Regulation-Induced Pollution Substitution

Regulations may cause firms to re-optimize over pollution inputs, leading to unintended consequences. By regulating air emissions in particular counties, the Clean Air Act (CAA) gives firms incentives to substitute: 1) toward polluting other media, like landfills and waterways; and 2) toward pollution from plants in other counties. Using EPA Toxic Release Inventory data, I examine the effect of CAA regulation on these types of substitution. Regulated plants increase water emissions by 105 percent (72 log points). Regulation of an average plant increases air emissions at unregulated plants within the same firm by 13 percent. This leakage offsets 57 percent of emissions reductions by regulated firms.