A Pigovian tax (also spelled Pigouvian tax) is a tax levied to correct the negative externalities of a market activity. In Economics, an externality is an impact on any party not directly involved in an economic decision
Pigovian taxes are named after economist Arthur Pigou (1877-1959), who also developed the concept of economic externalities. An economist is an expert in the Social science of Economics. Arthur Cecil Pigou ( November 18, 1877 &ndash March 7, 1959) was an English Economist. Year 1877 ( MDCCCLXXVII) was a Common year starting on Monday (link will display the full calendar of the Gregorian calendar (or a Common The year 1959 ( MCMLIX) was a Common year starting on Thursday (link will display full calendar of the Gregorian calendar. In Economics, an externality is an impact on any party not directly involved in an economic decision William Baumol was instrumental in framing Pigou's work in modern economics. William Jack Baumol (born February 26 1922) is a New York University Economics professor (although he is also affiliated with Princeton [1]
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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 social cost. In Economics social cost is defined as the sum of private and external costs ) 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. Economic efficiency is used to refer to a number of related concepts In Economics, an externality is an impact on any party not directly involved in an economic decision More recently, particularly in the United States since the late 1970s, and in other developed nations since the 1980s, 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. Emissions trading (or emission trading) is an administrative approach used to control Pollution by providing economic Incentives for Pollution rights markets are a part of the field of Environmental Economics generally, and Free-market environmentalism specifically. Environmental economics is a subfield of Economics concerned with environmental issues Free-market environmentalism is a position that argues that the Free market, Property rights, and Tort law provide the best tools to preserve the health
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, this is knowledge which could not be provided as a "given" by any "method" yet discovered, due to insuperable cognitive limits theorized by economists like Friedrich Hayek and researchers in the various fields of nonlinear dynamics.
Pollution taxes
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. This article is for the legal term For regulation of genes see Regulation of gene expression. 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. Pollution is the introduction of contaminants into an environment that causes instability disorder harm or discomfort to the physical systems or living organisms they are in The Genuine Progress Indicator (GPI is a concept in green economics and Welfare economics that has been suggested to replace Gross domestic product (GDP
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). Ecotax, short for Ecological taxation, can refer to A policy that introduces taxes intended to promote ecologically sustainable activities via economic incentives 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. The Human Development Index ( HDI) is an index combining normalized measures of Life expectancy, Literacy, Educational attainment, and GDP Ecotax, short for Ecological taxation, can refer to A policy that introduces taxes intended to promote ecologically sustainable activities via economic incentives 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. Norway ( Norwegian: Norge ( Bokmål) or Noreg ( Nynorsk) officially the Kingdom of Norway, is a Constitutional "Sverige" redirects here For other uses see Sweden (disambiguation and Sverige (disambiguation. The Netherlands ( Dutch:, ˈnedərlɑnt is the European part of the Kingdom of the Netherlands, which consists of the Netherlands the Netherlands 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. A pro-form is a type of Function word or expression that stands in for (expresses the same content as another word phrase clause or sentence whose meaning is recoverable Causality (but not causation) denotes a necessary relationship between one event (called cause and another event (called effect) which is the direct consequence
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".
The motivation for such a subsidy is trying to reach economic efficiency. When a positive externality is present, a firm's solution of its utility maximization problem does not account for the additional utility (to another agent) produced as a by-product (the externality), thus causing the firm to produce less than the pareto-efficient level . The Pigouvian subsidy thus internalizes the externality into the agent's utility function, by giving the firm incentive to produce more than it otherwise would.
An example would be a central government transfer that accounts for interjurisdictional spillover (usually in the form of matching grants).
Mentioned in Oates, Essay in Fiscal Federalism
Criticism
Such taxes can encourage smuggling and black markets, especially if they create large differences in the price of popular products in neighboring jurisdictions. Smuggling, also known as trafficking, is the clandestine transportation of goods or persons past a point where prohibited such as out of a building into a Prison
If lower income individuals tend to spend a greater portion of their income on the product with external social costs, such as cigarettes or electricity, then the corresponding Pigovian tax is regressive. A regressive tax is a Tax imposed in such a manner that the Tax rate decreases as the amount subject to taxation increases
See also
References
- ^ Baumol, W. In Economics social cost is defined as the sum of private and external costs A carbon tax is an environmental Tax on emissions of Carbon dioxide and other Greenhouse gases It is an example of a pollution tax. Emissions trading (or emission trading) is an administrative approach used to control Pollution by providing economic Incentives for The Pigou Club is described as "an elite group of Economists and pundits who have publicly advocated higher Pigovian taxes such as gasoline J. (1972), ‘On Taxation and the Control of Externalities’, American Economic Review, 62 (3), 307-322.
- N. Gregory Mankiw: Principles of Economics, Second edition, Harcourt College Publishers, 2001, page 216. Nicholas Gregory "Greg" Mankiw (mæŋˈkjuː (born February 3, 1958) is an American macroeconomist.
External links
- Cheap Gas Hurts (from a welfare analysis perspective) from Aplia Econ Blog
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