. 139. Suggestions about how to do this in the case of pub~c informa~on campa,!

gnseaii·· CHAPTER EIGHT

254
'· found in Weiss, "PolicyDesign for Democracy:A Lookat Public Infonnanon Campaigns,"¡g
THE TOOLS OF 140, JanetA. Weiss, "Theoretical Foundations of Policy I~tervention" in PublicManaa,·'
GoVERNME.NT Reformand InnOvation,eds. H. GeorgeFredericksonand JocelynJohnston (Tuscaloosa:Univ
sity of AlabamaPress, 1999). .
Corrective Taxes, Charges,
and Tradable Permits
JosephJ. Cardes

JtlanYother cities and towns, Seattle faced a problem of what to do about its trash.
·e cirywas-rapidly exhausting the capacity of its own landfill and needed to find a
· place to dispos~ of its garbage. Another county was willing to take Seattle's trash,
only if Seattle was willing to pay.1 Seattle's response was to start chargingits resi-
. for garbage disposal based on the arnount of trash brought to the curb. Seattle
j 15
.. ged $16.10 for each large trash can set out per week. To encourage recycling, paper
.d g1assthat was separated for recycling was hauled away free of charge, and the
ge for hauling away yard waste was set at $4.25 per month.
'seattle households responded in severa! ways. As intended, voluntary -recycling in-
. ed,and there was a significant decline in the total amount of tonnage thatneeded
' e buried. An unintended-and not entirely desirable-effect was also that residents
doing what has been described as the "Seattle stomp," which involved compress-
. garbage into the smallest volwne poss,ible to make it fit into a single can.
·In a completely different venue, the eJ;).vironmentalcompliance managers of two
·· ent electric power companief turned on their computers to look at the auction
ard for sulfur oxide emissions al!owances. The Clean Air Act of 1990 allowed each
'.•ty.to emit no more than a certain amount of sulfur oxide into th~ air, but the act
' permitted a company that was able to keep its emissions below its. allowed limit
.~sellits "unused ..allowance" to another company that could then use these extra
owancesto exceed its own limit.
~cording to the auction board that flashed on their computer screens, the "going
re" for the right to emit a pound of sulfur oxide was $90 per ton. The engineers for
·e company, which we shall call New El~ctric Power, estimated that it would cost $80
·· each extra ~on of sulfur oxide emission that New Electric...cutback. New Electric
r thus could earn a profit of $10 on each right to emita ton of sulfur oxide that
ould sel! in the open market. The other company, which we shall call Smokestack
wer and Light, estimated it would cost $100 per ton to cut back its sulfur oxide
· ns. Smokestack could save $10 on each right to emita ton of sulfur oxide beyond
legallimit that it could buy in the market. Thus, New Electric Power offered to sel!
right to emit ti.ve thousand tons of sulfur oxide at a price of $90 per ton, which
quickly snapped up by Smokestack.
·.The transaction was a win-win situation for a.u concemed. The utility that sold
"ssionallowances gamered a profit of $50,000, and the utility that bought this al-
ce enjoyed a cost saving of $50,000. Society also reaped benefits of $100,000 by
· · g ~ore of the responsibility for emissions reduction away f.rom a company where
. Wouldcost $100 for each ton of sulfur oxide emission tb.atwas cut backto a company
herethe cost of reducing sulfur oxide pollution was only $80 per ton.
' Thesevignettes differ in their specifics, but tllere is a common thread. Each illustrates
· _useof Adam Smith's famous "invisible hand" of the marketplace instead of direct
C!alregulation to change iocially harmful behavior. · 255
 256 In the trash disposal example, Seattle could have attempted to deal with its ; . r.rading are policy tools that rank moderately low in terms of coerciveness. On 257
1
THEToots OF disposal problem by refusing to pick up more than a certain number of trash ">ll& · · hand the use of these tools ultimately relies on the legal authority of the state
: 0 ne ' . CH 8:
GoVERNMENT household each week, or by requiring that glass and bottles be recycled, Instea<1, .' ge behavior. Por example, smokers would not voluntarily pay tobacco taxes, CoRRECITVB
city provided its dtizens with financia! incentives to cut back on the amount of -:..·Gh~arket in pollution permits would not exist but for the ex.istence of prior en- TAXES,
but the example also illustrates a potential pitfall of relying on the market. The ;.da ental regulation. However, unlike social regulation, which mandates changes in CliARGES,
disposal fee also encouraged people to change their behavior-by compacting ga, ·· 0 AND
~ r through relati.vely Coercive prohibitions and controls, corrective taxes and
TBADABLE
as densely as possible-in a way that was not entirely intended. - a'Y'l; an.dpermit trading schemes, rely on relatively noncoercive financia! disincen- PERMITS
The case of the buying and selling of emissions permits illustrates the use of .ars:;01discourage harmful acti.vities by making them costly, or to reward socially
incentives to achieve an existing regulatory ge>almore f!exibly and cost effectively,W. es . .
.' ,ñcial béhavior.
permit trading, governrnent regulators did not need. to know which electric Utility
able to·cut back emissions more cheaply. All that was needed was to allow Utilities'· irectness
trade with each other in rights .to pollute. The market price for such pennits ti, ':, ctness measures the extent to which the entity authorizing or inaugurating a pro-
automatically «sorted out" which company was "better" at achieving the overallr, ¡re is involved in carrying it out. Because corrective taxes, charges, and tradable
ulatory goal at a considerable saving in the amount of total social resources devotel. · its rely on largely decentralized market choices made by individuals and businesses
achieving iniproved air quality. · onse to financia! penalties or rewards, this class of policy tools is also less direct
P
• the too! of social regulation, although somewhat more dir .ect th an su b'di
s1 es. Wh en
aDgovernmenttaxes cigarettes, it does not explicitly instruct smokers to smoke less:
I. DEFINITION AND BASIC FEATURES · 'okers can smoke as much as they wish, provided that they are willing to pay the
; ·ce. However, the government does directly impose a cost, and the resulting higher
D<!}iningFeatures •~ce·of cigarettes creates a financia! incentive. to cut back on smoking. ,
similarly, in assessing taxes or fees on pollution or waste disposal, the government
Corrective charges and tradable permlts are a class of policy tools that involve usiJl ~ directly operate a .tax or fee· system~ but it does not dictate how much pollution
prices. and other market mechanisms to create financia) incentives for individuals..- ·:businessultimately emits, or how much trash a business or household brings to the
change their behavior, in ways that reduce social hanns or secure benefits fo;-soci" - bside. Nonetheless, polluters will have a financia! incentive to cut.back on polluti.on
at large. . ·· order to reduce their tax bill, and people and businesses will be more apt to think
As noted in Chapter 5, social regulation is one means of effectuating certain so · : 'ce about disposing "excessive amounts" oftrash if doing so is not free. In the case
desired change in behavior. A defining feature of social regulation as a policy too!' ftrading of pollution permits, a government b.ureaucrat is directly involved in setting
its reliance on command and control and other admiq.istrative procedures to com¡( ·· overall regulatory target that needs to be met, but the permit trading scheme es-
changes in behavior. If society seeks to curtail the harmfuJ consumption of tob '. tiallyleaves it up to individual companies to decide how each will choose to comply
and alcohol, laws can be enacted that malee it illegal to purchase tobacco or aleo , ·'th this overall target.
Businesses can be legally prohíbited from emitting more than a certain amount;'.
pollution into the air and water, or a city could attempt to solve its trash disp '
problem by refusing to pick up more than a certain amount of trash set out each isibilitymeasures the extent to which the resources devoted to a too! show up in the
at curbside. · rmalbudget process. Taxes and charges and permit schemes are rather visible policy
An alterriative to social regulation is to use financia) penalties or rewards to e .ols.Taxes and charges typically need to be explicitly approved and authorized by the
behav:ior. If society disapproves of smoking or drinking, it can make these activi,., ."propriatelegislative body, and in many· cases are subject to periodic review. Also,
more expensive and leave it up to indivi~uals to decide whether engaging in the ha · , · e regulatory standards that can obscure the ful! cost · of complying with social
activity is worth the cost. If society wants to encourage people to do. more recycling, tions because these costs are borne by private parties, corrective taxes make such
can malee it more expensive to dispose of garbage that is not recycled. Businesses ·~" , sts visible in the budget and political process. 2 Moreover, any decision to alter the
1 be allowed to em.it harmful substances·into the air and water ifthey are willing to cialincentives created by taxes and charges requires changing the rate and/or the
i:
¡,
someone for the privilege of doing so.
, eof the tax or charge, which almost always engenders considerable and highlyvisible
oliticaldebate. .
Relation to Key Tool Features · Allowingpolluters to trade rights to pollute is aiso an action that must be explicitly
.•thorized as part of broader legislation regulating industrial and other uses of the
As discussed in the introductory chapter, corrective taxes, charges, and pennit · . vironment. For example, as discussed in more detall below, the current system of
m.ay b~ usefully classifi.ed in terms of whether these tools are coercive, direct, ~I ollutiontrading in the. United States was established under Title N of the Clean Air
- and automatic. ,ctAmendments of 1990 (CAAA).
CÓerciveness . Utomaticity .
Coerciveness measures the extent to which a tool restricts individual or gl"oupbeba :· . UtoIIJ.a.ticity
measures the extent to whicli a tool utilizes an exí.sting ~dm·inistrative
as opposed to merely encouraging or dj.scouraging it. Corrective taxes, charges, · ctu.reto produce its effect rather than having to create its own special administrative
 ·---- ._..
.....

