In a post earlier this week I said:
Environmental Economists have long argued that in a simple world, a tax on 'bad' actions or a subsidy on 'good' actions can result in the same net outcome. That is, both are economically efficient. It's just a matter of who gains and who loses from the tax or subsidy.
Now I'm here to say...I screwed up, I was wrong, my bad. In an attempt to make a simple point, I oversimplified and SteffenH called me on it. So I'm asking for a Mulligan. Read on...
If you recall--and I know you do because all of you read and absorb every one of my posts--I was reacting to a story from CNN.com about Massachusett's plan to subsidize hybrid purchases. The subsidies are a proposed alternative to taxing SUV purchases. This simple interpretation led me to write my aforementioned blunder. As Steffen pointed out in his accurate and appreciated comment:
There is no equivalence between taxes and subsidies, even [if] you taxes or subsidize the harmfull activity (not as in reality, where we subsidize cars not emissions reductions). Remember the traditional Baumol-Oates-critique: A subsidy of s per unit reductions of the output X is equivalent to a lump-sum-payment of s*X and a tax of s per unit of production, since this is the subsidy payment forgone by producing an extra unit. Resulting profits create incentives for the countervailing entry of new firms to the industry. This incentive to market entry don't exist for taxes. See: Baumol, W.J. and W.E. Oates (1988). The Theory of Environmental Policy
True. In my never-ending attempt to simplify economics to convey the basics to the general public, I oversimplified. I assumed away the basic result that subsidies generate incentives for new entry into the subsidized. As John put it in an e-mail to me when I asked if he thought I had assumed away the result:
I think the market entry idea is easily understood by non-econ-ers. At least, my students get it. They always get it when I ask something like, what would GM prefer taxes on SUVs or subsidies for hybrids. A: subsidies. Why? They increase profits instead of reducing them. Increased profits potentially lead to market entry. (but in this case I don’t think so since autos isn’t really a competitive market).
Indeed, when put that way, it's pretty simple. Unfortunately I didn't think to put it that way. So, thanks Steffen for setting me straight, and thanks John for always being quick to point and laugh when I screw-up. The lesson...as always...I'm an idiot.
