Alternatives to the Pigou Club

Today’s Wall Street Journal prints various letters in response to my oped on gas taxes. Rather than responding to to the specific points, or to all the comments posted on this blog, let me try to spell out more generally the alternatives from which we must choose.

Members of the Pigou Club favor higher Pigovian taxes in order to remedy externalities such as pollution and congestion while raising government revenue. If you aren’t a member of the Pigou Club, you most likely fit into one of these four categories.

1. You deny the existence of these externalities as a type of market failure. Perhaps you think you live in a Coasian fantasy world where people bargain without transaction costs to reach efficient allocations. (Note: I am not suggesting that Coase himself thought we lived in such a world—he considered it only a useful thought experiment.)

2. You recognize the externalities but you don’t think the government should try to respond to them. You are such a believer in small government that you are willing to live with inferior economic outcomes, such as pollution and congestion.

3. You recognize the externalities, think the government should try to correct them, but think the current low taxes we put on gasoline are sufficient. In this case, you have weighed and rejected the evidence, such as that of Parry and Small, that higher Pigovian would be optimal. (Parry and Small calculate an optimal tax of $1.01 for the United States in today's dollars. After my proposed phase-in of a $1 hike, the U.S. tax would be $1.40. Assuming 10 years of 3 percent inflation, the tax in real terms would approach almost exactly what Parry and Small recommend. By the way, the published version of Parry and Small was in the American Economic Review, September 2005.)

4. You recognize the externalities but think the government should try to correct the market failure through regulations (such as CAFE standards) or through market-based solutions that do not raise government revenue (such as cap-and-trade systems). Perhaps you are concerned that government would waste the extra revenue on useless government programs.

Let me respond to group 4, because my guess is that this is the largest group of antipigovians.

The reason I am less concerned that the extra revenue will be spent is that it already has been spent. The federal government has promised benefits to the elderly far in excess of what it can pay. At some point the nation will have to reckon with the looming fiscal gap. The most likely political compromise will involve higher tax revenue. We should, therefore, be ready to increase revenue in a way that does the least damage—or, better yet, the most good. If not Pigovian taxes, then other taxes will be increased.

An optimistic libertarian might hope that we can deal with the looming fiscal gap without raising the ratio of taxes to GDP above its current level. I wish I could believe that this were possible. In a previous oped, I advocated increasing, slowly but substantially, the age of eligibility for Social Security and Medicare. But even if we could scale back government spending in such a radical way, Pigovian taxes would not lose their appeal. Let’s use the extra revenue from Pigovian taxes to reduce distortionary taxes, such as income taxes. Politically unrealistic, you say? Surely, if a future government were so libertarian as to manage a radical reduction in entitlement promises to the elderly, it would have no trouble delivering equally radical cuts in income taxes. In fact, the tax cuts would be the easy part of the package.

Update: Some comments suggested new categories of nonpigovians, and some suggested the categories I described were strawmen. To be clear, my goal was to categorize, as logically as possible, the various points of view. Let me try to put the issue in terms of a flow chart.

Question: Do you believe consumption of gasoline is free of negative externalities leading to market inefficiency?

If YES, you are part of group 1.
If NO, continue.

Question: Do you believe that public policy should ignore these externalities?

If YES, you are part of group 2.
If NO, continue.

Question: Do you believe the current tax on gasoline sufficiently internalizes the negative externalities?

If YES, you are part of group 3.
If NO, continue.

Question: Do you believe the best remedy for the remaining externalities is a regulatory system rather than a higher tax?

If YES, you are part of group 4.
If NO, you are a member of the Pigou Club.

Pigovian Questions

Ted Gayer, a member of the Pigou Club, emails me some good questions to put on the agenda for our next meeting (if we ever hold one):

Does the Club support Pigouvian taxes irrespective of the use of the tax revenues. Ideally, the revenues would be used to offset distortionary taxes (such as on labor or saving). But what about other uses, such as debt reduction? More problematic is if the revenue is used strictly to increase government spending. There's clearly a time-inconsistency problem here, but the Club may want to advocate an explicit linking of the Pigouvian tax to offsetting tax reductions.

