Liability is a Liability

Filed Under (Environmental Policy, Finance, Other Topics, U.S. Fiscal Policy) by Don Fullerton on May 7, 2010

Who should pay for the cleanup and damages in the Gulf of Mexico?  The rig was owned by Transocean and leased to British Petroleum (BP), while some drilling services were provided by Halliburton.  Here is some information from today’s New York Times, before we do some analysis:

“BP and Transocean have been named by the Coast Guard as “responsible parties,” which means they must cover all cleanup costs, including those incurred by the Coast Guard and other government employees.

“They will also have to compensate people and businesses for things like property damage, lost business revenue and harm to ecosystems. BP’s liability bill is capped at $75 million and Transocean’s probably at $65 million, but those caps could be lifted if the companies were found to have acted with gross negligence or to have broken rules that led to the spills.

“Or the government could rule that the spill involves more than one incident, which would mean higher caps. And three senators have introduced legislation to raise the $75 million cap to $10 billion.”

Economists have long espoused the “Polluter Pays Principle”, which might make you think those companies should pay for the damages.  First of all, however, that principle involves two completely different concepts.  Discussions in the popular press are usually related to issues of fairness, while economists are usually interested in issues of incentives, behavior, and economic efficiency.  Economists would say that the polluters should have to pay, primarily to give them the proper incentives for precaution in the first place.  If the polluter faces all of the potential costs of their actions, and can adequately judge the probabilities of an accident, then the private cost-benefit analysis is the same as the social cost-benefit analysis: the whole project is only worthwhile to the extent that the benefits exceed the cost, maximizing economic efficiency.

By the way, if the polluter might go bankrupt or otherwise avoid paying the cost, then that is a possible justification for earlier government action, in the form of regulation to make sure they take the proper level of precaution in the first place.

The other issue is fairness, which is primarily a personal value judgment.  Economists don’t have any special expertise about what is “fair”, but they do have something to say about how market forces shift around the burden.  Those who actually pay can be quite different from those who write the check, and fairness ought to be about who actually pays!

This oil spill is a great example.  The moment the spill is discovered, we see immediate declines in the value of BP and other companies’ stock, and we see immediate declines in the value of local homes, fishing fleets, and other businesses that might be damaged.  Most likely, some of those homeowners or businesses will sell out now, either because of frustration or because they were already planning to retire and move somewhere else.  Others buy those homes or businesses for cheap.  Then those new owners are physically damaged when the oil hits the coastline and fishing areas.  I use the word “physically” here, because they are NOT damaged economically.  Yes, their home or business is negatively affected by the spill, but they already bought the property for cheap, which makes up for it.  Nonetheless, because of physical damages, they can sue BP and other polluters.

If they are successful, then they reap a net GAIN from the whole fiasco.  Those who really lost but sold out early may never be compensated.

Similarly, some BP stockholders now sell while the stock price is low.  Others buy the stock for cheap, and they may be forced legally to write the check to the “damaged” parties, but they don’t really bear any burden at all!  The fact that they bought the stock for cheap makes up for having to write the check.

Does this system collect from the “responsible parties”?  The owners at the time might be responsible, but if they sold out, then the new owners write the check even though they are not responsible for the spill.

Does this system prevent people from taking “benefits” from imposing pollution on others?  Not a bit!  The BP owners at the time of the spill may be “responsible”, but they may not be getting any benefits at all from having used sloppy and inexpensive precautionary measures.  Their purchase of BP stock just got them the same expected rate of return that they could have earned in any other investment.

Who did “benefit” from the pollution, or from using cheap and inadequate precaution against a spill?  And should those people be made to pay back their ill-gotten gains?  For better or worse, those who got the “benefit” of cheap oil production are you and me!  We’ve been buying cheap gasoline for quite a while now, produced in a way that does not cover the true social cost of production.  We are the culprits, not the oil companies.  Maybe we should be made to pay back our ill-gotten gains.  But again, it can’t happen, as we’ve already sold our 8-cylinder Pontiacs and bought new fuel-efficient hybrids.

These market responses combine to make proper compensation impossible.  You can’t collect from those who really took advantage of others, and you can’t find all the people who really lost from the spill.

Who Bears the Burden of Energy Policy?

Filed Under (Environmental Policy) by Don Fullerton on Sep 4, 2009

Economists have tools to analyze the distributional effects of income taxes, payroll taxes, property taxes, and corporate income taxes.  Some existing research even looks at distributional effects of environmental or energy taxes used to help control pollution or energy consumption.  Yet most pollution policy does not involve taxation at all!  Instead, we use permits or command and control regulations such as technology standards, quotas, and quantity constraints.  Existing studies of energy policy are mostly about effects on economic efficiency, addressing questions such as: how to measure the costs of reducing pollution or energy use, how to measure benefits of that pollution abatement, what is the optimal amount of protection, and what is the most cost-effective way to achieve it.

