The Problem of Social Cost
The definition of the social product is queer but this does not mean that the
conclusions for policy drawn from the analysis are necessarily wrong. However,
there are bound to be dangers in an approach which diverts attention from the
basic issues and there can be little doubt that it has been responsible for some
of the errors in current doctrine. The belief that it is desirable that the business
which causes harmful effects should be forced to compensate those who suffer
damage (which was exhaustively discussed in Section VIII in connection with
Pigou’s railway sparks example) is undoubtedly the result of not comparing the
total product obtainable with alternative social arrangements.
The same fault is to be found in proposals for solving the problem of
harmful effects by the use of taxes or bounties. Pigou lays considerable stress
on this solution although he is, as usual, lacking in detail and qualified in
his support. Modern economists tend to think exclusively in terms of taxes
and in a very precise way. The tax should be equal to the damage done and
should therefore vary with the amount of the harmful effect. As it is not
proposed that the proceeds of the tax should be paid to those suffering the
damage, this solution is not the same as that which would force a business
to pay compensation to those damaged by its actions, although economists
generally do not seem to have noticed this and tend to treat the two solutions
as being identical.
Assume that a factory which emits smoke is set up in a district previously
free from smoke pollution, causing damage valued at $100 per annum. Assume
that the taxation solution is adopted and that the factoryowner is taxed $100
per annum as long as the factory emits the smoke. Assume further that a
smoke-preventing device costing $90 per annum to run is available. In these
circumstances, the smoke-preventing device would be installed. Damage of
$100 would have been avoided at an expenditure of $90 and the factory-owner
would be better off by $10 per annum. Yet the position achieved may not he
optimal. Suppose that those who suffer the damage could avoid it by moving
to other locations or by taking various precautions which would cost them, or
be equivalent to a loss in income of, $40 per annum. Then there would be a
gain in the value of production of $50 if the factory continued to emit its smoke
and those now in the district moved elsewhere or made other adjustments to
avoid the damage. If the factory owner is to be made to pay a tax equal to the
damage caused, it would clearly be desirable to institute a double tax system
and to make residents of the district pay an amount equal to the additional
cost incurred by the factory owner (or the consumers of his products) in order
to avoid the damage. In these conditions, people would not stay in the district
or would take other measures to prevent the damage from occurring, when
the costs of doing so were less than the costs that would be incurred by the
producer to reduce the damage (the producer’s object, of course, being not so
much to reduce the damage as to reduce the tax payments). A tax system
which was confined to a tax on the producer for damage caused would tend
to lead to unduly high costs being incurred for the prevention of damage. Of
course this could be avoided if it were possible to base the tax, not on the
damage caused, but on the fall in the value of production (in its widest sense)
resulting from the emission of smoke. But to do so would require a detailed
knowledge of individual preferences and I am unable to imagine how the data
needed for such a taxation system could be assembled. Indeed, the proposal
to solve the smoke pollution and similar problems by the use of taxes bristles
with difficulties: the problem of calculation, the difference between average and
marginal damage, the interrelations between the damage suffered on different
properties, etc. But it is unnecessary to examine these problems here. It is
enough for my purpose to show that, even if the tax is exactly adjusted to
equal the damage that would be done to neighbouring properties as a result
of the emission of each additional puff of smoke, the tax would not necessarily
bring about optimal conditions. An increase in the number of people living or of
businesses operating in the vicinity of the smoke-emitting factory will increase
the amount of harm produced by a given emission of smoke. The tax that would
be imposed would therefore increase with an increase in the number of those in
the vicinity. This will tend to lead to a decrease in the value of production of
the factors employed by the factory, either because a reduction in production
due to the tax will result in factors being used elsewhere in ways which are
less valuable, or because factors will be diverted to produce means for reducing
the amount of smoke emitted. But people deciding to establish themselves in
the vicinity of the factory will not take into account this fall in the value of
production which results from their presence. This failure to take into account
costs imposed on others is comparable to the action of a factory owner in not
taking into account the harm resulting from his emission of smoke. Without
the tax, there may be too much smoke and too few people in the vicinity of the
factory; but with the tax there may be too little smoke and too many people
in the vicinity of the factory. There is no reason to suppose that one of these
results is necessarily preferable.
I need not devote much space to discussing the similar error involved in the
suggestion that smoke-producing factories should, by means of zoning regula-
tions, be removed from the districts in which the smoke causes harmful effects.
When the change in the location of the factory results in a reduction in pro-
duction, this obviously needs to be taken into account and weighed against the
harm which would result from the factory remaining in that location. The aim
of such regulation should not be to eliminate smoke pollution but rather to
secure the optimum amount of smoke pollution, this being the amount which
will maximise the value of production.
Conclusion
Notes
See Also
References and Further Reading
About the Author/s and Reviewer/s
Author: international
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