The Third “Justification” for a Progressive Income Tax

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Aug 31, 2012

Here is the third in a series of blogs that I started on May 18.  The first was called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  The point is to think about whether the top personal marginal tax rate really should be higher or lower than currently, as currently debated these days in the newspapers.

However, perhaps we should also remember what is wrong with government using high marginal tax rates to take from the rich in order to help the poor.  The problem is that a higher personal marginal tax rate distorts individual behavior, particularly labor supply and savings behavior, by discouraging work effort and investment.  Since those are good for the economy, high marginal tax rates are bad for the economy!  In fact, economic theory suggests that the “deadweight loss” from taxation may increase roughly with the square of the tax rate.  In other words, doubling a tax rate (e.g. from 20% to 40%) would quadruple the excess burden of taxes – the extent to which the burden on taxpayers exceeds the revenue collected.

The point is just that we face tradeoffs.  Yes, we have four possible reasons that we as a society may want higher tax rates on the rich in order to provide a social safety net, but we also have significant costs of doing so.  Probably somewhere in the middle might help trade off those costs against the benefits, but it’s really a matter of personal choice when you vote: how much do you value a safety net for those less fortunate that yourself?  And how much do you value a more efficient tax system and economy?

In the first blog on May 18, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  In that blog, I put off the last three justifications and mostly just discussed the first one, namely, the arguments of “moral philosophy” for extra help to the poor.   As a matter of ethics, you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

In the second blog on July 13, I discussed the second justification.  Aside from that moral theorizing, suppose the poor are not deemed special at all: every individual receives the exact same weight, so we want to maximize the un-weighted sum of all individuals’ “utility”, as suggested by Jeremy Bentham, the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.   Also suppose utility is not proportional to income, but is instead a curved function, with “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich to help the poor.

The point of THIS blog is a third justification, quite different in the sense that it does NOT require making anybody worse off (the rich) in order to make someone else better off (the poor).  It is a case where we might all have nearly the same income and same preferences, and yet we might all be better off with a tax system that has higher marginal tax rates on those with more income, and transfers to those with little or no income.  How?  Suppose we’re all roughly equally well off in the long run, or in terms of expectations, but that we all face a random element in our annual income.  Some fraction of us will have a small business that experiences a bad year once in a while, or become unemployed once in a while, or have a bad health event that requires us to stop work once in a while.  To protect ourselves against those kinds of bad outcomes, we might like to buy insurance, but private insurance companies might not be able to offer such insurance because of two important market failures:

  1. Because of “adverse selection”, the insurance company might get only the bad risks to sign up, those who are inherently more likely to become unemployed or to have a bad year.
  2. Because of “moral hazard”, insurance buyers might change their behavior and become unemployed on purpose, or work less and earn less.

With those kinds of market failure, the private market might fail altogether, and nobody is able to buy such insurance.  Yet, having such insurance can make us all better off, by protecting us from actual risk!

Potentially, if done properly, the government can help fix this market failure.  Unemployment insurance is one such attempt.  But the point here is just that a progressive income tax can also act implicitly and partially as just that kind of insurance:

In each “good” year, you are made to pay a “premium” in the form of higher marginal tax rates and tax burden.  Then, anytime you have a “bad” year such as losing your job or facing a difficult market for the product you sell, you get to receive from this implicit insurance plan by facing lower tax rates or even getting payments from the government (unemployment compensation, income tax credits, or even welfare payments).

I don’t mean that the entire U.S. tax system works that way; I only mean that it has some element of that kind of plan, and it might help make some people happier knowing they will be helped when times are tough.  But you can decide the importance of that argument for yourself.

Next week, the final of my four possible justifications for progressive taxation.

The Second “Justification” for a Progressive Income Tax

Filed Under (Other Topics, U.S. Fiscal Policy) by Don Fullerton on Jul 13, 2012

Way back on May 18, I wrote a blog called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  This combination of economics and philosophy is meant to help each of us think about what really should be the top personal marginal tax rate: should it be higher or lower than currently?  This topic is hotly debated these days in the newspapers!