258 apparatus. Corrective taJ<es,charges, and perroit trading rank moderately high in te . .Og administrative mechanism (e.g., existing Sales tax collection processes), orto
THE TooLSOF of being automatic. For such· systems to work; structures-to collect fees and spe · ·. new mechanisms and procedures. The former offers obvious ef:6.ciencyadvan- CH$:
GoVERNMENT taxes must often be created..However, a smoker does not need to lcriow thé.social ,:ebut may subject -the tax to procedures t!;tatare not well targeted to the program's ComCI'IVE
of smoking in order for cigarette taxes to affect bis or her behavior. Every time he O TAXES,
bjectÍves.
she buys a pack of cigarettes, society is implicitly reminding him or her that it dit.apr CHAltGES,
proves of smoking by taxmg it. Similarly, a business or home that faces an appropria · · rrectivefees ANO
'!)ADA.BLE
charge for disposal of its waste does not need to know the cost of waste disposal to · e jssuesthat n~ed to be addressed in de_si~ing fe.es,_such as ch~rges for was~ _dis- PERMITS
commtinity. Finally, the market for pollution permits automatically creates incenti"Ves! se.l,are broadly s~ to those that anse 1n des1gnmg corrective taxes. Decis1ons
for businesses to find environmentally smarter ways of producing goods and serv¡ · . ,d 10 be made about what to charge for, how much to charge, and how to collect
Thus, this class of tools stands midway between vouchers and direct government in: 'd adroinister the charge. '
the degree of automaticity it exhibits. AJin the case of taxes, the choice of the base of a fee or charge has _an import"-?-t
t on its outcome as a policy tool. For example, the case of waste disposal fees m
Design Features and Major Variants ~e described in the introductory vignette illustrates how the choice of the base of
· ~rge can ha.veunintended as well as intended consequences. In that case, by gearing
Corrective taxes, charges, and pennit trading schemes share broad tool features ~ tbechargeto the volume, rather than the wei~t, of the waste, _Localauthorities created
common. However, they al.so differ from each other in a nwnb~ of important ways. incentive for residents to pack more waste mto each container. .
In this section we zero in on sorne of these differences. · A potentially important difference between corrective taxes and corre~ve fees and
Corrective Taxes ' argesis that the latter are more likely to be raised and administered independently
f the existing tax system, which can have both disadvantages and advantages. On the
Designing correcti.ve taxes or fees requires attention to issues that are ~mmon to the, · e hand, when a corrective fee or cP.arge is administered outside the. tax system,
design of all taxes. One must decide on what to tax (the tax base), how much to tai ~ · g and often proV"enstructures for raising tax r~enue cannot be used to admin-
(the tax rate), arid how to tax (the administrative mechanism for collecting the tax). . terthe collection of the fee and monitor compli.µice. On the other hand, the need to
As is discussed more in the basic mechanics section of this chapter, choosing the ate a new administrative structure may also help free the administration ¡Uld col-
base of a corrective tax often involves an add.ed.dimension because the underlying· ' ctionof corrective fees from legal and/ or .political constraints that are associated :wi~
objective of the taxis to elicit a desired change in behavior, rat:h:er
thán tO raise revenui raxes.In additionJ fees and charges often receive different bud.getarytreatment than do
per se. The case of alcohol and gasoline ta,xes is an example. In the case of alcohoi th,. ::mxes.~ For example, it is more likely that the revenue raised from a corrective fee or
intent is to curb abusive drinking, rather than drinking per se (unless one is a member, chargewill be dedicated to specific uses than the revenue raised from a corrective tax.
ofthe Women's Christian Temperance l)nion). In princ;iple, the goal would be to ta,r
only drinking that is, abusive. In practice, such a taJ<would be almost impossible to ..ermitTrading
design or administer, so one is left with taxing general alcohol consumption.~ :, 'bsuesraised in the design of permit trading schemes are quite different from those
A similar issue arises in the case of gasoline taxes. The obje_ctivemight be to en-: isedin the design of correcti.vetaJcesand fees. One important difference is that permit
courage automobile mak.ers to develop cars that not only used less fue! but also cleaner, tradinghas not been viewed as a policy tool for reducing the overall level of any
fuel. Howevér, a tax that accomplished this purpose would be more complicated than" ehavior.The main policy tool that serves this purpose is social regulati.on. Thus, in
a taJ<on purchases of gasoline by the gaJJon.' Such a levy, if set at a high enough leve,·. e introductory vignette, the permit trading scherrie did not define how much sulfur
would ~~ourage automobile makers to make more fuel-effi.cient c~s, and would alsQ; 'Oxide each utility was allowed to emit; that was deterrnin_ed_by the Clean Afr Act
encourage people to substitute mass transit for driving. There would, however, be no: !Amendmentsof 1990, a regulatory program.
financia! incentive for automobile makers. to malee cars that burn~d. more "environ-· ·. Moreover, although permit trading could be used in principie to raise government
mentally friendly" fuei or for drivers t<;>substitute such cleaner fue! for regular fu~ revenue,permit trading has yet to be used for this purpose and seems unlikely to be
unless "dirty" fuel (such as leaded fuel) were taxed more heavily than other fuel, as d; inthe future for reasons discussed more fully below. In the vignette, for exarnple, the
done in the Gerroan :federal Repu'blic.' · . . roceeds fro:U perrnit sales were kept by the utility that was able to sell emissions
There may also be a potential conflict between the objectives of raising tax revenue allowances.
and of using taxes and fees to regulate: behavior. For example, if the objective is ~: The defining feature of perrnit trading as a po\icy tool is that the intent is to rely on
maxim.ize the amount of revenue collected from a tax or charge, oné Illay seek to tal·' 'll•rket forces of demand and supply to allocaté the burden for complying with a
activities whose demand or supply is not sensitive to price, but using taxes as mstrn#_ ~mandated reduction in a given behavior, such as pollutant em.issions. In designing the
ments to influence behavior presupposes that the behavior to be influenced will be ª~ ·tool,the govenunent thus needs to create an administrative framework that allows the
least.somewhat sensiti.ve to price. Taxes that are good sources of revenue ate al.sooft~ .em.ergence of markets that ·are ."well behaved" in two d.imensions. The market for
levied on bases that are easy.to administei and.monitor. However, a"taJcthat is easyto Perm.its must have proi,erties that are typically associated with well-functioning private
administer may not create the financia! incentives needed to change behavior ffi: th~ arkets,such as adequate information about buyers; sellers, anc:lprices, and an ade-
way desired. . '·
quatevolume of ttades. In addition, the. volume of tra.ding that results must result in
Finaily, for a .corrective tax. to work, an ad.ministrative mechanism_must be esta~· ~ OV"erall allocation ·of allowances that is-consisten 1:i.-vitl:r
the oyerall level of behavior
lished to collect and enforce it. A major _designissue ·here is. whether to· rely. on ·that is mandated by Jaw.
 260 The exact mechanics of creating such a framework are discussed in more detall beio .. . arettes and on distilled spirits declined in inflation-adjusted terms by one-third. 11 261
but several elements are in volved in creating the needed framework. One is the abjj¡ W ~is txend was reversed in 1989, largely because the budgeta,:y environment created a CH 8:
THE TOOLS OF
GoVERNMENTto specify clear standards for expected performance both by individual parties and ¡, 1' orable political climate for increasing these taxes. CoRRECTIVE
the "system as whole," as well to monitor compliance with these standards. Another; Ja~side from these budgetary politics, which created strong incentives for Congress to TAXBS,
to provide or to facilitate institutional arrangements that make it e~ for buyers an: Ji11d ways of raising revenue that did not involve increasing income taxes, support for CHARGES,
ANO
sellers to arrange trades. A third is to ensure that permit ~kets functJ.on competiti,,. .• reasing taxes on tobacco and alcohol also fit a ne'Mound enthusiasm for placing
TRADABLE
and fairly. ¡nere reliance on the "marketplace" as a meaos of addressing a host of social problems. PERMITS
:ere were growing concerns about the costs to society both of smoking and abusive
nsumption of alcohol in the l 980s. Policymakers were seeking ways of reducing these
II. PATTERNS OF TOOL USE ·:'°cial costs by reducing the consumption of tobacco and álcohol. The idea of using
· _so es to restrict the consumption of certain goods by making them more expensive was
t new. Sumptuary taxes-tax:es on goo ds or activ1ties
Corrective Taxes and Charges in the United States
Corrective taxes and charges in the United States are levie4. in various forms by J. ,:y· ta.l< '''th ''db"J.Oun to e mor-
at soc1ety
objectionable" -had been levied both in the United States and elsewhere for several
·· nturies.12 What was different, however, was a shift in emphasis on consciouslyviewing
Ievels of government. It is difficult, if not impossible, to provide a single empiric,¡ ; :,ohol and tobacco taxes as an instrument for achieving ce.rtain ~ehavíoral objec-.
measure of how widely these tools are used to implement policy. On the one hand, · tives-such as preventing youths from becoming smokers, or reducmg death on the
corrective fees and charge~ are a relatively modest source of government revenue at highways.
lévels of govemment. Y et, the amount of revenue raised fro:111 a c~rrective tax or charge. Sincethe round ofincreases in federal cigarette taxes enacted in the early 1990s, and
· may not reveal its importance as a policy tool A co:t'rectivet~ for example, could · schoduled to take effect in 2000 and thereafter, there have been several attempts to
quite effective as a too! for reducing harmful behavior. while raising relatively li ·jncreasefederal cigarette taxes even more, driven in part by a de'sire to r;i.isemore tax
revenue precisely because it succeeded in redud.ng the amount of the taxed activity., .reYenuein ways that could be portrayed as reducing other social harms.
NOiletheless .the revenue raised from corrective taxes and charges provides so~: Alcohol and tobacco taxes comprise a larger share of revenues at the state than at
information about patterns of too! .use because, as discussed below, support for manr. :the federal level, and in rnany cases state taxes on tobacco and alcohol are higher than
corrective iaxes.and charges is often driven.by a desire t<;> raise revenue. Moreover (. . aretheir federal counterparts. In part, this ref!ects an implicit political understanding
in the case of alcohol and tobacco taxes), changes in the amount of revenue raisea to reserve sales and excise taxes as a revenue source for (mainly) state governments.
from corrective taxes and charges sometim.es signal changes in pattems of relianceon
this too! of policy. · tEnvironmental Taxes and Pees
¡· An alternative gauge of the extent of use of correctÍ'':"etaxes and charges.is the extent· . At the federal level, raising revenue from tax~s and charges levied ~n activities that
to"which the tax or charge actually provides measurable incentives for people 9r busi- 1 'have an environmental impact is still a relatively :inodest undertaking. AJanuary 1999
neSSesto change their behavior .. The rate at which certain activíties are taxed clearli , )oint Committee on Taxation (JCT) publication lists a total of three taxes (excluding
pI"ovidesiome indication·· of the size of the incentive, but ultimately. the effect of~ tbe gasoline tax) that are levied on tax bases that arguably bear at least sorne relation
corrective tax depends on, what is tax.ed as well as on the tax rate. ·: ',toenvironmentally harmful activities: the Leaking Underground Storage Tank (LUST)
"TrustFund excise tax, the gas guzzler excise tax, and the exclse tax on ozone-depleting
A.lcohol~~d TobaccoTrocé. ';cherrúcals. 13
Taxes on alcohol and tobacco are among the oldest and most widely used correcti~· · Taken together, federal environmental taxes raise less than $100 million in revenue
. taxes, nof only in the United States, but also abroad. Smoking and drinking are tax .··. 1·in 1999. Although the amount of revenue raised is at best a very imperfect indicator
at bóth the féderal and the state and local levels in the United States. In 1997, combino! ·:.of tool use the fact that federal environmental taxes raise such a small arnount of
1
federal and ·stiitétobacco taxes ranged from a low of 21 percent of the price of a pa -.revenuein~ $7 trillion economy suggests that presently they play a very modest role
of cigaretteS to a high of 49 percent. 7 Most recently, New York State increased its . asa too! of federal environmental policy.
on cigarettes to $!.11, which is currently the highest ip. the nation.• In fiscal year 1996, k These taxes also exemplify the somewhat different uses of environmental taxes and
federal alcohol taxes amounted to roughly $2.00 per fifth of 80-proof distilled spirl ,:charges.14 The LU.STTrust Fund tax is levied at a rate of 0.1 cent per gallon on gasoline
$0.30 penix-paclc ofbeer, and $1.75 per bottle ofwine.' . :·,andother motor fuels, with the proceeds of the tax earmarked to defray any costs of
· Taxes on tobacco and .alcohol, which· in 1950 CO!llprisedalmost 10 percent of , ..cleanupassociated with leaks from underground "storage tanks. The tax provides no
· federal tax collections, had steadily declined ·in importan ce as a revenue sour~e ov~! i•~ financia!incentive for changes in the design of such tanks, or other measures, that

forty-year period, and in 1989 accounted for only I percent of all federal taxes." Du . .;Wouldreduce the· inciden ce of leaks, and hence its underlying purpose is not to change
·thls same period, federal cigarette taxes as a percentage of cígarette prices fell from3 ·;,behavior.Rather, the tax "is intended to spread the costs of a government program to
to 11:percent .. This decline was caused in part by the growth in in come and Pª. . thosewho occasion such costs.
,·i;
taxes, bui it also reflected a certain ."benign neglect" by. Congress, which chose not ' In contrast, both the gas guzzler tax and the excise tax on ozone-depleting chem.icals
-:e\.:. ,. and tobacco tax rates· to keep .pa~e yvith inflation. Thus, ·accordingw
· ·adjUSt':a.J.cOhol · are intended to change behavior. The gas guzzler tax imposes a financial penalty on
.. 1990 Congressional Budget Office study, between 1950 and 1989, the tax rates ~ automobileswhose fu.el economy rating falls below a certain threshold. It is assessed
 -- .................. ·-·;.;.··-.- ..

