On the Shiftable Externalities

In the debate concerning how to treat the victims of a depletable externality, Bird argues that if the externality is shiftable, it is efficient to tax the victim′s shifting behavior or compensate his acceptance. Baumol and Oates accept his conclusion in the revised edition of their acclaimed textbook. However, Shaw and Shaw assert that Bird and Baumol and Oates′ taxation policy could be nonoptimal, since they overlook the possibility of resisting the shift of an externality and the victim′s conjectural variation. This paper shows that, with modifications made necessary by the conjectural variation, each of the policy prescriptions proposed by those previous studies provides theoretically correct incentives for the victims, but that they differ with respect to feasibility. Shaw and Shaw appear to have misinterpreted Bird and Baumol and Oates′ argument. The analysis in this paper reveals that, in the presence of a shiftable externality, the Pareto optimum must be at the corner. Some interesting implications can be derived from such a feature. It is argued that, in terms of feasibility, the most favorable policy is one which compensates the victim′s acceptance of a shiftable externality. This argument is in accord with that of Bird.