In that blog, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  I put off the last three justifications to later blogs and mostly just discussed the first one, namely, that some “ethicists” in the field of “moral philosophy” have found ethical justifications for extra help to the poor.  The moral justification may be the most common or usual one; you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

But that’s not the only reason to have some degree of progressivity in our income tax system (taking higher percentages of income from those with more income).  The second justification basically says okay, let’s skip the moral theorizing.  Instead, suppose the poor are not deemed special at all.  Suppose that ALL individuals receive the exact same weight.  Suppose the objective is to maximize the un-weighted sum of all individuals’ wellbeing (or what we call “utility”).  Actually, this is perhaps the view of Jeremy Bentham, who came to be considered the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.  That is, just add up all individual utilities, without weights, and maximize that sum.

So far, that might sound like no justification for taking from the rich to give to the poor.  However, we did not say just add up their incomes, or to maximize total GNP.   Instead, one might also believe that utility is not proportional to income, but is instead a curved function, as in the diagram below.  In other words, “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich in order to help the poor.

The only remaining question is the degree of curvature, or the rate at which marginal utility declines.  If it is a nearly straight line, then we might not want much redistribution.  But if it has a lot of curvature, then the sum of utilities could be maximized by taking more from the rich than we do currently.

So, what do you think?  I invite your comments.

Why YOU may LIKE Government “Theft”

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on May 18, 2012

Or, alternatively, “Why I Love Teaching”!  First, teaching lets me grandstand a bit, if that help students really think about the world around us.  Second, it lets me pretend to be an expert in fields other than economics, even fields such as philosophy (see below).  Third, trying to teach about a topic forces me to think hard about that topic myself!  A case in point is the standard lecture on “Justifications for Government Policy to Redistribute Income”, otherwise known as “Robin Hood”, otherwise known as government “theft” from the rich to give to the poor.   

One thing currently happening in the world around us is a heightened political debate about whether the top income tax rate is too low or too high.  See the diagram below.  So this “lecture topic” is not just textbook irrelevance.  It might even help YOU to think about what you read in the newspaper!  Then please decide for yourself.

I see four possible justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, however, then perhaps a different justification is more appealing. 

1.)    As described below, some in the field of “moral philosophy” have found ethical justifications for extra help to the poor.

2.)    Even if the poor are not deemed special in that way, and all individuals receive equal weight, it may still be that a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person (higher marginal utility).  If so, then equal weights on everybody would still mean that total welfare could increase by taking from the rich in order to help the poor. 

3.)    If incomes are generally uncertain, so that any individual might do well in some years and not in other years, then government might actually make all of us happier by the provision of implicit “insurance” – taking premiums in good times in order to help any person who suffers bad times.

4.)    A reduction in income equality could be a “public good”, like the classic example of a lighthouse that benefits all ships whether they have helped to pay for it or not.  Everybody’s individual incentive is therefore not to pay (to “free ride”).  The private market never exists.  But government can raise welfare for all shippers by taxing all ships and using the funds to build and operate the lighthouse.  Similarly, if many people would LIKE to have more income equality in society, they could “free ride” on others who do give voluntarily to help the underprivileged. If so, then government could fix that market failure by taxing everybody and using the funds to improve income equality.

Having used up several paragraphs already, I will miss the chance to explain all four of these important points adequately in this one blog, and so I’ll save a few for the next blog.  Let’s just start with the first one.

In the field of moral philosophy, some libertarians such as Robert Nozick believe that theft itself is ethically wrong, that each person is morally entitled to the fruits of their own labor.  No person is allowed to steal from a rich neighbor, even to give to the poor, so why would government be allowed to do so?  If theft is morally wrong in itself, then government should not be redistributing from rich to poor, no matter how needy the poor nor how worthy the cause.  On the other hand, by the way, government steals from individuals through taxes in order to build highways and provide for national defense, and so one may wonder why theft is justified for some purposes and not others.  One way out of that problem is to decide that a tax for public purposes is not in fact “theft”.

