Environmental Economics

Instructor:
Jiangtao FENG

PLEASE COMPARE
THE EMISSION CHARGE POLICIES AND
THE DISCHARGE PERMIT POLICIES

Produced by:
Mr. Thaninwat Nithiyosdiloksakul ID: 3113999047
Xian Jiaotong University
The report must contain more than 2,500 words.
Submit before 31st December 2014 to fjtes@mail.xjtu.edu.cn

Table of Contents

Table of Contents
1

Introduction..................................................................................................1

Emission Charge Policies.............................................................................2

2.1

What is emission charge?............................................................................................2

2.2

Advantages of Emission Charge Policies....................................................................3

Discharge Permit Policies............................................................................4

3.1
The Effects of Discharge Permit or Free Allowances on Incentives to Reduce
Emissions................................................................................................................................4
3.2

Do Discharge Permit Policies Limit Carbon Leakage?...............................................5

3.3

Can The Discharge Permit Policies Be Equivalent to A Subsidy?..............................5

3.4

What Does It Mean When The Free Allocation Amounts to A Subsidy?....................6

4 Compare the Emission Charge Policies and the Discharge Permit

Policies.................................................................................................................7
5

Conclusion.....................................................................................................8

Introduction

As of today, the environmental problem becomes a big issue in many counties. Because it is
effect on people health and could affect the economics of the country in one way or another.
The pollution causes diseases, so the government has to put more budgets on the health care.
Instead of, emphasize more on the quality of life in every dimension such as infrastructure,
education, and development of the country.
Nowadays, the world is moving forward to industrialize society. We have to be well
management of using all resources. Due to rapid rate of population growth of the world,
people need the basic needs such as residence, food, clothes, and medicine. The natural
production process cannot meet current human basic need. That is why we have to build a
sky-rise building and improve animals and plants food chain genetic to make it more endure
to the weather, disease, and insects. Moreover, the natural resources are used to produce
energy and are used as the primary source of raw materials for the industries. Industrial
development, in the process of production, it releases pollutions in term of water, air, and
solid waste. Some firms provide the cleaning methods of the waste or try to isolate the
harmful substance out of the water and air before discharging to the environment. However,
some industrial firms discharge the waste directly to the environment. The firm responsibility
to the environment and society is up to each firms policy and the community surrounding.
The community may complain about releasing pollution that effect to them, may be the smell,
or waste releasing, from the industry to the government agency to let them take care of the
problem. However, there are still ways to encourage and prevent the discharging from the
industry firms. This report will introduce to discharge permit policies and emission charge
policies. Before going to that, let see an example of unintentional use and unknown effect of
a high utilize substance at that time that can causes a big environment problem.
Many chemical substances can destroy the world environment and cause many problem such
as climate change, which effect to human and animals. For instance, CFCs or
chlorofluorocarbon, were developed in the 1930s as a replacement for the refrigerants in use
at the time. CFCs are extremely stable, nontoxic, and inert relative to the electrical and
mechanical machinery in which they are used. Thus, their use spread quickly as refrigerants
and as propellants for aerosols (hair sprays, deodorants, and insecticides), industrial agents
for making polyurethane and polystyrene foams, and industrial cleaning agents and solvents.
Halons are widely used as fire suppressors. Several decades ago, scientific evidence began to
appear that the ozone content of the atmosphere was showing signs of diminishing. Ozone
disappearance was linked to the accumulation of chlorine in the stratosphere. At first, when
these substances were introduced, attention was exclusively on their benefits; there was no
evidence that they could have long-run impacts on the atmosphere. Nevertheless, the very
stable nature of these gases allows them to migrate very slowly in the atmosphere. After
surface release, they drift up through the troposphere into the stratosphere, where they begin a
long process of ozone destruction.

