Author: Robert Frank

Robert H. Frank is the Henrietta Johnson Louis Professor of Management and Professor of Economics at Cornell's Johnson Graduate School of Management and the co-director of the Paduano Seminar in business ethics at NYU’s Stern School of Business. His “Economic View” column appears monthly in The New York Times. He is a Distinguished Senior Fellow at Demos. He received his B.S. in mathematics from Georgia Tech, then taught math and science for two years as a Peace Corps Volunteer in rural Nepal. He holds an M.A. in statistics and a Ph.D. in economics, both from the University of California at Berkeley. His papers have appeared in the American Economic Review, Econometrica, Journal of Political Economy, and other leading professional journals. His books, which include Choosing the Right Pond, Passions Within Reason, Microeconomics and Behavior, Principles of Economics (with Ben Bernanke), Luxury Fever, What Price the Moral High Ground?, Falling Behind, The Economic Naturalist, and The Darwin Economy, have been translated into 22 languages. The Winner-Take-All Society, co-authored with Philip Cook, received a Critic's Choice Award, was named a Notable Book of the Year by The New York Times, and was included in Business Week's list of the ten best books of 1995. He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought. He was awarded the Johnson School’s Stephen Russell Distinguished teaching award in 2004, 2010, and 2012, and its Apple Distinguished Teaching Award in 2005.

Financial Advisor Malpractice?

In light of how badly millions of Americans were burned in last year’s financial meltdown, there’s an eager audience for personal financial guidance. But consumers should take pains to ignore one particular piece of advice that’s been making the rounds of late.

I first heard about it in an October email from a Consumers Digest reporter who was writing a piece about financial planner Robert Pagliarini’s new book, “Plan Z: How to Survive the 2009 Financial Crisis.” Pagliarini urges his readers to employ the following strategy: Pay only the minimum payment on your credit cards, and deposit the difference into a savings account that can help you cover expenses in case of financial emergency.

Almost exactly the same advice was offered today by Nancy Langdon Jones, a “certified financial planner” from Claremont, California. Quoted in an article on RealSimple.com, Ms. Langdon Jones told consumers that “if you don’t already have an emergency fund, pay just the minimum on your credit-card bills and start one now.”

Having an emergency fund is a good thing. But creating one by carrying additional credit-card debt is a staggeringly dumb idea.

If you’re lucky, a $1000 deposit in your savings account might earn you an additional $15 in interest this year. But you’ll carry unpaid credit-card balances at 19 percent interest or more. So creating a $1000 emergency fund by not paying off credit-card debt ends up costing you $175 a year or more.

The best investment opportunity most families have, by far, is paying off credit-card debt. A family that chooses that option not only ends up well ahead financially, it also enjoys greater security against unexpected hard times. After all, if it reduces its credit-card balance by $1000, it not only saves a lot on interest payments, it can also borrow an extra $1000 on that card if it needs to.

Mr. Pagliriani admits that his proposed emergency fund strategy is a crazy solution for crazy times, but says it all boils down to this: Which would you rather have, no debt, or cash to pay for food, shelter and other essentials? “No debt” is the uniquely correct answer to this question.

Carbon Offsets: Better than Critics Think?

Although carbon offsets have been much maligned, they are a useful complement to policies that penalize carbon emissions.

“Humanity is sitting on a ticking time bomb.”

So begins the about-the-film section of the website for Al Gore’s 2006 Academy Award winning documentary, “An Inconvenient Truth.” The description continues with these ominous words: “If the vast majority of the world’s scientists are right, we have just ten years to avert a major catastrophe that could send our entire planet into a tail-spin of epic destruction involving extreme weather, floods, droughts, epidemics and killer heat waves beyond anything we have ever experienced.”

But as Mr. Gore explains in the film itself, there is hope. By taking prompt action to reduce greenhouse gas emissions, we can escape disaster.

Many have rebuked the former vice president for failing to heed his own message. For example, his 10,000-square-foot Nashville mansion used 221,000 kWh of electricity in 2006, more than 20 times the American household average.

In response, Mr. Gore’s spokesmen say he has recently installed solar panels and has purchased more than enough “carbon offsets” to make the house’s carbon footprint negative. That is, he has paid one of the dozens of companies around the world that specialize in helping people neutralize the environmental impact of their consumption by replanting forests, say, or by investing in renewable energy sources.