262 at rates starting at $1,0~0 per vehicle for vehicles whose fue] econ()rn.Yrating is
congress, and Title IV of the CAAA mandated the first large-scale use of tradablo 263'
THETOOLS OF than 22.5 miles per gallon, but at least 21.5 miles per gallon, and rises to $7,700
etJlisSions ~ei:m,itsas a to~l of environmental regulation. .
Gov>RNMENT vehicle for velúcles with a fue! economy rating of less than 12.5 miles per gallon p CH 8:
Similarly, the tax on ozone-depleting chemicals was crafted in response to an ;,1 ·
'!'h•first trade of perm1ts between two prívate companies took place in 1992 with C0RR.ECT1VB

nat1on
tb<,ale of 10,000 allowances by Wisconsin Power and Light to the Tennessee Valley TAXES,
. al agreement-the Montreal protocols-that restrictedthe production andeo -· . CHARGBS,
,1.uthorityata price of~265 per "!}owa_nce.The se~ond was the sale of25,000 allowances
sumption of owne-depleting chemicals. The tax identifies a list of eight chemicaJsn ANO
be taxed that correspond to those chemicals identified for control under the Montr t<i
bYtheAlcoa Corporation to Oh10 EdlSon at a pnce of $300 per allowance. Since then,
TRADABLE
protocol. The tax applies not only to domestic production but also to im¡,orts of
tb<pace of sales has accelerated. PERMITS
· . paul Joskow et al. report that between March of 1993 and March of 1997 permits,
chemicals, as well as to imports of goods that use these chemicals in productlon. T
,nowing the annual emission of over 12 million tons of sulfur dioxide (SO,) were
liability in 2000 is determined by multiplying the production of each chemical by $76-
per pound, and then again by an ozone-depleting factor that measures the amoun; O
tf3dedin these markets. Over 11 million tons of this total represents pri'Vatetrades.
envirorunentalharm done by each chemicaI.1s ª.· '!1i•total volume of trades represents roughly l O percent of the total allowances dis-
· As of this writing, hówever, despite a tlurry of interest in environmental taxes inth. tri'butedannually to polluters.
early l 990s, no new federal environmental taxes have emerged on the scene. There
a proposal to include a fairly substantial set of energy taxes in President ClinJon's ¡993 a,:es,Fees, and Permits in Internatúmal Perspective
budget proposal, but these taxes were quickly removed from the overall package in·
}ij in the United States, taxes on tobacco, alcohol, and gasoline are nearly ubiquitous
response to considerable political opposition.
At the state and local levels, there is a fairlywidespread use of various environmen · :inothercountries and have theirorigin.s as sumptuary taxes oras convenient ways of
taxes, fees, and charges at the state and local levels. In 1995, according to Boh.m .raising revenue.18 However, a number of European countries have made more con-
Kelsay (1999), 44 states levied a haz&rdous waste generator.fee, 43 Jevied a hazardo · ·scioususe of gasoline taxes as a corrective tax to discourage the consumption of gasoline
waste disposal fee, 38 levied an underground storage tank fee, 36 levied hazardo· ·andto reduce driving and emis::;ions.European cigarette taxes also make up a much
waste disposal fees, 28 levied waste tire fees, 14 levied a motor fuels fee, 7 levied a Iow'. ,Jargershare ofthe price of cigarettes than in the United States."
leve! radioactive waste generator fee, 6 .Jevied a coastal/inland spill fee, and 4 Jevied . Buropeancoun~es also rely more on incentive-based user chargesand fees for other
water quality fee. These taxes and charges represent a mix of "benefit taxes"' w purposes.In part, tlús may stem from the fact that, as noted by Stephen Farber (1998),
primary purpose is to generate tax revenue to fund environmental c1eanup,and ;the"polluter pays principie" has become a popular guiding principie in European
corrective taxes and fees that are consciously in.tendedto Changebehavior. .environmental policy. Under this rubric, polluters must either bear the cost of measures
'widertaken to reduce pollution or bear the costs of environmental darnage. By itself,
Gasoline Tax'es ·theconcept of polluter pays does not necessarily translate in.tothe explicit use of cor-
rectivefees and charges to change behavior, but environmental taxes ~nd fees that are
Federaland state gasoline taxes present an interesting separatecase. Initially, theset . designedto 'changebehavior, as well as to distribute-the costs of pollution to polluters,
were proposed as a kind of rough user charge to help pay for transportation infrasttu ·. ,aremore prevalent in European countries than they are in the United States.
ture and not as a correc¿ivetax. With the onset of the energy crisis of the 1970s, th i : In contrast, other countries have not yet explicitly linked perrnit trading schernes to
carne to be used. in a rougb.way, to encourage greater efficiency in the consumption- )najo~environmental legislation as has been done in the United States. In part, this
of gasoline. In the late l 980s, there was sorne discussion of raising gasoline taxesa¡: :mayreflect the fact that, especially in Europe, the process of environmental regulation
way of reducing airborne pollution, but it was recognized that taxing gasoline perse seemsto involve a greater degree of administrative giye and take between govermnent
was a rather blunt instrument for reducing pollution emitted by automobiles beca ' -Mdthe regulated. · ·
these taxes operated only by reducing consumption of gasoline.1' Thus·, at pres
although most observers would acknowledge that gasoline taxes could play a role as
inst~ment .ºf environment~ policy, these taxes are not consciously used for thispui·
BASIC MECHANICS
pose m the United States. They are seen first and forernost as a lúghway user chargt¡
second as a tool for dealing with energy security, and only then as.a possible fonn
.CorrectiveT a,c_esand Fees
environmenta! charge. ·
.Thegeneral mechanics of levying corrective iaJlfS and/or fees are basically similar to
thosethat arise in implementing any tax or fee. Mechanismshave ·to be put in place
Tradable Permits ~--ensurethat the ~ppr~priate acti':1tiesor:transactions are taxed, that the taxis col-
"'-"'d, that the tax
lS levied on the right entity, and that steps are taken to monitor and
The use of tradable permits as tools to supplement environmental regulation is q ·.',
enforcecompliance.
recent. Although the idea of using permit trading schemes to ~ut the costs of envir()II
mental regulation had been proposed by academic economists as early as the 197 . Deiermimng
• · the Base of the Tax or Charge .
the possibility of actually ad9pting such_a scheme became a reality in 1990 when
Bush administration proposed to implemeI\t permit trading in Title IV of the cAJ,1., 'f;.first .step in the process is deciding what is to be taxed .and then ensuring that the
Despite initial opposition (see below), the Administrarion's a¡,proach was ad.opted be15levied·correctly,-This can be a relatively simple matter. when the harrn that is to
preventedor reduced is directly associated with the· cohsumption or production of
.'

264 a particular good or service. For example, since the harm of smoking is direct1y . in favor of collecting corrective taxes from sellers rather than buyers: ·Corrective 265
ciated with the n~mber of cigarettes that are smoked, cigarette 1::onsumptionis: eS nd charges can also be collected from sellers, but in many cases can also be levied CH8:
THE TooLSOF
GoVERNMENT appropriate tax base. . :iiy on consumers, especially when the collection of the fee can be easily linked to CORIU!CTIVB
In the case of other corrective taxes, however, choosing the appropriate taJC.b~ ·.reyisionof a service-such as trash collection-that can be easily monitored. TAXES,
CHARGES,
more complicated. As Farber notes, in practice, selecting the base of a corrective f_ .~ rtunately,. there is little orno conflict between collecting a tax or fee from the side
AND
or fee typical.ly involves sorne compromise benveen the objective ofthe regulation ·, ,f ;. market that is easier to administer and pollee and making sure that the tax or TRADABLE
ease of administration. 20 For example, in the case of a good whos_eproduction ca··· . provides the desired financi~ incentive. for ch~nges in behavi~r. Th~ purpose of . PERMITS
the emission of pollution as a byproduct, one would, in principie, seek to ta)c ' · ·ng corrective taxes or chargmg corrective fees 1s to malee certain socially harmful
e~ission of the pollutant.directly, instead of imposing a tax on each· unit of the g<Írl eV)'lds or activities more costly. What ultimately matters is how the tax or fee affects
0
that is produced: This is necessary in _arder to provide the producer with a finant . market price of the taxed good or activity, and tax incidence analysis shows that
incentive to seek ways of reducing the amount of pollution that is emitted per ea· ~e economic effects of taxes are ultimately determined by the market forces of supply
unit of production. In practice, it may be hard to administer such a tax, and, instI :,.~ demand and not by who is required to remit the actual tax or payment to the
one may be left with the simple expedient of taxing the good. Thls reduces the ~ vernment.22Hence, policymakers are free to levy the tax on the side of the market-
to the environment by curtailing production and consumption of the good, but da~ goers or buyers-that is easiest to administer.
so in á second-best fashion. ·
¡t;ompliance
and Enforcement .
Determining the Tax Rate or Charge ·~ocedures must also be developed to monitor and ensure compliance with corrective
ollce the base of the tax or fee has been identified, the rate of tax or the amount · r es and fees. Monitoring typically takes the form of auditing the financia! records of
the fee Can bé.set. Because the rate of a corrective tax or fee willreflect objectives: · ose charged with collecting and remitting a tax or charge to make sure that proper
s'ocial policj,, this requires more information than is typic.ally required to choose a ,. ounts of tax are assessed and levied. .
1
ra"teor charge when the policy objective ~s simply to raise revenue.· · The ease of monitoring will depend not only on the number of entities that are
]ust as there are practica! problems in choosing the base of a tax or fee, probl . bject to monitoring, but also on the informational complexities involved in measur-
are also likely to be encountered in setting the rate of tax or the fee. Economists wo ,,.:g the range of activities that are subj~ct. to tax. It is: f?r exampl~, easier to ?1-onitor
argue that the rate of a. corrective tax or fee should be commensurate with the sci' .~omplíancewith a tax when the base 1s.linked to existmg financ1al, ac;count~g,. and
costs that arise from the activity one is se'eking to regulate. This approach to settilí ,,roduction records, such as the volume of goods produced and sold, than ·1t 1s to
the tax presumes, however, that there is sorne "optima!" amount ofharm that so · · :inonitor compliance with a tax base-for example, volume of pollution discharged
should be prepared to accept, wbich can be controversia!. · Jntothe atmosphere-requiring that new forms of recordkeeping be established.
· Moreover, even if there is broad agreement that the policy goal should be atta · • ,. In addition, those who must pay a tax or fee can legally avoid the ta:1<or charge by
a socially. optima! leve! of harm, infonnation about the relevant externa! costs of · -~bstituting untaxed for taxed activities, and those who are subject tcita;{es or fees will
'activity may be sparse. For example, suppose that the policy rationale for taxing ci~ ·. ek to exploit any legally available opportunity of making such substitutions. Thus,
rettes iS ·to malee sure the smokers bear the full social costs of tlieir a:ctions. :theimplementati~n of a corrective tax or fee will require that procedures be developed
choosing the "proper" ra1:eof corrective taxation requires informatiOn about the s .· ··ardetermining when an activity is or is not subject to a corrective tax or charge, as
costs of smoking that would not be borne by smokers if tobacco products were n' ,.;·ell ás fo'r iesolving legitimate disputes that can arise when there are differences of
taxed. Such estiro.ates are available, but there is enough wicertainty about their ma.· Oi,inionabout whether a particular good or activity is taxable.
nitude that they provide at best only a rough guide to setting the tax rate." ,· Taxes and fees also creite financial incentives for illegal evasion.Thus, the use of
A more niodest objective is to reduce a socially harmful activity by sóme legislativ }orréctivCtaxes and fees as a policy tool requires either the use of existing legal struc-
desired amount. To do so, one needs to choose a tax or fee tb.at raises tb.e price of :tures(or the creation of new ones) to determine when evasion has occurred, as well
regulated activity by "enough" to produce the desired cutback. ·. ··.sto assess civil or criminal penalties for illegal conduct. Since such mechanism.s are
In either case, choosing the tax rate requires that one have soine additional info~ ;óftenalready in place in ~sting tax systems, this becomes an argument for using taxes
. matjon.~bout .the good that is to be taxed. To implement the economists' approa .. .ratherthan specialized fees for such corrective purposes.
oll.e wOuld need t_ohave an estímate of the dollar magnitude of the harm caused ~
the activity. 'To_s~ta tax bigh enough to achieve some desired cutback in producti. '/llustration:De~igning a Tax on Ozone-Depleting Chemicals
one would need inform8tioil on how sensitive the activity was to changes in its pn -~e U.S. tax on ozone-depleting chemicals is a 'good illustration of several of the issues
As is illustrated by the case of the táx on ozone-depleting chemicals discussed belo~ andtradeoffs that must be resolved in the design of a corrective tax. 23 The goal was to
information of this sort can be quite sketchy. 'developa tax that would provide the appropriate incentives to reduce the use of ozone-
depietingchemicals, but that could also be feasibly administered.
Collecting the Tax or Fee A, noted by Thomas Barthold ( 1994), crafting an effective, yet also administratively
Axr~SemCD.ts rilust also be ~ade to collect the tax or fee. :A.s a general m.atter,;~ Workable,tax required that several issúes be resolved. One issue was that of what should
ádm.inis-irat·or~seékto iiiinimize 'the nuÍnber of taxpiyérs becá"useit simplifies coll .betaxed.Irt this case, an intemational consensus had been reached in the form of the
··a'.nd'lll~n.itorin.g'colnplliince with'.the' tax. As a practicál niat!er, this consideratioJI 11ontrealProtocoi which the Bush administration had endorsed, to reduce the emis-
 ----""--. --.-...:·-..-·

