Markets Are Not Perfect: Why We Should Consider Pigouvian Taxes, Socializing Insurance, and Nationalizing Healthcare

in economics •  last month

Before I begin, I would just like to point out that advocating the socialization and/or nationalization of certain industries does not constitute socialism. Every single capitalist economy that exists, or that has ever existed, has certain industries that are socialized or nationalized. The fact that the American military is a State-run ("socialist") industry does not make America socialist. America has "socialized" national defense, courts, police, postal services, etc. Nevertheless, America has a capitalist economy, not a socialist one. Advocating the socialization of certain industries does not make one a socialist, so long as they are not advocating the socialization of all industries. I do not necessarily have a problem with socialism as such, but merely mean to demonstrate that what I am talking about here is not socialism. There are a variety of different types of "socialism" in the marketplace of ideas, and some of them are really bad while others are really good. I will not discuss here the relative virtues of capitalism vs. socialism, but merely point out that there are certain industries where markets do not lead to the best possible outcome. Even under capitalism, it is best to socialize industries where markets fail to lead to a decent outcome.

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In most cases, under conditions of pure competition, it is in the best interest of businesses to provide the best possible service at the lowest possible price to the consumer. The market, if libertarian and competitive, would provide goods and services in the best possible way. Competitors will try to provide better products with lower prices in order to get consumers to purchase from them rather than from their competition. However, there are certain industries and services where the market incentives induce behavior that results in outcomes that are not in everyone's best interest. There are instances in which market incentives encourage companies to do things that are bad for society. For instance, companies have an incentive to cut prices, which they can do by becoming more efficient, but they can also do this by pushing the costs off onto the community. Toxic waste disposal can be very expensive. Throwing the toxic waste into the nearest creek or river is much cheaper. Under laissez-faire conditions, companies often choose to dispose of toxic waste by dumping into rivers and creeks. Pure propertarian (right-libertarian/conservative) analysis would imply that the private owner of land ought to be allowed to dump his toxic waste on his own land. The problem is that the toxic waste will run off onto other people's property. Such a laissez-faire approach to capitalism is not in the best interest of the community. This is an instance when the market incentive is for companies to do things that are socially harmful. The same sort of problem happens with air pollution. The company that pollutes the air amasses private profits but socializes part of the costs of production by polluting the air, which everyone breaths. It is not in the interest, in terms of profit-motive, of any private company under laissez-faire to cut carbon emissions or to seek more eco-friendly modes of production. The profit motive encourages pollution. One of the simplest and best ways to deal with this problem is to employ Pigouvian taxation. A Pigouvian tax is a tax on a market activity that produces negative externalities or costs that are not included in the market price. In the case of industries that cause pollution, the cost that is not reflected in the market price is the loss of clean air and water. The best solution that I can think of is to fine companies for polluting by way of a tax on pollution. This can be done in the form of cap and trade, where companies have to buy permits in order to pollute. In 1990, an amendment to the Clean Air Act was signed into law by George H. W. Bush. The amendment established cap and trade for sulfur dioxide (SO2), the leading cause of acid rain. SO2 from burning coal would reduce the PH of water vapor in the atmosphere, causing the rain to poison plants. The Acid Rain Program, established by the amendments, went into affect in 1995. Cap and trade led to a 40% reduction in SO2 emissions in 5 years. As a result of cap and trade for SO2 and other emissions associated with acid rain, acid rain is no longer an issue that people in America are accustomed to hearing about in the national news. If we adopted a cap and trade program aimed at combating global warming, such an approach could lead to drastic reductions in CO2 and other emissions that are associated with climate change. While cap and trade takes the form of a permit market, it is actually a Pigouvian tax on pollution. Other such Pigouvian taxes could be used to reduce pollution of land and water. I would suggest considering a progressive Pigouvian tax, so that the tax rate increases as the amount of pollution increases, thereby effectively creating a cap via prohibitory taxes. If you produce 10 tons of toxic waste a year, you pay a 2% tax on your profits. If you create 20 tons, you pay a 5% tax. If you create 30 tons, you pay a 10% tax on your profits. (These numbers and percentages, of course, are totally arbitrary. I am just trying to give a simple illustration of what I mean by a progressive Pigouvian tax.) This could be done via a system of cap and trade too. I believe that a decent scheme for cap and trade ought to have a differential tax on the sale of the permits. Let's assume that there are emission permits that start at 500 dollars. After you purchase 500 permits, then there is 25% tax on any additional permits you purchase. Each permit now costs 625 dollars. After you reach 600 permits, the tax rises to 50%, costing 750 dollars per permit. After 700, the tax goes to 100%, costing 1000 dollars for each additional permit. After 800, the tax goes to 500%, or 2,500 dollars per additional permit. After 850 it goes to 1000%, then after 900 it goes to 10,000% tax, where an additional permit would cost you $50,000 dollars, and so on until the tax becomes prohibitory. The differential tax effectively caps the number of permits that a single company can afford to buy. This will encourage big companies to pursue more eco-friendly modes of production and will ensure that big companies can't just buy all the permits and thereby prohibit smaller companies from competing with them. (Again, the numbers and statistics listed are just illustrations of what a differential tax is, not actual proposals for what rates and prices ought to be set at.)

