Bad Trade

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When the Clean Air Act was passed last year, the Bush administration hyped its market-based approach to reducing air pollution. And when the Chicago Board of Trade voted in July to allow trading in pollution permits, many saw the move as a market approval of the Bush approach.

But despite the Board of Trade's vote, some economists have reservations about the permit system's viability.

Under the Clean Air Act, the Environmental Protection Agency can issue permits that allow the holders to emit specified amounts of sulfur into the air. Companies can buy and sell the permits to increase or decrease their level of pollution. Those who produce less pollution than permitted can sell their rights, thus creating an incentive for companies to cut their sulfur emissions.

At least that's how it's supposed to work. But James L. Johnston, senior economist at Amoco Corp., has his doubts.

"If you read the act, the allowances—that's what they are referred to as, not rights—aren't property rights. The EPA reserves the right to modify or eliminate them at any time. And companies can't sue, even if the value of the allowances is driven to zero."

Permit trading is also supposed to force companies to search for the lowest cost way of cutting emissions, but Johnston says that isn't the case either. "Dig into the act and you find all sorts of indirect incentives to use high-sulfur coal with scrubbers, as well as a promise of $2.5 billion in direct subsidies for utilities to continue using high-sulfur coal. Never mind that it might otherwise be cheaper to switch to low-sulfur coal."

The effect of these loopholes, Johnston contends, is to undermine companies' confidence that the system will last and to make the permits less attractive to buyers. "At best, this is not a very graceful way of dealing with environmental problems," he says. "At worst, it may contain the seeds of its own destruction."

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