Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
The Best “Pick-and-Shovel” Play for the Online Grocery Boom - 18th July 19
Is the Stock Market Rally Floating on Thin Air? - 18th July 19
Biotech Stocks With Near Term Catalysts - 18th July 19
SPX Consolidating, GBP and CAD Could be in Focus - 18th July 19
UK House Building and Population Growth Analysis - 17th July 19
Financial Crisis Stocks Bear Market Is Scary Close - 17th July 19
Want to See What's Next for the US Economy? Try This. - 17th July 19
What to do if You Blow the Trading Account - 17th July 19
Bitcoin Is Far Too Risky for Most Investors - 17th July 19
Core Inflation Rises but Fed Is Going to Cut Rates. Will Gold Gain? - 17th July 19
Boost your Trading Results - FREE eBook - 17th July 19
This Needs To Happen Before Silver Really Takes Off - 17th July 19
NASDAQ Should Reach 8031 Before Topping - 17th July 19
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19
Stocks Market Investors Worried About the Fed? Don't Be -- Here's Why - 13th July 19
Could Gold Launch Into A Parabolic Upside Rally? - 13th July 19
Stock Market SPX and Dow in BREAKOUT but this is the worrying part - 13th July 19
Key Stage 2 SATS Tests Results Grades and Scores GDS, EXS, WTS Explained - 13th July 19
INTEL Stock Investing in Qubits and AI Neural Network Processors - Video - 12th July 19
Gold Price Selloff Risk High - 12th July 19
State of the US Economy as Laffer Gets Laughable - 12th July 19
Dow Stock Market Trend Forecast Current State - 12th July 19
Stock Market Major Index Top In 3 to 5 Weeks? - 11th July 19
Platinum Price vs Gold Price - 11th July 19
What This Centi-Billionaire Fashion Magnate Can Teach You About Investing - 11th July 19
Stock Market Fundamentals are Weakening: 3000 on SPX Means Nothing - 11th July 19
This Tobacco Stock Is a Big Winner from E-Cigarette Bans - 11th July 19
Investing in Life Extending Pharma Stocks - 11th July 19
How to Pay for It All: An Option the Presidential Candidates Missed - 11th July 19
Mining Stocks Flash Powerful Signal for Gold and Silver Markets - 11th July 19
5 Surefire Ways to Get More Viewers for Your Video Series - 11th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Does Taxing Pollution Lead to Higher Prices and Lower Aggregate Economic Output?

Economics / Economic Theory Apr 22, 2009 - 12:00 PM GMT

By: Paul_L_Kasriel

Economics

Congress is about to consider legislation that could result in a tax on the burning of fossil fuels. Some argue that such a tax would result in increased prices of a wide variety of goods and services and reduced aggregate output. I do not want to get into the argument as to whether the burning of fossil fuels is contributing to global warming or whether global warming is globally harmful. Rather, I want to discuss the issue of taxing pollution in general. In other words, I want this to be a discussion about economic theory, not political-economic theory.


Let's keep it simple. Suppose that the production of widgets emits pollutants into the air that above some level are known to cause human illness. Assume that if all the widget producers are operating at a normal level of output, enough pollutants will be emitted to cause illness to a large segment of the population. This means that population made ill by widget production will have to receive medical care. Again, keeping it simple, assume that those needing and receiving the medical care resulting from widget production pay for it themselves.

Given these assumptions, widget producers are not paying the full cost of production. Part of their cost of production is being borne by the segment of the population made ill from widget production. Under these circumstances, widget producers can keep their prices lower than would be the case if they were paying for the medical care of those they have made ill. By keeping widget prices lower than otherwise would be the case, the quantity of widgets demanded is greater and so, too, are the profits of widget producers.

What if the widget industry were told that only an amount of pollutant byproducts that would not cause illness would be allowed to be emitted? In order to pollute in connection with the production of widgets, a producer had to have pollution permits. Pollution permits would be issued up to the amount of pollution that would not produce illness. How might these pollution permits be distributed among widget producers? One way would be for the government to auction off pollution permits to the highest bidders. The more efficient the widget producer, the higher the price it could pay for the right to pollute and still earn a profit.

Unless methods of widget production could be devised that emitted less pollution, widget production would decrease. This would drive up the price of widgets, all else the same. The higher price of widgets would cause the quantity of widgets demanded to fall. So both the production and consumption of widgets would fall. Widget producers' profits would fall with less output and the increased cost of production from having to purchase polluting permits. So, all else the same, prices in the economy would rise and output would fall.

But all else would not be the same. The government could reduce general taxes by the amount of revenues it received from auctioning pollution permits. The public's reduced tax burden would lead to increased demand for other goods and services. But would not this drive up the prices of other goods and services? No. Recall that widget production would decrease. This would release labor and other factors of production that could be used to produce the goods and services now being demanded because of the tax cut. So, the increased supply of other goods and services would accommodate the increased demand, which would not cause prices to rise. Also, now that pollution had been reduced, households would spend less on medical care. This means that the demand for other goods and services would increase now that a smaller amount of funds were being spent on medical care. And just as factors of production were released from the widget industry, factors of production would be released from the healthcare industry. The shift back in the demand for healthcare would reduce the price of it.

In sum, "taxing" the pollution resulting from widget production would not lead to increased prices in general or decreased output. Rather it would lead to higher prices for and reduced output of widgets, lower prices and reduced output of healthcare and increased output of other goods and services with no increase in prices. Think about this when you hear the partial equilibrium sound bites on the subject of taxing pollution on CNBC and from other glib media sources.

This is how I got hooked on economics rather than phonics!

Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy

By Paul L. Kasriel & Asha Bangalore
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2009 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Paul L. Kasriel Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Rob
22 Apr 09, 20:03
Taxing pollution

Nice economic textbook article about widgets, except that it is not widgets but OIL that will get the massive green taxes which will RAISE THE PRICE OF EVERYTHING! Nice try but no cigar on that one.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules