Pollution Permits

PIGOVIAN TAXES AND POLLUTION PERMITS

The tax is a per ton of pollution tax.

The textbook states that Pigovian taxes are preferred to regulation because the tax reduces pollution more efficiently. Can you explain why?

"Harnessing the market to correct market failure."

Take care in interpreting this "demand curve for pollution." It really reflects the cost of reducing pollution. Anyone whose cost of reducing pollution by one ton is less than the tax, will act to eliminate the pollution rather than pay the tax. But reduction of pollution can be looked at as a "good" with a cost of production. The cost rises the more "pollution reduction" is produced, i.e., the less pollution remains.

Firms will stop reducing pollution and will exhibit a "demand" for pollution whenever the price (i.e., the tax per ton of pollution) becomes less than the cost of reducing by yet another ton.

The problem facing policymakers is that the Environmental Protection Agency doesn’t know the demand curve for pollution, so to reduce pollution to a given target, it doesn’t know what size tax to set. So instead of levying a tax, it has come up with the permit idea and let the market tell us the price for the quantity of pollution targeted.

EPA can target a given level of pollution, even though it doesn’t know the demand curve, and let the market find the price (= Pigovian tax) consistent with that level.

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This page was last updated on Friday, July 21, 2006.