The problem with Pigou Taxes

Is that politicians cannot leave well alone and keep them as Pigou Taxes.

Air Passenger Duty is a good tax, in that it does indeed correct for the externality of the emissions from planes. That rate has been pushed too high of course, because that’s what people who get to levy taxes do with them. And this problem is encapsulated here:

“However, it is important that the aviation sector plays a part in helping to bring down the deficit.”

No, a Pigou Tax is not there to raise revenue. It’s a nice side effect but that’s all. The rate must be at the cost of the externality.

And that of course is what is wrong with Pigou Taxes. That they’re open to being misused in this manner.

Still better than regulation or banning of course, but not perfect for the usual political reasons.

22 comments on “The problem with Pigou Taxes

  1. Which is why only a fool supports Pigou taxes. And, there’s much more than one problem with them anyway.

    1) You can’t actually objectively calculate the value of the externality. You can produce an impressive calculation, but that isn’t the same thing. It is impossible to measure all the subjective harms and benefits.

    2) Even if you could, there will always be two incompatible figures; the first is the aggregated externality cost, the second is the level of tax required to discourage the behaviour creating the externality.

    3) Even if you could do that, the compensation for the externality is not paid to those suffering the externality, but to the State, who then spend throw it into the general pot for spending on the State’s own perverse desires.

  2. It’s the revenue raising aspect of Pigou taxation makes it such a thoroughly bad idea. It involves governments.
    In the same way, one would wish to restrict firearms to adults. Not hand them out to infants.

  3. @ Ian

    1) Right ball park – a reasonably good guess?

    2) I don’t follow. If the tax is set at the externality cost, surely job done. I either don’t do “the action”, or if I do, then I pay exactly the cost that my action apparently caused. Do we even care about deterrence, which is what you may be implying?

    3) I completely agree, and with BIS’s excellent analogy.

  4. PF – no, Ian B is incorrect about 3. The point of Pigou taxes is NOT about “compensating” for an externality. It makes no sense to complain that the compensation is heading to the wrong place, it was never compensation in the first place. It’s just there to “price in” the externality into production and consumption decisions so that equilibrium is found at a better (utility raising) position.

    I do agree that the revenue-raising aspect leaves them vulnerable to political manipulation. I was trying to think of a way around that.

    That the proceeds should be invested in some charitable or social projects? Not sure that dependency on such income does any good to a charity, besides which it would presumably be offsetting government expenditure anyway and the “deficit reducing” potential would still apply. And ring-fencing revenue in this way is generally a stupid idea anyway, fungibility is good.

    How about borrowing off the land taxers – receipts from Pigou taxes get treated as a kind of dividend and added to Citizens’ Basic Income? Cuts the state out of the picture but can’t help wondering if politicians would be electorally tempted to raise (distort) rates to fatten the divvie.

    Perhaps explicitly recognised Pigou taxes should have their rates recommended by a grey and undemocratic expert panel. But the government could always overrule such a panel, probably without losing much political capital over it.

  5. It’s pretty obvious that if some victim suffers an externality A, caused by some sinner, that if you take A from the sinner and don’t give it to the victim, you haven’t returned to equilibrium, so it’s pretty pointless pricing the externality at A anyway.

    What you’ve actually ended up with is the strange principle that the sinner can pay a bribe to the State for the right to continue harming the victim…

    Which is why in practise nobody bothers, and just sets the rate politically. But this is the glorious nonsense of macroeconomics.

  6. The passenger sitting in a seat doesn’t cteate the externality here; the aircraft taking off, flying and landing does that. So why do we have an “Air Passenger Duty”?

  7. MBE
    Probably the best way to utilise Pigou taxes would be to use them to buy say consumer goods. Then destroy them. To be effective they have to reflect the cost of the externality without, repeat without, providing any other benefit.

    Or build bloody windmills, I suppose. They certainly fulfill all the criteria.

  8. Just to illustrate, imagine I’m pumping toxic slurry onto PF’s land. It costs him £1000/ year to clear up. This is the externality. The Pigovian then sets a £1000 tax on me per year. So, I carry on discharging the slurry, pay the tax, PF carries on having to clear it up, without any help from me or the State.

    So, the argument is, if I have to pay the £1000, I will stop discharging the slurry. Except why bother, when I can have PF do it for me? Neither does the government actually want me to stop, because they’re getting £1000 per year for doing fuck all. So, I’m at parity, the State’s in pocket, and PF is out by £1000/year. And PF can’t sue me, because the whole thing’s already being handled by the tax system. Are we sure this is a good idea?

    The reason anyone gets away with this barmcakery is that there are normally many PFs and the macroeconomist can slyly blur them into that nebulous thing, “the community” which is “represented” by the State and its tax system.

  9. Plus of course, since the costs of shutting down air travel would be far greater than the actual externality of emitting carbon (which is, um £0), the whole thing’s just a giant scam anyway.

  10. Perhaps it would be a good idea to treat the cost of taxes raised by Pigou taxation as an externality. And apply a Pigou tax to them. Which could be returned to the airline passengers.

    it’d keep the beancounters employed, which is usually the object of most things.

  11. 1) Externalities are invariably supposed to be negative or net negative. We all benefit one way or another from air travel. Is the World net worse off or net better off because of air travel?

