Knowing Pigovian Tax Mechanism

By Erikson Wijaya, an Employee of the Directorate General of Taxes

Taxes, when it plays its role on market mechanism as regulation it will lead to deficiency for both consumers and producers since it effects losses of raw burden expense greater than the potential revenue  that will be earned by the government. This happens because tax is applied as budgetair function in the market. If the focus is shifted to the intent regulerend then all the trade-offs that had been mentioned above will be no longer relevant.

As a tool to set lifestyle, tax is imposed on certain aspects in order to minimize the negative impacts that may arise for personal scale and corporate scale. The adverse effects will certainly bring negative externalities for the surrounding area, which will eventually arise and harm anyone who are or have been there. Real example is cigarette smoke, road congestion or discharge of industrial waste into the ocean.

That's why there are special taxes on certain products such as excise duty, and cigarette industrialists have any obligation as  collector of Income Tax Article 22 of 0,15% of the price per pack and VAT at 10%. However, as of January 1, 2009, the obligation to collect Income Tax, Article 22 was repealed, so that it was practically only for 1 year validity period. The motive of revocation is not clear yet, but the social costs that must be borne by the government will certainly increase in the future. This will not minimize the negative externalities.

Taxation which is intended for this kind of purpose is known as Pigovian Tax mechanism, taken from the name of the Cambridge University economist Arthur Cecil Pigou (1877-1959) as the initiators. As the manager of the country, the government intervened the economy in the form of direct control policy or to impose taxes. Tax is considered as an option that facilitates the central path for increasing government revenue without directly lowering industrial business. However, all the existing options bring their own costs.
Taking the tax as a mean to minimize externalities may make the government loses its firmness actually. To life in peace without negative externalities is public’s right. However, it become chances for the market to do lobbying since government needs the money.  There are some corporates who do not mind paying taxes if they earn higher profits. In another way, direct restriction without tolerance may turn off or reduce industrial productivity that bring longer butterfly effect, from a decline in potential tax payments to the employees laid off.

Accordingly, cost-benefit analysis is important due to this problem. Government should consider to the goal of each aspect with the opportunity costs incurred, for example considering the environment/health with the economic development and welfare. Pigovian tax mechanism could be an alternative to reduce the increasing social costs in the future while the direct control mechanism can be applied if indeed the source of revenue has been strong and independent.

*) This article is personal opinion, and is not an official statement of the institution in which the author works.