In the body of literature for nonpoint source pollution, the costs of managing pollutant loads and economic tools have become part of the dialogue. Cost-effectiveness measures have shaped environmental regulations in their evaluations of control measures and policy development.212 Economic incentives and market-based programs are encouraged as flexible and cost-effective alternatives to command-and-control regulatory approaches.213 Studies have employed economic indicators to assess the CWA and its goals.214 Other research has applied economic theories to evaluate water pollution control programs.215 Moreover, EPA (2001) estimated that flexible economic approaches to improving water quality as part of implementing TMDLs could save $900 million annually compared to the least flexible approach. The literature on
mechanisms that use financial motivation to achieve pollution control includes taxes, subsidies, tax-credits, cost-sharing programs, grants, land retirement, and trading programs.
211 Enforceable State Mechanisms for the Control of Nonpoint Source Water Pollution (Washington, DC: ELI, 1997); Almanac of Enforceable State Laws; Putting the Pieces Together.
212 Cochard, Willinger, and Xepapadeas, "Efficiency of NPS Pollution Instruments."; Wu and Babcock, "The Relative Efficiency of Voluntary Versus Mandatory Environmental Regulations," J. Envt'l. Econ. & Mgmt. 38, no. 2 (1999). 213 Pigou, The Economics of Welfare, 4th ed. (London, UK: Macmillan, 1952); Crocker, "The Structuring of Atmospheric Pollution Control Systems," in The Economics of Air Pollution, ed. Wolozin (New York: W.W. Norton & Co, 1966); Dales, "Land, Water and Ownership," Canadian Journal of Economics 1 (1968); Pollution, Property and Prices: An Essay in Policy Economics (Toronto: University of Toronto Press, 1968); Montgomery, "Markets in Licenses and Efficient Pollution Control Programs," Journal of Economic Theory 5, no. 3 (1972); Kneese and Schultze, Pollution, Prices, and Public Policy (Washington, D.C.: The Brookings Institution, 1975); Bohm and Russell, "Comparative Analysis of Alternative Policy Instruments," in Handbook of Natural Resource and Energy Economics, ed. Sweeney (North-Holland, 1985); Davies and Mazurek, Pollution Control in the U.S.; Horan and Ribaudo, "Policy Objectives and Economic Incentives for Controlling Agricultural Sources of Nonpoint Pollution," Journal of the American Water Resources Association 35, no. 5 (1999); Russell and Powell, "Practical Considerations and Comparison of Instruments of Environmental Policy," in Handbook of Environmental and Resource Economics, ed. Bergh (Cheltenham, UK: Edward Elgar Publishing Limited, 1999). 214 Lyon and Farrow, "An Economic Analysis of Clean Water Act Issues," Water Resources Research 31, no. 1 (1995). 215 Dales, "Land, Water and Ownership."; Stavins, Lessson from the American Experiment with Market-Based Environmental Policies (Resources for the Future, 2001); Tietenberg, ed. Tradable Permits in Principle and Practice, Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (New York: Oxford University Press, 2006).
From an economic standpoint, the direct regulation approach to managing both point and
nonpoint source water pollution is inefficient. Economists as early as Dales (1968) have criticized command and control regulation because: 1) regulations require pollution control activities that tend to be excessively costly; 2) the structure created for firms and individuals to comply lacks positive incentives to control pollution, but rather presents a negative incentive to avoid penalties.216 Researchers give several arguments for considering costs in environmental regulations.217 Others have concluded that environmental laws and regulations hold all firms to the same reduction target and hence, are not cost-effective because firms have different pollution abatement costs.218 Furthermore, the command-and-control approach to environmental
regulation allows for little flexibility and locks in certain technologies.219 The federal government has enacted strict laws and regulations, which lack the ability to capitalize on the private
information that polluters have about means and procedures they could use to minimize pollution.220
Cointreau and Hornig (2003) categorize environmental incentive programs into three categories. The first group, revenue-generating mechanisms, produces revenues through instruments such as pollution charges, taxes, reductions in subsidies, or tradable permits. Next, revenue-providing tools allow producers to receive income from other entities, usually governments. Examples of these include fiscal incentives, development rights, and tax credits. The third category, non- revenue instruments involve deposit-refund schemes and grandfathered permits. Within these terms, traditional command-and-control regulation would be considered revenue-neutral as well.221 The range of alternatives to regulatory programs is discussed in the following sections. Incentive-based programs
The most basic financial incentive measure is a Pigouvian tax, which equates private costs with social costs to reach an efficient level of production of a good.222 Pigouvian taxes create
216 Dales, Pollution, Property and Prices; Freeman, "Economics, Incentives, and Environmental Policy," in Environmental Policy: New Directions for the Twenty-First Century, ed. Vig and Kraft (Washington, DC: CEQ Press, 2006).
