Shapiro, Joseph and Walker, Reed “Is Air Pollution Regulation Too Stringent?” (Revised June 2023) | WP-312R

Abstract:
This paper describes a framework to estimate the marginal cost of air pollution regulation, then applies it to assess whether a large set of existing U.S. air pollution regulations have marginal costs exceeding their marginal benefits. The approach utilizes an important yet under-explored provision of the Clean Air Act requiring new or expanding plants to pay incumbents in the same or neighboring counties to reduce their pollution emissions. These “offset” regulations create several hundred decentralized, local markets for pollution that differ by pollutant and location. We show that these markets cover much US economic activity, experience search frictions, have rising prices over time, and reflect local regulatory stringency. We provide empirical and theoretical evidence consistent with the idea that offset transaction prices are close to the marginal cost of pollution abatement, and we compare offset prices to estimates of the marginal benefit of abatement from leading air quality models. We find that for most regions and pollutants, the marginal benefits of pollution abatement exceed mean offset prices more than ten-fold. In at least one market, however, estimated marginal benefits are below offset prices.