Unifying Pigouvian Taxation and Coasean Bargaining in Externality Regulation

This paper develops a unified framework for Pigouvian taxation and Coasean bargaining. Some polluter-victim pairs can engage in Coasean bargaining, while others cannot, yet the regulator cannot discriminate. This wedge causes unavoidable welfare losses: taxes that internalize damages for non-bargaining pairs distort behavior in pairs where bargaining would otherwise be efficient.

With an exogenous share of bargaining pairs, the optimal tax is below the Pigouvian benchmark and decreases in that share. Endogenizing the bargaining heterogeneity reveals complex interactions between regulation, the prevalence and costs of bargaining, and welfare.