Why I am Skeptical of Market Failure Corrections

In just about any economics textbook, one will find a discussion of market failure.  The conversation will usually go something like this: markets are great, but sometimes they fail.  If transaction costs are low, then no government remedy is needed.  But if transaction costs are high, then the government can (and should) step in to correct the failure.  One of the most common methods advocated to correct a market failure is the original from British economist Arthur C. Pigou: taxes.

A Pigouvian tax is a tax designed to fix a specific market failure: negative externalities.  A negative externality is a situation where costs are imposed on a 3rd party outside of the transaction.  Since they are not part of the original transaction, the monetary price that occurs in the market does not fully take into account their costs.  Thus, a tax can be applied that raises the market price, reduces the quantity in the market, compensates for the costs imposed, and the market failure is removed.  Negative externalities seem to be pervasive in society (pollution, bad smells, second-hand smoke, etc).  Furthermore, transaction costs are high (imagine if a power plant had to negotiate with every person who is affected by its smog!).  Consequently, you have many economists taking the need for Pigouvian taxes as a given.

I, however, am very much in a minority.  While I understand the logic behind Pigouvian taxes, I reject them as a practical solution; I do not think they are a 1st-best, or even 12th-best solution to market failure.  Public Choice economics gives us a major reason to be skeptical of government-imposed market failures, even so-called “market-based” interventions like Pigouvian taxes or cap-and-trade.  The assumption behind Pigouvian taxes (or any government intervention in the economy) is that the government is a benevolent dictator; it seeks to do the right thing and can do so unilaterally.  But Public Choice teaches us that we must consider the world as it actually is as opposed to some idealized alternative state.

In the real world, the government is neither benevolent nor a dictatorship.  Government agents are not benevolent, but neither are they generally malevolent.  They, like all of us, are looking out for their own best interests.  They want to keep their jobs, they want to do a good job, they want to go home to their families at the end of the day, etc.  They have hopes, dreams, and desires.  And they act in line with their incentives and their goals, which probably differ from most other people.  What incentive, then, is there for them to assign “the proper” tax to solve an externality, or even to gather all necessary information to properly assign it?

In the real world, the government (at least in the United States) is not a dictatorship.  It has many working parts.  Many policy decisions are made in committees, or determined by Congressional vote.  Policy-makers and decision-makers are balancing many, many different issues.  Consequently, policy more often than not deviates from a theoretical ideal and hedges more toward being politically correct. (By that I mean: the policy is correct for some political goal rather than some non-political goal.)  

In a recent post, Pierre Lemieux highlights one such case of politically-correct policy: tariffs on Chinese-made electric vehicles (EVs).  We are often told that global warming is a significant issue and one that warrants significant government involvement.  Indeed, it is the justification for many government subsidies to green energy (a reverse Pigouvian tax) and a carbon tax.  From that perspective, the tariffs on Chinese-made EVs make no sense.  If there is a negative externality, and there is a product on the market that can reduce the externality, then why effectively prohibit it?  The answer: because those cars were not politically correct.  They solved the market failure, but not in the politically desired way.  Thus, the administration, looking to protect its voter base and accomplish its own goals of staying elected, opted to take an action that makes the externality worse rather than better.  All in the name of stopping the externality.  

Why do I oppose a carbon tax?  Because I see no reason why it also will not become subject to such political correctness.  Even if it were possible to accurately and costlessly calculate the necessary tax, why should we believe it would not be implemented and designed in such a way as to favor certain groups and achieve political goals rather than economic?