From the beginning, critics have lampooned carbon offsets, likening them to an obese person paying others to lose weight for him. Others complain that offsets allow rich consumers to pollute with impunity while posing as friends of the earth. To dramatize its claim that offsets are a moral travesty, one group has even created a web site that promotes the opportunity to enjoy guilt-free extramarital affairs by paying third parties not to commit infidelities they otherwise would have.

The fact that offsets have been such a ripe target suggests that Mr. Gore may have compromised his advocacy for greenhouse gas reduction by building such a large house. He could have built a smaller one, after all, and used the money he saved to buy even more carbon offsets.

Yet carbon offsets make more sense than critics think.

Continue reading “Carbon Offsets: Better than Critics Think?”

Is Fundamental Health Care Reform Politically Impossible?

Paying for it is the real obstacle, but that problem can be solved.

Most industrial democracies employ some form of single-payer health care system. These systems not only deliver universal coverage, they also provide better health outcomes at far lower cost than the largely private health insurance system used in the United States. One of the main advantages of single payer is that it avoids the for-profit private insurance industry’s costly maneuvering to limit reimbursements and avoid issuing policies to the people most likely to need coverage. Health policy experts agree that if the United States were building a health care system from scratch, a single-payer system would be the way to go.

Yet none of the major health reform proposals currently under discussion includes a single-payer program. There’s a simple reason: As the Clinton reform effort discovered in 1993, most voters are reasonably satisfied with the employer-provided health insurance they currently have will and resist giving it up for something new and unfamiliar. To gain any traction politically, any new system must therefore give people the option of retaining their current coverage.

But that doesn’t mean single-payer is doomed.

Continue reading “Is Fundamental Health Care Reform Politically Impossible?”

Short-Run and Long-Run Stimulus in a Single Measure

In the short run, we want households to consume more. In the long run, we want them to save more. Passing a progressive consumption tax now to take effect later provides incentives for both.

In yesterday’s post I advocated a progressive consumption tax to help pay down growing federal budget deficits. An ancillary effect of adopting this tax would be to stimulate domestic savings, low levels of which helped precipitate the current downturn.

Of course, with the economy in the deepest downturn since the Great Depression, the immediate imperative is to increase spending, not reduce it. If we adopt a progressive consumption tax, we should phase it in only after the economy recovers.

Even then, some worry that a progressive consumption tax would dampen the consumption spending often described as the foundation of our economic prosperity. But consumption is not the cause of our prosperity; it is a consequence of it. If the tax were phased in gradually, its main effect would be to shift the composition of spending from consumption to investment. Because it is total spending, not just consumption, that determines output and employment, there would be just as many jobs as before the shift.

More important, by stimulating additional investment, a progressive consumption tax would also cause productivity and incomes to rise faster over time. Consumption would be a smaller fraction of income than before, but because of the higher growth resulting from higher investment, the new absolute consumption trajectory would quickly overtake the earlier one. If you like to consume, and most of us do, shifting from a borrow-and-spend economy to a save-and-invest economy is the best way to boost consumption in the long run.

By strategically timing the implementation of a progressive consumption tax, the government could thus promote both short-term stimulus and long-run revenue growth in a single stroke.

Suppose, for example, that the president signed a law this year calling for a progressive consumption tax to take effect the moment the national unemployment rate had again dipped below a threshold level, such as 6 percent. Any family that was contemplating a large purchase in the coming years would then have a powerful incentive to spend that money right away, so as to avoid the consumption levy.

Note the striking contrast between that incentive and the incentives confronting families under traditional stimulus measures, such as temporary income tax rebates. As experience has shown, people who are fearful about losing their jobs are likely to save such rebates or use them to pay down existing debt.

Most economic policy instruments confront us with painful tradeoffs between short- and long-term objectives. A strategically implemented progressive consumption tax is a conspicuous exception. By confronting families with powerful incentives to increase spending right away, it would reduce the demand shortfall that is currently holding the economy back.

Once the economy again reaches full employment and the tax starts being phased in, it would shift the economy’s focus gradually from consumption to investment spending, which would stimulate additional growth in both income and tax revenue. And should another recession occur, a temporary cut in consumption taxes would provide a much more powerful stimulus than the traditional remedy of a temporary cut in income taxes.

