Saturday, January 14, 2012

An Obsession with Pigouvian Taxation ?

Mankiw is perhaps the most well-known supporter of Pigouvian taxation on retail gasoline (also known as a carbon tax).  As a review, recall that Pigouvian taxes are taxes enacted to solve for potential negative externalities in a market.  Gasoline consumption leads to more carbon emissions which leads to pollution, which is the negative externality.  This is a simple problem to solve if we just get a handful of smart economists to measure the societal cost/value of the externalities associated with gasoline, slap a tax on the 'bad' stuff to cover that cost, and voila: not only would the government increase it's tax revenue, but more importantly it would incentivize individuals to use less gasoline, thereby polluting less.  

Pigouvian taxes have been proposed for all sorts of things, and some have been enacted in states while others remain largely a theoretical possibility only: tax car crashes, tax irresponsible borrowing, tax fatty foods, tax alcohol and (Mankiw's most recent object of support), a tax on cigarettes. There is evidence that these taxes do indeed create some incentives to 'improve' behavior.  Nevertheless, many mainstream economists are so focused on Pigouvian taxation that it seems they have simply altered their message that "markets are generally good at what they do," to tack on: "... and where they aren't, we can easily make them work properly by either taxation or subsidies."

The focus on Pigouvian taxation, as particularly espoused by New Keynesian economists, may in fact divert attention away from market problems other than simple cases of measurable externalities.  After all, not everything can be solved with taxation policies.  Issues of broken institutions - particularly in the realm of education for example (see our previous post here) cannot be solved by simply slapping a tax on the behavior (in this case, institutions which do not grant the kind of "equality of opportunity" which they are supposed to in a democratic society).  Issues of institutional fairness, corporate cronyism, socio-economic mobility and opportunity, and other more structural issues, are not likely to be easily solved by imposing a tax to try to punish the behavior.  Finally, issues of unbalanced and asymmetric information in many markets (including credit markets) are not going to be easily solved with simple taxation.  

In cases where Pigouvian taxation may be appropriate, there are further concerns with implementation.  For example, there may be additional bureaucracy that comes with the new source of tax revenue.  As technologies change and societal costs change, so too would the taxation policies need to be updated.  Would we trust congress to be dynamic enough to change these rates accordingly.  And if not, what sorts of negative effects on private activity might that cause?  And even if our government were to support pigouvian taxation long-term, does this mean we could or should do away with certain regulations to maintain 'optimal' performance?

Additionally, it is not an easy thing to measure the societal costs of specific behavior that may contribute to pollution, or poor health, and so on. Assumptions are often made in coming up with a calculation of 'optimal' Pigouvian taxation - assumptions that may be wrong, or right only in present circumstances.  You simply can't take a message like this to a politician and expect them to enact legislation based on it:
Despite all the uncertainties in the quantification of externalities [from waste disposal], this study has pointed out that preliminary estimates of external costs and benefits can be established. Such estimates cannot be presented as exact values, but they can be used as decision support and as an instrument to explain the trade-offs that are implicitly made in political decisions. 
Coase (of Coase's theorem) pointed out that many externalities are reciprocal in nature:  i.e. a polluter causes harm to those in a given area through it's actions, but those in a given area cause harm by forcing (or making it costly for) the polluter to change their actions as opposed to, for example, leaving the area.  Some economists might argue that he was simplifying the issue, but even so the solution of what is 'optimal' then becomes even more complicated:
Nevertheless, there are grey areas and situations change.  Thus, it may be desirable to have a system of bilateral taxation
Finally, at the end of the day, there is a political component to deciding the merits of pigouvian taxation.  Economists often discount politics as something outside their purview (despite their own internal biases) but all the studies in the world cannot convince politicians who may have an ideological disagreement with the government picking and choosing what behaviors are 'good' and what behaviors are 'bad'.  

So, when taking consideration of measurement problems associated with externalities (and changes in a measured externality over time), political barriers, and ideological barriers to pigouvian policies, it becomes less clear how useful such policies can be the real world.  Pigouvian taxation, at the end of the day, certainly has its place.  But one hopes that that place is not a grand pedestal that outshines all other solutions to the problems of the day.