On a related point, how strongly does the Club oppose a policy that re-distributes the revenue to the regulated entities. This is a bigger issue with respect to cap-and-trade programs (a form of Pigouvian taxes), in that the common practice thus far has been to allocate the permits to the regulated entities for free, rather than to auction them (as most economists prefer).

Thanks, Ted. Here is my view on these issues:

The Pigou Club wants to move beyond the rhetorical syllogism, all too common in Republican circles, that

1. Taxes are bad.
2. Pigovian taxes are taxes.
3. Pigovian taxes are bad.

Such a simplistic mindset makes it impossible for people to discuss in a responsible way the relative merits of different tax systems. Instead, we Pigovians acknowledge:

1. There will be some government spending.
2. This spending will be funded with taxes.
3. Government should use the least bad taxes it has available.

In fact, Pigovian taxes are not only least bad--they are good. They correct market failures when transactions costs are too high to expect the forces of the Coase theorem to fix the problem. Pigovian taxes allow truly distortionary taxes, either now or (through debt reduction) in the future, to be lower than they would otherwise be. And in the off-chance that we achieve libertarian utopia and reduce government spending below the level of revenue raised by optimal Pigovian taxation, the extra revenue can always be rebated lump-sum to the public.

I am less fond of cap-and-trade programs than Pigovian taxes because they, in essence, give the revenue from a Pigovian tax lump-sum to a regulated entity. Why should an electric utility, for example, be given a valuable resource simply because it has for years polluted the environment? That does not strike me as equitable. A new firm entering the market should not have to pay for something that an incumbent gets for free. And the fact that the incumbent has for years been taking a valuable resource from the rest of society is no reason to think it deserves a free ride in the future. On equity grounds, one could just as easily argue that the incumbents should compensate society for their past misdeeds.

Cap-and-trade systems are also relatively inefficient, for two reasons. First, they encourage utilities to pollute more before the cap-and-trade system is put into effect in order to "earn" pollution rights. Second, they waste the opportunity to use the Pigovian tax revenue to reduce distortionary taxes on labor and capital. Of course, cap-and-trade systems are better than heavy-handed regulatory systems. But they are not as desirable, in my view, as Pigovian taxes coupled with reductions in other taxes. One exception: If the pollution rights are auctioned off rather than handed out, then cap-and-trade systems are almost identical to Pigovian taxes, including all the desirable efficiency properties.

Pigovians have no magic bullet to keep down government spending. Like many others, I believe that government spending is too high. But Pigovians need not be united about this. The key thing that unites us is the belief that whatever government spending is done, the tax revenue to pay for that spending should be raised in a way that does the least harm or, better yet, the most good.

Pigou Club News

• Pigou Club member wins the Nobel Peace Prize.
• Pigou Club founder talks today at the University of Connecticut.

How to join the Pigou Club

Kevin Burke, a student at the University of Pennsylvania, has opened a facebook arm of the Pigou Club. The group now has 73 members. Anyone registered in facebook is free to join.

One member posted a link to the above graphic from Foreign Policy. For previous Pigou Club posts, click here and here.

Rogoff joins the Pigou Club

I am pleased to welcome my Harvard colleague Ken Rogoff into the Pigou Club. In his latest op-ed, he writes:

As for the US, a sharp hike in energy taxes on gasoline and other fossil fuels would not only help improve the government’s balance sheet, but it would also be a way to start addressing global warming. What better way for new US Treasury Secretary Hank Paulson, a card-carrying environmentalist, to make a dramatic entrance onto the world policy stage?

