Akiva Leeder

Law & Economics

Welfare Economics and Congestion Pricing

Introduction

Since at least the time of the industrial revolution economists have tried to

account for the existence and ideally solve the problem of externalities. Much of this

focus has been on the negative externalities associated with pollution and how the free

market has or has not been able to adequately address the problem. Despite the general

agreement that a problem exists, there is no shortage of opinions regarding why the

problem exists in the first place and how to deal with it. This paper will discuss the

externalities associated with traffic congestion and analyze one potential solution,

congestion pricing, within the framework of welfare economics.

Of the many economists who addressed the free market’s failure to compensate

for externalities, few have been more influential than Arthur Cecil Pigou and Ronald

Coase. While their approaches to the problem of externalities may seem different at first

glance, some have argued that many of Coase’s insights are borrowed from and built

  1 
upon Pigou’s work.1 These two economists’ views have been instrumental in shaping

free market policies with regard to externalities.

After the problems of externalities are recognized, a further question of how to

deal these problems emerges. While both Pigou and Coase offer some guidance, an

offshoot of welfare economics known as cost-benefit analysis has developed, providing

policy makers with a practical decision-making framework. Though imperfect, cost-

benefit analysis seeks to solve the problem of externalities by asking “whether society as

a whole will become better off by undertaking [a] project rather than not undertaking it,

or by undertaking instead any of a number of alterative projects.”2

Policy makers can use welfare economics to identify cases of externalities and

explore different methods of addressing them. Solutions can range from relying on the

free market to correct itself to government intervention in the form of taxes and/or

subsidies. Although it may be argued that policy decisions are ultimately political in

nature, welfare economics does provide an important framework for solving the problem

of externalities. Even when no active solution is undertaken, perhaps due to political

inertia, it should be recognized that this inaction is still a form of policy. Leaving

problems unsolved however is only sensible if “it would cost more to remove them than

we would gain.”3

                                                        
1
See Herbert Hovenkamp, The Coase Theorem and Arthur Cecil Pigou, University of Iowa Legal Studies
Research Paper 08-44, April 2009 (arguing that Coase built upon Pigou’s work more than Coase ever
acknowledged).
2
E.J. Mishan, Cost-Benefit Analysis, at xxix (4th ed. 1988).
3
RH Coase, ‘Social Cost and Public Policy’, in GA Edwards, ed Exploring the Frontiers of Administration,
Toronto (Canada), Bureau of Research, Faculty of Administrative Studies, York University, 1970 at 40.

  2 
The problem of congestion and the congestion pricing solution

Most commuters in urban environments, and many in suburban environments,

have encountered the phenomenon of congestion. Congestion, and more specifically

traffic congestion, occurs when traffic demand exceeds roadway capacity.4 Traffic

congestion affects people beyond those immediately involved in any particular

manifestation, as it tends to increase transportation costs, which in turn hurts the

economy in the form of lost jobs and wasted productive time.5 In addition, traffic
6
congestion adds to costs that are more difficult to measure, such as pollution, public

health (including the hindrance of emergency vehicles), and quality of life.7

The idea to alleviate congestion in urban areas is not new, though the typical

approach has been to simply increase public transportation.8 Adding an underground

railway, for example, gives commuters an alternative to driving, thus tending to reduce

traffic congestion. But, any reduction in congestion solely as a result of adding an

underground railroad fails to directly account for the social costs imposed by the driving

commuters whose choice to drive contributes to the congestion. The driving commuters

would enjoy the benefits in disproportionately high amounts as compared to the rail

commuters since the drivers’ costs do not increase.

                                                        
4
See http://www.fhwa.dot.gov/congestion/describing_problem.htm (defining congestion in terms of the
United States highway system).
5
See Partnership for New York City, Growth or Gridlock? The Economic Case for Traffic Relief and
Transit Improvement for a Greater New York (2006).
6
Id at 41.
7
Id at 5.
8
See E.J. Mishan, Cost-Benefit Analysis, 3-5 (4th ed., 1988) (discussing a cost-benefit analysis to the
implementation of an underground railway).

  3 
 William Vickrey emerged as an early proponent of congestion pricing to ease

traffic congestion in urban areas so as to more accurately account for costs imposed on

the transit system by drivers.9 While congestion charges can take many forms, the basic

idea is to charge drivers a fee to enter congested urban areas. How much to charge and

the details of implementing such a plan as well as how to allocate the proceeds (if any)

present additional issues that must be resolved before any such plan should take effect.

While there are several examples around the world of successful congestion

pricing schemes, none has yet been implemented in a major US city. The mayor of New

York City, Michael Bloomberg, proposed such a plan in 2007,10 but the proposal failed to

achieve enough support in the New York State Assembly.11 Ultimately it was a political

as opposed to economic failure as congestion pricing schemes can be justified by welfare

economic theory.

A Pigovian Approach to Externalities

Though Pigou did not use the word “externality” in his writings, it is clear that he

understood the concept in discussing the “divergences between marginal social net

product and marginal private net product.”12 For Pigou, a negative externality exists

                                                        
9
See William Vickrey, Pricing in Urban and Suburban Transport, The American Economic Review,
(May, 1963) at 460 (discussing the impact of a congestion charge).
10
See Mayor Bloomberg Presents PLANYC: A Greener, Greater New York, http://www.nyc.gov/ (Search
“PR- 119-07”).
11
See http://cityroom.blogs.nytimes.com/2008/04/07/congestion-pricing-plan-is-dead-assembly-speaker-
says/?hp.
12
AC Pigou, Economics of Welfare, 172 (Transaction Publishers 2009)(1920).

