Topic Area: Air Pollution
Geographic Area: United States
Focal Question: Was the use of economic incentives successful in the phaseout of leaded gasoline in the United States?
Sources:
(1) Nussbaum, Barry D. (1992). Phasing Down Lead in Gasoline in the U.S.: Mandates, Incentives, Trading, and Banking. Climate Change: Designing A Tradable Permit System. T. Jones and J. Corfee-Morlot. Paris, Organization for Economic Co-operation and Development Publication: 25-40
(2) Hahn, Robert W., and Hester, Gordon L. (1989). "Marketable Permits: Lessons for Theory and Practice", Ecology Law Quarterly 16(2): 361-406
Reviewer: Nicholas B. Lambert, Colby College '96
Review:

Gasoline in the early 1970's was the dominant source of environmental lead within the United States. Lead in itself is toxic to humans, and also serves to break down catalytic converters, which are used to reduce carbon monoxide, hydrocarbon, and nitrogen oxide emissions from vehicles. In 1973 the Environmental Protection Agency (EPA) imposed the first regulation on the lead content of gasoline in the form of the Lead Phasedown Program. This set a mandate on the total amount of lead per gallon allowed when all gasoline produced by a refinery in a given quarter was averaged.

By the mid-1980's, the EPA proposed the creation of more stringent controls. The original regulations measured the lead per gallon of the average gallon produced, covering both leaded and unleaded gasoline to create an incentive to switch to unleaded production. By 1982, unleaded gasoline had become an accepted fixture in the market, and thus the new regulations were applied to leaded gasoline only. Expectations were that the total quantity of leaded gasoline demanded would decline along with the lead content. In addition to the alteration in gasoline type included, the new regulations ended the special "small refinery standards". It was commonly believed that small refineries would face higher costs in meeting the standards relative to large refineries, and were thus previously given slightly higher grams per leaded gallon (gplg) limits in the 1973 regulations.

The goal set by the EPA was to reach a level of .10 gplg. Through a cost-benefit analysis of the impacts of the proposed limit, the EPA estimated $36 billion (1983 U.S. dollars) in benefits from reduced adverse health effects and $2.6 billion in costs to the refining industry. In order to gain these benefits at minimum cost and facilitate compliance, the EPA opted to utilize an economic incentive program of lead trading and banking to create flexibility in reaching reach the .01 gplg in a series of steps. Lead trading ran from implementation in 1982 to 1986, and banking ran from 1985 to the end of 1987.

With the implementation of the trading program in 1982, the EPA set the gplg limit at 1.10, and created a grace period for the small refineries to reach this level. The trading program created rights to add specified quantities of lead to gasoline and issued them to refineries based on their production level and the lead standard at the time. These rights could be traded between refineries, thus allowing those unable to meet the regulations to continue production without increasing the total amount of lead by using excess rights purchased from refineries able to produce below the standards. Up to the implementation of the banking program, if lead rights were neither used nor sold in the quarter in which they were created, they would expire.

On July 1, 1985 the EPA lowered the limit from 1.10 gplg to .50 gplg, and introduced the banking program. This added to the flexibility of the trading in that refineries were given the option to "bank" excess rights for future use. These rights were intended to facilitate the transition to the .10 gplg limit to be levied on July 1, 1986 and then to the end of the trading program on December 31, 1986. Rights would remain effective through 1987, at which point they would expire and all refineries would be held to the .10 gplg limit.

The EPA predicted the following outcome for the trading and banking programs; from 1982 to 1985 refineries would utilize the trading system as they lowered lead concentrations to the 1.10 limit, beginning in 1985 refineries would produce at lower concentrations than the given limits of 1.10 and possibly even the .50 limit once it was imposed in order to bank rights for use with the .10 limit, and in the 1986-1987 period concentrations would exceed the .10 limit as refineries utilized their banked rights to facilitate the final transitions.

As the programs ran their course, the EPA predictions and estimates proved to be relatively accurate. From the very beginning of the trading program, between one-fifth and one-third of the refineries utilized the option to purchase rights in order to comply with the standards. From 1983 to 1984 the amount of total lead involved in the trading grew from 7% to 20%. The acceptance and use of the trading system provided an early indication of the success of economic incentives in this situation. In 1985 the start of the banking program produced dramatic results, as refineries banked more than predicted. Within the first quarter nearly one-half of the refineries banked rights, the outcome of which was an actual gplg level of .70 for the industry, well below the 1.10 limit. Trading increased dramatically as rights became more valuable due to their extended usable life, and refineries were eager to bank rights for use with the .10 gplg limit. When the limit was lowered to .50 gplg in July of 1985 the industry concentration average was already below it. Once the .10 gplg limit came into effect the industry was able to operate above it temporarily with banked rights. As 1987 approached, however, concentration levels decreased toward the limit as technology improved in anticipation of production without banked rights, and with the end of the program the industry reached the .10 limit.

Along with the predicted results came several unexpected consequences and externalities. First, a number of refineries, mostly smaller in size, began the practice of blending alcohol into leaded gasoline, then claiming rights on the lead which had already been accounted for and selling the rights on the market. Second, as the banking program brought about the increase in trading, a small new industry of lead brokers emerged to match buyers and sellers, without ever taking possession themselves. The effects of this development were not measured directly, but it can be assumed that it lowered transaction costs of trading and thus increased efficiency.

The refining industry, already accustomed to sales and trades amongst themselves, faced little additional administrative cost in trading rights. The EPA, however, did find themselves confronted with additional costs and inefficiencies. The design of the program itself was to blame. As demand for and price of rights to bank increased, the incentive to cheat by means of "bogus" rights increased. By creating completely fungible lead rights with no certification of legitimacy, the EPA set itself up for complexities in tracing "bogus" rights when refineries began passing them. This required additional paperwork and enforcement measures for the EPA, but these costs were considered to be far less than those which the industry would have faced with less-freely transferable rights.

The various externalities and inefficiencies experienced, however, were minor when viewed in comparison to the overall efficiency and success of the program. The use of economic incentives in the form of trading and banking significantly reduced the costs imposed by the reduction of lead concentrations. In fact, it was argued that such a reduction over the relevant time frame would not have been possible at all with standard command and control approach binding all refineries to a series of declining limits. The EPA reported an estimated $65 million in savings to the refinery industry as a result of the trading provisions, and $200 million in savings from three years of banking. During the banking period, 10.2 billion grams of lead rights were set aside, and over the withdrawal period all but 2.3% of the rights were utilized. The small refineries were able to meet the regulations through trading and updating their technology. Arguably most important, however, not a single refinery requested government intervention in the trading process, any increase in rights, or additional time after the program's expiration for further capital investment to meet the final standards.

In conclusion, it can be drawn that economic incentive programs can be transferred from theory to practice with great success. In the case of the Lead Phasedown Program, the environment experienced a drastic reduction of a major pollutant, the refining industry was able to meet EPA regulations through an extremely cost effective means, and the government was able to accomplish it's goals with a minimum level of intervention.