Arnold Kling  

Feldstein vs. Nordhaus

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If you want to reduce gasoline consumption or carbon emissions, should you use a tax or tradable rights? Martin Feldstein argues for tradable gasoline rights (TGR's).


The government would decide how many gallons of gasoline should be consumed per year and would give out that total number of TGRs. In 2006, Americans will buy about 110 billion gallons of gasoline. To keep that total unchanged in 2007, the government would distribute 110 billion TGRs. To reduce total gasoline consumption by 5%, it would cut the number of TGRs to 104.5 billion.

William Nordhaus argues for a carbon tax.

if the curvature of the benefit function is small relative to the curvature of the cost function, then price-type regulation is more efficient; conversely, if the benefit functions are highly nonlinear while the cost functions are close to linear, then quantity-type regulation is more efficient.

While this issue has received little attention in the design of climate-change policies, the structure of the costs and damages in climate change gives a strong presumption to price-type approaches.


Feldstein's article does not really specify a "benefit function" for curbing the use of gasoline. One gets the feeling that his main concern is to fend off fuel economy regulations, which are indeed exercises in moral vanity--they do little to reduce gasoline consumption but they do help to brand auto companies as villains.


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TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/523
The author at The Glittering Eye in a related article titled Tradeable Gas Rights writes:
    The econbloggers are all abuzz with a proposal in the WSJ from Martin Feldstein for tradeable gas rights as a means of restraining the amount of oil consumed in this country: In a system of tradeable gasoline rights, the government would give each adul... [Tracked on June 5, 2006 9:02 AM]
The author at Knowledge Problem in a related article titled Martin Feldstein in WSJ on "Tradeable Gasoline Rights" writes:
    Lynne Kiesling Martin Feldstein has a column in today's WSJ (subscription required) in which he recommends that the government issue tradeable gasoline rights (TGRs) instead of either raising CAFE standards or imposing a gasoline tax. In a system of tr... [Tracked on June 5, 2006 10:17 AM]
The author at View From a Height in a related article titled Feldstein Proposes Gas Rationing - Roundup writes:
    Jaw-droppingly, that's what Martin Feldstein proposes in today's Wall Street Journal. In a system of tradeable gasoline rights, the government would give each adult a TGR debit card. The gasoline pumps at service stations that now read credit cards and... [Tracked on June 5, 2006 12:17 PM]
COMMENTS (12 to date)
Roger M writes:

Why reduce gasoline consumption? It seems to me that those who want to do so are just anti-trade. Yes, we depend on foreign oil, but oil exporters are more dependent on US dollars, and that's the way life should be. The natural division of labor forces us to depend upon each other and builds community.

Robert Schwartz writes:

TGRs are just rationing coupons. They will have a monetary value, which will be realized by old ladies living in high rises. A gas tax is the same, but the revenue goes to the public fisc.

rvman writes:

This is such a simple question - the tax is better. The information needed to set the tax correctly is a subset of the information needed to set the TGR correctly.

To correctly set the tradeable rights, you need to know what the 'right' level of purchasing is. In order to know that, you need to know the marginal social cost AND marginal social benefit of using gasoline, which includes both externalities and costs/benefits internalized by the buyer and seller. This involves exhaustive knowledge of private costs and benefits, as well as externalities.

To correctly set the carbon tax, you need to know the marginal externalities only. Private costs and benefits aren't needed, since the market will take care of them. This requires less knowledge - in fact, a subset of the knowledge the TGR requires. Unless gathering information on private values is free and perfect, (it is neither, for any non-trivial market) the tax is more accurate and/or less costly to determine.

Indeed, in all situations where you can choose either tradeable rights or an externality tax, the tax is better. Nonlinearity is irrelevant, except in near-perfect information environments. If you have nonlinearities, you set the tax based on your best estimate of externalities, and if the change in equilibrium Q is sufficient to change the marginal externalities, you adjust the tax to match. (Not only is the tax better than tradable rights, it is near-optimal, with decent information on externalities. Absolutely optimal, with perfect information on externalities, even with no knowledge whatsoever of the private values of the buyer and seller.)


