Taxing the bad beats subsidizing the good

Grist:

In a recent study using food subsidies and taxes to encourage healthier food purchases, researchers at SUNY learned something interesting:

• If you use subsidies to make healthy food cheaper, people buy more healthy food, but they use the savings to buy junk food.
• On the other hand, if you tax junk food, people buy healthy food instead.

The funny thing is, this was a psychology study, but an economist could have told you this would happen. When you lower the price of a good (healthy food), it creates an "income effect." People have more money and they will allocate it according to what goods will maximize their happiness. Since they can already afford more healthy food, it's not hard to imagine that the savings from cheaper health food goes to junk.

By solely taxing junk food, however, you don't have an income effect, but instead a substitution effect. People shift from junk food to healthy food because they can get more (and more happiness) per dollar that way.

The same concept applies to energy policy, and is why making renewable energy cheap (with tax credits) will not be sufficient to shift people away from dirty energy (coal, natural gas, fuel oil, etc). Instead, we need ways to increase the price of bad things, such as a carbon tax.

And there's another dilemma. Do you impose a carbon tax or price ALONE which will shift people away from dirty energy AND encourage conservation, or do you give the revenues back? A cap-and-dividend policy, for example, is much more politically palatable because most people get a bigger dividend than they will expend in higher energy consumption, but it also means there's only an incentive to shift consumption to clean energy, and not to reduce it.