Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Cutting the VAT for Green Products?

Written by johnleemk on 11:58:55 am Jul 21, 2007.

Today I saw an interesting proposal by the British and French Prime Ministers — a proposal to reduce or repeal the value-added tax for "green" goods.

For those who don't know what a value-added tax is, it is basically an indirect tax levied on all goods sold. The reason that the British and French heads of government jointly made this proposal is because they want the European Union to reduce the EU-wide VAT for green products.

The proposal is heartening in a sense, because it shows that both Gordon Brown and Nicolas Sarkozy have a grasp of the need for real incentives to make a green difference.

Or maybe just Gordon Brown. The BBC quotes him as explicitly invoking the term "incentive", but only says that Sarkozy complained it was not fair for green products to be taxed at the same rate as more polluting ones.

In any event, it's not going to be easy to implement this change. The EU is a notoriously slow and inefficient body, and the change would require the approval of all 27 EU nation-states.

Is the change, however, a fundamentally good idea? I'm not too convinced. I like the idea of creating an incentive for consumers to go green, because that is the Pigovian solution orthodox economics recommends.

However, the relevant question is, what sort of incentive should we be giving? Should we be taxing the goods which do harm, or should we subsidise the goods which (pardon the pun) do good?

This is not a new question to me, and it is one where I think taxing the bad ought to prevail. The reason is simple: we cannot say what the best solutions to a problem are. We can, however, identify the problem. Thus, we should create disincentives for the problem, but not create incentives and run the risk of identifying the wrong solutions.

A tax cut for green goods thus might make sense — but it depends on how we define "green goods". If our definition is simply "goods whose production entails emissions of not more than X amount of pollutants", or something along those lines, then this is probably a sensible policy.

If, however, our definition specifically singles out certain goods, such as "green" refrigerators or "green" automobiles, while not extending the tax cut to other potential solutions, then we have a bad and distortive policy.

It might not be worse than maintaining the present uniform tax. However, it will certainly end up diverting resources away from where they might be best utilised. All other things equal, I may not mind a green refrigerator, but still demand a car with the acceleration that only petroleum can provide (at least with the technology we have). A distorted policy which awards a tax cut to the refrigerator but not the car alters my decision, but not necessarily for the better, because although society may gain either way, I could have been better off.

The specifics of the proposal by Brown and Sarkozy remain to be seen. I hope, however, that they will err on the side of creating a disincentive to pollute, rather than an incentive to go green, because one of these is better than the other.

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Infernal Ramblings is a Malaysian website focusing on current events and sociopolitical issues. Its articles run the gamut from economics to society to education.

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