Apart from pollution, there are other areas where the market incentive of the profit-motive does not lead to a situation that is in the best interest of the people. Take insurance companies, for instance: it is always in the interest of the insurance companies to charge the highest price possible and cover as little as possible—to reject as many claims as possible. This essentially means that the market incentive of the profit-motive encourages insurance companies to operate in a way that runs counter to the entire purpose of insurance. The purpose of insurance is to cover you in case of an emergency, but the profit-motive encourages insurance companies to find justifications to not cover legitimate claims. We buy insurance so that the cost that comes with emergencies is spread out among a large group of people, keeping costs low—everyone pays an affordable monthly fee in exchange for the assurance that they will be covered in case of any emergency. Furthermore, doing insurance on a for-profit basis is counterproductive. For-profit insurance is about speculative investment. When you buy car insurance, the insurance company is speculating on the likelihood of you getting into an accident. When you buy health insurance, the insurance company is speculating on your well-being. It is in their best interest to not cover those services which you are most likely to need and to drop your coverage if it ever seems likely that you will make a significant claim. Why? Because their best interest is not to best serve the customers and ensure that everyone gets the best coverage possible, but rather to maximize their profits, which will go to paying their executives, CEO, and shareholders. The CEO of Allstate makes 17.1 million dollars a year. For-profit insurance companies are lousy at being insurance companies precisely because they funnel money away from the pool of funds that ought to cover the people buying into insurance. Thus, insurance companies would be better as insurance companies if they were not run on a for-profit basis. Additionally, insurance works better the more people buy into it. This is why the individual mandate in the Affordable Care Act was so important—by making everyone buy insurance, it becomes way more affordable. However, insurance also works better on a non-competitive basis. The more people that a company insures, the more money they have coming in to pay out insurance claims. If smaller insurance companies merge, then they can provide better service. Insurance is an industry where the economies of scale are quite important and it is hard to imagine a point when insuring more people would lead to diseconomies of scale or diminishing returns. The most successful welfare programs in America are Social Security and Medicare. These programs are so successful because they are run on a not-for-profit insurance basis. In my estimation, it would be best to socialize all insurance (car insurance, homeowners insurance, etc.).

Healthcare is another area where free competition in the marketplace doesn't always lead to an optimal arrangement. How much would you pay for the medicine that keeps you alive? The answer: as much as you possibly can. This is why Turing Pharmaceuticals was able to raise the price of Daraprim from 13.50 to 750 dollars a pill. The drug used to cost just 1 dollar a pill, and the cost of production has not changed, nor has the demand for the product went up. Knowing that this drug is necessary for survival, people will continue to buy it at 750 dollars a pill if they can afford it. Outside the U.S., where they do have socialized healthcare, the cost of Daraprim is still just 1 to 2 dollars per pill. The government has more power to negotiate costs with drug companies than individuals or insurance companies do. In the U.S., the price of Epinephrine raised from 100 dollars to 600 dollars. For certain people, an EpiPen is necessary, so people will still buy them even if the price is ridiculous. Outside of the United States, the price of Epinephrine did not spike. Abolishing intellectual property and monopolies associated with patents would help significantly to fix this problem, but I really want to emphasize here that people will pay whatever they have to when the item in question is necessary to save the life of a loved one or reduce the suffering of a loved one. With pharmaceuticals, it is theoretically possible to fix the problem above by abolishing monopolies and oligopolies created by patent laws. I am totally on board with the radical free-market libertarians who want to abolish intellectual property laws, getting rid of copyrights and patents. This would make price-gouging in the pharmaceutical industry impossible. Abolish monopoly, open it up to more competition, and the problem is solved. However, healthcare in general cannot be fixed through such a free-market approach. When you are in an emergency, you go to the nearest hospital. If you are in a car accident, are unconscious, and being rushed to the ER, you cannot shop around for the best price. Even if you are conscious, you probably won't shop around if you are either in pain or in urgent need of help. How much would you pay to keep your child alive? How much would you pay to reduce your mother's suffering while dying of cancer? You would pay whatever it costs. Demand sets price. Most things in the marketplace have an upper limit, a reasonable point at which people won't pay more for it. Healthcare has no upper limit. People will pay as much as they have too. Healthcare, like insurance, should not be done on a for-profit basis. Single-Payer Healthcare, or socialized health insurance, is a step in the right direction, but nationalizing healthcare may actually be preferable.

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I'd recommend breaking post like this up into several smaller posts.

The best solution that I can think of is to fine companies for polluting by way of a tax on pollution.

Rather than thinking of it as a fine, I'd say that it could be considered a rent. If you want to use the air that the rest of us breathe as a dump, then you have to rent the atmosphere from us (because you didn't make it and it belongs to all of us equally).


I like that. But the form of the policy, whether framed as a fine, tax, or rent, doesn't make much difference. It's like the Henry George proposal that I advocate: some people call it ground-rent while others call it land value tax. You can call it a "rent" or a "tax" but the difference is merely linguistic. But your comment made me realize that something like cap and trade could be seen as logically following from Georgism. I think I'm gonna explore this idea further. Thanks.

I would like your thoughts on the proposals at


Scott Smith's book is on my reading list. I don't know enough to give a really educated response, but it seems like what they're advocating is something I would generally agree with. I would have to know the finer points and details before I could wholeheartedly get on board, but I suspect their proposal is worth seriously considering.


Good to know its on your list. :-) I look forward to seeing a discussion in the future.

Such a wonderful post with smart ideas about world economics by @ekklesiagora
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@ekklesiagora sir
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Good luck..