EPIBuilding a Sustainable Future
Eco-Economy: Building an Economy for the Earth

Chapter 11. Tools for Restructuring the Economy: Tradable Permits

Environmental taxes and tradable permits are both economic instruments that can be used to reach environmental goals. The principal difference between the two is that with permits, governments set the amount of a given activity that is allowed, such as the harvest from a fishery, and let the market set the price of the permits as they are auctioned off. With environmental taxes, in contrast, the price of the environmentally destructive activity is set by government in the tax rate, and the market determines the amount of the activity that will occur at that price. Both economic instruments can be used to discourage environmentally irresponsible behavior.42

The decision of when to use taxes as opposed to permits is not always a clearcut one. When it is desirable to keep an environmentally destructive activity below a certain level, permits are more precise than taxes, which have a less certain effect. Once permits are set at the desirable level, the market decides what they are worth. When taxes are fixed at a certain level, the market decides how best to minimize their effect by reducing the undesirable environmental activity. Governments have much more experience with environmental taxes. It is also clear that environmental taxes work under a wide range of conditions. Still, permits have been used successfully in two widely differing situations: restricting the catch in an Australian fishery and reducing sulfur emissions in the United States.

Concerned about the threat of overfishing to its lobster fishery, the government of Australia estimated the sustainable yield of the fishery and then issued permits totaling that amount. Fishers could then bid for these permits. In effect, the government decided how many lobsters could be taken each year and let the market decide how much the permits were worth. Since the permit trading system was adopted in 1986, the fisheries have stabilized and appear to be operating on a sustainable basis.43

Perhaps the most ambitious effort to date to use tradable permits was the U.S. effort to reduce sulfur emissions by half from 1990 to 2000. Permits were assigned to some 263 of the more sulfur-dioxide-intensive electrical generating units operated by 61 electric utilities. These were mostly coal-fired power plants east of the Mississippi River. The result was that sulfur emissions were cut in half between 1990 and 1995, well ahead of schedule. Although this approach has occasional hitches, the sulfur reduction effort is widely seen as successful, an approach that minimized the costs of achieving an environmental goal.44

Trading permits had been proposed by the U.S. government as a way to reach the carbon reduction goals of the Kyoto Protocol. Permits are desirable when there is a specific goal, but if the purpose is to stimulate a long-term trend, then graduated taxes over time may be preferable. If the goal is to reduce carbon emissions worldwide, with higher goals for industrial countries who burn disproportionately large amounts of fossil fuels, then governments can set taxes at a level appropriate to each country's situation.45

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42. Roodman, op. cit. note 6, pp. 15-27.

43. Australia in John Tierney, "A Tale of Two Fisheries," New York Times Magazine, 27 August 2000.

44. Richard Schmalensee et al., "An Interim Evaluation of Sulfur Dioxide Emissions Trading," in Robert N. Stavins, ed., Economics of the Environment (New York: W.W. Norton & Company, 2000), pp. 455-71; actual reduction from ibid., p. 460.

45. "Bush Charts Global Warming Course," Associated Press, 6 June 2001.


Copyright © 2001 Earth Policy Institute