The Wikipedia Free Encyclopedia available on the internet sets out concisely what constitutes a Pigovian tax, so named after the economist Arthur Pigou who, in the 1920s, argued that industrialists tend to seek only their own marginal interest. When the marginal social interest diverges from the marginal private interest, the industrialist has no incentive to take upon himself the cost of the marginal social cost. The contrary also applies in that if an industry produces a marginal social benefit, the individuals receiving the benefit (the public) have no incentive or need to pay for that service.
Pigou gave numerous examples of incidental uncharged disservices to the social benefit. If a factory is built in the middle of a crowded neighborhood, the factory will cause uncharged disservices such as higher congestion, loss of light, air pollution and the decrease of health of the neighbours. He also mentioned the sale of alcohol as necessitating higher costs on policemen and prisons because of the crimes associated with alcohol.
In other words, the net private product of an alcohol business (the profit of the producer) may be large relative to the net social effect of the same business. Possibly more wrongly than rightly, Pigou suggested that this is why most countries tax alcohol rather heavily, but perhaps this is one of the dubious concepts which tend to emerge from Pigovian argumentation.
The divergence between the marginal private interest and the marginal social interest produces two primary results. First, the person creating the social harm does not pay for it, while the party receiving a social benefit likewise does not pay for it. Secondly, when the marginal social cost exceeds the private marginal benefit, the creator of the cost overproduces his goods. To deal with overproduction, Pigou recommended that a tax be levied on the offending producer. If the government can accurately gauge the social cost, the tax would lead to the producer having to pay for the social harm he is creating, and the measure would ultimately reduce the quantity of the product produced, thus moving the economy back to equilibrium.
It appears that the oft repeated proposal to levy a tax in Malta on vacant properties is an attempt to solve a perceived social cost caused by negative externalities through the imposition of a Pigovian tax
It appears that the oft repeated proposal to levy a tax in Malta on vacant properties is an attempt to solve a perceived social cost caused by negative externalities through the imposition of a Pigovian tax.
Pigou’s general line of reasoning was not precisely new as it had long been argued that such a tax should be applied as pure market economics often fail to provide a proper incentive to reduce negative forces. Unfortunately, these taxes are themselves negative and can be used for purely destructive purposes. Karl Marx had proposed to destroy the middle class and the bourgeoisie through the imposition of crippling taxation.
Apart from the dangers lurking behind such proposals, Pigovian taxes are notoriously difficult to formulate with any clarity: thus, which are the actual vacant premises that one would seek to tax and what actually constitutes vacant premises? Would it be logical to put all vacant properties into one category and subject the lot to the same levy?
A moment’s deliberation would immediately indicate that that would be both unrealistic and unfair, and that the proposed tax or levy would have to be subject to a nightmare of conditions and stipulations, to exemptions and exceptions: in fact very much like the extremely complex provisions contained in our tax code regarding capital tax and the property tax in respect of immovables.
Where Pigovian impositions have been levied, they have yielded some surprising results, mostly due to the basic impossibility of governments having complete knowledge of the market they desire to regulate, and its detailed workings. Events have often shown that the assumption that governments can determine the marginal social cost of negative externalities and convert that cost into a monetary value is a fundamental weakness of a Pigovian tax. (This seems to have been recognized locally by the collapse of the eco-contribution).
Moreover, the difficulty of determining the correct amount and the proper thrust of the imposition is compounded by the fact that the social costs of the offending externality may be largely psychological and relative to the individual cases concerned, but only marginally attributable to recognisable economic forces.
The most drastic of neo-Pigovian theories, Karl Marx’s proposal about the destruction of the social order, was never really tested.
The destruction he contemplated did take place under various communist governments, but not through the subtleties of punitive taxation which he propounded: autocratic governments simply grabbed everything in sight, packed off everybody to gulags or exile, killed millions and half-starved the remaining population.
Thankfully, we have never implemented negative levies of a pure Pigovian character. Rather, we have attempted the exact opposite (also contemplated by Pigovian theory) whereby negative externalities are tacked constructively by offering incentives and creating appropriate institutions.
The entrepreneurship which has produced our modern economy has been supported by helpful positive steps, not by negative destructive measures.
The effect on the economy has been both startling and by and large socially acceptable.
A perhaps not precisely related example regarding what was feared would be a destructive Pigovian tax but which, in fact, turned out to be rather beneficial, came about some 40 years ago when the income tax legislation was made applicable to the Church and its institutions. When the idea was first mooted it was feared that a hardline government was preparing a means of eliminating what it deemed to be the main stumbling block to absolute power in Malta by the application of Karl Marx’s theories.
In effect, however, the mild and reasonable rules introduced were met with approval of the highest Church authorities who immediately realised that this was an unexpected opportunity to force upon its institutions proper financial administration.
Many ‘entities’, the term used by the tax legislation for various Church structures, were jogged out of their positively medieval mentalities and practices, and not a few ongoing scandals which came to light were eliminated.
The general effect on the Church’s financial resources appears to have been negligible, and very little tax appears to have been generated in favour of the national coffers.
Wikipedia also provides a formidable list of harmful externalities, being costs (social or otherwise) affecting parties who had no part in their creation.
These include air pollution from burning fossil fuels, climate change as a consequence of greenhouse gas emissions, water and noise pollution in the process of production, storage requirements for toxic wastes, and the depletion ofliving species bringing some to the brink of extinction.
Some, if not all of these externalities could be a fit target for a Pigovian tax, but it will be noticed that action in their respect is all forward looking: what can be done in the future to remove harmful externalities. Taxing existing vacant properties, on the other hand, looks backwards in seeking to penalise an existing state of affairs in the hope that this will magically set it right.
With due respect, this is a totally wrong and misplaced approach: it makes more sense to be constructive for the future than to be destructive of the past in the present.
Edwin Vella is a retired consultant who has worked for over 60 years in taxation.