266 sions of chlorofluorocarbons (CFCs) into the envirotunent, because these ch

THETooLS oP were believed to play a major role in destroying stratospheric ozone. The broad Po . ¡errnit Trading 26?·
GoVERNMENT goal was to levy a tax that would lead to reduced emissions of these harmful chemi ·tb•mechanics of using permit ttading as a policy too! include sorne issues that are "'! 8: .
In principie, corrective taxes should impose taxeS on activities that are COillJllensca1s, CoRRECTIVE
l!llilOnto regulation. These are the need to clearly specify standards of performance TA.XES,
with the social harm done bythose activities. Yet (as in the case of alcohol consum "'. .:d to monitor and enforce compliance. In additlon, other issues need to·be addressed
discussed above), it was recognized that the production of chlorofluorocarbons ;tio whenpermit trading is used to implement such standards. .
CJi.AAGES,
AND
did not destroy stratospheric ozone, but rather the release of these chemicals in.toer . TRADA.BLE
atmosphere during the pr?duction process. As Barthold notes, more typically it ~. . settingStandards of Performance PEBMITS

the use of these chemicals as reírigerants in refrigerators and automobile air co ; rhe rationale for allowing perrnit trading is to permit an overall regulatory target-
tioners and in the production of electronic circuit boards that was the main sour n .1 for example, reduction in total emissions of M thousand pounds-to be achieved in
·
envrronmen tal hann , an d even more spea "fically 1t . the use of ce
· was not necessarily epo· thernost economically flexible manner. Regulators must, however, be able to ascertain
in automobile air conditioners that was a problem,· but rather the use of CFCs ,, thatthis overall goal is achieved, which requireS the ability t~ monitor compliance with
improperly installed and/or maintamed automobile air conditioners. By this logic the regulation at each source. This, in turn, means that one must be able to set clearly
most effective tax. would have been one that was placed on leales of CFCs from a' ,1efinedlimits on allowable emissions at each source. Title IV of the Clean Air Act
However, a tax that hened in only on those CFCs that harmed the ozone Iayo~to;; ,Alllendments of 1990, for e.xample, initially sought to reduce the 1980 leve! of emissions
not even remotely adm.inistratively workable. The ccideal"tax would need to be 1 : of SO, by 10 million tons per year (about a 50 percent reduction) by the year 2000.
on mi1:1ionsof ~ivers ~th faulty aut?mobile air-conditioning systems. Alternatively. To achieve this objective, individual companies ·were assigned an i.nitial limit on the
one m1ght cons1der taxmg more heavily at the production leve! refrigerants that w I alllount of SO, that they could emit that was consistent with this overall target. This
destined for use in automobiles when compared wi,th those destined far use in ho ·.·cargetwas administratively defined in ter~s of emissions allowances that were "given"
on the theory that refrigerants destined far use in cars we!e more likely to Ieak in , to each company-for e.xample, Metropolitan Power and Light was given allowances
·that would permit it to ernit, say, 100,000 tons of SO, during the year 1996. The major
~e _a~osphere, but there was no administratively workable way of making such
distinction. ionovation that accompanied the introduction ofpennit trad.ing was to give each com-
. pany considerable flexibility in complying with the law.
At the same time, there .were less than a dozen mantrl'acturers of ozone-deple)
chemicals, and only a few more importers of these chemicals from abroad. To · EnforcingStandards of Pe,formance
extent that one belieired that ali ozone-depleting chemicals ultimately found their
In addition to specifying standards of performance, sanctions need to be established
into the a~osphere in one way or another, a case could be made for imposing a .
fornoncompliance. In the case of the Clean Afr· Act of 1990, compliance was encour-
on domestic producers of these chemicals as well as on importers, arid such a tax could
aged by imposing a fine of $2,000 per each-ton of emissions that exceeded any year>s
be administered relatively easily. · .
·anowances,and by requiring violators to offset excess emissions in oné year by an equal
The treatrnent of imports raised a further issue. Did foreign environmentalregulati · amount oflower emisSions in the subsequent year.
and/ or taxes in crease the cost of imported ozone-depleting products by an amo
comparable to the tax. hnposed on domestic production of these goods? If the . · Relating Emissions to Permits
¡
was "yes," then domestic users would not have an incentive to avo id the U .S. tax br Permit trading requires an additional !ayer of monitoring to keep track of the trades
substituting imported for domestically produced ozone-depleting chemicals and goodi : that take place." In tl1e case of Title IV of the CAAA, such tracking is accomplished
using these chemicals.
by a computerized tracking system administered by the Environmental Protection
There was no reason, however, to assume that foreign-prodU:ced ozone-deple.' Agency.The system has the following e!ernents. Initially, each aff~cted unit is given an
products _were subject to comparable ~s or regulations. Hence, imports needed ~ individual allowance account (a "unit áccbunt") in the EPA computer system. A unit
b_etaxed ~ arder to ensure that Amencan users of ozone-depleting products did n could either be an entire company with a single plant, or eme of severa! plants owned
s1mply substitute cheaper foreign imports far American products. . ,.bythe sarne company. The allocations of each unit for each year between 1995 through
In addition to determining the most ad.m.inistratively workable base of the taX, • · 2025 a.re placed in these accounts. At the end of each year, each unit has enough
was necessary to choose the proper tax rate. A3 mentioned above, sorne effort was ma · , all.owari.cesof the appropriate vintages to cover its allowed ·emissions for that year. Far
to. ass'.gn diffe'.ential tax rates to different types of ozone-depleting chemicals based . · example, at the end of 2000, if Metropolitan Power and Light were assigned an overall
saentific studies of the ozone-depleting potential of each chemical and its Iongevity· · . emissions allowance of 100,000 pounds of SO,,then Metropolitan Power and Light
the upper atmosphere. Thus, in a crude way, the tax was designed to exact more of . Wouldneed to have 100,000 allowances in its accoúnt tO emit S0 2 either for the year
financia! penalty from those ozone-depleting chemicals that caused more physi · 2000,or previous years. (In other words, a company could bank or acquire opti.ons in
harm. Yet, as Barthold notes, there is no necessary link between physical and econol!IÍ, ; a current year for use in future years, but not «borrow" allowances from future years
harm. In other words, there is no evidence that in 2000 the base tax rate of $7.6 for use in the current year.)
corresponds to the environmental damage done by these chemicals. Moreover, thet
Creatingan Orderly Market for Permits
is sorne evidence that the initial tax. rates that were. chosen in 1989. were set at least·
·part with 8.1:1 _éyeto raísing a needed amount of revenue. Another issue in -the im]?lem~tation_ of penrilt ·tradin,g Schellles Js the creation of an
9rderly market to facilitafe trades. This .'Wasa' matter of some concern when permit
 268 trading was first launched. Thus, Title N ofthe CAAA mandated that the EPA hoJd. ' ohibit-or fail to include on the approved list-ways in which households on 269
THBTOOLS OF series ~f auctions that were intended to "jump-start" the market. These auctions \v '; ·therpr
;el • wn might find ways of cutting back on household waste. Suppose, h owever, th at CH 8<
tb"'ºere demand . .
GoVERNMENT held once. a year and covered only two or three vintages at a ti.me. The auction ·
held by withholding just under 3 percent of allowances and then selling these a!lo
in spot and seven-year advance auctions. Because the purpose of the auctions was
tb•~:
··
1
. o f garbage collecti' on
studies that showed that mcreasmg th e pnce
ercent per pound was likely to get households to cut back on the amount of
b1 /ought to the curbside by 25 percent. Then, one might expect that doubling the
CoRRBCT!VE
TAXES,
CHARGES,
AND
reveal infonnation about the market price of permits, an!i not to raise revenue, ·· :y¡as::ged for garbage collection would also achieve the de:sired cutback. In this case, TRADA.BLE
auctions were set up to be revenue neutral in the sense that auction revenues were .fee r it would be Jeft up to households to decide how they would cut back, and PERlv.tITS .
kept by the govemment, _but instead were returned to utilities in proportion· to noweveould
' be no need to implement and enforce a potent1·.uy comp licat ed set o f
shares of the allowances that were initially withheld. · ':~a:ons. All that one would need to d.o would be to raise the fee and Jet the market
I.n 1993 and 1994, allowances sold in EPA auctions accounted for overa half and°
quarter, respectively, of áll allowances traded. Since tllen, as noted _byJoskow et do the rest. . . .
other exarnple is the case that economists have made for usmg e1ther corr~ct1ve
.(1998), trading of pollution permits has talcen place in two very different arenas. :tion taxes or permit trading to achieve legislatively mandated levels of enVJ.ron-
majority of em.issions trades has occurred in the private_Illarketplace and has invol ··:entalquality.26The claim is that price incentives can help lower the costs of c_on-
bilateral transactions either di.rectly between two differeiit' utilities, or bet'ween as' . lling pollution whenever multiple sources con tribute t~ th~ overall l.evel.of ~o~ution,
utility and prívate market malcers who have found it pro:6.table to serve as bro · d gu!ators do not care how the required total reduct1on 1n pollut10Il,is dIStnbuted
between utilities seeking to buy and to sell permits. · anre the multiple sources. In such cases, it is desi~able to di
ainong b str1'bute th e t~t ald ·
. reh uct1on
The second way that allowances have been traded has been through a set of ann :inpollution so that the added cost of reducing emissions y a:ihextra :"'e!'t is t e.same
· auctions thát have been held by the government. The shar.e of publicly traded allow' Source which means that emissions from sources Wlt re1ativ y 1ow mcre-
at eac h , . 1 th
anees among overall trades dropped further to about I O percent of allowances in 199· ' tal costs of controlling pollution would need to be cut proporuonate y more an
and in 1997 accounted for about 5 percent of ali allowanc~ traded. Joskow et al. now _Jil~ • ns from sources with relatively high incremental costs of pollutiQn control.
that the initial auctions helped establish visible market values that served the basic g ' emiss10 . . · H
;. In principle, one could achieve this outcome by means of ~1rec: re~atio~.f. owe~er,
of getting the market started and helped stimulate the creation of prívate market tra · froma practica! standpoint, this would require regulators not on y to ave m ~rmatlon
activity of all kinds. Yet, one cl,earlesson from the Ticl.e.IVexperience is .that the priva I about "high-cost" and "low-cost" sources of .Polluti~n, but als~ to translate this knowl-
market was capable of responding quite rapidly to the potential gains from trade tha .edge into a set of differentiated targets .for pollut1on reduc~1on among. the sources.
were created by the permit tradlng scheme. As noted by Robert Stavins (1998), ' Aside from the rather substantial information. requirements of su~ a regulatory
experíence shows that « ••• the prívate sector (was able to) fulfill brokerage nee ' heme it would face formidable political obstacles, since it would requ1re sorne sources
(provide) price information and (match) trading partners, despite claims to the con se •
to cut back more pollution than others. Thus, it is no~ surprismg · · th . _ ª.t tr ad't'
1 ion al
trary when the prOgram was enacted, En:trepreneurs , , , stepped in to _maleeavailab ·."command and control" forms of environmental regulatton do not ~1Str1butereduc-
a variety of services, including private brokerage, electÍoniC bid/ask bulletin boiards¡, tionsin emissions in this mariner. Instead, regulations typically require·propottionate
and allowance price forecasts. »
reductions at all sources .
.Alternatively, instead of mandating the same proportional reductions of pollution
. at each source, a legislated target for overall pollution reduc?on could be. set, and
IV, TOÓL SELECTION ·polluters could then be required to pay the sarne tax on eac~ ~t of ~ffluent discharged
into the environment. Each polluter would have a financ1al mcentlve to reduce pol-
The basic rationale for using financial iricentives as a tool of policy is· that under th lution up to the point where the added cost of abating an addltional unit just equaled
right circumstances ·such deviceS can be at least as e:ffectiveas di.rect social regulatio· .the tax. Because ali polluters would face the sarne tax, the added cost of. reducing ª:'
while offering sorne additional benefits that come from giving more f!exibility)n d · additional unit would be the same at all sources. Producers who could control envi-
cidlng how to comply with regulations to those that are regulated. .ronmental emissions relatively cheaply would cut back pollution proportionately more
-'·thanbusinesses with relatively high costs of pollution control.
,Advantages:...:_Corrective Charges and Taxes · Several studies have compared the costs of limiting pollution through across-th.e-.
· board reductions in emissions at all sources, regardless of relative cost, with the cost
Flexibility and Efficiency ·ofachieving the same total change in emissio~. more tlexibly. These studies show that
·,ubstantial costs could be saved by moving away from the across-the-board approach.
One 6f the main advantages of relying on corrective taxes or fees Ílls'tead of dir '.Forexample studies that compared the cost of limiting emissions using direct controls
a
coritrols is that there are variety of situations in which relying .on market prices . withthe least-cost
• sólution have found cost savings as high as 50 percent. "
"economizes" on the infonnation that is needed to alter behavior. Wa:ste disposal offersJ
one example. The "Double Dividend"
Suppose that a municipality decides ihat it wishes to reduce the volume of garba&' ..Proponents of corrective taxes also contend that this policy tool offers a "double div-
:~:; ~:.: ·, · by, say, 25 percent. It can. try. to. achieve ¡bis 9bjective by in].plemei,tjng á set of ,:egu·
idend"because it allows government tax reven~e to be r$ed i.n.away ~at is less costly
,,:.:,-.
~.: 'lations that directs what people can.and cannot ~~ to th~-c;:U:rbsid~~-1'.h.CSe regulation5 to society while also serving sorne broader social purpose. !~g
particular goods or
would then need to be enforced, and it might well tum out that the régulations would activities generally causes less of the taxed good or act1Y1tyto be produced and
 ·--..;..··-;.-..·

