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3.1. Nature of Cost Savings Considered

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Savings from Economic Incentives

The savings considered will follow the approach taken in our principal data source, EPA 1990. In particular, the costs presented in this report represent estimates of direct regulatory implementation and compliance costs. They are the first-order, claimed to be out-of-pocket costs to those entities that implement control measures and undertake compliance activities. For example, the private costs associated with existing programs represent the before-tax expenditures associated with all compliance activities, including the purchase, installation and operation and maintenance of existing pollution control equipment; the private costs of new and future programs represent, for the most part, projections of before-tax capital investment and operation and maintenance costs calculated using engineering analyses. Recent evidence suggests that what firms perceive as environmental compliance expenditures in responding to Commerce Department surveys actually include many process improvements, energy saving outlays and the like. Consequently, reported environmental compliance expenditures appear to overstate actual compliance costs by a wide margin. (Morgenstern, et al, 1997).

Direct costs, whether overstated or not, are an imperfect proxy for the social costs of pollution control regulation. The true social costs of pollution control are represented by the total value that society places on the goods and services foregone as a result of resources being diverted to environmental protection. Compliance costs do not fully reflect social costs because they neglect direct regulatory impacts that do not involve out-of pocket costs as well as the intertemporal and secondary effects of environmental protection. In other words, they do not account for the dynamic, general equilibrium effects created throughout the economy that impose costs on industries and households not directly affected by regulation. Environmental protection imposes costs on virtually all economic entities including the general public that are largely hidden. Examples of social costs imposed by pollution controls that are not reflected in direct compliance cost estimates include lost or delayed production and consumption opportunities, reduced economic productivity, and higher price inflation. Some recent research suggests that compliance cost estimates may understate substantially the true long-term costs of pollution control (Hazilla and Kopp).

It is important at the outset to note that direct regulatory implementation and compliance costs properly include agency administrative costs and other transactions costs as well as capital and operating costs. These transactions costs include outlays by polluters when they search for or attempt to sell pollution credits or allowances, the costs of negotiating the transaction, and any subsequent monitoring or litigation-related costs. Administrative and other transactions costs are not well known for most pollution control programs, particularly those involving incentives. EPA (1990) provides estimates for a subset of administrative costs, but not other transactions costs. Similarly, analyses that show the potential cost savings from incentive mechanisms often ignore transactions costs.

Certain transactions costs tend to be relatively high for incentive-based approaches. For example, marketable credit systems and pollution discharge systems require fairly accurate measures of the quantity of pollution actually released. As noted in Section 2.2.2 above, however, monitoring costs have been falling rapidly and are likely to continue to do so in the near future. Marketable credit systems also require bid and offer information from participating sources. Sometimes this information is collected and disseminated by a government entity, though in other cases brokers enter the market to facilitate trading. Further, with marketable credit systems, a government entity must certify that the credits meet statutory and regulatory requirements (e.g., reductions are permanent, real, quantifiable and enforceable). Such certification involves costs. Pollution charge systems may require that pollution control agencies first estimate the probable response of sources to different charge levels before setting the charge. Some incentive systems are inherently simple and largely devoid of transactions costs, however. An example is pollution disclosure requirements.

While incentive-based approaches frequently involve significant transactions costs, they are not necessarily higher than in command and control systems. Command and control approaches require a determination by the pollution control agency of the controls that will be required. Typically, that process is complex, involving elements of engineering, economics, and the health sciences. Command and control approaches also require periodic monitoring to assure that sources are operating within prescribed limits. In the absence of any good data, this report assumes that to a first approximation administrative and regulatory costs are roughly equal with either a command and control or an incentive-based approach.

Some incentive mechanisms achieve results that could be very difficult to accomplish with traditional methods. Consider, for example, deposits imposed on purchases of lead acid batteries in ten states (see Carlin, 1990). Such deposits are likely to be far more effective than regulatory approaches in ensuring the return of used batteries. Per can fees imposed on household generation of solid waste are similarly viewed as more effective than regulations in reducing the volume of waste generated by households. (see Anderson et al., 1990). Consequently, the estimates provided here are conservative to the extent that traditional command and control approaches could not duplicate the pollution control results.

Cost savings are estimated in various ways. Existing published estimates are used when available. Where no estimates exist for a particular incentive, we first determine whether it is likely to produce significant compliance cost savings. If so, we make a rough estimate of the likely cost savings by making unit production cost or pollution control cost adjustments where these can reasonably be estimated. In some cases, a few of which are potentially important, there appears to be no basis for making even a rough estimate of compliance cost savings.

Cost savings from incentive mechanisms are disaggregated by medium (air, water, and land) and further disaggregated into principal EPA program areas. For example, air programs are separated into stationary sources, mobile sources, and radiation. This follows the approach taken in EPA (1990).

The savings are separated into two categories:

It is important to emphasize that the estimates presented suffer not only from the major sources of uncertainty of the underlying cost estimates for the present EPA programs listed in Section 8.2 of EPA (1990), but also the uncertainties as to how accurately it has been possible to apply the assumptions made in the last paragraph for each program for which savings estimates have been made.

Sections 3.2 through 3.4 present estimates of the projected savings of existing programs for the air, water, and land media, respectively. Sections 4.1 through 4.4 turn to the more difficult task of estimating the potential savings. Finally, the cost savings from both approaches are summarized in Section 5 .

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