
points to the right of the line indicate hazards for which people
thought the risk of dying is lower than it actually is. The chart
suggests that it is common to overestimate fatalities associated
with low-probability events and to underestimate fatalities
associated with high-probability events. These systematic
misperceptions may lead to misplaced pressures to overregulate
small environmental risks at the expense of addressing larger ones.


Achieving Goals Through
Cost-Effective Regulations

As discussed in Chapter 7, Government Regulation in a Free-Market
Society, when the assignment of property rights is insufficient to
achieve an efficient outcome, government intervention may help
achieve efficiency. Chapter 7 discusses government actions that can,
in principle, achieve an efficient outcome by incorporating the
costs of externalities into the market's price mechanism. It is
important that any regulatory mechanism that addresses externalities
do so in the least costly (that is, the most cost-effective) way so
that society's scarce resources are not wasted. This section focuses
on how to achieve air-quality goals cost effectively, but many of
the lessons can be applied toward achieving other environmental
goals, such as clean water protection and energy-efficiency
standards.

Command-and-Control Regulations

Air-quality command-and-control regulations prescribe specific
technologies that individual firms must use to control emissions, or
they set specific emission rates for individual firms. The United
States currently has many such environmental regulations. These
regulations are inherently inflexible and are ill-suited to
achieving emissions reductions in the least costly manner. While
some command-and-control air-quality regulations may be just
slightly more costly than cost-effective regulations, studies show
that others are up to 22 times more expensive than the most
cost-effective set of controls.

The reason command-and-control regulations are more expensive is
straightforward: suppose the regulatory goal is to halve the
emissions emanating from two firms. A command-and-control regulation
might require each firm to cut its emissions by half. However, if it
is less costly for one firm to reduce emissions, then--so long as
the health effects of the emissions depend only on the total from
the two emission sources--shifting the burden to the firm with lower
abatement costs would result in the same environmental improvement
at a lower cost. In general, the greater the differences across firms
in their emissions before the regulation, and the greater the
differences across firms in the rate at which each firm's costs rise
with additional reductions, then the more costly a
command-and-control approach is compared to more flexible approaches.
Cost-effective emissions reduction is achieved when the cost of
reducing an additional unit of emissions (the marginal abatement
cost) is equal across all firms.

An example of an inflexible command-and-control regulation is the
mechanism by which the Clean Air Act Amendments of 1990 address
hazardous air pollutants (HAPs). The Act specifies that the emissions
reduction standards for categories of existing HAP polluters must be
set at "the average emission limitation achieved by the best
performing 12 percent of the existing sources." While some
flexibility is allowed in establishing the emission limitations, the
command-and-control standard for regulating HAPs has frequently
been interpreted in a way that ignores the differential costs of
reducing emissions across existing sources within a category. This
likely results in higher costs than would a more flexible regulation.

Command-and-control regulations also fail to provide market
incentives for firms to explore less expensive means of reducing
emissions. More flexible, incentive-based regulations would provide
signals to the market of the increased demand for emissions
reductions. With proper incentives in place, markets can respond to
such an increase in demand with technological innovation and
efficient reallocation of their scarce resources to achieve the goal.

Command-and-control regulations can also unintentionally lead to
outcomes that are contrary to their environmental goals. An example
of this is the New Source Review component of the 1977 Clean Air
Act Amendments. This legislation required a strict control technology
for most new industrial facilities and for facilities that
undertook significant modifications, but it exempted existing
facilities that did not make major modifications from the same
standards. It was thought at the time to be more efficient to add
new pollution control technology when plants were upgrading or when
building new plants. This situation is known as new source bias
because it provides an incentive for existing sources of emissions
to continue their business operations for longer than would have been
the case under normal market conditions without the regulation. It
also provides an incentive for existing plants to forgo
modifications.

New pollution-causing production sources tend to be cleaner than old
ones even in the absence of regulations, so extending the business
operations of older plants without making modifications could result
in higher emissions. Applying different regulations for "routine"
versus "major" modifications also leads to ambiguity, litigation
delays, and uncertainty in business planning, all of which can harm
the economy and may impede environmental improvements. The
Administration recently addressed this problem by establishing clear
rules that remove disincentives for facilities to modify and
undertake routine maintenance, repair, and replacement activities
that could improve the safety, reliability, and efficiency of the
plants.


Market-Based Price Regulations: Emission Fees

Environmental regulations that provide firms with market-based
incentives for emissions reduction avoid the complications of
command-and-control regulations and achieve the same goals at lower
costs. In particular, emission fees and cap-and-trade programs are
usually less expensive than command-and-control approaches at
achieving regulatory goals. An emission fee involves a charge to
polluting sources for each unit of pollution emitted. Because each
successive unit of emissions reduction typically involves increased
costs, each source will reduce emissions until it would cost more
to reduce the next unit of emissions than it would to pay the
emissions fee. This results in equal marginal abatement costs
across all affected firms.

