5.7.1 Producers
For producers, the price signal to cut pollution is hence procyclical, just as Heutel and Fischer recommended. It is procyclical already without any variation of the nominal tax rates. So the finding that the degree of causation over the same damage varies along with the business cycle is not a problem for our causation concept. Instead, that variation is contributing to efficiency.
During a recession, firms carry a smaller relative burden from environmental taxes compared to the relative burden they bear during booms. Assuming that a tax policymaker focuses on the production side of the economy, the introduction of environmental taxes does then not necessarily pose greater trade-offs during downturns compared to during boom times. Instead, the Coasean-type bargain-ing over Pigouvian taxes solves this adjustment need, by varybargain-ing the burden on firms in a decentralised manner even without the state’s involvement.
5.7. Endogenous variation of price signals with stable tax rates From an Institutional Economics point of view, this is excellent news. We know that rules once implemented tend to persist (Acemogluet al., 2000; Acemoglu
& Johnson, 2005). Acting against this path dependence, loss aversion and the tendency of environmental taxes to produce more concentrated losses than gains implies that it is easier to coordinate lobby efforts for reducing environmental taxes than to adjust them upwards (Baldwin & Robert-Nicoud, 2007; Kahneman &
Tversky, 1979; Olson, 1978). So there can be ratchet effects where tax rates that the state adjusts downwards during a downturn are not adjusted back upwards after the recession passes. This would be a problem: it is already tough to implement optimal corrective tax rates at any time; if those tax rates would then need to be constantly adjusted with the business cycle, even a successful environmental tax reform that once sets these tax rates at the efficient levels might quickly be washed out with the next adjustment during a recession. It is then good news that tax policy does not need to go down this slippery slope during downturns to protect producers.
5.7.2 Consumers
For consumers, however, the burden of the environmental tax is countercyclical, so it is felt hard in times that are already hard. This pattern might immediately appear inefficient, but it is only a problem in some instances.
Consider first an environmental problem such as short-lived flows of air pollut-ants such as PM2.5, which is a relevant example because it currently carries the highest death-toll of all air pollutants (WHO, 2014). Some consumers die from PM2.5, and some consumers buy products that release PM2.5. The health ef-fects per unit of PM2.5 do not decrease with the business cycle,4 so reducing the tax rate would just mean that during the recession, some consumers bear
4Conversely, the health impacts per unit of pollution generally increase in downturns because fuel combustion falls, so the concentration of the pollutant decreases, and that raises the marginal damage because the dose-response function for PM2.5is concave (Limet al., 2014). So the marginal burden that consumers of polluting products impose on their neighbours suffering from these damages is increasing, not decreasing. The Pigouvian tax rate should then be increasing, not decreasing. Here we are concerned with papers by Heutel and Fischer that suggest that, instead, the tax rate should be decreasing. We want to show that their point may be questionable due to a separate argument.
In this text, we are concerned just with the variation of causation and its relation to the variation of effective liability, not with the dose-response relationship, so even though both arguments go against their suggestion, here we assume constant maginal damage to reduce the complexity of our counter-argument.
Chapter 5. Cyclical causation? Correcting social costs during bad times
non-internalised net damages from other consumers causing PM2.5 emissions.
Between consumers, the effect of a tax rate reduction is then a distributional change, but no social welfare gain.
The increased financial stress of consumers during a recession can nevertheless justify policy action. However, it would be more efficient for the state to provide direct poverty alleviation through means-tested benefits than to distort envir-onmental tax rates. Lowering the tax rates would distort consumption choices, and the absolute amount of economic benefit provided by reduced environmental tax rates would accrue mostly to higher-income households as long as the taxed products are normal goods (see chapter 12).5 While underpricing externalities then does not efficiently reach the poor,6 expenditure policies such as means-tested benefits can reach the poor much more efficiently. Accordingly, if the
Some further implications of the dose-response function (for the need for policy action when pollu-tion is already decaying) are covered in Heineet al.(2017).
5If the consumption of a good causes an environmental externality that is not being taxed, there is an implicit subsidy in the definition of Stiglitz (2006) and the IMF (Coadyet al., 2017). This impli-cit subsidy is paid on a specific rate basis through artificially reduced consumer prices. For normal goods, consumption rises with income, so a rich person receives these implicit subsidies more of-ten than a poor person. Any pre-existing level of inequality is thereby amplified through the non-internalisation of external costs. However, there is a counter-argument to this endogenous inequality creation. While the poor have a lower total expenditure on most polluting products such as energy and hence do not benefit from the mentioned implicit subsidies as often, the lower middle class spends a more substantial proportion of their income on energy. This proportion-based counter-argument overlooks, however, that compensation payments to households for phasing out the subsidy (e.g.
lump-sum transfers) would equally account for a larger proportion of poor people’s income. Unless a state internalises externalities (i.e. removes the implicit subsidies) without the use of such compens-ation policies, the maintenance of fuel subsidiscompens-ation (or non-taxcompens-ation of environmentally damaging fuels) therefore reinforces inequality.
Inequality outcomes of optimal environmental tax reforms are better than the inequality outcomes of keeping fuels subsidised (or equivalently keeping externalities underpriced) which themselves have better inequality effects than removing the subsidies without any compensation payments. For a well-designed environmental fiscal reform, which must involve simultaneous changes the tax and the expenditure side, inequality hence falls, not only statically but also over time. A simpler way to put this argument is that since the poor consume less fuel than the rich (energy being a normal good), poverty and inequality can be reduced by replacing low-priced fuels with targeted money payments to poor households or financing targeted support measures to break poverty traps, such as improved public education and vocational training. An illuminating case study is Iran. From 2010-2012, Iran replaced its fuel subsidies with a minimum income, using 50 % of the saved revenue. This proportion was enough to reduce inequality dramatically, from a Gini coefficient of 0.42 to 0.34 (Guillaumeet al., 2011). The absence of Pigouvian taxation accordingly increases inequality significantly.
6This effect has been most strongly shown for fuel subsidies (e.g. Arze del Granadoet al., 2012) but the underlying economic principle applies to underpriced externalities more generally, as there is economically no significant difference between the effects of directly subsidising a polluting fuel and implicitly subsidising it through unpriced externalities (Coadyet al., 2017).
5.8. Conclusion