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Another Pigouvian Tax Fail, Courtesy Of North Carolina And Stephen Colbert…

June 25th, 2013 · 42 Comments
Econ 101 · Environmental Econ · Policy

I guess Ben Franklin (or Chris Bullock, I suppose) was right about that death and taxes thing, since, if for no other reason, taxes are necessary in order to overcome the free-rider problem and collect the funds that provide the optimal quantity of public goods in a society.

Of fundamental importance, then, is how this tax revenue gets collected. Economists have a few different principles to think about on this front- one is the “ability to pay” principle, which, as its name implies, suggests that public goods should be funded by those most able to pay for them. Another principle is the “benefits” principle, which suggests that public goods should be paid for by those who benefit from the public goods the most. Unfortunately, economists don’t have a whole lot to say regarding the validity of these principles- the ability-to-pay principle has some grounding in a utilitarian framework at least, but the benefits principle is mostly something that seems intuitively reasonable.

Luckily, there is a third principle that is easier for economists to get behind- why not tax the production or consumption of things that impose costs on society at large? (In economic terms, why not tax those things that create negative externalities?) Left on their own, markets that create negative externalities produce more than is optimal for society because producers and consumers don’t fully take into account the effects of their choices on the well-being of society overall. Intelligently designed taxes on these markets (often referred to as Pigouvian taxes after economist Arthur Pigou) can get producers and consumers to internalize the costs to society into their decision-making processes so that the quantity of the good transacted is closer to what is best for society. And, hey, such taxes raise some money to fund the aforementioned public goods as well. (The flip side of this principle, of course, is to subsidize those goods that create benefits for society at large, i.e. that create positive externalities).

This logic is often invoked to justify taxes on items such as gasoline- consuming the gasoline is bad for the environment, but the driver of the car doesn’t bear all of that cost and thus doesn’t have the proper incentives to think about the cost of pollution when deciding how much to drive. The gasoline tax mitigates the problem to some degree and also gets the government some cash. But what happens when the gasoline tax works too well and people start buying hybrid vehicles?

If you’re a Virginia lawmaker, you likely think that the solution is to place a tax on hybrid cars. The reasoning behind this seems to be that hybrid car owners are escaping the gas tax to some degree and need to make up the payment somewhere else. The argument against it is one about Pigouvian taxes and subsidies:

“People who are doing their part to reduce oil consumption reward all of us with cleaner air and less climate pollution — but now Virginia will turn around and punish hybrid car owners,” Kemler said. “Just like many companies offer health incentives for quitting smoking, Virginia should reward, not punish, people who drive the cleanest, most fuel-efficient cars.”

In this particular case, the tax revenue would be used to maintain roads, so taxing hybrid owners to make up for them not paying the gas tax is in line with the benefits principle of taxation, but it fails a basic reasonableness criterion of “tax things you want less of and subsidize things you want more of.” (Income taxes also fail this test, as do general consumption taxes, but that is a conversation for another time.) I was hoping that this would be an isolated “oops” sort of incident, but apparently North Carolina is looking to follow Virginia’s lead:

Dear North Carolina: You’re doing it wrong. Economically speaking, both Virginia and North Carolina are saying that they want at least some of their residents to switch back from purchasing hybrid cars to purchasing regular gas guzzlers. The most frustrating part is that this makes perfect sense from a self-interest perspective- the state legislature certainly feels a lot more pain from having an increasing budget shortfall than it does from producing some more pollution that everyone else who doesn’t write stupid policy has to deal with. In essence, the externality problem exists not only at the level of individual production and consumption but also at the state regulatory level. (In fact, China seems to have a mentality that closely parallels this.)

Here’s the problem, though- it’s one thing for a for-profit business or consumer to be self-interested and not do what is best for society unless it has the proper incentives to do so, but a main principle of government is that it is supposed to have a fiduciary duty to society and be immune to what would typically be thought of as profit pressures. In this way, both Virginia and North Carolina are failing- can’t you both just find something that imposes costs on society to tax instead? (And no, you can’t just choose something that you personally don’t like.) If y’all can use lotteries to fund education, it really need not be the case that you fund your roads with something having to do with cars. You seem to have some wiggle room with your cigarette taxes, for example, but I think even I’m realistic enough to know how that conversation would go for you two.

