Environmental Regulation: Choice of Instruments under Imperfect Compliance

• Authors: Inés Macho-Stadler.
• BSE Working Paper: 189 | September 15
• Keywords: Environmental regulation , audits and compliance , environmental standards , other instruments
• JEL codes: K32, K42, D82
• Environmental regulation
• audits and compliance
• environmental standards
• other instruments

Compliance is an important issue in environmental regulation. In this paper, we discuss some of the key elements of the problem and analyze a situation where emissions are not random and firms are risk-neutral. We study the firm’s decision on emissions and compliance when the environmental regulation is based on standards and the enforcement agency audits the firm with a certain probability. We then compare total emissions when environmental regulation is based on different instruments: standards, taxes, and tradeable permits. We show that when compliance is an issue, environmental taxes are superior to the other instruments. We also analyze the (static) efficiency of the solution.