In contrast, John Rawls argues that the moral choice is to help the poor.  Actually he has two important ideas.  One is that those who are already rich have no moral justification to argue for reducing taxes on the rich, just as those who are poor have no moral justification to argue for raising taxes on the rich.  Such positions are merely self-interested.  Therefore, a useful thought experiment is to put yourself in what Rawls calls the “Original Position”, at the beginning of the World, before places have been assigned in the wide distribution of incomes and well-being.  That is, suppose resources are limited, and that the world will inevitably have a distribution of different human abilities and disabilities.  You don’t yet know your IQ, or whether you will have any particular talents in music, sports, the arts, or management.  Our job in this “original position” is to write a constitution, a set of rules for government and human interaction.

The purpose of this thought experiment is to try to strip away self-interest and think about how rules “ought” to be designed.  And then, Rawls’ second idea is about what any of us would likely decide to do in such a position.  He argues that the only natural choice, indeed the only logical choice, is to be extremely risk averse.  We are not talking about twenty bucks you might lose at the Casino, where risk is fun.  Instead, we are talking about your entire life’s prospects, where risk is not fun.  It must be great to be Brad Pitt, but what if you end up with little talent or ability.  You could end up homeless, or worse.   Given that risk, he argues, one should design the rules such that society would take good care of those who are disadvantaged, unlucky, or disabled.  You might well be the person on the bottom of the totem pole.

His treatise, called “A Theory of Justice” is 600 pages, so I haven’t even read it all!  So I won’t try to explain all the reasoning, but the interesting point is the connection between risk aversion and redistribution.  Rawls himself is extremely risk averse, saying we ought to maximize the welfare of the poorest person with the minimum income – the “maximin” strategy.  That does not mean perfect equality, as he points out that the poorest person’s welfare might be improved by giving the most talented individuals plenty of incentive to work hard and invent new technology that generates plenty of profits, market success, and economic growth.  But cutting the tax rate on the rich is only justified for Rawls if that really does improve the welfare of the poorest.

Well, out of space for today, so I’ll save the other justifications for next time.  But in case you don’t like the justifications of Rawls, those other justifications (#2 through #4) are completely different!

Negative Leakage

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Apr 20, 2012

What is that, a gastrointestinal disorder?   No, it’s the title of one of my recent research papers  (joint with Dan Karney and Kathy Baylis) about unilateral efforts to reduce emissions of greenhouse gases (GHG).   When worldwide agreement is not possible, then the question is whether GHG abatement policy might be implemented by only one country, or bloc of countries (or region or sector).   The fear of any one country or bloc is that they would only raise their own cost of production, make themselves less competitive, and lose business to firms in other countries that may increase production and emissions.  When only one country limits their emissions, any positive effect on emissions elsewhere is called “leakage”.

Yes, that’s a word in economics, see .

In efforts to “abate” or to reduce GHG emissions, the fear of lost business has pretty much deterred any attempt at unilateral climate policy.  That positive leakage might be called a “terms of trade effect” (TTE), because unilateral policy raises the price of exports and reduces the price of imports.   But our recent research paper points out a major effect that could offset part of that positive leakage.  The “negative leakage” term in the equation might be called an “abatement resource effect” (ARE).   That is, one additional thing happening is that the domestic firms face higher costs of their emissions, and so they want to substitute away from GHG emissions and instead use other resources for abatement – such as windmills, solar cells, energy efficient machinery, hybrids, electric cars, and even “carbon capture and sequestration” (CCS).  Thus they have at least SOME incentive to draw resources AWAY from other sectors or other countries.  If that effect is large, the result might shrink those other sectors’ operations overall, and thus possibly SHRINK emissions elsewhere.

I don’t mean to oversell this idea, because it probably does not completely offset the usual  positive “terms of trade effect”.  But in some circumstances it COULD be large, and it COULD result in net negative leakage.  The best example is probably to think about a tax or permit price for carbon emissions only in the electricity generating sector, within one country.  For simplicity, suppose there’s no trade with any other countries, so the only choice for consumers in this country is how much to spend on “electricity” and how much to spend on “all other goods”.   Demand for electricity is usually thought to be inelastic, which means consumers buy almost the same amount even as the price rises.  If firms need to produce almost as much electricity, while substantially reducing their GHG emissions, they must invest a lot of labor AND capital into windmills, solar panels, and CCS.  With any given total number of workers and investment dollars in the economy, then fewer resources are used to produce “all other goods”.

