Increasing the role of environmental taxes and charges as a policy instrument in developing countries: some conceptual considerations

American Journal of Economics and Sociology, The,  Nov, 2004  by Juergen G. Backhaus

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Although the principle is straightforward in its simplicity, its implernentation is not. When the use of the environment occurs in the form of spillovers, it goes by unaccounted for. When implications of contractual transactions are latent or unforeseeable, they remain likewise unaccounted for. And when liabilities for damages cannot be attributed, the damages remain where they happen to fall, causing changes in stocks when they should have caused changes in flows. The damages will take the form of windfall losses, unrelated to the economic activities and decisions that had caused them. This lack of accountability results in a welfare loss to society as a result of "normal" economic activity that may go largely unnoticed. The nature and extent of this welfare loss will be discussed in the next section.

III

What Constitutes Spillover or External Effects?

IN CLASSICAL PUBLIC FINANCE THEORY, taxes have the single purpose of providing revenues for essential governmental expenditures. In modern public finance theory, however, in as much as it follows the Pigouvian tradition, taxes also serve as instruments to correct for market failures. The Pigouvian tradition in public finance represents a departure from classical public finance theory in more than one respect, however. In assigning a regulatory function to the instrument of taxation, Pigouvian taxes no longer conform to the canon of taxation (see Section X below). Second, the Pigouvian view' implies certain assumptions about the role of governmental authorities in the economic process. The view constitutes a clear departure from the classical Scottish view of governmental restraint. It constitutes a departure from the classical continental view as well, which would have relied on government to correct for market failure either by means of governmental entrepreneurial activity or by using legal instruments.

Third, the focus on technical spillover effects, while correct in and by itself, de-emphasizes the question of why the legal order allows for some spillover effects to remain externalized while others have to be compensated for and thereby will be internalized. This third aspect has important implications for the problem of designing a tax constitution for a third-world development scenario.

The presence of externalities by necessity implies a less than judicious use of natural resources. Negative externalities signal an overuse of some input, typically a natural resource, relative to market valuation. In a third-world context, when the range of available tax instruments is limited, the Pigouvian tax/subsidy approach to spillovers is less realistic than in developed economies. It is therefore sensible to focus on the more traditional approach to handling spillover activities: the design of a legal system able to cope with such external effects.

In principle, the market economy is supported by three primary legal institutions: private property, freedom of contract, and liability (see further Section IX below). These three fundamental institutions tend to be hampered in their effectiveness when confronted with environmental spillovers or externalities such as (1) latent or unforeseeable consequences of contractual exchange or (2) cases of multiple causation in which liability by any one party cannot be established if the damaging effect occurred only as several parties acted together without (3) necessarily being able to anticipate the results of this concurrence.