  4 
when marginal private net product exceeds marginal social net product – that is,

situations in which “incidental uncharged disservices are rendered to third parties.”13

One example Pigou gives of this phenomenon is that of an “owner of a site in a

residential quarter of a city … when he invests resources in erecting buildings in a

crowded centre, which, by contracting the air space and the playing-room of the

neighborhood, tend to injure the health and efficiency of the families living there.”14 In

this example, the costs to the families, in the form of health and efficiency loss are not

borne by the builder and thus represent a classic example of a negative externality.

In discussing how to deal with these externalities, Pigou notes that simply

modifying the contractual relationship between any two contracting parties to a

transaction which causes externalities will not work “because the [externality] arises out

of a service or disservice rendered to persons other than the contracting parties.”15

However, Pigou notes that the State can remove these externalities by imposing

“‘extraordinary encouragements’ or ‘extraordinary restraints.’”16 Specifically, Pigou

notes that the most obvious “encouragements and restraints…[are] those of bounties and

taxes.”17

As an example of the implementation of tax to combat negative externalities,

Pigou cites the special taxes imposed on businesses producing and distributing alcoholic

drinks.18 In this case, the “extra costs in policemen and prisons which [alcohol] indirectly

                                                        
13
Id at 185.
14
Id at 185-86.
15
Id at 192.
16
Id.
17
Id.
18
Id.

  5 
makes necessary”19 is paid for by the tax on alcoholic drinks. By using the proceeds to

combat the negative externalities produced by the taxed item, the tax works to eliminate

the negative externalities altogether. In pigovian terms, this tax would equate marginal

private net product with marginal social net product. Such a taxing scheme, often referred

to as a pigovian tax, presents the ideal situation where those who cause the negative

externalities in the first place are the ones who must pay to eliminate them.

The pigovian tax scheme also works in the case of positive externalities where,

instead of a tax, bounties are paid to the producers of positive externalities so as to

encourage their production. Pigou cites agriculture as an example of an industry that

produces a positive externality - “the indirect service of developing citizens suitable for

military training.”20 Regardless of whether that benefit holds true today, the idea for

Pigou is that since “the private net product of any unit of investment is unduly small,”21 a

bounty can be given to encourage investment in those industries, such as agriculture, to

increase the amount of the resulting positive externalities.

Expanding on his agriculture example, Pigou notes that bounties can take the

form of “spreading information about improved processes of production.”22 Since

farmers “lack the appreciation on the part of potential beneficiaries, it would be difficult

to collect a fee for undertaking that task.”23 Assuming the agricultural industry does

produce this positive externality, giving farmers a bounty in the form free information to

increase their production accrues a net benefit to society at large.

                                                        
19
Id at 186.
20
Id at 193.
21
Id.
22
Id at 194.
23
Id.

  6 
 In addition to any tax or bounty scheme, Pigou acknowledges “the Government

may find it necessary to exercise some means of authoritative control.”24 He gives the

example of city planning where “power must be held by some authority to limit the

quantity of building permitted to a given area, to restrict the height to which houses may

be carried, for the erection of barrack dwellings may cause great overcrowding.”25 He

goes on to argue for the necessity of a government authority to “tackle the collective

problems of beauty, of air and of light, as those other collective problems of gas and

water have been tackled.”26

Even though Pigou’s “name remains attached to the notion that negative

externalities are ubiquitous and that government is systematically superior to markets in

reducing the associated social costs,”27 he was weary of the government’s ability to

successfully regulate. Pigou was cognizant that the government is subject to “sectional

pressure and to personal corruption by private interest,” and that companies “may employ

corruption, not only in the getting of their franchise, but also in the execution of it.”28

Furthermore, the fluctuating nature of a representative democracy “may lead to action

based on short views – views bounded by the next election, not extending to the

permanent interests of the community.”29 It is clear that although Pigou advocates for tax

or bounty schemes in order to deal with externalities, he understands that it is the

government that must implement them and therefore they either may not happen all, as

                                                        
24
Id.
25
Id.
26
Id at 195.
27
A.H. Barnet and Bruce Yandle, The End of the Externality Revolution (20060 at13, available at
http://mises.org/journals/scholar/barnett.pdf.
28
Pigou at 332.
29
Id at 334.

  7 
was the fate for New York City’s congestion pricing plan, or it may not be implemented

in a way providing the maximum benefit to society.

Pigovian Approach to Congestion Pricing

When Pigou was writing about externalities in the early 20th century he did not

address the specific problem of urban traffic congestion, but he did address the concept of

congestion pricing in his first edition of The Economics of Welfare.30 As laid out by

Pigou:

Suppose there are two roads ABD and ACD both leading
from A to D. If left to itself, traffic would be so distributed
that the trouble involved in driving a ‘representative’ cart
along each of the two roads would be equal. But, in some
circumstances, it would be possible, by shifting a few carts
from route B to route C, greatly to lessen the trouble of
driving those [sic] still left on B, while only slightly
increasing the trouble of driving along C. In these
circumstances a rightly chosen measure of differential
taxation against road B would create an ‘artificial’ situation
superior to the ‘natural’ one.31

In this example, ABD represents a shorter route than ACD such that ‘natural’ situation is

for drivers to choose take the shorter route until, due to resulting congestion, the travel

time for both roads is equal. Pigou offers a solution to this problem in the form of a tax

on the shorter route which would cause some drivers to shift to the longer route so as “to

                                                        
30
See Barnet at 7.
31
Robin Lindsey, Do Economists Reach a Conclusion, Econ Journal Watch, at 300 (quoting from the first
edition of Pigou’s The Economics of Welfare).

