Tuesday, January 5, 2021

Is Air Pollution Regulation Too Stringent?

This paper describes a novel approach to estimating the marginal cost of air pollution regulation, then applies it to assess whether a large set of existing U.S. air pollution regulations have marginal costs exceeding their marginal benefits. The approach utilizes an important yet underexplored provision of the Clean Air Act requiring new or expanding plants to pay incumbents in the same or neighboring counties to reduce their pollution emissions. These “offset” regulations create several hundred decentralized, local markets for pollution that differ by pollutant and location. We describe conditions under which offset transaction prices can be interpreted as measures of the marginal cost of pollution abatement, and we compare estimates of the marginal benefit of abatement from leading air quality models to offset prices. We find that for most regions and pollutants, the marginal benefits of pollution abatement exceed mean offset prices more than ten-fold. In at least one market, however, estimated marginal benefits are below offset prices. Marginal abatement costs are increasing rapidly in real terms. Notably, our revealed preference estimates of marginal abatement costs differ enormously from typical engineering estimates. Some evidence suggests that using price rather than existing quantity regulation in these markets may increase social welfare.
Table 2 compares the marginal benefits of pollution abatement to offset prices, using our full data from 16 states plus Washington, DC, over the years 2010-2019. Columns (1) and (2) describe transactions for NOx, and columns (3) and (4) for VOCs. Columns (1) and (3) show a mean which is weighted by the tons of pollution it represents; columns (2) and (4) show a mean which is weighted by the population it represents. Panel A pools all markets, while Panels B through E describe the four regions of the US, as defined by the US Census Bureau. 

Table 2 shows that national mean marginal benefits of abatement are well above offset prices. This provides our main finding that air pollution regulation in these markets is less stringent than is efficient. This conclusion is statistically precise at greater than 99 percent confidence for all pollutants and regions. On average for NOx, mean marginal benefits of abatement are $40,000 to $51,000, depending whether the average is weighted by tons of pollution or population. Mean offset prices, however, are $2,200 to $4,000. Thus, the ratio of mean marginal benefits of abatement to mean offset prices is 13 to 18. Of course, this is far above a ratio of one. Similarly, for VOCs, we obtain a ratio of 8 to 10.

To interpret these ratios economically, consider an incumbent firm deciding whether to decrease its NOx pollution emissions and thus generate offsets for sale. On average, the firm would receive between $2,200 to $4,000 per ton for cleaning up pollution. At the same time, by decreasing emissions, the firm would be creating $40,000 to $51,000 per ton in health and welfare benefits to society. In this sense, regulation is giving less incentive to clean up pollution than is optimal, and thus is too lenient.

Table 2, Panels B through E, show similar patterns in all four regions of the country. For both pollutants NOx and VOCs, both weighting schemes, and all four regions, the ratio of the marginal benefits of abatement to offset prices is well above one. This would suggest that the regulations we study are too lenient on average in all these regions. The ratios are largest in the Northeast and Midwest, where the marginal benefits of abatement are more than fifty times mean offset prices. For NOx in the Northeast, for example, the marginal benefits of abatement are approximately $44,000, but mean offset prices are only about $500. The ratios are modestly lower in the West, at 7.1 to 9.2. The ratios are the lowest in the South, at 1.4 to 6.6.

Figure 2 plots offset prices and the marginal benefits of abatement for all markets (Panel A) and for each census region (Panels B through E), separately by year. The marginal benefits of abatement vary year-by-year due to changes in population density and differences in baseline levels of all pollutants. For example, the marginal damages of emitting NOx depend on the baseline ambient levels of NOx, VOCs, and other pollutants in each market. Table 2 essentially shows the mean value of these lines in the period 2010-2019, while these graphs show the underlying year-by-year averages, for all years.

A glance at the lines in Figure 2 shows the enormous vertical distance between the marginal benefits of abatement and offset prices in most regions and pollutants. That gap reflects the finding that the marginal bene ts of abatement are much higher than mean offset prices. Once again, the only exception is for the VOC market in the South, where the marginal benefits of abatement and offset prices have been closer in the last decade. The year-by-year values in Figure 2 are similar to the mean values over the entire last decade from Table 2.
Given this heterogeneity across markets, it is striking that the ratio of marginal benefits of abatement to offset prices is high in so many markets. Across all markets in Table 3, the median ratio is 40. In about three-fourths of the markets, this ratio exceeds 10. The only markets with a ratio below 4 are a few large markets in California, the markets in Houston, and one market in Wyoming. Even for these markets with lower ratios, only one of the forty markets listed in Table 3 has a ratio below one|the market for VOCs in Houston.

by Joseph S. Shapiro & Reed Walker
Working Paper 28199; Issue Date December 2020

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