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As the result of ozone depletion, stratospheric ozone filters out most of the sun's potentially
harmful shortwave ultraviolet (UV) radiation. If this ozone becomes depleted, then more UV
rays will reach the earth. The UV radiation is a cause of health problem such as skin cancer,
eye disease, and weakening of human immune system. Adverse influences agriculture,
forestry, and natural ecosystems, several of the world's major crop species are particularly
vulnerable to increased UV, resulting in reduced growth, photosynthesis and flowering. These
species include wheat, rice, barley, oats, corn, soybeans, peas, tomatoes, cucumbers,
cauliflower, broccoli and carrots. Damage to marine life, in particular, plankton (tiny
organisms in the surface layer of oceans) are threatened by increased UV radiation. Plankton
are the first vital step in aquatic food chains. Decreases in plankton could disrupt the fresh
and saltwater food chains, and lead to a species shift. That is the cause of loss of biodiversity
in our oceans, rivers and lakes could reduce fish yields for commercial and sport fisheries.
Nowadays, the scientific improvement help us to understand more about what cause the
problem and be able to identify the source and how much emission on each exercise.
Therefore, this comes up with ways to control those emissions. However, in this study will
focus on the emission charge policies and the discharge permit policies. This study will
compare both methods and find out what it is, how it is difference, and which one is suitable
in which situation. [because it may tell the pros and cons of each type]

Emission Charge Policies

2.1 What is emission charge?

A pollution charge is a fee based on the quantity of pollutants that are discharged into the
environment. A user charge is a fee paid in exchange for the use of natural resources or for
the collection or disposal of pollutants. A product charge is a fee imposed on products that are
believed to have environmentally harmful effects. Although the terms fee, charge, and
tax are used interchangeably in this chapter, there are subtle differences. Under federal law,
a tax is a purely revenue raising instrument, whereas charges or fees are intended to offset
costs to the government. Thus, tax receipts would be part of general revenues. While many
charges and fees that are collected must be placed in the treasury general fund, some are
allowed to be retained and could supplement agency budgets. The different types of fees,
charges, and taxes discussed in this chapter can be classified in various ways.
Most environmental taxes are designed primarily to raise revenue, often to fund
environmental protection activities. The economic rationale behind such taxes is that those
who cause pollution should bear the costs. Such costs include both damages to the
environment and the administrative costs incurred by the authorities that regulate polluters.
To be economically efficient, environmental taxes should reflect both of these costs.
An emissions charge is simply that: a monetary charge applied to each ton of carbon dioxide
emitted (or the equivalent in another greenhouse gas) or to activities that lead to emissions.
An emissions charge imposes costs on the production of greenhouse gases providing an
incentive to reduce emissions. This is in contrast with levies or taxes that could be imposed
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on activities not directly related to emissions to fund acquisition of emission units for
compliance purposes.
2.2 Advantages of Emission Charge Policies
The advantages of emission charge policies focus on their efficiency, flexibility, and revenuegenerating properties.
1. Efficiency
The literature distinguishes between static and dynamic efficiency. The former refers to the
per-unit cost of aggregate emissions reductions attributable to a regulatory instrument in the
short run when abatement technologies are fixed. Theory suggests discharge fees enhance
static efficiency compared to discharge permit instruments for two reasons. First, they leave
each regulated plant free to choose the least expensive means of cutting pollution. By
contrast, discharge permit technology standards more or less dictate that groups of plants use
approved abatement technologies which are very unlikely to be cost minimizing for all of the
plants in these groups. The same is true of discharge permit emissions standards to the extent
they are technology forcing. For example, in the United States, emissions standards on
point sources administered under the Clean Water Act (e.g., effluent guidelines) are
developed with reference to the abatement capabilities of specific technologies. Firms adopt
these technologies to minimize the risk of being found in violation of the standards. Hence,
de jure emissions standards amount to de facto technology standards. Second, discharge fees
shift the burden of cutting aggregate emissions from plants with high marginal abatement
costs to plants with low marginal abatement costs. Plants with marginal abatements costs
lower than the discharge fee have a financial incentive to cut emissions to avoid paying the
fee while plants with higher marginal abatement costs have an incentive to pay the fee rather
than cutting emissions. In theory, as long as all plants pay the same discharge fee, their
abatement costs will eventually be equated at the margin, a necessary condition for
minimizing aggregate abatement costs. This result will obtain even when regulators have no
information about plants abatement costs. For a discharge permit policy to achieve this
result, the regulator must know the marginal abatement costs of every plant and must set
plant-specific standards, which is extremely unlikely in practice.
Dynamic efficiency refers to the per-unit cost of aggregate emissions reductions attributable
to a regulatory instrument in the long run when innovation in abatement technology is
possible. Discharge fee programs are said to enhance dynamic efficiency compared to
discharge permit policies because plants that pay discharge fees have a continuing financial
incentive to develop inexpensive ways to cut their emissions. By contrast, in a discharge
permit regime, incentives to innovate are often dampened by enforcement risks associated
with using a non-approved technology.
2. Flexibility
Compared to discharge permit, discharge fees are said to more easily accommodate change.
In a discharge permit system, the regulator usually sets different rules for different types of
plants. Collectively, these rules, which may be quite complex, imply an environmental quality
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standard. To change the environmental quality standard, or to facilitate the adoption of a new
abatement technology, the regulator may have to change the various rules. By contrast, in a
discharge fee system, the regulator typically sets a single fee that applies to all plants. Plants
retain control over complex abatement and technology adoption decisions. In principle, to
change the environmental quality standard, the regulator need only change the discharge fee.
3. Revenue
Finally, unlike discharge permit policies, discharge fees generate revenue. This revenue may
be earmarked for environmental expenditures. Although it has costs in terms of allocate
efficiency, earmarking is popular because it makes discharge fees more politically palatable
by returning revenue to those who pay the fees, and because it is seen as a means of
correcting for market failures that prevent firms from obtaining the investment credit.

