When the air or the water is too dirty, the standard analysis says that it is because polluters impose "externalities" (that is, harms) on those who breathe or drink. Even libertarians tend to agree that when externalities are present, markets alone do not achieve the best outcomes.

... a cap-and-trade system. In such systems those who pollute are given (or sold) "rights" to pollute in certain amounts (the "cap") and these rights are then traded in a market. Most specialists believe that such incentive-based systems as these should usually displace command-and-control regulation. We agree. Incentive-based approaches are more efficient and more effective, and they also increase freedom of choice.

Kind sir, I would like to take this opportunity to increase your freedom of choice by offering you, on the one hand, a bullet in the head, and, on the other hand, the freely-available alternative option of simply handing over your wallet to me. The choice is yours, and I would not want to take that choice away from you -- leaving you with less options than that. I want to give you options because I love freedom, you know. Now hand that wallet over before I give you a really bad case of lead poisoning.

... we think that this basic approach is compatible with libertarian paternalism because people can avoid paying the tax by not creating pollution. Especially when compared with command-and-control systems, economic incentives have a strong libertarian element.

Much of the time, the best approach to pollution problems is to impose a tax on the harmful behavior and to let market forces determine the response to the increased cost. The price of the harm-producing good will go up, and consumption will decline. Of course none of us likes taxes. But raising the tax on gasoline, for example, would eventually induce drivers to buy more fuel-efficient cars, drive less, or both. As a result, emissions of carbon dioxide, the leading contributor to global warming, would decline.

These incentive-based systems have not always gained political traction--in part, we think, because they make the costs of cleaning up the environment transparent.

One solution to the political problem of getting such bills passed may be to use some mental accounting. For example, the revenues from a carbon tax might be paired with a cut in personal tax rates, the funding of Social Security and Medicare, or the provision of universal health insurance. ... This linking of costs and benefits might help the pill go down more easily.

When voters are complaining about the high price of gasoline, it can be hard for politicians to unite on a solution that raises this price. A key reason is that the costs of pollution are hidden, while the price at the pump is quite salient.

It's not clear how many people would actually want to make their energy use public, and we don't think that we're at a stage when public officials should require people to do so.