What is Tax?
Tax is a mandatory financial contribution imposed by the government on individuals, businesses, or goods to generate revenue for funding public services. It plays a crucial role in financing essential functions like infrastructure, education, healthcare, and defense. Taxes are broadly classified as direct and indirect.Direct taxes, such as property and income tax, are paid by the person on whom they are charged and cannot be shifted.Indirect taxes, like Value Added Tax (VAT), are charged by the government on one person but paid by another, with the burden often borne by consumers.
Motive Behind Increasing Pollution
In a country like Nepal, there are not much regulations to control and manage industrial pollution and it there are, it's limited to the paperworks only. Hence, industries aren't charged for pollution emission. This acts like a motive for industries to pollute the environment. They then, get benefitted by increasing production without thinking of pollution increment.
The concept of Externality
An externality is a side effect or consequence of an economic activity that affects parties not directly involved in the activity. It can be positive or negative.
Positive Externality: When the external impact is beneficial to others, e.g., education benefits society beyond the individual learner.
Negative Externality: When the external impact is harmful to others, e.g., pollution from a factory affecting the health of nearby residents.
How tax internalizes Negative Externality?
Taxes can be used as a policy tool to decrease negative externalities, such as pollution from industries. This approach is known as a Pigovian tax, named after economist Arthur Pigou, who advocated for using taxes to correct market failures caused by externalities.
Governments can reduce pollution by taxing industries for emitting pollutants. This tax raises production costs, encouraging companies to minimize harmful releases. For instance, a factory emitting pollutants may not fully consider the health and environmental costs to the nearby community. A pollution tax internalizes these external costs, prompting the factory to invest in cleaner technologies or alternative methods to lower the tax burden. This discourages pollution and promotes environmentally friendly practices. Taxes, in this way, drive more sustainable and socially responsible behavior in economic activities.
How subsidy internalizes Positive Externality?
A subsidy is a financial incentive provided by the government to encourage certain activities that have positive effects on society. It works by reducing the costs associated with these activities for either producers or consumers. By doing so, the government aims to align private interests with the overall well-being of the community. For example, if the government gives a subsidy for solar panels, it makes them cheaper, motivating people to use cleaner energy and helping the environment. This is how subsidy encourages positive externalities.
Pollution Permits
Pollution permits set a limit on how much pollution a company can make. Each company gets permits, and if they pollute less, they can sell extra permits. For example, if a factory uses cleaner technology and doesn't use all its permits, it can sell them to another factory. This encourages companies to reduce pollution and helps control overall environmental impact.
That was it on how taxes internalize negative externality and subsidy internalizes positive externality.
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