Community-Based Tradable Permits for Localized Pollution

This paper considers the assignment of tradable permits—representing property rights of an environmental good—to community members who are harmed by pollution generated by firms. These community members can in turn sell permits to polluters according to their personal preferences. For a special case with a sole household, market transactions between the household and polluters achieve an efficient pollution level. However, for a group of households, the decentralized market solution fails to yield social efficiency because of competitive consumption of the environmental goods. We design a revenue-sharing mechanism akin to unitization, under which market transactions also achieve efficient resource allocation. Importantly, in some cases, efficiency can be achieved even when regulators are ignorant of the private valuation of the environmental good.