217 Kneese and Schultze, Pollution, Prices, and Public Policy; Freeman, "Economics, Incentives, and Environmental Policy."
218 Stavins, Lessson from the American Experiment.
219 Ibid.; Field and Field, Environmental Economics: An Introduction, 4th ed. (Boston: McGraw-Hill Irwin, 2006), 233. 220 Environmental Economics, 233.
221 Cointreau and Hornig, The Application of Economic Instruments in Water and Solid Waste Management, Regional Policy Dialogue (Washington, DC: Inter-American Development Bank, 2003).
222 Pigou, The Economics of Welfare; Baumol, "On Taxation and the Control of Externalities," The American Economic Review 62, no. 3 (1972); Barthold, "Issues in the Design of Environmental Excise Taxes," The Journal of Economic Perspectives 8, no. 1 (1994); Bovenberg and Mooij, "Environmental Levies and Distortionary Taxation," The American Economic Review 84, no. 4 (1994); Bovenberg and Goulder, "Optimal Environmental Taxation in the Presence of Other Taxes: General Equilibrium Analyses," The American Economic Review 86, no. 4 (1996); "Environmental Taxation and Regulation," in Handbook of Public Economics, Volume 3, ed. Auerbach and Feldstein (Amsterdam, The Netherlands: Elsevier–North Holland Publishing, 2002).
incentives as reductions in tax payments to private firms to establish efficient ways to reduce pollution. Application of these types of charges is limited because in some circumstances, it may not be feasible or politically palatable to require payment for pollution discharges. Hence, these charges or taxes are typically small components of government budgets.223 Similar to a tax, subsidies are more attractive, but also have the drawbacks of encouraging more environmentally harmful activity.224 Federal and state governments use cost-share programs as a primary strategy to manage nonpoint source pollution, especially from farming activities. Federal agencies are the main source of funds for cost shares; however, states have also established state-funded programs.225 ELI (2000) reviews state programs for nonpoint source pollution management including how cost-share programs have helped ensure compliance from these sources. However, the integration of cost share with enforcement has been difficult in some cases.226 Moreover, states have also developed property and income tax credits for installation of BMPs and land conservation. Jack et al. (2008) group subsidies, grants, and cost-share
programs within a broader framework of payments for ecosystem services (PES) policies, or a “voluntary, conditional agreement between at least one ‘seller’ and one ‘buyer’ over a well-defined environmental service—or land use presumed to produce that service.”227 Characteristics of payment programs can vary in form of: payment, providers, services, implementers, rules of participation, funding source, and the manner in which incentives are given.228
Land management policies can incorporate incentive-based initiatives to address nonpoint source pollution problems. These strategies, such as clustering, density bonuses, purchase of
development rights (PDR), transfer of development rights (TDRs), preferential property tax treatments, and wetland mitigation banking, encourage landowners to protect critical ecological habitats and natural resources.229 Walls and McConnell (2004) describe economic incentives- based programs in the Chesapeake Bay Watershed, including PDRs, TDRs, and development impact fees. The authors suggest the need for more coordination among policies focused directly
223 Sterner, Policy Instruments for Environmental and Natural Resource Management (Washington, DC: Resources for the Future Press, 2003).
224 Baumol and Oates, The Theory of Environmental Policy (Cambridge, England: Cambridge University Press, 1988). 225 Environmental Law Institute, Putting the Pieces Together.
