Ayn Rand hearts Pigou

When a firm produces a good, they face a certain set of costs.  These costs could include wages, rent, raw materials, etc.  If production also leads to pollution, then that is a cost as well.  This extra cost is called an externality, because it is shouldered externally by society and not by the firm.  Since this cost does not enter to the firm’s production function, the cost the firm sees is lower than the true cost, which leads to overproduction.  In other words, the presence of an externality leads to an economically inefficient outcome.  There are very real economic costs associated with pollution, and the externality cost effectively acts as a subsidy from the rest of society to the polluter.

What to do about this problem?  Many argue in favor of a Pigovian tax.  Pigou’s idea was to internalize this cost by calculating the cost to society imposed by the externality and then taxing the firm by this amount.  If a firm is polluting, you can calculate the cost to society per unit of pollution and then put a per unit tax on production so that the firm sees closer to the overall cost (It won’t see the full cost because the incidence of these taxes don’t fall fully on the producer, but that doesn’t really matter).  The result is that the firm’s supply curve shifts up (and the demand curve shifts down), so that the quantity produced will fall.  You can then use the revenue gained from this tax to compensate those who are affected by the externality.  This outcome is more economically efficient and the firm now has an incentive to make its production process cleaner.  Cap-and-trade works through different mechanisms, but the results and rationales are similar.

What’s important here is that the outcome where  Pigovian taxes (or cap-and-trade markets) are used is economically efficient, and the outcome where neither is used is not.  The implicit subsidy given to firms who pollute is no different than the explicit subsidies given to the poor in terms of decreasing economic efficiency.  These firms leach off the hard earned money of the rest of society, burdening it with extra costs.  As Ayn Rand once said, “Whoever claims the right to redistribute the wealth produced by others
is claiming the right to treat human beings as chattel.”

Welfare Queen:


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