270 consumed. If there is no social purpose in restricting output of fue taxed goo& 1 '[heFinancia!Burden 2n·
THE TooLS OF
sumers and producers suffer a loss in economic well-being. This excess burden is a 'frb.Dlthe perspective of those who are regulated, taxes and fees .pose an additional Clj 8:
GovERNMENT cost of col!ecting taires over and above the taires paid. In principie, the excess bu,'- oncial disadvantage when compared with direct regulation. Typically, a direct en- CóRRECTIVE
of taxation can be reduced, perhaps even eijminated, by taxing activities whose e T=s,
~onxnental regulation takes the fonn of requiring the bUSiness to emit no more than CHARGES,
swnption or production imposes social costs that are not reflected in m.arket p · "1rne roandated level, which requires an outlay to cut baclc emissions. However, if the AND
Beca use there are social gains from restricting such activities, taxing them may act sOtback is achieved by means of a tax or fee, the business bears not only the cost of . TRADABLE
improve economic well-being, or at least reduce_it less than ifmore socially desirab PER!Vl:lTS
.~ttinS back emissions, but also the cost of paying the tax ar fee on the remaining
activities are taxed. Many of the objects of social regulation-such as pollution, sn,O
~,rges. Severa! studies done in the 1980s showed that taxing pollution at rates high
ing, and abusive drinking-are widely believed to impose externa! social costs that • . ugh to create true incentives for abatement would easily increase revenues-and
not widely reflected in the prices of those goods and services. Thistranslates eas.ilyin 110
:~e a,ssociated :financia! burden-from environmental taies severalfold. 29 Moreover,
the perception that one cail "do well" (i.e., raise additional needed revenue), Wh.ii
,theseincreased taxes would not be evenly distributed among industries and products.
"doing good" (i.e., re4ucing the costs of envirorunental pollution) by taxing ce ·
'por example, in the case oftaxes on stationary sources _of air pollution, perhaps 75
socially undesirable activities. :percent of the added tax burden would fall on seven industries. Robert Crandall ( 1983)
Complements Other Regulatory Tools s suggested that these impacts could be softened by taxing emissions only above
.,amemínimum threshold. In principie, this approach would provide financia! incen-
In some other cases, corrective taxes, fees, or permit trading schemes can serve as
wes for abatement beyond this threshold leve! while reducing the burden (and the
. additional policy too! to reinforce direci social regulation. Smoking and drinkingar
·revenuecollected) from prospective taxes on pollution. It would, however, also increase
good exarnples. Society wishes to prevent smoking and drinking among teens. Th '
'thecosts of administering and complying with such taxes. This Problem, however, may
are laws that prohibit the sale of tqbacco and alcohol to minors, but these laws
not be as significant in the case of fees and charges on waste disposal, mainly because
imperfectly enforced. One way of providing an additional, and relatively easily enfor
·tbe leve! ofthe fee or charge that would be required to provide the desired incentives
signa! to minors that smoking and drinking are prohibited is to malee these activi ·
. uld not impose a large ta.x burden.
more expensive by taxing them. ·

Disadvantages-Corrective Charges and Taxes 'Advantages-Permit Trading

There are, however, also potentially serious disadvantages to relying on price incenti !Allowingpolluters to trade pollution permits with each other has many of the advan-
tagesof taxing pollution, while avoiding some of the disadvantages. As described above,
Uncertainty "lb.eessential feature of tradable permit schemes is th~t regulators set a desired leve! of
Often there is little or no information ahout how peOple are likely 1:o react to p · . overall environmental emissions, issue permits to pollut_e to individual polluters, and
incentives, while it may be relatively easy to observe and monitor the behavior that then allow pennits to be bought and sold. Under this arrangement, polluters with
is seeking to regulate. In sucli cases, implem.enting direct regulations may be the sur '. .relativelyhigh costs of controlling pollution would find it worthwhile to buy additional
way of achieving the desired policy goal. . "ghtsto pollute from polluters with relative low costs of control. Polluters with rela-
Similar issues arise when using environmental taxes or fees in place of direct re •tivelylow costs of controlling pollution would find the costs of cutting bacl< on pol-
lations. ··iutionto be less than the income they could receive by selling rights to pollute.
Regulators must live with a greater uncertainty abCIUtthe leve! of pollution con Bei:ause the total arnount of permits is fixed to equal the legislatively mandated leve!
when they tax the polluters than when the polluters are regulated directly. If, for of pollution, the trading of pollution permits does not affect the total arnount of pol-
ample, the tax rate is set too low because there is uncertainty about how bus~ess tion reduction. It does, however, redistribute total abatement among pollution
will respond to an emissions tax, pollution will be reduced by less than the legislativel : urces with the high and low costs of control. As long as trades can be arranged with ·
desired arnount. If the tax is set too high, pollution would be cut by more than , •Jittleorno transactions costs, pollution perrnits would be traded until each producer
legislatively mandated arnount. In principie, one could deal with this uncertainty b facedthe same marginal cost of abatement. Thus, like taxes, tI'adable permits can lOwer
adjusting the ta.x until the desired policy goal was attained, and the market would gi1 ·.thecost of achieving legislatively mandated levels of environmental quality. Unlike
the regulator the information needed to malee such adjustments. 28 However, fine- ' taxes,however, "tradablepermits would pro'ducé a certain level ofpolluti.on control. In
environmental tax I'ates má.y be easier ·said than done. If pollution tax rates cannot . :addition, tradable permits do not irnpose the·· same financia! burdeos on regulated
changed over time, or can be changed only infrequently, the choice between polluti . ··.industries.Indeed, when compared with the altemative of clirect regulation, all parties ·
taxes and d.irect controls involves comparing the more economically costly but , .invo!vedactually realize .a financia! gain from the ability to trade rights to pollute with
more certain control offered by direct regulation with the !ess costly but also less ce ·. eachother.
control offered by e:O.vironmentalcharges. Thus, relying on corrective taxes rather
direct controls to achieve legislatively maridated standards might be an attractive opti .
only if the certainty of control is less important than the costs of control. Howevet, '.Disadvantages-Permit Trading
cases_\\7here it is iniperatlve·to l:Ímit.emissions to a given amount_regai;dl:essofthe. As.noted by Stavins, one of fue. r~asons for .t:he.~~ative, s~c~ess· of the S02 trading
the uncertainty assodá.te.4 with correctlve chaI'ges becomeis a more se.rious llini~U :"'l>eriment is that the 'cost of achieving the overall· policy goal,differed widely among
 272 sources.'º A flexible market-based approach makes particular sense in such cir . plernenting social regulations th.rough corrective taxes and fees can actually be fi- 273
THE TooLS OP
stances, but there are other instances in Which such d.ifferences, and hence the Potell.,· ~ciallY more castly to the regulated than direct regulation. The relative uncertainty
gains from permit trading, may not be as great. In this case, the added benefit fr · CH 8:.
GOWRNMENT .~ aehieving desired targets can also be considered to be a political liability of certain CoRRECTIVE
relying on a r¡,ore decentralized approach may not be worth the added compleJ<:itie, TAXES,
·ta"and fee schemes.
creating such a system. , : 'fhe above criticisms, however, do not apply with the same force to perm.it trading CHARGJ!S,
Another potentially important limitation on the use of permit trading scherne, is '. scJiemes,which at least on paper seem to be a win-win situation for ali concerned. Yet, AND
implicit presumption that ccmore pollution than allowed" at one source can be offs :therewasconsiderable opposition to the inclusion of pennit trading in the CAftA.
TRADABLE
PERMITS
by a physically equal amount of ,clesspollution than allowed" at another source, lv! . Stavinsnotes that political opposition to p~rmit trading carne from severa! quarters.
this assun1ption effectively asswnes that the social harms to be avoided are at onewas symbolic: environmental groups that supported stricter regulations porirayed
roughly commensurate at each source. Yet, this may not always be true scientific uch programs as giving businesses a "license to pollute." These groups were also con-
In such cases, permit trading can iead to localized "hot spots" withrelatively high le,¡ :.i,,ed that giving firms emissions permits would seem to confer a property right-a
of pollution because of high costs of abatement. ·,¡ghtto emit-that would be difficult to curtail through the political process in the
.future.
Política! Considerations · Roger Noll (2000) also provides a fascinating account of how the political support
.'toremissions trading has ebbed aod flowed as a result of changes in the relative benefits
Despite the (almost uniform) support of economists f'or a greater reliance on market andcosts of.using different tools of environmental regulation. 32 Noll argues that initially
,based approaches to changing socially harmful behavior, the political acceptance of ; .therewas a tacit regulatory bargain between established industries and environmen-
policy too! has been uneven. There has, of late, been considerable political support fo
taliststhat favored adopting direct regulation over market-based incentives. This bar-
increasing taxes on smoking and fees on hazardous waste. In contrast, there are fo~. gain basically rested on implementing environmental regulations by enacting fairly
m.idable obstacles to the enactment of signiñcant environmental mxes, and the acce·' :praconian "new source performance standardsn that tended to favor established fa-
tance of pollution permit schellles has been rather limite<i .' .cilities over new ones. Thus, environmental regula ti o ns had the effect ·of protecting
Clearly, one ·political attraction of corrective taxes or fees is that they raise tax r; . ~tablished facilities frorn competition by new entrants. From the environmentalists'
enue. ln 1989, Congress was caught between Scylla and Charybdis of a large and ( perspective, this arrangement also made social regulation more palatable because it
the time) growing budget deficit, and a president who had issued a "read my lips, no
avoided imposing standards on establishe~ businesses that could have had the effect of
new taxes" pledge in the campaign. The president's stand made Congress especiall
:'bankrupting many companies and increasing unemployment in regulated industries.
receptive to policies that arguably could be described as serving a "larger social purposC·
Noll argues, however, that the passage of time, changes in demand, international
than .simply raising government revenue. Similar factors led to support for the e ' trade,and the advance of technology reduced the benefits of this bargain to both sides.
tax on ozo.ne-depleting chemicals, which, as noted by a staff member of the Jo"'.
'Established industries found themselves in a situation where they neede4:to modernize
. CoIIl.mittee on Taxation, emerged from an "almost serendipitous" consensu~-
'their increasingly obsolete facilities in order to meet import competitión;··and suddenly
The budget proposed auctioning the rights to produce such chemicals, although theytoo carne up against the new performance standards that had previously been their
administration officials indicated privately that a tax on the'producer's side would beas .¡ ·source of protection. Supporters of environmental regulation found it harder to enact
as an auction of the rights to produce. At the same time, a Congressional budge(
ac'ceptal;>le add.itional emission controls because of the increased opposition now com.ing froin
resolution mandated the House Committee on Ways and Means and the_Senate Committee .·establishedindustry. Thus, both the regulated and supporters of regulation found it in
· on Finance to raise revenue from sources within their jurisdictions, wlúch would inclu.de. i; · theiriµterest to explore more flexible forms of regulation that placed more reliance on
taxes, but not auctions..At least ·one member of each tax-writing committee had already · permit trading as a mechanism for reducing compliance costs.
introduced legislation to tax 'ozone-depleting chemicals. Consequently a tax on ozone- · Despite the increased openness to making environmental regulations more :flexible
depleting chemicals represented a sorely-needed revenue source which had sponsorshlp . _byintroducing permit trading schemes, Noll goes on to observe that the pace of adopt-
from within the tax-writing committees and had the endorsement ofthe President who '.ingthis reform has beer;i.slow because the basic thrust of recent policy was not just to
otherwisf!proclaimed he was opposed to new taxes. The result of t:h.isconfluence was that ~ substitute an arguably more flexible for a less flexible policy too!, but to combine this
· the tax wás included as part of the budiet reconciliation process with little opposition.31 . withincreasing the leve! of regulation. Noll argues persuasively that bundling a regu:
latory reform with increased regulatory stringency is likely to cause the reform to fail,
The same arguinent_:_that one could "do good while doing well for the Federal trea
, orbe less complete. One reason is that the initial system of relatively inefficient direct
sury"_:_was repeated again in President Clinton's 1993 proposed budget, whichin-
· regulation exists not because of sorne political átCident, but instead reflects a kind of
cluded a fairly sizable hike in federal tobacco wces that were described as "no regr.
' political equilibrium that gives more weight to certain interests. The other is that the
taxes." ·
· inevitableresult of making products, workplaces, or the environment more healthy and
The revenue that is collected from taxes and fees, however, reflects a tax that rn
safeis to subject sorne actors to regulation who have hitherto been able to avoid it,
be paid by so meo ne, and this too! feature genera tes poli ti cal opposition, especially~
. eventhough the new, more stringent system is structured to have lower compliance
taxes or fees that are perceivéd ás being 1'too hlgh." Toe fact that any a~ministrati. ,
:·,;,, ....
. tosts than the existing system. The upshot is that those who have a reason to oppose
·..workable tax: orfee typically must be.levied. o.n ali consu;mption or productipn, not J ..'
~ new regulation also h_ave a reason to oppose the reform that is tied to the new
or production .fuexcess of sorne legally mandated amount, means· ~
c"()QS.t.µ1?,ption regulation. ·
¡.
 ·-- .,.._... ·--...:-........._.