  8 
lessen the trouble of those still left [on the shorter route], while only slightly increasing

the trouble of driving along [the longer route].”32

A critic of Pigou, F. H. Knight, responded to the “two roads” problem by

proposing a private as opposed to public solution.33 Knight claimed that “if the roads are

assumed to be subject to private appropriation and exploitation, precisely the ideal

situation which would be established by the imaginary tax will be brought about through

the operation of ordinary economic motives.”34 The idea is that if the shorter road was

privately owned and the owner could impose tolls, the owner would “charge for its use a

toll representing its ‘superiority’ over the free road.”35 The owner will set this toll “up to

the point where congestion and diminishing returns set in,”36 and it is this point that

“maximize[s] the total product of both roads.”37 Thus Knight was able to propose a

solution that did not involve direct government intervention to solve the congestion

externality, but rather utilized the free market mechanism.

Instead of responding to Knights argument, Pigou simply removed the example

from later editions of his book and arguably conceded the point by doing so.38 Despite

this, Pigou continued to advocate for government imposed taxes (or bounties) as

solutions for externalities that the private market failed to correct.

If presented with the problem of urban traffic congestion, Pigou might very well

refer to his solution to the "two roads" problem. Since the roads in an urban environment

                                                        
32
Id.
33
See F.H. Knight, Some Fallacies in the Interpretation of Social Cost, The Quarterly Journal of
Economics, Vo. 38, No. 4 (Aug, 1924).
34
Id at 587.
35
Id.
36
Id.
37
Id at 588.
38
See Barnett at 7.

  9 
are a public good and it would be hard to envision Knight’s idea of their private

ownership, a properly administered pigovian tax could solve the problem.

Pigou would describe the problem of traffic congestion in terms of marginal

product - private net product exceeding social net product. That is, the private benefit

accruing to the individual drivers exceeds the societal benefit when traffic demand

exceeds capacity. Drivers travelling into urban centers under these traffic conditions

impose costs on society beyond what they bear themselves. A pigovian solution to the

problem would entail a form of tax on the drivers, the proceeds of which would go

towards abating the problems caused by the congestion.

It must be noted that a congestion problem only occurs when traffic demand

exceeds capacity, and this only occurs during certain times of day and only on certain

days of the week. Since the problem is that of congestion rather than any one driver’s

choice to travel into an urban center, a proper pigovian tax should only target those

drivers whose choice adds to the congestion problem.

Pigou addressed this notion of variable pricing when writing about railroad

rates.39 In addressing services generally, he notes that “though physically similar,

[services] are not necessarily similar in respect of cost when they are rendered at different

times or seasons of the year.”40 For example, consumers of electricity supplied during

peak hours are charged higher rates than during off-peak hours. In order to supply the

electricity required during peak hours, “a large quantity of equipment must be erected

                                                        
39
See Pigou at 290-317.
40
Id at 294.

  10 
additional to what would be required if there were no hours or seasons of exceptional

demand.”41 Pigou refers to this pricing scheme as the “cost of service principle.”42

Pigou extends this “cost of service principle” to transportation by noting that it

“would seem to warrant higher fares for travel at busy seasons and at busy hours of the

day than are charged at other times.”43 Further, even if rail ticket prices are not adjusted

to reflect the application of this principle, differential charges exist in “a concealed

form.”44 Specifically:

When a man traveling as a straphanger in the London Tube

at 5 o’clock in the evening pays the same absolute price as
he does when traveling in comfort at 3 o’clock, he is paying
that price for a different and much inferior service. There is
just as real a differentiation as there would be if he traveled
in equal comfort on both journeys and paid a considerably
higher fare at the crowded time.45

This same logic can be applied to a traffic congestion scenario. A driver who travels into

an urban center during congested times may pay the same absolute cost (i.e. fuel, wear

and tear, etc.) as the driver making the same trip during an un-congested time, except the

former pays more in the form of increased travel time and frustration.

The application of Pigou’s “cost of service principle” to traffic congestion does

not capture the costs imposed by drivers during congested times on others, particularly

other commuters. For example, drivers during congested times not only pay costs

themselves in the form of increased travel time and frustration, but also increase both of

these costs on commuters utilizing public transportation in the form of busses. In

                                                        
41
Id (Note Pigou’s analysis assumes that electricity must be produced at the time it is supplied).
42
Id.
43
Id at 295.
44
Id.
45
Id.

  11 
pigovian terms, the marginal private net product of the drivers during congested times

exceeds marginal social net product of all commuters.

A pigovian response to this divergence between marginal private net product and

marginal social net product would be to impose a tax on drivers who travel into urban

centers during congested times and use the proceeds to combat congestion. For example,

a toll could be imposed on drivers who travel into urban centers during periods of

congestion and the proceeds of the toll could be used to expand bus service. Assuming

such a toll could be properly administered, it would tend to reduce congestion by

preventing some drivers from traveling into urban centers during congested times while

offering an alternative to driving in the form of expanded bus services which reduces

congestion.

