Discretionary Exemptions from Environmental Regulation: Flexibility for Good or for Ill

We develop a model of firm and regulator behavior to examine theoretically the use and consequences of discretionary exemptions (also known as variances, waivers, or exceptions) in environmental regulation. Many environmental protection laws, such as the Clean Water Act, impose limits on harmful activities yet include “safety valve” provisions giving the regulator discretion to grant full or partial exemptions that provide permanent or temporary relief from these limits. This discretion begets flexibility over the stringency of environmental protection laws. Our model places a profit-maximizing discharger of pollution under the purview of a fully informed regulator who may seek to maximize social welfare by imposing limits. We show that when a regulation does not otherwise allow flexibility, an exemption that relaxes the limit for firms with high abatement costs can improve social welfare by reducing the costs of achieving the given level of environmental quality. We further demonstrate that if the effectiveness of abatement technology improves over time, a temporary exemption can increase social welfare by adjusting allowable pollution in response to these dynamic conditions. We also show that if the labor market is sticky, exemptions can benefit workers. Driven by an unequally weighted social welfare function, the regulator may use exemptions to meet redistributive ends. However, these beneficial impacts of exemptions rely on a fully informed and benevolent regulator; otherwise, the discretionary nature of exemptions leaves them open to abuse. A regulator who is captured by industry, focused only on her own jurisdiction or answerable only to a set of elites, can abuse exemptions in ways that reduce social welfare, such as allowing inefficiently high pollution or inducing a cost-ineffective pattern of abatement.