274. V. MANAGEMENT CHALLENGES AND

TmTooLSOF POTENTIAL RESPONSE uld be easily «.monitored" was not the actual amount of waste brought to the curb .2Ys'
GOVERNMENT . térIIlSof weight, but rather its bulk, ·measured in terms of whether the waste could q,¡ 2,
As noted in another chapter, relying more on economic incentiY"esas tools of , ·~ ¡nto a standard-sizC gar'pagecan. The result was a price incentive 'tha,tencouraged CORR.ECTlVE
policy is one response to the criticism that social regulation, withits command~o "' . ~ple not only to bring less waste to the curb, but also to pack their waste more TAXES,
control approach., can be overly restrictive as a policy tool. However, shifting to aii.4· .~,osely, which may not have been entirely compatible with the overall objective of CHARGES,

more decentralized, market-based approaches to regulation poses its own set of ~

ANO
: ,,ducing the total amount of waste to be disposed. TRADABLE
leng':5 b:ca~e implemen_ting ";'~ managing these policy tools either requires crea , · . PERlvilTS
new m.stitutions or adapting ex:istmggovernment institutions that have purposes tli
than regulating behavior. More generally, ·policymakers also need to ensur.° .
mar~t-based appro~ches a~ually provide meaningful financial incentives for PriVa !JIthe case of permit trading, one might think that the key manageroent challenge
parties to change their behavior. These management challenges are outlined more ·:,.,ouldbe to create and maintain a well-functioning market for permits. Yet, the ex-
below. · .'periencewith permit trading in the United States· demonstrates that such a ID:arketcan
be developed and sustained with a minimum of active govemment involvement, pro-
Establishing Appropriate Administrative Structures rided that there is adequate monitoring of the performance of private parties and
, ¡racl<lngof the volume of trades that take place.
Al~~ugh they.U:e oft~n consider:~ relatively autoniatic, corrective'fees and taxes ha. Creating such a monitoring and tracking $fStem, however, is a major management
their own ~dmm1Strattvecomplexities, as we have seen. Already established mechanis cl,allenge in itself. Adequate and timely monitoring of compliance with regulatory
for collectmg government revenue can be used to administer corrective taxes, but t · . target.s requires that technologies for measuring the physical amount of ernissions must
in~tutions need to be adapted to reflect the fact that su.ch taxes are levied to chan 'either exist or be developed, and sophisticated information systems for keeping track
so~ally harmful behavior ~s well as-t~ raise revenue. Por example, managing large- . 0 ¡ the buying and selling of permits must also be created. Clearly, both the measurement
envrronmental taxes reqwres experttse about both the design and administration andinformation technologies that are needed to implement a successful pennit trading
taxes that is to be found in tax agencies, and about the admmistration and inanagem i systemhave benefited greatly from 'the rapid diffusion of computers and management

of e~vironmental regulati.ons that is to be found in environmental agencies. Imposi.n" : jnfonnation systems in governnient and industry. ·
envrronmental taxes on "new" bases, such as ·emissions, may also réqu.ixe creating
mechanisms for ~onitoring tax compliance that differ from conVentional ways of au Coordination
diting financial and production records.
. In some cases, fees and charges can be collected under existing arrangements, butas A further management challénge to permit trading arises from the need to coordinate
· m the case of corrective taxes, these existing arrangeinents need to be modiñed. Im~ : theuse of this policy too! with other features of the regulatory landscape. For example,
plementing charges that are designed to foster recycling and reduce the amount of ' some opponents of.permit trading were concemed that utilities, which were the prime
brought to the curb might "simply" require replacing an existing flat monthly chargé i objectof regulati.011,Would not have an incentive to participate in permit trading be-
fqr trash service with a more elaborate schedule of fees to reflect the amount and · cause state regulatory commissions would not allow them to reap the rewards from
of trash left for pickup. Additional complexity, however, would be introduced into thi · lower costs of compliance. In fact, there is some evidence that this factor may have
process of preparing and collecting bilis, and new systems of monítoring would ~ . reducedthe amount of permit trading.~3
needed. For example, if the amount of the charge varied with the number of trash carii
left for pickup and the amount of trash that was presorted for recycling, the agency
charged with implementing the fee would have to develop an administratively workable, OVERALL ASSESSMENT
way of keeping track of the amount and type of trash left at curbside by each customet.
In º:h~r cases, there may be no existing arrangements that can be easily adapted~ Have corrective taxes, fees, and permit trading preved to be useful tools of policy? As
collectmg ~ new fee or charge. For example, a community that previously provide4 wehave seen, these tools ranl; fairly high in terms of efficiency.· More at issue, however,
waste disposal as a «free" public service would need to create a new system for impos' i.stheir effectiveness-whether corrective taxes, fees, and permits are capable of chang-
and then collecting charges for waste disposaí that varied with the amount and typto ingbehavior as·intended. Also of concern is their legitimacy and theircontribution to
trash collected. · ·' equity.In this section, we assess each of these .types of tools in terms of these criteria.

Creating Incentives Corrective T axes and Fees

Anothe~ management challenge is to balance the need for taxing activities that are "'1.
to monitor and administe~ with providing private parties with the_right incenti'ves.111
the case of the Seattle waste disposal program, levying a charge that varied withtb! So far·as corrective teces and fees are concern~d, as noted· earlier, one of the major
nu!Ilber of (standardized) garbage cans set out for pickup had the intende.d .~ fo
challengesis. to find a tax rate that is suffü:ient deter füe béhavior that public policy
reducing the overall volume ofv,aste thafrieeded.to be dis¡iosed, bui the.behavior . ~ trj>ing'Ndisc'ourage. Where the beÍiavior brirlgsuiúql!• ót especially large satisfaction
or'rewardStci cOnsWllerSOr·firms; the·tax !.itei maY xiééd.·to be·virtually confiscatory in
,-,.
'e,

276 ordE:rto deter the behavior. Therefore, one of the great concerns aboú.t correctiv-e 277
THE TooLS oi= and charges is that they may prove ineffective in precisely the circumstances where
¡,egitimacr
: ective tax:es also perform well in terms of legitimacy. This is so for two somewhat CH 8:
GOVERNMENT are most needed. COR.RECTIVE
. 01;rrent reasons. Taxing activities with social costs is seen as a legitirnate expression
Fortunately, empirical stüdies to date have tended to refute this concem, at least; TAXES,
d} e cietfs moral disapproval of certain actívities. As noted above, taxes on alcohol
part. Such studies consistently find that people and businesses do respond to corrett!v 0
CHA.RGES,
: ~~obacco have their origins as sumptuary tax.es-taxes imposed for moral or reli- ANO
taices and fees by curtailing a range of socially costly activities. There is considerabi'
evidence that smoking is fairly sensitive to price and thus can be curtailed by ~
. 8?us reasons ,on "sin.ful activities." 38 Similarly, taxes on polluters have been justified TRADAllLE

cigarettes. Estimates ofthis sensitivity indicate, for example, that the average cornbuitd
i giothe grounds that it is "only fairP that the polluter pay. ·PERMITS

federal-state cigarette taic rate, which raises the price of cigarettes by roughly 25 percen~
, onA.somewhat different rationale for corre~~ve taxes and .~harges ~ that. ~~ ~rovide
·, ean.s0f making sure that people pay for externa! costs that their actl.VItles1mpose
reduces consumption of cigarettes by between 10 and 25 percent. 34 It also appears tha;'
cigarette consumption by young smokers is especíally price sensitiv~. Indeed, recenu::
1 ·ª J1lthe rest of society. While this justification may seem similar to the sumptuary tax

