An investigation of market solutions to environmental externalities: The case of sulfur dioxide emissions

Title IV of the Clean Air Act Amendments of 1990 represents a fundamental shift in the orientation of environmental policy in the United States. The accompanying Acid Rain Program was instituted as a market-based mechanism designed to significantly reduce sulfur dioxide emissions from electric utility plants. The program established a system of tradable sulfur dioxide allowances and a framework under which these allowances were to be exchanged. Economists have long advocated the use of tradable allowance systems and lauded their potential to achieve a given overall emission reduction at the lowest possible cost. This dissertation evaluates the performance of the sulfur dioxide trading system, and its participant plants, based on the predictions of neoclassical economics. First, I calculate the shadow or internal value of an emission allowance for a sample of electric plants participating in the first Phase of the Acid Rain Program. Comparisons are made between these values and the prevailing emission allowance market prices to determine how well prices reflect the plant\u27s opportunity costs. Second, I calculate plant-level output allocative efficiency measures in order to determine whether plants are responding optimally to the nascent emission market. Regulatory or informational factors may preclude plants from making cost-minimizing abatement choices and may therefore lessen the program\u27s potential for cost-savings. Finally, I develop a technique for estimating the relative external damages caused by the sample of plants. A tradable permit system, while allowing for aggregate emission reduction at reduced cost, does not guarantee an equitable distribution of the benefits of pollution abatement. The existence of significant variance in the external benefits of abatement undermines a tradable allowance system\u27s ability to achieve improved social welfare. This dissertation provides an extended evaluation of the tradable allowance system as it is embodied in the Acid Rain Program and the sulfur dioxide allowance market. It serves as an additional resource in the growing public debate surrounding the implementation of market-based mechanisms in environmental policy