What Did the Market Buy? Cost Savings Under the U. S. Tradeable Permits Program for Sulfur Dioxide

Title IV of the 1990 Clean Air Act instituted a nationwide system of tradeable pollution permits for sulfur dioxide emitted by electric power plants. This paper asks: What were the cost savings from using a market-based instrument, rather than a more conventional prescriptive approach? Using an econometric model of the decision whether or not to install a scrubber under different policy regimes, I simulate the decisions that would have been made under prescriptive regulation. I find that under an uniform emissions-rate standard chosen to achieve the same aggregate abatement as actually occurred, the total number of scrubbers would have been about one-third higher than under the baseline cap-and-trade program. The change in the distribution of scrubbers among units is more striking. Under prescriptive regulation, installed scrubbers would have had systematically higher scrubbing costs than they actually did, and would have been installed at plants with significantly higher costs of switching to low-sulfur coal (the principal alternative to scrubbing). At the aggregate level, these effects translate into aggregate costs of compliance that would have been greater than actual costs by an estimated $150 million to $270 million per year. Thus the use of the market-based instrument resulted in cost savings of between 16% and 25%. The results provide a concrete demonstration of the influence of policy design on both unit-level choices of abatement technique and aggregate abatement costs.