Yet environmental mandates do impose costs, and an important question is who bears those costs.  Moreover, those restrictions provide benefits of environmental protection, so who gets those benefits?  Full analysis of environmental policy could address all the same questions as in tax analysis.  Perhaps it could use the same tools to address distributional effects – not of taxes, but of these other policies that are used to protect the environment.

Thinking about the distributional effects of environmental policy is interesting and difficult.  For example, a standard tax analysis would point out some complex implications of an excise tax: not only does it affect the relative price of the taxed commodity, and thus consumers according to how they use income, but it also impacts factors intensively used in the production of that commodity, and thus individuals according to the sources of their income.  Yet an environmental mandate can have those effects and more!  Consider a simple requirement that electric generating companies cut a particular pollutant to less than some maximum quota.  This type of mandate is a common policy choice, and it has at least the following six distributional effects.

First, it raises the cost of production like a tax, so it may raise the equilibrium price of output and affect consumers according to spending on electricity.

Second, it may reduce production like a tax, reduce returns in that industry, and place burdens on workers or investors.

Third, a quota is likely to generate scarcity rents.  For simplicity, suppose pollution has a fixed relation to output, so the only “abatement technology” is to reduce output.  Then a restriction on the quantity of pollution is essentially a restriction on output.  Normally firms want to restrict output but are thwarted by antitrust policy.  Yet in this case, environmental policy requires firms to restrict output.  It allows firms to raise price, and so they make profits, or rents, from the artificial scarcity of production.  Just as tradable permit systems hand out valuable permits, the non-tradable quota also provides scarcity rents – to those given the restricted “rights” to pollute.

Fourth, if it cleans up the air, this policy provides benefits that may accrue to some individuals more than others.  The “incidence” of these costs and benefits usually refers to their distribution across groups ranked from rich to poor, but analysts and policy-makers may also be interested in the distribution of costs or benefits across groups defined by age, ethnicity, region, or between urban, rural, and suburban households.

Fifth, regardless of a neighborhood’s air quality improvement, many individuals could be greatly affected through capitalization effects, especially through land and house prices.  Suppose this pollution restriction improves air quality everywhere, but in some locations more than others.  If the policy is permanent, then anybody who owns land in the most-improved locations experience capital gains that could equal the present value of all future willingness to pay for cleaner air in that neighborhood. Similar capitalization effects provide windfall gains and losses to those who own corporate stock: capital losses on stockholdings in the company that must pay more for environmental technology, and capital gains on stockholdings in companies that sell a substitute product.

Capitalization effects are pernicious.  A large capital gain may be experienced by absentee landlords, because they can charge higher rents in future years.  Certain renters with cleaner air might be worse off, if their rent increases by more than their willingness to pay for that improvement.  Moreover, the gains may not even accrue to those who breathe the cleaner air!  If households move into the cleaner area after the policy change, then they must pay more for the privilege.  The entire capital gain goes to those who happen to own property at the time of the change, even if they sell it at the higher price and move out before the air improves.  Similarly, new stockholders in the burdened company may be “paying” for abatement technology in name only, with the entire present value of the burden felt by those who did own the stock at the time of enactment, even if they sell that stock before the policy is implemented.

Sixth, strong distributional effects are felt during the transition.  If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm.  It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs.  These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry.  If the industry shrinks, those workers suffer a significant loss in the value of that human capital.  They must also move their families, acquire new training, and start back at the bottom of the firm hierarchy, with significant psychological costs.

The challenge here is that many of these effects of environmental policy are likely to be regressive.  Consider the six categories just listed.  First, it likely raises the price of products that intensively use fossil fuels, such as electricity and transportation.  Expenditures on these products make up a high fraction of low income budgets.  Second, if abatement technologies are capital-intensive, then any mandate to abate pollution likely induces firms to use new capital as a substitute for polluting inputs.  If so, then capital is in more demand relative to labor, depressing the relative wage (which may also impact low-income households).  Third, pollution permits handed out to firms bestow scarcity rents on well-off individuals who own those firms.  Fourth, low-income individuals may place more value on food and shelter than on incremental improvements in environmental quality.  If high-income individuals get the most benefit of pollution abatement, then this effect is regressive as well.  Fifth, low-income renters miss out on house price capitalization of air quality benefits.  Well-off landlords may reap those gains.  Sixth, transition effects are hard to analyze, but could well impact the economy in ways that hurt the unemployed, those already at some disadvantage relative to the rest of us.

That is a potentially incredible list of effects that might all hurt the poor more than the rich.  The challenge for those of us who want to claim to do policy-relevant research, then, is to determine whether these fears are valid, and whether anything can be done about them – other than to forego environmental improvements!