THE MYTH OF SOCIAL COST.pdf - Institute of Economic Affairs

EPILOGUE
Pigovian solution for an externality—a tax or subsidy imposed
unilaterally on its producer—did not result in an optimal
allocation of resources, because the behaviour of the consumer
of the externality has to be altered as well. If an optimal
allocation of resources is to result from an external diseconomy,
not only must the producer ofthe externality take into account
the costs imposed on the consumer, but the 'consumer' must
also take into account the costs imposed on the producer
(i.e., benefits forgone) by any reduction of his activities
resulting from the tax. And the 'consumer' will not do this
unless a 'tax' is imposed on him for securing the benefits of the
reduction in the externality.
The use of taxes and subsidies by government to correct for
externalities requires not unilateral tax/subsidisation on the
producer(s) of external effects but bilateral taxation/subsidisation
of both the parties to the effect. In other words, the use of
taxes and subsidies to correct for externalities could be administratively
very complex—and costly. This conclusion is
discussed further in 4 (below).
(Recently Professors S. A. Y. Lin and D. K. Whitcomb have
sought to defuse this criticism. 1 They show, in a mathematically-advanced
treatment, that it would be possible in principle
for government to operate a unilateral tax or subsidy scheme
to correct for externalities. Their model assumes, however, that
both firms and government have perfect and costless information,
and also that the costs of policing are zero. The absurdity
of the model is that, if these conditions were true, there would
be no need for government intervention to correct for externalities. A
'bargaining solution' would automatically emerge for every
externality: they would all be internalised by trade.)
3. Jointly-supplied external benefits and costs
Many external effects have both cost and benefit elements to
them—as in Professor Cheung's examples of airports and
neighbourhood schools (above, Section III). A Pigovian tax/
subsidy solution for such externalities would be even more
administratively complex—and costly.
4. The administrative costs of government correction of
'market failure'
An implicit—but clearly untrue—assumption of the Pigovian
1 'Externality Taxes and Subsidies', in S.A.Y. Lin (ed.), Theory and Measurement
of Externalities, Academic Press, New York, 1976, pp. 45-60.
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