226 Ibid. 227
Wunder, "The Efficiency of Payments for Environmental Services in Tropical Conservation," Conservation Biology 21, no. 1 (2007); Jack, Kousky, and Sims, "Designing Payments for Ecosystem Services: Lessons from Previous Experience with Incentive-Based Mechanisms," Proceedings of the National Academy of Sciences 105, no. 28 (2008): 9465. 228 Jack, Kousky, and Sims, "Designing Payments."
on land use. For instance, the strategies targeting urbanized land should be considered relative to the area of farms, forests, and open space.230
Farming operations contribute the majority of nonpoint source pollution.231 The literature for incentive-based initiatives for agriculture (e.g. subsidies, taxes on pollution, agrochemical input tax, and tradable permits) is extensive. Researchers have evaluated pollution control practices and programs for farm operations that enhance effectiveness of water pollution controls.232 Also, a couple studies conducted research on the adoption of environmental stewardship practices for subsidies.233 Studies have examined the effects of the decisions of farmers about crop choices and management practices on profitability, risk associated with alternatives, and spread of new practices and strategies.234 Additionally, researchers investigated the influence of decisions for conservation and environmental protection initiatives on ecosystem services.235 Osmond et al. (2012) assessed farmer acceptability of the most effective technical solution and follow-up operation and maintenance of practices to ensure water quality benefits.236
Although the U.S. has made voluntary incentives central to water quality policies for nonpoint source pollution from agriculture, there are numerous challenges. There has been evidence of farmer support of stronger water quality regulations in some states. Rinquist (1993) found that “the strength of the agricultural sector in a state exerts a significant positive influence over water quality regulations” because: 1) costs of regulation and its benefits are spread out across a large number of farms; and 2) self-interest.237 Still, voluntary application of pollution control practices has not expanded to sufficient levels.238 Taxes have not resulted in a widespread adoption of reduced agrochemical application.239 Tax rates would have to be set very high to generate
230 Walls and McConnell, Incentive-Based Land Use Policies and Water Quality in the Chesapeake Bay (Resources for the Future, 2004).
231 U.S. Environmental Protection Agency, "Non-Point Source Pollution," www.epa.gov/owow/nps/qa.html.
232 Protecting Water Quality from Agricultural Runoff (Washington, DC: U.S. EPA, 2005); Environmental Law Institute, Locating Livestock: How Water Pollution Control Efforts Can Use Information from State Regulatory Programs
(Washington, DC, 1999); Osmond et al., How to Build Better Agricultural Conservation Programs to Protect Water Quality: The National Institute of Food and Agriculture–Conservation Effects Assessment Project Experience (Ankeny, IA: Soil and Water Conservation Society, 2012).
233 Isik, "Incentives for Technology Adoption under Environmental Policy Uncertainty: Implications for Green Payment Programs," Environmental and Resource Economics 27 (2004); Ribaudo et al., Nitrogen in Agricultural Systems: Implications for Conservation Policy (Washington, D.C.: U.S. Department of Agriculture, 2011).
234
Wu et al., "From Micro-Level Decisions to Landscape Changes: An Assessment of Agricultural Conservation Policies," American Journal of Agricultural Economics 86, no. 1 (2004).
235 Ibid.; Langpap, Hascic, and Wu, "Protecting Watershed Ecosystems through Targeted Local Land Use Policies," American Journal of Agricultural Economics 90, no. 3 (2008); Swinton et al., "Ecosystem Services Afforded by Agriculture and Their Economic Value," in The Ecology of Agriculturalecosystems: Research on the Path to Sustainability, ed. Hamilton, Doll, and Robertson (New York, NY: Oxford University Press, 2012); Swinton et al., "Ecosystem Services and Agriculture: Cultivating Agricultural Ecosystems for Diverse Benefits," Ecological Economics 64 (2007).
236 Osmond et al., How to Build Better Agricultural Conservation Programs. 237 Ringquist, Environmental Protection at the State Level, 164-165. 238 Short and Duane, "Regulatory Spillover."
