When payments to government incur no deadweight loss, these are efficient fees. They can take the form of a tax, but in substance, efficient payments are necessarily in exchange for a service or penalties for causing damage. The main categories of efficient taxes are user fees, charges based on land value or rent, and charges that compensate for social costs such as pollution and congestion. Just as wages which are high enough to prevent inefficient turnover are referred to in economics as "efficiency wages," payments to government, those which have no excess burden and so don't reduce economic productivity, are efficiency taxes.
Lump-sum or head taxes are sometimes regarded as efficient, because as a fixed charge, they don't impose any extra payment for extra income or purchases. But if the payment comes from wages, then the worker has to labor extra hours to pay the tax, reducing leisure, so a poll or head tax is not neutral with regards to the leisure-labor tradeoff. Ultimately, efficiency is not about goods, but about the subjective utilities of human beings, and imposed charges that reduce non-harmful utility are inherently inefficient.
The tax systems prevalent in the world today are inefficiency taxes, imposing excess burdens, beyond what is paid to government. By making goods and production more costly, inefficient taxes reduce production and consumption, thus creating a "deadweight loss" of wasted and misallocated resources. This loss has been estimated to be over $1 trillion per year in the USA, and even greater if we consider the lost additional income we could have had if there had been efficiency taxes instead. The excess burden is similar throughout the world.
But this colossal deadweight loss can now be a useful resource! We are in a unique moment in time in global history when we can be very thankful for the waste caused by taxation.
Global warming is a looming catastrophe, and there is strong evidence that it has been significantly caused by the pollution of the atmosphere. The fact that there were previous eras of global warmth does not contradict the proposition that today's global warming is man-made and potentially catastrophic to human well being.
The deadweight losses from taxation, regulation, and excessive litigation offers us a unique way to greatly reduce greenhouse gases. The reason the world has not moved to rapidly reduce harmful emissions is that regulations mandating lower levels of pollution would be very costly to implement, causing a great loss of production and massive unemployment.
But a shift to efficiency taxes would reduce greenhouse emissions without any long-run economic damage. In fact, efficiency taxes would substantially increase productivity and wages. As described by Hanno Beck, the green shift would abolish all taxes on income, sales, value added, and buildings, and replace them with user fees, pollution charges, and the tapping of land value and rent.
A revenue-neutral increase in environmental taxes and simultaneous reduction of sales and income taxes has been called a "green tax shift" or ecological tax reform. The "polluter pays" method is more efficient than command-and-control regulation, since it does not force everyone to use a specific method, but allows each person and company to adjust according to its own costs and benefits. For example, regulations about automobile engines, smog tests, and gasoline additives could be replaced by a simple charge based on the actual pollution of cars. Owners of highly polluting cars would have an incentive to replace their cars, fix their cars, or avoid driving their cars, depending on their own particular situations.
Another approach to reducing pollution is with tradeable permits. With a fixed number of permits, a firm that seeks to expand production that increases pollution buys a permit from a firm holding a permit. California has enacted legislation that seeks to reduce emissions with such permits. Permits are more efficient than regulations, but the gains go to grandfathered privileged firms holding the permits, with no revenue to government and no green tax shift.
A shift to environmental taxes would not increase the overall tax burden on industry, because the increase in pollution levies would be offset by the decrease of productivity taxes, causing industry to shift towards goods and methods with much less pollution. The transition can be even less costly if the shift replaces all taxes with efficiency taxes. This would include more user fees and the tapping of most of the economy's land value or rent. A simultaneous shift that decreases taxes on sales, income, and buildings while increasing levies on land value, pollution, and congestion would reduce pollution while increasing economic efficiency, raising profits and wages. We would limit global warming and reduce poverty at the same time.
We should be very grateful that governments use punitive taxation, because if the world's public revenues came from land rent today, then there could be no green tax shift, but only an increase in environmental taxes that would increase the costs of industry. Today's deadweight losses gives us the opportunity to shift to efficiency taxes that offset the cost of environmental taxes with reductions in punitive taxes.
But if the governments of the world instead use regulations and permits to deal with global warming, they will have squandered a unique opportunity to have a welfare-enhancing leap of fate. The public will resist economy-destroying means of reducing pollution. Only with efficiency tax reform will the public welcome a global campaign to limit global warming.
There is a movement in the USA by local and state governments to enact measures to limit greenhouse emissions, while the federal government hesitates. We need to push them to enact efficiency taxes rather than commands and controls, otherwise nature may punish us with coastal flooding, the spread of disease, turbulent weather, and catastrophic losses of species.
Skeptics point out that we don't have absolute certainty that human-caused pollution will cause such disasters, but since an efficiency tax shift would have net benefits regardless of global warming, it is foolish to ignore the most important rule of natural law: don't mess with mother nature!
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FRED E. FOLDVARY, Ph.D., (May 11, 1946 — June 5, 2021) was an economist who wrote weekly editorials for Progress.org since 1997. Foldvary’s commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and San Jose State University.
Foldvary is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary’s areas of research included public finance, governance, ethical philosophy, and land economics.
Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.