Bovine Intervention

A couple of weeks ago, economist Greg Mankiw pointed to an interesting story about so-called cow tax proposals in Europe. The taxes would apply to farmers and ranchers, based on the number of animals they raise—the more cattle in your herd, the larger the tax bill. Thus far, lawmakers in Ireland and Denmark have struck such measures down. The defeated Irish proposal put the tax at €13 for each dairy cow and the Danes were considering a tax as high as €80 per cow.

Why tax livestock? In a word, flatulence. (In two, enteric fermentation.) Cows belch and otherwise discharge their way to about 14% of the world's methane emissions. Like carbon dioxide, methane is a greenhouse gas. Although methane accounts for a relatively small share of all greenhouse gas emissions, it is alarmingly effective at preventing heat from escaping the planet. Compared to carbon dioxide, a little bit of methane goes a long way toward raising the potential for climate change. Reducing methane emissions would help Denmark and Ireland meet their EU climate policy commitments.

Raising livestock generates a negative externality: the costs of methane emissions are born by the general public rather than those directly involved in the production and consumption of meat and dairy. The emissions cause the marginal social cost of producing a pound of beef to exceed the marginal private cost.

The proposed taxes are an attempt to force farmers and ranchers to internalize the heretofore external costs of the methane emissions, bringing the private costs of raising livestock closer inline with the social costs. The tax would raise the costs of producing meat and dairy, reduce the supply of such products, and, consequently, lower methane emissions.

While a tax based on the number of cattle in a herd would undoubtedly reduce farming-related green house gas emissions, it would do so in rather blunt fashion. To see why, consider two ranchers. The first uses specialized cattle feed to reduce the methane emissions of his herd. The second sticks to traditional methods with the typically methane-intensive results. The cow tax, however, is levied equally on each head of cattle, failing to account for the methane reduction efforts of the first rancher.

While the cow tax provides an incentive to cut back on cattle, it doesn't encourage ranchers to adopt any of the promising technologies devised to reduce methane discharge from individual cows. Ideally, climate change policies should focus on the amount of methane emitted rather than the number of cows.

Discussion Questions

1. Can you think of policies to incentivize the adoption of methane-reducing technologies in farming and ranching?

2. Governments in Europe and the United States heavily subsidize the farming and ranching sectors of their economies. How would the removal of such subsidies impact methane emissions in Europe and the U.S.? What about methane emissions from less developed countries?

Oil Prices and Expectations

Harvard economist Martin Feldstein's latest opinion piece in the Wall Street Journal argues that we can implement policies today that will impact the current price of oil. Current oil production responds to expectations about the future, Feldstein explains. Any significant change in expectations about the future price of oil will have an immediate impact on the current supply of oil. Broadly speaking, the expected price of oil changes for one of two reasons:

1. Changes in expectations about the growth of oil demand; and
2. Changes in expectations about the growth of oil supply.


How might changes in expected oil demand lead to higher current prices? As Feldstein points out, "when oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed." If oil producers expect higher future prices for oil, they will curb production today (leave some oil in the ground) in hopes of extracting it at higher prices in the future. On the graph, the current supply of oil shifts to the left, to S1, causing the current price of oil to rise to P1 and the current quantity of oil to decline.

How might changes in expected oil supply lead to higher current prices? Again, from the editorial: "[C]redible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil." If producers expect oil supply growth to weaken in the future, the expected future price of oil rises, and oil producers leave some oil in the ground today in order to extract it at higher future prices. Once again, we'd expect the supply curve for oil to shift to the left, causing the price of oil to rise (to P1) and the quantity of oil to decline.

An increase in expected oil supply or a decrease in expected oil demand would lead to lower current oil prices. If oil producers think that future cars will be much more fuel-efficient than previously believed, they'd expect relatively weak growth in oil demand, and correspondingly lower future prices. In this case, producers respond by pumping more oil today in an effort to avoid lower future prices. Similarly, as Feldstein points out, "increasing the expected future supply of oil would also reduce today's price."

