Pigou versus Progress

To borrow directly from Left Foot ForwardTim Montgomerie quotes Allister Heath in City AM:

“The top 10 per cent of earners are already set to pay 53.6 per cent of income tax in 2008-09; the top five per cent will pay 43 per cent and the top one per cent 23.9 per cent. Yes, that’s right, just one per cent of the population will pay close to a quarter of the total income tax take, funding a massive chunk of the welfare state – who ever said the rich don’t pay their “fair share”, whatever that means?”

As Will Straw convincingly argues, all the above describes is that people who earn a lot, earn a lot, and as a consequence are responsible for a large portion of our income tax receipts. In our unequal society the existence of the incredibly wealthy means that a large proportion of income tax receipts must be from this group.

Moreover, there is also a consensus that taxation should be progressive, those who earn lots should pay a larger share of their income in tax than those who earn very little. As Paul Sagar argues that even Adam Smith would probably be in favour of this sort of progressive taxation is something.

In his piece on Left Foot Forward, Will goes on to present a graph and argues that, despite Montgomorie’s protests, our tax system is not progressive enough.

Tax by decile

Instead, because of the existence of regressive consumption taxes, which unite Left Foot Forward and Guido Fawkes in opposition, the poorest have the highest overall tax burden. The richest get away with paying a smaller share in tax of their overall income than everyone earning above median income.

The tax structure in this country unfairly penalises the poor, out of keeping with the consensus in favour of progressive taxation. There is widespread condemnation of this from the right and left but fixing this is harder than it would appear.

But. as Matt Sinclair of The Other Taxpayers Alliance points out VAT is not the only indirect tax which penalises the poor.  Pigouvian taxes are designed to put a price on the negative spillovers of a given activity.

In economic parlance a spillover or externality is an effect which impacts on a party that is not directly involved in a transaction. For example, a factory polluting a river is a negative externality and in this case a pigou tax could be levied to cover the price of cleaning up the river.

We already levy a great number of pigouvian taxes. For example, we tax tobacco heavily to cover the cost of treating those falling ill as a result because we have a national health service, and tax alcohol heavily to staff A & E on a Friday night to cover the costs of the ensuing fights. [1]

Like Joseph Stiglitz, I am firmly in favour of a carbon tax to deal with climate change. At the moment we are effectively subsidised by the wider world because we are able to pollute the environment without picking up the tab for the damage caused.

A fair price for this externality would be something approaching $80 a tonne of carbon emitted. This would work to change behaviour so less carbon is emitted and the money could be used to ameliorate the negative effects of any continued warming.

However, this tax presents a big problem for those in favour of progressive taxation because this is by definition not a progressive tax. It will have to be borne equally and it will have to be reflect the true cost of carbon emissions. This means it will hit the poorest hardest.

There is the option of providing subsidies to the poorest so that they can continue to consume as before. The death toll from our current cold snap tells us why this may be a sensible move.

The revenues from this taxation can also be used to lessen the impact of other taxes, for example a reduction in VAT or a cut in the basic rate of income tax. This would involve taking from the poorest with one hand to take a little less with the other.

Of course, our present situation is even more perverse, although they are taxed heavily our poorest are still being subsidised by the suffering – both potential and current – by the poorest of entire the world to the tune of around $80 dollar per tonne of carbon.

Ultimately and unfortunately we are going to have to admit that there will be losers from the implementation carbon tax. We have to be honest and say that the tax is intended to produce losers, because if people don’t lose then that means they aren’t changing their behaviour and that is what we need.

[1] It should be noted both of these seem to be taxed out of proportion to what would be valid as a pigou tax. As well as a little social engineering both are nice little earners for HM Treasury.

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2 thoughts on “Pigou versus Progress

  1. You write: A fair price for this externality would be something approaching $80 a tonne of carbon emitted. This would work to change behaviour so less carbon is emitted and the money could be used to ameliorate the negative effects of any continued warming.

    There is the option of providing subsidies to the poorest so that they can continue to consume as before.

    You have identified the problem, and come so close to the solution. The Pigou tax incorporates all the costs forced on the rest of us by C02-emitting polluters. The right thing to do is not to reduce VAT or income tax, but to distribute the Pigou funds equally amongst everyone in the country.

    This is both the correct action (everyone is damaged equally by climate change. Cutting the rate of tax preferentially distributes money to the well-off.) and has the side benefit that if you ring-fence funds this way, the government can’t use it as a stealth fundraiser. Of course, it has the weakness that a government can use it as a blunt redistributionist tool under the cover of Pigou parity.

    1. Hmm… I’m not sure everyone is damaged equally by climate change. The wealthy are able to implement mitigation techniques the rest of us just don’t have access to. For example air conditioning or emigration.

      So although the climate changes the same for everyone the effect is not the same on everyone. This is one reason I don’t think you can just price this in and let the market sort things out. The adjustment period would be too painful and the Pigou pricing would be abandoned.

      I am well aware that providing subsidies to the poorest so they can continue as before isn’t optimal, but as the poor are quite numerous it seems politically the only option.

      As to how the funds are allocated there are a variety of options. A basic income could be provided that’s true, but again that would ignore the fact that the poorest bare the worst costs of climate change.

      Politically, making it fiscally neutral would probably the easiest option to get it through any legislature.

      Some interesting points though. You don’t think it would be legitimate at all to use it reduce other taxes? Or you don’t trust Govt. to actually do that?

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