"It doesn't have to be complicated. Estimate the monetary cost of the negative externalities associated with gasoline use, set the appropriate tax, and then do nothing else. The market price then sends the correct signal to investors about how to take advantage of new opportunities in alternative energy."
No, no, no, I did not take this passage straight out from Pigou's "Economics of Welfare." It is from a post written by economist Andrew Samwick at his blog, read more here.
Frankly, I am shocked by the fact more than 40 years after publication of "The Problem of Social Costs", there are still economists out there who buy into the whole Pigovian taxation approach in dealing with "externalities."
But does the term externality have any economic meaning at all?
Back in the 1970, Professor Steven Cheung wrote in "The Structure of a Contract and a Theory of Non-exclusive Resource", Journal of Law and Economics:
"The process of arriving at a useful concept of analysis is not only slow andpainful, but may also go astray and attain nothing useful. Someone begins withone example or observation, followed by a theory which is intuitively plausible.A theoretical term associated with a vague concept is coined. Examples of aseemingly different type emerge, which call for another theory. The process goeson. As examples and theories continue to accumulate, the different categoriesunder the same heading of analysis serve only to confuse and each associatedtheory becomes ad hoc. Such has been the fate of the concept of ‘externality.'"
That still rings true today!