E C O N O M I C R E P O R T O F T H E P R E S I D E N T

compliance costs may fall by less than anticipated, and the ambitiousenvironmental goal may prove extremely costly to meet.These incentive-based approaches also provide an opportunity for thegovernment to raise revenue, either through the auctioning of tradable permitsor through the system of charges. Such revenue can be used to reduceexisting taxes, thereby delivering additional economic benefits relative to atraditional regulatory approach (Box 7-4).Important Issues in DesigningIncentive-Based InstrumentsEnvironmental problems come in various forms, some of which may bebetter addressed through emissions trading, others through charges, and stillothers through other means. By tailoring policy instruments to the characteristicsof a given type of environmental pollution and its sources, policymakerscan implement policies at lower cost than with traditional approaches.Uncertainty About Costs and BenefitsThe tradable permit approach imposes a fixed quantity restriction on agiven type of pollution in the aggregate, whereas a charge approach imposesa specified price on pollution. In a world with perfect information and certainty,these two instruments would have identical effects on emissions abatementand cost. An omniscient regulatory authority could set a charge knowingit would deliver a certain level of emissions, or it could set the quantity oftradable permits in the knowledge that it would deliver a certain price ofemissions abatement. In the real world, however, uncertainties about costsand benefits can influence which approach is preferred. For example, if thereare paramount concerns about the environmental effects of a control policy,a tradable permit approach may be preferred. This could be the casewhere a small increase in the level of emissions could result in a large decreasein benefits. On the other hand, if the costs of achieving a given emissionslevel are highly uncertain, the charge approach may be preferred. This couldbe the case where estimated abatement costs for a given level of emissions liein a wide range. If there are concerns about both costs and benefits, a hybridapproach could allow for sources to engage in a tradable permit system butplace a ceiling on the permit price (for example, a price at which the governmentwould sell additional permits), to ensure against exorbitant compliancecosts that exceed the marginal benefits.250 | Economic Report of the President