Policy options include direct regulation (or pejoratively, command and control regulation) and incentive-based approaches, including pollution taxes and tradable permits allocated to polluters. Direct regulation includes requirements for pollution permits that polluters install the best available control technology when rebuilding power plants. Pollution taxes have fallen out of political favor, and may have constitutional challenges because the optimal pollution tax may vary over time and each tax adjustment could legally require congressional approval. Tradable permits give the holder the right to pollute a certain amount, to buy permits if emissions increase, and to sell permits if emissions decrease. One version of tradable permits is to lease the permit at a market auction. The so-called property rights solution is to allocate tradable permits in accordance with past levels of pollution, in essence appropriating common property and giving the property right to the polluter, without a corresponding property tax or any recognition of the economic rent.
If the property right to cause the externality resides with the party causing the damage, then the WTP is the correct marginal benefit curve. If the property right resides with the damaged party, the WTA is the marginal benefit curve (see Fig. 2). Solutions proposed by economists imply different allocations of property rights. Pollution taxes retain the property right for the public. Tradable permits, whose allocation is based on past levels of pollution, allocate the property right to the polluter. If tradable permits are leased at auctioned prices, the public retains the property right. When the U. S. Environmental Protection Agency changed direct regulations so that dirty power plants no longer had to be retrofitted to reduce pollution, the property right shifted from the pollutee to the polluter, and the marginal benefit curve was reduced by fiat, from the WTA to the WTP in Fig. 2. There is no unique optimal level of externality abatement without assuming who should own the property right, a normative issue.
Modern economic analysis favors the property rights solution to negative externalities. This selection is based on the criterion of static economic efficiency applied to Fig. 2. The solution requires setting the permitted amount of externalities equal to NC—NP and polluters will trade permits if they can reduce pollution at a marginal cost less than the price of the permit. The result will be NP abatement and the equilibrium price of the permit equal to the optimal pollution tax, TP This solution avoids the cost of direct regulation inherent in having regulators determine the cost of technology—a job best left to the market.
The property rights solution is an obvious misnomer since the other solutions—taxes, direct regulation, and auctioned leases of tradable permits—all have property rights retained by the public. Because the tradable permits are not subject to property taxes, it is also a misnomer to refer to the right to pollute as private property. An alternative is to lease tradable permits, retaining the property right for the public; this is referred to as the common property solution, favored by a small but growing group of influential economists. The common property solution—leasing tradable permits to pollute NC—Na—results in NA abatement and an equilibrium price equal to TA in Fig. 2.
Both the property rights tradable permits and the common property tradable permits options do not result in efficiency unless the amount of permitted pollution depreciates over time so that abatement increases in accordance with the analysis in Fig. 3, with the marginal benefit of abatement increasing over time due to the public good nature of abatement and population growth, and the increase in the pollution concentration shifting the intercept of the marginal benefit.
More problematic for the tradable permit approaches is that they do not acknowledge the joint pollutants, nonconvexities, and subtle cascading effects among natural and economic systems that render marginal benefit and marginal cost curves irrelevant.