TY  - JOUR
AU  - Allcott,Hunt
AU  - Mullainathan,Sendhil
AU  - Taubinsky,Dmitry
TI  - Energy Policy with Externalities and Internalities
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 17977
PY  - 2012
Y2  - April 2012
UR  - http://www.nber.org/papers/w17977
L1  - http://www.nber.org/papers/w17977.pdf
N1  - Author contact info:
Hunt Allcott
Department of Economics
New York University
19 W. 4th Street, 6th Floor
New York, NY 10012
E-Mail: hunt.allcott@nyu.edu

Sendhil Mullainathan
Department of Economics
Littauer M-18
Harvard University
Cambridge, MA  02138
Tel: 617/496-2720
Fax: 617/495-7730
E-Mail: mullain@fas.harvard.edu

Dmitry Taubinsky
Harvard University
E-Mail: taubinsk@fas.harvard.edu
AB  - We analyze how the traditional logic of Pigouvian externality taxes changes if consumers undervalue energy costs when buying energy-using durables such as cars and air conditioners. First, with undervaluation, there is an Internality Dividend from Externality Taxes: aside from reducing externalities, they also reduce allocative inefficiencies caused by consumers' underinvestment in energy efficient durables. Second, although Pigouvian taxes are clearly the preferred policy mechanism when externalities are the only market failure, undervaluation provides an Internality Rationale for Energy Efficiency Policy, including fuel economy standards and subsidies for energy efficient goods. However, this Internality Rationale has surprising features: it does not apply to all classes of behavioral biases, and the socially-optimal response to undervaluation may include energy taxes higher or lower than the externality damages, despite the resulting distortion to utilization. We calibrate our results in a simulation model of the US automobile market, finding that Pigouvian taxes actually increase consumer welfare and that the optimal subsidy for high-fuel economy vehicles could be quite large.
ER  -