Are Additionality-Based Payments for Environmental Services Efficient?

This article studies the efficiency of payments for environmental services (PES) based on additionality. We consider a farmer who allocates his land between crops and grass strips with different environmental impacts. Using a two-period model, we introduce environmental taxes on damage-generating crop production and a PES remunerating additional grass strips. We show that the additionality-based PES distorts the behavior in the initial period to obtain more payment in the final period. The second-best PES to limit this behavior is equal to the discounted difference of the net marginal environmental benefits in each period. When environmental policies interact, environmental taxes are no longer equal to the marginal damage, and they consider the distortions caused by the additionality-based PES. We show that imperfect competition on the biodiversity-friendly crop market reduces these distortions. Finally, an additionality-based PES never achieves environmental efficiency. This paper provides new insights into understanding the interactions between different environmental policies.