The ability of consumers to substitute between the two goods (electricity vs “all other”) is called the “elasticity of substitution in utility.”  The ability of firms to substitute between GHG emissions and those OTHER inputs is called the “elasticity of substitution in production”.  If the former is bigger than the latter, then net leakage is positive.  If the latter is bigger than the former, then net leakage can be negative.

Okay, too technical.  But the point is that other researchers have missed this “abatement resource effect” and overstated the likely positive effect on leakage.  And that omission has led to overstated fears about the bad effects of unilateral carbon policy.  What we show is that those fears are overstated, in some cases, where leakage may not be that bad.  With some concentration on those favorable cases, one country might be able to undertake some good for the world without fear that they just lose business to other sectors.

Cheaper Gasoline, or Energy Independence: You Can’t Have Both

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Mar 23, 2012

Politicians like to say they want the U.S. to produce at least as much energy as it consumes – “energy independence”.  And they certainly want to reassure consumers that they are doing something about the high price of gasoline.  But the two goals are inconsistent.  You can’t have both.  Indeed, the current high price of oil is exactly what is now REDUCING our dependence on foreign oil!

We all know the price of gasoline has been increasing lately, now well over $4 per gallon in some locations.  Five-dollar gas is predicted by Summer.  In addition, the New York Times just reported that our dependence on foreign oil is falling.  “In 2011, the country imported just 45 percent of the liquid fuels it used, down from a record high of 60 percent in 2005.”  The article points out that this strong new trend is based BOTH on the increase of U.S. production of oil AND on the decreased U.S. consumption of it.  And both of those factors are based on the recent increases in oil and gasoline prices.  Those higher prices are enough to induce producers to revisit old oil wells and to use new more-expensive technology to extract more oil from those same wells.  The higher prices also are enough to induce consumers to conserve.  Purchases of large cars and SUVs are down.  Many people are driving less, even in their existing cars.  A different article on the same day’s New York Times, on the same front page, also reports that “many young consumers today just do not care that much about cars.”

Decreased dependence on foreign oil does sound like good news.   Actually, it is good for a number of reasons. (1)  It is good for business in oil-producing states, helping raise them out of the current economic slow-growth period.  (2) It is good for national energy security, not to have to depend on unstable governments around the rest of the world.  (3)  It reduces the overall U.S. trade deficit, of which the net import of oil was a big component.  And (4) the reduced consumption of gasoline is good for the environment. 

On the other hand, the increased U.S. production of oil is not good for the environment, as discussed in the same newspaper article just mentioned.   As an aside, I would prefer to do more to decrease U.S. consumption of oil – not only from increased fuel efficiency but also by the use of alternative non-fossil fuels – and perhaps less from increased U.S. production of oil from dirty sources such as shale or tar sands.  But that’s not the point for the moment.

The point for the moment is just that maybe the higher price of gasoline is a GOOD thing!  We can’t take even small steps toward decreasing U.S. dependence on foreign oil UNLESS oil and gas prices rise.  Any politician who tells you otherwise is pandering for your vote.  It is the high price of oil that is both increasing U.S. production and decreasing U.S. Consumption.



Make the LEAP!

Filed Under (Other Topics, U.S. Fiscal Policy) by Don Fullerton on Mar 2, 2012

Academic research is inherently a “public good”, which means that once a professor does all the research work and writes the paper, the social marginal cost of another reader is ZERO!  If the research is useful, then it could be useful to additional readers at no extra cost whatsoever.  Any charge for reading it would discourage those who could benefit while imposing no social cost whatever.  Thus, the optimal price to charge per reader is zero.

But that’s not what journals charge.  Non-profit associations might charge very little to subscribe to their journals, basically enough to cover their printing cost and mailing cost.  Now, however, any research paper can be provided even more cheaply on a website.  One useful purpose of an academic journal, still, is for the editor and reviewers to pass judgment on whether the research is good enough to be published, and to make further suggestions for improvement before publication.   So, each paper to be published has some cost to review it and some cost to post it on the web.  Even then, the social marginal cost of one additional person to read it is still zero!

