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AS Market Failure

Government Intervention & Externalities

How can we take into account some of the third party effects that arise? Is there anything that the government can do? To many economists interested in environmental problems and who believe that that the government can successfully intervene in the price mechanism, the key is to internalise some or all of the external costs and benefits to ensure that the businesses and consumers who create the externalities include them when making decisions.

Taxes

One common approach to adjust for externalities is to tax those who create negative externalities. This is sometimes known as “making the polluter pay”.  Introducing a tax increases the private cost of consumption or production and ought to reduce demand and output for the good that is creating the externality. According to the Department of the Environment, “Taxes send a signal to polluters that our environment is valuable and is worth protecting.”

Some economists argue that the revenue from pollution taxes should be ring-fenced and allocated to projects that protect or enhance our environment. For example, the money raised from a congestion charge on vehicles entering busy urban roads, might be allocated towards improving mass transport services; or the revenue from higher taxes on cigarettes might be used to fund better health care programmes. Usually in the UK, revenue from environmental taxation simply goes into the general pot of taxation which is then used to finance all types of government spending.

Examples of Environmental Taxes

1. The Landfill Tax - this tax aims to encourage producers to produce less waste and to recover more value from waste, for example through recycling or composting and to use more environmentally friendly methods of waste disposal. The tax applies to active and inert waste, disposed of at a licensed landfill site.
2. The Congestion Charge: -this is a very high profile environmental charge introduced in February 2003 by the Mayor of London Ken Livingstone. It is  designed to cut traffic congestion in inner-London by charging motorists £5 per day to enter the central charging zone – for more information go to the Transport for London web site
3. Plastic Bag Tax: In Ireland a pioneering new 15 cent levy on plastic shopping bags was launched in 2002. The tax is designed to encourage people to use reusable bags and has stimulated an increase in the availability of biodegradable bags. Payable in all sales outlets 15 cents are charged for each bag issued and itemized separately on receipts. Proceeds from the tax go to the Environment Fund and are used to fund various waste management and other environmental initiatives. 

Problems with Taxes to Curb Pollution

Many economists argue that pollution taxes can create further problems which lead to government failure and little sustainable improvement in environmental conditions. The main problems are as thought to be as follows:

(1) Assigning the right level of taxation:

There are problems in setting tax so that private cost will exactly equate with the social cost. The government cannot accurately value the private benefits and cost of firms let alone put a monetary value on externalities such as the cost to natural habitat, the long-term effects if resource depletion and the value of human life

(2) Imperfect information:

Without accurate information setting the tax at the correct level is impossible. In reality, therefore, all that governments and regulatory agencies can hope to achieve is a movement towards the optimum level of output.

(3) Consumer welfare effects

1. Taxes reduce output and raise prices, and this might have an adverse effect on consumer welfare. Producers may be able to pass on the tax to the consumers if the demand for the good is inelastic and, as result, the tax may only have a small effect in reducing demand
2. Taxes on some de-merit goods (for example cigarettes) may have a regressive effect on lower-income consumers and leader to a widening of inequalities in the distribution of income.

(4) Employment and investment consequences:

If pollution taxes are raised in one country, producers may shift production to countries with lower taxes. This will not reduce global pollution, and may create problems such as structural unemployment and a loss of international competitiveness. Similarly higher taxation might lead to a decline in profits and a fall in the volume of investment projects that in the long term might have beneficial spill-over effects in reducing the energy intensity of an industry or might lead to innovation which enhance the environment.

Dumped rubbish on the streets of the UK – the landfill tax is widely regarded as having encouraged fly-tipping

Command and Control Techniques – Regulation

Instead of trying to change market prices and therefore affect the behaviour of consumers and producers, the government may choose to intervene directly in a market through the use of regulations and laws.

For example, the Health and Safety at Work Act covers all public and private sector businesses. Local Councils can take action against noisy, unruly neighbours and can pass by-laws preventing the public consumption of alcohol. Cigarette smoking can be banned in public places – such as the ban on smoking in workplaces and bars and restaurants introduced in Ireland in 2004. The British government is currently consulting about a ban on smoking in public places from 2006. However the government has also introduced a more liberal licensing law for the sale of alcohol, although this has met fierce resistance from come critics.

The European Union has also introduced a wide range of directives on how consumer durables such as cars, batteries, fridges freezers and other products should be disposed of. The onus is now on producers to provide facilities for consumers to bring back their unwanted products – but the costs of disposal eventually get past onto consumers.

Can the market mechanism find the right incentives for consumers to recycle – or is there a need for government intervention and regulation to make us recycle more of what we consume?

Carbon Emissions Trading – Marketable Pollution Permits

Some countries have moved toward market-based incentives to achieve pollution reduction. This new approach involves the creation of a limited volume of pollution rights, distributed among firms that pollute, and allows them to be traded in a secondary market. The intent is to encourage lowest-cost pollution reduction measures to be utilized, in exchange for revenues from selling surplus pollution rights. Companies that are efficient at cutting pollution will have spare permits that they can then sell to other businesses. As long as the total bank (or stock) of permits is reduced year by year by the government or an agency, cuts in total pollution can be achieved most efficiently.

Quite simply, limiting emissions makes polluting a scarce resource, and scarcity brings economic value. Emissions’ trading is a central feature of the Kyoto Protocol and the European Carbon Emissions Trading Scheme started in full in January 2005.

Is carbon trading the best market-based solution to the threats from global warming?

In short, carbon trading is designed to reduce the cost of achieving sustainable cuts in greenhouse gas emissions and secondly to extend the principle of property rights as a means of meeting environmental objectives.

Subsidising positive externalities

An alternative to taxing activities that create negative externalities is to subsidise activities that lead to positive externalities. This reduces the costs of production for suppliers and encourages a higher output. For example the Government may subsidise state health care; public transport or investment in new technology for schools and colleges to help spread knowledge and understanding. There is also a case for subsidies to encourage higher levels of training as a means to raise labour productivity and improve our international competitiveness.