A Coasean approach to Externalities

Coase was able to take a different approach to the problem of externalities from

that of Pigou by framing the problem in the first instance as a reciprocal one. Coase

notes that the traditional approach to dealing with externalities involves the scenario

where “A inflicts harm on B” and the question to be decided is “how should we restrain

A?”46 Instead, Coase argues that the “real question that has to be decided is, Should A be

allowed to harm B or should B be allowed to harm A? The problem is to avoid the more

serious harm.”47 By framing the question in this way Coase seeks to maximize social

                                                        
46
RH Coase, The Firm, the Market and the Law, 96 (University of Chicago Press, 1990)(1988).
47
Id.

  12 
welfare through an efficient allocation of resources. In this regard, Coase’s objective is

similar to Pigou’s goal of maximizing marginal social net product.

Unlike Pigou’s system of government imposed taxes and bounties to address

externalities, Coase had faith in the free market to deal with these problems on its own so

long as an initial determination of rights has been made.48 Moreover, Coase argues “the

ultimate result (which maximizes the value of production) is independent of the legal

position if the pricing system is assumed to work without cost.”49 Essentially Coase

argues that as long as rights with respect to liability are clear (regardless of how they are

assigned) and there are no transaction costs involved in the market, the ultimate result of

maximization of the value of production will occur naturally through the free market

mechanism, eliminating the need for government intervention. While this prospect is

certainly intriguing, it relies on the highly theoretical assumption of a market free of

transaction costs.

Understanding that the assumption of zero transaction costs is “very

unrealistic,”50 Coase acknowledges that a “rearrangement of rights will only be

undertaken when the increase in the value of production consequent upon the

rearrangement is greater than the costs which would be involved in bringing it about.”51

Furthermore, once transaction costs are taken into account, “the initial delimitation of

legal rights does have an effect on the efficiency with which the economic system

operates.”52 That is, after transaction costs are taken into consideration there is no

                                                        
48
Id at 104 (arguing that without the establishment of initial delimitation of rights there can be no market
transactions to transfer and recombine them).
49
Id.
50
Id at 114.
51
Id at 115.
52
Id.

  13 
guarantee that the market will be able to bring about the “optimal arrangement of rights,

and the greater value of production which it would bring.”53

In certain situations where transaction costs are sufficiently high, Coase accepts

that government intervention could “lead to an improvement in economic efficiency.”54

He then offers the example of the “smoke nuisance,” where “a large number of people is

involved and when therefore the costs of handling the problem though the market or the

firm may be high.”55 While it seems here Coase would be in favor of government

regulation, he is quick to point out that a “further alternative” exists; “to do nothing about

the problem at all.”56 The idea for Coase is that government regulation may bring about

the optimal solution, but it is far from certain. It may be the case where, despite the

existence of negative externalities, the best course of action is simply inaction.

It is at this point in “The Problem of Social Cost” that Coase is essentially calling

for a type of cost-benefit analysis. He argues “all solutions have costs, and there is no

reason to suppose that governmental regulation is called for simply because the problem

is not well handled by the market.”57 Instead of defaulting to government action, Coase

would have economists and policy makers undergo “a detailed investigation of the actual

results of handling the problem in different ways.”58 It is in this regard that Coase’s

solution to a problem requiring governmental action is similar to that of the cost-benefit

analysis championed by E. J. Mishan.59

                                                        
53
Id.
54
Id at 118.
55
Id.
56
Id.
57
Id.
58
Id at 199.
59
See E.J. Mishan, Cost-Benefit Analysis, at xxix (4th ed. 1988).

  14 
 A Coasean approach to Congestion Pricing

The ideal Coasean solution to the problem of traffic congestion would be market

based. This would entail a clear delineation of rights and a transaction costless market

through which all participants could bargain to reach an optimal solution. If the

congestion problem were neatly confined to two rural roads, like that of the “two roads”

problem, Coase would likely support Knight’s solution. Coase would explain that by

clearly defining property rights in the roads and assuming low costs in extracting and

enforcing tolls, the free market mechanism would achieve the optimal level of congestion

thus eliminating the need for government intervention.

This example breaks down, however, when applied to urban traffic congestion. It

is hard to conceive of private ownership of city roads, but even this would fail to account

for other negative aspects of urban traffic congestion such as pollution. Furthermore,

even if property rights could be established so as to account for all the externalities,

transaction costs would be prohibitively high considering the large number of people

involved. Because of these issues, Coase might treat urban traffic congestion in a similar

manner to the problem of smoke nuisance.60 If so, urban traffic congestion may represent

an “occasion” where, due to the “large number of people involved,” government

regulation may “lead to an improvement in economic efficiency.”61 However, Coase

would only support such intervention if it can be shown that the costs associated with

such intervention do not exceed the benefits. If the costs were to exceed the potential

benefits, Coase would likely advocate for the alternative of doing nothing at all.
                                                        
60
Coase at 118.
61
Id.

  15 
 Coase is generally critical of the pigovian tax scheme as a method of solving

externalities. In the context of smoke pollution, Coase argues that the “aim of such

regulations should not be to eliminate smoke pollution but rather to secure the optimum

amount of smoke pollution, this being the amount which will maximize the value of

production.”62 In the context of traffic congestion, Coase would argue that the aim of any

congestion charge should not be to rid urban areas of congestion completely but rather to

achieve the optimum level of congestion. It may be the case that some level of

congestion actually produces higher net benefits than a charge sufficiently high that it

eliminates congestion altogether.

