Oren Cass On The Problems Governments Face In Trying To Control Externalities

See The New Central Planners. Cass is with the Manhattan Institute. Excerpt:

"The theory is fine. If producing a ton of steel costs $50 but also releases $10 of pollution, society should want the manufacturer to behave as if the ton's cost were $60. A $10-per-ton tax would accomplish that. This idea can be formulated as a more general rule; as Nathaniel Keohane and Sheila Olmstead write in Markets and the Environment, the basic text of the Harvard Kennedy School's course in environmental economics: "A tax on pollution equal to the marginal damage at the socially efficient level of pollution will achieve the socially efficient outcome."

But what is the socially efficient level of pollution? A market economy traditionally relies upon a market price to facilitate an efficient level of production and consumption, yet that signal is precisely what the new central planner wishes to subvert. Even if he can determine that a marginal ton of pollution at the current level costs $10 (which he cannot, because of the challenges in cost-benefit analysis discussed below), he has considered only one external effect of the economic activity and has no idea of the magnitude or even the direction of its net social impact, nor whether the socially efficient level is higher or lower than the current one. Even if he could reliably determine the net impact of that factory's steel production for each marginal ton, he could not extend the conclusion to other locations or other points in time. Nor would his calculation identify the potentially counterintuitive and counterproductive distributional implications of his intervention.

The greatest obstacle to counteracting an externality is that neither the externality nor its "solution" acts in isolation. The case of fossil fuels provides an excellent example. Recall the IMF's conclusion that market prices for the fuels represented a multi-trillion dollar "subsidy" because negative externalities went uncorrected. But deep in that report, the Fund acknowledged that, at the "right" price, electricity and gasoline consumption in Asia would fall by about 25%. Any positive externalities of that energy use among predominantly impoverished communities — from general economic growth and associated public-health improvements, to the education of children whose schools need heat and light — would disappear. Depending on the relative value of those positive externalities compared to the negative ones emphasized by the IMF, the socially optimal level of fossil-fuel consumption may actually be higher, lower, or equal to the prevailing market level.

More generally, the same industrial activities that produce negative environmental externalities also provide employment, wages, and tax payments, offering a variety of social and public-health benefits to families and communities. Anne Case and Angus Deaton of Princeton University provide a prominent recent example, finding that increased substance abuse, liver disease, and suicide among non-Hispanic whites aged 45 to 54 had led to the equivalent of nearly 500,000 extra deaths between 1999 and 2013, affecting most dramatically those with a high-school education or less. The authors suggest that "economic insecurity" may be a driver. Indeed, it would be surprising if declining economic fortunes for blue-collar workers did not produce an uptick in such maladies, just as surely as an increase in pollution from industrial facilities might produce an uptick in other health problems. One can add any favored or disfavored social phenomenon to the ledger. The IMF study includes the congestion, accidents, and road damage associated with driving petroleum-powered vehicles.

Researchers in the United Kingdom have linked road-traffic noise to strokes and death, a finding that should interest residents protesting the construction of subsidized but noisy wind-turbine farms near their homes. If our ton of steel were manufactured at night, perhaps "light pollution" — which EPA administrator Gina McCarthy has declared to be "in our portfolio" — would come into play, to say nothing of the effect night shifts may have on family and social-capital formation. On the other hand, long-term unemployment — including of those who might otherwise work a night shift — has been linked to poor outcomes for the children of the unemployed.

The eager analyst may be tempted to begin quantifying all the steel ton's externalities, so that a careful calibration of taxes and subsidies to offset each will get the price just right. But such an exercise is ludicrous on its face, both because each individual quantification will be wrong and because unintended consequences will be ignored. If government were capable of it, central planning might actually work. Instead, it mandates children remain in bulkier car seats for more years, then discovers with dismay that families purchase larger and less fuel-efficient cars, then mandates automakers improve fuel-efficiency and promises it will save those families money as gas prices rise, then provides large subsidies for the purchase of electric vehicles that are too small for those families and out of their price range anyway, then watches gas prices plummet, then celebrates that gas prices are low while lamenting they are not higher.

The good news is that such a comprehensive analysis of all relevant externalities is unnecessary, because it amounts to asking a much simpler question: Is the steel factory, given all its social benefits and costs, helping or harming the community in which it is located? If the community sees the steel factory — or, more precisely, the factory's marginal unit of production — as beneficial, restricting its output through a tax is backward. If anything, the community would prefer a subsidy that expands production further. The carefully calculated cost of the associated pollution determines nothing.

The question is also exceedingly situation-specific. A struggling community with clean air and large numbers of unemployed blue-collar workers probably favors production increases — a colloquial way of observing that the net externalities are likely positive, an insight confirmed by the enormous tax breaks new facilities frequently attract. A booming metropolis struggling to reduce smog, meanwhile, may view the marginal cost of further pollution as exceeding the marginal benefit of an additional job. A coastal enclave of educated elites may care mostly about increased traffic and an influx of new workers and thus have no interest in any facility regardless of either job creation or pollution.

Such NIMBYism raises the further question of whose costs and benefits should even count and whether distributional impacts matter. If the coastal enclave's relevant population expands to include outlying working-class communities, its analysis would change. When the costs and benefits act at different scales, managing the balance of equities becomes more difficult still. In some situations the air pollution might spread downwind while jobs remain local, but in others there may be regional economic benefits while only the facility's immediate neighborhood suffers the stench. Particularly in the case of environmental regulation, concentrated costs will often fall on labor and capital within an industry, and on its customers through higher prices, while diffuse benefits will accrue to different groups entirely.

It is also critical to contemplate how changing property values affect who the ultimate beneficiaries will be. Where an externality causes a constant level of harm over time, the value of property in affected locations should be lower by the net present value of that harm (that is, all future harm discounted back to today). Indeed, in some situations economists actually use housing-price differentials as indicia of how much pollution costs. But like a property tax, the entire future burden of an externality will be borne by the owner of property at the moment the burden becomes known. Renters or future buyers pay less for their housing, so they should find themselves no worse off than had the externality never existed. Conversely, where the net externalities generated from an event — such as the opening of a plant — are positive, the entire benefit is captured immediately. Future residents will pay more to move into town.

The transmission of externalities through property values turns the concept of "environmental justice" on its head. Activists commonly claim that the distributional effects of regulation support their agenda, suggesting that low-income and minority communities suffer disproportionately from pollution and other externalities. But that reasoning should apply only to residents who owned property at the time externalities were introduced. A low-income family renting an apartment near the steel plant should pay lower rent than in the absence of the steel plant by precisely the amount of harm the steel plant causes them. Removing the steel plant's pollution would not benefit them, because the value of their apartment and thus the rent charged would increase accordingly. It should not be surprising if heavily polluting plants are found disproportionately in low-income communities; those residents are the ones most likely to live in the accordingly lower-cost housing. Without the presence of the pollution, they might very well be priced out.

Nor do indications point toward low-income communities viewing the marginal cost of pollution as exceeding the marginal benefit of additional industrial activity. To the contrary, as Politico reported perplexedly last September, "President Barack Obama's aggressive environmental agenda is running into a surprising source of opposition: Black elected leaders." The article quoted a letter to President Obama from Steve Benjamin, mayor of Columbia, South Carolina, and president of the African American Mayors Association, explaining that "mayors, county officials and governors still face the challenge of curtailing ozone while expanding the industrial production, construction, and infrastructure projects that create jobs and grow our tax base." In general, the widespread enthusiasm that accompanies the announcement of a new plant's construction, and the dismay that accompanies notice of an impending closure, suggest that current levels of environmental regulation are out of balance with society's needs."