The Pigou Club is an elite group of economists and pundits with the good sense to have publicly advocated higher Pigovian taxes, such as gasoline taxes or carbon taxes. Here are some examples of the current membership:

• Greg Mankiw (Fortune 5/24/99, WSJ 1/3/06, 5/31/06)
• Bill Nordhaus (Foreign Policy in Focus 3/27/06)
• Martin Feldstein (WSJ 6/4/92)
• Gary Becker (Businessweek 5/27/02)
• Robert Frank (NY Times 2/16/06, 6/8/06)
• Andrew Samwick (his blog)
• Ted Gayer (Regulation)
• Mike Moffatt (about.com)
• Ken Rogoff (Project Syndicate)
• Paul Krugman (Slate 4/18/97)
• Greg Easterbrook (NY Times 5/25/04)
• John Tierney (NY Times 10/4/05, 5/23/06)
• Jonathan Rauch (National Journal 2/9/02)
• Thomas Friedman (NY Times 9/21/05, 2/8/06, 6/16/06)
• Joe Klein (Time 5/7/06)
• Andrew Sullivan (Time 4/11/04)
• Jane Galt (her blog)
• Christopher Farrell (Businessweek 8/19/05)
• William Baldwin (Forbes 6/19/06)
• Clive Crook (National Journal 6/2/06)
• Al Gore (Charlie Rose Show 6/19/06 at 42:45)

We are always looking for more members. An elected official or two would be nice.

Update: Alan Greenspan signs up. So do George Schultz, Tony Lake, Nicholas Stern, Hal Varian, Larry Summers, Richard Posner, David Frum, Nouriel Roubini, Joe Stiglitz, Brink Lindsey, Tim Harford, Rob Stavins, Ray Magliozzi, Robert Samuelson, Dan McFadden, Charles Krauthammer, Paul Mulshine, Kevin Hassett, Jason Furman, Anne Applebaum, Paul Volcker, Bill Frenzel, Isabel V. Sawhill, Charles Stenholm, William Hoagland, Robert Shapiro, David Leonhardt, Morton Kondracke, Gilbert Metcalf, Fred Foldvary, Arthur Laffer, and a majority of economists.

Al Gore in the Pigou Club

Al Gore on the Charlie Rose Show this week reaffirmed his membership in the Pigou Club. Starting at 42:45, he endorses a revenue-neutral shift toward carbon taxes.

The Pigou Club is an elite group of economists and pundits with the good sense to have publicly advocated higher Pigovian taxes, such as gasoline taxes or carbon taxes. The current membership includes:

• Greg Mankiw (Fortune 5/24/99, WSJ 1/3/06, 5/31/06)
• Bill Nordhaus (Foreign Policy in Focus 3/27/06)
• Martin Feldstein (WSJ 6/4/92)
• Gary Becker (Businessweek 5/27/02)
• Robert Frank (NY Times 2/16/06, 6/8/06)
• Andrew Samwick (his blog)
• Paul Krugman (Slate 4/18/97)
• Greg Easterbrook (NY Times 5/25/04)
• John Tierney (NY Times 10/4/05, 5/23/06)
• Jonathan Rauch (National Journal 2/9/02)
• Thomas Friedman (NY Times 9/21/05, 2/8/06, 6/16/06)
• Joe Klein (Time 5/7/06)
• Andrew Sullivan (Time 4/12/04)
• Jane Galt (her blog)
• Christopher Farrell (Businessweek 8/19/05)
• William Baldwin (Forbes 6/19/06)
• Clive Crook (National Journal 6/2/06)

We are always looking for more members.

Pigou Club news

From my inbox:

I thought you might be amused to see this. At Metrovino, a restaurant in Portland, Oregon where I run the bar, we needed a name for a drink we serve that's a slight variation on the Pegu Club (a classic gin cocktail). "Pigou Club" was the first thing to come to mind. I doubt many guests know what the name alludes to but it makes me happy and the drink has become one of our bestsellers. A photo of the menu is attached.  The recipe and background are here.

Also, by the way, Australia has joined the club, amidst significant controversy.

Welcome to the Club, Jay

This is a first: A candidate for the U.S. Senate emails me to apply for membership in the Pigou Club.

Hello Greg,

I am a candidate for the U.S. Senate in New Hampshire (www.buckey08.com) and believe we should address our energy problem through a National Security Levy on oil. I have worked with Doug Irwin and Jon Skinner from Dartmouth on the National Security Levy (Doug says hello), and have also consulted with Andrew Samwick.