The Ultimate Tax on Harmful Activity?

Why not tax consumption rather than income?

When the dollar, US treasury bills, and stock prices slumped yesterday because of growing concerns about the U.S. government’s debt rating, Treasury Secretary Tim Geithner hastily reassured nervous investors that the Obama administration has clear plans to reduce the country’s massive budget deficits going forward. But as I argued in a recent post, accomplishing that will require significant new sources of revenue. And if new taxes are indeed necessary, by far the best ones are those that discourage harmful activities.

But new taxes on congestion and pollution will probably not be enough. The president has already proposed to allow the Bush tax cuts for top earners to expire as scheduled in 2010. Many economists caution against even further increases in top marginal income tax rates, which would discourage effort and savings.

Fortunately, there is a compellingly attractive alternative: abandon the income tax in favor of a much more steeply progressive consumption tax. Doing so would generate more than enough revenue to balance the federal budget without requiring painful sacrifices from anyone. Under a progressive consumption tax, each family would report its income to the IRS and also its annual savings, much as many now document their annual contributions to 401(k) and other similar accounts.

A family’s income minus its annual savings is its annual consumption, and that amount minus a large standard deduction—say, $30,000 for a family of four—would be its taxable consumption. Rates would start low, perhaps 20 percent, then rise gradually with total consumption. For example, a family that earned $60,000 and saved $10,000 would have annual consumption of $50,000, which, after subtracting the standard deduction, would mean taxable consumption of $20,000. It would owe about $4,000 in tax, about the same as under the current income tax.

With savings tax-exempt, top marginal tax rates on consumption would have to be significantly higher than current top rates on income. But that’s not problematic, because higher top rates would actually encourage saving.

Consider, for instance, how the tax would affect a specific high-end spending decision. The Smiths, a wealthy couple approaching their 25th wedding anniversary, are trying to decide what kind of party to throw. Their close friends, the Joneses, recently spent $2 million to stage a gala celebration of their own silver anniversary. The Smith would prefer not to spend that much, but one of their goals is for their family and friends to share a memorable celebration, and they understand a memorable occasion is an inherently relative concept. So they reluctantly decide to stage a $2 million party of their own.

But the same decision would have almost surely played out differently under the incentives inherent in a progressive consumption tax. If the top marginal rate on consumption was, say, 100 percent, the after-tax cost of what would have been a $2 party under the current income tax would instead be $4 million. Facing that extra cost, couples like the Smiths and Joneses would typically scale back, spending perhaps only half as much as they might have. If the pre-tax cost of the party they chose were $1 million, the after-tax cost would be $2 million. The government would get $1 million in additional revenue, which could be used to pay down debt.

By staging a lavish party, a couple typically has no intention to harm its friends and relatives. Yet the bar that defines how much one must spend to mark a special occasion is an inescapably social construct. When some spend more, others must follow suit or be seen as having failed to grasp the magnitude the occasion. The rub is that when all spend more, the occasions seem no more special than before. As in the familiar stadium metaphor, all stand to get a better view, yet no one sees better than if all had remained seated.

Like a tax on congestion or pollution, a progressive consumption tax is thus a tax on harmful activity. The real attraction of all such taxes is that they essentially create real resources out of thin air. The less expensive mansions people build, the cleaner, lighter vehicles they drive, and the less costly parties they stage are just as satisfying as the more elaborate versions would have been.

Some worry that by discouraging consumption spending, a progressive consumption tax as politically unrealistic. But in a future post, I’ll cite evidence that this tax enjoys support from across the political spectrum.

Would a Carbon Tax Make Higher Gasoline Taxes Unnecessary?

Its contribution to global warming is only a fraction of the damage done by burning a gallon of gasoline: to that add pollution, congestion, accidents, sprawl, and the vehicle-weight-and-horsepower arms races. So we should tax gasoline specifically as well as carbon emissions generically, and fix the resulting distributional issues with annual rebate checks.

As I argued in an earlier post, any serious effort to bring deficits under control must entail finding additional sources of revenue. The prospect of new taxes is never pleasant, of course. But if tax we must, why not kill two birds with one stone by taxing activities that cause harm to others?

