When do we want regulation in addition to a Pigouvian tax?

I haven’t followed the details of President Obama’s campaign to regulate fossil fuels through the EPA, but I thought it was worth reviewing when regulations might be desirable in addition to Pigouvian taxes.

One problem with a Pigouvian tax is you may fail to meet the threshold of a desired outcome, given that the market response to the tax is uncertain.  For instance if the government put on a stiff carbon tax there is a chance dirty coal use simply might continue, albeit at higher prices, and thus no problem would be solved.  A very very high tax could ensure a movement away from dirty coal but then perhaps the tax is much higher than it needs to be and that too will bring significant distortions.

In that case, it can in principle make sense to supplement the Pigouvian tax with some kind of “best practices” standard or quantity regulation on the side of emissions.

Now here’s the catch.  Let’s say you have been arguing that the transition to green energy can be a smooth and certain glide.  In that case you should want the tax only (admittedly you still might favor direct regulation as a substitute, given the absence of a tax).

Let’s say you wring your hands about the ability of the market to find a good substitute for the dirtier fossil fuels.  You’re really not sure whether that can be done or not at a reasonable price.

In that case there is the uncertainty and you might favor the Pigouvian tax plus the regulation.  Or if you are truly fearful about substitutability, and don’t assign high enough priority to emissions control and climate issues, you might want no tax and also no major regulations.

One odd mix of positions is “I’m very unsure how well and how smoothly this transition will go and I want only a Pigouvian tax.”

Another odd mix is “I’m sure this transition will be a smooth and easy glide, I want both Pigouvian taxes and lots of regulation.”


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