Socially Unacceptable Externalities

David Beckworth:

Which Externalities Should Be Internalized?, by David Beckworth: Robert Frank's NY Times column on using Pigovian taxes as an "efficient" way to deal with the negative externalities of gas consumption ... points to an important question that has been bugging me for some time. But first ... Gabriel Mihalache ... points out an important assumption in Frank's analysis:

...A Pareto improvement [from imposing a Pigovian tax on gas consumption] means that afterwards, everyone is at least as well off (subjectively) as before and some are better off. ...

The implicit, unstated, assumption of Frank’s article is that we could compensate the losers from the new energy policy from the gains of others.., there exist potential transfers to compensate the losers and still leave the winners better off.

When supporters of free trade point out that the net losers from the full opening of borders could be compensated with transfers from the net winners, the common criticism is that those transfers are both politically and institutionally unfeasible. There’s no mechanism we can trust that would identify the correct transfers (from whom, to whom, how much?) and make it in a way that’s politically acceptable.

I will unashamedly yield the same critique against Frank. He wants to seduce us with Pareto improvements but he only tells us half the story, less that half really… he mentions introducing the carbon tax but he remains strangely silent on the ways he’d use to compensate the losers.

Gabriel suggests we avoid resorting to the Pareto efficiency argument and say up front there may be net losers. Josh Hendrickson, meanwhile, also questions the usefulness of invoking Pareto efficiency and goes on to stress that the proper use of a Pigouvian tax requires a Herculean ability to properly assess social costs:

The problem inherent in any such analysis is the view of societal benefit and societal loss that is assumed to be easily calculated and dealt with through Pigouvian taxation. The ability to identify the social cost of a particular action is extremely difficult as each individual has his or her own subjective valuation. The problem is communicating each of these preferences in aggregate form to some central authority. This is a distinct problem in terms of both Hayekian knowledge and a neoclassical framework (Arrow’s Impossibility Theorem). In the absence of this ability, setting the tax rate is extremely difficult.

In short, both of these commentators suggest we should be more humble about our ability to (1) rigorously justify and (2) precisely implement a carbon tax. As noted above, Frank's column also points to another important question that I have been wrestling with for some time: exactly which externalities should be internalized? There are so many negative externalities in society so why stop at those created by gas consumption? Frank alludes to this in his article:

Gasoline is one of a host of goods whose production or consumption generates costs that fall on outsiders. Noisy goods, like leaf blowers, for example, can jolt whole neighborhoods from calm. And goods that don’t biodegrade readily, like many plastic bags, can generate costly waste streams. The list goes on.

Okay, then, why not tax noisy leaf blowers (noise pollution) or billboards along the highway (sight pollution) or rancorous, smelly, ugly people (noise, sight, and smell pollution)? Conversely, should we subsidize quiet neighbors, firms that do not advertise on highway billboards, and beautiful, well-kept people?

Now I am not advocating we tax or subsidize the above items. However, this list does illustrate the fact that society does choose to correct only certain externalities. So what is the decision criteria used in this process? Presumably it involves equating some margins; I am just not sure which one they are though. Any thoughts?

In closing, let me refer you to Peter Klein who, in the context of applying a Pigouvian tax to negative externalities, makes the following statement:

But my main beef with today’s Pigouvians is that they cherry-pick a case here and there — taxes on gasoline, primarily — without fully pursuing the implications of the analysis. If increasing gasoline taxes is efficient, why stop there? What other market failures should the state be empowered to remedy? Here’s my question, specifically:

Please name the activities you believe deserve Pigouvian subsidies. For each activity provide the efficient subsidy amount, explain how this was calculated, and say how the revenues should be raised.

