The Pigou Club Reconsidered
By David Henderson
Last Friday, I highlighted Ross McKitrick’s exposition of the argument that taking account of the “tax interaction effect” (TIE) leads to the conclusion that the optimal Pigovian tax on carbon is less, and possibly substantially less, than the one that you would estimate without taking this interaction effect into account.
I also wrote:
But, as far as I know, good economists who are members of the Pigou Club–three who come to mind are Tyler Cowen, Greg Mankiw, and William Nordhaus–have not responded to this critique. Has anyone seen a response by any of these three?
In exploring further, I did find some pieces by Greg Mankiw that give a further case for the tax. His latest is “Smart Taxes: An Open Invitation to Join the Pigou Club,” Eastern Economic Journal (2009), 35, 14-23. In that article, he doesn’t address the TIE.
Mankiw also claims that “a majority” of economists favor higher taxes on fossil fuels. He’s probably right: He gives some evidence for this from a 2006 article by Robert Whaples, “Do Economists Agree on Anything? Yes!,” The Economists’ Voice, 3(9). But he goes too far in interpreting other evidence on economists’ views. He quotes a Wall Street Journal article by Phil Izzo in which Izzo reports on a survey of economists. The survey found 54 percent of economists polled saying that the most economically sound way to encourage development of alternatives to fossil fuels is” to impose higher taxes on fossil fuels.
This latter does not mean that 54 percent of those economists favor imposing higher taxes. I trust the reader to figure out why. One hint: If you asked me to give the best way to encourage development of alternative fuels, I would probably answer “higher taxes on fossil fuels.” But I don’t believe in higher taxes on fossil fuels.
Is there somewhere else where Greg Mankiw considers possible objections to a Pigovian tax on carbon? Yes, there is. It’s here. He gives four possible reasons for people to object. The closest he comes to considering the TIE is his reason #3. Mankiw writes:
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.)
Parry and Small do reference the literature on the TIE. So one could say that Greg Mankiw has answered the McKitrick point indirectly, by referencing Parry and Small.