Discharge Permit Policies

There are several reasons for allocating emission allowances free of charge. One is political;
introducing a scheme for taxing polluters is difficult as it implies costs for domestic industry,
an important constituency for policy-makers. Initially distributing allowances free of charge
is a way of introducing the costs gently before gradually moving into other modes of
distribution, such as auctioning.
Other reasons are related to concerns of carbon leakage and distortions in competitiveness.
Carbon leakage is when emissions are reduced in one country as a consequence of climate
change regulation, then increased elsewhere. This economy-wide concept relates to the
environmental impact of the measures. Carbon leakage can appear through three channels.
First, it can result from a loss in market share in the domestic market on behalf of foreign
competitors. Second, it can arise from new investment taking place on foreign markets.
Lastly, as demand for fossil fuels decreases at the domestic market following the carbon cost,
the price of fossil fuels will decrease, leading to an increased demand in other countries.
3.1

The Effects of Discharge Permit or Free Allowances on Incentives to Reduce

Emissions
The basic idea with free allocation of allowances is that, irrespective of the means of
allocation, emission allowances carry an opportunity cost. Thus, a firm using an allowance to
account for its emissions loses the opportunity to sell the allowance at the current market
price. This, in theory, creates an incentive for producers to reduce emissions, allowing them
to sell their allowances.
However, it is difficult to apply theory to evidence. In practice, the capacity of free
allowances to contribute to lowering emissions depends on a number of factors, such as the
method for determining the amount of free allowances to be distributed to individual firms,
the actual carbon cost, the type of cap, and the level of the cap. Grandfathering, a too
generous cap and, as a result, an insignificant carbon cost, are all factors contributing to
undermining the intended incentives to reduce emissions. Even when there is an actual
opportunity cost, this does not seem to be taken into account as real costs by firms; indeed,
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there is a tendency to pass through parts of the opportunity cost when possible, rather than to
use the margin created by the free allowance to curb emissions.
However, in a longer perspective, it is possible that the mere existence of a carbon price puts
pressure on industry to invest in efforts to reduce emissions. Indeed, in the current debate
about climate change regulation, industries worldwide are increasingly expressing concerns
that they may suffer from reduced competitiveness if their governments do not send clear
signals of a political commitment to reduce greenhouse gas emissions.
3.2 Do Discharge Permit Policies Limit Carbon Leakage?
If the incentives from free allowances to cut emissions are unclear, this intuitively has an
effect for the ability of free allowances to reduce the risks for leakage. Indeed, if firms do not
make as large efforts to curb their emissions as intended, a consequence must be that the risks
of leakage are reduced.
Even when recognizing the risks of leakage, free allowances will likely have little or no
impact on leakage in the short term, at least in case of an absolute cap. The reason is again
that firms will generally pass through the opportunity costs and thereby risk losing market
share. However, as outlined above, this theory does not always hold and the effects in the
long term are very unclear. Further, under output-based caps, carbon leakage could indeed be
curbed, however, the environmental effectiveness of the policy will also be undermined.
3.3 Can The Discharge Permit Policies Be Equivalent to A Subsidy?
There is no commonly agreed economic definition of a subsidy, which complicates any
attempt to answer the question above. A common characteristic of tentative definitions is
though that a subsidy confers a benefit to producers or consumers, which has been chosen as
the basis for the economic analysis below.
An inherent characteristic of the free allocation of allowances is to improve the financial
position of the recipients compared to a situation where they would have had to buy the
allowances, and compared to firms not receiving the allowances free of charge. Therefore,
recipient firms will be in a better position to invest, and a stronger financial position will also
tend to result in secondary benefits, such as lower costs of capital.
In addition to this general effect, there are certain ways in which the free allocation can be
