A Call For The Implementation of A Pigovian Tax System

(Cross-post from my Posterous)

Here’s a crazy suggestion, why not freely allow — but also tax — activities that harm other people? Well, that is the basic logic behind Pigovian taxes. With a Pigovian tax in place there is always an incentive to reduce the negative externality that is being taxed upon (such as pollution). In contrast stands regulation. Regulatory programs (such as cap-and-trade) do not allow for any incentive geared towards the reduction of said negative externality. Why would one pollute any less than what is allowable if there is no reward for doing so?

From The Pigou Club:

Imagine a small village with a lake. Nobody owns the lake – it is there for everyone to enjoy (they could privatize it, but that’s another story). Anyone can swim in it and catch fish.

Now meet John, he is an avid fisherman. He would like to catch fish every day.

Every time he catches a fish, he gains a fish and the community loses a fish.

But there is a problem – John’s overfishing is causing the number of fish to go down.

What will happen in the future? Here are a few options:

1. John will continue fishing. One day the fish are nowhere to be found. Everyone loses.
2. The village people ban fishing. John is very unhappy. He can’t even catch a reasonable amount of fish that wouldn’t harm the fish population (some people even claim that there are too many fish in the lake and that they are biting them while they are swimming).
3. The village people tax fishermen for every fish they catch. John is moderately happy because he can still catch fish and the community is also happy – the fish stocks are stable. Villagers can lower their taxes because of John’s contributions and spend the extra money any way they like.

The third option serves as a prime example of how a community could implement such a tax system.

The Pigou Club essentially advocates for the use of Pigovian taxes. Founded back in 2006 when Gregory Mankiw called for the implementation of a Pigovian gas tax in his legendary Wall Street Journal manifesto, the Pigou Club has since seen its membership grow. It is important to note that the Pigou Club includes academics, economists and politicians from both sides of the political aisle. Even Paul Krugram, who has had his fair share of beef with Mankiw, has come out in support of a Pigovian gas tax.

Unfortunately, the majority of politicians are against the implementation of any sort of Pigovian tax (as any kind of tax is often seen as election suicide). I would, however, advocate for their use. Take, for example, a gasoline tax. Setting global warming skeptics’ concerns aside, it is safe to say that the burning of gasoline emits several pollutants, none of which are healthy for the environment and its inhabitants. Higher gasoline taxes, perhaps as part of a broader carbon tax, would be the most direct and least invasive policy to address environmental concerns.

Let’s assume for a second that you couldn’t care less about the environment. Regardless, here is another reason why one should support a gasoline tax: road congestion. There is only one way to reduce the number of cars on the road, and that is by raising the price of gasoline. A gasoline tax would reward those who use less gasoline while punishing those who use more. This greatly differs from the complicated system of cap-and-trade, which most economists happen to be against. As any public finance expert will tell you, consumption taxes are generally better than income taxes for sustainable economic growth, as income taxes discourage saving and investment.

Some quick facts about our gas tax example:

• A $1 per gallon tax on gasoline would bring in $100 billion a year in government revenue, making a sizable dent in the looming fiscal gap.
• As a higher gas tax would discourage the consumption of oil, the price of oil would fall in world markets. As a result, the price of gas to consumers would rise by less than the increase in the tax. Some of the tax would in effect be paid by oil nations such as Saudi Arabia and Venezuela.
• A gas tax would encourage firms to devote more research and development spending towards the search for a gasoline substitute.