Externalizing the Internality

We use a theoretical model and empirically-calibrated simulations of the automobile market to show how the traditional logic of Pigouvian taxation changes when consumers are inattentive to energy costs. Under inattention, there is a "Triple Dividend" from externality taxes: aside from reducing the provision of public bads and generating government revenue, they also reduce allocative ine¢ ciencies caused by underinvestment in energy e¢ cient capital stock. While Pigouvian taxes are clearly the preferred policy mechanism when externalities are the only market failure, inattention provides an "Internality Rationale" for alternative policies such as subsidies that reduce the relative price of energy e¢ cient durable goods. However, heterogeneity in the way that consumers optimize or misoptimize means that non-discriminatory taxes and subsidies are blunt instruments for addressing misoptimization: any given policy is too strong for some consumers and too weak for others. We therefore discuss "Behavioral Targeting": the use of mechanisms such as tagging, screening, and nudges that preferentially a¤ect misoptimizers. We also formally de…ne a class of mechanisms called "Nudge-Inducing Policies," which are taxes speci…cally designed to encourage …rms to use advertising, information provision, retail sales interactions, and other nudges to debias misoptimizing consumers. JEL Codes: D03, D04, D11, H21, H22, H23, L51, L62, L97, Q41, Q48 Keywords: Energy e¢ ciency, energy-using durables, implied discount rates, inattention, internality taxes, nudges, salience, targeting. — — — — — — — — — — — — — — — — — — — — — — — — — — — — We thank Liran Einav, Michael Greenstone, Nathan Wozny, and seminar participants at the Environmental Defense Fund, MIT, and the 2011 ASSA meetings for feedback and helpful conversations. Rich Sweeney provided insightful research assistance. We are grateful to the Sloan Foundation for …nancial support of our research on the economics of energy demand. Allcott: New York University and NBER. Mullainathan: Harvard University and NBER. Taubinsky: Harvard University.