Maybe someone has thought about this more than I have, and your comments are welcome and encouraged, but a couple of quick reactions. It seems to me that one way societies solve this problem is to define which externalities are actionable and which are not through the political process, and then prohibit them by decree rather than through incentive mechanisms such as taxes. Whether you care about the noise from leaf blowers or not, loud music, etc., so long as it's before 10 p.m., you are stuck no matter how much it bugs you - nothing can be done. But after 10 p.m., there are exact restrictions in terms of decibels on how loud music, etc. can be. If someone violates that rule, police will enforce it if asked to do so. For barking dogs, the rule is equally explicit, if it barks continuously for more than a half hour (you are supposed to record it), it is actionable - you can call and have animal control do something about it. Many externalities are like this, the community decides what is and isn't acceptable, whether you like it or not. Some externalities can be stopped, others you are stuck with (though you can still negotiate on an individual level, but the response "there's no law against it" is always available to the person being asked to be more considerate). This isn't the most efficient solution, but it is practical (and given how hard it would be to do individual calculations, it may be the best solution available) - it defines community preferences through the political process and forces adherence to them. This notion works at the local level - e.g. neighborhoods that enforce how houses are painted for example - but I'm having a harder time fitting it into national issues such as global warming, and to issues where taxes are used to discourage behavior rather than issuing blanket prohibitions. But I guess it's the same. If all nations but one decide that polluting the atmosphere with greenhouse gases is just fine, little can be done, it does not violate community standards. If one country really cares about the issue but others don't, it can turn down its music voluntarily at 10 pm to be courteous, i.e. try to fight the problem on its own, but it's only when the majority of nations agree that it is a problem that effective enforcement can begin. Anyway, I've pushed this far enough - thoughts?

Comments

[Bruce Wilder]

Here's an example I ran across many years ago, which, I think, offers some insight into the political problem.

The problem was the noise from airplane flights in the neighborhoods surrounding an airport. It was suggested that it would be efficient to tax the flights, and, perhaps, have an escalating fee for flights at later hours of the night, in lieu of an absolute prohibition after a certain hour.

Sounds vaguely sensible, doesn't it?

The question then arouse, what do you do with the money from the noise tax?

You could give it to the property owners, to compensate them for the noise. Politically, that would create a political interest group to support the noise tax.

But, as far as Pigou was concerned, transferring compensation to the property owners would be economically inefficient. Do you see why?

Making the airlines pay the cost of their noise was good. But, compensating the property owners would be bad.

Human intuition wants a complete transaction and compensation. Pigovian taxes are half a transaction, with no compensation.

[save_the_rustbelt]

Could it be that some economists think the ordinary folks are ignorant, and therefore Pigovian taxes are a means of moving the masses toward enlightenment, or at least the politically correct behavior? (see Mankiw, for example)

Trouble is, I'm not certain I want the members of that school of economics manipulating anything.

Methinks economists should study and advise, I get a little queasy when they want to manage my life.

[SGC]

Non-economists immediately come up with the obvious criticism to a high gas tax: In the US this is a regressive form of taxation.

The poor are less likely to be able to avoid gasguzzlers and in this country rarely have access to reasonable public transportation -- especially the rural poor. Theoretically there's a very strong argument for a gas tax, but how can it possibly be implemented in a fair way?

As far as wanting a list of all goods that should be subject to taxation due to externalities, I don't see a problem with the "we know it when we see it" approach.

[Jim Harrison]

In a world whose movers and shakers could care less about achieving Pareto optimality, professionals who only recommend policy measures that preserve Pareto optimality effectively side with the existing winners, who only listen to them when a proposal furthers their fortunes and ignore them when it doesn't. Thus the beneficiaries of a Pigovian tax are much more likely to be inconvenienced members of a privileged group than the endlessly screwed underlings.

[2slugbaits]

In the case of greenhouse gases those who will most benefit are not yet born, so just as a temporal issue it might be a bit tricky to redistribute from tomorrow's winners to today's losers. Of course, it's not clear why today's losers should be compensated at all. The idea behind an negative externality is that the market price doesn't fully capture all of the costs, so what is the complaint when people are told that they must begin paying the full cost?

In the case of taxing greenhouse gases doesn't it make more sense to use the tax revenue to pay for the development of new technologies that reduce the very need for the tax. The reason we tax externalities is not because the govt wants another revenue stream; it's because we want to reduce the activity that is generating the negative externality. I've always thought that when the govt taxes an externality and then uses the revenue to provide some unrelated good to a different constitutency, that's the road to doom. For example, taxing tobacco is fine and the intent should be to lower tobacco consumption. But what happens when school districts become dependent upon the tax revenues from tobacco sales? This creates conflicts of interest. Another example is when the state gets to depend upon revenues from casino operations. The rationale for taxing casinoes is that the revenue should be used to pay for gambling addiction programs. So we watch late night television and find the public service announcement for gamblers anonymous is immediately followed by the commercial telling us how exciting it would be to win the lotto and play slot machines at the casino.

