Gruber4e_ch06

Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 1 of 44Copyright © 2012 Worth Publishers

Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 2 of 44

6

Dan Sacks

P R E P A R E D B Y

6.1 Acid Rain

6.2 Global Warming

6.3 The Economics of Smoking

6.4 The Economics of Other Addictive Behaviors

6.5 Conclusion

Externalities in Action: Environmental and Health Externalities


C H A P T E R 6 ■ E X T E R N A L I T I E S I N A C T I O N : E N V I R O N M E N T A L A N D H E A L T H E X T E R N A L I T I E S

6.1

Acid rain is a classic negative production externality.

• Acid rain: Rain that is unusually acidic due to contamination by emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx).

• Two-thirds of SO2 emissions come from coal-fired power plants, mostly located in the Ohio River Valley.

The Damage of Acid Rain



6.1

Acid rain causes damage in a variety of ways :

• Increased acidity of lakes and streams

• Forest erosion

• Damage to property

• Reduced visibility

• Adverse health outcomes

The Damage of Acid Rain



6.1

To combat acid rain, Congress passed the 1970 Clean Air Act.

• 1970 Clean Air Act: Landmark federal legislation that first regulated acid rain–causing emissions by setting maximum standards for atmospheric concentrations of various substances, including SO2.

• Regulations only affected new plants, however, encouraging use of older, dirtier plants.

History of Acid Rain Regulation



6.1

How does acid rain (or SO2) affect health?

• The typical approach taken in this literature is to relate adult mortality in a geographical area to the level of particulates (such as SO2) in the air.

• The results are suspect: Areas with more particulates may differ from areas with fewer particulates in many other ways, not just in the amount of particulates in the air.

Estimating the Adverse Health Effects of Particulates



Estimating the Adverse Health Effects of Particulates6.1

Chay and Greenstone (2003) studied this question.

• Used an excellent quasi-experiment by examining the infant mortality rate, using the regulatory changes induced by the Clean Air Act of 1970.

• Some areas (“attainment”) did not have to reduce SO2 levels.

• Others (“non-attainment”) were required to do so.

• Infant mortality declined substantially in non-attainment areas, relative to attainment ones.



6.1

SO2 Levels in Attainment and Non-Attainment Areas



6.1

• Clean air acts reduced SO2 emissions but encouraged use of older plants.

• The 1990 amendments and emissions trading attempted to rectify this.

• SO2 allowance system: The feature of the 1990 amendments to the Clean Air Act that granted plants permits to emit SO2 in limited quantities and allowed them to trade those permits.




6.1

Has the Clean Air Act Been a Success?

• Led to dramatic improvements in infant health, among other things.

• But may have cost 600,000 jobs and $75 billion in polluting industries.




6.2

Global warming is a serious environmental externality.

• Gas emissions lead to increased global temperature because of the greenhouse effect.

o Greenhouse effect: The process by which gases in the Earth’s atmosphere reflect heat from the sun back to the Earth.

• Global temperatures are increasingly more rapidly than any time in the last 1000 years.

• Temperatures are projected to rise even more rapidly over the next century.

Global Warming



6.2

CO2 Output: 25 Largest Contributors



6.2

International cooperation will be necessary to address global warming.

• Montreal Protocol of 1987, which banned the use of chlorofluorocarbons (CFCs), an early example.

• As with global warming, this was a potentially enormous long-run problem.

• The CFC problem was showing itself immediately and urgently: By the 1980s, a 25-million-square-kilometer hole had opened in the ozone layer over Antarctica!

APPLICATION: The Montreal Protocol



APPLICATION: The Montreal Protocol6.2

• The Montreal Protocol was adopted, aimed for complete phaseout of specified chemicals (mostly CFCs and halons) according to specified schedules.

• The result is that scientists predict the hole in the ozone layer will begin to recover and return to normal around 2050.

• It may take some type of exciting event to spur action on global warming, which will not be solved for centuries after emissions are greatly reduced.

• If the world waits for a crisis to spur us into action, it may be too late.



6.2

In 1997, Kyoto hosted international negotiations to govern carbon emissions.

• 38 industrialized nations agreed to combat global warming by reducing their emissions of greenhouse gases to 7% below 1990 levels by the 2012.

• Written into a treaty that has since been ratified by 35 of the 38 signatory countries, and went into effect in early 2005.

• Not ratified by the United States.

