Saturday, April 28, 2007

Happy Tax Payers and Elasticity

Garth writes


The whole notion of:
"But, once we make that guess we add it to the price of gasoline and our motorist is once again happy in the knowledge that she has made the world a better place."

...is wrong. They are not "happy." If they were happy to pay the higher price, you would not have had to tax them in the first place!!!

That leaves us with two problems: how can we compensate both the losers in the present (due to higher taxes) and the losers in the future (environment).

We do this by taking the revenue from the tax hike to repay the current losers, and we ASSUME the elasticities are such that carbon consumption falls by enough to provide the adequate benefit to the future.

So you see, the assumption of elasticity IS important if you intend to compensate the current losers (as Mankiw would want to do)


The happiness was a joke. Its a device I somtimes use in class. In economics we assume that people are out to satisfy their own interests but we find that they often end up maximizing social welfare.

I sometimes take the tact that our protagonist wants to maximize social welfare (as many young students imagine themselves) but ends up realizing that all she has to do is act in her own self interest. So long as the government corrects for externalities and the like.

As for the elasticities. You are right that the government does not actually compensate the taxpayers. This does create messy distributional issues.

However, if we were willing to accept Kaldor-Hicks then the elasticity wouldn't matter.

Suppose there were perfect substitutes so that the elasticity was infinte. Then gas would be completed replaced by some alternatives at no cost at all to the consumer. The tax would have the result of completely protecting the environment.

Suppose the elasticity of gas was zero. So that people just had to have it no matter what. Then there would be no change in consumption. Assuming that the damages are not infinte (some might disagree) this is also optimal.

Now, yes we have taken away revenue but we did it a no economic cost. Since, their behavior didn't change there is no deadweight loss. For real nerds, zero elasticity must mean that the compensated elasticity is zero, and that the income elasticity is also zero. If the income elasticity of gas is zero then the gas price elasticity of labor supply must also be zero. This means that high gas prices do not discourage work or investment. In effect we have found the perfect tax.

So at either extreme the gas tax works so long as we ignore distributional issues. By the way those issues are precisely why I think gas tax revenue should go towards increasing the EITC.

16 comments:

Dex Kaden said...

I am confused.

When you say "Suppose the elasticity of gas was zero. So that people just had to have it no matter what. Then there would be no change in consumption" what you're saying is that people need to travel and they travel by putting gas in their cars, and because they have to put gas in their cars, they'll pay whatever the price is...right?

And then when you say "This means that high gas prices do not discourage work or investment. In effect we have found the perfect tax."

This is where I get confused because I only have X amount of dollars, and if I pay MORE for gas that I have to have, then I have LESS to spend on other things, like investments---and if I want to maintain my current standard of living, I'll have to work more to have the same amount of spending money.

And I am more confused when you say "We do this by taking the revenue from the tax hike to repay the current losers" because wouldn't it be more efficient to just let the "losers" keep their money in the first place rather than taking it?

Or my confusion could just be the result of not having any economic training to speak of.

happyjuggler0 said...

The more I think about the public choice implications of trying to pass Pigouvian taxes, i.e. taxes on negative externalities, the more I am convinced that 100% of the tax proceeds, minus the bureaucracy's cut, ought to be distributed to 100% of the citizenry in a permanent dividend fund on an equal shares basis, i.e. one person one share.

For example, if a tax on carbon emissions yielded $100 billion dollars a year from all sources (electricity, planes, trains, automobiles), then all of that $100 billion ought to be disbursed to the US citizens. With about 300 million Americans, that works out to about an annual check for $330 for each man, woman and child. Without taking into account the incidence of corporate GHG taxation, this would appear to the average citizen (and media nitwit), after doing the math, to be a gain for everyone except for mean, greedy, polluting corporations.

One is still left with the zero sum problem of corporations moving to China (or wherever) at the margin as a result of higher costs, and I don't have an easy answer to that. However a start would be to simply kill the corporate income tax after a decent attempt to explain to the populace the incidence of corporate taxation. It would likely be an easier tutorial when there are those screaming that this tax means jobs going overseas.

I feel the same way about water pricing by the way. In my opnion government owned, or government regulated utility (privately owned) water "natural monopolies" ought to price their water at about 95% of replacement costs via desalination plants and accompanying infrastructure. The excess "profits" would then be disbursed to the shareholders, namely every man, woman and child in the relevant jurisdiction.

This would have the effect of ending 95+% of droughts in my opinion, with drought being defined as a persistent greater use of water than is replaced by rainfall, and would do so without causing hardship on the average person or using government coercion or shame tactics to induce people to conserve water. The poor would plausibly even gain in this equation, contrasted with the claims of such pricing being "regressive" without such distribution of "profits".

Anonymous said...

dex, the gas tax deosn't discourage work/investment at a non-chanign level of gas usage since it acts like a lumpsum tax.

Michael said...

I dunno. I still strongly feel that Pigouvian taxes and whether poor people have enough money are two separate issues.

I understand that a regressive Pigouvian tax seems bad. But if the result of the Pigouvian tax is that poor people don't have enough money, then government policy should just give them more money.

I guess what I'm hoping for is a standalone criterion that can tell us when we are redistributing "enough" to poorer people. Sure, emotionally it seems heartless to just jack up a regressive tax. But how do we know our current levels of redistribution to poor people aren't already heartlessly low? I want a criterion of "heartlessness" that is a little more fulfilling than "worse than current levels = heartless".

That's why I don't like the earmarking of Pigouvian revenues for payment to Pigouvian taxpayers. Because it incorrectly ties together two different purposes of government: to internalize costs, and to make sure poor people have enough money.

Garth said...

Karl,
Thanks for the reply. I don't disagree that gas taxes "work" from an efficiency standpoint (disregarding distributional issues - though I would argue distributional issues could also effect long-run efficiency....).

I suppose my biggest problem with gas taxes is that elasticities DO matter once you look beyond the simple assumptions and if you understand that your goal is not just efficiency, but to better the environment.

You say: "Suppose the elasticity of gas was zero. So that people just had to have it no matter what. Then there would be no change in consumption...no change in behavior...no deadweight...optimal."

That makes sense to me but I would think we need to look beyond that...for the fact that you have to compare that to what actually would happen.

Gas demand is not perfectly inelastic (though close) and is not a perfect extreme. So, a gas tax WOULD in fact reduce consumption and reduce people's happiness - at minimal effect to the environment and at a cost to both consumers and producers. The 'cost' would then be collected as government revenue.

Let's assume, oppositely for example, that gas demand were very elastic, then that same gas tax would have a much bigger effect on the environment, though it would raise less revenue for the govnernment.

So you see by those two examples, when gas elasticity is low, for a GIVEN gas tax, the environment is better of. Since some policy maker has to 'fix' the tax hike at some level - that fixed level won't be as effective than if demand were more elastic - though it equally as efficient. So while from an efficiency stanpoint, a gas tax MAY make sense (IF you can determine costs etc - which I have doubts), it doesn't make sense if your policy goal is to better the environment - and that's regardless of distributional issues.

Once the government has to decide what to do with the revenue, that opens up a whole 'nother can of worms I would think....

Garth said...

small correction to my previous comment:

"when gas elasticity is low, for a GIVEN gas tax, the environment is better of:"

and by "low" I of course mean "high" (elastic)

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