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Savings from Economic Incentives

The United States currently spends approximately $200 billion annually on pollution control. Outlays for pollution control would be even higher were it not for the use of many forms of economic instruments such as pollution charges, trading of pollution reduction obligations, deposit-refund systems, liability for harm caused by releases of pollution, disclosure requirements, and voluntary pollution reduction programs.

In contrast to more traditional command and control methods for achieving environmental goals, economic instruments make every unit of pollution costly to the source. Because of a continuous price signal that pollution is costly, sources look for relatively low cost means of reducing pollution below usual regulatory limits. The result is that environmental goals can be achieved at far lower cost with an incentive-based strategy than through traditional regulatory approaches. The theoretical evidence on this point is very strong and as more economic instruments are tested and implemented, the empirical evidence also reveals significant cost savings.

This paper examines many situations in which economic instruments have been applied and estimates the cost savings relative to more traditional regulatory strategies. Based on that record and theoretical modeling of more extensive use of economic instruments, the paper then estimates what the potential savings in compliance costs would be with maximum use of such instruments under existing statutory authority. Finally, the paper considers what the savings could be with new statutory authority regarding economic incentives.

The largest single source of potential savings would arise if the U.S. were to ratify the Kyoto Protocol to limit greenhouse gas emissions. That agreement, signed in December 1997, calls on the U.S. and 37 other industrialized nations to limit their emissions of greenhouse gases by an average of 5% relative to 1990 levels by the years 2008-2012. Such a reduction in carbon dioxide and other greenhouse gas emissions would be unprecedented during a period of economic growth. The Clinton Administration has proposed a system of marketable greenhouse gas permits to limit the costs of meeting such an agreement. Emission trading and economic instruments more broadly offer the prospect for meeting pollution control goals at much lower costs than traditional command and control regulations.

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