With an emission fee, the total level of emissions reduction will
depend on the per unit fee: a higher rate will achieve more
emissions reduction. The emission fee also provides incentives to
reduce emissions, because the better a firm is at reducing emissions,
the lower the total fee the firm must pay. This sends a market signal
that pollution has a price (equal to the emission fee), and any
innovative means of reducing emissions will save firms from paying
the fee. This market signal is likely more adept than the government
at spurring technological innovation, adapting to changes in the
economy, and shifting resources to reflect the increased demand for
emissions reduction.


Market-Based Quantity Regulations: Cap-and-Trade

The main problem with an emission fee is that it is difficult to
know beforehand what fee level will achieve the desired amount of
pollution reduction. A cap-and-trade regulation addresses this issue
and provides market incentives to reduce emissions in a
cost-effective way. Such regulations "cap" the amount of allowable
emissions and require that a firm own a permit for each unit of
pollution emitted in a given period (for example, a year). This
permit effectively establishes a legal property right for the air
affected by the pollution, so that any emissions must be paid for by
the firm. The government allocates the pollution permits to the
emission sources and then allows the sources to buy and sell permits
from each other.

Under a cap-and-trade system, a source with a high cost of reducing
an additional unit of emissions would be willing to purchase a permit
from a source with a lower marginal abatement cost. With a
well-functioning market for the permits, sources will trade permits
until the price for the permits equals the marginal abatement cost.
As with the emission fee, the marginal abatement costs will be equal
across sources, leading to a cost-effective result. The cap-and-trade
system also provides an incentive to reduce emissions because each
unit of emissions reduction saves the source the price of another
permit. This regulation sends a market signal that there is a price
for emissions and any innovative means of reducing emissions will
save firms from paying the price. The cap-and-trade system therefore
achieves the target level of pollution reduction at the lowest cost.

One consideration for a cap-and-trade system is how to allocate the
permits initially. A cap-and-trade system that allocates the permits
based on historic emissions or other firm characteristics, known as
grandfathering, in essence gives away a valuable asset--the permits.
A grandfathering system could establish a barrier to entry for new
firms because any new entrant would have to purchase permits from
existing firms.

One way to avoid these problems is to auction the permits at some
regular interval to the highest bidders. Firms with higher marginal
abatement costs would bid more for permits than those that can
achieve less-costly emissions reductions. While auctioning the
permits would result in lower profits for the regulated firms
(compared to giving away the permits), it would not affect the firms'
output decisions. Grandfathering versus auctioning the permits is
primarily a question of distribution, not efficiency--it is a
question of whether a public asset should be given to firms for free
or sold as a means of generating public revenues.

A notable example of a cap-and-trade system is the sulfur dioxide
(SO2) trading program created under Title IV of the Clean Air Act
Amendments of 1990. The program set a goal of reducing emissions by
10 million tons from the 1980 level by 2010. This was to be
accomplished in two phases. The first phase, which began in 1995,
initially capped the SO2 emissions at 263 individual units which were
owned by 110 electric utility power plants in 21 eastern and
midwestern states. These plants, which were primarily coal-fired,
emitted the greatest amounts of pollution among power plants in these
regions. From 1995 to 2000, an additional 182 units were allowed into
the program. The second phase, which began in 2000, further decreased
the annual emissions of SO2 and required all large fossil fuel-fired
power plants in the contiguous 48 states and the District of Columbia
to hold permits to cover their emissions.

In both phases, power plants could purchase permits from other power
plants in order to meet their emissions coverage. The program also
allowed plants to carry over (or bank) unused permits to use in later
years, which gives firms even greater flexibility in achieving
long-term pollution reduction. In contrast to a command-and-control
system, this cap-and-trade system allows plants that find it costly
to reduce their SO2 emissions to purchase credits from plants that
can reduce SO2 at lower cost.

Evidence indicates that such cost-saving trades did indeed take place
as firms took advantage of the system's inherent flexibility
(Chart 9-4). Each bar in the following chart represents the emissions
rate each plant achieved after trading permits in 1997. The
superimposed line in the figure shows the level of emissions each
plant would have had to achieve in the absence of trading. Bars below
the line indicate plants that reduced their emissions by more than
the required amount and sold their excess permits or banked them.
Bars above the line indicate plants that purchased permits or used
previously banked permits to avoid costly abatement. The figure shows
that almost every plant took advantage of the flexibility of the
system, suggesting that plant-level costs of reducing SO2 emissions
vary greatly.

