Pollution Permits: Can They Be Traded?

Pollution permits are a method to reduce pollution to a more socially efficient level. They are issued by governments or central authorities to firms, giving them the legal right to produce a certain amount of emissions. The permits are tradable, meaning they can be bought and sold between firms. If a firm produces less pollution than its permit allows, it can sell its excess permits to other firms that require more permits. The aim of pollution permits is to incentivize firms to reduce pollution and the associated external costs. While pollution permits can be an effective way to reduce overall pollution, they have also been criticized for not adequately addressing the issue of pollution and creating a system where the least polluting firms receive the smallest number of permits.

Pollution permits are tradable

Tradable pollution permits are a method to achieve a desired level of pollution control at an optimal cost to society. They are a way to make the price of pollution permits as close as possible to the social marginal cost. The aim is to increase the cost of producing pollution and create an incentive for firms to reduce the quantity of pollution.

In an emissions trading system, the government sets an overall limit on emissions and defines permits, which are limited authorisations to emit up to the level of the overall limit. The government may sell these permits, but in many existing schemes, it gives permits to participants (regulated polluters) equal to each participant's baseline emissions. To demonstrate compliance, a participant must hold permits at least equal to the quantity of pollution it emitted during the time period. If every participant complies, the total pollution emitted will be at most equal to the sum of individual limits.

Because permits can be bought and sold, a participant can choose to use its permits exactly, emit less than its permits and sell the excess, or emit more than its permits and buy permits from other participants. This creates a market for pollution permits with the price set by demand and supply. For example, a firm that produces less pollution can sell its pollution permits to other firms. However, if it produces more pollution, it has to buy permits from other firms or the government.

Tradable pollution permits also give firms an incentive to develop new technologies aimed at reducing pollution inexpensively. Over time, the existence of pollution permits should reduce demand for pollution. Firms will want to avoid paying the cost and find a way to reduce pollution. As demand for permits falls, the price of permits will fall. In this case, the government may respond by steadily reducing the supply of permits. By steadily reducing the amount of permits, the government can steadily reduce the quantity of pollution.

They incentivise firms to reduce pollution

The concept of using a permit market to control pollution levels was first developed by Canadian economist John Dales and American economist Thomas Crocker in the 1960s. The idea is that pollution permits will incentivise firms to reduce pollution by making it more expensive to produce pollution and creating a market for pollution permits. The price of permits is set by demand and supply.

In an emissions trading scheme, a central authority or governmental body allocates or sells a limited number of permits that allow a discharge of a specific quantity of a specific pollutant over a set time period. The government may sell the permits, but in many existing schemes, it gives permits to participants for free, based on each participant's baseline emissions. To demonstrate compliance, a participant must hold permits at least equal to the quantity of pollution it emitted during the time period. If every participant complies, the total pollution emitted will be at most equal to the sum of individual limits.

Because permits can be bought and sold, a participant can choose to use its permits exactly, emit less than its permits and sell the excess, or emit more than its permits and buy permits from other participants. Firms that emit less can sell their permits for an amount greater than or equal to the cost of their own emissions reduction, resulting in profits in the permit market. This creates an incentive for firms to reduce their emissions, as they can make money from selling their excess permits.

Over time, the existence of pollution permits should reduce demand for pollution. As the government reduces the number of permits available, the price will increase, creating a growing incentive to reduce pollution. Firms will want to avoid paying the cost and will find ways to reduce pollution. As demand for permits falls, the price of permits will fall, and the government can respond by reducing the supply of permits further, steadily reducing the quantity of pollution.

Economic incentives have been shown to provide cost savings relative to traditional regulatory approaches. One study estimates that the potential savings of widespread use of economic incentives could reach $45 billion annually. They can also provide impetus for technological change.

They can be used to raise government revenue

The sale of pollution permits can be a way for governments to raise revenue. In an emissions trading scheme, a central authority or governmental body sells a limited number of permits that allow a specific quantity of a pollutant to be discharged over a set time period. The permits are sold to polluters, who are required to hold permits equal to their emissions. If a polluter wants to increase its emissions, it must buy permits from another participant willing to sell them.

