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Public Policy: Using Market-Based Approaches taxed. Market failures could arise in these markets if the input were already subject to some form of price distortion or if the output market were supplied by a monopolist, for example. These problems can be minimised through appropriate tax design, in particular, by taxing the input or output most strongly correlated with pollutant levels and by taking account of other market imperfections when setting the tax rate. DETERMINING THE APPROPRIATE LEVEL OF TAX The appropriate level of unit tax is the level which will lead to the optimal level of pollution. This requires knowledge of incremental costs and benefits of pollution damages over a substantial range, a feat that is likely to be difficult to achieve in practice. Estimating benefits of pollution reduction is particularly problematic. As Baumol and Bradford (1972) demonstrate, the nature of negative externalities mean that there is unlikely to be a single appropriate level of tax that would result in an equilibrium output level. In that case, it may be better to control the quantity of the negative externality, through permits, and letting the market determine the appropriate level of the tax. Political interference/inappropriate use of tax Although the purpose of the tax may be to control pollution, governments may be tempted to use the tax as a revenue-raising device. This may lead to the tax being set at a higher level than is optimal. Such inappropriate use could also undermine support for the real objective of correcting for the negative externality. Growth and inflation A nominal tax designed to induce optimal emissions at one point in time will fail to do so in the future in the presence of growth and rising prices. This requires continual upward revision of the tax by the government, which is likely to be both costly and politically unpopular. Tradable permits on the other hand automatically accommodate these features of a dynamic economy. 236 Location The effect of emissions on the environment and thus the optimal level of emissions is likely to vary across different locations, suggesting a differential unit tax that is unlikely to receive political support. However, imposing a uniform tax may lead to sub-optimal outcomes. 237 236 Cropper, M. and W. Oates. (1992) ‘Environmental Economics: A Survey’, Journal of Economic Literature 30(2). 237 Cropper, M. and W. Oates. (1992) ‘Environmental Economics: A Survey’, Journal of Economic Literature 30(2).. 192
SUBSIDIES In some cases, instead of taxing pollution, governments have introduced subsidies for pollution abatement. This can include subsidies for using lowemissions technology. However, the long-term effects of such subsidies have been poor. In some cases, the subsidy may induce so much entry that in the long run there is an increase the total amount of pollutant emitted. 238 For this reason, taxes on the emission of pollution are often preferable to subsidies for lowpollution technology. Opening access to natural monopolies UNDUE GOVERNMENT INTERVENTION As we noted in Part III, regulated access is only likely to be appropriate in a very limited number of cases. In practice, the majority of cases of regulated access have been in previously nationalised monopolies. There are good reasons for this. The provision of access at a regulated price necessarily involves an appropriation by government of some of the assets of a private firm. If the firm has acquired these assets through legitimate investment in the market, then the use of regulated access can deter investment. Any short-term benefit in terms of price, will likely be more than out-weighed by the long-term effects on firms’ incentives for investment. ASYMMETRIC INFORMATION If regulated access is, however, deemed appropriate, then it should be granted at an appropriate level. This will normally be at a level that bears some relation to cost. In setting this level, the regulator is at a disadvantage compared with the regulated firm. The regulated firm will have more information about its own costs than an external regulator possess. Moreover, it faces an obvious incentive to have the access charge as high as possible. The result can be an incentive for the regulated firm to inflate its costs, with the consequence of an inefficiently high access charge. Moreover, even if a correct access charge were set, the process for acquiring and analysing the necessary information can be costly. COST OF REGULATION Section 12 – Issues in the implementation of market mechanisms In the case of natural monopoly, the efficiency losses from allowing one private firm to supply the market and extract monopoly rent may be less than the cost of regulation. This is suggested by Harberger’s empirical estimates of the cost of monopoly in the US, which suggests the deadweight loss from monopoly is of a relatively small magnitude. 238 Baumol, W. and W. Oates, (1988), The Theory of Environmental Policy, Second Edition, Cambridge, England: Cambridge University Press. Kohn, R. (1985) ‘A General Equilibrium Analysis of the Optimal Number of Firms in a Polluting Industry,’ Canadian Journal of Economics 18(2). 193
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DTI ECONOMICS PAPER NO.14 Public Po
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DTI ECONOMICS PAPER NO.14 Public Po
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Contents Acknowledgements vi Forewo
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Contents Section 11 Emissions Tradi
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Foreword There is increasing intere
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SECTION 1 Introduction and summary
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Public Policy: Using Market-Based A
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SECTION 2 Using market mechanisms U
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SECTION 3 Lessons for the design an
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SECTION 4 Introduction This part of
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SECTION 7 Market-Based Mechanisms W
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SECTION 8 Framework for assessing m
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Part IV Case Studies 73
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● the Green and White papers behi
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A prison failing to deliver on its
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Table 9.3 Companies providing priso
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Section 9 - Competitive Tendering o
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detect any deviation from a collusi
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at HMPS began as an equal mix of th
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(e.g. lighting). This impact could
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MARKET POWER The full benefits of c
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However, it should be noted that te
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on competition is uncertain. The ab
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Controlling for problems of asymmet
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Procurement process design One way
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however, financial deductions are m
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The Independent Monitoring Board at
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Figure 9.1: Difference between the
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‘While there were staff in the pu
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design the invitation to tender and
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and demand conditions. Second, we d
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DEMAND Anyone can apply to a local
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● Rent deposit guarantee by the l
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The Green Paper stated the Governme
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It was not an objective of ODPM or
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DESCRIPTION OF MARKET MECHANISM The
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Once the outcome is determined, fee
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DEVELOPMENTS OVER TIME The major mo
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Concerns about capacity constraints
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from those already located within t
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In several areas, registrations by
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Controlling for information problem
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extent though, it was competition b
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Section 10 - Choice-Based Letting i
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