The trading program has achieved its pollution-reduction goals at
great cost savings. By the end of the first phase, emission
reductions were almost 30 percent below the required level. The
flexibility of this approach has been estimated to provide cost
savings of approximately $0.9 billion to $1.8 billion a year compared
to costs under a command-and-control regulatory alternative; other
tradable-permit markets have had significant cost savings as well
(Table 9-1).




Emission Fees Versus Cap-and-Trade

As mentioned previously, one problem with emission fees is that it
is difficult to know beforehand at what level to set the fee to
achieve the desired pollution reduction. This might require
periodic adjustments of the fee level, and such adjustments would
introduce uncertainty that could interfere with firms' planning
decisions. The emissions fee does, however, allow the government to
set with certainty the marginal cost of emissions reduction. For each
emission fee there is a corresponding allocation of permits that
would achieve the same results; however, it is difficult to know
beforehand what the market price for permits will be once trading
actually takes place.

One way to reconcile these issues is to offer a cap-and-trade system
with a safety valve. The safety valve sets a maximum price for a
permit, which guarantees that the price of reducing emissions does
not exceed the expected benefits. The regulatory agency issues and
sells extra permits on request from any firm at this fixed safety
valve price, thus guaranteeing that the market permit price does not
exceed this level. A cap-and-trade program with a safety valve
achieves the target level of emission reductions in a cost-effective
manner, while protecting the regulated firms against unexpected
short-term price increases in emissions reduction.


The President's Cap-and-Trade Program

An example of a well-designed incentive-based regulatory approach
is the President's Clear Skies proposal for reducing emissions of
sulfur dioxide, nitrogen oxides, and mercury from electric utility
generators by approximately 70 percent by 2018. Clear Skies would
cost-effectively reduce emissions by establishing a cap-and-trade
system for each of the three pollutants. The EPA has estimated the
benefits of the Clear Skies Act at $113 billion annually by 2020,
compared with $6 billion in projected annual costs. These include
$110 billion in annual health benefits (including the prevention of
14,100 premature deaths and 30,000 hospitalizations and emergency
room visits) and $3 billion in annual benefits from increased
visibility at national parks.  Under the existing Clean Air Act,
the EPA issues national air-quality standards for certain
pollutants, including particulate matter and ozone. The EPA projects
that compared with existing programs, the Clear Skies Act would lead
35 additional eastern U.S. counties to meet the particulate matter
standard by 2020, leaving only eight counties not meeting the
standard. The EPA expects that the remaining counties not meeting
the standards would move closer to achieving them due to the Clear
Skies Act.

To mitigate the effects of market shocks that potentially affect the
costs of emissions reduction, Clear Skies would establish a safety
valve price for permits of each pollutant. It would also provide
regulatory certainty by achieving the reductions of all three
pollutants in two phases. Firms would therefore plan their reductions
of the three pollutants together and over the long term. Indeed,
because the Clear Skies plan allows the banking of permits for future
use, it provides an incentive for firms to achieve reductions
quickly. Additionally, Clear Skies would provide revenue for the
government because it phases in an auction system for the permits.

Clear Skies demonstrates the lessons learned from past regulatory
experiences: instead of imposing an inflexible, command-and-control
regulation to achieve emissions reduction, it offers a market-based,
cost-effective, cap-and-trade program to achieve large reductions in
emissions from electric utility generators.

Conclusion

Economic growth and environmental improvements are at times
incorrectly seen as competing aims. Increased economic production
can indeed lead to greater environmental degradation. However, an
increase in economic resources provides more options (most notably,
technological advancements) for addressing environmental problems.
Moreover, a growing economy can also lead to increased demand for
environmental improvements. It is therefore important to weigh the
direct environmental benefits of a regulation against its economic
costs. The goal should be to maximize the net benefits to society,
while also giving due consideration to distributional issues.
Maximizing net benefits is best achieved in a free-market setting
unless there are spillover costs to third parties.

Spillover costs are best addressed by establishing property rights
that will lead the affected parties to negotiate a
mutually-beneficial outcome. If the costs of such negotiations
are prohibitive, however, government should respond carefully and
always keep in mind the possible government spillover costs. To make
effective regulations, the government must first assess the
environmental problems using sound, unbiased estimates of the hazards
and then craft incentive-based regulations to address them. Such
regulations can address the spillover costs of environmental problems
at lower costs to society than the traditional command-and-control
regulatory methods. These principles, and the lessons learned from
our past regulatory experiences, as described throughout this
chapter, should guide our future regulatory endeavors to achieve
environmental improvements coupled with economic growth and
efficiency.