Wednesday 21 December 2011

Pigovean paternalism

Frances Woolley reports on problems in her students' understanding of Pigovean taxes. After a set-piece question asking students to calculate equilibrium Pigovean tax in an externality case, students were told to answer this last bit:
Opponents of the tax on potato chips take a careful look at Dr. Economides’ study. It turns out that the only people harmed by potato chip consumption are potato chip eaters themselves, as potato chip consumption is associated with bad skin, weight gain and depression. Does this strengthen or weaken the argument for taxing potato chips?
Frances rightly notes that weakens the case for Pigovean taxation; I'd go farther and say that it darn near obliterates it. If the argument for taxation is consumer irrationality, then, as Seamus has noted before, we've stepped rather outside of the rational choice framework that's necessary for assessing costs and benefits in the first place. What does a demand curve even represent in the case where consumers aren't competent to evaluate net personal benefits? Maybe we can derive it from observing consumer behaviour, but revealed preference goes away and the welfare analysis then has to start from a rather different place. Some of the behaviouralists have started building frameworks for that kind of analysis, with multi-self Pareto criteria, but it's hardly canon.
...it seems that some students really don't believe that people are rational decision-makers, fully taking into account the long-term effects of their consumption choices. Even when people are only harming themselves, they support Pigouvian taxes on paternalistic grounds, to stop people from harming themselves.
It seems to take irrationality of a very particular form for Pigovean taxes to be a solution to internality problems. We need it to be the case that consumers irrationally discount health costs of monetized value x but to respond optimally to taxes of equivalent value. If consumers are also irrationally price-insensitive, you've doubly hurt them by imposing the tax. And we still have the problems that arise once revealed preference can't form a starting point for welfare analysis.

And, despite the explicit framing of the question - that consumers only harm themselves - some students read into it that they were hurting the taxpayer through the public health system:
Some students disputed the basic premise of the question, the idea that potato chip eaters are only harming themselves. Bad skin, weight gain and depression, they argued, are harms to others, because we have a public health system. ...
What interested me about this response was how "health" becomes a lens through which public policy issues are viewed, and a justification of policy choices. Perhaps, though, the students were just mislead by the wording of the question. Guessing that the specific details about bad skin, weight gain and depression must matter in some way, they figured that the question must be asking about health care. 
These are upper level undergrads in economics, and they're messing up the distinction between pecuniary and technological externalities. Costs through the public health system are only a transfer unless these consumers are eating more potato chips than they would in a private system; in that case, only the deadweight costs of the increased portion of consumption get to count as policy-relevant on an efficiency standard.

I hate to keep banging on about this [hit the fiscal externalities tab below]. There's no way that the folks at Carleton wouldn't have hammered home the distinction between technological and pecuniary externalities. But fiscal externalities - externalities that work through the budget constraint but via the tax system - keep seeming technological to students when they're really mostly pecuniary. Partially this is because folks don't start with Buchanan and Stubblebine, but I expect that it has more to do with that fiscal externalities have seemed perhaps an interesting sidebar not worth extensive class time.

We are graduating too many students who know that negative externalities are bad and that government should tax negative externalities, but who have little sense of which ones actually have efficiency consequence.

13 comments:

  1. Eric - thanks so much for the link.

    To be fair - there are two public econ courses at Carleton, and the one that I teach has lots of non-majors. Now, given that these are likely to be future journalists, policy analysts, etc., any lack of understanding is a worry. But some of the students have had nothing more than econ 1000.

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  2. @Frances: We need, as a profession, to fix how we teach students about externalities at 100-level. Just about everything in the world is a potential externality demanding policy intervention IF fiscal externalities are technological. But they're mostly not. And we don't do enough to hammer that in.

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  3. "But fiscal externalities - externalities that work through the budget constraint but via the tax system - keep seeming technological to students when they're really mostly pecuniary. "

    This is a very good point. I get the sense that the concept of pecuniary externalities isn't one that instructors usually spend much time talking about - would you agree?

