EconPort - Subsidies for Abatement

Why Subsidies?

A student of economics might ask why and how subsidies can be used to control pollution. After all, subsidies are largely seen in economics circles as inefficient results of a corrupt political system. There are economic organizations, like the Global Subsidies Initiative or GSI, whose sole purpose is the reform or elimination of subsidies in industrial sectors like agriculture and energy.

But these are campaigns against what many consider to be 'perverse subsidies': the type that benefits companies who are largely at fault for such global problems as pollution. These 'perverse subsidies' actually support these firms that are creating negative externalities. The subsidies in question here go to give these firms an extra incentive to reduce their pollution, not to continue on with the status quo level of pollution.

Use of Subsidies

Subsidies are basically negative taxes, although what constitutes a subsidy is still up in the air among economists. So subsidies that can are targeted on reducing pollution can be consider negative Pigovian taxes. Subsidies can be used to increase pollution abatement (decrease pollution). They also change the rational conclusion of a firm’s cost-benefit analysis. Now when choosing to reduce pollution, the marginal benefit of reducing the next unit is increased. Here the marginal cost equals the marginal benefit at a higher abatement level (lower pollution level) because the subsidy installs additional benefits for the firm.

Instead of coming in the form of a direct payment, oftentimes subsidies are given as tax credits which reduce a firm's tax liability by a certain amount or proportion. This decreases the government's revenue, but doesn't entail in additional expenditures on their behalf.

Subsidies are very interesting economic mechanisms because they reward the firms for being better corporate citizens, by internalizing the externality they produce. As opposed to regulatory policies, which tell firms exactly how to reduce, subsidies leave the reducing up to the firm. Producers are financially rewarded if the levels of pollution are reduced to the acceptable range.

Subsidies can also be given to individuals in the form of feebates, which reduce people's tax liability when they do something beneficial for society, like installing solar panels on their house.

Downsides of Subsidies

Some people might object to the government paying the responsible firms to reduce their pollution. This is contrary to the polluter pays principle, which says the guilty party should be responsible for correcting the negative externality (Hanley, 257).
Related to this, many subsidy critics would find assigning the property rights to pollute to the polluter. They would prefer that the firms don't have the right to pay, and thus the firms would be asked their willingness to pay (WTP) for abatement, not their willingness to accept compensation (WTAC) for the same reduction (Hanley, 26).
Firms could become dependent on he financial benefit of the subsidy, so much so that their business model might hinge on getting the subsidy. Some firms' income is so low that without the subsidy payments, they would go out of business. This tool is not intended to keep firms in business.
As subsidies are the flipside of taxes, the associated deadweight loss with taxes also occurs with subsidies. This deadweight loss can be offset by the gain in society's welfare.
The following is not so much a downside as it is a qualification of the use of subsidies: Many environmentalists and economists have focused their energy on getting rid of 'perverse subsidies', not on getting beneficial subsidies instituted. Of course if these 'perverse subsidies' are eliminated, firms might lobby heavily for beneficial subsidies in their stead.

Conclusion

Even taking these potential downsides into account, subsidies can be a useful policy tool to address pollution externalities. One key strength is that subsidies already enjoy support among industries and politicians. They already use them- just for economically unsound reasons in many cases. If it's possible to use that same political will and business support to shift the revenue being used on 'perverse subsidies' to beneficial subsidies, then that would be desirable on many levels. There have presently some subsidies for pollution abatement, in the form of tax credits for individuals who buy fuel-efficient hybrid vehicles. Governments have also subsidized- usually through a reduction in tax liability- whole industries such as the bio-fuel manufacturers. So there is some basis for the use of subsidies for pollution abatement.

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Sources: Hanley, Nick, Jason F. Shogren, and Ben White. Introduction to Environmental Economics. 2001. Oxford University Press, NYC.
Global Subsidies Initiative (GSI)