significant reductions in nutrient application rates.240 Farmers may depend on and expect
programs, such as subsidies, cost-share, and tax credits, to be available in the future. Moreover, expanding funding payments through federal programs may be politically difficult through the existing Farm Bill.241 In addition, agricultural groups and members of Congress have opposed initiatives for farmers to implement BMPs due to adverse economic effects.242 Hence, state governments are more hesitant to take measures beyond voluntary approaches for pollution abatement because of the prominence of the agricultural sector to state economies.243 Moreover, Isik (2004) reveals the uncertainty of the ecological returns from the adoption of pollution control practices, the future of subsidy programs, and the investment decision of farmers.244 Lastly, the integration of cost-share and technical assistance with fully developed enforceable mechanisms has been an issue because the enforcement function is administered by a separate entity.245 For any policy instrument for nonpoint source reduction, the overall success is contingent on
participation from farmers and proven effectiveness of implemented practices. Water Quality Trading Programs
Economists have claimed that pollution trading programs provide an efficient approach to environmental improvements.246 Pollution trading, also called “cap-and-trade,” sets a total allowable pollution limit, allocates allowances to pollutant sources, and allows for trading permits, or rights, to pollute. Market forces determine permit prices. Examples at the federal level for pollution control include sulfur dioxide (SO2), lead, water quality, and chlorofluorocarbons (CFC). Initiated from Coase’s (1960) transferability of property rights, where market forces determine the best use of resources, Crocker (1966) established a theoretical model of tradable permits for air pollution.247 Following his predecessors, Dales (1968) developed a theoretical prototype for water pollution, while Montgomery (1972) applied it formally.248 Additional research has also utilized trading models with either solely point sources or both point and nonpoint sources.249 However,
240 Swinton and Clark, "Farm-Level Evaluation of Alternative Policies to Reduce Nitrate Leaching from Midwest Agriculture," Agriculture and Resource Economics Review 23 (1994); Claassen and Horan, "Uniform and Non-Uniform Second-Best Input Taxes: The Significance of Market Price Effects on Efficiency and Equity," Environmental and Resource Economics 19 (2001); Ribaudo et al., Nitrogen in Agricultural Systems.
241 Batie, "Green Payments and the US Farm Bill: Information and Policy Challenges," Frontiers in Ecology and the Environment 7 (2009).
242 Rosenbaum, Environmental Politics and Policy, 8th ed. (Washington, D.C.: CQ Press, 2008), 202. 243 Ibid.
244 Isik, "Incentives for Technology Adoption."
245 Environmental Law Institute, Putting the Pieces Together.
246 Crocker, "The Structuring"; Dales, Pollution, Property and Prices; Montgomery, "Markets."
247 Coase, "The Problem of Social Cost," The Journal of Law and Economics 3, no. 1 (October) (1960); Crocker, "The Structuring."
248 Dales, Pollution, Property and Prices; Montgomery, "Markets."
249 "Markets."; Krupnick, Oates, and Verg, "On Marketable Air-Pollution Permits: The Case for a System of Pollution Offsets," Journal of Environmental Economics and Management 10 (1983); Shortle and Abler, "Nonpoint Pollution," in The International Yearbook of Environmental and Resource Economics, ed. Tietenberg (Cheltenham, UK: Eduard Elgar,
proven results in areas such as air pollution management and acid rain do not guarantee that market-based instruments would be successful in water pollution control.
Studies in activity from these market-based mechanisms have been limited and are primarily inventories of existing programs or single case studies.250 As of 2012, there were 63 water quality trading programs currently active or in development internationally.251 Greenhalgh and Selman (2012) performed a comparative analysis of these water quality trading programs based on various criteria including general details, underpinning policy, trading status, trading rules,
program obstacles, and other observations. In this evaluation, the researchers found that most of the programs in the U.S. were driven by TMDLs or the threat of impending regulations. Aside from this research, few other studies have methodically compared programs from a number of countries to identify factors that contribute to success of programs.
Most of the existing program designs are for point-nonpoint transactions of nutrient credits within a watershed.252 Furthermore, the economic concepts and limited evidence shows the fiscal viability of point-nonpoint trading, as nonpoint sources can reduce nutrient loads at a lower cost than point sources in many watersheds.253 Scholars have identified examples of water quality trading programs in the U.S., such as the Long Island Sound (CT) and Tar-Pamlico Basin (NC), which have documented pollutant load reductions and cost-savings.254 Greenhalgh and Selman (2012) made the following recommendations for advancing successful water quality trading programs:
1997); Netusil and Braden, "Transaction Costs and Sequential Bargaining in Transferable Discharge Permit Markets," Journal of Environmental Management 61, no. 3 (2001); Hung and Shaw, "A Trading-Ratio System for Trading Water Pollution Discharge Permits," Journal of Environmental Economics and Management 49, no. 1 (2005).
