The Everyday Economist

Russ Roberts weighs in with more on the Pigouvian myth:

But the Pigovians among us will surely argue that this new discovery that the risks of soot are higher than before increases the justification for raising the gasoline tax as a way to reduce cardiovascular death among women.

But thinking about externalities in a Coasian way suggests an alternative approach.

Most economists think that the essence of Coase’s insight about externalities is that in a world of zero transaction costs, externalities take care of themselves. The implication here would be that if transaction costs were zero, and if the harm to women from a higher risk of death was larger than some of the benefits from driving, women could get together and pay drivers to drive less. The payments would cause drivers to internalize the externality—they would now bear a cost from driving in the form of foregone payments so they would now drive the “right” amount, the same amount that they would drive under the correctly set Pigovian tax.

But of course this scenario is absurd. Transaction costs are not zero. This whole payment scheme is immensely impractical. So this whole Coasian argument seems to go out the window.

But the payment scheme is a parody of Coase. Coase did point out that when transaction costs are zero, externalities will take care of themselves. But he recognized that transaction costs are never zero and are often prohibitively high. Coase’s real insight was that because transactions costs are not zero, you should be careful as to how you assign property rights and liability. When you assign those property rights and liability for harm, take into account the costs of compliance.

What I learn from Coase in this example is quite surprising. Assume the facts about soot in the story are true. Do women want a tax on drivers or a change in the standard to force cities to clean up their air?

The answer seems obvious. Of course they do. But the answer is not obvious. If the costs of compliance with those stricter mandates of the EPA are high enough, women would prefer that nothing happens. (And the costs here include the foregone net benefits from the lower amount of driving and other economic activity reduced by the tax or the standard.) Why? Why would women want to endure greater risk? The answer is that the costs of compliance with say, stricter standards may be very high and a serious chunk of those costs will fall on women. Maybe there is a cheaper way for women to avoid the harm from cardiovascular risk, by the creation of a medication that reduces the risk of a heart attack or the risk of dying from a heart attack. Or maybe not. Maybe it’s really hard to come up with such medications or medical treatments. Maybe there’s no way to avoid the damage from the extra risk in which case a stricter standard or an increase in the gas tax might be a good idea.

But the point is that there is no way to argue on purely economic grounds that the increased risk from air pollution justifies a higher tax on gasoline or stricter standards even in a world where politics plays no role in setting those standards or the level of the tax. (And I would argue that assuming that politics will NOT play a role is akin to assuming a world without transaction costs.) [Emphasis added.]