Cap and Trade, Part 5:
How Pigouvian taxes turn into mere revenue generators
13 Oct 2009 in Regulatory Economics, Legislation
Economic incentive schemes are popular among economists and increasingly embraced by legislators. Cap-and-trade to control greenhouse gas emissions is perhaps the most visible of these incentive schemes. Pigouvian taxes are the other, and news today from an unexpected source provides useful and interesting lessons in how such taxes can work -- and how they can degenerate into plain vanilla taxes.
First, some background. The theory behind proposed cap-and-trade legislation to reduce greenhouse gases is simple, elegant and very conventional in economics circles: When market transactions impose costs on people who are not parties to a transaction, the quantity of the good or service in the market is too large because the price is too low. This "externality" can be eliminated either of two ways: (1) by imposing a tax on the good or service equal to the value of the damage it causes, or (2) by establishing a scheme of property rights whereby those who would engage in the activity must first own a permit, with the cost of the permit also equal to the value of the damage. In theory, there is no difference in economic efficiency if these property rights are sold at auction or assigned at random.
Cap-and-trade is an example of the latter approach, though in its various proposed legislative manifestations it is not an exemplar of the genre. The reasons are threefold. First, none of the bills would actually establish a property right. That means the government could confiscate them at will or destroy their value by flooding the market with excess supply. Second, each of the bills would distribute these ephemeral permits to rentseekers of various hues and stripes. Because rentseeking entails a real social cost, current cap-and-trade proposals would will be much more costly than what the economic theory of emissions allowances predicts. Third, the government intends to use the sale of greenhouse gas emission permits to generate revenues for funding other programs. Whereas the economic purpose of cap-and-trade is to make carbon-based forms of energy relatively more expensive, cap-and-trade as proposed amounts to a significant generalized tax increase. The bills set the equilibrium price at a level that does not "internalize the externality" of carbon emissions, but rather maximizes revenue to the government.
Emission taxes -- often called Pigouvian taxes after the economist who first proposed them, Arthur Cecil Pigou -- are the other conventional way to internalize externalities. They suffer from two of the three practical defects that afflict emission permits. First, they prompt unbridled rentseeking. Nothing compels Congress to apply the tax consistency, and the history of tax policy is riddled with rentseeking in pursuit of favorable tax treatment. Further, nothing compels Congress to limit the tax rate to the marginal damage caused by greenhouse gas emissions. Indeed, Congress should be expected to use a carbon tax to generate revenue to fund other programs.
At every level of government, taxes are initially proposed to "internalize externalities," but they quickly evolve into schemes for generating revenue. Recent examples include Congress' action in 2007 to raise tobacco taxes to fund an expansion of the State Children's Health Insurance Program (SCHIP). In an August 2007 blog post, we noted that this linkage made the federal government a partner with cigarette manufacturers in the cultivation and preservation of smoking. (If every smoker quit today, revenue to fund the SCHIP expansion would disappear.)
In today's Washington Examiner, staff writer Alan Suderman reports on a proposal by Chevy Chase Village (MD) police chief Roy Gordon to buy 12 Tasers. They would be paid from out of $30,000 in fines exacted on drivers caught by the Village's speed cameras.
This proposal is controversial because there is no obvious connection between the externality for which speed cameras were the solution and the Taser program Gordon wants to fund:
Montgomery County Councilman Phil Andrews, a longtime supporter of speed cameras, said the money raised by the machines ought to be spent on fixing the problems they were supposed to address.
"I think the public would prefer to see speed camera revenues directly related to traffic safety," said Andrews, adding that such spending controls would temper the frequent criticism of speed cameras that local governments see them as an easy way to raise extra revenues.
One example of a public safety program that is plausibly related to excess speed is residential speed humps. Like them or hate them, there is no disputing the fact that they reduce drivers' speed. (An interesting sidebar story is that many of those responsible for the externality are noticeably unhappy about having to conform their behavior to local norms.)
An appeal to legalism is often the first refuge of those who want to use Pigouvian tax revenue for unrelated purposes:
Gordon said he was only following the law, which allows governments to spend speed camera money "solely for public safety purposes, including traffic safety purposes."
Others respond that once the linkage between the Pigouvian tax and the externality is severed, governments are highly susceptible to the temptation to use such taxes merely to generate revenue:
The village's cameras on Connecticut Avenue between the District line and Bradley Lane drew fire last year from drivers advocacy group AAA Mid-Atlantic, which said the village was using them to make money and not to reduce safety.
And there appears to be ample nearby evidence that speed-camera fines have become just another revenue source:
In addition to the Tasers, [Chevy Chase Village] plans to spend $1.2 million building a sidewalk on Brookville Road and $4.6 million in building new streetlights and putting energy-efficient bulbs in existing ones, according to the report.
Montgomery County [MD] is spending about $11.5 million of speed camera revenues on its police and fire departments. Much of the money the county spends with its camera money does not have a direct link to improving traffic safety, the report shows.
Gaithersburg [MD] spent $37,000 raised by speed cameras during the last fiscal year on accident reconstruction equipment, digital cameras and traffic vests, according to the report.
And Rockville [MD] spent $100,000 on a police vehicle and a truck to fix traffic lights, the report said.
A question that has not been asked (or answered) is: Does Chevy Chase Village need Tasers? A case might be made if the Village police had regular experience using deadly force, for which Tasers could be a helpful substitute. Crime statistics for the Village do not appear to support this notion. From 1999-2008, there were a total of 12 assaults and 10 robberies.
Nothing in the Examiner story suggests that Chief Gordon intends to use the 12 Tasers to enforce the Village's traffic laws. However, he might be able to use them to deal with a new externality: drivers honking in protest about having to slow down to cross speed humps.
