Toward a Pigouvian state.

AuthorMasur, Jonathan S.
PositionII. Agency Authority and the Absence of Pigouvian Taxes B. The Clean Water Act 2. New Sources through Conclusion, with footnotes, p. 122-148
  1. New Sources

    EPA has separate authority to regulate water pollution emanating from "new sources" that have been constructed or brought on line since the passage of the Clean Water Act. (127) The Clean Water Act treats new sources more strictly than existing sources, which are governed by the provisions discussed immediately above. With respect to new sources, EPA has the authority to set "standard[s] for the control of the discharge of pollutants which reflects the greatest degree of effluent reduction which the Administrator determines to be achievable through application of the best available demonstrated control technology, processes, operating methods, or other alternatives, including, where practicable, a standard permitting no discharge of pollutants." (128)

    This statutory section differs from EPA's more general authority over existing sources of pollution in two important ways. First, it is not technology-focused in the same way. The statute references the best available technology but does not suggest that EPA must mandate this technology as part of the standard. Rather, the "standard for the control of the discharge of pollutants" is tied to "the greatest degree of effluent reduction." The result is ambiguity regarding whether the standard must be structured in terms of a type of technology or an effluent limitation.

    Second, the statute permits more stringent regulation. A standard based upon the "best available demonstrated control technology" is stricter than one based upon the "best practicable control technology" or the "best available technology economically achievable," which are the standards governing existing sources. (129) The statute even explicitly contemplates an effluent limitation of zero pollution. This should facilitate EPA imposition of an effluent limitation of zero for purposes of creating a Pigouvian tax.

  2. Toxic Pollutants

    Finally, EPA has separate authority to regulate pollutants that have been designated as toxic. (130) Under this section, each toxic pollutant "shall be subject to effluent limitations resulting from the application of the best available technology economically achievable ...," (131) Though this section of the Clean Water Act uses language that again differs slightly from other parts of the statute, it resembles the statutory section governing existing sources in significant respects. The effluent limitations chosen by EPA are meant to "result [] from the application" of pollution-controlling technology, suggesting that regulation should specifically incorporate a mandate to install a particular type of technology. (132) The "best available technology economically achievable" language is also identical to the language governing existing sources. (133) Accordingly, the above analysis of Pigouvian taxes for existing effluent sources should apply here as well.

    All told, there would undoubtedly be hurdles to any EPA attempt to regulate certain types of pollutants and certain types of sources with Pigouvian taxes. But these complications, which are neither insurmountable nor ubiquitous, can hardly explain the complete absence of any regulations styled as Pigouvian taxes or, to our knowledge, any serious attempt to regulate using Pigouvian taxes. For such an explanation we must look elsewhere.

    1. Financial Regulation

    We next turn to financial regulation. Although commentators do not typically discuss financial regulation in terms of Pigouvian taxation, Pigou's theory applies to financial regulation just as it does to environmental regulation. (134) Financial institutions, like factories, generate negative externalities, and will not reduce their activity to the socially optimal level unless forced to do so by regulators.

  3. Negative Externalities in Finance

    1. The Risk of a Panic

      Banks and other financial institutions frequently fund themselves through very short-term debt, including debt that is due on demand. Commercial banks heavily rely on deposit accounts, where customers park funds for short periods in return for interest and checking services, and can also withdraw those funds at any time. Commercial banks and other financial institutions--including investment banks--also fund themselves through the repo market. In this market, large institutions, like pension funds, make short-term (one- or two-day) collateralized loans that are routinely rolled over. "Withdrawing" effectively occurs when the lender refuses to roll over a loan because it prefers to invest those funds elsewhere.