    2) Where externalities are positive, why don’t we get a tax credit?

    3) Pigou Taxes should properly be called Piggy Taxes because their primary aim is to provide swill for the troughing political and bureaucratic classes.

  12. All taxes are intended to raise revenue. You can call them Pigou, Bijou or Dell Boy taxes but the result is the same.

  13. @Ian: “It’s pretty obvious that if some victim suffers an externality A, caused by some sinner, that if you take A from the sinner and don’t give it to the victim, you haven’t returned to equilibrium, so it’s pretty pointless pricing the externality at A anyway.”

    Just as a note to passing economics students, don’t write that in your exams, folks. It isn’t about redress for a victim, nor is it about “returning to equilibrium”.

    The standard argument boils down to this: there is a market equilibrium without taxes on externalities, and another equilibrium with such taxes. Both equilibria are productively efficient. However, the equilibrium without Pigou taxes is not allocatively efficient due to the externality. For instance, air travel without a Pigou tax would be “too cheap” in the sense that when paying for a flight, I would not have to pay for the environmental damage that was being caused – resulting in more flights, and less of other goods and services, than socially optimal. The true cost of a flight includes pollution, but without a market in or tax on pollution, that cost would not be reflected in production or consumption decisions.

    Honestly Ian, I know you have waded all the way through Keynes, could you at some point read through a first-year textbook? You are an intelligent man capable of original thought , and a bit of reading couldn’t do any harm. It’d make your pontifications more interesting, if anything.

  14. @ MBE

    It’s very interesting.

    In the economic world, we have “the standard argument”.

    On the other hand, back in the make believe world, the Maldives are all about to drown…

  15. MBE-

    This is the problem with this kind of arithmetical economics. It detaches from the actual world it’s decribing into an imaginary world on a blackboard, where satisfying some equality becomes the purpose.

    Presuming that the externalites can somehow be measured, the Pigovian approach still doesn’t produce a real world equilibrium which is correct. (I note you say “it’s not about equilibrium and then, yourself, immediately start talking about equilibria). You haven’t set all the variables to their “correct” values. You’ve simply ignored some and say they don’t matter. In particular- (a) the costs to the sufferer of the externality and (b) the government’s additional budget, which are theoretically of equal value, but since one is not corrected by the tax and the other created artificially by it, push the market equally far in a wrong direction, just a different one. The only way to (theoretically) “fix” the market would be by direct compensation. The government doesn’t have any stake in this; it is neither the creator of the externality, nor the sufferer of it. In practical terms, it is like saying, “Andrew stole £1000 from Bob, so the solution is for Andrew to give the £1000 to Charlie”. This makes no sense at all. Bob is still out of pocket, and Charlie has £1000 he doesn’t deserve. Where is the sense in this? Saying “Well, I am only interested in Andrew and it’s not meant to fix Bob and Charlie’s problems” doesn’t get you out of that.

  16. Ian B: with the Pigou tax, you will pump the slurry only if the benefit to you is more than the clean-up costs. That’s a sensible outcome.

  17. Paul, it’s not sensible at all. It’s just doing some arithmetic. In practise, the whole point of a Pigou tax is that we presume that the sinners will carry on sinning, and paying the tax, as with aircraft emissions. Planes will keep flying. Nobody wants them to stop flying.

    So a Pigou Tax is notdesigned to stop me “pumping my slurry”. It’s designed to extract the externality cost and give it to the government, and thus designed for Bob to have to carry on clearing my slurry off his land.

    Things get even worse if we consider a real world situation and try to be honest about the total externalities. It may be that the overall externality is positive; perhaps I am running a tourist attraction and the extra income to the general community is much more than the £1000 slurry cleanup cost. Let us say my venue generates £1500 in additional economic activity (other than my own income). In which case, if we were consistent, the government would pay me £500 (my net externality), Bob still is £1000 out of pocket, the general community’s additional (externality) income has been lost to taxes, and the economy is now more unbalanced than it was before we started dicking about with it.

  18. Air travel is essential to a growing global economy so it can be said to play a role in alleviating poverty, i.e. as John B suggests, its benefits outweigh any costs. It is also far from clear that it has negatives as commonly proposed (though it may cause a little lost sleep for those living near an airport and the occasional plane does drop out of the sky):

    http://www.spectator.co.uk/features/9057151/carry-on-warming/

  19. “However, it is important that the aviation sector plays a part in helping to bring down the deficit.”

    Why not directly address the cause of the deficit? Surely it is but a few days since a politician announced a new wheeze that involved borrowing and spending more.

  20. @CHF
    It’s also an excellent example of why Pigou taxation in the hands of government is a non-starter.It’s supposed to be deterring the activity by imposing the cost of the externalities. Yet there you’re seeing it used to mitigate the externalities of government behaviour. It doesn’t serve to alleviate problems, it just shifts them somewhere else..

  21. I also noticed that in the original article “An HM Treasury spokesman said: “The Government has frozen APD in real terms since 2010, and in the last year, APD has not changed at all for the majority of flights. Passenger numbers are going up, and airlines do not have to pass on the cost of APD to passengers.”

    That last sentence was extraordinary, even bizarre, although it explains a lot about the previous and current governments if that’s the level of understanding of business within the Treasury.

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