ECONOMICS
Do Pigouvian Taxes Work?
A short review I wrote at Imperial College discussing the efficacy of Pigouvian taxes in the UK, dated 11 November 2020.
Note: This review was written in conjuction with Adam Wood, Amalie Kjaer, Bastian Shi, Henry Jones and Tom O’Brien.
The 1996 UK Landfill Tax reduced biodegradable waste sent to landfills from 35.7 million tonnes in 1995 to 7.7 million tonnes in 2016 [1]. However, Pigouvian Taxes like this do not always produce the desired effect, since they assume a government possesses accurate and representative information to determine optimal supply and demand, which is rarely true [2].
Firstly, social costs are difficult to capture holistically and impossible to accurately measure as they include individual, psychological and emotional costs [3]. This means that governments have to estimate the value of social costs which introduces numerous inaccuracies.
Secondly, the ‘Law of Unintended Consequences’ implies government intervention can introduce unintended negative externalities [4]. An example was the ‘Eat Out to Help Out’ scheme. The subsidy temporarily boosted the economy but increased COVID-19 cases and may be a key factor that resulted in another lockdown and ultimately a weaker economy [5].
Finally, determining social costs could be influenced by political factors, including lobbying, mitigating the benefits of taxing to cover social costs.
Pigouvian taxes are also regressive. This means poorer individuals are affected more, thus reducing society’s net utility which is unfavourable from a utilitarian point of view. Furthermore, taxes encourage evasive behaviour, particularly when tax is greater than the total sanction cost.
A possible improvement to Pigouvian tax would be to make taxation levels more adaptable to perceived levels of social cost to align the taxation level more consistently with the optimum and reduce unintended consequences.
In conclusion, the net effect of Pigouvian taxes isn’t necessarily positive, and they can unfairly punish individuals. Governments could offer subsidies to encourage actions with positive externalities, but this comes with drawbacks too. Therefore, while Pigouvian taxes discourage damaging behaviour, they should be closely assessed to ensure that they are fair.
References
[1] ONS, 2018. “Five facts about environmental taxes” https://www.ons.gov.uk/economy/environmentalaccounts/articles/fivefactsaboutenvironmentaltaxes/2018-10-09
[2] Pigou, A. C., 1954. “Some Aspects of the Welfare State”
[3] Baumol, W. J., 1972. “On Taxation and the Control of Externalities” The American Economic Review
[4] Norton, R., 2019. “Unintended Consequences” https://www.econlib.org/library/Enc/UnintendedConsequences.html
[5] Skopeliti, C., 2020. “‘Eat Out to Help Out’ scheme accelerated coronavirus second wave across UK, study says” https://www.independent.co.uk/news/uk/home-news/eat-out-to-help-out-second-wave-coronavirus-rishi-sunak-covid-b1446586.html