Discussion Questions

1. Although Feldstein points out that a significant increase in expectations about the future supply of oil would put downward pressure on today's price of oil, he does not explicitly endorse a policy of drilling in currently protected areas of the United States. The crucial question is whether or not future drilling in currently protected areas would have a large enough impact on worldwide oil supply to trigger production changes today. What do you think?

2. There's much discussion in the news about how to develop alternative sources of energy that would reduce the future demand for oil. What are some policies that would reduce the future demand for oil and oil-derived products, like gasoline? Would government commitment to these types of policies be credible enough to lower expectations of future oil prices?

3. Not all economists agree with Feldstein about the ability of current energy policies to impact current oil prices. Many (though not necessarily most) believe that there is very little the government can do to achieve lower oil prices in the next few months or years. Why might this be the case?

Ireland's Plastic Bag Tax

In an important scene from the 1999 movie American Beauty, two characters—Jane and Ricky—watch footage of a plastic bag dancing in the wind. That there's beauty all over the place, even in garbage, seems to overwhelm Ricky: "Sometimes there's so much beauty in the world, I feel like I can't take it, like my heart's going to cave in."

Unlike Ricky, Dubliners have to live without the heartbreaking splendor of airborne garbage. Plastic bags nearly disappeared from Ireland's cities after the government began taxing them in 2002. The tax, 33 cents per bag, was enough motivation for most shoppers to replace plastic bags with reusable cloth bags. Ireland's experience illustrates a basic principle of taxation: if you want less of something--like the not-so-biodegradable, sewer-clogging plastic bag--tax it. Read Elisabeth Rosenthal's New York Times article to learn more about Ireland's bag tax.

Discussion Questions

1. There's nothing like a green tax to bring out our inner-environmentalists. As Rosenthal points out, after the tax passed, plastic bag use became socially unacceptable in Ireland. In what way does the tax lower the barrier to adopting a disapproving attitude toward plastic bag use?

2. Ohio issues yellow and red license plates to drivers convicted of drunk driving (apparently, Ohio officials didn't give much thought to tourists from the great state of New Mexico). Can you think of other situations or even laws that are governed largely by the threat of disapproval from others?

3. How is the Irish government's campaign against plastic bags similar to government campaigns against tobacco? In what ways do cigarette and plastic bag taxes increase efficiency for society as a whole?

4. Taxing bad behavior can be good, but implementation and enforcement are issues. It'd be relatively easy to cut down on paper waste from ATM receipts because the fee can be collected electronically at the site of the transaction. Why does a plastic bag tax that works remarkably well in the digitized supermarkets of Ireland run into implementation problems among the vendors and mom and pop shops in China?

Labels: Taxes, Incentives, Market Failure, Externalities, Environment

Can Economics Take the Guilt out of Conspicuous Consumption?

Looking at the world through economic lenses can often take the emotional charge out of otherwise controversial decisions. Take the environmental consequences of gasoline consumption. Instead of feeling guilty about driving a big SUV or thinking ill of those who do, why not take the approach suggested by this Time magazine article on carbon budgeting?

What if everyone in the country received the same number of pollution credits regardless of whether they owned a car? The question of who gets to pollute is reduced to a matter of who is willing to incur the cost. And people who do not own cars or who seldom drive benefit from their ability to sell their credits to those who need or want them. The next time someone passed you in a Hummer, you'd know she paid a greener soul for the right to do it.

Discussion Questions

1. How would the pollution-credit scheme change the tradeoff between driving and alternative modes of transportation?

2. Harvard economist Greg Mankiw advocates a gasoline tax for a variety of reasons, including environmental considerations. How is a pollution-credit scheme different from enacting a stiffer tax on gas? How would government enforce pollution-credit usage? Which system would require fewer administrative costs?

