How Bush Sr. Solved Acid Rain with Basic Economics

North America's acid rain problem emanated in the American West and Midwest, where coal-fired power plants were discharging vast clouds of sulfur dioxide into the atmosphere. This sulfur dioxide was drifting eastward and falling back to earth in the form of acid rain, damaging lakes, forests, buildings, and human health across eastern Canada and the eastern United States. This was a classic case of an industry generating what economists call "external costs", where the industry created costs that they themselves (and, in this case, their consumers also) were able to avoid, but that others were forced to pay.

(Image from Forbes)

By the late 1980's, though, George Bush Sr. was in the White House. He had campaigned on addressing environmental issues, specifically acid rain, and was looking for a solution. At the same time, the seemingly unlikely combination of some open-minded environmentalists and some concerned free-market conservatives were floating the idea of a market-based approach to the issue: put a limit on each power plant's sulfur dioxide emissions, but don't tell the utilities how to achieve those reductions. Impose stiff penalties for those who exceeded their limit but, and here is the particularly unique economic approach being floated, consider those limits as being "allowances to emit" and let the utilities buy and sell these allowances among themselves. The allowances would thereby become a commodity that could be traded in the marketplace.

What this approach would do is allow each power plant's management to innovate as they saw fit and to find their own least expensive means of lowering their sulfur dioxide emissions. They could look into using low sulphur coal, or consider installing scrubbers to clean their discharged smoke, or they could even increase their allowed emissions by purchasing allowances from other utilities. Of course, those allowances would only be available if another plant's emissions fell below their own allowance. In total, then, the industry as a whole still would be meeting the overall emission guidelines. The allowance system also allowed for the banking of unused allowances, so a utility could save them for the future if they chose not to earn more revenue by selling them in the current year.

This new approach was included in the Clean Air Act of 1990 and, while initially described as "emissions trading", it soon became known as "cap and trade": "Cap" emissions and allow utilities to "trade" their allowances, or credits.

(Bush signing Clean Air Act - image from epa.gov)

Many environmentalists questioned this approach, some believing it was a license to pollute and others feeling that it abrogated the role of regulators. Many industry leaders expressed concern about buying and selling the allowances ("Is there value in these pieces of paper?") and estimated that achieving the prescribed reductions would end up costing between $5 billion and $25 billion a year. The Environmental Protection Agency estimated these costs at $6.1 billion.

So, jumping to the bottom line, what were the results of this innovative approach? Did it actually work? Well, once the federal government got the ball rolling by buying allowances for its Tennessee Valley Authority (TVA) electricity provider, the industry never looked back. By 2004, sulfur dioxide emissions had fallen 36%, while power output had increased by 25%. Three years later, the 8.95 million ton cap was reached and three years after that, emissions were down to 5.1 million tons. Cost-wise, industry and independent researchers in 1998 put the price tag for implementation at between $1 billion and $2 billion dollars; a recent study put it at $3 billion a year, while achieving benefits of $122 billion a year.

With such a success, it's not surprising that Europe and the state of California have adopted similar programs to begin reducing their carbon dioxide output, a primary contributor many scientists have identified behind the earth's rising temperatures over the past quarter century.

We like this approach, too, and encourage today's so-called conservatives to utilize free-market economics to help solve these types of problems. Of course, they'll have to start by admitting a problem exists and not burying their head in the sand, hiding behind the "I'm not a scientist, so I don't know" response that seems to be used almost unanimously by them today.

{Our two primary sources for this article were Richard Conniff's story "Blue Sky Thinking" from the August 2009 Smithsonian magazine and a story by Justin Gerdes, a Forbes contributor, written in 2012, which references a 2011 study done by the Harvard Environmental Economics Program. We recommend both articles for additional detail.}