By the time it is consumed or used, every good and service in an industrialized economy has generated environmental externalities, meaning environmental costs that are not included in the price. Large or small, hidden or obvious, those environmental costs instead are imposed on third parties who are strangers to the transactions that injure them.
To the Niskanen Center, the government’s proper role in environmental protection is as the corrective mechanism for these systemic market failures. And today we are witnessing something very unusual: in the face of federal inaction, local governments are trying not only to compel polluters to internalize their externalities, but are doing so in a way that may be more economically efficient than anything the feds could come up with.
A single source, such as a coal-fired power plant, can impose a multiplicity of such externalities. Locally, people downwind are exposed to pollutants that directly injure their health, such as particulate matter and mercury. Regionally, it emits large amount of oxides of nitrogen, one of the precursors to ground-level ozone. And globally, coal-fired power plants are the largest source of CO2.
There are two ways to get a pollution source to deal with these unpriced externalities: government intervention or legal liability to the people injured by these emissions. In turn, government intervention takes one of two forms: command-and-control regulation, which directly limits the amount of pollution released, or a pricing system, which reduces pollution by imposing a monetary cost for each unit of the pollutant released.
Governments prefer regulation, which provides more certainty both that emissions will be reduced, and about which sources will be doing so. Industry generally prefers pricing systems, as they are more economically efficient at reducing emissions. Either way, government action eliminates the externality and thus protects its citizens.
In the United States, we have largely opted for government intervention over tort liability, and most of that intervention has come in the form of command-and-control regulation, with only limited use of pricing. That pricing has come in the form of cap-and-trade systems (which are actually regulation-pricing hybrids), such as the federal sulfur dioxide program and California’s CO2 market. And, as government intervention has grown, the practice of imposing tort liability has diminished; in some instances, government intervention has eliminated, or greatly reduced, the pollution; in others, by complying with the terms of the permit limits, the polluter may be shielded from third-party liability.
However, sometimes the government does not ensure internalization of environmental externalities, necessitating resort to torts. Interestingly, liability is essentially a pricing system; the chief economic difference between the tort system and a tax or cap-and-trade system is that the former determines prices by the actual costs of the injury, and the latter imposes costs instead by the amount of emissions. Thus it may be that such liability is the more accurate mechanism for pricing externalities.
And that brings me to a rather unique form of government action, the tort cases filed against the fossil fuel industry by New York City, San Francisco, Oakland, and six smaller California cities and counties. The Niskanen Center approves of these local governments’ efforts to get the fossil fuel industry to internalize the costs of climate change, the biggest externality in history.
The local governments’ narrative is that the defendants produced coal, oil, and natural gas, and that at some point they became aware of the potentially catastrophic consequences. To protect their financial interests, the defendants (at best) remained silent about those consequences or (at worst), actively worked to conceal this information. And now, when defendants can no longer plausibly deny their products’ externalities (or even, as some defendants have done, admit that fossil fuels are the primary cause of global warming), they plan to produce more, and even more carbon-intensive, fossil fuels.
Given this conduct, say the plaintiffs, in choosing between those defendants and the taxpayers, who should pay for the things that these governments must do in order to protect their and their citizens’ property?
In other words, these local governments are attempting both to price the climate externality, and to set the price based on the actual injuries. If successful, as rational economic actors, defendants presumably would then internalize that price going forward. In other words, these lawsuits may result in an internal carbon tax set at the level required to compensate for the actual injuries caused by these fuels, and thus be the most economically efficient pricing mechanism for climate externalities.
Copyright ©2018, Environmental Law Institute®, Washington D.C. www.eli.org. Reprinted by permission from The Environmental Forum®, May-June .