The permits themselves grant a firm the legal right to produce a fixed level of pollution. If a firm produces less pollution than its permits allow, it can sell its excess permits to other firms. This creates a market for pollution permits, with the price set by demand and supply. The existence of tradeable permits enables pollution abatement to be achieved in a cost-effective manner. Over time, pollution standards can be tightened, increasing the value of permits and the pressure on market participants.

The government can also generate revenue by steadily reducing the supply of permits over time. As the number of permits decreases, the price of permits will increase, creating a growing incentive for firms to reduce pollution. The idea is that this will give firms time to invest in less polluting technology. As demand for permits falls, the government can respond by reducing the supply of permits, thereby reducing the quantity of pollution.

In some schemes, a proportion of all traded permits must be retired periodically, causing a net reduction in emissions over time. Environmental groups may buy and retire permits, driving up the price of the remaining permits. Usually, the government will lower the overall limit over time, with the aim of achieving a national emissions reduction target.

They can be bought and sold between countries

The idea of pollution permits was first developed by Canadian economist John Dales and American economist Thomas Crocker in the 1960s. Pollution permits are issued to firms, giving them the legal right to produce a certain amount of emissions. The aim is to incentivize firms to reduce pollution and the external costs associated with it.

Pollution permits can be bought and sold between countries. The 1997 Kyoto Treaty enforced tradable pollution permits across countries, with each country awarded a pollution permit to limit carbon dioxide emissions. Countries that successfully reduced emissions cheaply could sell the rest of their quota to countries that needed more permits. This system does not necessarily reduce pollution but shifts it from richer countries to poorer ones. For example, the EU Emissions Trading Scheme (ETS) has been criticized for failing to reduce carbon dioxide and reverse global warming.

In a similar way, permits can be bought and sold between firms. If a firm produces less pollution than its quota, it can sell its permits to other firms that have exceeded their limit. This creates a market for pollution permits, with the price set by demand and supply. Over time, as demand for permits falls, the price and supply of permits should also fall, leading to a decline in pollution.

While pollution permits can create incentives for firms to reduce pollution, critics argue that they do not adequately address the issue. Pollution permits may not substantially reduce pollution levels, and they can be difficult to implement due to the challenge of measuring pollution levels.

They are criticised for not addressing the issue of pollution

The concept of pollution permits, also known as emissions trading, involves allocating permits to firms, allowing them to produce a certain amount of emissions. The aim is to incentivize firms to reduce pollution and its associated external costs. While this approach has its advantages, it has also faced criticism for not adequately addressing the issue of pollution.

One of the main criticisms of pollution permits is that they can simply shift pollution from richer countries to poorer ones. In a global context, developed countries with higher pollution quotas can purchase permits from less developed nations, allowing them to maintain or even increase their pollution levels. This dynamic fails to address the overall goal of significantly reducing pollution on a global scale. For instance, the EU Emissions Trading Scheme (ETS) has been criticized for not effectively reducing carbon dioxide emissions or mitigating global warming.

Another concern is the potential for perverse incentives within the emissions trading system. Allocating permits based on historical emissions ("grandfathering") may discourage firms from reducing their emissions since lowering emissions would result in fewer permits in the future. This dynamic creates an incentive for firms to maintain or even increase their emissions to secure more permits.

The effectiveness of pollution permits also relies on accurate measurements of pollution levels and proper administration. However, measuring pollution levels can be challenging, and there is a risk of underreporting or manipulation of data. Additionally, the implementation of pollution permit schemes incurs administrative costs, which can impact their overall efficacy in reducing pollution.

Furthermore, critics argue that pollution permits can lead to inequities, particularly in a global context. For example, critics like Louise Comeau of the Sierra Club have pointed out that emissions trading could allow individuals or entities to buy their way out of making necessary lifestyle changes. This criticism highlights the potential for pollution permits to exacerbate social and economic inequalities, as those with financial means can continue their polluting activities without facing significant consequences.

While pollution permits aim to reduce pollution levels, the criticism that they do not adequately address the issue underscores the complexities of environmental policy. To effectively tackle pollution, a combination of approaches, including regulations, taxes, and market-based incentives, may be necessary.

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