designed or implemented that can confer additional benefits to the producers, thus render the
free allowances a subsidy. Many of these are in practice difficult to avoid.
First, there is a risk of over-compensation. This can happen in two distinct ways. First, if
firms are allocated more allowances than they need to cover their emissions. The excess
allowances can then be sold on the market. Such over-allocation is most likely in case of
grandfathering. Second, it is possible that firms receiving allowances free pass through the
opportunity costs of these allowances, resulting in a net profit. These profits are referred to as
windfall profits, and have under the EU emission trade scheme been evident for example in
the power sector. In both cases, firms would be able to make a profit through the allowances,
without any actual requirements to abate emissions.
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Policies related to new entrants and plant closures and how these cases are treated with
respect to the free allocation of allowances can also amount to subsidies. Allocating
allowances free of charge to new entrants can be considered an investment subsidy.
Moreover, allocating free allowances in proportion to the carbon intensity of new entrants can
undermine abatement incentives. As for plant closures, withholding the free allocation of
allowances in case of plant closure turns the allocation into a subsidy to production, as firms
only receive free allowances if they (continue to) operate the installation. Naturally,
incentives to keep inefficient installations running would not be beneficial for climate change.
Finally, differential free allocation between sectors may create distortions in competition. It
has been shown in the EU, that free allowances have been distributed unevenly between
different sectors in different countries. This could in principle lead to firms in the same sector
competing on different terms and conditions, something that could be equivalent to a subsidy
and possibly distort trade among them. This may lead to concerns that trade with competitors
in third countries could also be distorted, something that would need to be examined further.
3.4 What Does It Mean When The Free Allocation Amounts to A Subsidy?
Subsidies are problematic in many ways. Often they are inefficient, expensive, socially
inequitable, and environmentally harmful, and impose a burden on government budgets and
taxpayers. Moreover, they are able to distort any market in which the subsidized firm
operates. Distortions in international trade will reduce the opportunity of trade to contribute
to economic growth and sustainable development. Therefore, it is crucial that policy
measures intervening on the international level be well designed and targeted, to address the
aims in an efficient manner while reducing adverse effects.
In the case of free allowances, it has been shown that their environmental effectiveness is
unclear. Indeed, free allowances risk reducing the environmental benefits of an emissions
trading scheme compared to if polluters were required to pay for their allowances.
With respect to international trade and competition, it is difficult to say what the effects of
free allowances could be. At this early stage of climate change regulation, there is little
empirical evidence. Complicating the assessment of the effects on trade is the fact that the
very aim of these free allowances is to prevent changes in trade patters to curb carbon
leakage.
If the practice of allocating emission allowances free of charge would prove to be capable of
influencing competition between firms receiving respective not receiving free allowances, as
the analysis above indicates, then it is possible that the implications for third countries would
be quite broad. In the case of border measures, the main alternative to free allowances for
mitigating carbon leakage concerns, regulators would likely wish to target the exports from a
few, big-emitting economies within a few sectors. Subsidies in the form of free allowances
would on the contrary be less selective, as they could potentially impact production decisions,
prices, and the competitive position of the domestic industry. This could potentially have an
impact on competitors in all trading partners, importers, as well as exporters, including
developing countries.
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It naturally also depends on which element of the free allocation amounts to a subsidy. One
thing is very clear however; the recorded windfall profits are of such a magnitude that they
must affect international competition, and thereby trade.

