Perverse Incentives with Pay for Performance: Cover Crops in the Chesapeake Bay Watershed

Policymakers are concerned about nitrogen and phosphorus export to water bodies. Exports may be reduced by paying farmers to adopt practices to reduce runoff or by paying performance incentives tied to estimated run-off reductions. We evaluate the cost-effectiveness of practice and performance incentives for reducing nitrogen exports. Performance incentives potentially improve farm-level and allocative efficiencies relative to practice incentives. However, the efficiency improvements can be undermined by baseline shifts when growers adopt crops that enhance the performance payments but cause more pollution. Policymakers must carefully specify rules for performance-incentive programs and payments to avoid such baseline shifting.