Better Incentives
When incentives are misaligned, governments can realign them through mechanisms like taxes or cap-and-trade systems to address problems such as pollution.
THE IDEA
Better Incentives
When incentives are badly aligned, it is appropriate for government to try to fix the problem by realigning them. In fact, although economists are often a contentious group, this is one topic on which there is nearly unanimous agreement: if we think we are emitting excessive amounts of greenhouse gases (or any other pollutant), then we should make sure decision makers face costs that give them the correct incentives to cut back.[12] In the environmental arena, two broad approaches have been proposed.
The first is to impose taxes or penalties on those who pollute. A tax on greenhouse gas emissions is one example. The second approach is called a cap-and-trade system. With cap-and-trade, those who pollute are given (or sold) a limited number of “rights to pollute” (the cap), and these rights are then traded in a market. If polluters exceed their allowances, they are in violation of the law. Although each approach has its adherents, we will not take a stand on which approach is better. That’s a tough question, and reasonable people disagree. The two methods come at the problem from different directions.
When to use it
Implementing a carbon price to encourage companies to invest in clean technology.
Using congestion pricing to reduce traffic and pollution in urban centers.
Designing a deposit-refund system for beverage containers to increase recycling rates.
Creating a market for tradable fishing quotas to prevent overfishing.
FROM THEORY TO EVERYDAY LIFE
In practice
Carbon Tax on Fossil Fuels
A government imposes a tax on each ton of carbon dioxide emitted by power plants, increasing the cost of fossil fuels and encouraging a shift to renewable energy.
Cap-and-Trade for Sulfur Dioxide
The U.S. Acid Rain Program set a cap on sulfur dioxide emissions from power plants and allowed trading of emission allowances, successfully reducing acid rain at lower cost than expected.
A MOMENT TO REFLECT
Put it to work.
How might you realign incentives in your organization to reduce waste or improve efficiency?
What are potential unintended consequences of a carbon tax on low-income households?
In what other policy areas could cap-and-trade be applied, such as water usage or fishing quotas?
CONTINUE THE CONVERSATION
Source texts
- Nudge The Final Edition (Richard H. Thaler Cass R. Sunstein)