3. Critics note that stiffer gasoline taxes would be regressive. That is, a relatively rich person with a gas-guzzling SUV would still devote a smaller share of his or her income to gas taxes than a poor person with a fuel-efficient compact. Would a pollution-credit system face similar concerns?

Taxing Traffic

In a bold speech delivered on Earth Day, New York City Mayor Michael Bloomberg proposed broad changes to improve the environment in the city. A centerpiece of this proposal, sure to be controversial, is an attempt to deal with traffic problems by imposing congestion charges on drivers who enter Manhattan. By charging motorists, the mayor aims to reduce pollution and relieve driving difficulties in the city. The plan would result in payments of up to $8 per day for drivers ($21 for trucks) who enter the busiest sections of the city—what the report calls the “Manhattan Central Business District.” The revenues generated by the fees would be used to fund transportation programs throughout the city, including road improvements, expansion of public transit, promotion of cycling, and increased enforcement of traffic laws.

While Bloomberg’s proposal is innovative, New York is not the first city to consider such fees. Congestion charges have been in place since 2003 in London; and Stockholm, Singapore, and Toronto (among others) employ similar types of fees. The results in London have been fairly dramatic: the number of automobiles in the city decreased by more than 30%, traffic delays declined by 20%–30%, and average road speeds increased by nearly 20%. Opponents of the London plan—and there were many—argued that it would “strangle retailers,” but the feared drop in sales has not materialized.

City traffic imposes dual externalities on residents and commuters—there is the pollution produced by the vehicles in the area, but there is also the effect of traffic itself on drivers. Each driver represents only a small proportion of the actual traffic, but when all of the drivers are added in, the impact can be dramatic, slowing commute times substantially. Congestion charges represent a direct application of what is referred to as a corrective tax—forcing drivers to internalize the external costs that they impose on other drivers. For example, if the average commuter’s opportunity cost is $16 per hour, and the presence of an additional motorist increases the driving time of all other drivers by a total of 30 minutes each day, then the proposed charge of $8 per day could be interpreted as an appropriate tax.

Discussion Questions

1. How would drivers who pay the fees benefit from this program?

2. Beyond the expected benefits of reduced pollution and traffic congestion resulting from the congestion charges, are there other effects that could result from the imposition of these fees?

3. How would the benefits and costs of such a program be distributed?

Harold Elder is a professor of economics at the University of Alabama. His research and teaching focuses on applied microeconomics, including law and economics, public sector economics, and a range of public policy topics. He regularly teaches Principles of Microeconomics in the College of Commerce and Business Administration and is the advisor for his university's master's and Ph.D. programs.

Tiger Conservation

The EDS Corporation's cat herding commercial is good for a laugh, but Barun Mitra--director of the Liberty Institute--is entirely serious about tiger ranching in China and India. According to Mitra, tiger pelts sell for as much as $20,000 on the black market and growing demand for traditional Chinese medicines makes other parts of the tiger lucrative as well. The currently illegal trade in tigers and tiger parts presents an increasingly valuable opportunity for poachers. Poaching, in turn, plays a significant role in keeping the tiger close to extinction. Mitra believes a legal market for tiger parts will save the tiger from extinction. Read his op-ed column in The New York Times to see why.

1. What is the current approach to tiger conservation in India and China?

2. Mitra points out that farmers and ranchers have a strong incentive to ensure that marketable species of livestock (sheep, cattle, chickens, and the like) do not go extinct. Does his argument for conservation through market mechanisms apply to other wild endangered species? Do tigers need to be ranched like cattle in order to give humans an incentive to conserve them?

3. Consider an alternative to outright tiger ranching. Mitra cites a program in Zimbabwe where villagers had property rights on local wildlife. How did the villagers use their property rights to earn money? What conservation incentives did they face? Would similar programs in China and India reduce the threat of tiger extinction? How would villagers with property rights on tigers feel about poachers?

