Knowing and Making

Most economists are inclined to agree with Greg Mankiw that a high tax on carbon, reflecting the best estimate of its social cost, is the best way to mitigate the effects of carbon emissions. [ Edit : In this posting I consider a carbon tax to be roughly equivalent to cap-and-trade - of course there are differences but my point applies to both mechanisms ] In theory, this should encourage the right mix of reduced growth in consumption, development of energy-efficient technology, and compensation to those affected by climate change. Economic theory says that the market will respond in the most efficient way to a tax which fully reflects the external costs of the activity (known as a Pigovian tax after economist Arthur Cecil Pigou who was an early proponent of the concept). In particular, it should not be necessary for the government to subsidise research into green technologies - they might pick the wrong ones, and they will probably end up wasting more money than the market would if...

Hal Varian in the WSJ (via Mark Thoma and Marginal Revolution) has touched on a topic I have been thinking about for a while: how is the fiscal stimulus best spent? On consumption or investment? There are essentially two tools available for the stimulus: tax cuts and government spending. And there are five main sources of demand in the economy: private consumption, private investment [optionally divided into business and residential investment], government consumption, government investment and exports. I am not going to address all ten combinations, but focus on private investment - should we promote it, and if so, which are the best tools to do so? I am a priori neutral between tax cuts and spending; tax cuts are good because they let people allocate spending by efficient private choice; spending can be good if it achieves public goods that are not best purchased in the marketplace. My intuition, like Hal's, is that private investment is important. But is there a clear argument...