[David Shor]

It's not really a matter of a community divide, so much as it is a matter of administrative costs and tractability.

For example, economic textbooks speak of wearing perfume as a positive externality. But can you imagine a perfume subsidy program? No, because the benifits caused by wearing perfume are non-linear, non-uniform, and subject to horrible threshold effects. For the perfume externiality, we must rely on Coase's theorem to save us(Consider the dating game as nothing but a vast perfume incentive program).

[don]

Transaction costs limit applications of the Pigovian tax solution to many cases. 2slugbaits' first paragraph is right on. No matter what happens to the tax revenue, people should pay the true economic cost of their consumption. As for what to do with the money, an obvious choice is to reduce the income tax. People get income by producing something of value to others. We discourage such activity when we tax it.

[kharris]

When something is so hard to do that it is unlikely to be done, we might want to stop pretending that it could be done. Discussion of Pigovian taxation is intellectually useful, but if we are fairly sure taxation won't be remotely Pigovian, we don't want to waste actually policy-making time on the effort. We can all carry in our heads what we know about the intellectual exercise, but we shouldn't actually carry on about it.

Of the taxes now in place, how many are explicitly Pigovian in their origin? Don't most relate to other principles of taxation, such as identifying revenue sources that can't slip away (W2 taxes, sales taxes, property taxes, license fees), imposing taxes that have a counter-cyclical element, and so on? If we intend to address an important negative externality (I'd argue there is more than one) associated with gasoline use, do we really want to muck it up with a debate that isn't going anywhere? Can't we address externalities without all this Pigovian posturing?

I think the poor should get a fair break, but I also think they should use less petroleum, just as we all should. Jawing about how to do it nice is not doing it. Rather than "compensating" the poor, let's just arrange society so the poor are less poor. Doesn't have to be through Pigou.

[GA]

Isn't the argument that these taxes are regressive ... um... stupid?

Give a tax break to the low end of the population, balancing the regressivity. Is this so hard? Isn't this what British Columbia's carbon tax does?

And isn't this precisely why McCain's gas tax holiday is so dumb? It gives the tax break to everyone who won't notice it, while providing no meaningful income relief to those at the bottom?

Sorry, perhaps those questions are, in retrospect, rhetorical?

[Eric Dewey]

The problem is that, even if you find the political will to establish such a tax, and solve the administrative challenge of who gets to play with the money raised, you're still thinking of them as "externalities".

Using the term "externality" is itself the problem, because it is not an accurate description. It projects an "us-them" "internal-external" linguistic attitude that is not appropriate to objective science.

The key is to quantify the distinctions between things that are mere nuisances (airplane noise?) from things that have more significant costs (toxic pollution), and to better illustrate the tradeoffs that the market is making.

Once the relative societal costs become known, society begins to take them into account in making political decisions.

As a much younger person, I despaired about whether people in the US would ever change their anti-environmental stance. However, over the course of my lifetime the costs of our wasteful behaviors have become clearer - and things are changing. I was wrong to despair (but would have been more wrong not to care).

Who in 1970 would ever have believed that a former VP of the US would win the Nobel prize for an environmental cause?

They'll never change fast enough for some, but it's astounding how the momentum has changed.

Economists need to accept that the tragedy of the commons is not theirs to address - except by making us aware of the costs and tradeoffs (in plain English, please).

As STR said, economists should study and advise, and should refrain from trying to quantify normative behavior patterns.

[Alan]

A technical question from a non-economist -- I thought that a policy that could theoretically compensate losers if other actions were taken is a Kaldor-Hicks and not a Pareto optimum. I have found that a useful distinction, since I am often skeptical of compensation promises. But is my terminology confused?

[SGC]

GA: "Isn't the argument that these taxes are regressive ... um... stupid?"

It's definitely stupid, if you are an economist who doesn't worry about "frictions" like the problem of implementing a policy in the US.

[daveNYC]

And isn't this precisely why McCain's gas tax holiday is so dumb?

I thought the stupid in the gas tax holiday came from the fact that gas is selling at $x.yz a gallon, and will continue to sell at $x.yz a gallon regardless of how much of that price is due to taxes.