The Kyoto Treaty



6.2

The Kyoto treaty allowed for international emissions trading.

• International emissions trading: Under the Kyoto treaty, the industrialized signatories are allowed to trade emissions rights among themselves, as long as the total emissions goals are met.

• Allows efficient countries to reduce their emissions on behalf of less-efficient ones (for a price).

Can Trading Make Kyoto More Cost-Effective?



Can Trading Make Kyoto More Cost-Effective?6.2

Price of reduction per metric ton of

carbon

Carbon reduction(millions of metric tons)

SUS

SR

$210

440190

20

0



Can Trading Make Kyoto More Cost-Effective?6.2

Price of reduction per metric ton of

carbon

Carbon reduction(millions of metric tons)

SUS

SR

59040

$50

0 630

ST



6.2

The Kyoto treaty did not involve developing nations.

• But by 2030, developing nations will produce more than half of the world’s emissions.

• Much cheaper to use fuel efficiently as you develop an industrial base than it is to “retrofit” an existing industrial base.

• By some estimates, an international trading system that included developing nations would reduce the cost of the Kyoto treaty by a factor of four.

Participation of Developing Countries



6.2

Developing nations want no part of this argument.

• The problem that the world faces today is the result of environmentally insensitive growth by the set of developed nations.

• Why should they be forced to be environmentally conscious and clean up the mess that the United States and other nations have left behind?

Participation of Developing Countries



6.2

• Developments since the Kyoto treaty of 1997 do not bode well for short-term agreements:

o United States rejection of the Kyoto treaty

o Difficulty of persuading developing nations to agree to reductions

• Recent evidence suggests that the nations of the world can come together to combat a global environmental threat, but only when that threat is urgent.

What Does the Future Hold?



6.2

In 2009, the House passed the American Clean Energy and Security Act (ACES) to help combat global warming.

• Lower limits on the amount of emissions allowed, and firms could comply with the tighter targets in a number of ways:

o Emissions reductions

o Purchase emissions permits

o Purchase pollution credits to offset their emissions

APPLICATION: Congress Takes on Global Warming



6.2

The ACES Act drew criticism from several sources:

• Some feared increased costs of energy production:

o Emitting firms would now either need to buy permits, buy credits, or undertake other expensive actions to reduce their emissions.

• Some felt that the full value of the allowances should be rebated to consumers and not simply given back to the polluting industries.

• Prospects in the Senate are unclear.

APPLICATION: Congress Takes on Global Warming



6.3

• Not all externalities are large-scale environmental problems.

• Some of the most important externalities are local and individualized.

• Many of these arise in the arena of personal health, and one of the most interesting is smoking.

The Economics of Smoking



6.3

Per Capita Annual Cigarette Consumption, 1990−2010



6.3

Cause of Death % of all deathsHeart disease, hypertension 22.9%Smoking 18.3Cancer 16.1Stroke, Alzheimer’s disease 8.4Respiratory diseases, flu, pneumonia 7.7Accident, suicide, homicide 6.5Diabetes, lung, liver, kidney diseases 5.8Other 14.2

Leading Causes of Death, 2008



6.3

Does Smoking Have Externality?

• Negative health consequences do not, by themselves, mean smoking has externalities.

• Externalities require that the smoker not bear all these costs.

• Rational smokers—who know the health risks—may internalize these costs.

• But there are several reasons that the costs might not be internalized.



6.3

The Externalities of Smoking: Increased Health Care Costs

Smoking increases health care costs. An externality?

• Not if people pay for their health care themselves

• Or if their insurance premiums are actuarially adjusted

o Actuarial adjustments: Changes to insurance premiums that insurance companies make in order to compensate for expected expense differences.

• Yes, if their insurance premium is not adjusted since non-smokers pay some of the cost



6.3

Smokers have lower workplace productivity because they are more likely to get sick and to take (smoking) breaks. Externality?

• Yes, if smokers and non-smokers are paid the same amount; then smokers end up taking profits from their employers or wages from non-smokers

• No, if smokers are paid according to their productivity

The Externalities of Smoking: Workplace Productivity



6.3

Smokers are much more likely to start fires than nonsmokers, mostly due to falling asleep with burning cigarettes. Externality?

• Yes, if smokers burn other people’s things

• Yes, if smokers burn their own things and fire insurance/fire department costs aren’t actuarially adjusted

• No, if smokers burn only their own things and the costs are actuarially adjusted

The Externalities of Smoking: Fires



6.3

Smokers’ early death might be a positive externality.

