Uncertainty and the choice of policy instruments - A note on Baumol and Oates propositions

Baumol and Gates' propositions, the irrelevancy of benefit uncertainty and the importance of cost uncertainty on the choice between a tax and a system of marketable permits, are limited to a large-number case in which the opp ortunities for victims of pollution to participate in a permit market are n on-existent. However, with the evolution of environmental groups and coalit ions of victims in neighborhoods, the large-number case can easily transfor m into a small-number case. This paper shows that when the pollution standa rd, set at what appears to be optimal ex ante, is excessively lenient, the system of marketable permits offers such groups a flexibility to buy pollut ion permits in a competitive market and destroy them until the optimal solu tion is realized. In the reverse situation, however, Baumol and Gates propo sitions are unambiguously valid.