Mobile phone use is under stricter scrutiny, both in public places, such as restaurants and commuter trains, where the behavior is fabulously annoying, but also in vehicles, where it has been linked to a higher rate of accidents. Texting is the second-most dangerous thing you can do while driving a car, next to driving drunk.
In Chicago, Mayor Richard Daley attempted to impose a 1-cent tax on every $2 of take-out food purchases, arguing that the “litter tax” would reimburse the city for the costs of picking up litter, much of which consists of discarded fast-food containers. The mayor’s economics were sound—litter is a classic externality—but a judge ruled the ordinance unconstitutional because it was “vague and lacking in uniformity” in the way it dealt with different kinds of fast-food containers. Now there is talk at the federal level of a junk food tax (or a soda tax) to deal with a different kind of food-related externality: obesity. The health care costs associated with obesity are now roughly as high as those related to smoking. Society picks up at least some of the tab for those bills through the costs of government health programs and higher insurance premiums—giving me a reason to care whether you have a Big Mac for lunch or not.
Global warming is one of the most difficult international challenges in large part because firms that emit large amounts of greenhouse gases pay only a small share of the cost of those emissions. Indeed, even the countries in which they reside do not bear the full cost of the pollution. A steel plant in Pennsylvania emits CO2 that may one day cause a flood in Bangladesh. (Meanwhile, acid rain caused by U.S. emissions is already killing Canadian forests.) The same thing is true in all kinds of factories around the world. Any solution to global warming will have to raise the cost of emitting greenhouse gases in a way that is binding upon all of the earth’s polluters—not the easiest of tasks.
It is worth noting that there can be positive externalities as well; an individual’s behavior can have a positive impact on society for which he or she is not fully compensated. I once had an office window that looked out across the Chicago River at the Wrigley Building and the Tribune Tower, two of the most beautiful buildings in a city renowned for its architecture. On a clear day, the view of the skyline, and of these two buildings in particular, was positively inspiring. But I spent five years in that office without paying for the utility that I derived from this wonderful architecture. I didn’t mail a check to the Tribune Company every time I glanced out the window. Or, in the realm of economic development, a business may invest in a downtrodden neighborhood in a way that attracts other kinds of investment. Yet this business is not compensated for anchoring what may become an economic revitalization, which is why local governments often offer subsidies for such investment.
Some activities have both positive and negative externalities. Cigarettes kill people who smoke them; that is old news. Responsible adults are free to smoke or not smoke as they choose. But cigarette smoke can also harm those who happen to be lingering nearby, which is why most office buildings consider smoking to be slightly less acceptable than running through the halls naked. Meanwhile, all fifty states filed suit against the tobacco industry (and subsequently accepted large settlements) on the grounds that smokers generate extra health care costs that must be borne by state governments. In other words, my taxes go to remove part of some smoker’s lung. (Private insurance companies do not have this problem; they simply recoup the extra cost of insuring smokers by charging them higher premiums.)
At the same time, smokers do provide a benefit to the rest of us. They die young. According to the American Lung Association, the average smoker dies seven years earlier than the average nonsmoker, which means that smokers pay into Social Security and private pension funds for all of their working lives but then don’t stick around very long to collect the benefits. Nonsmokers, on average, get more back relative to what they paid in. The good folks at Philip Morris have even quantified this benefit for us. In 2001, they released a report on the Czech Republic (just as parliament was considering raising cigarette taxes) showing that premature deaths from smoking save the Czech government roughly $28 million a year in pension and old-age housing benefits. The net benefit of smoking to the government, including taxes and subtracting public health costs, was reckoned to be $148 million.3
How does a market economy deal with externalities? Sometimes the government regulates the affected activity. The federal government issues thousands of pages of regulations every year on everything from groundwater contamination to poultry inspection. The states have their own regulatory structures; California, for example, has a strict set of emissions standards for automobiles. Local governments have zoning laws that forbid private property owners from impinging on their neighbors by constructing buildings that may be unsafe, inappropriate for the neighborhood, or simply ugly. The island of Nantucket allows only a few select colors of exterior paint lest irresponsible property owners use neon colors that would destroy the quaint character of the island. I live in a historic neighborhood in which every external change to our homes—from the color of new windows to the size of a flower box—must be approved by an architecture committee.
There is another approach to dealing with externalities that tends to be favored in some cases by economists: taxing the offending behavior rather than banning it. I’ve conceded that my Ford Explorer was a menace to society. As Cornell economist Robert Frank noted in an op-ed for the New York Times, we are locked in an SUV arms race. “Any family can only choose the size of its own vehicle. It cannot dictate what others buy. Any family that unilaterally bought a smaller vehicle might thus put itself at risk by unilaterally disarming,” he wrote.4 Should the Hummer be banned? Should Detroit be ordered to manufacture safer, more fuel-efficient cars?
Economists, including Mr. Frank, would argue not. The primary problem with SUVs—and all vehicles, for that matter—is that they are too cheap to drive. The private cost of driving a Hummer to the grocery store is obviously far lower than the social cost. So raise the private cost. As Mr. Frank writes, “The only practical remedy, given the undeniable fact that driving bulky, polluting vehicles causes damage to others, is to give ourselves an incentive to take this damage into account when deciding what vehicles to buy.” If the real cost to society of having an Explorer on the road is 75 cents a mile instead of the 50 cents a mile that it costs the vehicle’s owner to operate the vehicle, then tack on a tax that equates the two. This might be accomplished with a gas tax, or an emissions tax, or a weight tax, or some combination thereof. The result will make driving a Hummer to the grocery store a lot less attractive.