4. Is poaching the only thing keeping tigers close to extinction? What about habitat encroachment? Could a legal market in tiger parts or licensed tiger hunting help to preserve tiger habitat?

Tax Carbon, Not Income

Charles Wheelan--Yahoo! Finance columnist, author of Naked Economics: Undressing the Dismal Science, and public policy lecturer at Chicago's Harris School--has a knack for user-friendly explanations of economic ideas.

The Naked Economist has a modest policy proposal for Presidential hopefuls, Democrat or Republican: Tax carbon, not income. Wheelan proposes a revenue neutral tax policy: Increase taxes on carbon-based energy, like gas and coal, reduce income and payroll taxes, and engineer the changes in such a way that government tax revenues remain the same. Americans might balk at paying even higher prices at the pump, but under Wheelan's proposal they'd write smaller checks to the IRS. Wheelan makes the case for revenue neutral energy tax reform in his latest Yahoo! Finance column.

1. How would the carbon tax change our behavior--the cars and appliances we buy, our driving habits, the way and extent to which we heat or cool our homes? According to Wheelan, what are some environmental and geo-political benefits of the carbon tax? How do payroll and income tax cuts affect our incentive to work?

2. Negative externalities occur when we do stuff that's bad for other people without compensating them for the inconvenience. To what extent would a carbon tax reduce negative externalities associated with fossil fuel consumption?

3. A tax is regressive when the share of your income devoted to the tax declines as your income rises. Since lower-income households tend to spend a greater share of their income on energy than higher-income households, the carbon tax would be regressive. How could policymakers reduce the regressive impact of the carbon tax when cutting income and payroll tax rates?

4. How would our long-term response to carbon taxes present problems for the revenue neutrality of Wheelan's proposal? (In econ jargon: how does the price elasticity of demand for carbon- based energy change as time passes?)

A Convenient Falsehood?

Global warming is in the news a lot lately, not least because of "An Inconvenient Truth," a documentary about Al Gore's position on the subject. Ten years ago, the discussion about global warming centered on whether it exists; a broad scientific consensus now seems to have concluded that it does. Therefore, the question now under discussion is: What should we do about it?

Bjorn Lomborg's answer is: not much. Lomborg, an associate professor of statistics at the University of Aarhus in Denmark and the author of "The Skeptical Environmentalist," organized a conference called the "Copenhagen Consensus." In 2004 he invited a number of notable economists, including four Nobel laureates, to discuss the greatest challenges facing humanity--and to evaluate the relative costs of meeting them. A few weeks ago, he followed this up with a group of U.N. ambassadors. To each group he posed the classic economists' question: in a world of scarcity, what is the best use of resources? A more prosaic way of posing the same question: given a certain amount of money to "do good" with--say, $50 billion--what is the most effective use of that money?

Both the economists and the U.N. ambassadors ranked combating climate change at the bottom of the list. Their logic was that the other potential uses of resources--providing sanitation to combat malaria, giving relief to post-conflict regions to help reduce the risk of repeat conflict, etc.--had a much higher benefit than directing resources to combat climate change. For example, according to Lomborg, the panels found that:

Forty dollars of good would be achieved for every dollar spent on HIV/Aids prevention. In other words, a dollar's worth of condoms in the right place would bring benefits an Aids-affected community would value at $40…Spending the world's limited resources combating climate change would achieve good, but would cost more than it would achieve. That money could be better spent elsewhere.

Lomborg is, of course, right that resources are scarce, and that the costs and benefits of any action should be carefully considered. He may even be right that in monetary terms, other, more immediate projects have a bigger bang for the buck. But there is a valid counterargument.

On the Environmental Protection Agency's web site on global warming, there's a section designed for kids. It poses the problem of climate change as follows:

Sometimes little things can turn into big things. Think about brushing your teeth. If you don't brush for one day, chances are nothing bad will happen. But if you don't brush your teeth for one month, you may develop a cavity. It's the same thing with global temperatures. If temperatures rise above normal levels for a few days, it's no big deal – the Earth will stay more or less the same. But if temperatures continue to rise over a longer period of time, then the Earth may experience some problems.

