Understanding the effectiveness of environmental offset policies

In the real world, taxes and cap-and-trade systems are rarely implemented in their pure form. In this paper, we examine a related approach that has been used widely in practice—which we refer to as an “offset.” The idea behind offsets is to encourage firms or entities that may not be a part of the main regulatory system to produce environmental improvements. These improvements can then be used to offset pollution reduction requirements for regulated entities. This paper analyzes how offsets are used in practice, and identifies key economic and political factors that help explain the use of offsets in certain situations. We find that offsets may often fail to take adequate account of environmental or ecosystem damages. We argue that the effectiveness of an offset policy depends on the political and institutional context in which it is developed.