But now we have entered strange terrain. Is it appropriate to allow some drivers to pay for the privilege of driving a vehicle so bulky that it might run over a Mini Cooper without even spilling the sixty-four-ounce drink in the monster cup holder? Yes, for the same reason that most of us eat ice cream even though it causes heart disease. We weigh the health costs of Starbucks Almond Fudge against that divine, creamy taste and decide to have a pint every once in a while. We don’t quit ice cream entirely, nor do we have it with every meal. Economics tells us that the environment requires the same kinds of trade-offs as everything else in life. We should raise the 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 we know which party has the right to do what. (As we’ll explore later in the chapter, property rights often involve things far more complicated than just property.) Does Stuart have the right to make whatever noise he wants? Or do I have the right to work in relative quiet? Presumably the statutes for the city of Chicago answer that question. (The answer may depend on time of day, giving him the right to make noise up until some specified hour and giving me the right to silence during the nighttime hours.)
If I have the right to work in peace, then any payment would have to go the opposite direction. Stuart would have to pay me to start banging away. But he wouldn’t do that in this case, because it’s not worth it to him. As a temperamental writer, the silence is worth $100 to me, so Stuart would have to pay me at least that much to endure the noise. Playing the bongos is only worth $50 to him. He’s not going to write a check for $100 to do something that provides only $50 of utility. So I get my silence for free.
This explains Coase’s second important insight: The private parties will always come to the same efficient solution (the one that makes the best use of the resources involved) regardless of which party starts out with the property right. The only difference is who ends up paying whom. In this case, the disputed resource is our common wall and the sound waves that move back and forth across it. The most efficient use of that resource is to keep it quiet, since I value my peaceful writing more than Stuart values his bongo playing. If Stuart has the right to make noise, I’ll pay him to stop—and I get to write in peace. If I have the right to silence, Stuart won’t be willing to pay enough for me to accede to his bongos—and I get to write in peace.
Remarkably, this kind of thing actually happens in real life. My favorite example is the Ohio power company that neighbors claimed was emitting “a bizarre blue plume” that was causing damage to property and health. The Clean Air Act gave the town’s 221 residents the right to sue the utility to stop the pollution. So the American Electric Power company had a decision to make: (1) Stop polluting; or (2) pay the entire town to move somewhere else.5
The New York Times reported on the answer: “Utility Buys Town It Choked, Lock, Stock and Blue Plume.” The company paid the residents roughly three times what their houses were worth in exchange for a signed agreement never to sue for pollution-related damages. For $20 million, the utility’s problems packed up and went away—literally. Presumably this made financial sense. The New York Times reported that this settlement was believed to be the first deal by a company to dissolve an entire town. “It will help the company avoid the considerable expense and public-relations mess of individual lawsuits, legal and environmental experts said.”
Coase made one final point: The transactions costs related to striking this kind of deal—everything from the time it takes to find everyone involved to the legal costs of making an agreement—must be reasonably low for the private parties to work out an externality on their own. Stuart and I can haggle over the fence in the backyard. The American Electric Power company can manage to strike a deal with 221 homeowners. But private parties are not going to work out a challenge like CO2 emissions on their own. Every time I get into my car and turn on the engine, I make all of the six billion inhabitants of the planet slightly worse off. It takes a long time to write checks to six billion people, particularly when you are already late for work. (And it’s arguable that some people in cold climates will benefit from climate change, so maybe they should pay me.) The property rights related to greenhouse gases are still ambiguous, too. Do I have the right to emit unlimited CO2? Or does someone living in a Pacific island nation have the right to stop me from doing something that mi
ght submerge their entire country? This is one conflict that governments have to tackle.
But let’s back up for a moment. Government does not just fix the rough edges of capitalism; it makes markets possible in the first place. You will get a lot of approving nods at a cocktail party by asserting that if government would simply get out of the way, then markets would deliver prosperity around the globe. Indeed, entire political campaigns are built around this issue. Anyone who has ever waited in line at the Department of Motor Vehicles, applied for a building permit, or tried to pay the nanny tax would agree. There is just one problem with that cocktail party sentiment: It’s wrong. Good government makes a market economy possible. Period. And bad government, or no government, dashes capitalism against the rocks, which is one reason that billions of people live in dire poverty around the globe.
To begin with, government sets the rules. Countries without functioning governments are not oases of free market prosperity. They are places in which it is expensive and difficult to conduct even the simplest business. Nigeria has one of the world’s largest reserves of oil and natural gas, yet firms trying to do business there face a problem known locally as BYOI—bring your own infrastructure.6 Angola is rich with oil and diamonds, but the wealth has financed more than a decade of civil war, not economic prosperity. In 1999, Angola’s rulers spent $900 million in oil revenues to purchase weapons. Never mind that one child in three dies before the age of five and life expectancy is a shocking forty-two years.7 These are not countries in which the market economy has failed; they are countries in which the government has failed to develop and sustain the institutions necessary to support a market economy. A report issued by the United Nations Development Program placed much of the blame for world poverty on bad government. Without good governance, reliance on trickle-down economic development and a host of other strategies will not work, the report concluded.8
Naked Economics Page 9