Externalities, Public Goods, and Property Rights Revisited: Regulations Based on Traditional B-C Analyses are Too Lax

Abstract

Pigou (1920) advocated for taxes, set equal to marginal damages, on goods produced and consumed that involve negative externalities. Samuelson (1954) laid out the conditions for optimal pure public goods provision, but noted that free-riding (the “demand revelation” problem) was likely to pose great difficulties in knowing what public goods to provide (e.g. which species do we save) and how much to provide (e.g. how much air or water quality is optimal). Both Pigou and Samuelson believed that non-excludability implied that government intervention was required for proper resource allocation. However, Coase (1960) argued that, if transactions costs are sufficiently small and a legal system exists to define/enforce property rights, government intervention is unnecessary. Under the conditions underlying the Coase Theorem, externalities would be self-internalizing without need for Pigouvian taxes, and public goods would also be provided optimally by the private sector. Because of the stringency of the conditions underlying the Coase Theorem, however, controversy about its importance continues to this day. I add to the controversy here by describing a previously unexplored relationship between externalities, public goods, and property rights. The claim to be defended here is that non-excludable goods—particularly environmental goods—are undervalued by the methods currently employed by economists. This implies that Pigouvian taxes should generally be larger than currently thought and that command and control regulations are too lax. The Coase Theorem is seen to have less relevance than is typically supposed.