The details of the National Security Levy are enclosed. [Here is a link.] The e-mail we sent out about it earlier appears below.

Think we could be listed as a member of the Pigou club?

Look forward to talking with you.

Sincerely,
Jay

----

Dear Friends,

If we needed confirmation that we've lost control of our energy future, we got it on Tuesday. President Bush was in Saudi Arabia trying to convince King Abdullah to help out our economy by increasing oil production. According to the report I read, the King's response was "lukewarm."

Now it's time for the American people to choose our energy future. We can either devote ever-increasing resources to defending our access to oil overseas -- and deal with the effects of global warming. Or we can use our technological skills to make the transition to renewable alternatives.

At a news conference yesterday in Manchester, I proposed a new plan to take charge of our future through a National Security Levy on oil.

Basically, the National Security Levy would be a fee on every barrel of oil consumed in the U.S -- combined with a price floor guaranteeing that oil would not sink below a certain price. The National Security Levy would be phased in slowly so that consumers wouldn't face a sudden price shock.

Part of the revenues from the levy would be rebated to working families to help compensate for increased energy costs. The rest would help finance an Apollo Program for Energy to make the US a world leader in energy development and production. This technological drive would create new jobs and businesses here in New Hampshire, where we have a growing alternative energy economy. The details of the National Security Levy are on our website: http://www.buckey08.com/issues.html.

This plan is going to require everyone in the US to change how they use energy. This may make the plan unpopular with some. But I got into this Senate race not to just look for the politically popular path, but to do things that need to be done. And getting serious about our energy problem is way overdue.

As a nation, we can be great at this transition. No other country on Earth has the talents, resources, and drive to change from petroleum to renewable alternatives as well as we can. Also, spending billions of dollars for energy here in the United States that we otherwise would have sent to foreign governments is going to be an enormous economic boost for us. But we have to get started.

I'm very glad to be able to put this proposal forward. But I can't make it happen alone. Please tell your friends about it, ask them to join us, and contribute to the campaign. With your support, we can succeed. I look forward to hearing from you.

Sincerely,
Jay

Note to journalists out there: Give this guy the attention he deserves. It is brave and honorable to try to turn this good policy into successful politics.

Pigou Club News

A loyal reader alerts me to an article in the latest issue of The Atlantic by Pigou Club member Clive Crook, including this paragraph:

Tax increases are unlikely to happen accidentally, as a natural result of partisan contention. They will require courage and creativity. But a solution is available that practically cries out: the gas tax. Raise it modestly to start with, but announce a schedule of further increases over the next ten years. On grounds of economic efficiency, the case for a bigger gas tax is unassailable. Politically, it could be linked to deeply resonant issues--the environment, energy independence--and might offer a measure of face-saving for the administration. You could sweeten it further: promise up front that 50 percent of the proceeds will go to deficit reduction, and 50 percent to reductions in the Social Security tax, or to an expanded earned-income tax credit (both of which especially help the low-paid).

Another reader points out that Nobel economist Dan McFadden has joined the club:

McFadden suggested imposing a carbon emissions tax or introducing tradable emissions licenses as incentives to promote energy conservation.

The Boston Globe reported today that President Bush will focus on global warming in his state of the union speech tomorrow. I am hoping for the outside chance that he will propose a Pigovian tax, perhaps in exchange for permanence of his income tax cuts. The options mentioned in the article--tighter regulations and greater subsidies to energy alternatives--are more intrusive, require higher distortionary taxes, and are less effective.

Larry Summers in the Pigou Club

I ran into Larry Summers at a party recently, and he asked to be inducted into the Pigou Club.

Larry reminded me of an article of his in the November 30, 1987 issue of The New Republic, called "A Few Good Taxes," in which he wrote:

Raising gasoline taxes would encourage energy conservation....It would also force motorists to pay more of the congestion, maintainance, and accident costs they impose by driving.