250 Hoag and Hughes-Popp, "Theory and Practice of Pollution Credit Trading in Water Quality Management," Review of Agricultural Economics 19, no. 2 (Autumn - Winter, 1997) (1997); Environomics, A Summary of U.S. Effluent Trading and Offset Programs (Washington, D.C.: Dr. Mahesh Podar, Office of Science and Technology, U.S. EPA, Office of Water, 1999); Woodward, "Lessons About Effluent Trading from a Single Trade," Review of Agricultural Economics 25, no. 1 (2003); Breetz et al., Water Quality Trading and Offset Initiatives in the U.S.: A Comprehensive Survey (Hanover, NH: Dartmouth College, 2004); Selman et al., Water Quality Trading Programs: An International Overview, Issue Brief, Water Quality Trading: No.1 (Washington D.C.: World Resources Institute, 2009); Stephenson et al., "An Evaluation of Nutrient Nonpoint Offset Trading in Virginia: A Role for Agricultural Nonpoint Sources?," Water Resour. Res. 46, no. 4 (2010); Greenhalgh and Selman, "Comparing Water Quality Trading Programs: What Lessons Are There to Learn?," Journal of Regional Analysis and Policy 42, no. 2 (2012).
251 "Comparing Water Quality Trading Programs."
252 Breetz et al., Water Quality Trading; Greenhalgh and Selman, "Comparing Water Quality Trading Programs." 253 Baumol and Oates, The Theory of Environmental Policy; Pearce and Turner, Economics of Natural Resources and the Environment (Baltimore, MD: Johns Hopkins University Press, 1990); Faeth, Fertile Ground: Nutrient Trading's Potential to Cost-Effectively Improve Water Quality (Water Resources Institute, Washington, D.C., 2000); Selman et al., Brief No.1. 254 Breetz et al., Water Quality Trading; Abdalla et al., "Water Quality Credit Trading and Agriculture: Recognizing the Challenges and Policy Issues Ahead," (2007).
- Use operational market places (e.g. NutrientNet);
- Identify of a “trading champion” to motivate activity;
- Adequately enforce water quality regulations;
- Streamline trading process to reduce transaction costs;
- Tie trading to implementation systems (e.g. reverse auctions, trading banks); and
- Monitor water quality for track performance.255
Nonetheless, most of the existing programs thus far have not provided enough data to support a full analysis, suggesting the mismatch of theory and practice.256 The context for most of the research to identify barriers to productive water quality trading program, differs from study to study and has rarely been conducted in a systematic manner.
Although water pollution regulators are opting for more innovative approaches, such as trading systems, to reduce pollutants to water bodies, water quality trading is still in its early stages and transaction procedures are yet to be fully defined and vary among programs. While economists favor trading as a cost effective alternative approach to attaining water quality goals, there has been a growing body of literature on the limitations of trading systems for water quality markets.257 Studies have commented on design options of water quality trading systems.258 Woodward and Kaiser (2002) identified water pollution trading structures: exchanges, bilateral negotiations, clearinghouses, and sole-source offsets. Adaptations of these basic markets have been further
255 Greenhalgh and Selman, "Comparing Water Quality Trading Programs." 256 Abdalla et al., "Water Quality Credit Trading and Agriculture."
257 Malik, Letson, and Crutchfield, "Point/Nonpoint-Source Trading of Pollution-Abatement - Choosing the Right Trading Ratio," American Journal of Agricultural Economics 75, no. 4 (1993); Stavins, "Transaction Costs and Tradeable Permits," Journal of Environmental Economics and Management 29, no. 2 (1995); Woodward, Kaiser, and Wicks, "The Structure and Practice of Water Quality Trading Markets," Journal of the American Water Resources Association 38, no. 4 (2002); King and Kuch, "Will Nutrient Credit Trading Ever Work? An Assessment of Supply and Demand Problems and Institutional Obstacles," ELR News & Analysis 33, no. 5 (2003); Hennessy and Feng, "When Should Uncertain Nonpoint Emissions Be Penalized in a Trading Program?," American Journal of Agricultural Economics 90, no. 1 (2008); Horan,