The Naked Pigovian

Here is Charles Wheelan, author of The Naked Economist:

Should we implement a federal carbon tax and/or significantly raise the gas tax?

My answer: Absolutely. If you believe in markets when they work well, then you have to understand how they need to be tweaked when they don't. If page 10 of any introductory economics text explains the wonders of supply and demand, page 12 usually explains that markets don't deliver an efficient outcome when eager buyers and sellers impose some harm, or negative externality, on a third party.

If I can change the oil in your car more cheaply than the competition by dumping the old oil in Lake Michigan, that's not the kind of market transaction that got Milton Friedman so excited. Yes, I make profits and you save money -- a mutually beneficial, voluntary exchange -- but anybody who cares about Lake Michigan is not happy at all, and they aren't represented in our little transaction.

When the price of some activity is artificially cheap because society is picking up part of the tab, people do too much of it. That's not the economically efficient outcome that markets usually deliver. One standard economic fix is to impose a tax on whatever private activity imposes the social cost; when the price of the activity goes up, people do less of it.

That's exactly what a carbon tax or a higher gas tax would do. There's nothing voluntary about me breathing your tailpipe emissions. If we raise the private cost of driving, people will be less likely to commute 60 miles alone in a Chevy Tahoe.

The optimal market outcome isn't always synonymous with doing nothing; in this case, the market works best when the government does something. That something happens to be a tax, or anything else that raises the cost of the polluting behavior.