Lawrence Solomon
National Post
January 16, 2008

Arthur Cecil Pigou, the celebrated 20th century economist who created a discipline over externalities, has developed a large following over the notion of taxing “bads” such as gasoline, and not just among economists. Environmentalists have taken up the theme over the last decade, and so, too, have many conservatives. Why tax meritorious activities such as earning an income, or purchasing a product, many argue, when taxing activities without merit can instead raise tax revenues?

Pigou provides an answer here, too. He didn’t just advocate taxing activity that creates harmful side effects, or negative externalities. He advocated subsidizing activities with beneficial side effects, or positive externalities. One such example, perfectly obvious to him in the early part of the last century, was farm subsidies to promote a sturdy labour force that could be conscripted for war. Another equally obvious example, in line with the Garden Suburb fashion of the day, was urban planning: It is as idle to expect a well-planned town to result from the independent activities of isolated speculators as it would be to expect a satisfactory picture to result if each separate square of inch were painted by an independent artist. No “invisible hand” can be relied on to produce a good arrangement of the whole from a combination of separate treatments of the parts. It is, therefore, necessary that an authority of wider reach should intervene and should tackle the collective problems of beauty, of air and of light, as those other collective problems of gas and water have been tackled.

The “bounties” that he advocated for the beautification of urban spaces – then the object of social reformers of all stripes – did come about, as well as the seizure of property rights that he espoused. These policies brought us slum clearances, abject public housing complexes, and the modern suburb, innovations that today’s urban planners generally revile. More profoundly, in hindsight most urban planners have come to value highest the old, unplanned parts of cities, a valuation that the public as a whole echoes, judging by the real estate prices in what we call Heritage Districts today.

Perhaps someone wiser than Pigou and the elites of his day would today know what future generations would value and what they would not. Perhaps government today are not subject to fads and ill-considered decisions. The problem remains, even for a prescient government, that activities some might write off as unmeritorious have enormous merit. In fact, this is precisely why activities with large negative externalities exist. The larger the negative externality, as a rule, the larger the positive externality.

Take the automobile, a common target of environmentalists, myself included. With proper policies, in my view, the auto would lose much of its market share, to the general benefit of society. The auto’s negative externalities are indisputable, I believe, but I also believe its positive externalities are indisputable. Without the auto, how could the sick be rushed to hospital, how could rural folk do their shopping, how could urbanites get to provincial parks on the weekends? The internal combustion engine is not without merit.

Other activities with large negative externalities – those coal plants that spew mercury, that pulp and paper mill that pollutes downstream residents, that boisterous neighbourhood bar – also keep our lights on, support rural communities, provide comradery and social cohesion. If it is fair to tax them for the bads they provide, it must be fair to reward them for the good they do.

But who would set those Pigouvian values by judging the rights and wrongs of each activity, and what confidence do we have that Pigouvian value setters would arrive at better results than those now on offer: the ballot box (which ultimately delivers polluting mill towns), the courts (which regulates nuisances and other common laws), and the marketplace (which drives efficiency improvements)? All three of these institutions need reform, by improving democracy, by strengthening the common law, by promoting freer markets. Pigou, undoubtedly, also has a role to play, one inversely proportional to the success in the reforms of these institutions.

Lawrence Solomon is executive director of Energy Probe and the Urban Renaissance Institute.