Wouldn't a good target for the funds of an externality tax be either the source of the externality or the externality itself? So a gas tax could pay for public transportation, better mileage research, or some (transportation) pollution cleanup program. A airplane noise tax could go towards tax credits on noise insulation, research for quieter jet engines, or a fund to move the airport further away from population centers. It's not perfect, but this isn't exactly rocket science.

[robertdfeinman]

I think the problem with many of these economic issues is that they are too theoretical. Since I think of economics as a sort of axiomatic system, I also think it tends to get tied down in "how many angels on the head of a pin" type discussions.

Certainly some sort of increase in the cost of liquid fuels would have some sort of effect on overall consumption, this seems obvious and therefore it is an easy example to focus on. The real problem is that there are many activities which have negative externalities, but the US lacks sufficient democratic mechanisms to deal with them. At present the US is a semi-democracy. We get to vote, but we don't get to set policy or even to pick politicians who will set the policies we favor.

To cite just a few obvious examples: universal health care, winding down the wars and better schools. The will of the people is being thwarted by the permanent government-industry alliance.

Some examples where the negative externalities are ignored and have adverse effects right now, not just for future generations:

Pollution from Midwest power plants harming the wilds of NY and New England (acid rain and Mercury).

Mountain top removal in West Virginia causing flooding and pollution (not to mention the destruction of the landscape) to those living below.

Depletion of wild salmon, cod and other fish from both Atlantic and Pacific ranges.

Or for a non-ecological example: allowing direct to consumer advertising of prescription drugs. Only the US and NZ permit this. The consequence is over prescribing of drugs, higher prices, more money spent on marketing than on R&D and more people suffering side effects (including death) from taking drugs they don't need. The libertarian argument doesn't hold. People are not well enough informed to decide if these drugs are appropriate, the ads are misleading and so are many of the studies they are based on. That's why everywhere else the evaluation of treatments is left to professionals.

As I've said before you can use a tax to alter behavior or to raise revenue, you can't do both.

If it is desirable to force fuel use down then why not using rationing? Give every driver a smart card (or similar) with an allotment. Those who drive less can sell their excess and vice versa. The government lowers the total amount yearly to force additional efficiencies. To the complaint that poor people who have to drive far will be disadvantaged, I can only repeat the wise remark of our former president: "Live isn't fair".

[hari]

ED - you're more or less echoing my sentiments about these socalled *externalities* - I find these (many others too) very disturbing when used in a public or intergovernmental decision-making process. Why? Because the notion is not precise and, for serious economists, to use such terms is distrubing at best and raises q's about what they're really trying to prove....

Academic approach is fine as long as there is an objective to define and prove something resembling a theoretical model or whatnot.

This is principal reason why I've difficulty with theoretical economists - Greq included with his pigue about Pigovian tax!

[Andrew]

Alan,
You are correct. If something is pareto optimal, there are no losers. With Kaldor Hicks, there may be losers, but they could be compensated because of a net gain.

To a gasoline tax, an easy way to address much of the regressive nature would be a progressively graduated income tax return funded through the gas tax. Not a perfect fix, but it would go a long way. Fuel consumption would continue to decline because this would not diminish what people pay at the pump. As people use less gas, the fund diminishes and payments are reduced, reviewable annually.

[Andrew]

I agree with our host that the reason we choose to correct certain externalities and not others boils down to a simple matter of practicality. The author's attempt to equivalate a carbon tax to taxing ugly people is silly at best, dishonest at worst.
It also often boils down to money and entrenched interest, as well.

[Bruce Wilder]

I tend to agree with robertdfeinman that this discussion tends to become way too theoretical. Part of its appeal is its navel-gazing arrogance, which lets an economist feel smarter, without actually knowing all that much about how the world works, or hangs together. That "first, we assume a can-opener" approach is very popular.

My own take on the "hurts the poor more" complaint about the gas tax is that it expresses not a concern for the welfare of the poor but a partial, almost instinctual insight into how the price of gas fits into the overarching structural system of transportation, distribution and property values. The Pigou tax analysis is just an idle way to avoid the kind of meso-economic analysis that's really needed, to understand how the price of gas interacts with the paradigm we've used to elaborate the infrastructure of the American and world economy for more than 90 years.

