The issue
Most people don't know how to deal with an externality, and don't understand the purpose of Pigouvian (not Pigovian - see footnote) taxes. 'Most people' is more likely than not to include you too.
Shock value
The extent to which people change their actions as a result of pigouvian taxation is irrelevant. So, a pigouvian tax on carbon emmissions is the best response to global warming, even if it does not lead to any reductions in carbon emissions.
The snappy part
An externality is generated when I do not take into account the full social costs of my actions when making decisions. In other words, I do something I like which you don't, but because I don't care about your feelings I end up doing it too much.
For an externality to create problems, two things must be going on:
a. no clearly established property rights (am I entitled to polluting or are you entitled to a clean environment?)
b. trade between the holder of the property rights and the non-holder is not possible (i.e. I can't compensate you to allow me to pollute if you are entitled to a clean environment, or you can't pay me to not pollute if I am entitled to pollute).
Let's stick with carbon emmissions. Property rights are well established: they are held by governments, and they can choose to represent the rights of all people of the world, the fauna and the flora of the world and generations yet unborn as they see fit. So no problems there.
The means to trade are also present: enter pigouvian taxation.
Now, most people think that a pigouvian tax ought to be imposed to reduce pollution, full stop. If the pigouvian tax has only a small effect on carbon emmisions, the thinking goes, then the pigouvian tax has 'failed' and other measures ought to be taken, namely non-price restrictions (e.g. banning carbon emmissions above a certain level, restricting the supply of oil, etc).
This is wrong. The degree to which the production of carbon emmissions changes is irrelevant. As long as your pigouvian tax equates the private to the social costs, you are in the best possible world. If you don't agree, then your problem lies with the initial allocation of property rights or with the distribution of the pigouvian tax revenue or with democracy itself, not with correcting for the externality in the world in which we live in.
The only 'problem' stemming from an 'uncorrected' externality is inefficiency, and the best way to deal with that inefficiency is to apply an appropriate pigouvian tax. Any perceived problems beyond inefficiency should not be addressed in the context of 'correcting' the externality.
Illustrative example - post starts getting boring from here onwards
I like driving my car around your garden. You like your garden to be car-free. I produce an externality in that my private actions affect your welfare.
Possibility A: You own the garden. If driving my car is worth more to me than having a car-free garden is worth to you, I can pay you so that you let me drive in your garden. If not, I don't pay you and you have a car-free garden. That's Pareto efficiency; you can't make anyone better off without making someone worse off.
Possibility B: I own the garden. If driving my car is worth less to me than having a car-free garden is worth to you, you can pay me so that I don't drive around. If not, you don't pay me and I keep driving around. That's Pareto efficiency again.
Now, substitute 'you tax me' for 'I pay you' and you can relate this to the rest of the post.
And if you believe that the outcome is not socially optimal, then you really have a problem with the initial allocation of property rights, not with the means by which the externality is handled. Voicing your concerns now doesn't make sense; your grievances have nothing to do with the externality we discuss here.
What you believe is that the initial allocation of wealth is wrong on grounds of fairness. The way to combat this is by moving some wealth from the garden guy to the car guy or vice versa. The tax/subsidy on car-driving is not really central to your argument.
Now you may want to skip to the footnote; for the remainder of the post I simply repeat everything I said earlier in an irritating manner
Tyler Cowen, who easily ranks amongst the top thinkers we have on social and economics issues, shocked me with this post. (One of the most powerful economists in the world also shocked me for similar reasons in a talk I attended recently, but I expected more from Tyler).
Tyler's post discusses whether it makes sense to drill in Alaska (the ANWR), and here's an excerpt:
2. There is a general global warming case against developing the resource. Note that supply restrictions can be far more effective than a Pigou tax. A Pigou tax doesn't guarantee the stuff won't be pumped anyway, albeit at lower profit.
There can be no 'general global warming case'.
Fighting global warming is a means to an end, not an end in itself. I don't want a guarantee the stuff won't be pumped away, I just want those who suffer from the externality (be it non-users of fuel, Africans, wild animals or children yet to be born) to be adequately compensated by those who benefit from burning fuel.
Remember the Coase theorem! The Pigouvian tax can be seen as the result of the bargaining between the different social groups with their different preferences. A crude instrument, I know, but the problems associated with establishing the optimal Pigouvian tax rate do not go away when considering non-price restrictions (and what is banning something if not an extremely large Pigouvian tax, implying an extremely large externality?).
If you are arguing against developing ANWR 'because supply restrictions can be far more effective than a Pigou tax' then why don't you also make a 'general global warming case' against developing Africa (you could use the resources to install solar panels), against reading books (you could use the resources spent reading them to pay people not to use fuel) and against living and breathing (you produce carbon emmissions)?
3. The Pigouvian case against developing ANWR makes sense only if we are taking other systematic actions to raise the price of fossil fuels and restrict fossil fuel use.
Again, the point is not to restrict fossil fuel use for its own sake, or even to raise the price because we want less consumed for the fun of it. All a Pigouvian tax has to do is equate the private with the social costs of polluting; if that is the case, whatever carbon emmissions there are at equilibrium represent the optimal amount.
Why does this misunderstanding about externalities and pigouvian taxation persists?
I can only speculate. Firstly, standard textbook treatments do not bother with where the funds go (beyond stressing that, to get a neat solution, they are not to be redistributed back to the externality generators - polluters). Secondly, the sloppy ('common sense') thinking often applied requires that we should be looking to
eliminate anything 'bad' such as carbon emissions, not merely restricting it to socially optimal levels.
The footnote
Pigovian is the most funny Americanism there is. You can spell labour 'labor' and behaviour 'behavior', but the guy wasn't called Pigo.