• Social Security and Medicare pay out until death.

• Early death of smokers means smokers receive less payment, leaving more money for non-smokers.

• But dying earlier also means smokers have fewer years to pay taxes.

The Externalities of Smoking: The “Death Benefit”



6.3

Secondhand smoke appears to be a classic externality.

• Yet the costs of secondhand smoke are not easily added to the list of external costs:o There is considerable medical uncertainty about

the damage done by secondhand smoke.

o Most of the damage from secondhand smoke is delivered to the spouses and children of smokers.

What about Secondhand Smoke?



6.3

• Economists usually assume that smokers follow the rational addiction model:

o They know the costs (which occur far into the future).

o They understand the possibility of addiction.

• This model may not be a good description of smoking.

o Youth smoking: More than 75% of adult smokers begin smoking before their nineteenth birthday.

Should We Care Only About Externalities, or Do “Internalities” Matter Also?



6.3

Many adults who smoke would like to quit but are unable to do so.

• Eight in ten smokers in America express a desire to quit the habit, but many fewer than that actually do quit.

• According to one study, over 80% of smokers try to quit in a typical year, and the average smoker tries to quit every eight and a half months.

• 54% of serious quit attempts fail within one week.

Adults Are Unable to Quit Smoking Even if They Have a Desire to Do So



6.3

Many smokers suffer from self-control problems and use commitment devices.

• Self-control problem: An inability to carry out optimal strategies for consumption.

• Commitment devices: Devices that help individuals who are aware of their self-control problems fight their bad tendencies.

o Smokers who want to quit make public promises to do so, making it embarrassing to smoke.

Adults Are Unable to Quit Smoking Even if They Have a Desire to Do So



6.3

If smokers are not rational, then intervention may be justified because of internalities.

• Internality: The damage one does to oneself through adverse health (or other) behavior.

• Taxation of cigarettes is a plausible, effective mechanism to discourage smoking.

Implications for Government Policy



6.4

The economics of drinking are different than smoking.

• Very large externalities:

o Damage due to drunk driving.

• Smaller internalities:

o Drinking in small quantities, while it may impair one’s driving, may actually be good for long-run health.

The Economics of Other Addictive Behaviors: Drinking



6.4

Drinking is regulated as well as taxed: People younger than 21 cannot drink.

• How does this regulation affect people’s health?

• Carpenter and Dobkin study this question using a regression discontinuity design, a very clean strategy.

• The RDD compares health outcomes of people just above and just below their birthday.

• These people are likely to be quite similar, so the RDD estimates the causal effect of being able to drink.

EVIDENCE: The Effects of the Minimum Drinking Age



6.4

EVIDENCE: The Effects of the Minimum Drinking Age



6.4

Most of the externalities associated with illicit drugs arise because of their illegality.

• Legal consumption of some illicit drugs is likely to have much lower externalities than consumption of alcohol.

• Milton Friedman in 1972:

“The harm to us from the addiction of others arises almost wholly from the fact that drugs are illegal…. addicts commit one-fourth to one-half of all street crime in the U.S. Legalize drugs, and street crime would drop dramatically.”

Illicit Drugs



6.4

Obesity has both enormous externalities and internalities.

• Addressing obesity through tax policy is hard: While every cigarette is bad for you, clearly some food consumption is good for you!

• Major policy focus:

o Improved information about caloric/nutrition content

o Targeting of the substances most closely linked to obesity, such as “trans-fats”

APPLICATION: Public Policy Toward Obesity



6.4

Alternative policies are under consideration:

• A number of states are considering taxes on sugary sodas.

• Some states have moved directly to charging individuals for being obese or for not caring for their weight.

• Other states and employers are providing financial incentives for employees to enroll in wellness programs that will help them manage their weight.

APPLICATION: Public Policy toward Obesity



6.5

• Public finance provides tools to help us think through the regulation of many kinds of externalities:

o Regional externalities such as acid rain

o Planet-wide externalities such as global warming

o Even the “internalities” of smoking and other health-related decisions

Conclusion



6.5

• Careful analysis of public policy options requires:

• Discriminating external costs from costs that are absorbed through the market mechanism

• Understanding the benefits and costs of alternative regulatory mechanisms to address externalities

• Considering whether only externalities or also internalities should count in regulatory decisions

Conclusion

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