Regulation via the Polluter‐pays Principle

We consider the problem of regulating an economy with environmental pollution. We examine the distributional impact of the polluter‐pays (PP) principle which requires that any agent compensates all other agents for the damages caused by his or her (pollution) emissions. With constant marginal damages we show that regulation via the PP principle leads to the unique welfare distribution that induces non‐negative individual welfare change and renders each agent responsible for his or her pollution impact. We extend both the PP principle and this result to increasing marginal damages due to pollution. We also compare the PP principle with the Vickrey–Clark–Groves scheme.