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Monday, February 11, 2008

Pigouvian Taxes and Equity

In the debate over global warming and what to do about it, we often hear arguments such as:

In particular, we could go to Greg Mankiw, founder of the Pigou Club. He would no doubt argue that the proper way to handle the negative externalities ... would be to tax them. Then, there's no need to stamp out industry... Rather, we simply give the market an incentive to reduce the bad effects.. The idea is that larger social goals are perfectly compatible with the preservation of individual choice...

But yet, despite the economic superiority of taxes over mandates in terms of the efficiency properties, there is substantial public support for mandates such as CAFE standards over taxes, and mandates continue to garner enough votes in the legislature to pass and be signed into law.

Why might that be? In thinking about efficiency as the primary reason for promoting one policy over the other, I think we might be missing something important: equity. More choice is best most of the time, but when it's a matter of being constrained, of not being able to do something you want or need to do, people want that constraint on behavior to be shared equally - especially when it involves something as essential to daily life as energy. If we impose an energy tax (carbon tax), the wealthy will pay more for their fuel, but the jets will still fly. We know that if the price of gas goes up a dollar or two due to a carbon tax, many people at the upper end of the income distribution will hardly notice, they won't be constrained in the same way the average or poor household will be. They can still drive their cars, heat their pools and houses, and so on. Their savings might not accumulate quite as fast, but to what extent are they really paying the same cost as a poor person?

Progressive carbon taxes anyone?

That might work, but even with a progressive carbon tax many people toward the upper end of the income distribution would not be very constrained in what they can do. With CAFE standards at least there's a chance that the cost of the policy action will be shared more equally. I realize that people have found a way to evade the CAFE standards (e.g. classify an SUV as a truck and make trucks subject to different standards), and evasion is always a problem, but that's largely a matter of will and closing loopholes. With mandates, at least the perception that we are trying to distribute the costs more equally is there.

I don't think policies that allow certain segment of the population to "buy out" of the constraint will find much popular support. If the poor are passed by roaring, gas guzzling, sports cars on the freeway as they drive their gas saving, small hybrid, they won't feel that is fair, not unless our transportation infrastructure changes dramatically. We can promise that with a carbon tax the proceeds will be redistributed to the poor so they are left harmless, but credibility over the long-run is a problem (what if the next administration cuts the government transfers to the poor?), people won't necessarily believe it will be fair to them individually, and there remains the problem of certain groups buying their way around the constraint and the public perception that comes along with that.

Maybe I'm wrong about this, but I do think we should spend more time thinking about the equity of these proposals and how fairly the (utility) cost is distributed across the population. A mandate, done properly, may have poor economic properties, but I think people support them because at least there's a chance that a mandate will force the luxury cars to abide by the same mpg restrictions as the lower price cars driven by the typical household. If we are going to go the carbon tax route, touting the efficiency properties won't be enough, I think we will need to find a way to convince people that everyone will share the costs (approximately) equally before it will find popular support.

    Posted by on Monday, February 11, 2008 at 03:16 PM in Economics, Environment, Taxes | Permalink  TrackBack (1)  Comments (69)


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    » Carbon Taxes from Political Animal

    CARBON TAXES....Carbon taxes are clearly a more efficient way of reducing greenhouse gases than a growing hodgepodge of regulations, so it would make sense to quit adding regulations to the pile and instead enact a carbon tax, right? But we... [Read More]

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