Recommended reading:
Lawrence H. Goulder and Ian W. H. Parry, Instrument Choice in Environmental Policy, Review of Environmental Economics and Policy
http://reep.oxfordjournals.org/cgi/content/abstract/ren005v1
Abstract: The choice of pollution control instrument is a crucial environmental policy decision. We examine the extent to which various environmental policy instruments meet major evaluation criteria, including cost-effectiveness, distributional equity, the ability to address uncertainties, and political feasibility. Instruments considered include emissions taxes, tradable emissions allowances, subsidies for emissions reductions, performance standards, mandates for the adoption of specific technologies, and subsidies for research toward new, "clean" technologies. We consider policies that address pollution externalities and policies that deal with market failures associated with efforts to invent or deploy new technologies. Several themes emerge. First, no single instrument is clearly superior along all the dimensions relevant to policy choice; even the ranking along a single dimension often depends on the circumstances involved. Second, significant trade-offs arise in the choice of instrument: for example, assuring a reasonable degree of distributional equity will often require a sacrifice of cost-effectiveness. Third, it is sometimes desirable to design hybrid instruments that combine features of various "pure" instruments. Fourth, for many pollution problems, more than one market failure may be involved, which may justify (on efficiency grounds, at least) employing more than one instrument. Finally, potential interactions among environmental policy instruments and among regulatory jurisdictions need to be carefully considered.
