Welcome to the WaddellCast: The podcast where a fiscally-conservative, small-government Democrat discusses the issues.

In this episode, I discuss the importance of environmental protection and provide an effective and economically-efficient approach to it.

The theme song for the WaddellCast is Waterfall by Jeff Wahl. You can find this, and other great songs at Magnatune.com.

First of all, thank you to all of you who are listening to the WaddellCast for the first time. This is my third episode since I started last month. My goal is to publish 1 or 2 episodes each month. I have posted a list of topics on my website for future shows – please visit MWaddell.com and post any other topics that you would like me to address in this podcast.

Today, I would like to talk about environmental protection. In this episode, I will focus specifically on industrial pollution – I plan to address wildlife conservation, recycling and automobile pollution on future episodes.

Throughout the history of the industrialized world, mankind has been taking natural resources and producing waste products. As our population increases, our demands for manufactured products increases, and our methods of extracting natural resources and producing waste products become more efficient, we are putting an increasing strain on our world. In order to maintain a habitable planet, we must recognize that, as large as our world is, its size is still finite.

In the U.S., our current method of environmental protection is to allow each company to pollute at no cost up to a certain point, and any pollution above that level is forbidden. There are many problems with this current solution and I will address five of them here. First, because the limits are set on a per-company basis (or a per-factory basis, per-smokestack basis, etc.), they need to be modified as the number of companies changes. Second, the current laws and policies are unnecessarily complex and poorly enforced. The reason that they are poorly enforced is because of the third and forth problems with this system. Third, companies have a lot of lobbying power to make the pollution laws weak and to add numerous loopholes that can be exploited. And fourth, if companies are caught exceeding their pollution limits, they can use their massive legal departments to reduce their fines to a minimum. And finally, we are currently allowing companies to “pollute for free,” but all of the costs of enforcement are paid for by tax money. Shouldn’t the polluters be the ones who have to cover the financial burden of polluting instead of the us taxpayers?

The approach that I will present today for solving this problem utilizes two things that businesses understand very well and are highly motivated by: the free market and financial incentives. The free market (if left to its own devices) is poorly equipped to deal properly with environmental protection. This is because, unlike other raw materials (such as iron or wood), using up clean air or water is free. In a free market, whenever raw materials are offered at no cost, they will be overused. Currently, if a power plant pollutes the air, it is effectively “using up” clean air and “creating” dirty air as a waste by-product. And, as long as the plant uses up less clean air than some arbitrary level, they don’t pay anything for it. They are in effect “polluting for free.”

An alternate system for enforcing environmental protection that would be far more effective and economically-efficient that our current system would be to charge each polluter for all of the pollution that they put out. Companies would then have a great financial incentive to work hard to limit their use of these resources in order to save money – just as companies currently work hard to use all of their other raw materials more efficiently.

One common criticism of the idea of charging companies for their pollution is that it is morally wrong to sell “licenses to pollute.” My response to this criticism is two-fold. First of all, how is selling a license to pollute worse than allowing companies to pollute for free, as we do now? Secondly, I am not proposing that we allow a company to release an arbitrary amount of pollution as long as they pay some set rate for it (for example: $100 per cubic foot of mercury released into the water). I agree completely that this would be a bad idea.

Instead, I propose that we treat clean air and water as any other valuable commodity. The EPA would set a level for each pollutant that would be the acceptable level of that pollutant to be emitted per year for the entire country. Permits would be created for each pollutant in some fixed quantity. For example, if the acceptable limit for mercury pollution is 10,000 cubic feet per year, then 10,000 permits, each for 1 cubic foot of mercury polution, would be created. Those permits would be auctioned off at the beginning of each year, and the permits could be traded in the commodities market. At the end of the year, each company would have to give the EPA enough permits to cover all of the pollution that they emitted into the environment for the entire year. Each year, another set of permits would be issued and the cycle would repeat. The EPA would use the money made from the auction to monitor the pollution level of each company so that they would know at the end of the year how many permits each company needs to have. The more effectively they monitor and enforce the permits, the fewer companies will try to get away with polluting beyond the number of permits they own, and, in turn, the more valuable the permits become. The more valuable the permits become, the larger the EPA’s budget for the next year. Thus, the EPA has a great incentive to do their job well, because if they are lax in their enforcement, then fewer companies will bother to buy permits and the EPA’s budget will go down. In fact, environmental groups could easily monitor how well the EPA is enforcing each type of pollution by simply reading the commodities section of the Wall Street Journal!

