“The Suitability of Government for Economic Valuation of Natural Resources and Environmental Harm”

Appearing in JNREL Vol. 20, No. 1, the following Note was written by former staff member LeeAnne Edmonds Applegate. Staff member Katie Huddleston wrote the following abstract.

Law and economics arose in the 1970's as a legal theory that promoted the application of economic principles to the law. Despite many evolutions over the past three decades, the theory has remained and has been applied to many legal fields, including environmental law. Its application in this field provides an interesting example of the theory at work and of the various criticisms made of the theory.

From the standpoint of law and economics, commercial transactions that produce environmental effects result in market failure. In such transactions, the environmental effects of consumer activities are not included in the price of such activities. Rather, these additional costs are borne by the larger society, people outside of the actual commercial transaction. In economic terms, this is a market failure. Therefore, government regulation has evolved in an effort to rectify this market failure by making the cost of such transactions to the consumer more closely approximate the larger cost of the activity to society.

The modern trend is to rectify market failure through the use of a "sin tax." A "sin tax" uses tax incentives to promote environmentally beneficial behavior, while imposing taxes for environmentally damaging behavior. The major problem with this approach is that to determine the appropriate amount for the "sin tax," the government must calculate the value of the environment and the societal cost of damage to it.

There are two main theories as to how to make these seemingly impossible valuations. Preservationists seek to set the tax according to an evaluation of the intrinsic value of the environment in its natural state. Conservationists, on the other hand, think the tax should be set according to the value of the environment as a resource. For example, when a tree is cut down, preservationists would value that tree in accordance with its function of air purification, soil retention, animal habitat, etc. Conservationists would set the value of the tree based on the value of the lumber that could be derived from it.

Aside from these two theories on valuation, there are two methods of economic valuation that can be used in setting the taxes. First is the Market Price Method. This method is useful when a market actually exists for the parts of the environment sought to be valued, such as products or resources derived there from. The current market price for the "commodity" is measured and studied for changes over time. This method is useful because it uses actual, easily identifiable and understandable data. However, it has limited applicability because of the limited markets for the environment and environmental goods. The market price may also bad indicator of the true, underlying value to society of such goods and activities, merely perpetuating the problem of market failure.

The other option is the Contingent Value Method. This method involves surveys in which people are interviewed about various hypothetical situations and asked to put a dollar value on an environmental service or commodity. This method has the benefit of being more flexible than the Mark Price Method. However, critics cite the time and effort that must be put into designing such surveys, the lack of actual observation of consumer behavior and the possibly inaccurate results that could result from it.