The price of gas is tied directly to the marginal cost of a trip in the network system of transportation. The lovely market-oriented decentralization of economic activity has a specific structure built around the price of petroleum. Economic freedom has meant freedom to travel: to drive to a better job, a better house, a better school, a better price at CostCo. Economic growth and productivity growth, to a large extent, has been built around the reliable expectation of a declining marginal cost of trips (and, not incidentally, in the allied electrical and communication systems, a declining marginal cost of services from electrical appliances and communciations from communication and computing devices).

The complaint about the distributional effects of a carbon tax is, imho, a signal of a somewhat incohoate concern about the implications of trying to back out of an economic structure built around an expectation of declining marginal costs of energy. Forward motion, when the unit cost of petroleum was declining, was pretty easy: productivity rose, resource values rose, building out the system in growth was straightforward. A rising cost of energy actually implies un-building this system to some extent: abandoning previous investments, declining productivity, declining asset values, economic decline.

Suggesting a reduction in income taxes is just a declaration that a person does not want to think about these systematic implications. The real problem is not how much one pays in income taxes, or how much one pays relative to someone richer, the real problem is how does the average person make a life and realize a modicum of prosperity amid the inevitable decay of systems of transportation, distribution and production built around a low and declining marginal unit cost of energy, when the marginal unit cost of energy is high and rising.

The reactionary impulse is to continue to milk the existing system for all its worth: cutting the gas tax, if we are going to be letting the infrastructure depreciate anyway. (This is one reason why Robert Frank's failure to acknowledge the tie between the gas tax and infrastructure maintenance seems telling to me.)

The pie-in-the-sky approach is to believe in the technology fairy coming to the rescue with a magical solution that provides some "perfect" substitute for petroleum, which allows us to resume building out a system based on a declining unit cost of energy.

The prudent course of action is plan for a higher unit cost of energy, while also acknowledging the need to curtail use of petroleum.

The really hard thing, politically, will be the point at which we have some alternative energy sources that we can build out, with less environmental impact, and we don't need as much petroleum as we can produce and distribute, and the unit cost of petroleum plummets -- in part because the infrastructure of petroleum production, distribution and refining is underutilized and in the process of being abandoned.

None of this is meant to belittle cap-and-trade schemes, where the tax is the cap, which is sold by the government. Recognizing that we have yet to discover the future recommends the certain modesty of economic policies, which don't pretend to know more than we do about how to engineer the future. I am only criticizing the failure to acknowledge fully how we have engineered the past, and its immediate implications.

[Bruce Wilder]

inchoate

Why can I not spell?

[Ken Houghton]

I'll provide the outline of an answer to Dr, Klein, a UC-B alum and my Econ professor from MBA school.

"Please name the activities you believe deserve Pigouvian subsidies. For each activity provide the efficient subsidy amount, explain how this was calculated, and say how the revenues should be raised."

Clean air (limit asthma deaths and illness, make people more productive), clean water (avoid all those nasty diseases that plague third-world countries, and make women outcasts before they are 25), usable property (land not left with high amounts of contaminants after you close your factory and turn the place into a scene from The Lorax.)

The answer to how much we should subsidize them: we already do. We provide tax breaks to coal-burning plants to install filters, we provide tax breaks for "R&D" efforts, we provide Superfund monies and public subsidies to clean up the grounds and water polluted by GE or Exxon or the shoe factory that became a now-closed IBM plant up by Binghamton, or...

If you're telling us that we shouldn't be subsidizing them, then you have to explain why we do (with more than what you always said when I pointed out such examples in class: that it's "just corporate welfare").

Incentives matter. The current incentives are vastly more prone to subsidize than to extract the full value. Which is why Exxon still hasn't paid one cent toward its 1989 destruction in Alaska, and why asthma sufferers should know better than to move to Knoxville.

So let's use some of the Pigouvian tax to pay for the extant Pigouvian subsidies. At least it would come close to balancing the budget.

