Time for Some Pigovian Taxes

Leaving the merits of capitalism or socialism aside for a moment, let’s consider the case for taxing bad behavior versus good. Adam Davidson, economics columnist and founder of NPR’s Planet Money, reviews the case now being made by a growing number of economists on both the left and the right. They all come to a similar conclusion: Forget about taxing good or constrictive behavior such as entrepreneurialism. Rather, it’s time to tax people for doing destructive and damaging things.

Arthur Pigou, the early-20th century economist, for whom Pigovian taxes are so named, argued that people should face the consequences of externalities. An externality covers an action that we take and that affects others, but to which the market cannot, yet, assign a price. Here’s an example. Say on your morning commute to work your bad habit of driving while using a mobile phone causes an accident followed by an hour-long traffic jam — the lost productivity from all those stuck behind you on the highway is an externality. So, the thinking goes, what if we were to tax such errant behavior? Not only would governments secure an alternate, or — sigh — yet another form of revenue, but we could also collectively discourage bad behavior through monetary means. Taxes on tobacco are a good example — more so due to the addictive nature of nicotine.

Perhaps it’s time for a tax on burgers and fries, a tax on sneezing and coughing in public, and, why not, a tax on those who sing out of tune.

[div class=attrib]From the New York Times:[end-div]

Driving home during the holidays, I found myself trapped in the permanent traffic jam on I-95 near Bridgeport, Conn. In the back seat, my son was screaming. All around, drivers had the menaced, lifeless expressions that people get when they see cars lined up to the horizon. It was enough to make me wish for congestion pricing — a tax paid by drivers to enter crowded areas at peak times. After all, it costs drivers about $16 to enter central London during working hours. A few years ago, it nearly caught on in New York. And on that drive home, I would have happily paid whatever it cost to persuade some other drivers that it wasn’t worth it for them to be on the road.

Instead, we all suffered. Each car added an uncharged burden to every other person. In fact, everyone on the road was doing all sorts of harm to society without paying the cost. I drove about 150 miles that day and emitted, according to E.P.A. data, about 140 pounds of carbon dioxide. My very presence also increased (albeit infinitesimally) the likelihood of a traffic accident, further dependence on foreign oil and the proliferation of urban sprawl. According to an influential study by the I.M.F. economist Ian Parry, my hours on the road cost society around $10. Add up all the cars in all the traffic jams across the country, and it’s clear that drivers are costing hundreds of billions of dollars a year that we don’t pay for.

This is how economists think, anyway. And that’s why a majority of them support some form of Pigovian tax, named after Arthur Pigou, the early-20th-century British economist. Pigou developed the idea of externalities: the things we do that affect others and that the market is unable to price. A negative externality is like the national equivalent of what happens when you go to dinner with three friends and, knowing that you’ll pay only a fourth of the bill, decide to order an expensive entree. Pigou argued that there are so many damaging things that we do — play music too loudly, drive aggressively — and that we’d probably do less if we had to pay for them.

The $10 I cost the economy was based on Parry’s algorithm, which calculates that drivers should pay a tax of at least $1.25 a gallon. Forty percent of that price, he says, is the cost that each vehicle adds to congestion. Another 40 cents or so offsets the price of accidents if we divided the full cost — more than $400 billion annually — by each gallon of gas consumed. (Only about 32 cents would be needed to offset the impact on the environment.) According to Parry’s logic, if we paid a tax of $1.25 per gallon instead of the current average of 50 cents, the price of gas would increase by about 25 percent to around $4 a gallon, which is still well below what much of Europe pays. But it would still encourage us to drive less, pollute less, crash less, lower the country’s dependence on foreign oil and make cities more livable. Not surprisingly, several studies have found that people — especially in Europe, where the gas tax is around $3 a gallon — drive a lot less when they have to pay a lot more for gas.

The idea of raising taxes to help society might sound like the ravings of a left-wing radical, or an idea that would destroy American industry. Yet the nation’s leading proponent of a Pigovian gas tax is N. Gregory Mankiw, chairman of President George W. Bush’s Council of Economic Advisers and a consultant to Mitt Romney’s 2012 campaign. Mankiw keeps track of others who support Pigovian taxes, and his unofficial Pigou Club is surely the only group that counts Ralph Nader and Al Gore along with leading conservatives like Charles Krauthammer, Alan Greenspan and Gary Becker as members.

Republican economists, like Mankiw, normally oppose tax increases, but many support Pigovian taxes because, in some sense, we are already paying them. We pay the tax in the form of the overcrowded roads, higher insurance premiums, smog and global warming. Adding an extra fee at the pump simply makes the cost explicit. Pigou’s approach, Mankiw argues, also converts a burden into a benefit. Imposing taxes on income and capital gains, he notes, punishes the work and investment that improve society; taxing negative externalities allows the government to make money while discouraging activity that hurts the overall economy.

[div class=attrib]Read the entire article after the jump.[end-div]

[div class=attrib]Image: Arthur Cecil Pigou, 1943. Courtesy of Ramsey and Muspratt Collection.[end-div]