Question

5. Suppose you wanted to hasten the transition from a depletable fossil fuel to solar energy. Compare the effects of a per-unit tax on the depletable resource to an equivalent per-unit subsidy on solar energy. Would they produce the same switch point? Why or why not?

Answer 1

Production brings about externalities—whether it be positive or negative, positive external benefits are good for the community and lead to a rise in the overall welfare while negative externalities lead to not only depletion of resources but also may hamper sustainable development. A per unit tax may be beneficial since it may lead to an overall reduction in excessive usage of the resource and may even lead to low wastage of the resource. There by seeking to gain in the ultimate motive of conserving it.

This policy measure may be matched up by a subsidy on the solar energy thus signalling to the market the transmission of resources from fossil fuel to solar energy. The subsidy may be able to efficiently off set the tax burden borne by the seller when there is a tax on per unit usage of fuel. If the need of the hour is to hasten the process then the subsidy will have to be provided equivalent to the burden of the tax as borne by the manufacturer. This is necessary for the policy to meet its goal of reducing fuel consumption.

The firms in their endless ‘run’ for profits will not realise the damage they are doing to the environment and in order to ensure that ‘conservationism’ is practiced such measures are needed. A tax added to the cost of production may ensure that the marginal social cost is considered and not just the private cost. The idea is to internalise the externality.

However, it may be argued that a per unit tax on fossil fuel may not always be effective or equal to a subsidy since the exact value of the tax imposed may not be known since we are dealing with externalities and not costs of production alone faced by the producer. A subsidy will have the effect to reduce the price of the good. But in cases where it is not possible to give a subsidy worth the tax burden borne by the seller , would lead to a situation of lees then optimal social welfare. However ,a subsidy on solar energy will necessarily lead to a popular demand for solar base processes and may actually lead to a lesser burden on the manufacturer.