Wednesday, January 27, 2010

Economists need to do a better job of explaining Pigouvian Taxes

I am actually surprised that there is much of an argument about taxing large banks in order to recover TARP funds. We certainly have adequate evidence that "too large to fail" financial institutions impose social costs on the economy. We also have ample evidence that bank managers, knowing that they are managing "too big to fail" institutions, will take on excessive risk, unless they are actively discouraged from doing so.

Textbook economics says that when an action creates social costs, it is optimal to tax it. It is, of course, difficult to know what the precisely correct tax rate should be, but we can probably come up with a reasonable approximation. And getting taxes slightly wrong is probably less distortionary than getting regulation wrong/

I long thought that if Fannie and Freddie had to pay a Pigou tax on their debt, they would avoid getting into trouble. Alas...


David Barker said...

Agreed. The reason for the argument might be that the tax is wrapped in soak-the-rich populist rhetoric that upsets the right. It has not been presented as a Pigouvian Tax.

John said...

Tax will always be a problem. But that's inevitable responsibility.