In addition to calls for taxing carbon directly, President Obama has also been urged by the New York Times editorial board and others to adopt steeper taxes on gasoline.

In contrast, Matt Yglesias of the Center for American Progress and others argue that a carbon tax or a carbon cap and trade system would make higher gasoline taxes redundant. But limiting greenhouse gases is not the only, or even the most important, reason for taxing gasoline more heavily. Gasoline taxes are required not just to discourage carbon emissions, but also to limit many other costs that gasoline consumption imposes on others.

Selling carbon permits and levying higher taxes on gasoline will also generate billions of dollars of additional federal revenue. Unlike the taxes that conservatives bemoan, these taxes will make the economy more efficient, not less. But because they will raise the prices of basic commodities, they will also cause distress for at least some low-income families. The traditional remedy has been to return some or all of the tax revenue by reducing the payroll tax, which falls disproportionately on low-income workers.

There is, however, a far more effective way of reducing the burden on the poor. More on that in a moment.

The Intergovernmental Panel on Climate Change has estimated that a CO2 tax of approximately $80 per ton might be necessary by 2030 to reduce emissions by enough to achieve global climate stability by the year 2100. A CO2 tax set at that level would add about 70 cents to the price of a gallon of gasoline. But that tax would attack only one of a long list of external costs associated with additional consumption of gasoline.

Most gasoline is used to power cars and trucks. When people drive more, they cause additional traffic congestion, which imposes costly delays on others; they generate additional urban smog, which causes increased mortality and morbidity; they generate additional noise; they increase the risk that others will die in accidents; they increase the cost of road maintenance; they send money to petro-dictatorships that support terrorists; and they increase the risk of military conflicts to preserve access to foreign oil.

Beyond imposing these direct costs on others, low gasoline prices also contribute to various indirect forms of waste. For example, they foster urban sprawl, which increases all forms of energy use.

Cheap gasoline also encourages consumers to spend in mutually offsetting, wasteful ways. One strategy for reducing one’s risk of dying in a head on collision, for instance, is to buy a heavier vehicle. But when all follow that strategy, everyone’s risk of dying actually rises. Low gasoline prices also encourage wasteful horsepower arms races. Many people like fast cars, but how fast a car needs to provide that satisfaction depends on context. A car that is experienced subjectively as fast is simply one that accelerates more briskly than other cars in the same local environment. So when all purchase cars with more powerful engines, the same car that once seemed fast no longer does.

No one knows exactly how high gasoline taxes would have to be to induce consumers to take full account of such external costs. But trans-national experience suggests that gasoline consumption would remain inefficiently high even if taxes were $2 per gallon higher than current levels. Gas taxes are more than that much higher in Europe, where consumers have responded by buying much lighter and more fuel efficient vehicles than in the United States. There is no evidence that Europeans are less satisfied with their cars than Americans are, or that European tax levels have fully neutralized all the negative externalities associated with gasoline consumption.

When large gasoline tax increases have been proposed in the past, the tradition has been to propose a simultaneous reduction in the payroll tax, thereby to curb the economic hardships imposed by the tax. But such hardships are likely to be smaller than most people expect. And if the aim is to cushion them, there is a much better way to do it.

If the current price of gasoline were $2 per gallon and an additional tax of $2 per gallon were added, how would that affect the typical family? On average, an American family of four currently consumes almost 2,000 gallons of gasoline annually. A family that continued to consume at the same rate after the imposition of the tax would thus pay $4,000 in additional gasoline taxes annually. But if the family was about to replace its aging Ford Explorer, which gets 15 miles per gallon, it could buy Ford’s Edge wagon, which has almost as much cargo capacity as the Explorer and gets more than 30 miles per gallon. If it made the switch, its annual fuel costs would remain the same as before, even if it drove just much as it used to. And if other families adjusted in similar ways, none would feel disadvantaged by driving a smaller vehicle; and none would be at greater risk from dying in a head-on collision.

From the experience of the 1970s, we know that consumers respond to higher gasoline prices not just by buying more efficient cars, but also by taking fewer trips, forming carpools and moving closer to work. If norms shifted in those ways, a family might actually find itself with greater disposable income because of the higher gas tax.

