The Net Benefits of Incentive-Based Regulation: A Case Study of Environmental Standard Setting

Economists interested in environmental, safety, and health regulation have long argued that decentralized, incentive-based (or IB) policies are more efficient than centralized, command-and-control (or CAC) approaches (see Charles Schultze, 1977, for instance). These arguments generally have been based on the assumption that IB policies will accomplish the same goals as their CAC counterparts, but at less cost to society. However, some of those touting IB policies have overlooked an important point: environmental, workplace, or even productsafety standards typically take the form of maximum permissible concentrations of harmful substances, so that compliance only requires that all monitoring points or samples register readings below these critical levels. For this reason, IB policies typically assign a shadow price of zero to improvements that exceed the standard(s), while more crude CAC policies generally result in ";overcontrol" beyond the standards. If there is no value to this overcontrol, CAC policies will not improve at all on IB approaches and will indeed be more expensive. If, however, reduced concentrations below the level of the standards bring with them further improvements in health or the environment, CAC approaches will produce greater benefits than IB approaches. Thus, a fair comparison between the two necessitates that any additional benefits associated with CAC policies be offset against the cost advantages enjoyed by their IB counterparts. Although this possibility has been recognized by others (Scott Atkinson and T. H. Tietenberg, 1982, for instance), it is little appreciated and its empirical significance has never been ascertained. That is our purpose here. We do so by developing data on the costs and benefits of controlling a common air pollutant, total suspended particulates (or TSP), in Baltimore. By comparing the TSP levels likely under both IB and CAC approaches, we are able to estimate the marginal costs and benefits associated with a variety of alternative air quality standards which take the form of maximum permissible concentrations. This in turn allows us to determine the net benefits arising from the two kinds of regimes. In the next section we present a simple conceptual framework for our analysis. Section II describes the estimation of the costs and benefits of our hypothesized air pollution controls in Baltimore. Section III presents our somewhat surprising findings, and Section IV discusses those findings and their potential significance for regulation in the "real world."