Energy Policy with Externalities and Internalities
We analyze optimal policy when consumers of energy-using durables undervalue energy costs relative to their private optima. First, there is an Internality Dividend from Externality Taxes: aside from reducing externalities, they also offset distortions from underinvestment in energy efficiency. Discrete choice simulations of the auto market suggest that the Internality Dividend could more than double the social welfare gains from a carbon tax at marginal damages. Second, we develop the Internality Targeting Principle: the optimal combination of multiple instruments depends on the average internality of the consumers marginal to each instrument. Because consumers who undervalue energy costs are mechanically less responsive to energy taxes, the optimal policy will tend to involve an energy tax below marginal damages coupled with a larger subsidy for energy efficient products. Third, although the exact optimal policy depends on joint distributions of unobservables which would be difficult to estimate, we develop formulas to closely approximate optimal policy and welfare effects based on reduced form "sufficient statistics" that can be estimated using field experiments or quasi-experimental variation in product prices and energy costs.
This paper previously circulated as "Externalities, Internalities, and the Targeting of Energy Policy." We thank Ryan Bubb, Meghan Busse, Lucas Davis, Liran Einav, Larry Goulder, Michael Greenstone, Garth Heutel, Ryan Kellogg, Ted O'Donoghue, Jim Sallee, Josh Schwartzstein, Glen Weyl, Nathan Wozny, two anonymous referees, and seminar participants at the 2011 ASSA meetings, Duke, the Environmental Defense Fund, Harvard, MIT, NBER, New York University, the Stanford Institute for Theoretical Economics, UC Santa Barbara, Universidad de los Andes, and Yale for feedback and helpful conversations. We are grateful to the Sloan Foundation for financial support of our research on the economics of energy efficiency. MATLAB code for replicating the analysis is available from Hunt Allcott's website. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Allcott, Hunt, Sendhil Mullainathan, and Dmitry Taubinsky (Forthcoming). “Energy Policy with Externalities and Internalities.” Journal of Public Economics. Volume 112, April 2014, Pages 72–88 citation courtesy of