When Does Noncompliance Pay Off?

From Thermal-FluidsPedia

Not all polluting industries choose to comply with regulations. From a purely economical standpoint, if polluters’ marginal cost of compliance outweighs its marginal benefit, polluters are better off ignoring regulations. They may instead opt to pay fines and accept other punishments such as adverse public relations, potential losses in sales, and possibly even jail time. Costs of compliance are related to the cost of new pollution reduction equipment and the additional resources that are ultimately diverted to pollution control efforts. Benefits associated with compliance can be measured as the money saved due to reductions in the amount of fines and other penalties, improved public relations, and a potential for higher sales volume. The marginal cost of compliance increases as a firm decides to comply more and more with the regulations. The marginal benefit of compliance is highest when a firm does not comply with any regulations and thus is most vulnerable to being fined. As a firm complies more, often its chances of being caught and so its marginal benefit falls (Figure 1). The point where MB and MC of noncompliance cross is where the firm can afford to avoid compliance. For any additional incidence of non-compliance, the firm will have to pay fines that exceed its marginal benefits. From the discussion above, it can be concluded that to reduce non-compliance, either the marginal cost of noncompliance must be increased (such as stiffer fines or longer jail time) or its marginal benefits reduced.

Example: A power generating station is considering reducing the total particulate emission from its smoke stacks. Reducing the particulate emission is easiest for the larger particles with the biggest mass, and therefore a large portion of particulate mass can be removed with filters at a relatively low cost. The medium-sized particles can be removed by bag houses at somewhat higher costs, whereas the smallest particles require very expensive electrostatic precipitators. A cost analysis is made to calculate the marginal cost (cost for an additional unit of reduction) of particulate cleanup. The result is tabulated below:

% reduction in total mass	Total costs in millions of dollars
10	1
50	11
90	33
95	61
99	96

To promote a cleaner environment, the government is offering polluters a tax credit that varies depending on the degree of reduction that is made. The most benefit can be reaped if the largest, more massive particles are eliminated because these particles most effectively reduce visibility, form fog, and soil buildings. The amount of tax credit reduces as particle sizes become smaller. The table of tax credit is shown below:

% reduction in total mass	Tax Savings (Revenues) in millions of dollars
20	30
40	52
60	68
80	80
100	9

What is the Pareto efficient point for pollution reduction?

Solution: The optimum pollution reduction level is at the point where MC and MB of pollution abatement are equal. The marginal benefits and costs are calculated and shown graphically. The two curves cross at a percent reduction where MC = MB = $14 million, for a reduction of 68% in total particulate mass.

References

(1) Toossi Reza, "Energy and the Environment:Sources, technologies, and impacts", Verve Publishers, 2005

Further Reading

Chapman, D., Environmental Economics: Theory, Application, and Policy,” Addison-Wiley, 2000.

Goodstein, E. S., Economics and the Environment, 4th Ed., John Wiley & Sons, 2002.

Siebert, H., Economics of the Environment: Theory and Policy, Springer Verlog, 2004.

Dauvergne, P., Handbook of Global Environmental Politics, Edward Elgar Publishing, 2005.

Journal of Environmental Economics and Management (JEEM), the journal of Association of Environmental and Resource Economics.

Ecological Economics – Direct Science Elsevier Publishing Company, the journal of the International Society for Ecological Economics (ISEE).

Environmental Economics and Policy Studies – Published by Springer-Verlog, New York is the official journal of the Society for Environmental Economics and Policy Studies.

External Links

US Agency for International Development (http://www.usaid.gov/)

National Center for Environmental Economics (http://yosemite.epa.gov/ee/epa/eed.nsf/pages/homepage).

United Nations Development Program (http://www.undp.org).

United Nations Environment Programme (http://www.unep.org).

Intergovernmental Panel on Climate Change (http://www.ipcc.ch).

World Resource Institute (http://www.wri.org)

Union of Concerned Scientists (http://www.ucsusa.org).