Friday, May 16, 2008

Tax and Redistribute

Janet Stemwedel had a post yesterday on water conservation:

If there's a drought looming, a water district would like water users to cut back their water usage. If they don't, the water district could run out of water, which is bad for everyone.

Ramping up the price of any water usage is one option, but it would fall unfairly on the folks with less money. Water is not something you can opt out of using if the price of using it passes a certain point. We are not a society that openly embraces dessicating the poor.

Since people need to use some water (to drink, to boil ramen noodles, to wash, etc.), a water district wants a policy that acknowledges the necessity of water usage while discouraging water usage that can be avoided.

She goes on to describe how alternative proposals, e.g. charging for relative increases in use, create bad incentives and are unfair on those who had previously "cut their water usage down to the bone." How, then, can a society ration scarce resources effectively without "dessicating the poor"?

Actually, it's easy. Ramp up the (tax) price of all water usage, just as initially suggested, and then redistribute the proceeds among all taxpayers. Those who use more water end up compensating those who use less, so the poor (and other low-consumption users, e.g. conservationists) can actually expect to make a net profit out of this system. (They receive an $(X/n) payout, which is more than enough to pay for their essential water usage, and they can then pocket the rest.)

Really, this should be a no-brainer. And note that the lesson generalizes. Whenever someone complains that an economic disincentive "unfairly burdens the poor", the solution is to redistribute the proceeds. (Example: worried that gas taxes are a burden to the poor? Solution: redistribute the proceeds. The poor will profit, as will the environment.)

Why is this not common knowledge?


  1. While I agree in general, I do think we have to be a bit cautious here. The operative question will always be how one will go about redistributing the proceeds, and whether that method of redistribution really in the end sufficiently compensates for the disincentive. In many cases such methods can be found (in the water district case it would presumably be fairly easy to set up), but I don't think we can assume offhand that they will be available in every case (I've never seen a good plan for redistributing gas tax proceeds, for instance).

  2. The western systems, particularly the American one, generally lack faith that if you make one concession (allowing higher prices) you will get an equivalent concession (redistribution) elsewhere so every one fights for every inch and good game theory results never get formed.

  3. Where I am (souther Portugal) we have a three tier system.

    A low (€10 a month or so) fee for the basic water supplies to run a household. A medium fee (€35 or so a month) which will provide enough to run a household plus water the garden etc....lawns do take a lot of water.

    Then, if you go above the volumes paid for by that medium fee you face ever rising chrages for the marginal litres above that. Not just a fee per litre, but each extra litre has a higher price than the one before (well, not quite, but in bands).

    Works pretty well actually: the people with the big villas keeping the gardens green in August subsidise the poorer families.

  4. I think most places especially in the western US where water is scarce have a two tier system. Go above a certain amount and huge penalties are incurred.

    The problem with water in the west is that it is easier to get bonded than to simply raise rates due to the way loans are made to cities and counties. So this tends to add incentives to not do water wisely.


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