Inevitably, however, some families would be unable adjust their consumption patterns, and these families would pay a price. But trying to compensate them by reducing the payroll tax would be extremely inefficient. For one thing, payroll tax reductions would not help retirees or those who are unemployed. For another, they would transfer money not just to low-income workers, but also to those already earning high incomes. Even more troubling, a payroll tax reduction would quickly become invisible. In contrast, the gasoline tax would remain salient and would continue to draw political fire.

As the political scientist Steve Teles has suggested, a much better approach would be to return some portion of the additional revenue in the form of a yearly rebate check from the IRS issued to every family that files a tax return. Scheduled to arrive in early December, it would provide a vivid reminder of the offset against the additional taxes. The size of the rebate could also be inversely related to the family’s income, the better to target relief for those most in need.

Because gasoline consumption generates many external costs besides global warming, carbon taxes do not eliminate the rationale for imposing additional taxes on gasoline. By encouraging consumers to take account of those external costs, such taxes would make the economy more efficient. Evidence suggests, moreover, that people have wide latitude to escape the burden of higher energy taxes by changing their behavior. The taxes would create far less hardship than many expect, and such hardship as they would create could be easily remedied.

Cap and Trade vs. a Carbon Tax

Both good ideas. The differences are more in the optics than in the outcomes.

In yesterday’s post, I argued that the easiest path to deficit reduction is to impose new taxes on activities that cause harm to others—Pigouvian taxes on negative externalities, in the economist’s parlance. Probably no negative externality has commanded more attention in recent years than the emission of CO2 and other greenhouse gases.

One of the central weapons in President Obama’s proposed attack on global warming is a carbon cap and trade system. Under cap and trade, the government first sets a limit on how much total carbon can be released into the atmosphere each year (the “cap”). Companies can still employ production processes or sell products that release carbon into the atmosphere, but only if they first purchase a permit for each unit of carbon released (the “trade”). For example, if the cap were set at 5 trillion tons per year, the government would auction off that many tons of annual carbon permits to the highest bidders.

When economists first proposed a similar system of pollution permits for attacking the problem of acid rain during the late 1960s, critics complained that it would “let rich firms pollute to their hearts’ content.” Such statement betrayed a comically naive understanding of the forces that guide corporate behavior.

Firms don’t pollute because they take pleasure in fouling the air and water but because clean production processes cost more than dirty ones. Requiring firms to buy pollution permits gives them an incentive to adopt cleaner processes. To avoid buying expensive permits, firms that have access to relatively cheap, clean alternative production methods will be quick to adopt them. A firm will buy pollution permits and continue polluting only if it lacks such alternatives.

Auctioning pollution rights makes sense because it concentrates the burden of pollution reduction in the hands of those who can accomplish it at the lowest cost. It minimizes the total cost of achieving any given air quality target—an outcome that is clearly in the interest of all citizens, rich and poor alike. The more people learn about the auction method, the less likely they are to oppose it. For instance, although environmental groups once bitterly opposed pollution permit auctions, they now endorse them enthusiastically.

Firms that lack cheap ways of eliminating carbon emissions from their operations would have to charge higher prices to cover the cost to the required permits. The cap and trade system is thus functionally similar to a tax on carbon.

Indeed, in stable world with perfect information, cap and trade would be exactly equivalent to a carbon tax. Of course, we don’t live in such a world. This has led many critics to favor a carbon tax over cap and trade. These critics argue that by setting a fixed tax and sticking with it, government could create the stable incentives that make firms willing to undertake costly investment projects.

But committing to a fixed carbon tax entails risks of its own. Although we have estimates of the amount by which carbon emissions must be reduced to achieve climate stability, we have no idea how high a carbon tax would have to be to achieve those reductions. If the tax were set too low—the more likely outcome politically—it would soon be necessary to raise it, which would invalidate many of the investments that had made on the basis of the original tax. To avoid such costs, cap and trade advocates favor starting with what we know best—the emissions target—and then letting the “market” (as embodied in the permit auction) reveal the effective tax required to get there.

In short, there are sensible economic reasons for taking either side in the cap and trade vs. carbon tax debate. But the smart money seems to be lining up behind cap and trade for essentially political reasons. A carbon tax is an explicit tax, and Americans are notoriously tax phobic. In contrast, cap and trade levies an implicit tax on carbon. In purely economic terms, it’s a distinction without a difference. But if someone offers you an even-money bet on which system congress will adopt, pick cap and trade. RBC’s Steve Teles disagrees, suggesting that the recent Republican proposal for a carbon tax might make that route the more politically promising one.

