Tax shifting: A gimmick with legs

While I admire Green Party leader Elizabeth May as a committed environmentalist, I have a big problem with her pushing “tax shifting”, which goes by the slogans “tax the bad things like pollution not the good things like employment and work” and “getting the market prices right”. This makes for a great political campaign but one that promises more than it can deliver. Slogans generally make for bad economics (remember “tax cuts pay for themselves” last seen in the 2001 BC election).

Don’t get me wrong. By all means I think we should impose ecological taxes on bad things we do not like. But the idea that these can replace income, sales and other taxes as a legitimate base to fund social programs, income transfers and all the other good stuff we like from governments (and the the right hates) is nonsense.

Here’s why: Low levels of the tax do not much affect behaviour but bring in decent and stable revenue; but at high levels of the tax, this does affect behaviour (which is what we want) but revenue drops. If the tax is truly successful at its environmental aims, it will raise little or no revenue. So this puts policy makers in a conflict of interest, of sorts, because environmental “bads” are not stable revenue sources over time. You cannot bank your health care system on pollution taxes because if pollution taxes really did the promised job, there would be no or few revenues to the government.

So tax shifting fails the test of being a good revenue base. Again, this is not to say that we should not use eco-taxes as part of the broader public policy mix in achieving our environmental goals. They definitely belong in the arsenal. But sometimes good ol’ regulation is what we want to clean the air and the water. Rules that prohibit certain adverse behaviours. Why put a tax on toxic discharges on the belief that funds will be used for clean-up when we can just ban them in the first place?

The same holds true for existing taxes like alcohol and tobacco taxes or gas taxes – and for other proposed taxes like the Tobin tax on financial transactions. In fact, look at the impact of high gas prices on behaviour. Gas prices are currently far in excess of what many would have proposed for a gas tax increase several years ago back when gas was much cheaper. The impact has been negligible: some behaviour change on the margin like less new SUV purchases, but no notable reduction in congestion on our city streets. Ultimately, the behavioural response is all about the elasticity, and gas is highly inelastic.

Some readers may recognize the depiction of behavioural response as the Laffer curve, which became popular in right-wing circles in the 1980s in regards to income taxes, and still crops up in the occasional political campaign these days. The idea is that people are so overtaxed that reducing the taxes will make people work harder and invest more, so that revenue will actually go up on the basis of this new economic growth. But the assumption was that we were on the backward bending side of the Laffer curve and this has not proven to be the case. For the range of recent historical tax rates, the elasticity of labour effort is close to zero (it is inelastic as most people have little choice over the number of hours they work and whether they will or will not get a job).