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Pigou in the 21st century
(2021)
The year 2020 marks the centennial of the publication of Arthur Cecil Pigou's magnum opus The Economics of Welfare. Pigou's pricing principles have had an enduring influence on the academic debate, with a widespread consensus having emerged among economists that Pigouvian taxes or subsidies are theoretically desirable, but politically infeasible. In this article, we revisit Pigou's contribution and argue that this consensus is somewhat spurious, particularly in two ways: (1) Economists are too quick to ignore the theoretical problems and subtleties that Pigouvian pricing still faces; (2) The wholesale skepticism concerning the political viability of Pigouvian pricing is at odds with its recent practical achievements. These two points are made by, first, outlining the theoretical and political challenges that include uncertainty about the social cost of carbon, the unclear relationship between the cost-benefit and cost-effectiveness approaches, distributional concerns, fragmented ministerial responsibilities, an unstable tax base, commitment problems, lack of acceptance and trust between government and citizens as well as incomplete international cooperation. Secondly, we discuss the recent political success of Pigouvian pricing, as evidenced by the German government's 2019 climate policy reform and the EU's Green Deal. We conclude by presenting a research agenda for addressing the remaining barriers that need to be overcome to make Pigouvian pricing a common political practice.
Carbon dioxide removal (CDR) moves atmospheric carbon to geological or land-based sinks. In a first-best setting, the optimal use of CDR is achieved by a removal subsidy that equals the optimal carbon tax and marginal damages. We derive second-best policy rules for CDR subsidies and carbon taxes when no global carbon price exists but a national government implements a unilateral climate policy. We find that the optimal carbon tax differs from an optimal CDR subsidy because of carbon leakage and a balance of resource trade effect. First, the optimal removal subsidy tends to be larger than the carbon tax because of lower supply-side leakage on fossil resource markets. Second, net carbon exporters exacerbate this wedge to increase producer surplus of their carbon resource producers, implying even larger removal subsidies. Third, net carbon importers may set their removal subsidy even below their carbon tax when marginal environmental damages are small, to appropriate producer surplus from carbon exporters.