Incentives, taxes and policy feedback

by Henry on December 22, 2006

Via “Dan Drezner”:http://www.danieldrezner.com/archives/003069.html, Greg Mankiw “accuses Deval Patrick”:http://gregmankiw.blogspot.com/2006/12/deval-patrick-is-no-pigovian.html of not understanding basic economics.

The money quote from Patrick:

“If we’re trying to cultivate here in Massachusetts an energy-smart economy, then the notion of relying for additional revenues on something we’re trying to break our dependence on doesn’t seem to me to be a formula for long-term success.”

Mankiw’s response:

Okay, let me get this straight: It is important that we reduce our consumption of oil. Therefore, we should not tax it.

Hmmm….Governor Patrick was Harvard class of 1978, and it’s a good bet that he took ec 10. I wonder what they taught about the slope of demand curves back then.

There usually isn’t much need to remind well known right-of-center economists of the importance of incentives, but it looks to me as though Mankiw is misreading an on-the-face-of-it-quite-reasonable claim here. Patrick is suggesting, as far as I can see, that if we want to move away from a petroleum based economy, it may be a bad idea _ex ante_ to make gas into an important source of tax revenues for the government. If the Massachusetts state government comes to rely on a gas tax as a significant source of income, then it will have an incentive over the longer term not to want to lower tax revenues, say, by introducing non-tax regulations that make hybrid vehicles more attractive and gas-guzzlers less so. It will have created a long term constituency that favors the status quo, and that is likely to resist vigorously attempts to move away from it that would threaten funds going to this or that favoured project.

This kind of feedback loop, in which policy shifts create and provide resources for new constituencies which then push for the maintenance of that policy, has been explored at length by Paul Pierson and others (see “here”:http://64.233.161.104/search?q=cache:LbUegaZYGqEJ:www.yale.edu/coic/pierson.doc+%22paul+pierson%22+%22effect+becomes+cause%22&hl=en&gl=us&ct=clnk&cd=9 for a nice and reasonably brief overview). Now it could be that this effect is swamped by the substitution effects and so on described in basic micro textbooks. But it also could be that it isn’t swamped – and I can’t think of any very good way empirically to test for which effect is likely to prevail under which circumstances. Mankiw and Patrick are on different sides of an argument about the appropriate instruments for changing incentives. But this in no sense means that Patrick is an economic illiterate.