The BP oil spill reveals the risks associated with oil production, risks that translate into large social costs that are not priced into the oil market. Diane Lim Rogers, Concord’s chief economist, notes that this is a classic case of what economists call a “negative externality,” where the social costs of producing and consuming a good exceed the private costs paid through market prices.
In such a case, intentionally distorting market prices through a tax can offset the negative externality and improve economic efficiency. But the U.S. gasoline tax is far too low by international standards, and we generally aren’t in the practice of taxing environmentally harmful activities.
In fact, Rogers points out, we’re in the habit of subsidizing the oil and gas industry via tax preferences. That increases the deficit, and worsens the economic inefficiencies (and environmental damage) associated with fossil fuels. Now, with the BP disaster, we should be trying to correct those mistakes. Rogers argues that the government should implement a climate change policy that would raise fossil fuel prices (that all of us pay) and raise revenue to reduce deficits.
Oil spill costs: What will BP really pay?