It is clear that Coase would only support a pigovian congestion charge if the

empirical data supports the conclusion that the benefits exceed the costs. In Coase’s own

words; “it is all a question of weighing up the gains that would accrue from eliminating

these harmful effects against the gains that accrue from allowing them to continue.”63

Essentially Coase is calling for a type of cost-benefit analysis before undergoing a

program intending to reduce a negative externality.

Cost-benefit analysis

As stated by Aaron Wildavksy, “the purpose of cost-benefit analysis is to secure

an efficient allocation of resources produced by the governmental system in its

interaction with the private economy.”64 The idea behind the analysis is that only

                                                        
62
Id at 153.
63
Id at 131.
64
Aaron Wildavsky, The Political Economy of Efficiency: Cost-Benefit Analysis, System Analysis, and
Program Budgeting, Public Administration Review (December 1966) at 293.

  16 
projects whose benefits exceed its costs should be undertaken. To make this

determination, “streams of costs and benefits are discounted so as to obtain the present

value of costs and benefits.”65 While seemingly straightforward, assumptions and

judgments must be made in conducting the analysis, many of which amount to educated

guesses.

A classic example of a cost-benefit analysis involving a major public project is

that of an underground railway.66 Mishan frames the analysis as “estimating the initial

capital outlays which will be spread over five years against … the stream of future net

benefits (gross benefits less operating costs) spread over fifty years.”67 Curiously,

Mishan claims that “there is no difficulty in estimating” these initial costs for such a

project despite the fact that cost estimates for construction projects, particularly for public

transportation projects, are routinely understated, while the benefits are routinely

overestimated.68

Even if construction and operating costs on an underground railway can be

accurately estimated, one still has to estimate the benefits, for both expected users of the

service and others. For example, “ for some portion of the expected users … the benefits

would be calculated as a cost saving as compared with their existing form of travel” and

may be “augmented by some estimate of the value of the greater comfort” which

                                                        
65
Id.
66
See Mishan 3-5.
67
Id at 3.
68
See Bren Flyvbjerg, How (In)accurate Are Demand Forecasts in Public Works Projects?, Journal of the
American Planning Association (Vol.71, No.2 Spring 2005) (arguing that routinely inaccurate cost and
benefit estimates for major transportation projects lead to flawed decisions).

  17 
traveling by underground rail might provide.69 Also, there may be some people “that

might not travel at all if there were no provision for underground railway services.”70

For those who will not be users of the underground railway but will continue to

travel on roads, benefits may include “some saving of time,” as well as “an increase in

safety and an increase in comfort.”71 Mishan goes further to point out that even those

who never plan on using the new form of transportation may still benefit from “a partial

form of insurance” – the railway will be “an alternative that is always open to them

should their customary means of travel fail.”72

Mishan cautions, however, not to include among the benefits “any rise in land

values resulting from the new underground service,”73 for doing so would be double

counting. Mishan argues that the advantages leading to any increase in property value,

such as increase “job opportunities, shopping opportunities, or outings,” should have

“been entered into the cost-benefit analysis of the railroad on an annual basis.”74 To add

the “capital gains,” in the form of property value increases, “would amount to a clear case

of double-counting.”75

A Cost-Benefit Analysis of Congestion Pricing

To justify the imposition of congestion pricing based on a cost benefit analysis,

the present value of the initial and operating costs should be less than the present value of

                                                        
69
Mishan at 4.
70
Id.
71
Id.
72
Id.
73
Id.
74
Id at 78.
75
Id.

  18 
the benefits. In his comprehensive study of the London Congestion Charge,76 Jonathan

Leape outlined the costs and benefits of the scheme the London Congestion Charge

Research Program (LCCRP) took into account in conducting a cost-benefit analysis.77

Costs for the congestion charge were divided up into five categories; the initial

set-up costs, the operation costs, the supervisory costs associated with managing the

scheme, traffic management costs, and charge-payer compliance costs.78 The benefits

included the “time savings to drivers and passengers of vehicles that continue to use the

road system after charging is introduced,” “improved journey time reliability,” as well as

“reduced accidents and lower carbon dioxide emissions.”79 The net proceeds of the

scheme were not included as a benefit, but “given the UK government requirement that

all charge revenues be spent on transport improvements, the charge payments are likely

to be generating significant additional benefits in reduced travel times and accidents and

in other savings.”80

Costs involved with the set-up and enforcement of a congestion pricing plan has

long been an attack against the implementation of such schemes. As Vickrey notes in his

1963 essay, “talk of direct and specific charges for roadway use conjures up visions of a

clutter of toll booths, an army of toll collectors, and traffic endlessly tangles up in

queues.”81 Vickrey accepts that “conventional methods of toll collection” would be

costly in terms of “manpower, space, and interference with the smooth flow of traffic,”82

                                                        
76
See Jonathan Leape, The London Congestion Charge, Journal of Economic Perspectives, (Vol. 20, No.4,
Fall 2006).
77
See Id at 171.
78
Id.
79
Id.
80
Id.
81
Vickrey at 457.
82
Id.

