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Project Status: complete

Report Published June 1982:

Title: Implementing tradable emissions permits for sulfur oxides emissions in the South Coast Air Basin

Principal Investigator / Author(s): Cass, Glen R

Contractor: Environmental Quality Laboratory, California Institute of Technology

Contract Number: A8-141-31

Research Program Area: Economic Analysis

Topic Areas: Benefits


Since the mid-1970s, public policymakers have had increasing interest in making greater use of economic incentives for the purpose of improving the cost-effectiveness of environmental regulation. At the federal level, the Environmental Protection Agency has encouraged the development of so-called "controlled trading options," a series of policies for introducing more flexibility into air pollution regulation by allowing businesses to make compensating changes in emissions that reduce total abatement costs so long as the environment does not suffer. Several states have actively pursued these possibilities. And, in water pollution, one state -- Wisconsin is developing a tradable emissions system in some areas for discharges into rivers and lakes.

The fundamental idea of tradable emissions permits is as follows. Regulators would set ambient air quality standards for a region, and would use air quality modeling to estimate the amount of areawide emissions that could be permitted without exceeding the standard. Regulators would issue permits for emissions of this amount which would then be allocated among the sources of emissions according to a market process. Assuming that the market is sufficiently competitive, this procedure would then naturally lead to a final distribution of emissions that minimized the total costs of abatement for the airshed. The reason is that each business, in attempting to minimize its costs of production, would view the environment, through the permits market, as a scarce resource not to be wasted.

Noticeably absent from the preceding discussion is the activity that consumes a large share of the time of regulators: writing technical standards for emissions sources. In its purest form, a permits market does not require case-by-case regulation of source categories. The specific abatement technologies and quantities of emissions at each source would be selected by the business manager, based upon the costs of abatement and the price of emissions permits. In this pure form, regulators need only know how many permits are held by each source. Inspection and enforcement activities would be set up to assure that each source emits no more than is allowed by its permits.

The advantages of a tradable emissions permits system are its simplicity and its use of incentives to achieve abatement at minimum cost to society. New sources of emissions can enter an airshed by purchasing emissions permits from older, established sources in a regularized market, rather than by going through a time-consuming permitting process. All sources can avoid the costs and uncertainties of protracted regulatory proceedings that establish source-specific standards. Regulators and the public can be assured of achieving air quality objectives, as long as an appropriate total ceiling on emissions is established and enforced.

The purpose of this project is to examine the feasibility of a system of tradable emissions permits for dealing with the problem of controlling sulfate particulates in the South Coast Air Basin. This particular problem was selected to provide a focus for what we hope is work of more general applicability. By working through the problem of how one might implement a tradable emissions permits system for this case, questions that would be relevant in any example can be articulated and methods developed and demonstrated for answering them. Sulfate particulates in Los Angeles were selected because adequate data and models of the relationship between emissions and air quality are available for doing meaningful empirical work on the issue, and because for various technical reasons the problem of sulfate particulates appears especially likely to be amenable to solution through the use of economic incentives.

While substantial work has been done on the general properties of economic incentive systems, including tradable permits, relatively little attention has been paid to the details of how such systems might actually be implemented. In reality, there are several specific and potentially important issues to be resolved about exactly how the market will be set up. The term "market" is a generic one that refers to a wide variety of institutional forms. One question regulators must face is precisely what form of market is most promising for tradable permits. Another ambiguity arises in the very definition of the permits themselves: over what geographic area can they be traded, how long will they be effective, and what controls, if any, will be placed on who can own them and on who must own them? Still another question is how the market will be initialized. Will the government organize the initial sales, or will it stand by passively and let industry develop a market by negotiating trades? Will participation in the markets be voluntary or mandatory? And who will sell the permits -- the existing polluters (and if so, how will their initial holdings be determined), or the state?

The feasibility of tradable emissions permits depends on a number of performance features of the system that is adopted. Tradable permits are an attractive alternative to source-specific standards only if they reduce the costs of regulation - both compliance costs and the costs of the regulatory process - without sacrificing air quality objectives. Their feasibility will also depend on the degree to which they are perceived to be a fair and equitable approach to the problem of controlling pollution, which in turn depends in part on who benefits and who loses from the switch to a tradable permits scheme. Finally, there is a question of legal feasibility what changes, if any, must be made in regulatory law before a true tradable permits system can be enacted?

The object of our research was to perform the work necessary to evaluate alternative forms of markets on the basis of their expected performance with respect to these design questions. Our aim was to find out as much as we could about the effect on the performance of a permits market of choices among the different ways a market could be organized. Such information would be useful to regulatory policymakers and the general public in understanding the tradable permits approach and selecting a reasonable method for implementing it. Currently , regulatory attention is focused largely on problems of implementing EPA's controlled trading options; however, by taking a more general approach, we hope to shed light on not only the reform proposals of immediate concern, but also on other approaches that, while similar in spirit to the current approach, are in some ways quite different. This report, then, seeks to be a kind of manual concerning the range of possibilities for setting up markets for emissions permits, with the sulfate particulate problem in the South Coast Air Basin providing the data for illustrating how one can approach the design questions raised above.

Our approach to assessing the feasibility of tradable emissions permits is as follows. First, we attempted to identify the potential pitfalls of a market approach to regulating air pollution. Second, we undertook research to determine whether these potential pitfalls are empirically important in the case of sulfate particulates in Los Angeles. In so doing, we illustrate the methods of analysis that would be necessary to perform a similar assessment for other pollutants and/or other regions. Third, for the problems that appear to be serious for Los Angeles, we investigate whether they can be avoided or substantially ameliorated by the details of the design of the tradable emissions permits system.

For ease of exposition, we have categorized the problem areas that we face as follows: (1) technical - relating to issues of modeling the relationship of emissions to air quality and actually achieving air quality targets; (2) structural - relating to problems that might prevent a market from working smoothly and efficiently; (3) distributional - relating to the effects of an emissions market on industrial structure and wealth in the region; and (4) legal -relating to the congruence between legislative and regulatory law and the concept of a tradable emissions permit system. Each of these problem areas are analyzed separately in the project report and are summarized here.


For questions regarding this research project, including available data and progress status, contact: Heather Choi at (916) 322-3893

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