Naked Economics by Wheelan, Charles (best books to read .TXT) 📗

cost of driving an SUV (or any vehicle) to reflect its true social cost and then let individual drivers decide if it still makes sense to commute forty-five miles to work in a Chevy Tahoe.

Taxing a behavior that generates a negative externality creates a lot of good incentives. First, it limits the behavior. If the cost of driving a Ford Explorer goes to 75 cents a mile, then there will be fewer Explorers on the road. As important, those people who are still driving them—and paying the full social freight—will be those who value driving an SUV the most, perhaps because they actually haul things or drive off-road. Second, a gas-guzzler tax raises revenue, which a ban on certain kinds of vehicles does not. That revenue might be used to pay for some of the costs of global warming (such as research into alternative energy sources, or at least building a dike around some of those Pacific island nations). Or it might be used to reduce some other tax, such as the income or payroll tax, that discourages behavior we would rather encourage.

Third, a tax that falls most heavily on hulking, fuel-hungry vehicles will encourage Detroit to build more fuel-efficient cars, albeit with a carrot rather than a stick. If Washington arbitrarily bans vehicles that get less than eighteen miles per gallon without raising the cost of driving those vehicles, then Detroit will produce a lot of vehicles that get—no big surprise here—about eighteen miles a gallon. Not twenty, not twenty-eight, not sixty using new solar technology. On the other hand, if consumers are going to be stuck with a tax based on fuel consumption and/or the mass of the vehicle, then they will have very different preferences when they step into the showroom. The automakers will respond quickly, and other products like the Hummer will be sent where they belong, to some kind of museum for mutant industrial products.

Is taxing externalities a perfect solution? No, far from it. The auto example alone has a number of problems, the most obvious of which is getting the size of the tax right. Scientists are not yet in complete agreement on how quickly global warming is happening, let alone what the costs might be, or, many steps beyond that, what the real cost of driving a Hummer for a mile might be. Is the right tax $0.75, $2.21, $3.07? You will never get a group of scientists to agree on that, let alone the Congress of the United States. There is an equity problem, too. I have stipulated correctly that if we raise the cost of driving gas guzzlers, then those who value them most will continue to drive them. But our measure of how much we value something is how much we are willing to pay for it—and the rich can always pay more for something than everyone else. If the cost of driving an Explorer goes to $9 a gallon, then the people driving them might be hauling wine and cheese to beach parties on Nantucket while a contractor in Chicago who needs a pickup truck to haul lumber and bricks can no longer afford it. Who really “values” their vehicle more? (Clever politicians might get around the equity issue by using a tax on gas guzzlers to offset a tax that falls most heavily on the middle class, such as the payroll tax, in which case our Chicago contractor would pay more for his truck but less to the IRS.) And last, the process of finding and taxing externalities can get out of control. Every activity generates an externality at some level. Any thoughtful policy analyst knows that some individuals who wear spandex in public should be taxed, if not jailed. I live in Chicago, where hordes of pasty people, having spent the winter indoors on the couch, flock outside in skimpy clothing on the first day in which the temperature rises above fifty degrees. This can be a scary experience for those forced to witness it and is certainly something that young children should never have to experience. Still, a tax on spandex is probably not practical.

I’ve wandered from my original, more important point. Anyone who tells you that markets left to their own devices will always lead to socially beneficial outcomes is talking utter nonsense. Markets alone fail to make us better off when there is a large gap between the private cost of some activity and the social cost. Reasonable people can and should debate what the appropriate remedy might be. Often it will involve government.

Of course, sometimes it may not. The parties involved in an externality have an incentive to come to a private agreement on their own. This was the insight of Ronald Coase, a University of Chicago economist who won the Nobel Prize in 1991. If the circumstances are right, one party to an externality can pay the other party to change their behavior. When my neighbor Stuart started playing his bongos, I could have paid him to stop, or to take up a less annoying instrument. If my disutility from his noise is greater than his utility from playing, I could theoretically write him a check to put the bongos away and leave us both better off. Some contrived numbers will actually help to make the point. If Stuart gets $50 of utility from banging away, and I feel the noise does $100 an hour of damage to my psyche, then we’re both better off if I write him a check for $75 to take up knitting. He gets cash that does him more good than the bongos; I pay for silence, which is worth more to me than the $75 it costs.

But wait a minute: If Stuart is the guy making the noise, why should I have to pay him to stop? Maybe I don’t. One of Coase’s key insights is that private parties can only resolve an externality on their own if the relevant property rights are clearly defined—meaning that