Pollution rights are a market-based system for dealing with environmental problems. At first, the idea of pollution rights may seem like an oxymoron—i.e., who gave anyone the “right” to pollute? The logic behind pollution rights is based on economics. First, most environmental systems can accept certain amount of pollution without seriously harming the environment (often called carrying capacity). If the marginal (extra) cost of reducing or eliminating pollution is greater than the cost to the environment, it does not make economic sense to continue to reduce pollution. Second, if the current level of pollution is unacceptably high, encouraging those who can most easily reduce pollution to do so will cost less than making all polluters reduce their discharges into the environment. Requiring all polluters to reduce their discharges— called regulation or the command-and-control approach— has been the traditional method of addressing pollution problems. Because of such regulations, companies have installed pollution-control equipment, made operational changes in production, and replaced existing machinery with more efficient technologies. In some firms and industries, the costs of pollution reduction are modest. Some firms actually saved money by installing more energy-efficient equipment in response to environmental regulation, but in other firms and industries the cost of pollution reduction can be significant. Economists have long debated the issue of pollution rights. With Title IV of the 1990 CLEAN AIR ACT (CAA), the United States created the first pollution-rights market for sulfur dioxide (SO2). The system established a market for transferable emission allowances among electric utilities. Utilities facing significant marginal pollution-abatement COSTS could purchase the right to emit SO2 from firms with lower costs of pollution abatement. The firms with lower cost of abatement profit by the difference in the price of the pollution right they sell and their cost of pollution reduction. The most controversial part of the system is the allocation of pollution rights—i.e., since society owns common property resources like air and water, why should producers be given the rights to polluting these resources? Nevertheless, the system went into effect in 1995. According to the Environmental Protection Agency (EPA), in the first year SO2 emissions decreased by 3 million tons. Further reductions dropped emissions by 6 million tons below the base year (1980) level, and in 2002 emissions were running more than 30 percent below allowable levels. Costs associated with emissions reductions were 75 percent below the initial industry estimates. The SO2 pollution-rights program has been hailed as a major success by some and a questionable success by others. The utility industry aggressively opposed the pollution rights program and, like “Chicken Little” and the falling sky, claimed it would force them to significantly raise electricity prices. One of the reasons the costs of pollution reduction were so much lower than projected was because early estimates exaggerated the true cost. Critics also point to some studies indicating that SO2 reductions have not decreased acid rain (high-acidity rain that changes the pH of water, thereby harming the ecosystem) proportional to the decrease in emissions. Critics also question whether the pollution-rights program is resulting in environmental injustice, with poor neighborhoods continuing to experience environmental problems while wealthier neighborhoods are experiencing pollution abatement. A Journal of Political Economy article on the SO2 pollution-rights market concludes the claims for the program

...are misleading, especially the suggestion that formal trading has lowered the cost of SO2 abatement severalfold. In contrast, we reach the following conclusions.

1. Marginal abatement costs for SO2 are much lower today than those estimated in 1990...
2. This decline in marginal abatement cost, if one assumes that it was not caused by Title IV, has lowered the cost of achieving the SO2 emission cap under both the leastcost solution and enlightened command and control...
3. Comparing the least-cost solution to achieving actual emission reductions with actual abatement cost indicates that actual compliance costs exceed the least-cost solution by $280 million in 1995 and $339 million in 1996. This suggests that the allowance market did not achieve the least-cost solution, even though marginal abatement costs under the solution were approximately equal to allowance prices...
The 1990 CAAA represents a dramatic departure from the pollution regulations which utilities were previously subject, and taking full advantage of their flexibility may require time. With the perceived success of the SO2 pollution-rights market, in 1999 the EPA instituted a pollution-rights market for nitrous oxide (NO2), which reacts with volatile organic compounds to form ground-level ozone, contributing to global warming. The EPA program requires 392 facilities in 13 states to reduce annual NO2 emissions by a total of 510,000 tons. The 392 producers will participate in a pollution cap and trade program, with each “allowance” equal to 1 ton of emissions. The EPA also created an Online Allowance Transfer System to facilitate trade in SO2 and NO2 markets. One criticism of the program is it puts the EPA in a situation where it is acting like the SECURITIES AND EXCHANGE COMMISSION (SEC), a role that is not typically the domain of an environmental management agency. In theory, individuals and environmental groups can buy pollution rights, decreasing the supply in the market and increasing the market price, which will encourage firms to reduce pollution rather than purchase higherpriced pollution rights. For a few hundred dollars, one junior high school environmental science class purchased a sulfur emissions right. A third pollution-rights market has been proposed as part of the 1997 KYOTO PROTOCOL, the global agreement to reduce carbon dioxide (CO2) emissions. Increased levels of carbon dioxide are considered a major cause of global warming. While the current Bush administration withdrew U.S. participation in the Kyoto Protocol, the participants are developing a pollution-rights market based on the SO2 program in the United States. One problem with carbon dioxide is that the savings through fuel switching are not as great as in sulfur dioxide. According to the ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD), another concern is that with the United States not participating in the protocol, demand for carbon-emissions rights will decrease significantly, possibly reducing the market price from $100 to $10 per ton. In 2002 President George W. Bush announced his atmospheric-emissions effort, labeled the Clear Skies Initiative. The initiative sets fixed limits on power-plant emissions of SO2, NO2, and mercury, but ties carbonemissions cuts to the country’s GROSS DOMESTIC PRODUCT (GDP). Nitrous oxide emissions are to be cut from 5 million tons to 2.1 million tons by 2008 and 1.7 million tons by 2018. Sulfur dioxide emissions will be cut from 11 million tons to 4.5 million tons by 2010 and 3 million tons by 2018, and mercury cut by 69 percent during the same time period. (Mercury is found in coal and released in the air through burning.) The programs are all voluntary. Unlike the Kyoto Protocol, the Clear Skies Initiative cuts U.S. carbon dioxide emissions based on greenhouse-gas intensity, meaning the amount of carbon dioxide emitted per economic output. The Bush program would decrease U.S. greenhouse gas intensity by 18 percent in the next 10 years, from an estimated 183 tons of CO2 per million dollars of GDP to 151 tons of carbon per million dollars of GDP. (U.S. GDP has been decreasing in greenhouse intensity as the economy has become more service-oriented and less manufacturing-oriented.) The administration hopes to use a pollution-rights approach to meet these objectives. Critics point out that if the administration’s ECONOMIC GROWTH projections are correct, U.S. CO2 emissions will increase by 14 percent, and voluntary compliance will probably not have the same impact as mandatory measures espoused in the EUROPEAN UNION and elsewhere. The Economist criticizes the Clear Skies Initiative for not putting either a tax or mandatory limits on carbon emissions. Many environmental economists have advocated a carbon tax as the simplest way to achieve a reduction in carbon emissions. The United States is the world’s largest consumer of hydrocarbons and emitter of carbon dioxide. Most of the rest of the industrialized world uses carbon taxes to reduce CONSUMPTION and therefore emissions.
See also EXTERNALITIES; SUSTAINABLE GROWTH AND DEVELOPMENT.