The advantages of this plan are numerous. For example, because the total amount of pollution is fixed by the number of permits sold, this amount does not need to be adjusted if the total number of polluting companies changes dramatically. Second, the EPA can gradually reduce the number of permits they sell each year, which will result in a reduction in the overall pollution. Third, environmental groups have an easy way to directly reduce pollution. They can raise money to buy up permits that they have no intention of using. This will effectively reduce the number of permits available to businesses. Fourth, this plan is very economically efficient because the money spent to reduce pollution will be spent by those companies who can reduce their emissions the most for the least cost. Fifth, all companies will have a financial incentive to reduce their emissions throughout the year because they can likely sell their unused permits at a profit later in the year to companies that were formed after the auction and need to purchase permits before the end of the year. Under our current plan, companies that are compliant with the emissions laws have no incentive to further reduce their emissions.

The only disadvantage that I can see someone bringing up with respect to this plan is that it is possible that a few companies will buy the majority of the permits and be allowed to emit a large amount of pollution in a few specific locations. My answer to this disadvantage is five-fold. First, having a few companies that produce that majority of our pollution is already what happens under our current system, so we would be no worse off than we are now. Second, because these major polluters would be forced to pay for all of their pollution, they would have a greater financial incentive than they do now to reduce their emissions. Third, the type of pollution released by these major polluters would be the primary target of environmental groups buying up permits to prevent their use. Fourth, because much of the pollution would be located in a few small areas, enforcement would be less costly and a portion of the EPA’s budget could go to cleaning up those specific areas. Finally, this entire plan could easily be implemented state-by-state instead of having one set of permits for the entire country. For reasons of ease of implementation and economic efficiency, I believe that having a single set of permits for the entire country is preferable, but I concede that a plan where each state issues it’s own set of permits may be more politically acceptable.

Another major advantage to this system of environmental protection is that it is much simpler to implement than the complex set of statues and policies currently in effect. Plus, in this system there would be no loopholes (like there are now). Currently, if a company can convince their senator or representative that it would be too hard for their company to meet the EPA’s guidelines, they are likely to get an exemption. Under this market-based system, a company’s only recourse for not reducing their emissions would be to buy more permits. This would increase the overall demand for permits and raise their price accordingly. If the company cannot afford to buy enough permits at this higher price, then they will become unprofitable and go out of business – just like any other company that cannot make enough profit to cover its cost of raw materials. If they were able to convince their senator or congressman that they should be given special treatment, the only aid they could be given would be tax credits to help offset the cost of purchasing extra permits. (I will discuss this, and other types of corporate welfare in a future episode.)

Finally, I want to make clear that this plan does not sell permits for all pollutants. There are some types of pollution where the only acceptable level of pollution is zero (for instance, dumping arsenic in the water supply). For these types of pollution there are no permits sold, they are simply banned completely. Also, there are some pollutants that cannot be accurately measured and thus cannot have permits issued for them. However, under our current system, you cannot enforce pollution limits on these unmeasurable pollutants anyhow, so we are no worse off under this new system. Also, once a measurement technology becomes available, it will be simple to begin selling permits for this new pollutant as well. Since the EPA would get their funding based solely on the sales of permits, they would have a great financial incentive to develop measurement technologies for pollutants that are currently unmeasurable.

At this point, I would like to make two notes on what I have been calling the “EPA” throughout this episode. First of all, the EPA must get 100% of its funding through the sale of permits in order for it to have adequate incentives to enforce the permits effectively. It has been estimated that, if implemented correctly, this plan would provide the EPA with 5-6 times its current annual budget – and none of that would be from taxpayers! Secondly, (because I really dislike monopolies), I would personally prefer that the “EPA” actually be a group of environmental organizations that all compete for the proceeds from the sale of permits – where the organization that is most effective at enforcement of a certain pollutant would receive the proceeds from the sale of the permits for that pollutant. However, I am willing to concede this as a possible future step, since I know that breaking up the EPA into a group of smaller organizations would be a very unpopular idea politically.

Although I said at the beginning of this episode that I would not discuss automobile pollution until a future show, I would like to point out that this permit system could be applied easily to automobiles in one of two ways. One option would be to require car owners to purchase permits for all of the pollution that their car emits instead of the emissions tests that many cities now require in order to renew a car’s registration. The second option would be to require permits for the suppliers of gasoline and diesel: either the gas stations themselves, or the producers of these petroleum products.

The plan that I have presented today is not a new idea, and I can’t take credit for inventing it. If you would like to explore this plan in more detail, I highly recommend Alan Blinder’s excellent book “Hard Heads, Soft Hearts.” This is an incredibly readable economics primer for anyone interested in the disconnect between politics and economics. In chapter 5, Alan discusses this approach to environmental protection in more detail than I have provided today, and he proves how using this approach will achieve a cleaner environment for a much smaller economic cost to society as a whole.

Thank you for joining me for this episode of the WaddellCast. As always, you can contact me with any questions, comments or constructive criticism you may have by visiting my website at mwaddell.com.