How can a non-profit journal cover the cost of editing and reviewing the paper, and still provide free access?  Just as for many kinds of “public good”, the nonprofit organization might need donations!

Even worse is the still-huge number of academic journals that are published not by a non-profit research association or by a university press, but by a private for-profit company.  Those private publishers own the copyrights, and so they can charge a high enough price to make money, above and beyond their costs.  And even worse than most private for-profit publishers is Elsevier.

Elsevier had a good idea, years ago, when they founded a large number of field journals in economics and in other disciplines.  Elsevier now owns about 90% of the private for-profit academic journals, a virtual monopoly, so they charge huge prices and make huge profits.  Those journals have become prestigious, and so authors want to publish in them.  In order to “get in good” with the editors, those potential authors are willing to review other submitted papers for free.  Elsevier uses all this free help from university professors who are reviewers, to improve the quality of the product that they sell, in order to make even higher profits.

I don’t blame Elsevier, a private company, for trying to make money.  They have done a good job of it.  But as university professors, we do NOT need to provide free help to them!  I highly recommend reading a paper by Ted Bergstrom called “Free Labor for Costly Journals” in which he points out that we academic researchers at non-profit or state-run universities are helping private publishers make profits.  I would also recommend a new blog by Prof. Jacob Vigdor of Duke University.   

Mathematicians are forming a boycott of Elsevier.  For another example, the nonprofit “Association of Environmental and Resource Economists” (AERE) are discussing whether to break away from Elsevier and start a new non-profit journal (read about all the difficulties in an article starting on page 23 of the AERE Newsletter).   Finally, Ted Bergstrom has lots of info on his website.

We are stuck in a “bad equilibrium.”  University researchers want to publish in the prestigious journals, which are often journals of private publishers like Elsevier.  So those researchers review for free, for Elsevier, and they want their university to subscribe to those good journals of Elsevier.  And profits are made, by Elsevier.  We’d all be better off if we could “leap” to the “good equilibrium” where only non-profit associations and universities publish academic journals, at cost.  Then when we review papers for free for those journals, and when the universities subscribe to those journals, we are all contributing to a public purpose, the provision of a public good.

Nothing Good about Cheaters

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Jan 13, 2012

Taxes are bad, on that we can agree.  So not paying taxes must be good, right? 

Wrong.  A reform to cut taxes for everybody might be a good idea (or not).  But having millions of individuals cheat to reduce their own taxes is never a good idea.  It is a tax cut without reason, without fairness, and without the incentive or cost advantages of a cut in tax rates.

Just to focus on that last point, note that some people have to go to a lot of trouble to re-arrange their affairs to be able to cheat on their taxes, and they have to take on extra risk to do so – the risk of getting caught.  So their net “advantage” from cheating is much less than their dollars of tax savings. That cost of tax cheating does not apply to the case where Congress and the President agree to cut taxes for everybody, because then all those dollars stay in the private sector instead of being wasted.

The IRS has just released new numbers on the “tax gap” in the United States, the amount of U.S. tax liability that goes unpaid.  From 2001 to 2006, as you can see in the table below, the tax gap increased from $290 billion to $385 billion.  Just to reverse the increase in unpaid tax would gain the much-discussed and much-needed $100 billion revenue per year, or $1 trillion over ten years.  The percent of tax voluntarily paid has fallen from 83.7% to 83.1%.  After expected small amounts are recovered by our meager enforcement efforts, the “overall net compliance rate” has fallen from 86.3% to 85.5%. 

The average taxpayer cheats on about 15% of their tax liability, but almost nobody is “average.”  Rather, the huge majority of Americans earn wages and salaries that are reported by their employers to the IRS, on which tax withholding is paid by the employer to the IRS.  Workers cannot cheat on that income, and so the huge majority of Americans pay all of their tax due.  The cheating is highly concentrated among other Americans, especially those who are self-employed and get paid in cash that is never even reported to the IRS.   In fact, the IRS estimates that noncompliance or misreporting is 1% of  wages and salaries, but a huge 56% of proprietor income!

