Congestion

I applaud New York City Mayor Bloomberg's attempts to impose a "congestion fee" on drivers entering Manhattan.  Nanny state, you may say? Hardly.  In fact, such forms of regulation help the free market function properly in ways that a total lack of governmental intervention could not achieve.

Transactions and/or the exercise of property rights in the marketplace may produce externalities, or impacts on third parties not involved in the transaction or use itself.  A positive externality is one that confers a benefit to third party for which the parties to the transaction receive no compensation.  For example, you decide to repaint your house and create a beautiful garden.  Your actions, which have costs and benefits to you, may also incidentally raise the value of your neighbors property.  In this case, the property value increase is a positive externality.  In a perfect market, you should be able to knock on your neighbors door and tell them that your actions raised their property value by X amount of dollars, and then bill them for it.  Of course, that never happens, not the least of which is that the third party never consented to being part of the transaction.  Thus, you shoulder 100% of the burden but perhaps receive only 90% of the benefit.

The flip-side to a positive externality is a negative one, and the examples here are quite familiar.  Pollution is a classic example of a negative externality.  Company X opens a factory next to a river which is upstream from a city.  They proceed to dump toxic chemicals into the river as part of their manufacturing process.  Later on, as a result of the pollution, several costs are incurred by third parties.  The citizens who become sick pay for medical treatment, the city pays for clean-up, drinking water is tainted, requiring more treatment, the wildlife in the river dies off, the aesthetics of the city's waterfront deteriorates, etc.  Meanwhile, Company X, in the absence of environmental laws, is laughing all the way to the bank.  They received 100% of the benefit, but perhaps only shoulder 50% (or 10% or 5% or 1%) of the burden.  (To be fair to Company X, their activities may produce several positive externalities, such as employment of the city's workforce, decreased crime and increased taxes due to that employment, etc.  That being said, for the purposes of this post we can just treat Company X as the villain.)

All of this is pretty clear when framed in the examples above.  The trickier question is how to address these issues.  In our polarized political environment, we tend to hear two answers.  One answer is what can be called traditional command-and-control regulation.  In the example of the polluter above, simply outlaw, or limit, dumping pollution into the river.  This is a form of regulation traditionally associated with Democrats, and in many instances it makes a lot of sense.  Other times, it simply corrects the symptoms of the problem, not the cause.  Fuel-efficiency standards do not change the fact that the price of gas does not account for its negative costs to the environment.  During the last decade, demand for inefficient vehicles was not affected by the fuel-efficiency standards.  Only now, as gas prices approach four dollars a gallon, are people seriously considering which car to drive based on fuel efficiency.  Also, as a form of regulation it incurs its own costs.  In the Company X example, you have to monitor the company or test the water in order to ensure compliance.  When command-and-control regulation is applied often and to increasingly narrow issues, larger causes of the problems may remain unaddressed, and the government gets hit with that ugly label, nanny state.

The idea of a "nanny state", of course, sets the stage for the Republican counterattack.  If regulation increases government, increases transaction costs, and creates a nanny state, then the logical answer is of course deregulation of all kinds.  Of course, this approach does not get us anywhere in solving issues of externalities.  Like in the example of Company X, someone has to clean up the river and pay the medical bills and without some form of governmental intervention it won't be Company X.  

For all the libertarians out there who may be screaming at me that I just don't get it, let me say this.  First, I am not equating current Republican philosophy with libertarian philosophy, nor, I hope, would anyone else who has been watching the last eight years.  If at one point they had a common ancestry, they are now different beasts.  Second, for the sake of limiting the scope of this post I won't fully explore the libertarian viewpoint.  But for the reader's interest I should say that there is a school of thought that externalities are a product incompletely specified property rights.  And to the extent that my analysis is predicated on the idea that some property rights simply can't be specified sufficiently for the market to function accurately (such as a property right in clean air), then my views are compatible, or at least not at odds, with the libertarian view.

So, returning to the start of the post, the idea of using a tax, such as a congestion tax, to influence behavior in order to correct a market failure (a pigovian tax) is not new.  However, it is a refreshing reminder of a middle path we can take between command-and-control regulation on one hand and no regulation on the other.

The use of cars is rife with negative externalities.  The true costs of congestion, noise, air pollution, etc. are not really covered by the user of the automobile.  Another post could be written about the hidden costs of free parking alone (Cameron?) but I think we all get the picture.  

So what to do about it?  Well, you could always build more public transportation.  New York has one of the best subway systems in the world, and extensive commuter train networks.  However, this doesn't really solve the problem.  If the problem is that the price to the driver of driving does not take into account the true costs of the activity, then by definition too many people will be on the road.  If the free market is designed to find that perfect balance between supply and demand, when the price is artificially low the demand is artificially high.  By contrast, the true benefits of public transportation are not really allocated to the user.  The benefit of moving people in and out of the city without massive amounts of pollution and congestion are paid, at best, indirectly through tax dollars.  In a sense, those who pay $2 a pop to ride the subway are subsidizing those who drive into the city.

To properly correct the market failure, you need to allocate the costs of those negative externalities to the drivers themselves.  A gas tax/carbon tax is a good way to address the issue of CO2 emissions, due to the quantifiable connection between the amount of gas used and CO2 generated.  Congestion is rather more amorphous.  In either case, it is usually impossible to know with complete accuracy the true cost of something like congestion or air pollution.  You can, however, come up with some reasonable estimates.  And to say that because there is uncertainty we should therefore not even try is disingenuous.

Is $8 to high?  Too low?  It would be hard to tell until the tax is implemented.  Even then, the answer can be gleaned only by studying the effects of the tax, an inherently subjective exercise.  Still, I'm excited by the idea.  Why? Because someone is trying.  And while congestion may be a big problem to New Yorkers, global warming and dependence on foreign oil are big problems to the country and to the world.  Cap-and-trade and carbon taxes are forms of the same type of market-based regulation as the congestion tax.  Both options could significantly decrease CO2 emissions at a relatively low societal cost (more on this in another post).  In our federal system of government, we often rely on cities and states to test drive policies which could then be implemented on a national level.  Let's hope that if a congestion tax is successful in New York, the country will be more willing to adopt a carbon tax nationally.