Regulating Pollution under Asymmetric Information: The Case of Industrial Wastewater Treatment

We present in this paper an empirical evaluation of a contract-based environmental regulation under asymmetric information. An imperfect pollution tax results in the necessity of regulating industrials by a contract-based policy, in order to promote a higher level of pollution removal. The local regulatory agency has imperfect information on costs of abatement and must design a feasible mechanism providing incentives for industrials to extend their wastewater treatment plant capacity. The optimal policy consists in regulating only the most efficient industrials in the abatement activity. Empirical evidence reveals that the pollution tax should be more than twice its present level to attain the fully internalizing Pigouvian tax level.