Nonpoint pollution control: Inducing first-best outcomes through the use of threats

This paper develops an economic model to analyze the use of a policy that combines a voluntary approach to controlling nonpoint-source pollution with a background threat of an ambient tax if the voluntary approach is unsuccessful in meeting a pre-specified environmental goal. We show that such a policy can be designed to induce cost-minimizing abatement without actually imposing the tax because the threat of imposition of the tax is sufficient to induce voluntary compliance. Thus, the combined policy approach can not only be more effective in protecting environmental quality than a pure voluntary approach but can also be less costly than a pure ambient tax approach. However, whether the cost-minimizing choices are a unique equilibrium or not depends on the design of the tax policy and whether or not it can be applied retroactively. All results still hold if the background threat takes the form of a reducing in government subsidies.