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Incentive-Based Regulatory Approaches: Environmental Taxes & Tradable Permits

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  • 0:49 Command and Control…
  • 1:54 Incentive-Based…
  • 3:02 Environmental Taxes
  • 3:58 Subsidies for…
  • 4:31 Tradable Permits
  • 6:11 Lesson Summary
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Lesson Transcript
Instructor: Rebecca Gillaspy

Dr. Gillaspy has taught health science at University of Phoenix and Ashford University and has a degree from Palmer College of Chiropractic.

An incentive-based regulatory approach aims to reduce environmentally-harmful pollutants by offering inducements to polluters who limit their emissions. Learn how environmental taxes and tradable permits are utilized to help protect the environment.

Incentives and Environment

I think most people would agree that it's easier to perform a task if there is an incentive to get the job done. Incentives provide us with motivation. Take Timmy for example. Timmy does not recycle, and even though he feels recycling is a good idea, he doesn't see it as being worth the effort. Now, let's give Timmy a dollar for each pound of waste he recycles and see what happens. Yep, when Timmy is given a financial incentive, he now sees recycling as being worth his time and effort. This is how incentive-based regulatory approaches work. In this lesson, we will learn how these approaches motivate companies to take more environmentally beneficial actions.

Command and Control Regulatory Approach

When you get right down to it, there are two ways to motivate people to change their ways. You can set a rule or limitation and penalize anyone who breaks the rule or goes over the set limitation. Or, you can give people an enticement or incentive that provides them with a reward for taking action.

These same two approaches can also work when it comes to controlling pollution. One way pollution is controlled is through the command and control regulatory approach, which works toward preventing environmental problems by legislating what is permitted. In other words, a company would be held responsible for going over any limits set on the generation of pollution. The command and control approach provides polluting entities with detailed quality standards set by a government authority that must be met. Ongoing inspections are then used to ensure that the standards are being met. If the company is not compliant with the regulations, then a sanction would result, such as a fine or prosecution.

Incentive-Based Regulatory Approach

The command and control approach differs from the incentive-based regulatory approach, which works toward preventing environmental problems by providing inducements to encourage polluting entities to reduce pollution. Incentive-based regulatory approaches are sometimes referred to as market-based approaches because the market, including private-sector companies, is driving the change. Through this approach, companies are rewarded for incorporating pollution reduction into their business decisions. The rewards are typically some type of financial gain.

This approach solves the common complaint associated with the command and control approach. Under the command and control approach, a company is only motivated to reduce pollutants to a regulated level. With the incentive-based approach, companies are rewarded financially for reaching even lower pollution levels. Therefore, a benefit of the incentive-based approach is that it encourages the creation of innovative and cost-effective methods of pollution control. These new methods can be adopted throughout an industry for greater gains in environmental protection.

Environmental Taxes

One example of an incentive-based regulatory approach is environmental taxes. Environmental taxes are defined as an approach to environmental protection that utilizes taxes connected to pollution emissions and waste production. The primary objective of environmental taxes is to encourage entities that create pollution to act in more environmentally-responsible ways and in essence, 'go green.' Therefore, environmental taxes are sometimes referred to as green taxes. Green tax revenues may be used to promote conservation efforts or to promote environmentally-friendly energy technologies, such as wind power. While taxes may not seem like an incentive, economic theory suggests that taxes on polluting emissions will reduce environmental harm in the least costly manner, by encouraging changes in behavior by those firms and households that can reduce their pollution at the lowest cost.

Subsidies for Pollution Control

Subsidies for pollution control are another incentive-based approach. This is defined as financial support granted by the government for activities and products deemed to be environmentally friendly. Instead of attaching a charge to companies that create pollution, subsidies for pollution control reward companies and industries that take steps to reduce pollutants. These types of subsides can be awarded in different ways, including grants, favorable tax treatment or low-interest loans.

Tradable Permits

Another example of an incentive-based regulatory approach is tradable permits. Tradable permits are an approach to environmental protection that utilizes government-issued permits, which can be traded among polluters, for the release of a set amount of pollution. Let's take a look at how tradable permits work. The total amount of allowable emissions is set by a government authority. For example, the government understands that through the process of manufacturing and distributing products and services, a certain amount of carbon dioxide and other greenhouse gases will be produced and emitted into the atmosphere. The government decides on an allowable amount of emissions that enables businesses to function, while at the same time provide some environmental protection.

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