In any event, the good news is that after years of denying the problem even existed, our political system seems ready to take serious steps to address global warming.

Why Spending Cuts Aren’t the Answer

The question isn’t how much the government spends, it’s the rate of return on that spending.

The nonpartisan Congressional Budget Office projects that President Obama’s recently proposed budget will cause the national debt to double over the next ten years. Deficits aren’t an immediate problem, since the economy is in the midst of the deepest downturn since the Great Depression. In fact, most economists argue that we should be running even bigger deficits in the short run. But most economists also agree that we need to bring deficits under control in the long run.

There are only two ways to do that—by cutting government spending and by raising taxes. Cutting wasteful spending would obviously be a good thing. Every president promises to do this. Yet federal spending has continued to grow in every administration, and there are good reasons for believing that spending cuts won’t be the answer this time, either.

Government programs have constituents. On the rare occasions when programs get cut, they are typically not the ones that deliver poor value, but rather those whose constituents have the least power to object. For example, the Bush administration, self-proclaimed enemies of government waste, cut the Energy Department’s program for rounding up poorly guarded nuclear materials in the former Soviet Union, the National Science Foundation’s budget for basic research, rehabilitation programs for injured veterans, and nutritional assistance programs for poor mothers of small children. Each of these programs was delivering good value for the money.

Although it is extremely hard to cut existing programs, it is easier to avoid launching new ones. But much of the new spending proposed by the president is for public investments with high rates of return. Failure to make these investments will actually make us poorer. For instance, if the government borrowed a trillion dollars at 4 percent and invested the money in projects with an annual return of 7 percent, we’d actually be richer each year by $300 billion than if we hadn’t made those investments. And because investment in the public sphere has been neglected for decades, there are thousands of shovel-ready projects with extremely high rates of return.

A specific example: Because a handful of low-clearance bottlenecks currently make it impossible to ship double-decker cargo containers along the northeast rail corridor, these containers must be carried by trucks. The result is bumper-to-bumper truck traffic along I-95, which has diverted a growing volume of truck traffic 200 miles west onto I-81. According to one study, the cost of eliminating the rail bottlenecks would be $6 billion, and the benefits would be more than $12 billion, not even counting the value of reduced greenhouse gas emissions. Failure to make investments like that would not be a smart move.

Of course, there is other wasteful spending that should be cut. But much of that spending occurs because legislators feel pressure to enact programs that benefit campaign contributors. If we really want to attack that kind of waste, we’ll first have to make substantial progress with campaign finance reform. In the meantime, our best bet for curbing deficits is to raise additional revenue.

But proposing new taxes has always been the third rail of American politics. The key to solving that problem lies in shifting the focus of what we tax. Our current system taxes many beneficial activities, such as saving and new job creation. We could raise all the revenue we need by shifting to a system that taxed only harmful activities. I mentioned taxes on congestion in yesterday’s post. I’ll discuss additional examples in future posts.

How to Promote Greater Reliance on Market Pricing

Compensate the losers.

When people are permitted to use a scarce and valuable resource for free, they use it wastefully. Access to congested roadways is a case in point. When motorists can enter such roadways free of charge, the delays caused to others are typically much greater than their own benefit from using the road. The simplest way to eliminate this kind of waste is to charge for the valuable resource.

After a daily fee of $14 was imposed on cars entering central London in February 2003, downtown traffic fell by a third and travel times on some bus lines fell by half. Londoners also saw carbon dioxide emissions fall by 20 percent, and there were substantial declines as well in emissions of particulates and nitrogen oxides, the main components of smog. The combined dollar value of those benefits was far more than enough to offset the total hardships associated with the congestion fee.

Yet a congestion fee inevitably causes some hardship for people with low incomes. And it’s an iron law of politics that the losers from any policy change scream louder than the winners sing. Social critics are right to complain that the poor often get short shrift in electoral systems dominated by big money. But that doesn’t mean the poor get ignored completely.

