The 21 July 2007 weekend Financial Times has the headline, “France and UK push for green tax cuts.” Government chiefs Nicolas Sarkozy and Gordon Brown are advocating a lower value-added tax (VAT) by the members of the European Union (EU) on ‘green” products that reduce the use of energy.
The intent is good, as such a tax would shift production in favor of those which pollute less. But the implementation would be difficult. The tax authority would have to provide a list of products which would be eligible for the tax cut. There would be a political battle by producers who wish to be included. Cars and appliances which produce relatively fewer emissions would be clearly eligible, but what about materials that can help reduce the use of energy, such as insulation? Insulation is used in many applications already.
A problem for implementing a green tax cut is deciding how far up the production stream it would apply. Does it only apply to the final product, or also to the production process? If the latter, then the green tax cut could be used to discriminate against the goods of less-developed countries which allow production to ruin their environments. Also, using less energy does not necessarily imply polluting less. There can be furniture that sits there using no energy, but emits noxious chemicals into the air.
The more effective way to reduce emissions is to levy a charge directly on the pollution. This has been in standard mainstream economics for the past hundred years, ever since the economist Arthur Cecil Pigou analyzed the economics of negative external effects such as pollution. A pollution tax is often called “Pigovian” after Pigou. This is standard in every microeconomics textbook.
So it is a mystery why government chiefs who wish to reduce emission are not advocating pollution levies instead of the less effective green tax cut. A green tax shift would replace taxes on wages, goods, and enterprise profits with pollution levies, and for a complete shift, also tap land values.
The fact that Sarkozy and Brown are advocating a lower VAT for green goods shows that they well understand the destructive effects of the VAT. Since a lower VAT for green goods increases the production of those goods, it would be best for the economy if the VAT is entirely eliminated, replaced by green taxes on emissions. One would then not have to struggle with which goods should have a tax reduction.
With the green tax cut, the reduction in taxes would have little relation with the reduction of emissions, since all the eligible products would have the same VAT. In contrast, a pollution tax can be levied in proportion to the damage caused by various pollutants.
The green tax cut would be better than no action, but since a green tax shift would be much more effective, surely some of the EU finance ministers should know this if they remember their economics lessons. If you live in Europe, write to your finance minister and tell him to enact a green tax shift instead of the green tax cut.
A revenue-neutral green tax shift would also be a tax cut, as it would reduce the deadweight loss caused by VAT, and reducing economic waste is in effect a tax cut. Evidently the EU chiefs are deeply committed to their destructive value added tax. VAT is like a religion in Europe, and even when better alternatives are pointed out, shifting out of the VAT is like changing religions. And that’s why the bad becomes the enemy of the best.
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FRED E. FOLDVARY, Ph.D., is an economist and has been writing 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 has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at 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 include 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.