Here’s a quick list of reasons to tax. Each have a bit longer explanation down below.

We tax to…

1. pay for public services that are easier or more efficient to provide as a community than to pay for individually.  (AKA public goods)
2. correct for inequalities in individual wealth or income – to provide some basic level of food, shelter, medial care, etc. (AKA welfare and other social services)
3. correct for externalities.
4. Change behavior – encourage or discourage through incentives

1. Public Services/Public Goods:  There are services that many people want, but individually we could not afford to buy them. While it is possible for groups of individuals to come together privately to pool their funds and provide the service, they often run into the free rider problem. So we give government the ability to build roads, provide police and fire protection, and many other worthwhile goods and services. Often times voters have to approve the tax to pay for these. Here are some other posts on the topic.

2. Income Redistribution / Social Services: In some economies there is an explicit goal for a Robin Hood policy (take from the rich and give to the poor) – purely to even out income or wealth. In the United States and many other countries there is a social ethic or value that says that the poorest members of society should be able to live in at least some minimum level. This ethic or value is controversial, of course. Some voters support strong government efforts to improve the lives of our poorer members – along the lines of European social democracies. Other voters prefer a self-determination, self-reliance model, where citizens have opportunities but are left to their own to survive or advance in the world. And many voters are somewhere in between. In a later post we’ll show how many tax strategies focus on extracting more tax revenue from the wealthy than from the poor.

3. Correcting Externalities: In economics we call the presence of externalities a market failure. When someone outside of a market transaction is either harmed by or benefits from that transaction, we have an externality. If there is an externality then the market will produce either too much or too little of that good, and will not reach a social optimum. The most common example is factory pollution. When the factory produces a good and pollutes while doing that, others outside the factory are affected. See more on externalities here.

4. Incentives to Change Behavior: Some times we enact taxes to discourage behavior. “Sin taxes” are one such example. Tobacco taxes can be used to defray state health care costs. Generally this is a pretty inefficient mechanism since many of the “sins” are addictive and demand for them price inelastic. More often a tax on tobacco or alcohol is just a convenient way to raise revenue, and voters are more likely to support those taxes over more general income or sales taxes. A more modern application of this category is called a Pigovian tax, and the prime example being discussed is a carbon tax. Taxing activities and products that release carbon into the atmosphere should discourage and reduce those activities.  We also give tax credits for behavior we want to encourage.

From the April 9 edition of The New York Times, comes a report of a public-private solution to the management of commerical fishing stocks off the coast of New England. As with most commercial fisheries, the fish population is declining, due to over-fishing. The Federal Government, through NOAA and regional councils, sets limits on fish catches – hoping to keep fish stocks sustainable. Within those limits, however, fishing boat owners compete to find the fish. Now NOAA is instituting a private ownership system.

In an ownership, or “catch share,” system, individuals, companies, cooperatives, communities or other entities receive the right to take a set percentage of the annual catch of particular fish in particular areas. The system gives fishermen a powerful motive to fish sustainably, because the value of their share rises as fish stocks increase.

The economic concept here is that private ownership will increase the sense of responsibility on the part of group owners, and that they will make decisions to increase the long term value of their ownership investment.

Public Goods…

… have three important characteristics:

• They are a good or service that has wide appeal in a community
• They are non-exclusive, which means that anyone can benefit from them – no selling of tickets
• They are non-rival, which means that if one person “consumes” or benefits from a public good, nothing is used up in that good and others are free to continue using it.

A lighthouse is the classic example, where anyone in sight of it can benefit, and one person’s use of it does not restrict or diminish someone else’s benefit. You can extend this example to a wide range of public services, including public roads, fire and police protection, a national military, bridges, and more.

In addition to the three characteristics listed above, public goods generally are too expensive for a private solution – though individuals may value the good, their individual value is insufficient to justify a private purchase. If I lived on a dirt road in town, I would love to have it paved, and might even value that improved condition at something like $1,000. That sum, however, is not enough to pay for paving. The only way to garner support for a public good is to add the individual values placed on the good. If all of my neighbors chipped in, along with those who might drive down the road, we might be able to pay for the paving. The sum of those values tells us whether there is a possible solution in the community.

Sometimes community members can band together informally, or at least outside the auspices of government, and collect the funds necessary to purchase the public good. They then run into the problem of one or more free riders. Public goods are usually available to everyone – it is impractical to sell tickets or restrict the benefits to only some people. So someone who did not participate in the original funding can still benefit. As more people realize this, the group action falls apart. There is no incentive to participate and pay money if you can benefit later, for no cost. The solution to the free rider problem is government action, which usually involves taxation and enforcement.