[2slugbaits]

Bruce Wilder,

I think you've quietly shifted the discussion. The original question was about how to handle negative externalities and ways to compensate losers. Your post addressed a perfectly valid but different concern, which is how to deal with the permanent issue of rising energy costs as a consequence of peak oil. But there is a connection worth pursuing. All production decisions involve substituting inputs, such as capital and labor. Most realworld models go beyond the simple 2-input example and include not only capital (K) and labor (L), but also energy (E) and materials (M). These are the so called KLEM models. What you're talking about is really finding ways to either substitute more K, L or M as the price of E increases, or (and less palatably) reduce output overall. Rallying people to live more Spartan lives has never been a winning political strategy, so I'll skip that option. One way to address both the negative externality issue associated with greenhouse gases from energy consumption is to use the revenue to develop technologies that would assist in substituting across inputs. Notice that this is not the same as calling for new technologies that give us new sources of energy; this is using tax revenues to substitute toward increased use of K, L and M. For example, a lot of tasks could easily be done at home or at centralized common work stations rather than requiring people to physically travel to their office. This is the kind of problem that can be solved by changing capital and labor costs. The "virtual office" is something that can be overcome with capital investment and adjustments to labor inputs. Or businesses can use capital investment to improve inventory models (I don't recommend using the crap that comes with most overpriced enterprise software...I won't mention any names, but the initials SAP come to mind). A lot of inventory reduction has come about by increasing transportation inputs (next day delivery) rather than better forecasting. And as Prof. Thoma's video lectures demonstrate, there is really no compelling reason why students should commute to classes each day.

[Eric Dewey]

BW - thanks for "quietly shifting" the discussion as 2slugbaits put it (and the short intro to mesoeconomics). And in plain English, no less (no demerits from me for misspelling).

2slugbaits, by preferring to discuss only "politically winning" options, you seem to be missing part of the point - at some point, there are no more politically acceptable options, and a significant reduction in living standards takes place. Are we at that point yet? Depends on who you ask - but would you rather that society be run by well-prepared boy scouts or the type of guys who leveraged Bear Stearns and the rest of the US to the hilt?

Ken Houghton, you're absolutely right that incentives matter, but only if the incentives are clear and visible.

As a non-economist, it seems clear to me that the concept of Pigovian tax incentives (a really cool name, that is) has some short-term merit as a stopgap measure to attempt to prevent foreseeable, incipient collapses from occurring.

But my earlier point remains - the extent of what economics can offer is to quantify costs and advise on potential solutions. The best solution, imho, is to truly internalize significant social costs (using KH's algorithm?).

Will the political system resolve the issue?

Only when they have incentive to do so - which unfortunately may mean that disasters will occur before political action is taken.

But it may also mean that, if the right economists are ready with solidly constructed options when the political tides turn, disaster can be averted, or at least recovered from.

How did Keynes do it? By writing a letter to the NYT - the early 20th century equivalent of blogging?

So my question to the eminent commenters on this blog is, do M. Pigou's tax concepts really represent a step forward for economics?

[Bruce Wilder]

2slugbaits: "All production decisions involve substituting inputs, such as capital and labor."

I've objected to that way of thinking in comments before. If you leave aside the critical importance of the control scheme in the production process, you can have an exaggerated sense of the breadth of alternative, feasible input substitution.

Just-in-time production schemes, which you reference, are not so much about conserving inventories, per se, as in driving forward a control architecture toward less and less error and waste -- a technical efficiency improvement rather than an allocational efficiency improvement or input substitution.

Capital investment is typically sunk cost investment tied directly to the control scheme, and labor/capital ratios are dictated by the capital-intensity that follows from the capital investment in the control scheme. The simple example that Pareto noticed long ago: it is hard to imagine how one would design a farm tractor that made good use of more than one driver.

So, yes, it is possible to accelerate the rate of investment in improving the technical efficiency with which energy is consumed somewhat. And, the choice to wander all over the field is not available; one chooses an architecture, and follows a path forward, and the path is fairly narrow.

Yes, it is possible to choose a different system path -- say, building high-speed rail instead of airports/airplanes for inter-city travel; or internet conferencing in place of inter-city business travel; and, then, exploiting the higher potential of these alternative system paths (alternatives to cars and highways) to achieve greater fuel efficiency with some loss of output. Realizing the economies of these paths forward involves elaborating investment over many years.

I don't know if that sketch will make much sense. I see a potential error, here, which is not unlike the proneness of some economists to recommend, as an industrial development strategy, that a country "invest in its comparative advantage" with the idea that a China or India could feasibly invest in advanced labor-intensive manufacturing as a way of taking advantage of its large, underemployed populations. Like there's such a thing as "advanced labor-intensive manufacturing technology", when such a thing is a bit of a contradiction in terms -- technical efficiency in the control of production processes tending to dictate an evolution toward large sunk-cost investments in schemes that don't require much direct labor.

