March/April 2014

The Market’s Role in Resolving Pollution

Is it possible to address environmental problems, such as pollution, without resorting to the traditional regulatory approach? In the new issue of the Cato Journal, economists Geoffrey Black, D. Allen Dalton, Samia Islam, and Aaron Batteen offer one prominent example of allowing the market to work. By examining the New York City Watershed Memorandum of Agreement (MOA), the authors demonstrate how large-scale externalities can be successfully internalized with minimal state intervention.

In 1997, New York City entered into an agreement in which it assigned the area’s watershed communities the property rights to continue developing, despite the fact that some of those activities degraded the city’s drinking water. This assignment placed the burden of water quality on the city. Once responsibility was established, the government opted to buy lands that were contributing to water quality degradation, instead of building a multibillion-dollar filtration system. In turn, the residents and landowners upstream were compensated for development restrictions incurred from the agreement. In short, the New York City Watershed MOA is the first of its kind. “The negotiations forged a new method for dealing with externalities showing how … solutions could be facilitated and used in wide-reaching economic conflicts,” the authors write.

In September 2012, seven weeks before the presidential election, a Congressional Research Service (CRS) study claimed that there is no evidence that changes in top marginal tax rates have had any impact on U.S. economic growth since World War II. The mainstream media, politicians, and political groups favoring higher taxes on the wealthy widely cited the study as evidence against Mitt Romney’s economic program and in favor of President Obama’s plan to raise top marginal rates. In “Marginal Tax Rates and U.S. Growth,” economists Jason E. Taylor and Jerry L. Taylor revisit the CRS analysis and pinpoint its fatal flaw. “Our results are consistent with what economists have long understood: that a tradeoff exists between income redistribution and economic growth,” they conclude.

Despite pronounced differences in medical financing arrangements, the United States and other countries throughout the Organization for Economic Cooperation and Development (OECD) have witnessed a tremendous growth in health care costs over the last several decades. In “The Medical Care Cost Ratchet,” scholars Andrew Foy, Christopher Sciamanna, Mark Kozak, and Edward J. Filippone explain that health care spending increases over time as new technologies that confer only modest clinical benefits are incorporated into the traditional standard of care. They argue, furthermore, that encouraging individuals to economize on nonemergent health care decisions would help bend the cost curve over time. “Reform efforts,” they conclude, “should focus on rejuvenating market forces that have been systematically suppressed.”

Forecasts of future economic activity underlie any budget revenue projection. However, public choice models of political decisionmaking suggest that government agencies such as the Congressional Budget Office (CBO) and Office of Management and Budget (OMB) face pressures that are likely to result in systematically biased forecasts— whereby, for instance, rosy growth forecasts are rewarded and underforecasted growth penalized. In his article, economist Robert Krol finds that while the CBO, consistent with the private-sector forecast, has a downward bias, the OMB estimates indicate a significant upward bias—which is “interpreted to mean executive branch political pressure influences the forecast.” Other contributors include Thomas L. Hogan and William J. Luther on “The Explicit Costs of Government Deposit Insurance,” Paul H. Rubin on “Pathological Altruism and Pathological Regulation,” and Paul Ballonoff with “A Fresh Look at Climate Change.”

The Winter 2014 issue also features reviews of books on the importance of Ayn Rand’s ideas, a theoretical framework for understanding the financial crisis, and the famous bet between Julian Simon and Paul Ehrlich.