0 12 polluter pays principle

POLLUTER PAYS PRINCIPLE

Prof Prabha Panth,Osmania University

Environmental Goods are Public Goods:-1. Ownership:

Economic goods have ownership, the owner has the right to sell it in the market.

But Environmental goods, such as oxygen, or an ocean, are not owned by anybody, so cannot be bought and sold in the market.

2. Excludable: Economic goods: It is possible to exclude others from using the

good you own. E.g. your TV, others cannot use the same TV. Others are excluded from consuming the goods that you have purchased.

Using environmental goods – others can’t be excluded. For e.g. if you breathe oxygen from the air, you can’t prevent others from doing so.

CHARACTERISTICS OF ENVIRONMENTAL GOODS

3. Rival Goods: If one person uses an economic good, then the same good is not available in the shop/ market for others. E.g. if you buy a TV and take it away, then the number of TVs in the shop will be reduced by one.Environmental goods are also rival. If a factory pollutes a lake, it affects fishermen fishing in the lake.

4. Externality: The person using the economic good gets the benefits and pays the cost. E.g. you pay for a TV set, and you enjoy the programmes on it.Environmental goods: the costs/benefits are not borne by those who use it. E.g. your car emits air pollution, but you don’t pay for the air that you are using up. But people on the road have to pay for treatment of asthma, and other lung diseases that your pollution has caused.

NATURE OF ENVIRONMENTAL GOODS

• Since environmental goods cause external disbenefits, the question is who should pay? Or bear the cost of environmental degradation?

• It is unfair to make victims of environmental disasters pay for the cost of controlling and cleaning the environment.

• The Polluter should Pay for the damage he is causing to the environment.

WHO PAYS THE COSTS

• Polluters or environmental violators will not willingly pay for the clean up of the environment, even though they are guilty of spoiling it.

• Therefore the Government undertakes to force polluters to pay for their environmental damages.

Through: 1) Direct Command and Control methods, and

2) Market controls, i.e. internalising the external costs of pollution, and making the polluter pay for it.

POLLUTER PAYS PRINCIPLE (PPP)

• Since pollution costs are external costs, the government tries to internalise these costs to the polluter.

• Called Command and Control or C and C.• When environmental costs becomes part of the

polluter’s money costs, he has to either pay them, or to avoid these payments , reduce his pollution.

• The Government can follow two methods:1) Non-market controls: such as fines, fees, penalties,

legal action, closure of polluting factories, and imprisonment for breaking environmental laws.

DIRECT METHODS – C AND C

2) Market controls: consists of (i) pollution taxes, and (ii) marketable pollution permits.

(i) Pollution Taxes: suggested by Pigou (1932) to internalise external costs. Based on the social marginal costs it imposes on society.

a) Pigovian taxes: A lump sum tax is imposed on the output produced, since pollution rises with rising output. Assuming that the firm is in perfect competition, AR = MR, and MC is a rising curve.

MARKET CONTROLS

The Pigovian tax is a corrective instrument to realise the socially optimal level of economic activity generating pollution.

• In Fig.1 the firm is in perfect competition, producing output Q1, at A where its MR=MC. MC is its private cost

• The Social Marginal Cost (SMC) is equal to private cost plus marginal environmental cost, where MEC = AB

• So SMC = MC + MEC• Now the optimum level of output for

the firm is at C, where MR = SMC.• .

A. PIGOVIAN TAXES

Output

Rs.

0

PAR=MR

MC

SMC = MEC + MC

Q2 Q1

C

D

B

A

Figure 1. Pigovian Tax

MEC

= Ta

x

• Now the optimum level of output for the firm is at C, where MR = SMC.

• The cost of pollution AB = CD, and if this can be internalised to the firm’s costs, then the firm will be at the new equilibrium C.

• According to Pigou, AB = CD should be the pollution tax levied by the government, to force the firm to reduce its output to Q2, and thus reduce its pollution.

A. PIGOVIAN TAXES

Output

Rs.

0

PAR=MR

MC

SMC = MEC + MC

Q2 Q1

C

D

B

A

Figure 1

• Limitations: How to identify pollution and get its monetary cost? Is it only cost

of clean up? Social marginal cost or impact of pollution on society and ecology

is too enormous, spread over time and space, and cannot be measured and monetised.

Reducing output is not the answer, as the pollutant may be toxic even in small quantities.

Oligopoly and monopoly exist, not perfect competition, so sellers can pass on the burden of extra cost MEC to the consumers.

Also they make huge profits, so they may pay the tax, and continue to pollute.

A. PIGOVIAN TAXES

• Taxes to control pollution may not work, as many firms will find the costs too high, and may be driven out of the market.

• Another method to internalise pollution costs is by Marketable Pollution Permits.

• It is a combination of Command and Control and market based instruments to control pollution.

• It penalises high polluters, but rewards those who control their pollution.

B. MARKETABLE POLLUTION PERMITS:

• Some firms may incur high costs to reduce pollution.

• Others may either produce with lower pollution levels, or with lower costs of pollution control.

• The Government sets an acceptable level of pollution per firm, e.g. BOD 250 mg/litre.

• All firms have to reduce their water pollution to this level, or face penalties.


• Assume that Firm X is emitting more pollution than the government standard (i.e. > 250 mg).

• Another Firm Y is emitting pollution less than this level.• Then Firm X can “buy” this level of pollution from Y, and

show it as its own reduction!• Firm Y gets paid for its lower pollution,• And Firm X redistributes its pollution to X, without having

to reduce either its output, or incurring greater costs of controlling its pollution.

• Then aggregate pollution from both firms will be equal to the Government permitted level of pollution.



BOD mg/l

050

100150200250300350400

Figure 2 Pollution Permits

Firm X Firm Y

Mg/

litre

• In Fig.2 Firm Y emits only 150 mg/l of BOD which is 100 mg less than Government’s minimum of 250 mg/l.• Firm X emits 350 mg/l, which is 100 mg higher than the limit.• Now X pays Y for the difference of 100 mg, i.e. it transfers its own extra mg to Y for a payment. It buys the lower pollution levels of Y.• Now both would have reached the government’s limit of 250 mg/l of BOD!

• Firm Y will sell its extra permit because it can earn income on its compliance.

• Firm X will buy the permit, because it will be saving on higher pollution control costs.

• This may be beneficial to both in the short run.• But how long will X pay Y? • In the long run it is better for it to install

pollution control mechanisms to reduce its pollution.


• Limitation: What is the price that X pays to Y? Is it a fair

amount? Although Government puts a limit on pollutants, it

does not mean that both firms should not pollute less than this level.

Distributional problems arise if both firms are not equal in status.

At the global level, the Kyoto Summit on Climate Change allows international permits in CO2 emissions.


Less developed countries are given “credits” for their lower pollution, which they can trade with the more polluting nations in the West.

For instance, Europe and USA buy permits from less developed countries, and continue to pollute.

But price of carbon credits per ton is only about USD 15 to USD 40.

Cost of reducing CO2 per ton is naturally much higher. So rich countries prefer to pay the carbon credits, and save on their pollution control costs.

Pollution still continues – global warming results.


0 12 polluter pays principle

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