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Response to Nye: a Pigou tax on gasoline is robust to further considerations.

Article Excerpt
John Rye reminds us of some important--and often neglected--principles of welfare economics for converting estimates of externalities into Pigovian tax recommendations. Most significant among these are:

* Pigovian taxes are reduced when there is some scope for the private sector to internalize externalities.

* Pigovian taxes interact with pre-existing tax distortions in labor and capital markets, and this affects their optimal levels.

* Pigovian taxes also need to account for pre-existing regulations, or distortions, affecting activities that are closely related to the taxed activity.

* The behavioral response to Pigovian taxes may be very limited.

Despite the usefulness of these points, we dispute Prof. Nye's claim that they cast doubt on Pigovian tax estimates in the specific case of gasoline.

INTERNALIZING EXTERNALITIES Clearly, the case for corrective taxation is undermined to the extent that private agents might account for "externalities" in their own decisions. For example, a dominant airline might partly internalize congestion at a hub airport in its fares and flight schedule if the costs of delays are largely borne by its own passengers and crews. However, the main externalities relevant for fuel taxes--including local pollution, congestion, and climate change--involve huge numbers of individuals producing widely dispersed external costs. That makes any internalization infeasible--by Coasian bargaining or any other means.

The accident...

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