the World Bank has offered a strong endorsement of using cigarette taices to
smoking worldwide. ' 3
cJ: _!
':·º~·onale,
ra
1
there is an important difference. Jfcorrective taxes "areseen as legitimate for
nomicrather than for moral reasons, the magnitude of the tax should, in principle,
'. :':ar sorne relatíonship to the economic costs ofthe social harm thatthe taxis intended
Other studies have also found that cigarette taxes affect-cigarette consumption in"-·~
way ·that is similar to- increasing smokers' perceptions <?fthe risks of smok,ing. l<i; ,
... correct. For example, there is ·some evidence that current federal and state tobacco
10
'I:
¡axesfully ref!ect the costs of smoking. that _are not borne by Americ:"' ~mokers. one
Viscusi (199_7),for example, has shown that the average national excise tax on smokütg'
has the same discouraging effect on smoking as would ·a perceptiém by smokers that . accepts this evidence, the case for: taxmg ag~rett~~ ev:n ~ore heavily _is.w.eak~ if 1;he
- olicyobjective is to reduce smoking to a soc1ally optimal leve! than 1t IS 1fthe policy
there Was a 27 percent chance that smoking causes lung cancer. 1;"
!bjective is to curtail smoking as mu~ as possible because it is wrong to smoke. 39
Alcohol taices also appear to be effective tools for curbing abusive drinking. Ther~i,
broad evidence that alcohol consumptio~ is sensitiVe to p~ce,_and ()Demajor studyhas'
found that higher beer taices contribute to reduced highway fatalities from drunk driv .. permit Trading
ing accidents. 36 As in the case of ci~ette taxes, there is also evidence that younge/
consumers, who are more apt to be abusive drinkers, are more sensitive to price, anc1·
hence more sensitive to alcohol taxes than older drinkers. Efficiency
Charges for waste disposal also have performed as expected, When Seattle began Trading of environmental p~rmits also seores high in terms of ef:ficiency.By increasing
charging $16.10 per month for each can picked up weekly, and coupled this charg, flexibilitypermit trading has lowered the costs of complying with environmental reg-
with an offer to haul away for free paper, glass, and metal that had been preseparat,d ulations. Several different estimates suggest that allowing permit trading may have cut
for recycling, total tonnage that needed to be buried fell by 22 percent, and voluntal),: · . the costs of complying with the CA.AAby between 30 and 50 percent.
recycling rose from 22 percent of waste to 36 perceni_.:_a rate that was almost three1 . -,.,.
times the national average. When Charlottesville, Virginia, decided to charge $.80 per, Effectiveness
32-gallon bag or can of residential. garbage collected at. curqside, the volume of garbage Perhaps just as important, the f!exibility built into the permit trading system has pro-
presented for collection was E:stimated to decline by· 3_7"¡,ercen4 after controllingi duced sorne surprises in terms of effectiveness. One was the rapid expansion in the
for other factors. (The weight of Charlottesville garbage, however, fell by a smaDer·, nationwide use of relatively cheap, low-sulfur coal that became possible because of
amqunt-14 percent-in part because Charlottesville residents began practicingtheir significant declines in rail rates. While no one clairns that allowing permit trading
O'Wil version of the Seattle stomp.' 7) . · . caused rail rates to decline, there is a general agreement that the fl.exibility introduced
Whether similar results will obtain in othei' settings where the behavior to'be affected. by permit trading made it possible for utilities to take advantage of this development.
· · involves greater economíc stakes is an_open _question. Polluters may,_foÍ"example, will· Another unexpected outcome was that many utilities found it economically advan-
ingly pay·a fee or charge.rather than reduce their emissions unleSS.the fee or-chargeis tageous to exceed the required cutbacks required under Phase I of the CA.AAin order
set exceedingly high. , , to be able to bank allowances for future use in Phase 11,which began in January 2000.
N ev~rtheless, the ~den ce to date is more encouraging about the effectivenessof A, noted by Douglas Bohi and Dallas Burtraw," banking of allowances was a "win-
correctivE!charges than skeptics have assumed. win"outcome fo.r the environment and for industry. ''Overcompliance" with emissions
targets set for Phase I provided environmental and public health benefits sooner than
Equity
would otherwise have occurred. In exchange, irldustry was able to cut its cost of com~
On balance, the use of corrective taices ·and fees as policy too Is also meets gener,IIY · pliance and ease into the more stringent emissions set in Phase II.
accepted notions of fairness, provided that the rate of the tax or fee bears some relatiOJl ·
to the harm that the fee or tax is in tended to correct. Thus, even though a tax on. Equity
smoking m.ay be regressive with respect to income because it bits the peor harder ~an Allowing permit trading may seem to transfer in come from high-cost companies (who
the Pch, it nonetheless can .be .regarded as fair to the extent that the tax bears sorue Wil!buy permits) to Jow-cost companies (who will sell permits), but this disguises the
:t: .":;: relation to the-.external co~ts borne by s11:1okers. Similarly, with reSpect to environroental factthat both buyers and ~ellers are made better off by being allowed to trade, compared
!axes .and. other charge~ such as waste disposal fees, 'the charge is fa.ir_ as long as the taJ'.. Withthe alternative of direct controls. A potentially more serious concern that blends
or fee is related to the enYironmental damage to be pre'Vented or ~eliorated. · concerns of fairness ~ong with those of economic efficiency is that perm.it schemes
 278 that are imp)emented by distributing emissions allowances free of charge to
businesses favors existing :firms and can be a barrier to new entran"t5.
v-Ill- SUGGESTED READING 219 '
THE TOOLS OF
G.OVERNMENT qi ¡3: u
o,rrective T axes and Pees CbRRECTIVE
Legitimacy TAXES,
partJlold, Thomas. "Issues in, the Design ofEnvironmental Excise Taxes," JouT"nalofEconomic CliARGES,
As noted above, counterbalancing these advantages, permit trading does have the dii::
p,rspectives8, no. 1 (1994): 133-151. AND
advantage ·of appearing to give polluters a "license to pollute." As such, it lacks solllé eook. Phillip, and Michael Moore. "Alcóhol," National Bureau of Ecollomic Research, Working TRADABLE
legitimacy. The concept of allowing. more pollution at one site to be balanced by le,{ paper W6905 (1999). . PERMITS
pollution at another can also be controversia!. As noted by siavins, such ethical objecé) ¡:acber,.Stephen. "'Enviroruriental Tues and Fees,: in Htiti.dbookon Taxation, eds. W. Bartley
.tions to the use of market incentives to ·control pollution have diminished in recen( Hildreth and James A. Rlchardson. New York: Marcel Dekker, 1999.
years, but have not disappeared ~tirely. 41 _ ·. WorldBank. Curbing the Epídemic:Governmentsand the :Bconomics.ofTobaccoControLWash-
. ington, D.C.: World Bank, 1999. '

permit Trading
VII. FUTURE DIRECTIONS
Bohi, Douglas, and Dallas Burtraw. "S0 2 Allow~ce Trading: How Experience and Expectations
. Measure Up," Resources for .the Future, Discussion Paper 97-24 (1997).
The acceptance of using market incentives to regulate socially harmful behavior 1ias'·
Joskow,'Paul L., Richard Schmalensee, and Elizabeth Bailey. "The Market for Sulfur Dioxide
grown, although skeptics remain. The skepticism seems gr eatest when proposals to. Emissions," American EconomicReview 88, no. 4 (1998): 669-685.
e:xpand the range and scope of existing regulations are under discussion. If "past • · Noll,Roger. The Economicsand Politicsof the Slowdown in RegulatoryReform. Washington, D.C.:
prologue,'' this observation implies that the political clima~ for using market incentives: AEI-Brookings Joint Center for ~gulatory Studies, 2000.
as a regulatory policy too! is likely to be most favorable after the initial political battle schmalensee, Richard, Paul L. Joskow, A. Denny Elleiman, Juan Pablo Montero, and Elizabeth
for regulating private behavior has been fought and won. Bailey.«An Interim Evaluation of Sulfur Dioxide Emissions Trading," fournal of Economic
Nonetheless, the future seems bright for the use of corrective taxes, fees, and tra&:. Perspectives12, no. 3 (1998): 53-68.
Stavins,Robert N. "What Can We Leam from the Grand Policy ~eriment? Lessons from 50 2
a ble permit schemes. Malcing more use of market incentives to modify socially hannful Allowance Trading." fournal ofEconomic Perspectives12, no. 3 (1998): 69-88.
behavior has garnered significant support, based in no small part on the demonstrate<!:
success of these policy. tools.
There is evidence that using market incentives to change socially harmful bebavior ACKNOWLEDGMENTS
can be effective and ·offers fairly signiñ~ant economic bene:fits COil:lparedwith moré
J am grateful to Thomas Barthold, Bruce Davie, and Lester Salamon for helpful com.ments on
direct means of control. In the case of corrective· taxes and fees, the past record shows
earlierdrafts of this chapter. ·
that people and businesses respond in predictable ways to financia! incentives, and thi
prospect of raising revenue from taxi.ng activities that ai:-ewidely reg~ded to be "s~
bads" can be politically attractive. The first large-scale experiment with permit trading
also has achieved resu!ts that are largely consisient with the expectations of its pro',
ponents, and this success should contribute to. more acceptance of this tool in the', l. This vignette is based on the description of the Seattle program fóWld in The Economicsof
future. PublicIssues,eds. Roger L. Miller,Daniel K. Benjam..i.n,and Dquglass C. North (Reading, Mass.:
This is important beca use past poli ti cal opposition to the adoption of such market·' Addison-Wesley, 1999), 164-171.
2. Sée Paul Portney; "Econornics and the Clean Air Act;"· fournal of EconomicPerspectives4,
based regulatory tools has been motivated in part by a real concern about the practica!,
no. 4 (1990), 173-81, v,,:honotes that only a small fraction ofthe cost of environmental regu-
feasibility ·of achieving policy goals with such decentralized approaches. Continuini lations are reflected in gov~rnment outlays, with the bulle.of such cost.s borne by private com-
improvements in measurement and information technologies are likely to diminishth panies.
force of this concem even further. In the case of corrective environmental taXeS imd. 3. See Thomas .Pogue and Larry Sgontz., "T;odng to Control Social Costs," American Economic
darges; improved. measurement technologies should malee it easiéi over time to tal Review79,no. 1 (March 1989), 235-243. ·
socially harmful activities more directly~for example, by taxing ernissions insteado\ 4. For a discussion, see Congressional Budget Office, Federal Taxation of Tobacco,Alcoholic
havi.ng to tax mO;t"eeasily observed activi.ti.essuch as prodllction or .sales. Better mea·. Beverages, and Motor Fuels (Washington, D.C.: Congressional Budget Office, 1990), 56-65.
S. Bundesministerium der Finanzen (German Finance Ministry), UnsereSteuern von A bis Z
surement and information technologies also malee it easier to implem~nt'permit tradin!" ·. (Our Taxes from A-to .Z), p. 122, at hrtp;I/WWW.bllildesfi.nanzministerium.de.
schemes. More g~nerally, as the costs of acquiring and processing infon:nation con~~e.: 6. Congressional Budset Offices,The Growthof FederalUserCharges(Washington, D.G.: Con-
market-based approaches seerns likely to nse,; &ressionalBudgei: Offi.ce~1993), 3-14.
to fall, the workability of such fle:x:i"ble,
thereby helpirig to e:xpand the prospects for such market 0 based tools for influencinl· 71 ActiOn on Sriloking and Health, Ciga.retteFacts,Includinglnternationat Historicat and State
behavior. Tables,17 January 1999, at http://ash.org/cigtaxfacts.html.In 1997 the federal taX on cigarettes
"'1asincreased to $0.34·per pack ~ 2000.-2001, and $0.39..,insubs~q~t years, while in fiscal year
 '-