Compare the Emission Charge Policies and

the Discharge Permit Policies

Pollution charges are frequently seen as an alternative to tradable permits, another incentivebased mechanism. While both possess advantages, their applicability depends upon both the
specific environmental problem being addressed the particular objectives of the public policy.
This section offers a quick comparison of the two systems to highlight the circumstances
under which each is likely to be most appropriate.
1. Permits fix the level of pollution control while charges fix the marginal costs of pollution
control. Under a permit system, policy makers determine how much total pollution can occur
(through the issuance of permits), but they cannot set bounds on expenditures for pollution
control. This strategy could be particularly appropriate for environmental problems with tight
margins of error or with marginal costs of control that do not rise dramatically with
increasing regulatory stringency. Charge systems, on the other hand, control the maximum
amount that a firm may pay for each increment of emissions, but do not dictate with certainty
how much control will actually occur. Such a tactic may be more suitable where the margin
of error on damages is not tight but the potential industrial impacts of over-control are
especially great. This could occur, for example, where small increases in control costs lead to
very large swings in production and employment.
2. In the presence of technological change and without additional government
intervention, permits freeze the level of pollution control while charges increase it.
Under a permit system, technological improvement will lower pollution-control costs and
permit prices, rather than emissions levels, unless the government intervenes. Such
technological change under a charge system, however, will both lower total pollution-control
costs and increase levels of control. Although firms will choose to control more emissions
and pay less tax, this can be offset by the expanded production that results from lower
operating costs.
3. With permits, resource transfers are private-to-private while they are private-to-public
with pollution charges. Under permit trading, firms choosing to emit pollution beyond their
initial permitted level must make payments to other firms who agree to control more than
their initial share. With charges, payments for uncontrolled emissions flow to government.
For those who believe that the private sector can utilize these resources more effectively,
permits offer an advantage over charges. Alternately, the government can earmark the
revenue from charges for environmental investments deficit reduction, or reductions in
distortionary taxes.
4. While both charges and permits impose costs on industry and consumers, charge
systems make the costs more explicit to both groups. Both charges and permits force firms
to internalize the costs of their pollution, either through expenditures on pollution controls or
through cash payments (buying permits or paying charges). Charge systems, however, make
these costs very visible to both industry and the public. While this may be problematic for
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short-term political reasons, it may ultimately be advantageous in that it can educate the
public about the costs and trade-offs associated with various levels of environmental control.
5. Permits adjust automatically for inflation, while charges do not. Because a permit
systems currency is emission rights, price movements in the overall economy will not affect
levels of emissions control. Under a charge system, however, inflation would reduce the taxes
(which are expressed in dollars per ton, for example) in real terms. Firms would therefore
control less. An obvious way to resolve this problem would be to link the charge rate to some
price index.
6. High transaction costs can drive up the total costs of compliance, having a negative
effect under either system. Transaction costs (e.g. costs associated with identifying willing
buyers and sellers of permits or costs of tax collection) can decrease the amount of trading
that will occur in a marketable-permit system and the amount of pollution control that will be
achieved with a charge system.
7. Permit systems may be more susceptible to strategic behavior. If any one firm controls a
significant share of the total number of permits, it activities may influence permit prices.
Although no magic cut-off point exists, it is unlikely that firms could engage in price-setting
behavior if they controlled less than 10% of the market. If other firms present credible threats
of entry to the market, it is less likely that anticompetitive behavior can thrive.

Conclusion

It would conclude that the allocation of discharge permits or free allowances is problematic.
From an economic perspective, free allowances, as such and certain elements of their
allocation, can constitute a subsidy, thereby being able to affect any market in which the
subsidized entities operate. No trading partners can be exempt from the effects of subsidies;
there would in other words be no room for more favorable treatment of developing countries,
as required by the United Framework Convention on Climate Change and the general
practice in the World Trade Organization.
In general, taking into account the fact that the allocation of discharge permits is becoming
common practice, and the possible effects of such allocation, it is necessary that more
empirical analysis is performed and that this issue is featured in international climate change
and trade negotiations. Developing a set of guiding principles or a best practice for emissions
trading schemes and the use of free allowances might be one idea worth being taken under
consideration, in order to ensure that efforts to address climate change are efficient and
effective and that possible adverse effects are minimized.
These emission charge policies accomplish this in a number of ways. First, they lower the
total costs of control to society while achieving the same level of aggregate control as
conventional regulations. Second, they encourage rather than hinder the development of
alternative technologies, and third, they promote awareness of true environmental costs
among both firms and consumers. In so doing, they provide an opportunity to capture the
double dividend of increasing pollution control while raising government revenue in ways
that do not distort markets.

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Application of pollution charges to both the threat of global climate change and the need for
cleaner energy production are possible. Charges linked to the carbon content of fossil fuels
may provide a feasible alternative for reaching CO 2 emission reduction objectives at the
lowest cost to society; and by properly realigning the price structures used by electrical
utilities to include the environmental impacts of alternative fuels, energy producers can be led
close to the right mix of resource-use options.
As new environmental problems arise and old ones persist, the limited resources of
government agencies and society will be stretched further and further. Pollution charges and
other incentive-based instruments offer opportunities to continue environmental protection
while cost-effectively leveraging existing resources.

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