Internalities, Externalities, and Fuel Economy

Abstract

It is standard to think that corrective taxes, responding to externalities, are generally or always better than regulatory mandates, but in the face of behavioral market failures, that conclusion might not be right. Fuel economy and energy efficiency mandates are possible examples. Because such mandates might produce billions of dollars in annual consumer savings, they might have very high net benefits, complicating the choice between such mandates and externality-correcting taxes (such as carbon taxes). The net benefits of mandates that simultaneously reduce internalities and externalities might exceed the net benefits of taxes that reduce externalities alone, even if mandates turn out to be a highly inefficient way of reducing externalities. An important qualification is that corrective taxes might be designed to reduce both externalities and internalities, in which case they would almost certainly be preferable to a regulatory mandate.