Designing markets for pollution when damages vary across sources : Evidence from the NOx Budget Program

Designing markets for pollution when damages vary across sources : Evidence from the NOx Budget Program. Existing and planned emissions trading programs are almost exclusively “emissions-based”, meaning that a permit can be used to o¤set a ton of pollution, regardless of where in the program region the ton is emitted. Designing programs in this way presumes that the health and environmental damages resulting from the permitted emissions are independent of where in the regulated region the emissions occur. A growing body of scienti…c evidence indicates that this is not the case for nitrogen oxides (NOx). When marginal damages from incremental emissions reductions vary signi…cantly across sources, there is the potential to signi…cantly improve the e¢ ciency of permit market outcomes by using facility or region-speci…c marginal damage estimates to determine the terms of permit trading. We estimate the e¢ ciency gains from “damage-based” trading in the context of a major NOx emissions trading program. We …nd that, under the damage-based trading regime, levelized annual abatement costs increase by an estimated $12 M ( i.e. less than 2 percent). However, damages associated with permitted emissions decrease by approximately $62 M annually. The net bene…ts under the policy that incorporates spatially di¤erentiated trading increase by 17%, or almost $50M annually. Keywords: Market-based Policy, NOx Budget Program, Policy Instrument Choice. JEL Classi…cations: Q54, Q53, Q58 Acknowledgements: Muller wishes to thank the United States Environmental Protection Agency for support under award: EPA-OPEI-NCEE-08-02.