[gordon]

I will (im)modestly toot my own trumpet with a reference to http://economistsview.typepad.com/economistsview/2008/05/the-invisible-h.html#c116287410>my comment on the post "The Invisible Hand is Shaking" which I think was based on the same R.Frank piece which Beckworth is referring to (Beckworth's link is broken, so I can't be sure).

In that comment, I suggested that compensation should precede imposition of a Pigovian tax. Only in that way can consent to the tax really be said to reflect a social desire to control the externality. The alternative is rationing and price control, as Roberdfeinman has also noted.

But I really want to congratulate Prof. Thoma for breaking open the issue and frankly raising regulatory responses as options which are real and which may well be more practical and effective than all the agonising over carbon taxes and cap-and-trade systems which are currently plaguing the global warming debate (and other environmental debates too). There is a lot of technical work to do to estimate the value of the compensation which should be paid and how it should be paid, and maybe that is what economists should really be doing.

This is the most cheering blog post on this issue I have seen for many a long day.

[Gil]

Did D. Shor hit upon the point? People who inadvertedly cause positive externalities aren't rewarded so why should anyone who inadvertedly cause negative externalities be punished?

[gorobei]

The airplane noise thing is a great example. Clearly, we give the collected taxes to the citizenry as a whole (either flat or regressively as rebates, or as lowered tax rates overall, or increased servies, it doesn't matter that much.)

Eventually, we wind up at a stable point. If the number is high, well, big deal, a bunch of deaf people get cheaper housing on the LHR approach - more power to them.

[Winslow R.]

Economists should spend less time on poking their noses in tax farming (fiscal policy) as the political system has worked pretty well as it usually self corrects. Besides, fiscal policy is outside of the economist's stated realm of expertise.

Spend more time on fine tuning interest farming(monetary policy) as this is where a suboptimal system flourshes. Besides, monetary policy is directly related to economics.

A large portion of fiscal trash is currently being created by an overflow of monetary trash.

Mankiw should clean up his own playground rather than pushing economics into the political/fiscal realm.

[David Shor]

Gil, that was not quite the point I was trying to make.

In the case of perfume, society does internalize the benefits of wearing perfume(See the dating system). I'm pretty sure it's not optimal, but it does a fairly good job. It's a nice example of Coase's theorem at work. More importantly, it does a better job than any government program could hope to.

I feel this is most likely the case for most of the "trivial" externialities that the author brought up. Sometimes it will extend to the local level, but the general principle is the same.

Of course, for certain things(Pollution and traffic are the big examples that come to mind, but there are others), this is not possible due to basic game theory and transaction costs. For those, we should have some sort of pigovian inspired tax(I'm a fan of Cap'n'trade for pollution, and some sort of real-time congestion pricing for roads). As far as that goes, I have one major concern:

Don't let the perfect be the enemy of the good. We might not know the optimal tax policy to combat an evil, but it's fairly easy to determine what would be an improvement over the status quo.

[Mike Jones]

Some sort of legal resolution does seem appropriate. Though it seems likely that most of the solutions to externality problems have been conjured up. The magnitude of correcting every potential externality does seem gargantuan, as almost every choice results in some sort of social cost not realized.

Alas, if only free markets were perfect.

[bakho]

The electric utilities operate by incentives and regulations. There are minimum efficiency standards for every major electrical appliance sold in the US. This is done to decrease the average cost to everyone.

They also have incentives to people who insulate or buy more efficient appliances.

How are automobiles and fuel efficiency different than electric utilities and appliance efficiency????

[Bernard Yomtov]

But, as far as Pigou was concerned, transferring compensation to the property owners would be economically inefficient. Do you see why?

Bruce,

I don't see why.

I'm going to guess that it's inefficient for people to live near noisy airports, so if you don't compensate them they will be more inclined to move elsewhere, reducing the net damage from the noise. But doesn't that assume that the cost of moving elsewhere, including the ongoing cost of living in a less preferred location, is less than the cost of the noise. Why should that be?

Am I missing something? Isn't this a straight Coasian situation?