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  4. My sample size is too limited. I know our 100-level lecturers spend time on it, and that our calc-stream intermediate micro course does too.

    I can only infer what other places do from that so many folks who seem to have taken Econ 1 somewhere along the track make the mistake. And it isn't helped by that most texts use the "works through a market process" delineation of pecuniary versus non-pecuniary externalities rather than the Buchanan/Stubblebine "works through the budget constraint or works through the utility/production function" distinction. The two usually give the same answer, but fiscal externalities affect the budget constraint outside of a market process.

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  5. I don't know why it's so bizarre to use taxes paternally. Aren't most safety regulations there to protect people from their own stupidity? Would you prefer to get rid of them all? Seatbelt laws? Hard hats on construction sites? Fences on high bridges to dissuade suicide?

    While I agree that this type of regulation is seriously overt the top (in Australia at least, compared to Europe for example), it doesn't mean it should all be scrapped.

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  6. "Would you prefer to get rid of them all? Seatbelt laws? Hard hats on construction sites? Fences on high bridges to dissuade suicide?"
    Yes.

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  7. It seems to take irrationality of a very particular form for Pigovean taxes to be a solution to internality problems. We need it to be the case that consumers irrationally discount health costs of monetized value x but to respond optimally to taxes of equivalent value. If consumers are also irrationally price-insensitive, you've doubly hurt them by imposing the tax. And we still have the problems that arise once revealed preference can't form a starting point for welfare analysis.

    Cigarettes.

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  8. Also, if you think depression or obesity only have costs to society via medicine, you're simply hopelessly not-even-wrong.

    Question: am I more productive at work on a normal Tuesday, or in a locked mental ward? What if I was on the slab getting a triple bypass? Being ill stops people from working, and also forces other people to drop what they are doing and look after you.

    Extra credit: in a private medical system, what does the existence of potato-chip eaters in the population do to the premiums paid by everyone, including non-eaters, given that it is a priori impossible to say whether someone will eat chips at some point in the indefinite future?

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  9. If folks want to impose taxes for paternalistic reasons, they should be advocated and defended as paternalistic rather than hidden behind dodgy social cost numbers.

    People are paid roughly their marginal product; productivity is a personal cost, not a social cost.

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  10. @Cameron: If somebody wants to advocate a paternalistic tax explicitly and say "I think people cannot make good decisions on their own; this tax will force them to think harder about what they're doing to themselves", that's honest. I'll dispute the premise, but I won't get all angry about it.

    If instead they want to say "We need this tax because these evil smokers/whatever are imposing an externality through the tax system and we know that externalities are inefficient", that's just dishonest; the bulk of the effect is pecuniary, not technological, and (at least for smoking), the sign goes the other way.

    @Alex: If you're less productive, you're less likely to get a raise or promotion. Productivity isn't a cost to the country, it's a cost to you. And we indeed find that smokers earn less than others.

    Further, insurance companies aren't idiots. If you prove to be a higher ongoing risk, as revealed by cholesterol counts at later check-ups, they'll hike your premiums. Simply put, you don't have to be able to observe the inputs if you can observe and set premiums based on intermediates - the consequences of unhealthy behaviours that are the precursors to health costs.

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  11. "Costs through the public health system are only a transfer unless these consumers are eating more potato chips"

    That doesn't make sense.

    Do you perhaps mean "are not a transfer unless" or "are only a transfer if"?

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  12. If potato chip consumption is constant across private/public health world states, payment for health consequences is a transfer. If the shift to public defraying of costs results in greater consumption, the excess costs of that increased portion are efficiency relevant. I'm pretty sure that's what my sentence said....

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  13. Interesting article for you. Not of relevance to current post but would be interested in your post and comments
    http://www.project-syndicate.org/commentary/shiller80/English

    happy New Year,
    Phil Sage

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