Lucas: Shaping Preferences With Pigouvian Taxes

Gary Lucas, Jr. (Texas A&M; Google Scholar), Shaping Preferences with Pigouvian Taxes:

A Pigouvian tax is a tax that is imposed to correct an externality, which arises when a person engages in behavior that harms others without their consent. Pigouvian taxes are popular among academics—with prominent economists and legal scholars arguing for their imposition on myriad goods and activities that harm third parties, like carbon emissions and alcohol. Policymakers have recently been receptive to at least some of these arguments as evidenced by taxes imposed on or proposed for a variety of externality-generating goods, including guns, plastic bags, and sugary drinks.

The conventional economic rationale for Pigouvian taxes assumes that they affect behavior by increasing the price of taxed goods and not by altering people’s underlying preferences for them. For example, a carbon tax reduces driving by making gasoline more expensive, but it otherwise leaves people’s desire to drive unchanged. This conclusion follows from the standard assumption in economics that people’s tastes and preferences are fixed and determined exogenously to public policy.

Contrary to standard analysis, I argue that Pigouvian taxes can in fact shape preferences and that policymakers should consider using them for that purpose. A carbon tax, for instance, would not only make driving more expensive, it might also modify preferences such that people develop a taste for alternative modes of transportation—making driving less desirable, even if we ignore the increase in gas prices.

I make an original contribution to the literature on Pigouvian taxes by explaining in detail the psychological mechanisms through which these taxes can alter preferences. I also argue that once we relax the assumption of fixed preferences, the already strong case for Pigouvian taxes often becomes even more compelling. Specifically, preference endogeneity means that the loss in consumer utility resulting from Pigouvian taxes will often be smaller than standard analysis suggests. Moreover, malleable preferences dramatically expand the potential scope for Pigouvian taxes and enhance their impact on behavior through a social multiplier effect that can make taxes more effective in achieving public policy goals than scholars have traditionally assumed. I illustrate these points in a variety of policy-relevant contexts, including environmental law, gun control, and public health policy.