This issue is covered nicely in the blog by Bruce Bartlett, who also points out that “The number of IRS employees fell to 84,711 in 2010 from 116,673 in 1992 despite an increase in the population of the United States of 53 million over that period.” Fewer auditors chase large numbers of tax cheaters, so of course compliance falls.  When I worked at the U.S. Treasury Department, in the Office of Tax Analysis, I used to hear about revenue/cost ratios of ten to one!  That is, one additional dollar spent on enforcement could generate an additional ten dollars of revenue.  And the problem has only gotten worse since then.

We don’t want a huge number of IRS enforcement agents to strike fear into the hearts of average law-abiding Americans who do pay their taxes on time.  But a lot of us might feel better about our country if a few more IRS agents struck some fear into the hearts of those who are supposed to pay their taxes and don’t!  And those cheaters don’t have to bear extra cost of getting caught, if they just paid taxes instead of cheating.


Social Security Funding

Filed Under (Finance, U.S. Fiscal Policy) by Don Fullerton on Dec 30, 2011

Here is an interesting article, in the Washington Post, entitled “Payroll tax cut raises worries about Social Security’s future funding“.  It points out that the recent payroll tax cuts are intended for short term stimulus, but they muck with the way that social security benefits are funded.  Instead of coming frm payroll taxes, that money now will haveto come from general revenue. 

As it points out: “For the first time in the program’s history, tens of billions of dollars from the government’s general pool of revenue are being funneled to the Social Security trust fund to make up for the revenue lost to the tax cut. Roughly $110 billion will be automatically shifted from the Treasury to the trust fund to cover this year’s cut, according to the Social Security Board of Trustees. An additional $19 billion, it is estimated, will be necessary to pay for the two-month extension.” 

As it goes on to say, “The payroll tax cut changes that. Instead being a protected program with its own stream of funding, Social Security, by taking money from general revenue, becomes more akin to other government initiatives such as Pentagon spending or clean-air regulation — programs that rely on income taxes and political jockeying for support.”

A Global Problem with No Solution

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Sep 25, 2011

If one town’s water pollution flows into another town, the two towns can negotiate a solution with no need for the state to intervene.  But if all towns are polluting all neighboring towns, the lines of communication are too complex to negotiate – requiring the state to pass a law to solve the problem.

If one state’s water pollution flows into another state, the two states can negotiate a solution with no need for Federal intervention.  But if all states are polluting all neighboring states, the lines of communication are too complex to negotiate – and it takes a national government to solve the problem.

In other words, those problems have solutions.  If one nation’s water pollution flows into another nation, then (potentially, at least) the two nations can negotiate a solution with no need for a global government to intervene.  But if all nations are polluting all neighboring nations, the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

I’m currently pessimistic about two of the worst problems the world has faced: global climate change, and global financial contagion.  Both are “externalities” in the classic sense.  Each nation’s greenhouse gas emissions pollute the whole world, and the only really effective solution is a worldwide global agreement to reduce emissions.  In fact, we don’t really “need” all nations to reduce emissions; all we really need is an agreement among all nations saying that if SOME countries reduce emissions then the other countries won’t increase emissions to steal their business.  But the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

Environmental policy is my usual bailiwick.  At the moment, however, I’m even more worried about global financial contagion.  It seems that one small country can have lax financial regulations that allow banks or investment companies to take on too much risk.  Or a small country can overspend, taking on too much debt.  In the olden days, that country could go down in flames, with no big problem for the rest of the world.  With tremendously increased globalization, however, all financial markets are highly integrated.  One country’s borrowing may come from any or all other countries of the world, and one nation’s problem become the world’s problem.  If banks in other countries loan to that small country, then a financial crisis in that small country may create fear about the financial well-being of the banks that lent to them, causing a run on the banks in all those other countries.  Moreover, globalization means much more trade in commodities.  If one small country faces severe financial difficulties and must cut back all spending, that reduces aggregate demand worldwide, and can spread a recession worldwide.

A strong global government could rein in the poorly managed countries by requiring larger capital requirements, careful financial scrutiny, and only tax-financed spending.  But we don’t have any such global government.  As a result, even a small country like Greece can over-spend for years without oversight.  The situation in Greece may be made worse when banks in other countries raise the rate at which Greece can turn over its debt and borrow again, making the financial situation in Greece even worse.