For example, when New York City Mayor Michael Bloomberg proposed last year to levy a congestion fee on motorists who enter Manhattan on weekdays, many legislators went ballistic. City councilman Lewis Fidler called the plan “outrageous, because they’re saying rich people can come into Manhattan and poor people may not, and that is just wrong, wrong, wrong.”

When such concerns are not satisfactorily addressed, they invariably prevent us from reaping the gains made possible by greater reliance on market mechanisms. The Manhattan congestion fee, which would have created substantial benefits for rich and poor alike, was never adopted. It’s a pity, because the objections to the mayor’s proposal could have been overcome very easily.

The classic case study was the New York State Public Service Commission’s attempt to impose fees for directory assistance calls in the mid-1970s. At the time, any telephone subscriber could place an unlimited number of directory assistance calls free of charge. That policy was wasteful because it encouraged consumers to use directory assistance services that were costly to provide, even for numbers they could easily look up on their own. The commission proposed a ten-cent charge for each directory assistance call. By encouraging consumers to use directory assistance only when necessary, the proposal promised to free up operators and equipment for more valuable tasks.

As with the mayor’s proposed congestion fee, the commission’s proposal was greeted by a firestorm of protest. Social scientists appeared before the commission to testify, preposterously, that charging for directory assistance would disrupt vital networks of communication in the community.

With its defeat seeming all but certain, Commission officials then introduced a simple amendment that rescued it. In addition to charging ten cents for each directory assistance call, they proposed a thirty-cent credit on each consumer’s monthly phone bill, a reduction made possible by the additional revenue from the charge and the savings from reduced volumes of directory assistance calls. Political opposition vanished instantly, and today no one questions that the new policy makes perfect sense.

Essentially the same strategy could salvage the proposed congestion fee for Manhattan and other cities. Most people who commute regularly by car into Manhattan are not poor, and most low-income workers in Manhattan already use public transportation for their daily commute. The problem cases are low-income workers who must occasionally drive into the city on weekdays. For such people, congestion fees would indeed constitute a new burden.

But this burden could easily be eliminated by giving every low-income worker in Manhattan an annual allotment of transferable congestion vouchers. On the rare occasions when these workers needed to drive into the city, they could do so free of charge. And they could earn some extra money by selling any vouchers they didn’t need on Craigslist.

Economic efficiency is a good thing for everyone, not just the rich. Any policy change that makes the economic pie bigger necessarily makes it possible for everyone to have a larger slice than before. But often the same policies that make the pie bigger impose difficult hardships on the poor. And in those cases the efficiency gains are likely to go unrealized unless we take specific steps to make everyone whole.

The good news is that such steps are often simple to implement. We don’t need to impose unacceptable burdens on low-income workers to reap the benefits of cleaner air and reduced traffic congestion.

Cash for Clunkers?

The proposal is better than nothing, but could easily be improved.

Congress is considering legislation to provide vouchers of up to $4,500 to help consumers scrap their gas guzzlers and buy more fuel efficient new cars. Details of the proposal, from the House Committee on Energy and Commerce, are available here.

Proponents argue that in addition to curbing greenhouse gas emissions, the measure would provide much needed economic stimulus. Germany, which recently enacted a similar measure, is the only country in which automobile sales increased last year.

Is this program a good idea?

It depends on what the alternative is. If it’s to do nothing, the proposal is a clear winner—even if we completely ignore its environmental impact. Yet the proposal is deeply flawed. With a few simple tweaks, it could be made much better.

Unemployment and idle capacity in the American auto industry are at their highest levels in decades. As the German experience indicates, auto vouchers are likely to produce an immediate surge in auto sales. This would put people to work who would otherwise be doing nothing. A $4,500 voucher that leads to production of an additional $25,000 car would generate $25,000 of additional income along the value added chain, which in turn would generate more than enough tax revenue to pay for the voucher.

But the mere fact that a program is better than doing nothing does not mean that we should adopt it. Adopting this program means not adopting some other variant of it. And with a few simple modifications, the existing cash-for-clunkers proposal could deliver much better results.

For one thing, the program could offer much stronger incentives choose cars with better fuel economy. As the House proposal stands, a consumer gets a $3500 voucher for abandoning an 18 mpg vehicle for one that gets 22 mpg, but only $1000 more for switching to one that gets 28 mpg or more. The real fuel savings and emissions reductions come when someone swaps a 10 mpg Ford Excursion for a 41 mpg Ford Fusion hybrid. New car purchases have long-run consequences. If we’re going to encourage swaps in the first place, why not provide stronger incentives to make the right ones?