Tags: Econ 101 · Environmental Econ · Policy

42 responses so far ↓

  • 1 Billy Valenzuela // Jun 25, 2013 at 5:54 pm

    I love your blog, thank you for the great economic observations. Keep up the great work. If this air pollution/autism link holds up then clean air is going to be more valuable than ever.

  • 2 BZ // Jun 25, 2013 at 6:49 pm

    Wonderful article. I had a funny thought while reading the ending:

    “government … is supposed to … be immune to … profit pressures.”

    Then along came James Buchanan, who shot that duck right out of the air.

  • 3 Ryan // Jun 25, 2013 at 7:18 pm
    ^ – How about this one?

  • 4 IRS // Jun 25, 2013 at 8:25 pm

    I think there is a bit of sense to the policy, in that hybrids cause much more non-combustion related environmental harm (primarily battery disposal), so if we are going to structure our taxes by environmental impact, there should be a bit of a hybrid surcharge.

    Except, of course, that this means that hybrids are now subsidized at purchase and charged a surcharge over their life, which I think makes any claim of sanity somewhat suspect.

  • 5 JamesInCA // Jun 26, 2013 at 4:22 pm

    There are two obvious solutions to Virginia’s and North Carolina’s “problem”:

    1. Raise the state gasoline tax.

    2. If the concern is that hybrid or electric vehicle drivers are, for example, contributing to road wear whose repair gas taxes are meant to fund, then raise the annual vehicle registration fee, and/or charge varying registration fees based on vehicle weight.

  • 6 Philip Nolan // Jun 26, 2013 at 5:16 pm

    Jodi says “it fails a basic reasonableness criterion of ‘tax things you want less of and subsidize things you want more of.’”
    First question is “Who decides, what we want more or less of?” The popular notion is that the omniscient, beneficent elected officials, decide. Well they just did, so what’s the gripe?

    Second, OK, but doesn’t society want roads? If you tax gas-fueled cars and exempt hybrids people will buy hybrids, tax revenues fall which means you have fewer roads for all those hybrid cars to drive on. Of course, you can then tax hybrid owners some other way, but what have you solved? All you have done is moved the tax from gasoline ot something else.

    And who says we want more hybrids? I don’t want one, they are death traps. I would rather sacrifice a little fuel efficiency for greater safety.

    But ultimately all we are doing is trading one externality (pollution?? do modern cars pollute?) for another, free riders (literally, people riding on roadways for which they did not pay). Who says that one is preferable to the other?

    The reality is this is all about trade-offs. Who says that society does or ought to prefer hybrids over roadways? Think of the advantages of having a fully functional, well maintained, efficient highway system. Roadways allow ambulances to carry hybrid drivers injured in collisions with bicycles speedily to hospitals, highways bring food to markets cheaply and quickly, and they take people to work and school.

    Hybrid owners should be made to “pay their fair share.”

  • 7 The gas tax: A Pigovian tax or roadway maintenance fund? - Transitized // Jun 26, 2013 at 5:57 pm

    [...] Beggs at the blog Economists do it with Models, and also the guide to economics, has an interesting take on what two state legislatures are attempting to do to fix how their roads are [...]

  • 8 econgirl // Jun 26, 2013 at 9:01 pm

    @ JamesInCA: Have I ever told you that you would make a good policy maker? :) I guess the registration fee doesn’t get at how many miles a vehicle travels like the gas tax does, but it would at least address the fact that hybrid cars are equivalent to regular cars from a road damage perspective. More importantly, your suggestion highlights the fact that there are intelligent options to be found once you stop trying to grab revenue in the first place that you see.

    @ Philip Nolan: I agree that the want less of/want more of issue can get tricky, but I doubt anyone is going to argue that we want more pollution. Also, you are perfectly justified in your preference for a non-hybrid car, which is why Pigouvian taxes are preferred to outright bans and such. A Pigouvian tax just makes it so the people who want to consume something that imposes a cost on society want to consume the thing enough that they are willing to pay for the cost they are imposing on everyone else.

