Pigovian tax
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A Pigovian tax (also spelled Pigouvian tax) is a tax levied to correct the negative externalities of a market activity. For instance, a Pigovian tax may be levied on producers who pollute the environment to encourage them to reduce pollution, and to provide revenue which may be used to counteract the negative effects of the pollution. Certain types of Pigovian taxes are sometimes referred to as sin taxes, for example taxes on alcohol and cigarettes.
Pigovian taxes are named after economist Arthur Pigou (1877-1959) who also developed the concept of economic externalities.
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[edit] Workings of Pigovian tax
Pigovian Taxes. See Workings of Pigovian tax for explanation.
The diagram to the right illustrates the working of a Pigovian tax. (For an explanation of this type of diagram, see the social cost article.) A tax shifts the marginal private cost curve (MPC) up by the amount of the tax (to MPC + T). Faced with this cost increase, the producers have an incentive to reduce output to the socially optimum level (Qs) by reducing the marginal externality to the marginal tax. The total tax revenue (which could be used to mitigate the effect of the negative externality) is equal to the area 0EAB.
A key problem with Pigovian tax is that of calculating what level of tax will counterbalance the negative externality. Political factors such as lobbying of government by polluters may also tend to reduce the level of the tax levied, which will tend to reduce the mitigating effect of the tax; while lobbying of government by special interests who calculate the negative utility of the externality higher than others may also tend to increase the level of the tax levied, which will tend to result in a sub-optimal level of production.
A Pigovian tax is considered one of the "traditional" means of bringing a modicum of market forces, and thus better market efficiency, to economic situations where externality problems exist. More recently, particularly in the United States since the late 1970's, and in other developed nations since the 1980's, an alternative to Pigovian taxation has arisen: the creation of a market for "pollution rights." Pollution rights markets are not generally more efficient than Pigovian taxes but are often more appealing to policy makers because giving out the rights for free (or at less than market price) allows polluters to lose less profits or even gain profits (by selling their rights) relative to the unaltered market case. Markets for emissions trading have been set up to bring better allocative efficiency and improved information sharing to the pollution externality problem. Pollution rights markets are a part of the field of Environmental Economics generally, and Free-market environmentalism specifically.
Perhaps the biggest problem with the Pigovian tax is the "knowledge problem" suggested on page 6 of Pigou's essay "Some Aspects of the Welfare State" (1954) where he writes, "It must be confessed, however, that we seldom know enough to decide in what fields and to what extent the State, on account of [the gaps between private and public costs] could interfere with individual choice." In other words, the economist's blackboard "model" assumes knowledge we don't possess -- it's a model with assumed "givens" which are in fact not given to anyone. Indeed, usually this is knowledge which could never be provided as a "given' by any present or future "method", due to insuperable cognitive limits on knowledge explored by economists like Friedrich Hayek and researchers in the various fields of nonlinear dynamics. So the limits identified by Pigou are limits which theoretically and empirically could never be remedied by any current or yet to be developed modeling technique.
[edit] Pollution taxes
One argument that has been put forward against the levying of Pigovian pollution taxes is that if the tax is too high it will lead to a level of pollution that is less than the social optimum. The alternative, regulation, is viewed as having a higher cost to society because Pigovian taxes raise revenue and respond automatically to changes in the market such as lowered cost of production or pollution mitigation. With a Pigovian tax there is always an incentive to reduce pollution, whereas with direct regulation, a polluting company has no incentive to pollute any less than what is allowable.
Economic theory predicts that in an economy where the cost of reaching mutual agreement between parties is high, and where pollution is diffuse, Pigovian taxes will be an efficient way to promote the public interest, and will lead to an improvement of the quality of life measured by the Genuine Progress Indicator and other human economic indicators, as well as higher Gross domestic product (GDP) growth.
Economic theory predicts that, under certain conditions, a double dividend could appear. The first is the reduction of pollution. The second consists in the recycling of the government revenue from the green tax. If the government keeps its revenue constant, some other taxes have to be cut (see Green tax shift). If the government chooses to cut the most distortional taxes, the costs of the swap to green taxes could be negative.
Research on green taxation suggest that during the 1990s there was significant correlation between a country's UN Human Development Index (HDI) rank per fixed amount of GDP, and its level of green tax as a percentage of total tax revenues. Furthermore, over periods longer than 5 years, data suggest that countries having higher green tax rates such as Norway, Sweden and Netherlands experience higher GDP growth and higher HDI growth rate. However, it cannot be confirmed that an increase in green tax rates causes higher GDP growth and higher HDI growth rates. It may be a correlative effect as opposed to a causal effect.
[edit] Negative Pigovian tax (Pigovian subsidy)
One can encourage certain behaviors by subsidizing them, for instance donating to socially beneficial non-profits or installing solar panels to avoid pollution. Such a subsidy of a positive externality can be considered a "negative Pigovian tax".
[edit] See also
[edit] References
- N. Gregory Mankiw: Principles of Economics, Second edition, Harcourt College Publishers, 2001, page 216.
