Sunday, November 05, 2006

Pigouvian Taxes: Regressive?

Pigouvian taxes are taxes levied to correct the negative externalities of a market activity. Perhaps the most significant negative externality today is the destruction of the environment. An example of a Pigou tax would be a tax on gasoline consumption in order to encourage less of a dependence on gasoline, and more investment in alternate energy sources.

Such a tax, considering the importance of the environment, and the gravity of the situation, seems to be a viable and effective tool to curb gasoline consumption. Yet many argue that the tax is not morally defensible on the grounds that it is inherently regressive - that is, the tax would be more of a burden on the poor than on the rich. As conventional taxes go, such a regressive effect seems to be contradictory to the purpose of taxes themselves. Yet the purpose of a Pigou Tax is not to raise revenue for the government, nor to create more equality. The purpose is to correct negative externalities of the market and regardless of whether the tax is 'unfair' or not, the effectiveness is what is most important, and therefore the fact that the tax is regressive must be disregarded.

Nevertheless, the fact that a gasoline tax is regressive is apparent, and makes the tax an issue of political importance rather than solely an economic one. Therefore, some form of compensation for the poor must be available, if not to make it more morally appeasing, then to make it more politically viable. One possible solution is to take the revenue from the gas tax and distribute it in an expanded Earned Income Tax Credit (EITC). The Earned Income Tax Credit is a refundable tax credit that reduces or eliminates the taxes that low-income working people pay (such as payroll taxes) and also frequently operates as a wage subsidy for low-income workers. The credit would not just be given to those who are harmed by the gasoline tax (indeed that would give the poor an incentive to consume gasoline, exactly the opposite aim of the tax,) but would be distributed to all poor, as it is now. Such a scheme would at the same time reduce consumption of gasoline and alleviate the strains of poverty.

A hike in the gasoline tax is a necessary component of the attempt to save the environment. Such a tax, along with an expanded EITC, would contribute both to reducing gasoline consumption as well as reduced dependence on volatile oil producing states. Such advantages, at an expense that can hardly be considered tremendous, as other options to transportation certainly exist, would greatly benefit America as well as the environment.