Pollution and Taxation

Back in my final two years of high school, I took a little opted-for subject called EVS (as opposed to the compulsory EVE). Unlike EVE, EVS focused primarily on ecology and economics and was jointly taught by a biology teacher and an economics teacher(the latter of whom, was probably one of the best high school teachers I've had the pleasure of studying under), and it was one of those classes where participation and discussion was encouraged(admittedly, the class size was small, starting off with just myself before 3 other people joined).

Among the topics on which we had a very active discussion and debate, were Pigouvian taxes. Pigouvian taxes are taxes imposed to correct for negative externalities, usually keeping in mind social costs that are created by the activities of industries. The classic example(which was also the one discussed in class) was that of a firm belching out toxic fumes while manufacturing a particular commodity, causing acute bronchitis in the local population. We assume that the marginal social cost increases at a higher rate than does the marginal cost of production. The graph looks something like this:

Now, we impose a tax:

As one can see, to maintain the same price level, the firm has to cut down on production significantly, or switch to cleaner technology.

The good thing about a pigouvian taxation system is that unlike what other environmentalists demand, it is pragmatic, compatible with market economics and conventional ideas of growth (Unfortunately, my dear anarchists, that 'total revolution' is an a dream way, way too fanciful).

Before proceeding any further, when we were first taught this model, a few of us did raise an objection to this: Say the emissions caused cancer and untimely deaths, how do we quantify that with taxes?

It's been five years since then, and my assessment of the morality of quantifying deaths has changed, but it turns out that the basic argument is still valid; in fact, this was something Arthur Pigou pointed out himself, that the marginal social cost itself is quite difficult to estimate. Nevertheless, as the graph shows, such a policy is not necessarily ineffective either. The only thing that needs to be considered here is how much damage you perceive the firm is causing and imposing a tax on that basis to force the firm to acquire cleaner technology or become undercompetitive.

A more sophisticated objection was raised by Ronald Coase, who said the burden should not be borne by the firm alone and if such a tax is indeed implemented, it should only be imposed once.

Why? Because Coase points out that with the first round of taxation, the firm is forced to use cleaner technology, making the area more livable, thereby attracting more residents. However, with the increase in the number of residents, the marginal social cost will increase again, drawing in another round of taxation and so on, in essence according to him, punishing the firm for making the area more livable.

Even if you may accept Coase's objection in general, I do not think that it applies to greenhouse gas emissions. For one, climate change brought about by a greenhouse effect is a global phenomenon. Secondly, locational constraints do not apply to vehicles.

A more illuminating objection is that such a tax may not have any long term effects, since it will only constrain the output of an individual firm, but it does not consider the fact the number of firms may increasing, thereby negating the effects of the tax on total production.

This in my opinion, does give some indication of what a good environmental tax policy should look like. The tax may be more effective on the demand/consumption side of things, which is the principle behind a carbon tax. Consider a tax on petrol for instance. At a certain level, this would reduce consumption of petrol in general and would drive up demand for more fuel efficient vehicles.

There is some evidence that taxes on consumption do affect demand, for instance, in the UK and the EU with strong environmental laws, high fuel prices and costlier insurance on less efficient vehicles, the demand for and sale of economical cars is rising faster than in America, where regulations are more lax and fuel prices are low.

There are still certain issues with this, since a similar tax on diesel would increase transportation costs of other commodities and running costs of equipment such as tractors etc. In effect, personal diesel vehicles would need to be taxed at much higher rates than corresponding petrol vehicles to compensate for higher running costs of the petrol vehicle during its life-cycle.

The good thing about such taxes is that the revenue collected from it may be used to fund a hydrogen fuel network and offer subsidies on zero emissions vehicles like the new Toyota Mirai, but at this point of time, it appears not much more than wishful thinking at best.

Of course, for this to work, there needs to be global consensus on this and that looks far from likely. Also, people go batshit crazy with any talk of raising petrol prices, especially the Left these days. Despite that, pigouvian taxes are a far more reasonable option than what deep ecologists suggest, which is absolutely impractical: Going cold turkey.