In: Economics
Tax: A tax is a compulsory financial charge or some other type of levy imposed upon a taxpayer by a governmental organization in order to fund government spending and various public expenditures. A failure to pay, along with evasion of or resistance to taxation, is punishable by law. Various taxes are imposed like VAT, custom tax, GST, Income Tax, property tax and lot more.
A Pigovian tax is a very speial type of tax tax on any market
activity that generates negative externalities (costs not included
in the market price). The tax is intended to correct an undesirable
or inefficient market outcome (a market failure) and does so by
being set equal to the external marginal cost of the negative
externalities. Social cost includes private cost and external cost.
However, in the presence of negative externalities, the social cost
of market activity is not covered by the private cost of the
activity. In such a case, the market outcome is not efficient and
may lead to over-consumption of the product. Often-cited examples
of such externalities are environmental pollution and increased
public healthcare costs associated with tobacco and sugary drink
consumption.
In the presence of positive externalities, i.e., public benefits
from market activity, those who receive the benefit do not pay for
it and the market may under-supply the product. Similar logic
suggests the creation of a Pigovian subsidy to help consumers pay
for socially-beneficial products and encourage increased
production. A carbon emissions tax or a tax on plastic bags are
examples of Pigovian taxes.
It was named after English economist Sir Arthur Cecil Pigou.
The Pigovian tax is meant to discourage activities that impose a
cost of production onto third parties and society as a whole.
According to Pigou, negative externalities prevent a market economy
from reaching equilibrium when producers do not take on all costs
of production. This adverse effect might be corrected, he
suggested, by levying taxes equal to the externalized costs.
Ideally, the tax would be equivalent to the external damage caused
by the producer and thereby reduce the external costs going
forward.
Negative externalities are not necessarily “bad.” Instead, a
negative externality occurs whenever an economic entity does not
fully internalize the costs of their activity. In these situations,
society, including the environment, bears most of the costs of
economic activity.
A popular example of a Pigovian-style tax is a tax on pollution.
Pollution from a factory creates a negative externality because
impacted third parties bear part of the cost of pollution. This
cost might manifest through contaminated property or health risks.
The polluter only takes into consideration the private costs, not
the external costs. Once Pigou factored in external costs to
society, the economy suffered deadweight loss from excess pollution
beyond the “socially optimal” level. Pigou believed that state
intervention should correct negative externalities, which he
considered a market failure. He suggested that this be accomplished
through taxation.
In some cases, Pigouvian taxes can effectively deal with the
problem of negative externalities. Some of the advantages
include:
1. Fosters market efficiency
Pigouvian taxes promote market efficiency by incorporating the
additional costs imposed by negative externalities.
2. Discourages harmful activities
In certain cases, Pigouvian taxes may effectively discourage the
activities that lead to negative externalities. For example, the
introduction of a carbon tax may place a significant burden on a
company that produces substantial emission gases. Therefore, a
company may decide to transfer to operations that produce fewer
emission gases.
3. Generates additional government revenue
Pigouvian taxes generate additional revenues for the government.
The additional funds may be used to subsidize initiatives and
programs that will further challenge negative externalities.
Disadvantages:
1. Hard to measure- Pigovian taxes encounter what Austrian
economist Ludwig von Mises first described as “calculation and
knowledge problems.” A government cannot issue the correct Pigovian
tax without knowing in advance what the most efficient outcome is.
This would require knowing the precise amount of the externality
cost imposed by the producer, as well as the correct price and
output for the specific market. If lawmakers overestimate the
external costs involved, Pigovian taxes cause more harm than
good.
2.Political Issues: The imposition of Pigouvian taxes is frequently
associated with political problems. Government attempts to
introduce such taxes generally face resistance from lobbyists who
support parties that can be affected by the taxes (e.g., tobacco
producers). Therefore, such taxes are not always an optimal
solution from a political perspective.
Quantitative form of Pigovian tax includes reasons to impose taxes
and qualitative form of tax represent how much tax should be
imposed on products.
Pigou’s externality theories were dominant in mainstream economics for 40 years but lost favor after Nobel Prize-winner, Ronald Coase, presented his ideas. Using Pigou’s analytical framework, Coase demonstrated that Pigou’s examination and solution were often wrong, for at least three separate reasons:
1.Negative externalities did not necessarily lead to an inefficient result.
2.Even if they were inefficient, Pigovian taxes did not tend to lead to an efficient result.
3.The critical element is transaction cost theory, not externality theory.
Despite any counterarguments towards Pigou's theories, Pigovian taxes are prevalent in society today. One of the most popular Pigovian taxes is a carbon emissions tax. Governments impose a carbon emissions tax on any company that burns fossil fuels. When burned, fossil fuels emit greenhouse gases, the cause of global warming, which is damaging our planet in a multitude of ways. The carbon tax is intended to factor in the real cost of burning fossil fuels, which is paid by society. The end role of the carbon tax is to ensure that the producers of carbon pro
Despite any counterarguments towards Pigou's theories, Pigovian taxes are prevalent in society today. One of the most popular Pigovian taxes is a carbon emissions tax. Governments impose a carbon emissions tax on any company that burns fossil fuels. When burned, fossil fuels emit greenhouse gases, the cause of global warming, which is damaging our planet in a multitude of ways. The carbon tax is intended to factor in the real cost of burning fossil fuels, which is paid by society. The end role of the carbon tax is to ensure that the producers of carbon products are the ones incurring this external cost.
Another Pigovian tax, common in Europe, is a tax on plastic bags, and sometimes even paper bags. This encourages consumers to bring their own reusable bags from home to deter the use of plastic and paper. Plastic is a by-product of burning fossil fuels and results in the damage of marine life, while paper bags encourage deforestation.
All of the above products cause a negative externality, whose price does not take into consideration the cost to society. The implemented taxes are a measure to redistribute those costs back to the producer and/or user that generate the negative externality.
Another Pigovian tax, common in Europe, is a tax on plastic bags, and sometimes even paper bags. This encourages consumers to bring their own reusable bags from home to deter the use of plastic and paper. Plastic is a by-product of burning fossil fuels and results in the damage of marine life, while paper bags encourage deforestation.
All of the above products cause a negative externality, whose price does not take into consideration the cost to society. The implemented taxes are a measure to redistribute those costs back to the producer and/or user that generate the negative externality.
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