The financing and provision of a public good is one of those infrequent times when government intervention in a market can benefit society without harm to others.

An associated concept is

Common Good

A common good shares the attributes of general attractiveness and non-exclusivity. The important different between a public good and a common good is that the latter is rival. That means that one person’s consumption uses up or affects the possible use by someone else.

Clean air is a good example of a common good. Everyone can enjoy it, but if one or more players “use it” – by releasing pollutants, for example, their use diminishes the ability of someone else to benefit from that air.

The “tragedy of the commons” is a favorite allegory here. Imagine a small village, where families are largely self-sufficient, but where there is publicly-owned grazing land. Individual families bear no cost when they allow their livestock to graze in the public land. Each individual family sees substantial benefit from the grazing opportunity and feel a very small proportion of the cost. Each family, making a rational decision, will increase its use of the grazing land as long as the marginal benefit to the family exceeds the marginal cost to the family. Put together, however, the decisions of all the families causes the land to be over-grazed. This is the tragedy of the commons. Private decisions lead to a public problem.

When lumber operations were in full swing here in the Rogue Valley individual mill operators could release smoke and other particulants into the air for a very low cost. They might feel some concern over the increasing smog and thermal inversions, but the benefit to each of them outweighed their share of the total cost. The result was increasing pollution in the valley, with consequences to all of the citizens.

Government can often provide a socially efficient solution in the case of a common good that is being depleted. Pollution regulation can offer a way to avoid the tragedy of the commons.

In a later post we’ll discuss the different ways government can provide incentives for polluters to change their behavior.

I’ll write a longer description of public goods later. Here’s the quick version…

Public goods have three important characteristics:

• They are a good or service that has wide appeal in a community
• They are non-exclusive, which means that anyone can benefit from them – no selling of tickets
• They are non-rival, which means that if one person “consumes” or benefits from a public good, nothing is used up in that good and others are free to continue using it.

The classic example of a public good is a lighthouse protecting a harbor. Many people benefit from it; everyone can use it, and it doesn’t get consumed or used up in the process. And yet no one person would value the lighthouse enough to pay for it privately. And an informal collection taken from those who benefit has the free rider problem – someone who benefits but declines to chip in.

So, usually we turn to government to finance public goods. Government can levy taxes, with appropriate voter approval, and enforce contributions from everyone.

There’s an inherent problem, though, in voting for taxes for public goods. It is hard to gather enough “yes” votes.

Here’s why…

We can construct a demand curve for a public good, by adding the individual value each community member places on that good. To keep it simple let’s say there are 7 people in our community, and they are expressing their interest in a public good. Each person sets a dollar value for that good – that is how much they would be willing to pay to see the good provided:

• Person A: $100
• Person B: $200
• Person C: $300
• Person D: $50
• Person E: $0
• Person F: $50
• Person G: $0

For a public good we would add these values (it is called adding demand curves vertically) and come up with $700. In an informal system, where everyone chips in, we could pay $700 towards the public good.

Now, though, we need to vote, and if the vote passes everyone will have a tax of $100. As each voting citizen considers their vote, they will compare the value of the public good to them against the potential tax of $100. In this example there are 3 people who value the public good at $100 or greater. Presumably they vote “Yes”. There are 4 people who place a value lower than $100 and they will vote “No”. In the simple averaging method used here for the tax the people who value the public good strongly have no stronger voice than the people who are only mildly opposed. The result is voting that will likely tilt “No”.

Real public good issues and their votes and taxes are more complicated, of course. Still, there is an inherent bias against approving these levies.

School levies are complicated, indeed. Only a portion of the community will benefit directly – those with children in the schools. Broader minded citizens without children in the schools will realize that there is added value in the community for good schools – expressed as better property values, lower crime rates, etc. And in simple majority voting situations, the committed parents can engage in a get-out-the-vote campaign among parents and bring in a strong vote in favor. In Oregon’s double majority situation the challenge is greater – the proponents have to find not only parents but enough other interested voters to reach the 50 percent participation rate. And on top of this they face the inherent bias against the proposal that I’ve described.

Throw into the mix a confusing and misinformed editorial (in opposition we think..) in the local paper, and a strong sense of community-school identity and it’s tough to predict the outcome.

Election Results: the day after…

I should keep my day job, sticking to economics. I called the state-wide initiative results exactly the reverse of the actual outcome. The tobacco tax-supported option to pay for an expanded child health insurance program failed. The measure to restore some teeth to land use planning passed.

Pertinent to this post, the school levy proposal in Ashland passed the double majority hurdles – almost 60% of registered voters submitted a ballot, and 65% of those who voted supported the school levy.