Lomborg's argument, in short, comes down to this: on any given day, there are better things to do than go to the dentist. The appropriate counterargument is: yes, but if you never go to the dentist, your teeth rot.

1. Apart from global warming, what do you think is the single most important issue facing the nation and the world? If you had $50 billion to spend on that and on measures to combat global warming, how would you allocate those resources?

2. One of the necessary conditions of examining climate change is developing some way of comparing current costs and future benefits. Economists usually do this by discounting--that is, multiplying future benefits by a factor less than one to calculate the "present value" of those benefits today. How would a change in this discount factor affect the relative merits of different programs? If the discount factor were higher (closer to 1), would combating global warming have had a higher ranking by the Copenhagen Consensus? How would you compare the costs of combating global warming with the benefits?

3. One of the greatest challenges to the U.S. economy is the skyrocketing cost of health care. As with global warming, part of the health care challenge is that we have bad habits--like eating burgers and fries--that, added up over the course of a lifetime, result in serious conditions like heart disease. However, the immediate taste benefit of eating any particular burger may be much greater than the incremental health cost of eating that burger. Similarly, for you, the benefits of driving to work on any given day outweigh the costs to the environment--but when taken in total, the costs of everyone driving to work every day for decades on end mount up to serious problems. What methods do people use to develop healthier lifestyles? Could those methods be applied to the problem of global warming?

Dollars for Trawlers

Trawlers are boats that drag large nets along the bottom of the ocean in an effort to catch ground-fish like cod, haddock, and flounder. As a recent National Public Radio (NPR) story reports, trawler captains along California's central coast made a killing in the early 1980s. Predictably, other trawlers arrived on the scene to get in on the exceptional profits. Dragging a big, weighted net along the ocean floor is not without its environmental impacts. A permit system prevented over-fishing, but the environmental consequences for the seafloor escalated even as a combination of restricted fishing, competition from new trawlers, and rising fuel costs weakened the earnings of central coast trawler captains.

Enter the Nature Conservancy.

The Nature Conservancy offered to buy fishing permits and trawler boats. After purchasing permits the Conservancy can retire permits entirely or lease them back to the fisherman with a legal constraint on the fisherman's vessel that prohibits trawling. Either way, the trawler buy-out program reduces trawling--those captains who lease permits from the Conservancy are free to fish for permitted species so long as they swear off trawling. The program illustrates an important point. Frequently, the most efficient use of a resource--in this case the seafloor--is its conservation.

1. Fishermen who lease permits from the Conservancy can catch as many fish as the permits allow, provided they use non-trawling techniques. As the NPR story mentions, the federal government is also stepping up efforts to protect swaths of seafloor from trawling.

How will the reduction of trawling along the coast affect the price that California fishermen receive for their catch of ground-fish (the types of fish most commonly caught by trawler nets)? How does the trawler buy-out program affect the trawler captains who choose not to sell their boats or permits to the Conservancy? Do you think the combination of federal regulations and private trawler buy-outs will lead to newer, less environmentally intrusive methods for harvesting ground-fish?

2. The Conservancy's trawler buy-out program is a market-based solution to a negative environmental externality (neither the trawler captains nor the fish consumers incur the environmental costs of seafloor disruption). The government's role is limited to enforcing the contracts between the Conservancy and the fishermen.

How does the Conservancy's approach to conservation differ from that of other environmental groups?

3. Other examples of market-based efforts to curb environmental degradation include greenhouse gas credit buy-outs (see a related Marketplace story here). In what ways are systems of exchangeable permits and credits more efficient vehicles for conservation than government regulations that cap harvests or emissions on a firm-by-firm basis?

Go here for more information on the Nature Conservancy's trawler buy-out program.