Congestion Pricing Requires a Careful Balance

Adam Milsap shares news of a new paper by Jeffrey Brinkman that serves as a reminder of the world's complications, especially with regard to congestion and agglomeration economies.

For those unfamiliar with the latter term, Milsap defines agglomeration economies as "the benefits that occur when firms and workers are in proximity to one another." Importantly, agglomeration economies are a behavior commonly found in firm clusters and cities.

While taxing activities that generate negative externalities and subsidizing activities that generate positive externalities is economically sound, calculating the appropriate tax or subsidy is often difficult in practice. The key problem, according to Milsap: "Since congestion is a result of the high population density that is also associated with agglomeration economies, there is tradeoff between the two."

So Jeffrey Brinkman's paper, published in the Journal of Urban Economics, argues:

…if city officials ignore the positive effect of agglomeration economies on productivity when calculating their congestion taxes they may set the tax too high. Overall welfare may improve even if the tax is too high (it depends on the size of the DWL when no tax is implemented) but society will not be as well off as it would be if the positive agglomeration effects were taken into account.