Thursday, November 19, 2009

Members of the Pigou Club Should Transfer to the "Coase Club"

Harvard economist Greg Mankiw reminds us (here) that today is the 132d birthday of Cambridge economist Arthur Cecil Pigou  (left), pioneer of modern Welfare Economics and the namesake of Pigovian taxes, which are designed to internalize externalities (e.g., polllution taxes). Mankiw is the leader of what he calls the Pigou Club, which favors use of taxes over other mechanisms (such as cap-and-trade) for dealing with climate change, among other environmental problems.

I have nothing against Pigou per se, but, if pressed, I suspect that Professor Mankiw would concede that he really favors what might be called "Coasian taxes" over Pigovian taxes. In his famous 1960 article, "The Problem of Social Cost," Ronald Coase (right) demonstrated that, in the presence of transaction costs, some externalities might be efficient because the cost of internalizing them might exceed the benefits. So, whereas Pigou would set the tax to internalize all externalities, regardless of transaction costs, Coase would seek to tax only inefficient externalities - those that could be internalized at net social benefit. A Coasian tax is, at least in theory, more efficient than a Pigovian tax.

Coase, by the way, will be celebrating the centenary anniversary of his birth in 2010.

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