Taxation and Perverse Incentives
Al Gore has come out in favor of taxing pollution (the good), and replacing payroll taxes with these pollution taxes (the bad). The potential problem is that such a set up could work against reducing pollution (the ugly).
NEW YORK (Reuters) – Former U.S. Vice President Al Gore on Monday suggested taxing carbon dioxide emissions instead of employees’ pay in a bid to stem global warming.
“Penalizing pollution instead of penalizing employment will work to reduce that pollution,” Gore said in a speech at New York University School of Law.
The pollution tax would replace all payroll taxes, including those for Social Security and unemployment compensation, Gore said. He said the overall level of taxation, would remain the same.
The problem is that taxes on pollution are intended to reduce pollution by either inducing firms to modernize/upgrade or shut down heavily polluting plants. The problem here is that if the taxes work too well, then it could be the case that revenues fall so much that the government actually doesn’t want to reduce pollution anymore. It could even be the case that the government cuts the pollution taxes to encourage more pollution to make sure that the budget is met. Not exactly the scenario one wants when trying to reduce pollution.
Think of it this way, the ideal is to drive pollution as low as possible and still enjoy as much utility (well being) as possible. But, if by driving pollution so low that the tax revenues are no longer sufficient to meet the needs of Social Security and/or Medicare then there is an incentive to allow more pollution than people might like. So taxing pollution is a good thing, but using those taxes to pay for something like Social Security, unemployment compensation or Medicare probably is not a good thing.
An even better solution could be to use a cap-and-trade program where the amount of pollution is capped and a number of permits for trading are issued and firms are allowed to buy and sell such permits. Those firms that are already efficient or find installing pollution reducing technologies more desirable can sell their permits. This will help internalize the costs of pollution and reduce the overall level of pollution. In fact, the level of permissible pollution could be set to decline over time as well. Of course some research indicates that these results are dependent on the amount of competitiveness in the economy.