Non-separable pollution control: Implications for a CO2 emissions cap and trade system

The federal government now confronts considerable political pressure to add CO2 to the existing set of criteria air pollutants. As with current criteria pollutants, proposals call for control of CO2, assuming that the control of each of the three criteria pollutants is separable from the others. However, control of CO2, SO2, and NOX emissions is most appropriately viewed as joint rather than separable based on engineering relationships. Empirically, we also find considerable jointness. Using a 10-year panel for 77 U.S. electric utilities, which comprise the largest sector in terms of energy-related CO2 emissions, we estimate a multiple-input, multiple-output directional distance function combining good inputs (production capital, pollution control capital, labor, and energy) and a bad input (sulfur burned) to produce good outputs (residential and industrial/commercial electricity production) and bad outputs (SO2, NOX, and CO2). We find that while utilities do not directly control CO2 emissions, considerable jointness exists across SO2, NOX, and CO2 emissions. Failure to account for this jointness increases the cost of pollution control, making it less acceptable to the public and policymakers. We also compute the technical efficiency of our set of utilities and find that considerable cost savings can be achieved by adopting the best technology for production of electricity and reduction of pollutants.