Emissions Trading versus Pollution Taxes: Playing Nice with Other Instruments

Traditionally, scholars debating the choice between emissions trading and a pollution tax as environmental policy instruments have not considered interactions between policies. Instead, they consider these environmental protection instruments in isolation. But governments usually do not rely on a tax or trading program exclusively to address significant environmental problems. Instead, a pollution tax or a trading program almost always operates in conjunction with other programs. The existence of multiple programs raises the question of which market-based instrument works best with other programs. This article focuses on this question, which arises frequently in the context of air quality management, but also, at times, in water quality and waste management. This article argues that a pollution tax works much better with other programs than emissions trading. A pollution tax provides an added impetus for pollution sources to accept complementary regulation. Pollution sources carrying out other requirements to reduce emissions end up reducing their tax bill and further enhancing environmental quality. Furthermore, because every ton of pollution remains subject to a tax, polluters acquire an incentive to consider going further than required when a more specific reduction requirement applies to them. By contrast, a trading program systematically undermines supplemental measures. Additional programs do not usually generate extra emission reductions, as any additional pollution reductions arising from a supplemental program will usually generate credits that can be sold to polluters as a substitute for their local compliance with the trading program. As a result, a new program working together with trading often raises compliance cost and limits flexibility without necessarily adding environmental benefits. For these reasons, emissions trading will have the tendency to retard the development of robust multi-faceted approaches to environmental problems. This article asks whether a pollution tax’s superiority in “playing nice with other instruments” constitutes an important advantage, and concludes that for a complex long-term problem like transboundary air pollution, it does. Indeed, this paper shows that this ability to play nice with other instruments, at least in some contexts, matters a great deal more than the efficiency and simplicity arguments that scholars have conventionally focused on in debating instrument choice.