  • 9 JDG // Jun 28, 2013 at 8:47 am

    So, a person that buys a Chevy Cruze, which is rated at 46 mpg (hwy) with a regular gas engine, will not pay a penalty for using less fuel (and denying the states of more gas tax revenue) and a person that buys a Honda Accord Hybrid that gets 35 mpg (hwy) will pay extra taxes, for cheating the state out of revenue? Sounds logical to me!

  • 10 econgirl // Jun 28, 2013 at 1:19 pm

    Exactly, and this is the sort of thing that happens when lawmakers see taxes mainly as a way to collect money rather than a means of changing behavior (in both productive and unproductive ways). You would get to pretty much the conclusions that these states are reaching if you made the incorrect assumption that tax policy doesn’t change people’s behavior.

  • 11 Jason // Jun 29, 2013 at 1:58 pm

    Living in Canada, I don’t have a strong understanding of the road tolls in America, but wouldn’t raising the toll rates help with this problem too? If anything it would help push people off the road that don’t need to be on there as often and make those who use them pay more for the upkeep.

    @Philip Nolan: The idea is not so much that we want more hybrid cars, but that we want less pollution. Hybrid cars just happen to be a way to do that. Taxing hybrid car owners for buying less gas doesn’t make sense. You don’t charge people for consuming less of something. The solution is to make everyone who uses the road pay more, not just a specific subset.

    Understandably the government does need to earn revenue, but punishing people that reduce negative externalities is a bad way to do it.

  • 12 Brendan Perrine // Jun 30, 2013 at 5:56 pm

    IF you really wanted to be self interested in road maintainance and pay for who damages the road and have it somewhat make less pollution wouldn’t part of vehicle registration each year make a tax for wieght of the vehicle. Although the batteries in a hybrid does make them heavier.

    Although all other things equal lighter cars pay get better gas mileage as you don’t use energy pulling excesss weight around. Also incentivies the development of lightweight materials like carbon fibre on cars and uses more aluminum as then the users have to pay less in taxes.

    One other factor is it subsides manual transmissions which are genrally lighter so car enthusiasts get some benefit as well. As manual transmission owners will have to pay less in taxes on the same car.

  • 13 J.D. // Jun 30, 2013 at 6:04 pm

    The best approach is to toll all roads, so that the people who used them most bear the cost of maintaining them.

    Absent that, the best approach is a comprehensive basket of targeted taxes.
    (1) Registering vehicles has two fees: (a) one based on the cost of processing the registration that is used to pay for DMV and (b) a charge based on the vehicle’s weight that goes to DOT.
    (2) A mileage tax. This makes people economize on traveling. But how to record mileage without violating privacy? Simple: tax tires. The wear out at a rate that is highly collinear with miles travelled.
    (3) Since a high gas tax is no longer needed to pay for roads, eliminate the gas tax. However, since our goal is reducing carbon emissions, leave a pared back tax in place to encourage less use of carbon producing fuels.

    I had a similar comment to this effect featured in the WSJ back in Sept. of last year.

  • 14 North Carolina, You’re Doing It Wrong | Common Sense // Jul 1, 2013 at 3:45 pm

    [...]  Ok, I saw Jodi Begg’s post on how North Carolina may follow in Virginia’s footsteps by creating a … last week and I laughed a bit, it’s no more than a money grab. Perhaps some legislatures [...]

  • 15 Jeff // Jul 2, 2013 at 10:42 pm

    So… Would you consider prison “membership” an example of the “free rider problem” while you are on the topic?

    Also, I have to say I am immensely disappointed to find that Pigouvian taxes are not from the root words “Pig Out”.

    But on a more serious note, I would suggest that public goods and externalities both point to commons, as in “tragedy of the”. Two other commons that are worth mentioning are the Middle Class and our political system, as you make a reference to above. Middle class is actually a very interesting one because it has a very close “carrying capacity” analog to the original model, and in that sense, progressive income taxes could be thought of as Pigouvian taxes.

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