Study notes

Negative Externalities and Government Intervention

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB

What forms of government intervention might help to correct the market failure from negative externalities?

To many economists interested in environmental problems the key is to internalise external costs and benefits to ensure that those who create the externalities include them when making decisions.

Negative externalities and market failure - revision video

Pollution Taxes

  • One common approach to adjust for externalities is to tax those who create negative externalities.
  • This is known as "making the polluter pay".
  • Introducing a tax increases the private cost of consumption or production and ought to reduce demand and output for the good that is creating the externality.
  • Some economists argue that the revenue from pollution taxes should be 'ring-fenced' and allocated to projects that protect or enhance our environment.
  • For example, the money raised from a congestion charge on vehicles entering busy urban roads, might be allocated towards improving mass transport services; or the revenue from higher taxes on cigarettes might be used to fund better health care programmes.

How to deal with the mountain of waste?

Despite a decade of soaring recycling rates, the UK still landfills more rubbish than any other country in Europe. Each landfill site releases huge amounts of methane – a greenhouse gas 20 times as damaging as CO2 – into the atmosphere. Reports suggest the UK is now running out of places to bury its waste – one study found every landfill site will be full by 2018.

Under severe pressure from the European Union to cut the amount of rubbish it buries, the British government introduced a landfill tax for local authorities that mean the amount they must pay per tonne rises with every passing year. From a base rate of £7-per-tonne in 2000, the charge has now hit £56 – and will rise to £80 by 2014.

To get to a 'zero waste' economy local authorities will have to persuade people and businesses to create less waste in the first place, as well as re-use and recycle more. Where it's not possible to turn waste into new products, it makes more sense to use it to generate power for homes and businesses, rather than send it to landfill. So enters the spectre of the incinerator, long associated in this country with dirty, industrial plants spewing out toxic smoke.

But new technology allows for other ways of dealing with waste. Anaerobic digesters are another option, taking green and organic waste and using biological processes to turn it into electricity.

Burning rubbish is such old technology," said an anti-incinerator campaigner. "If you burn things, there have to be emissions.

Source: News reports

Examples of Environmental Taxes include:

  1. The Landfill Tax - this tax aims to encourage producers to produce less waste and to recover more value from waste, for example through recycling or composting and to use environmentally friendly methods of waste disposal
  2. The Congestion Charge: -this is a high profile environmental charge introduced in February 2003. It is designed to cut traffic congestion in inner-London by charging motorists £8 per day to enter the central charging zone
  3. Plastic Bag Tax: A tax on plastic bags has not been introduced into England and Wales
  4. Vehicle excise duty (VED): VED starts from a theoretical 'nil' rate and accelerating up depending on the carbon emissions of the vehicle
Share of CO2 emissions in the UK - by industry / sector

Evaluation: Problems with Environmental Taxes

Pollution taxes can lead to government failure

  1. Assigning the right level of taxation: There are problems in setting tax so that private cost will exactly equate with the social cost.
  2. Consumer welfare effects: Producers may pass on the tax to the consumers if the demand for the good is inelastic and, as result, the tax may only have a small effect in reducing demand. Taxes on some de-merit goods (for example cigarettes) may have a regressive effect on lower-income consumers and leader to a widening of inequalities in the distribution of income.

Employment and investment consequences: If pollution taxes are raised in one country, producers may shift to countries with lower taxes. This will not reduce global pollution, and create problems such as unemployment and a loss of international

Externalities and Regulation

The government can intervene in a market using regulations and laws. For example, the Health and Safety at Work Act covers all public and private sector businesses. Local Councils can take action against noisy, unruly neighbours and can pass by-laws preventing the public consumption of alcohol. The British government introduced a ban on smoking in public places from July 2007. The European Union has introduced directives on how consumer durables such as cars, batteries, fridges freezers and other products should be disposed of. The onus is now on producers to provide facilities for consumers to bring back their unwanted products.

Examples of regulations to address negative externalities

  • Health and Safety at Work Act covering all businesses.
  • Renewables Obligation Certificates to encourage the supply of renewable energy (+ penalties for not meeting targets)
  • Councils using by-laws preventing public consumption of alcohol.
  • Consumer protection legislation e.g. against dangerous goods
  • Laws such as the ban on smoking in public places from July 2007
  • The European Union has introduced directives on how durables such as cars, batteries, fridges freezers should be disposed of
  • The EU also imposes increasingly tough rules on carbon emissions from vehicles which all EU manufacturers must meet
  • Speed limits on roads and weight limits for lorries
  • Quotas on how much fishing can take place in EU waters
  • Bans on sale of certain substances / minimum age of legal sale
  • Lowering alcohol limit for drivers – reduced by Scotland in 2014

Alternative to taxing the bad - subsidising positive externalities

  • An alternative to taxing activities that create negative externalities is to subsidise activities that lead to positive externalities
  • This reduces the costs of production for suppliers and encourages a higher output
  • For example the Government may subsidise state health care; public transport or investment in new technology for schools and colleges to help spread knowledge and understanding
  • There is also a case for subsidies to encourage higher levels of training as a means to raise labour productivity and improve our international competitiveness
Regulations to address negative externalities - revision video

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