The problem may be caused by Greece or not.  Regardless of “fault”, if Greece any small country were to go into default in years past, then the cost would be primarily on that small country.  Now Greece could go bankrupt and impose horrible costs on the entire World?!?

Green Taxes Part III: Potential Revenue for Illinois?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jul 15, 2011

In my last two blogs, I wrote about ways to meet the Illinois state revenue needs, ways that might work better than the increase in the income tax.  This blog continues the list of possible “green taxes”.  In general, a green tax applies either directly on pollution emissions or on goods whose use causes pollution.  For raising a given amount of revenue, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate what caused the fiscal crisis in Illinois, nor argue the merits of cutting spending versus raising revenue.  Instead, we just take it as given that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of a few green taxes as alternative ways to raise revenue.

While many green taxes are possible, we focus on four examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  In past weeks we covered Carbon Pricing and Gasoline Taxes.  This week we cover Trucking Toll and Garbage Fees.

Every day hundreds of thousands of vehicles crowd Illinois’s roads and highways.   Data from the Federal Highway Administration indicates that over 50,000 trucks (six tires and over) cross into Illinois from neighboring states along the interstate highway system.  While these trucks bring needed goods to Illinois, they also congest the roads, degrade the road surfaces, and fill the air with soot.  They also become involved in vehicle accidents that cost the lives of many in Illinois.  To compensate the state, Illinois can impose a toll for long-haul trucks using Illinois’s highways.  For example, a $5 per truck toll on 50,000 trucks daily would raise almost $100 million annually.  (In comparison, the existing Illinois toll road system generates approximately $600 million annually.)  The truck toll can be implemented using existing transponder technology deployed at weigh stations along the interstate highways.  (As an aside, we note, the constitutionality of state trucking tolls is not clear, because the federal government determines the rules of interstate commerce; however, major portions of the existing interstate highway system are subject to tolls, including the heavily travelled I-95 corridor in Delaware. )

Next, residents of Illinois generate approximately 19 million tons of garbage per year (or more than one ton per person per year), and 60 percent of that waste ends up in landfills.  Currently, large municipal waste landfill operators currently pay state fees that total $2.22 per ton of solid waste dumped.  But few municipalities in Illinois charge fees designed to discourage the creation of waste by residents (Don Fullerton and Sarah M. Miller, 2010, “Waste and Recycling in Illinois,” Illinois Report 2010, pp.70-80). 

However, empirical evidence shows that taxing garbage at the residential level does reduce garbage production (Don Fullerton and Thomas C. Kinnaman, 1996, “Household Responses to Pricing Garbage by the Bag,” American Economic Review, 86, pp. 971-84).  Yet the exact garbage taxation mechanism varies by program.  For instance, a fee can be levied on garbage bags themselves or on the containers that hold the garbage bags.  Regardless, a tax rate equivalent to one penny per pound of garbage would generate almost $240 million in revenue per year, or 6.3% of the expected revenue from the income tax increase.

Finally, consider a Portfolio Approach.  Remember, at issue here is not whether to raise taxes.  We presume the State has decided to raise taxes by $3.8 billion (as done already through the income tax increase).  Here, we merely explore alternative ways to raise revenue other than through the income tax. 

Anyway, instead of implementing only one of the green taxes describe above, Illinois could choose to implement several green taxes simultaneously.   This portfolio approach would keep rates low for each individual green tax, but still generate large amounts of total revenue that can add up to a large share of the total expected revenue from the recent income tax hike.  According to the numbers in all three blogs, one simple and moderate plan would combine the following green taxes and pay for more than  half of the needed revenue:  A carbon tax of $10/ton would collect $1 billion (raising electricity prices by about 7.5%), a gas tax increase of 14 cents per gallon would collect $0.7 billion (raising gas prices by about 4.4%), a trucking toll of $5 would collect $100 million, and a garbage fee of one penny per pound would collect $240 million.  Then the recent income tax increase could be cut by more than half.

Moreover, green taxes have the added benefit that they provide incentives to reduce the polluting effects of carbon emissions, gasoline use, truck exhaust, and household garbage generation.