Markets, tax and price

"For every human problem there is a solution that is simple, neat and wrong." - H.L. Mencken

To concede a point, there's no doubt that you can reduce congestion on roads by pricing them. At the ASI, Dr Eamonn Butler argues that:

If charging does not deter traffic, the charge is not high enough. There is some price at which the traffic will flow. If the charge makes people avoid the morning peak, all the better. And since the Park and Ride bus sits in the same traffic queue as everyone else, that's not an answer. (Sure, there are occasional bus lanes – but they just squeeze motorists into even less road space.)

The market is the best way of allocating most resources, roads included. Of course, you have to cut the other taxes on motoring, and provide realistic alternatives for those priced out by the charge. But without some such solution, congestion will inevitably get worse: and that costs businesses and the public dear.

Of course, if a congestion charge is introduced in Cambridge, no taxes will be cut and no realistic alternatives will be introduced for those priced out by the charge. I think Dr Butler knows that; they haven't been in London. This is a simple process of pricing the poorest off the roads they have already paid for, through taxation, for the benefit of the better off.

There are other ways to reduce congestion. Simply banning private vehicles from town centres, or making the roads far too narrow and inconvenient to drive (in other words, deliberately introducing impractical levels of congestion), and allowing delivery vehicles only in the small hours are all viable approaches. None favours the rich over the poor. Many towns operate the first of these three policies, Amsterdam operates the second two with some success.

Since this came from the Adam Smith Institute, it's intersting to read what Smith had to say about road tolls:

When the carriages which pass over a highway or a bridge, and the lighters which sail upon a navigable canal, pay toll in proportion to their weight or their tonnage, they pay for the maintenance of those public works exactly in proportion to the wear and tear which they occasion of them. It seems scarce possible to invent a more equitable way of maintaining such works. This tax or toll too, though it is advanced by the carrier, is finally paid by the consumer, to whom it must always be charged in the price of the goods. As the expense of carriage, however, is very much reduced by means of such public works, the goods, notwithstanding the toll come cheaper to the consumer than the; could otherwise have done; their price not being so much raised by the toll as it is lowered by the cheapness of the carriage. The person who finally pays this tax, therefore, gains by the application more than he loses by the payment of it. His payment is exactly in proportion to his gain. It is in reality no more than a part of that gain which he is obliged to give up in order to get the rest. It seems impossible to imagine a more equitable method of raising a tax.

When the toll upon carriages of luxury upon coaches, post-chaises, etc., is made somewhat higher in proportion to their weight than upon carriages of necessary use, such as carts, waggons, etc., the indolence and vanity of the rich is made to contribute in a very easy manner to the relief of the poor...

Smith was looking at ways the cost of transport links and facilities could be fairly attributed to their users and would, I think, have been revolted by the idea of a taxation system that favoured the indolent and vain rich over the poor, yet this is exactly what an institute with his name is suggesting. Why?

Two reasons: a misunderstanding about the mechanisms of markets and prices, and what Chris Dillow recently pointed out is a widespread failing among free market enthusiasts:

... the argument for free markets have been besmeared by their (unnecessary) association with the self-interest of the rich

To say this association is unnecessary is an understatement. In fact, free markets operate very much to the disadvantage of the rich. It's not as though Milton Firedman didn't point this out repeatedly, identifying large businesses and unions both as vested interests that would manipulate big governments, and that this was one of the reasons why he disliked big government.

But in his ASI piece, Dr Butler identified a tax imposed by a local government as a market mechanism, and that's ridiculous. Markets operate when producers interact with consumers, and they are free if the only forms of regulation are laws of contract and disclosure, so both parties know what is being offered by the other. Prices are measurements of perceived value (though there are ideas about "natural" prices these don't, in my opinion, interact with reality in any significant way). Congestion charging is a form of pigovian tax - a tax intended to alter and/or compensate for behaviour.

Congestion charging is a pigovian tax intended to alter the behaviour of some drivers, by making them avoid certain roads. Those drivers so affected are, quite simply, the least well off. And, as I said at the outset, it works. If the effect diminishes with time, the charge can, as Dr Butler asserts, be raised until it operates at the desired level. In the case of goods deliveries, the charges will, perhaps, be passed on to the consumers of the goods being delivered, thereby apportioning them appropriately (as Smith suggested), but the congestion charge proposals are much less discriminate than that, and this is why they are unjust.

In the piece linked to above, Dillow was writing about suggestions that the sale of patio heaters be banned, saying that:

This is just moronic.
Let's grant that patio heaters make a large contribution to climate change, thus imposing an external cost onto others. In this case, the solution is to either tax them or - more likely - tax energy usage so that products that use lots of fuel such as patio heaters are more expensive. This would ensure that the private cost of the patio heater equals the social cost.
Such a policy is obviously better than an outright ban. This is because there are some people who derive enormous pleasure from such heaters and would be happy to pay extra to keep using them - possibly by cutting other forms of energy use. And their extra payment - by definition - compensates everyone else. A ban hurts these people, with no offsetting benefit.

And in the comments, Tim Worstall expanded on this:

Well, we do have a good estimate (it's one of many but still....) of the social cost. It's $85 per tonne CO2. Thats from the Stern Review.
All we need is a Pigou Tax of that amount upon emissions (suitably tweaked for methane etc etc) and we're done. Air Passenger Duty is at that level now. So we're finished with aviation. Fuel Duty is vastly above it so we're done in the transport sector all told.

So if a patio heater user or airline passenger pays a tax set in this way the social costs are offset and everyone else is compensated? How?

"Social Cost" is my favourite. What on earth is this supposed to mean and how is it to be measured? If CO2 is causing warming, how do these revenues offset this? And if the extra CO2 is generated and the tax is raised, in what way has this helped? Assuming these are the costs, and Al Gore and Madonna don't feel deterred from flying or installing patio heaters, but I can't afford the surcharge at my home, yet the pub can so I go there instead, what have we achieved, exactly? If I neither fly nor install a patio heater, but others do and pay extra, and my taxes keep rising with no reference whatsoever to the extra pigouvian revenues (and you can bet that's what will happen), in what way have I been compensated?

If a resource is scarce, is price a reasonable mechanism for limiting its consumption? Water is scarce in the south of England. Should some people be priced out of the market? Or should people simply pay what it costs to provide them with water, plus a profit margin moderated by competition? How about roads? The congestion charge isn't a mechanism for getting people to pay what it costs to provide them with roads, it's a way to stop some people using roads. That's very different.

If a resource nobody has yet paid for - diamonds from the mine in my back garden - is scarce, then price is the natural mechanism for rationing them to those who want them enough and can afford them. But if a resource we have all already paid for - the roads - are oversubscribed, any mechanism for rationing their use should be equitable. Congestion charging is not.