Welcome to the Club, Larry. Your secret decoder ring is in the mail.

On a related matter, membership in our facebook chapter is now up to 369.

Prop 87 is not Pigovian

An ec 10 student asks me whether the Pigou Club approves of Prop 87, a ballot initiative in California, described by San Francisco Chronicle as follows:

Prop. 87 aims to raise $4 billion by placing a new tax on oil production, in addition to taxes oil companies already pay. The money would be used to finance research and development of alternative fuels; education campaigns; and subsidies to consumers who buy vehicles that use alternative fuels and businesses that produce and distribute alternative fuels.

The measure is supported by both Bill Clinton and Al Gore.

The goal of Pigovian taxes is to ensure that market prices reflect social costs. Once private and public interests are aligned, people are then free to make their own decisions over the allocation of resources, and they will have the right incentives to reach an efficient outcome.

By contrast, this measure seems more like government central planning. Indeed, the spending side of the proposition is exactly that. But what about the tax itself? Advocates claim that the tax would not be passed on to consumers. Given that oil prices are set in a world market, this claim seems about right to me. Most of the tax would likely be paid by local oil producers rather than oil consumers. Although this lack of pass-through to consumers may make the tax more attractive politically, it means that there would be no incentive working through the price system for people to cut back on oil consumption.

From a Pigovian perspective, the tax proposed by Prop 87 makes sense only if there are negative externalities from oil production in California. If we want Californians to produce less oil and import more from Saudi Arabia and Venezuela, then the proposed tax is well designed. But this goal does not seem the right one to me. I see negative externalities flowing from oil consumption rather than domestic oil production.

I doubt, therefore, that a majority of the Pigou Club would support the measure. But I am only one member. If the Club ever has a meeting, I will make sure to put the question on the agenda.

A Reading for the Pigou Club

And also about the Pigou Club, from the NY Times.

Lindsey on Stimulus

Larry Lindsey's plan to stimulute the economy, including his membership application to the Pigou Club:

Permanent tax cuts offer a much better option. The incoming chairman of the Council of Economic Advisers, Christina Romer, has estimated that the macroeconomic benefits of tax cuts can be two to three times larger than common estimates of the benefits related to spending increases. The relative advantage of tax cuts over spending is even clearer when the recession is centered on the household balance sheet. Some relatively minor changes, like making the current 15 percent tax rate on dividends and capital gains permanent, would not only help household cash flow, but also put a floor under equity prices much as their introduction did in 2003. This would help protect against further wealth destruction and balance sheet deterioration.

But the centerpiece of any tax cut should be employment taxes: in particular, a permanent halving of the current 12.4 percent Social Security payroll tax on the first $106,800 of wages, split evenly between workers and employers. The direct revenue effect of that would be a bit under $400 billion per year, roughly in line with the present quantitative needs of the economy. It also meets our three tests of effective stimulus.

First, the funds would flow directly to households through higher take-home pay and indirectly through a reduction in the cost of employment. Economic studies conclude that the benefits of a reduction in the employer portion of the payroll tax are ultimately received by employees. But the immediate effect would be an improvement in the cash flow of credit-starved businesses (as well as being a marginal incentive to keep
employment up).

Second, the funds would be extremely timely, with the benefits hitting the economy with the first paycheck after the plan was implemented.

Third, by lowering the taxation of labor, the plan would help produce a higher-employment recovery than would otherwise be the case. Since the tax cut should be permanent to have maximum effect, the biggest challenge would be how to make up for the lost revenue once the macroeconomic need for fiscal stimulus had passed. In the short run, effective fiscal stimulus requires that government revenue drop, thereby enriching the private sector, and with the Treasury making the Social Security trust fund whole by way of intergovernmental bookkeeping. Longer term, however, spending cuts or a new source of revenue would be needed.