  19 
but he had the foresight to envision technological solutions to these problems. His vision

of cars being scanned by roadside equipments and bills being sent out to drivers83 is not

so different from London’s enforcement scheme of “video cameras at every entry point…

using automatic number plate recognition technology… to identify vehicle registration

number[s].”84

The main benefits of a congestion pricing scheme take the form of reducing

traffic congestion that would tend to decrease travel time, accidents and pollution while

increasing journey time reliability. These benefits are harder to estimate than the set-up

and enforcement costs largely because they depend on “assumptions made about the

value of time, the value of lower pollution and reduced accident rates.”85 Making

difficult assumptions like these is all part of conducting a cost-benefit analysis as noted

by Wildavsky; “if certain costs or benefits are deemed important but cannot be

quantified, it is always possible to guess.”86 Though seemingly unwieldy in application,

computer modeling techniques allow for the easy adjustment of assumptions to create

reliable models – this was how the cost-benefit analysis was conducted prior to the

implementation of the Congestion Charge in London.

Various Congestion Charge Models

One of the basic theories underlining a congestion charge is that “a journey

should be undertaken only if its value is at least as great as the costs which it imposes on

                                                        
83
See Id at 458.
84
Leape at 163.
85
Laura Blow, Andrew Leicester & Zoë Smith, London’s Congestion Charge, Briefing Note 31 at 8, The
Institute For Fiscal Studies (2003).
86
Wildavsky at 296.

  20 
the community.”87 Since “the congestion problem arises because drivers are not faced

with the full costs of their actions, … an obvious solution is to make them pay these

external costs.”88 The charge works by making sure “that only those drivers with a

valuation of their journey (above private costs already incurred) greater than or equal to

the charge continue to travel.”89 This raises the question of what level to set the charge

so as to adequately reflect the cost on the community.

License Plate Rationing

While not a charge per se, license plate rationing programs seek to reduce traffic

congestion by only allowing certain vehicles to travel into congested urban areas on

certain days of the week. A typical plan “restricts a set of vehicles from entering a

specified area on certain days based on the last digit of the vehicle’s license plate.”90 The

theory behind such plans is that the restrictions will compel drivers to shift their mode of

transportation, change the time of day they travel, carpool, or simply not make the trip at

all. If successful, such plans would result in less congestion, thereby deriving similar

benefits to those of a congestion charge outlined above.

Such plans are usually accompanied by the imposition of fines for violators set at

high levels. While one could theoretically avoid the plan simply by paying the fine, the

price is usually set sufficiently high and may be coupled with vehicle impounding91 so

that drivers seeking to avoid the plan resort to other means. One common avoidance
                                                        
87
David G. Tipping, Time Savings in Transport Studies, The Economic Journal at 852 (Vol. 78, No.
312)(Dec. 1968).
88
Blow et al at 3.
89
Id.
90
Cambridge Systematics, License Plate Rationing Evaluation, Technical Memorandum ES-1 (Dec. 2007).
91
See Id at 2-5 (noting that Mexico City’s plan penalty includes impounding the violating vehicles for a
period of 48 hours).

  21 
method for those who can afford it is to simply purchase a second vehicle. If the

particular plan only distinguishes between odd and even numbered license plates (like

that of Athens),92 this method of avoidance is particularly effective. If the second car

purchased is of lesser quality and therefore emits more pollution, then the plan may

actually end up causing more pollution while not reducing congestion. Furthermore,

since the acquisition of a second vehicle to avoid the restrictions may only be available

for the wealthy, such plans may disproportionately impact those with lower incomes.93

Though several of these programs are in effect in cities around the world, the

long-term effects are questionable and the programs require strict enforcement.94 License

plate rationing schemes cause drivers to expend resources avoiding the plan while

requiring funds from other sources for the plan’s implementation and thus may be

inferior to congestion pricing schemes.

London

London’s congestion charge imposes a £8 daily fee95 to drive into central London.

The charge is a form of “‘area license’ in that the fee effectively buys for the purchaser

the right to drive into and out of the charging zone as many times as desired throughout

the day, with charges applicable between 7:00am and 6:30pm.96 The charge is the same

for all eligible vehicles, except that disable persons, emergency vehicles, and certain

alternative fuel vehicles are exempt.97 The charge is enforced through vehicle plate

                                                        
92
See Id at 2-23.
93
See Id at 4-1.
94
See Id.
95
The charge is £8 if you pay on the day of travel or £10 if you pay the first charging day after travel.
96
Blow et al at 5.
97
See Id at 6.

  22 
recognition technology that captures each vehicle’s plate number, which is then stored in

a database and compared at the end of each day with those numbers for which the owners

have paid the charge.98 Those who fail to pay receive a fine of £120, which is reduced by

a 50 percent discount if payment is made within two weeks or increased to £180 if no

payment is received after 28 days.99

It can be argued that a flat blanket charge is not the optimal solution since it does

not “internalize the externalities imposed by road users slowing down everyone else.”100

The ideal charge would differentiate “by both the specific route taken and by the time of

day, to reflect different levels of congestion in both a geographic and time-specific

sense.”101 However, this would require more sophisticated systems and likely increase

monitoring costs, though such a scheme is currently place in Singapore. In any event,

London’s Congestion Charge has been a success by several measures.

The congestion charge has successfully been able to influence “the decisions of

road users on various margins: whether to take a particular trip, which mode of transport

to use, and when to travel.”102 Since implementing the charge, average travel speeds

have increased almost 17 percent and congestion has “dropped an average of 30 percent

from the start in February 2003 to mid-2005, at the top end of expectations.”103 Another

result was an increase in journey time reliability; surveys showed that the “standard

                                                        
98
Id.
99
See Penalties and enforcement, http://www.tfl.gov.uk/roadusers/congestioncharging/6714.aspx.
100
Blow et al at 7.
101
Id.
102
Leape at 165.
103
Id at 166.