What happens to the gas guzzlers that voucher recipients unload? Environmentally, sending them to the scrap heap isn’t necessarily a good idea, since keeping them on the road a little longer would spare the substantial energy use and additional emissions that accompany new vehicle production. By creating a huge boost in the supply of used gas guzzlers, a voucher program would produce an immediate steep decline in their price, which would make them an economical choice for many drivers who use their vehicles only sparingly. Although the per-mile cost of operating these vehicles would still be high, owners would be compensated for that by their low purchase price.

But an even more effective way to encourage reduced emissions and fuel use would be to couple the voucher program with a steep new tax on gasoline whose gradual phase-in would begin only after the economy has again reached full employment. The revenue from such a tax could be used to help pay for a cash-for-clunkers program with even stronger incentives to purchase more efficient new vehicles.

Another problem is that the current cash-for-clunkers bill refers only to fuel economy, not emissions. Although only 10 percent of cars on the road in Los Angeles are more than 15 years old, these vehicles, which are exempt from emissions control laws, account for a majority of the smog in the area. Many of these vehicles would be ineligible for a voucher under the proposed legislation, even though the environmental case for including them is compelling.

The real imperative, however, is to act quickly. Unemployment is like empty seats on a commercial airliner. In each case the opportunity to produce something of value is lost forever. If congressional leaders cannot muster the votes necessary to pass the right cash-for-clunkers bill, even the current version would be much better than doing nothing.

Update Will Schroeer of Smart Growth America dissents:

Robert Frank endorses, with suggestions for improvement, both the environmental and economic stimulus benefits of proposed “cash for clunkers” legislation. I take issue with only two parts of his analysis: the environmental part and the stimulus part.

1. Let’s start with the claimed environmental benefits. Prof. Frank observes that “the program could offer much stronger incentives to choose cars with better fuel economy”, but this is a pretty weak objection to the bill’s almost complete lack of actual GHG benefits. If you trade one SUV for a slightly more efficient new one as subsidized by legislation, you will take 20 years to work off the GHG emissions of building the SUV…and only then will you start producing GHG reductions of 11% per mile.

Next, Prof. Frank moves to smog-reduction benefits: the current legislation doesn’t aim at these at all, and he wants it to. True, older cars produce the majority of smog emissions. And he has some history on his side: there were a variety of “cash for clunkers” programs in the early 90s, several of which performed so well environmentally that EPA under Bush I issued guidance on how programs could take credit under the Clean Air Act for the emissions reductions they would produce. (I wrote that guidance, and remarkably, it’s up on the web.)

But a lot has changed since 1991. The difference between old and new cars drives (ahem) benefits from scrappage, and that difference has shrunk substantially. In 1991 the emissions differences between old and new car emissions were as high as 70x.

Since the 90s, there’s been enormous fleet turnover, and with some exceptions, the 70x criteria polluters are gone. There are still occasional serious emissions control failures thanks to complicated modern electronics, but as far as I know the kind of differentials you used to see on the criteria side just aren’t there anymore.

2. Pressed on environmental benefits, scrappage proponents generally revert to economic stimulus benefits, and Prof. Frank is with them 100% on this point: “Is this program a good idea? It depends on what the alternative is. If it’s to do nothing, the proposal is a clear winner—even if we completely ignore its environmental impact.”

But our choices are not limited to 1) a bad scrappage program, 2) a better scrappage program, or 3) “do nothing”. If the goal is stimulus, and/or the economic health of autoworkers, there is a long list of policies that handily beat these three.

What most concerns me is that someone as consistently sensible on these subjects as Prof. Frank seems to buy the idea that building new cars is a de facto worthy goal: “Unemployment is like empty seats on a commercial airliner. In each case the opportunity to produce something of value is lost forever.” Yes, but society is made no better off by sending someone on a JetBlue flight to LA if he doesn’t need to go there, just to fill the seat. Ditto new cars if we don’t need them. And people today are driving less and shedding cars.

How to help unemployed autoworkers is a very real problem. But having them build cars for the sake of building cars is not the answer.