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 Pigou-vian 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\u85ne a class of mechanisms called "Nudge-Inducing Policies, " which are taxes speci cally designed to encourage \u85rms to use advertising, information provision, retail sales interactions, and other nudges to debias misoptimizing consumers