  23 
deviation of travel times decreased 27 percent during the morning peak and 34 percent

for return journeys.”104

The congestion charge also had a significant effect on public transportation.

Though there was no increase in rail trips,105 there was a large increase in bus ridership.

From autumn 2002 to autumn 2003 there was an increase in bus passengers of 38 percent,

half of which it is estimated is from an improved bus service and half to the congestion

charge.106 One explanation for the better than expected increases in bus ridership is due

to the so called ‘virtuous circle’:

The higher price of rush-hour car travel induces some to

switch to public transport, increasing revenues to transport
providers. At the same time, reduced congestion leads to
increased travel speeds for buses which, in turn, further
encourage patronage while also reducing average costs per
passenger to transport providers. Increased passenger
numbers and reduced average costs enable providers to
offer some combination of improved service levels (more
routes, higher frequencies) and lower fares. Improved
services and reduced fares stimulate further shifts from car
travel to public transport, resulting in additional reductions
in congestion and gains to public transport.107

Additionally, this ‘virtuous circle’ leads to more reliable bus service, as evidenced by the

30 percent drop experienced in excess waiting times for buses in the charging zone in the

first year after the introduction of the charge.108

In a certain sense the congestion charge had been too successful since revenues

from the charge have been far lower than estimates. The shortfall in revenues, at about
                                                        
104
Id at 167.
105
Id at 168 (Leape cites other factors for this including the prolonged closure of the Central Line,
downturn in the local economy, the war in Iraq, and the drop off in tourism).
106
Id.
107
Id.
108
Id.

  24 
half the level originally predicted, was “due to the scheme’s greater-than-expected impact

on car traffic – a drop of 30 percent in potentially chargeable vehicles entering the zone

compared to the mid-point prediction of 20 percent used to project revenues.”109 The

drop in revenue was also affected by a higher than expected number of discounted or

exempt vehicles, “reflecting, in part, the success of the scheme’s incentives for using

low-emission vehicles.”110 The shortfall in revenue was also attributed to higher than

expected implementation and enforcement costs.

Overall, London’s Congestion Charge has been “both a practical success in

reducing congestion and a popular success.”111 Though the benefits “appear to be largely

in line with expectations,” the resource costs of running the scheme “have been twice as

high as expected.”112 Despite this, the “net benefits of congestion pricing seem to be

positive, but less than commonly anticipated.”113 While it can be called a success,

London’s experiment shows the pitfalls associated with a cost-benefit analysis – the costs

are routinely under-estimated while the benefits are routinely over-estimated. However,

London’s experience provides a valuable guide for other major cities considering such a

plan by using the results to conduct a more accurate cost-benefit analysis.

Singapore

Singapore first implemented a paper-based congestion charge scheme (Area

License Scheme) in 1975, which was converted to an electronic system (Electronic Road

                                                        
109
Id at 169-170.
110
Id at 170.
111
Id at 173.
112
Id.
113
Id.

  25 
Pricing) in 1998.114 Singapore’s scheme differs from London’s in a few major respects;

each car is fitted with an in-vehicle unit which requires drives to use pre-paid cards, the

amount charged varies throughout the day, charges are paid each time a vehicle enters the

charging zone, and busses and taxis are not exempt from payments.115

Singapore’s system of fitting each car with an in-vehicle unit is in line with

Vickrey’s vision116 and allows the system to adjust the price based on prevailing traffic

conditions. Since a driver is charged each time they enter the charging zone, it forces a

driver to make the conscious decision whether to incur the payment for each trip, as

compared to London where a driver may make unlimited trips in a single day and only

make one payment. In this respect, it could be argued that Singapore’s system is more

“optimal” than London’s in that is seeks to more accurately “internalize the externalities

imposed by road uses slowing down everyone else.”117

Singapore’s original Area Licensing Scheme (ALS) was more like that of London

in that it offered unlimited number of entries into the charging zone and only charged one

flat rate.118 While the ALS was effective in initially reducing by 44 percent, by 1988 the

drop was only 31 percent.119 Since the charge was either $3 or nothing, the system led to

“sharp and short peaks of entering traffic volume.”120 A variable pricing system could

                                                        
114
Blow et al at 16.
115
Id.
116
See Vickrey at 459.
117
Blow et al at 7.
118
See Kian Keong Chin, Road Pricing Singapore’s Experience at 3 (2002), http://www.imprint-
eu.org/public/Papers/IMPRINT3_chin.pdf.
119
Id at 5.
120
Id at 6.

  26 
reduce these peaks in traffic, but such a pricing scheme was thought to be too difficult to

administer with the manual ALS.121

With the introduction Electronic Road Pricing Scheme (ERP), it was possible to

charge variable rates and easier to charge drivers each time they entered the charging

zone. As a result, the ERP reduced traffic volume by about 10-15 percent as compared to

the manual ALS.122 Much of this reduction is attributed to ERP charging for multiple

entries, forcing multiple trip-makers to reduce the number of trips and/or utilize public

transportation.123 The ERP system also allows for optimal road use; “when too few

vehicles are deemed to be using the roads…the road pricing charge can be reduced to

allow more vehicles to use the roads,” and conversely if “too many vehicles are on the

roads… the road pricing can be increased.”124 While the effect on drivers’ decision at the

margin to make a trip based on the variable price is unclear, in theory such pricing should

provide for more optimal road use.

