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A great book, but is a Pigouvian tax a nudge?

posted Jul 9, 2014, 8:59 AM by Joel Wood

I finally got around to reading Nudge by Richard Thaler and Cass Sunstein. I had been meaning to read it for a while and actually read several books that touched on behavioral economics (e.g., The Why Axis, Thinking Fast and Slow) that were obviously motivated by the success of Nudge. I’d say it was perfectly written for a pop economics book, and highly recommend it for anyone with an interest in improving public policy.

An underlining part of Nudge is that standard economics assumes people are econs (i.e., rational), while many experiments in psychology and behavioral economics have shown that in many instances people are instead humans (i.e., prone to many cognitive bias that influence their rationality). Thaler and Sunstein outline what they term libertarian-paternalism and argue that there is room for government (or other organizations) to help humans overcome these cognitive biases through small “nudges”. One example they provide that I liked was with respect to voter turnout. They cited studies that have found that simply asking people the day before an election if they intend to vote increases their likelihood of actually following through on that intent! This is a “priming” nudge. I plan to write a post in the future on possible ways to use nudges to increase voter turnout in Canada. They focus a lot on default options and how choices within policies are framed. An example here is organ donation, Canada and the US are currently on an opt-in organ donation system, and Thaler and Sunstein compare this to Europe where many countries have switched to an opt-out organ donation system and have much higher donation rates (a friend of mine from high school is co-leading a campaign to switch Canada to an opt-out system). In a nut shell, Thaler and Sunstein argue for paternalistic nudges that preserve choice while making people better off.

One thing I found surprising, however, and is what motivated this blog post, is in their chapter on nudges for saving the planet. They do talk about simple ways to make information disclosure effective at helping people make better energy choices. However, where they kind of lost me is when they start advocating for market based environmental policy instruments (Cap and Trade, Pigouvian taxes) over traditional government regulation. As an environmental economist I obviously agree with them that environmental taxes and tradable permits are preferable to many environmental regulations, and with a wicked environmental problem like climate change, they are workable whereas Coasian bargaining is not. Even many libertarians, not just the paternalistic ones, have also made similar arguments (Jonathan Adler does here). What I am getting at here is that I don’t really see how a carbon tax fits as a nudge? Most of the other policies that Thaler and Sunstein put forward are (arguably) small interventions and often just changes in “choice architecture” to take into account (or take advantage of) cognitive biases. A carbon tax on the other hand is a government implemented increase in the relative price of carbon intensive goods and services to account for external effects. I don’t see the cognitive bias here; people are arguably acting rationally by not reducing their emissions in the absence of a tax because of the free-rider problem. To put it in the language of Thaler and Sunstein, people are actually acting like econs!

I can see how a carbon tax could fit with libertarian-paternalism; it is a paternalistic policy that preserves choice more-so than alternative policies. However, I just don’t see it as a nudge. A carbon tax isn’t a nudge, it’s just standard economics.