Rent creation and rent seeking in environmental policy

For similar arguments see, for example, Stavins (1998), Cramton and Kerr (2002), and Hepburn et al. (2006). Another argument extends this perspective by suggesting that the only politically feasible instrument is a non-revenue-raising quantity mechanism—such as freely allocated permits—as this reduces the financial burden on regulated entities (e.g., Goulder and Parry 2008).

Indeed a common argument for the non-revenue-raising instruments being so frequently used is that it is the ‘path of least resistance’ as the regulated entities try to persuade the regulator to avoid raising revenue (Buchanan and Tullock 1975). In the framework of Buchanan and Tullock (1975) firms prefer direct control over taxes because this provides a form of monopoly rent whereas society prefers the tax due to the revenue-raising capabilities. It is argued, then, that direct control occurs as the firms are more organized in lobbying the government than society.

See http://​www.​nyserda.​ny.​gov/​-/​media/​Files/​Publications/​Energy-Analysis/​RGGI/​2009-Q4-RGGI-Status-Report.​pdf.

Finkelshtain and Kislev (1997) use the model of Grossman and Helpman (1994) to compare tax and quota regimes. They find that the relative difference between taxes and quotas depends on the elasticity of the demand, supply of the product, and the number of politically organized firms. Their approach, however, is not concerned with uncertainty of control costs nor the revenue-raising capabilities of regulatory regimes, which is central to the argument about regulatory instrument choice presented in this article. See also Miyamoto (2014). Lake and Linask (2015) analyze tariffs versus quotas within a Grossman and Helpman (1994) framework but they abstract from differences in the size of rent-seeking groups as well as the level of efficiency loss from rent transfer: the key elements of this article.

In MacKenzie and Ohndorf (2012) the policy level is exogenously fixed and social welfare is compared among policies. As such, the MacKenzie and Ohndorf (2012) approach neither investigates the regulator’s policy choice nor the issue of uncertainty, which is the main objective of this article.

Very few articles focus on the revenue generation component within this setting (Schöb 1996; Quirion 2004). Quirion (2004) shows that analyzing price regulation versus quantity regulation in a world of distortonary taxation strengthens the comparative advantage of revenue-raising instruments and then argues that there is no rationale for implementing non-revenue raising instruments. In contrast, however, the analysis presented here provides a positive analysis of the regulatory process, where it is shown that it is entirely possible for a regulator to prefer non-revenue-raising instruments: the key determinants are the efficiency of rent transfer and the population of rent seekers.

Players can be interpreted as individuals or special-interest groups.

This benefit can also be experienced over the population \(\Psi \) without any difference in results.

This assumption is easily relaxed: if uncertainty is realized after players invest in capturing the rents, players will rent seek over the expected rents rather than the realized value.

This contest structure is the most commonly used mechanism to investigate rent seeking. An alternative contest—an all-pay auction—is also a feasible mechanism (Hillman and Samet 1987; Hillman and Riley 1989). Using such a mechanism results in complete rent dissipation on average.

Under the interpretation of earmarked revenues, it is possible that the process of earmarking incurs additional rent seeking. This is compatible with the analysis presented here because the important link is the interaction between players and the politician. In such a case, the politician’s rent being diminished due to earmarking can be interpreted as additional regulatory or legislative checks and balances. It is unlikely that a politician has full control over the entire revenue raised, thus, in such a case, we would expect \(\delta <1\).

For a full report on how auction revenue is used as an investment, see https://​www.​rggi.​org/​docs/​ProceedsReport/​RGGI_​Proceeds_​Report_​2014.​pdf.

Throughout this article players non-cooperatively invest in rent-capturing activities. The framework can easily be extended to include groups. Either one can interpret each player as a specific lobbying group or one can enhance the model by allowing for an additional stage where inter-group rent seeking occurs followed by intra-group rent seeking or sharing of the rent (see, for example, MacKenzie and Ohndorf 2012).

It is, of course, feasible that non-regulated entities rent seek for quantities, e.g., environmental groups, but this appears not to be the case. To include such aspects in the analysis, one simply needs to incorporate a further subgroup of the entire population \(\Psi \) into the game.

Throughout this analysis administration costs are assumed to be comparable for all mechanisms. Inclusion of these costs does not alter the results of this article. Note that when \(\delta\,<\,1\) under price and revenue-raising quantity regulation, this reflects inherent bureaucratic inefficiencies over and above any administration costs. Another possible interpretation is that \((1-\delta )\) of the rent is earmarked for use and thus non-contestable. Thus \(\delta\,<\,1\) of the rent is contestable.

The cost and benefits detailed here are associated only with abatement activity and all other costs are directed to the net rent-seeking function. The objective function can also be rewritten to balance social welfare (inclusive of rent-seeking costs) and the advantages to the politician of rent-seeking efforts. Under price regulation, for example, the objective function can be rewritten as \(\max _{p}{\mathbb {E}}\left[ \mu \left( B(q(p,\theta ))- C(q(p,\theta ),\theta ) -K^{*}_{T}(p,\theta )\right) +(1-\mu )K^{*}_{T}(p,\theta )\right] \).

As already discussed, \(\delta \) can represent the revenue-recycling effect. To take into account a tax interaction effect this analysis can follow Quirion (2004) and allow a parameter to alter the slope of the marginal cost function. In the current context this would simply result in a redefinition of the cost function, without any significant difference to the results. The approach followed here is similar to the ‘weak double dividend’ (e.g., Goulder 1995; Parry 1995; Goulder et al. 1999).

If the politician receives negative payoffs from rent-seeking efforts similar (but opposite) results are found. To ensure the existence of a Nash equilibrium, the marginal benefits of pollution reduction are required to be sufficiently large.

For an analysis of corner solutions see Goodkind and Coggins (2015).

Note that relative difference is half of the Weitzman (1974) result due to \(\mu =1/2\).

As can be observed, the equilibrium policy level is independent of \(\delta \) as the politician’s objective is to maximize the gains associated with rent creation and extraction for a given \(\delta \). A variation in \(\delta \) will simply alter the level of rent seeking but not affect the optimal policy level that maximizes the gains associated with rent-seeking efforts. As we will show in the next subsection, \(\delta \) does become influential in determining the policy level when a politician aims to maximize both social welfare and the gains associated with rent creation and extraction. A choice of policy level will simultaneously alter rent-seeking efforts and social welfare: \(\delta \) has a scaling effect on the relative impact of rent-seeking effort and, therefore, the politician’s choice of policy level is now dependent on \(\delta \).

In particular, \(\Lambda \) can be arranged so that:.