Given the agenda of the incoming administration, the best source of such funds would be a greenhouse emissions tax. It would be a much more efficient way of achieving the desired environmental objectives of the administration than any of the regulatory or "cap and trade" ideas now being considered. Such programs have failed in Europe since they are so easily gamed. Unlike regulations or cap and trade, moreover, an emissions tax can be phased in and calibrated as macroeconomic conditions permitted, specifically as the unemployment rate declined.

Sounds good to me.

Update: More Pigou Club endorsements here and here.

A Letter to the Pigou Club

From Congressman Bob Inglis:

Dear Pigou Club Members,

A revenue-neutral carbon tax could set up a bi-partisan triple play of this American century. We can clean up the air, create jobs, and enhance our national security.

My Raise Wages, Cut Carbon Act of 2009 cuts payroll taxes and, in equal amount, imposes a tax on carbon dioxide emissions. The tax is border adjustable and is designed to be WTO compliant.

We're conducting a "Virtual Hearing" on the Raise Wages, Cut Carbon Act of 2009 in the hopes of improving the bill before I actually file it. I've kicked off the "hearing" with an opening statement, which you can find here, along with a copy of the bill, a summary, and various white papers addressing different portions of the bill. I'd love for you to look over these materials, and then tell me what you think by posting a YouTube response to my opening statement. You can do that here.

Thank you, and I look forward to benefitting from your expertise and insights!

Sincerely,

Bob Inglis
Member of Congress (R-SC4)

The Stimulus versus the Pigou Club

A reader points out this small part of the budget story in California:

A 12-cent-per-gallon increase in gasoline taxes that was initially part of the package has been eliminated -- replaced with federal economic stimulus money.

So, in effect, part of the stimulus spending has gone to fund a lower gasoline tax. The Pigou Club would have preferred a cut in, say, the payroll tax.

Pigou Club News

The Wall Street Journal reports that a member of the Pigou Club is running for the Republican nomination for Governor of California:

California's fiscal crisis is giving Tom Campbell, an ex-congressman with few resources, a fighting chance to become the state's next governor....Democrats scorn his ideas for permanent cuts to welfare and social services in lieu of one-time fixes, while Republicans strongly oppose his proposal for a steep increase in the state's gasoline tax....Armed with a University of Chicago doctorate in economics and a Harvard Law School degree, he represented Silicon Valley for five terms in the U.S. House, served as business-school dean at the University of California, Berkeley, and also as the state's finance director under Gov. Arnold Schwarzenegger.

Pigou Club News

A reader from across the Atlantic points out that the European Commission is poised to join the Pigou Club:

The Commission will on 28 March present ideas for “green taxes” to save energy and cut greenhouse gas emissions. It says that such an ‘ecological tax reform’ could increase the bloc’s competitiveness by shifting the burden away from labour taxes.

The Pigou Club Manifesto - Director's Cut

On my Harvard website, I have posted a talk I gave earlier in the year, called Smart Taxes: An Open Invitation to Join the Pigou Club.

Regular readers of this blog will recognize the issue and many of the arguments, but I thought it would be useful to collect the ideas in one place and to develop the case a bit more thoroughly than is possible in a blog post or in a newspaper op-ed.

Cato takes on the Pigou Club

A new Cato Institute publication says "state and federal gasoline taxes should be abolished." I have not read it thoroughly enough to comment (the weather has been too nice and my kids are still out of school), but as founder of the Pigou Club, I thought I should alert my blog readers to this new study on the principle of full disclosure.

I do have one question for the authors: If Congress were considering repeal of the gasoline tax together with an income tax increase to make up the lost revenue, would you favor this revenue-neutral change in the tax mix?

Update: Jerry Taylor from Cato emails me:

The answer to your question is that we would favor an elimination of federal highway and mass transit spending to correspond with an elimination of the federal gasoline tax. Highway and mass transit programs are more appropriately shouldered by state and local governments.

Judge for yourself whether that answers the question.

The Pigou Club on NPR

This morning, NPR's Marketplace gives the Pigou Club some much appreciated publicity. NPR also links to a Pigouclub.com website, which I did not create but is helping to push forward the cause.

Addendum: Related stories in the LA Times and the NH Concord Monitor.