The welfare ranking of prices and quantities under noncompliance

Abstract

We study the welfare ranking of an emission tax and emissions trading when firms self-report their emissions to the regulator and may be noncompliant. We allow for the subjective probabilities of auditing, and using conventional assumptions find that an emissions tax produces a higher level of welfare than emissions trading under noncompliance. The main driver of the result is that the compliance pattern of the firms affects the marginal compliance cost (price of emissions) in the case of permits, thus affecting the level of emissions and welfare. The result also holds when enforcement and sanctioning costs are taken into account and differs from the result found by Montero (2002, Journal of Public Economics). We also show that the ranking may be reversed if these costs are taken into account and the regulator must audit at least one firm. We also analyze the welfare ranking when the expected penalties depend on relative violations.

On the Non-compliance of a Polluting Mine under an Emission Tax

“…A key assumption, although very typical in the relevant monitoring and enforcement literature, is that the expected penalty depends on the absolute size of the violation. An alternative for this is to assume that the expected penalty depends on the relative size of the violation, that is, on the ratio between the violation size and the emission report as in Hatcher (2005Hatcher ( , 2012 and Lappi (2016). This assumption may correspond more closely with practice, but it also seems to result in significantly more complex analysis in particular regarding the time path of the violation level.…”

“…(Yle News, 2016) Contrary to the literature on mining and environmental policy, the literature on the monitoring and enforcement of environmental policy instruments is large, but little interest has been dedicated to the polluting exhaustible resources, environmental policy instruments and compliance. Instead, the literature has focused on general properties of the enforcement of environmental policy (Harford, 1978(Harford, , 1987Malik, 1992;Sandmo, 2002), pollution permits (Malik, 1990;Stranlund and Dhanda, 1999;Stranlund and Chávez, 2000;Lappi, 2016), individual transferable quotas in fisheries (Hatcher, 2005), technological development (Arguedas, Camacho, and Zofío, 2010) and prices versus quantities -discussion (Montero, 2002;Stranlund and Moffitt, 2014). Dynamic models include Harrington (1988) and Livernois and McKenna (1999) on pollution standards, Montero (2002) on emission tax and emissions trading, Stranlund, Costello, and Chávez (2005) and Lappi (2017) on emissions trading and Arguedas, Cabo, and Martín-Herrán (2017) on optimal emissions standards and non-compliance.…”

Emissions trading, non-compliance and bankable permits

“…It may be expected that zero reported emissions yield a higher probability of auditing compared to positive reported emissions even if the violation size is the same. Therefore, it would be interesting to generalize the audit probability function to allow the probability to depend on the size of relative violation, as described in the studies by Hatcher (2005) and by Lappi (2016).…”

“…is the Hamiltonian. 11 Any solution to our problem, must satisfy the following conditions: 12 −e −ρt C ′ − e −ρt S ′ + µ ≤ 0, e ≥ 0, e(−e −ρt C ′ − e −ρt S ′ + µ) = 0,…”

“…Since −C ′′ < 0, −C ′ is strictly decreasing in e. The basic properties of invertible functions imply that the inverse of −C ′ , that is (−C ′ ) −1 , is also strictly decreasing. According to equation (12), emissions are therefore decreasing in time, when the firm is compliant. We are mostly interested in the case in which the firm becomes non-compliant, but note that time path e(t) may hit zero and remain at zero until the end T .…”