This isn't a situation like in macro money where you can try to hit the equilibrium by controlling either variable - that would be the choice between TGRs and price controls. Both substitute government judgement for market choice. This is a choice between a real market with an externality adjustment, or an artificial market with a predetermined outcome in quantity.

Boonton writes:

If I had to rank how perferable these would be I would say a tax would be the best method because it is the most simple, fuel economy the second and tradable gasoline rights dead last.

Tradable emission rights have been shown to be quite useful but this method here seems very prone to abuse, huge administrative costs and endless bickering about allocations. A simple gas tax would accomplish all of the benefits while leaving the administrative costs much easier. If you're a deficit loving Bushie you could make the tax revenue neutral by using the money raised from it to lower some other tax.

Barring that I think fuel economy regulation does shift tastes away from gas guzzlers, especially during periods when cheap gas prices will encourage people to overlook the cost. I don't have the rigerous theoretical language to describe it but I would sum it up as "if you build it they will come". In other words, if the auto makers put resources into competiting on fuel economy sales will be driven there, if they compete on size sales will be driven there. The market in this case is imperfect.

That being the case, fuel economy standards are a blunt instrument. There is no reason an oversized SUV may not be the more efficient option in some cases. If, for example, you're managing a large carpool of 5 people an SUV probably burns less gas than buying 2 or 3 small cars (even if they are hybreds). A gas tax does not destroy the incentives for people to make such distinctions while fuel economy standards will.

mike writes:

It's not clear at all that a tax is better - even from an administrative viewpoint. Permits can trade on an open market and do not necessarily have to be initially allocated to anyone. However, one can envision that permit systems can be used as a de facto welfare program. Families that live in inner cities and do not need automobiles do not need permits - so if you allocated permits to everyone on an equal basis, these can be sold for revenue each year. This seems to be more palatable than a simple cash transfer program. However, such a program will not be such a good deal for the poor living in rural areas.

Matt writes:

I would like to hear the reason we want to reduce gas usage, according to Feldstein. The issue came up on Brad Delong's site.

If the reason we want to reduce gasoline usage is because of the national security cost, then deal with that. If it is global warming, then deal with that. If it is just price, then deal with that.

dWj writes:

Logistically, a gas tax seems easier, but cap-and-trade doesn't have to be purely "quantity-like"; you can start with an auction in which the quantity offered is a function of the price bid, in which case you end up presenting a God-fearing supply curve instead of one that has either zero or infinite elasticity.

another mike writes:

A day later, I still find it hard to believe that someone like Martin Feldstein would seriously propose such a thing. Maybe it was his tribute to the late John Kenneth Galbraith. The whole TGR thing sounds a lot more like a Hilary Clinton idea.

Maybe Feldstein is positioning himself for 2008.

Roger M writes:

I'm with Matt! Someone tell me why we should reduce gasoline consumption!

James writes:

I recall once reading Thomas Sowell where he explained that prices can be used as a rationing mechanism. I guess that idea is presently out of vogue...

Gary Rogers writes:

If the government decides to limit gasoline consumption, just think of the black market it would create. Then we could turn around and spend billions of dollars fighting crime and bringing those "low down" gas smugglers to justice. Never mind the sharp increase in gas prices that would be created by artificially fixing the supply below demand.

I vote for old fashioned market forces to keep supply and demand in balance and to encourage investment in new technologies when prices rise to the point that they become economically viable!

Gary Rogers writes:

The idea of a tax is not as scary as attempting to fix consumption, but a tax is just what it claims to be, a tax. It takes money out of the economy and puts it in the hands of our government who does not have the best record of spending money wisely. I agree that this would reduce consumption, but by inflicting the pain of even higher fuel prices on the consumer. Of course, to be fair, the "pain" caused by the high oil prices would have to be offset through subsidies for low income households. This would cost more than the revenue from the tax, but it is for the good of the people.

In short, I cannot see how this could be considered a good idea.

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