Pigouvian subsidies

In the previous post we discussed pigouvian taxes as a possible method to reduce negative externalities. We originally intended to title that post “Pigouvian taxes & subsidies”. For reasons of limited time we decided to split that post in two parts and discuss pigouvian subsidies in another installment.

Whereas pigouvian taxes are meant to discourage causing negative externalities, a pigouvian subsidy would be a reward for creating positive externalities. To recap: an externality is an unintended consequence upon third parties caused by one’s action. A positive externality means that there’s a benefit for third party.

However, by definition people cannot be excluded from enjoying a positive externality, and hence they cannot be charged effectively for their consumption. Consequently there is little incentive for private entrepreneurs to produce such externalities, though society at large would gain from it. Therefore the production of positive externalities is often in under-supply.

One way to counter this, is that the government would create an incentive for creating positive externalities by offering monetary rewards. Though entrepreneurs cannot still charge their “consumer”, they get at least an opportunity to make money from their activities. Needless to say some checks should be implemented to prevent abuse of such subsidies.

A pigouvian tax might, maybe surprisingly, also reduce negative externalities. If a certain good can be produced in two ways, A and B, and one is cheap for a business but has a lot of negative externalities, while the second method is more expensive but has much less negative externalities. In this scenario the government could either tax A or subsidies B. If it would subsidies B, the costs of method B will be lower and if the subsidy is sufficient B will be less expensive than A.

Pigouvian taxes and subsidies are just two tools among many, to regulate externalities. What tool is most appropriate should be decided upon a case-by-case base.

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6 thoughts on “Pigouvian subsidies”

  1. This is a great idea, but its implementation would be highly problematic. Fair arbitration is the big problem. For example, the Obama Administration has been trying to increase clean/renewable energy subsides in the U.S. while also trying to eliminate special interest tax breaks enjoyed by the fossil fuel industry. His efforts have been vigorously opposed by conservatives, and therefore have been only marginally successful. If a pro-fossil fuels government returns to power in America, this kind of activist governance would likely produce more negative externalities.

    How is fair arbitration enabled? Who decides what policies are considered as socially “positive” and “negative?” In your previous post you discussed the metrics of externalized costs to third parties, but didn’t specify how those assessments would be made.

    1. >>In your previous post you discussed the metrics of externalized costs to third parties, but didn’t specify how those assessments would be made.

      We intended to give a general introduction to this subject, and not to provide a definite conclusion (which I believe also would be impossible). Nevertheless this issue does deserve a more elaborate discussion.

      >>Who decides what policies are considered as socially “positive” and “negative?”

      I agree that this distinction is difficult to made, and to a certain extent it is also highly subjective. The decision of what is considered as “positive” or “negative” should be made in an open democratic process.

      >>This is a great idea, but its implementation would be highly problematic. Fair arbitration is the big problem.

      The implementation of any policy would face serious problems, which needs to be discussed carefully. As I said, we should consider different policy tools and pick what is most appropriate in a certain situation.

      >>For example, the Obama Administration has been trying to increase clean/renewable energy subsides in the U.S. while also trying to eliminate special interest tax breaks enjoyed by the fossil fuel industry. His efforts have been vigorously opposed by conservatives, and therefore have been only marginally successful.

      Established interests are a serious challenge for anyone to push for serious reforms. One of our reasons for space colonization is to use the opportunity to sidestep such established interests. But we need to be quick and forge the iron when it is still hot. If you wait a little bit too long, we will get exactly the problem you described.

      >>in America, this kind of activist governance would likely produce more negative externalities.

      I fully agree.

  2. Since I have not read your site for a long time I will just have to flip through and see if I find a few that might be of interest ……. or not.
    The word Pigouvian caught my attention. I Googled and now know less than I did before 😦

    Then read your comment about Arthur Pigou to John Z. and now know a bit more than I did before. 🙂

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