      Short-term debt creates a negative externality. (135) When a depositor or other short-term lender withdraws money, it increases the probability that the borrower will not have enough funds to pay other lenders when the loans are due or demanded. Those lenders will not be able to recover in full because of bankruptcy. To protect themselves, lenders may withdraw funds in response to other lenders withdrawing their funds, leading to a run. The firm may be forced to sell assets into a declining market, resulting in losses. If firms are shut down, then real value consisting of the firm's private information and contacts may be lost. (136) And if the collapse of one firm leads to the collapse of other firms, resulting in a full-blown contagion of the sort seen in 2008, the sudden massive withdrawal of credit from the economy can cause severe macroeconomic effects, including unemployment.

      The government tries to deter runs by requiring banks to offer FDIC insurance to depositors and by acting as a lender of last resort. (137) The idea is that if short-term lenders know that the government will protect them, they are less likely to jump the gun and withdraw. However, government insurance creates a new problem in the form of moral hazard. Because financial institutions expect to be rescued, they will take greater risk, enjoying the upside if the risk pays off and transferring the loss to the government if it does not. Moreover, even if deposit insurance were correctly priced, or creditors adequately monitored financial institutions, every institution would still create a negative externality from risk-taking behavior by increasing the probability of default and losses to other institutions, which could in turn trigger a system-wide collapse with negative effects for the economy. (138)

      As John Cochrane has argued, the simplest response to this problem is a Pigouvian tax. (139) Every time a bank borrows $100, there is a tiny increase in the risk of a run that could result in a financial crisis. (140) Although the risk is tiny, the losses associated with financial crisis are huge, so the tax itself may well be substantial. Cochrane suggests a tax of five percent--meaning that the bank would be required to pay $5 to the government for every $100 it borrows, with the precise amount depending on various factors including the maturity of the debt.

      With the Pigouvian tax in place, the bank would borrow on the short-term debt market only when its private gains exceed the social costs--the private cost of paying interest to the creditor plus the expected social cost of a run. If the cost is too high, the bank will either lend less money, or raise money on the equity markets. Because equity investors have no right to payment, an equity investment does not raise the risk of a run. Cochrane believes that a Pigouvian tax would reduce banks' reliance on short-term debt, which should create a safer banking system and a lower risk of financial crises.

    2. Races to Information

      A second example of the social cost of financial activity is the problem of "races," first identified by Jack Hirshleifer. (141) The value of an asset is a function of information about the various factors that affect the supply and demand of that asset. For example, the price of oil depends on information about the prospect of war in the Middle East or the likelihood of continued economic prosperity in China. When new information about events like these comes into existence, market participants will scramble to be the first to trade on the information.

      To understand why, suppose that a barrel of oil currently trades at $100. A terrorist attack destroys a pipeline in an obscure part of the world and raises the possibility of additional disruption of the oil supply. When the market learns of the attack, the price of oil will rise to $105. Any person who learns about the terrorist attack first, can buy oil (or oil futures or other derivatives) at $100 and reap a quick profit of $5 per barrel by selling when the price rises.

      The prospect of such profits will encourage investors to spend money to obtain information about events before others. Investors have spent vast sums to construct fiberoptic cables that increase the flow of information by nanoseconds. For example, Spread Networks, a high-speed trading firm, paid $300 million to build cables from New York to Chicago so that they could trade on the Chicago exchange using New York information microseconds before the market learned the information. (142) Investors have purchased and leased buildings close to exchanges for the same reason. (143)

      This activity is socially wasteful. (144) To see why, consider first why it is valuable for information to spread at a relatively speedy rate. If terrorism is increasing, then oil will become more expensive because it will be harder to produce and ship. If the market learns this information quickly, then airlines, trucking companies, consumers, and others can quickly adjust by engaging in alternative activities--for example, by relying more on electricity. However, the key point is that the broader market will not benefit at all if information about terrorism, as embodied in market prices, reaches them a nanosecond quicker than it otherwise does. Thus, high-speed investors incur expenses in a socially wasteful race.

      This problem can be addressed with a Pigouvian tax. The economist James Tobin famously advocated just such a tax, now known...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT