Emission Taxes

Emission taxes provide a solution to the failure of the free market caused by problems involving negative externalities.

Using an emission tax, the government simply sets an amount of tax that companies pay for every unit of pollution they produce. The ideal tax rate would be the exact social cost per unit of pollution.

This policy has a couple of advantages. For one thing, it successfully forces businesses to internalize negative externality costs.

It also solves the problem of economic inefficiency by allowing firms to maximize profits and pollute at the most efficient level. If one company incurs great expense in reducing pollution, it can simply pay the tax. If another company can easily reduce pollution, it will do so to avoid having to pay the tax. This means that less cost is induced by eliminating the same amount of pollution.

This method is superior to direct controls (setting allowable pollution levels) because direct controls are economically inefficient. However, the comparison with tradable emission permits is more complicated.

One drawback to emission taxes is that the government must correctly calculate the tax level to maximize economic efficiency. This requires a thorough analysis of all the social costs caused by each unit of pollution.

Sometimes a government may want to ban all emission of a pollutant. In this case, adirect control preventing any pollution would be most effective.

A final problem occurs with all types of pollution regulation. It is not always easy to measure exactly how much a company is polluting, which makes regulating pollution levels a difficult task.

____________________________________http://library.thinkquest.org/26026/Economics/emission_taxes.html

Why are direct controls over pollutant emissions less economically effective than setting emissiont taxes? To start with, direct controls impose an absolute level of allowable pollution. Polluters will face varying costs in trying to reduce pollution to certain levels. Unfortunately, the simplification of standard pollution levels creates problems. I got this example from the same website: Imagine that Company A can reduce pollution much more easily than Company B. Rather than mandating that Company A and Company B reduce pollution to a medium level, it would be more efficient to have Company A reduce pollution greatly, and B only slightly. As a compensation, Company B could make a payment to A.

In the above example, money would be saved overall by not using direct pollution controls. This example is basically an illustration of the use of what are known as tradable pollution permits. As an alternative, emission taxes also provide an economically efficient solution.

Another problem with direct pollution controls is one that arises only in practice, not in economic theory. Clearly the government cannot monitor every single car or factory to ensure that they comply with pollution regulations. The difficulty of enforcing direct pollution controls reduces their effectiveness.

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