280 1996, state cigarette taxes averaged $0.317 per pack, ranging from a low of $0.25 in Virgin,¡a ·.
. 27• Michael Maloney and Bruce Yandle, "Bubbles and Efficiency," Regulation(May/June 1980): 281
a high of $0.815 in Washington State. See Kip Viscusi, "Tobacco Taxes," in Encyclopedia tq·;·
THE TOOLS OP ·.9·_52.
GoVERNMENT Taxation and Tax Policy, eds. Joseph J. Cordes, Robert D. Ebel, Jane G. Gravelle (Washingtoº: ,4 28. This argument is made.in William J. Baumol and Wallace Oates, The Theory o/Enviran- CH 8:
D.C.: The Urban Instituto Press, 1999), 406-408. · "'· COR.RECTIVE
; entalPolicy(Cambridge: Cambridge University Press, 1988). TAXES,
8. "Big Tax Hike on Cigarettes Hurts Small N.Y. Stores," Washington Post(l6 July 2000),A¡¡i ·ti' 29• Robert J. Crandall, ControllingIndustrial Pollution (Washington, D.C.: The Brookings CliAR.GES,
9. Thomas F. Pague, "Alcohol Beverage Tax.es, Federal," in Cordes et al (1999), 6-7. '. 11
titution, 1983); and David Terkla., The Efficiency Value of Effluent Tax Revenues,." Journal AND
10. Congressional Budget Office (1990), 103-108. ' :..{environmental Economicsand Management 11 ( 1984): l 07-123. TRADABLE
11. Congressional Budget Office (1990), 11. ·' 30. Robert N. Stavins (1998). . PEBMITS
12. Bn.ic~D~vie, "Sumptuary Taxation," in The Encycloped~aofTaxation and Tax Policy,eds.: ;1. Barthold (1994), 137.
Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle (Washington, D.C.: The Urban Institu~·
32. This section summarizes points made in Roger G. Noll, The Bconomicsand Politicsofthe
Press, 1999). · • · :swwdawn in Regu.lato1y,
Reform (Washington, D.C.: AEI-Brookings Joint Center on Regulation,
13. Joint Committee on Taxation, U.S. Congress, Schedule of Present FederalExcise T~ 99), at http://www.aei.brookings.org/publications/.
(Washington, D.C.: U.S. Government Printing Office, 29 March 1999), 17-22. , 19
· · 3;. Stavins (1998), 81.
14. This section, and the discusslon of federal environmental taxes, generally draws heávil.y:' 34.Viscusi (1999). See also Kip ·Viscusi, "Cigarette Taxation and the Social Consequences of
on Thomas Barthol(4 "Issues in the Design of EnviroIU11ental Taxes," ]ournal of EconomicPe,.: 0lcing,"in Tax Policyand the Economy, ed. James M. Poterba (Cambridge, Mass.: MIT Press,
spectives8; no. 10. (1994), 133-151. · . <' J995). .
15, Thus, for example, the chemical CFC-:11 is 8.Ssignedan ozone-depleting factor of 1.0, wbile , ;s.World Bank (1997).
Halón-1211, 1301, and 2402 are assigned factors of 3.0, 10.0, and 6.0, respectively. Other chemJ, : ;6. Cook and Moore (1999); and Christopher Ruhm,·"Alcohol Policies and HighwayVehicie
icals, such as CFC-113 and 115, and methyl chloroform are assigned factors ofless than l.O, The '.patalities,"National Bureau ofBeónomic Research, Working Paper W5195 (July 1995).
result is that the ozone-depletion excise tax per pound of CFC-12 equals $7.60 per pound, the'· 37. Miller, Benjamin, and Nofth (1999), 164-171.
taxes that apply tO Halon-1211, 1301, and 2402 are thiee, tet4 and six .times that amount, re-· 38.See Davie (1999), 343.
spectively, and the excise taxes on CFC-113, 115, and methyl chloroform are Iess than $7.60. The· 39, The-s.ocially optimal leve! would .be .the amount of smoking. that results when the price of
base rate of ,µie ozone-depleti.ng ch~micals tax is scheduled to increase by $0.45 per pound p~ a packof cigarettes (inclusive of cigarétte taxe:S)just equals the cOsts that a smoker imposes on
year. See Barthold (1994) and Joint Committee on Taxation (2000). 'iberest of soc!~ty by smoking thát pack. ·
16. Congressional lludget Office (1990), 58-59. 40. Bohi and Burtraw (1997). .
17. Paul Joskow, ruchard Schmalensee, and Elizabeth M. Bailey, "The Market for SulfurDi:,~ 41. Stavins (1998), andas cited in Michael J. Sandel, "It's Immoral to Buythe Right to Pollute,"
oxide Emissions," The American EconomicReview 88, no. 4. (1998): 669-685. ,NewYork Times (15 December-1997), A29. ·
18. See Davie (1999).
19. Cigarette taxes range from a low of 70 percent of the price of a pack of cigarettes iD Sweden',
to a high of 85-percent in the United Kingdom. See Action on ~moking and Health (1999_). ,.
20. Stephen Farber, "Environmental Taxes and Fees," inHandbookon Taxation,eds. W: Bartle)'.
Hildretb and. James A. Richardson (New York: Marce! Dekker, 1999). ,
21. See, for exam.ple, World Bank, Cur.bingthe Epidemic:Gcrvernmentsand the Economicsof
Tobacco Control (Washington, D.C.: World B.ank. 1999); and Philip J. Cook and Michael i,,.
Moore, "Alcohol," National Bureau of Economic Research, Working Paper W690S (Januaíf
19~9).
22. See Joseph J. Cordes and Harry S. Watsot4 "The Theory and Practie:e of Tax Incidence'
Analys~" in Han4,bookof Public finance, eds. Fred Thompson aJ'ld Mark T. Green (New York(
Marce! Dekker, 1998), 93-135.
2~. This discussion draws extensively on BaI:thold (1994), 138-142.
24. One reason for considering taxes as a means of reducing the producti.o:n. of CFCs wasto
pre~t .Produ_Cersof. these chemicals from eaming •1excess profits" as a result of legally being.t
req,uired to restrict supply. I am grateful to Bnlce Davie for raising this point. ·.
1
25. This section draws extensively on the descriptions of pennit trading provided in Douglas
Bohi and Dallas Burtraw, "50 1 Allowance Trading: How Experience and Expectations Measure.
Up," DiscUSSion Paper· 97-24, Resources for the Future, February 1997; Joskow et al. (1998);
Richard Schmalensee, Paul L. Joskow, A. Denny Ellerman, Juan Pablo Monté:ro, and Elizabeth'
Bailey, "An Inte'rim ·Evaluation of Sulfur Dio.xide Emissions Trading, » ]ournal of EconomicPer·:
spectives12, no. 3 (summer 1998): 53-58; and Robert N. Stavins, "vVha_tCan We Learn frotn
the Grand Policy Experiment? Lessons from 50 1 Allo~ce Trading," ]outnal of BconomicPer-·
SpectiVes12, no:·3 (Súinmer 1998): 69-88.·
·.. ,26. This' séction draws heavily from Joseph Jo Cordes, Eric_M. Nicholson, and Frank J. SaDl·,.
martino, "Raising Revenue by Taxing ·Activities with Social Costs," National Tax ]ournal43 ·
(1990): 343-356.
 •.--..-.;.: .....
.__ ____,_

CHAPTER NINE ·..~-'. ··)2'sD

,)
;:ofpefense chooses to huy "':eaponsfrom Contractors.2 Governments huyan enorm.Ous
r,Jlgeof products and services, from personal computers, office supplies, and lawn- ------
~·_p.,-9:
Contracting :Jl')owingseyvj_cesto child protective .services, huge database software programs, and CONTRACTING
, ghterplanes. .
·,6 'fhe second basic feature of a contract is that it is a "business arrangement» analogous
Steven J. Kelman , to business arrangements that o'.ccurin the private sector. Unlike some other tools of
º"ernroent, such as tax incentives or vouchers, conti'act:ing is used widely outside
. :O"ernroént.~or. ~ple, Coca-Cola uses contracting as a tool when it deals with
,.:dvertisingagenaes, 1nformation technology provide.rs,.or corn syrup vendors. By far,
thevast majority of contracting occurs among business firms. Experience from private-
Students applying for the federal government's student loan program might reasonab{; sectorcontracting may be relevant to government contracting, __ 1?.othin thinking about
ass~e tha: they ~ come in contact, at some point, with the Office of Student al theappropriate boundaries for in-house production versus contracting and in thinking
'.about·howbest to structure a business relationship.
nanc1al Ass!Stance m the U.S. Departrnent of Education, the federal agency with ,
si:io=bility for this program. But nothing could be further from the truth. In fa~. ·: Another significant fearu.re of contracting is the distlnction between contracting for
VIrtually every contact these students will have will be with a private organizati ...procurement of products and services. used -directly by the govemment agency and
serving as a contractor for the federal government. . Ori_. '.·contractingfor the delivery of government-funded services by thi.rd parties to external
The application forro, for example, has been developed by an outside contract '· •·recipients.The latter is often called "purchase-of 0 service" (POS) contracting. This chap-
and the forms themselves -areprlnted and mailed by contractors. i A con tractor en~ . ter focuses primarily on procurement contracting, and the following chapter focuses
the.data from the filled-in forros and sends the data electronjcallyto anothercontracto,;' ':onPOS contracting.
which used a computer program to determine student eligibility with the aid
government-established fomiulas. The con tractor then sends the eligibility informatio Relation to Key Tool Features
to the university the student has applied to._Even the servicing of ihe loan is handled'
by a contractor, and, if the student defaults, the government will have to enlist anothei : Contracting may be compared to other tools described in this book along the four
contractor to collect. · : dimensionsidentified in the introductory, chapter: directness,automaticity, coercion,and
This example illustrates an important point: none of the tools of government di,'.• ' ,isibilit)I.
cussed in this book is more ubiquitous than contracting. People worlóng in the o~
partment ofVeterans Affairs need not concem themselves with tax incentives; thosein·
a state highway departrnent can ignore vouchers; empfoyees of a local school district : Directnessmeasures the extent to which the entity authorizing or inaugurating a pro-
never run into loan guarantees. There are even important governm.ent misSions that gramis involved in executing it. On the directness scale, compared 'with other tools~
use few or no regulatory too Is to achieve their missions (diplomacy and war fightiog; , contractingis ranked in the medium category. In one sense, contracting is less direct,
for example). However, every public agency and every private organization of any s~ since it leaves production in private hands. However, in a number of important ways,
contracts for some of the goods and services needed to achieve its purposes. Therefore¡ contractingmay be a more direct tool of government action than many other tools.
almost eve:cyone working in the public sector will come into contact,_at le_astto some First,in a contract the governJ:11.ent
is free to be as explicit as it chooses in the require-
extent, with the tool of contracting. mentsit imposes on the contractor. It may·be more directive than the most directive
PI?Jectgrant in imposing requirements on a contractor, o?-H-i11ayleave as much dis-
·. cretion to the contractor as is left fu the 1.ea'Stdirecti.ve lilóck grant. Generally, the
l. DEFINING THE TOOL .- governmentimposes more requirements on contractors than it does on private parties
. whose behavior it seeks to change through other economic incentive tools such as tax
Contracting, as a tool of govemment, is a business arraD.gementbetween·a governmenti expenditures,vouchers, c;,rloan guarantees. ·
agency and a private entity in which the private entity promises, in ~challge for money, Second, although contracting uses economic incentives to induce behavior that oth-
to deliver certain products or services to the government agency or to others on tite. . erwisewquld not have occurred, it is more direct thazi mOst -Other economic incentive
government's behalf. The prívate entity m.ay 'pe either a for-profit business ora noJh toolsbecause in a contract the thi.rd-party behavior ihat is being sought is clearly
pro:fi.torganization. · : hrought forth in response to the tool. By contiast, tóols that simply subsidize or en-
couragecertain behaviors by prívate parties, such as tax expenditures or loan guaran-
tees,spend considerable resources paying for behavior that might have taken place
Defining Features anyway.
Implicit in this definition are a number ofkey feature$ that characterize contractiJlg. ·: b Third, contracting, except for POS contracting, is more direct than sorne other tools
a tool. First, contracting involves a choice by govemment not to produce a product , · ecause generally the authorizing g~vernment cg,ntracts for inputs into final services
se~ce itself b~t to huy it from the outside. Thus, rather than produce _weaponsi ~ ·. ~at govemment, not the contractor, delivers .. Contractors produce weapons, not na-
282 as 1t has sometimes done in the past through goyernment-run arseD.a.1$,
the Departrn . tio~aldefense; coinputer systems-used at botder checkpoints, not bord.er control; evc!l-
i Uattonsof policy effectiveness, not policy choices.