Spitting In The Ocean
Gap Closers and Gap Causers:
Marginal Cost Pricing for Nutrient and Sediment
Reduction in the Chesapeake Bay Drainage
(Note: This was prepared for a poster presentation that never happened. I'm posting it here because it may describe the unit pricing idea more thoroughly than earlier posts. RW)
The current mix of policies for restoring the Chesapeake Bay includes regulations that require nutrient and sediment load reductions from some sources. It also includes plans to use public sector resources to encourage other sources to reduce nutrients and sediments by paying them to implement qualifying abatement practices. More recently, experimental trading programs are being developed that would allow regulated pollution sources to reduce their compliance costs by buying pollution reductions from sources that can supply them more cheaply.
Trading programs are expected to achieve several results; some of which are more likely than others. Many policy makers believe that trading programs will bring additional resources to the task of buying nutrient reductions from unregulated sources. But, the water quality benefits from any increase in funding to unregulated sources are offset by the increase in load from the regulated source. Thus, there is no net gain in water quality; only a change in liability for payment. More substantially, by allowing the substitution of low cost reductions for high-cost reductions, trading programs should generate cost efficiencies such that meeting some given level of pollution reduction will impose lower total social costs.
Another, and perhaps more subtle result from trading programs is that, by pricing the tradable asset - mass measures of annual nutrient and sediment export reduction - an incentive will be provided to suppliers to choose practices and land uses that generate greater yields in pollution reduction per dollar cost. By focusing the exchange on this desired product, pollution trading arrangements should also induce suppliers to effectively sort themselves from lowest to highest cost. Buying nutrient and sediment reduction from that type of sorted supply will ensure greater yield per pollution reduction dollar than existing pricing schemes. However, one does not need a trading program to enjoy this benefit.
Current programs that support agricultural non-point source nutrient and sediment pollution reduction practices are functionally indifferent to the number of pounds of nutrients or sediments generated by the practices that they support. Payments under those programs are based on per acre average implementation costs. USDA support for riparian buffers, for example, is paid at a fixed rate per riparian acre, regardless of whether the acre is expected to reduce 20 pounds of Nitrogen (to pick one nutrient), or 30 pounds of Nitrogen per year.
It has been thought too difficult to base per acre payments on the number of pounds of nutrients reduced by a specific type of buffer on a specific type of acre. However, the imposition of the TMDL provides a simple means to do this. Under the models on which the TMDL is based, the implementation of riparian forest buffers generates expected nutrient reduction at a rate defined by the prior land use on the acres that are converted to forest, plus a hydro-geomorphic region-specific reduction efficiency for pollution effluent from four up-gradient units of land. Thus, if you know the prior land use on acres where riparian forest buffers are installed and the land use on the up-gradient acres, and if you know the hydro-geomorphic region in which the buffer is implemented, then you know how many annual pounds of Nitrogen reduction to expect from implementing the practice.
At some fixed value per pound of nitrogen reduction, the number of pounds of nitrogen reduced per acre (as defined by the foregoing Bay Model parameters) times price per pound defines the value of the riparian buffer BMP on any given acre. If acres of riparian buffers were priced in this manner, then those acres that generated larger reductions would be paid a higher price and acres that generated less reduction would be paid a lower price. In this way, greater reductions would be achieved at any given level of expenditure, compared to current policy.
In order for such a pricing scheme to be practical, there needs to be some way to communicate to both buyers and sellers the value per acre of the range of possible load mitigation practices. One means of doing this is to use a computer-based algorithm to collate load reduction values for specified practices. We have created several such tools using hypothetical prices and Chesapeake Bay Model (5.3) parameters for delivered loads and posted them on the web at www.mainstreeteconomics-b.com. Currently, these tools only address cover crops and riparian buffers in Maryland, but similar tools could be built for other practices, in other jurisdictions.
While the accuracy of Chesapeake Bay TMDL-based pollution loads and load reductions is open to argument, the fact that the regulation is based on those expectations provides a means for jurisdictions to minimize their costs in complying with the regulation. It is not clear how the model-based TMDL expectations can be accurate in total, if they are not accurate at finer scales. Moreover, if TMDL-based pollution reduction expectations are used for experimental trading programs, it is not clear why they would not be adequate for existing public sector support for pollution reducing practices.
The problem in promoting this innovation in the context of Chesapeake Bay restoration policy-making is that it is not apparent who to present it to. Who has the capacity, authority and incentive to adopt a more precise pricing scheme among the current federal and state programs aimed at reducing non-point source pollution?