This Article represents an attempt to fill a gap in the existing environmental law and policy literature by exploring the interplay between the extent to which, and the conditions under which, polluting firms are allowed to bank excess pollution credits and the strength of the incentives for polluting firms to invest in the development of new pollution reduction and control technologies. The central argument in the Article is this: permitting the banking of pollution credits has both a pro-innovation and anti-innovation incentive effect, and the anti-innovation effect for each firm is a function both of how many credits that firm has in the bank and of how many credits it knows that its competitors have in their banks. Although my analysis does not point to any particular rule regarding banking, it does provide some support for limits on the banking of credits. The intuition behind the analysis is simple: once firms have banked pollution credits, they are in the position of both a prospective buyer and a prospective seller of pollution credits. As prospective buyers of credits, firms have an incentive to further the development of pollution reduction and control technology that will (in addition to other things) reduce the prevailing market price for credits. As prospective sellers of pollution credits, by contrast, firms have an incentive to deter, or at least not further, the development of pollution reduction and control technology that will reduce the prevailing price for credits.

Date of this Version

February 2005