Energy Policy with Externalities and Internalities

Hunt Allcott, Sendhil Mullainathan and Dmitry Taubinsky

No 17977, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: D03 D04 D11 H21 H22 H23 L51 L62 L97 Q41 Q48 (search for similar items in EconPapers)
Date: 2012-04
New Economics Papers: this item is included in nep-ene, nep-env and nep-exp
Note: EEE PE
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Citations: View citations in EconPapers (8)

Published as 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

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