Auctions and alternative procedures for allocating pollution rights

Systems of transferable pollution rights are presently of interest to both researchers and policymakers due to their potential efficiency in controlling pollution. A range of alternative procedures for allocating pollution rights is examined. Using simulations based on realistic data from 2 water-pollution-control case studies, an investigation is conducted of rights programs based upon: 1. sales of rights by the government under 2 distinct types of auctions, and 2. free initial distribution of rights by the government to dischargers on some basis, followed by exchange among dischargers of rights and funds. It is suggested, based on both theoretical and practical considerations, that a basic trade-off exists between decreasing the financial burden of rights purchases and removing the incentives for strategic behavior. Very few dischargers in either case study would have lower expenses under government sales of rights than under uniform treatment, no matter whether sales are by single-price or by incentive-compatible auctions. In spite of some problems regarding incentive compatibility, the rights allocation approach of free distribution followed by exchange appears to offer the most desirable package of features. The incentive-compatible procedure may be optimal regarding such objectives as individual incentive compatibility and efficiency.