Enforcing market -based environmental policies

The market-based approach to controlling industrial pollution is a major innovation in environmental policy, and is rapidly gaining support among policy makers. It is likely that environmental quality standards can be achieved at much lower cost with market-based policies than with traditional command-and-control regulations because they provide sources of pollution more flexibility and greater incentives to find and implement cost-effective ways to control their emissions. However, a key component of market-based systems has not been adequately addressed; namely, how they should be enforced to achieve acceptable levels of compliance. This dissertation extends the theoretical analysis of compliance and enforcement in market-based environmental policies, focusing primarily on developing practical guidelines for the design of appropriate enforcement strategies. After a description of the structural design and enforcement strategies being pursued in two major U.S. market-based systems, three theoretical models are developed. Each of the models assumes that the enforcement objective is to achieve complete compliance to a transferable emissions permit system (each firm holds enough permits to cover its emissions) in a cost-effective manner. In addition, each of the models assumes that firms in a market-based control system are required to provide reports of their emissions to an enforcement authority. The first model of this dissertation assumes that regulated sources of pollution operate under a perfectly competitive transferable permit system. The model allows the development of a number of practical guidelines for enforcing competitive market-based policies that are focused primarily on the use and value of self-reporting, the value of firm-specific information to an enforcer, the desirability of targeted monitoring, and guidelines for setting penalties. The second and third models of this dissertation reconsider the design of effective enforcement strategies when certain market imperfections exist. Specifically, the second model considers the consequences of transaction costs on enforcing transferable emissions permit system. Finally, the third model considers enforcement design when a firm can exercise price-setting power in a market-based system