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Abstract

Economists argue that policymakers should take advantage of market principles in designing environmental regulations. Such market-based approaches--environmental taxes and cap-and-trade--use economic incentives to achieve environmental goals at lower costs. Market-based approaches have now become common due to near-unanimous advocacy by economists and early positive policy experiences. Despite this acceptance, policymakers have often merged market-based incentives onto existing non-market approaches resulting in a set of mixed policies whose economic properties are often difficult to unravel. Thus, even the most prominent market-based regulations contain many nonmarket elements. The authors review the economics literature on the rationale for and optimal design of environmental taxes and cap-and-trade systems. They then discuss the structure and economics of the major U.S. market-based policies.

Ted Gayer is an adjunct scholar at AEI. John K. Horowitz is a professor the in Department of Agricultural and Resource Economics at the University of Maryland.

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