Revenue Taxes, and Behavior Taxes

I just had an idea I thought I’d share. One that maybe the state of Vermont in particular could benefit from at the moment.

It seems as if Vermont legislators could use an update in their thinking about tax policy, in particular regarding funding road repairs and weatherization projects and addressing economic and environmental costs associated with driving and home heating.

On February 27^th a WCAX report noted that the state of VT wants to add a tax on electric vehicles because the state is bringing in about 2/3 of the revenue it needs for infrastructure because residents used 45 million gallons less gas in 2018 than in 2005. It shouldn’t be a problem that residents used 45 million gallons less gas. It’s a solution that residents used 45 million gallons less gas. The Vermont government should be celebrating this and trumpeting the lives saved. It shouldn’t be the responsibility of those individuals who most contributed to this solution to fix the government’s budget short-fall. Which brings me to my view of this problem.

Then on March 27^th a VPR report noted that the VT house approved a tax increase on home heating oil, to obtain funds for weatherization funding.  There was criticism that this would “drive up the cost of living for the people who can least afford it.” So how can the state raise funds for weatherization, create economic incentives that match policy aims, and avoid regressive cost of living increases?

Problem

How can governments best structure taxes that are consistent with their budget and their policy aims?

Objectives

Presumably the state of Vermont, or any governmental entity, has three primary objectives when they develop economic policy via taxation.

1. Minimize market failures:  create economic incentives to avoid cost that are not monetized and accounted for in the current market structure
2. Achieve government revenues consistent with government budgets: raise the funds to support the activities of the government
3. Minimize perverse incentives:  Avoid creating additional market failures or restricting the markets in a manner inconsistent with the degree of progressive economic and tax policy desired by society as expressed through its representatives.

Comment on 1. Presumably the reason that a gas tax was levied is not that a gas tax is the easiest way to generate revenue. Or even if it was easy, it was likely easy because it was also seen as an appropriate behavior tax on those using the infrastructure the revenue would go towards.  In other words, my conclusion is that the gas tax was intended to rectify the market failures inherent in the cost of gas. That is, to compensate for the externalities of driving and gas prices by adding a cost to account for those market failures. This is all a way of saying it seems that governments often institute taxes to change behavior, and as a way to make prices reflect aspects of the human and social economy that the market does not otherwise price.

Comment on 3. The status quo alternative of a gas tax, or a heating oil tax, creates a perverse incentive for the government.  Rather than having an interest in further reductions in gasoline and heating oil purchases, the government now has an interest in maintaining the market failure to achieve its revenue needs.  The government loses revenue if the increase in the cost of gasoline or heating oil results in the expected changes to the economy.

Alternatives

• Status quo – a single tax at the point of the market failure as both a market driver and a source of revenue
• The idea: governments utilize two forms of taxes, behavior taxes and revenue taxes.
  • Behavior taxes:  All taxes aimed at addressing market failures are made revenue neutral. Revenues from these taxes are redistributed to the public in the form of a dividend.
  • Revenue taxes:  All taxes aimed at bringing in government revenue are as economically neutral as possible. Seemingly these are typically income taxes or sales taxes.  I don’t know enough about tax policy’s economic impacts to know what the most neutral form would be, and it is likely impossible to be fully neutral, but some are better than others certainly.

Trade-offs

There is clearly a long-term trade-off between minimizing market failures and achieving revenue. That is, the more successful a tax is at minimizing a market failure the less revenue it will achieve. Therefore, the best performing tax structure needs to find a win-win solution to this trade-off. While a single tax is unlikely to do so, I think a combination of two or more tax structures may.  Using both a behavior tax that is revenue neutral and a separate revenue tax could decouple the relationship between using taxes as a tool to address market failings and government revenue.  Use the behavior tax if the objective is to fix a market failure and avoid the externalities caused by the undesirable behaviors resulting from the market failure.  Use a revenue tax to raise funds.