Energy Policy with Externalities and Internalities

54 Pages Posted: 6 Apr 2012 Last revised: 14 Feb 2021

See all articles by Hunt Allcott

Hunt Allcott

New York University (NYU)

Sendhil Mullainathan

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Dmitry Taubinsky

Harvard University

Date Written: April 2012

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.

Suggested Citation

Allcott, Hunt and Mullainathan, Sendhil and Taubinsky, Dmitry, Energy Policy with Externalities and Internalities (April 2012). NBER Working Paper No. w17977, Available at SSRN: https://ssrn.com/abstract=2035321

Hunt Allcott (Contact Author)

New York University (NYU) ( email )

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Sendhil Mullainathan

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Dmitry Taubinsky

Harvard University ( email )

Cambridge, MA
United States

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