While it can be argued that Singapore’s ERP provides a more ‘optimal’ use of

roads than that of London’s Congestion Charge, it must be noted that the ERP

requirement of each car having its own device adds a considerable amount of cost to the

initial set-up costs of a congestion charge scheme. Though these costs may be justified in

the long term due to increased efficiency, this would require a separate cost-benefit

analysis.

                                                        
121
Id.
122
Id at 8.
123
Id.
124
Id at 9.

  27 
New York City

After studying the successes of cities around the world, New York City recently

sought to implement its own congestion pricing scheme. The proposed plan would be

modeled after London and impose an $8 daily charge for cars and $21 for trucks who

enter Manhattan below 86th Street between 6 a.m. and 6 p.m., Monday through Friday.

Like the London program, all the revenue raised from the charge would be entirely

dedicated to transportation investments.125

Despite various studies126 indicating such a scheme would be successful in

reducing congestion and political support from most of the city, the plan failed to win the

requisite support among city representatives from outer boroughs and among State

Representatives. Since the implementation of the plan required the support of New York

State, the lack of support among State Representatives prevented the plan from being

implemented.

Common among the complaints was the belief that congestion pricing tends to be

regressive by imposing a disproportionately higher burden on low-income drivers. Such

beliefs have strong political implications even if economic theory does not support them.

Indeed some economists, including David Tipping, would claim this is a “silly

argument,” since “only the rich can afford to do anything which happens to be expensive.

There is no public insistence on subsidizing villas in the South of France.”127 These

economists would argue that the congestion charge more accurately reflects the true cost

                                                        
125
See Transportation Report (2006),
http://www.nyc.gov/html/planyc2030/downloads/pdf/report_transportation.pdf.
126
See Id (incorporating figures from various studies).
127
Tipping at 853.

  28 
of driving into congested areas and therefore if the charge makes a trip too expensive

then this is no different from any other good that is too expensive.

As New York City’s ill-fated plan makes clear, ultimately the imposition of a

congestion charge is not simply an economic decision. As Tipping notes, “it is a matter

for political decision, influenced by but not determined by the sums done by economists

and engineers.”128 Recognizing this, the London Congestion Charge program made a

point to ‘earmark’ revenues of the charge for public transport.129 Specifically,

“earmarking was seen as important in offsetting the potentially regressive effects of the

congestion charge which, as a flat-rate charge, imposes a heavier burden on low-income

drivers. Thus … earmarking played a crucial role in securing political support for the

congestion charge.”130 Though the New York City plan called for such earmarking, it

was not enough to convince a majority of the State Representatives that the plan would

not be regressive.

Conclusion

Welfare economics can be used to explain and justify the imposition of a

congestion charge in order to reduce traffic congestion. While Pigou and Coase’s

theories diverged in many respects, both economists’ theories can be used to support the

implementation of a congestion pricing scheme.

Pigou’s concept of taxing those who cause negative externalities and using the

proceeds of the tax to combat the effects of the negative externalities is a rough

                                                        
128
Id at 854.
129
Leape at 170.
130
Id.

  29 
approximation of what a congestion charge seeks to accomplish. If the charge is set up

so that the proceeds are used to provide enhanced bus service, like it is in London, the

congestion charge begins to look like a classic pigovian tax.

The optimal solution envisioned by Coase, the assignment of rights and letting the

free market work itself out, is not feasible in the case of urban traffic congestion.

However, this would not stop Coase from blessing a congestion charge as a solution to

the problem. Ultimately Coase advocated for a change of approach in dealing with

problems of welfare economics; start with a “situation approximating that which actually

exists, to examine the effects of a proposed policy change, and to attempt to decide

whether the new situation would be, in total, better or worse than the original one.”131

In the end, a public project like that of a congestion charge should past muster

under an actual cost-benefit analysis and not be based solely on “blackboard

economics.”132 While tending to be complex and requiring assumptions - even outright

guesses at times - such analysis is effective in determining whether a project should be

undertaken. Before implementing the program in London, the government conducted an

extensive cost-benefit analysis that demonstrated the likely benefit of the program.

Though it turned out that costs were underestimated and benefits overestimated, the

positive benefits predicted in the analysis did materialize and the program is considered a

success.

It may be argued that, economic theory and cost-benefit analysis aside, the

decision to implement a project like a congestion charge is ultimately a political one.

                                                        
131
Coase at 154.
132
See Coase, Social Cost and Public Policy, at 41-42 (arguing that economic policy conclusions derived
from calculations which fail to consider how social institutions work in practice have little relevance for
economic policy in practice).

  30 
New York City’s experience is an example of a policy that ultimately failed not because

of unsound theory or a negative cost-benefit analysis, but rather due to politics. It must be

realized, however, that this failure to implement the congestion charge in New York City

was itself a form of policy – one of inaction. Coase would support a policy of inaction if

it indeed resulted in the least cost to society. But, if economic theory and cost-benefit

analyses show that action, a congestion charge in this case, would result in lower costs to

society than inaction, then even Coase would support it. In this regard, a congestion

charge represents a welfare economics based solution to the negative externalities

imposed by urban traffic congestion that policy makers should take seriously.

  31