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ib economics hl notes

Internal Assessment Taxation

UPDATED ON - 16 APR 2020
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This article focuses on the concept of negative externalities of pollution from a coal-burning company called Cinergy and how they plan to deal with this problem.

‘Asking to be Taxed and Regulated’

This article focuses on the concept of negative externalities of pollution from a coal-burning company called "Cinergy" and how they plan to deal with this problem. An externality occurs when there is a divergence between social and private costs and benefits. The private cost is the price of an activity to the individual producer – in this case, the cost of running the power plants that Cinergy owns. In the diagram below we can see that free-market allocation (considering only the private costs to Cinergy) would settle at q0.


The social cost is the total cost of an activity to both the individual consumer/firm and the rest of society as well. The social cost is equal to the private cost plus the externality. Negative externalities are spill-over effects that arise from the production or consumption of goods and services that have had no specific compensation. With negative externalities, like pollution, the social cost is greater than the private cost. The 56 million metric tons of carbon dioxide that the company Cinergy spews is the negative externality in this article and its costs are borne by society as a whole. The socially optimum allocation is at q1 where the social marginal cost = social marginal benefit. In the diagram, we can see that firms such as Cinergy will not consider social costs and will overproduce. Cinergy produces too much compared to the socially optimal level. In the diagram we can see that on units q0q1 the social marginal cost is greater than the social marginal benefit, therefore there is allocative inefficiency (market failure). Allocative efficiency is where no resources are wasted – when no one can be made better off without making someone else worse off.



When the CEO of Cinergy, Jim Rogers, claims he ‘is an outspoken advocate of regulating carbon and imposing a price on emissions’ he is admitting that he realizes the pollution that his company is responsible for. His proposals of a ‘regulatory scheme that would force power companies to cut carbon emissions’ and spending ‘$1 billion to increase the use of cleaner-burning natural gas’ can be seen as an attempt to get closer to the socially optimum level of production. In the diagram, we can see that if Cinergy cuts its carbon emissions and cuts reliance on coal from 87% to 73% (from q0 to q1) it moves its marginal private level of production closer to the social optimum level of production (where MSC = MSB). The aim is to reduce the negative externality, and regulation is one way. The taxation mentioned in the title of the article refers to the idea that if carbon is taxed, then the indirect tax (a fee charged by the government on a product/activity) lowers supply, which then raises the price to P1 and lowers quantity supplied to q1. This tax can be viewed as a pollution tax, it reduces the rate of new carbon dioxide that Cinergy releases (as represented by the fall to q1)


The author is correct when mentioning that regulating and taxing Cinergy's carbon emissions will help the environment, but overlooks the fact that the problem with these solutions is assessing the actual value of the negative externality, more specifically how much damage has already been done by the carbon emissions. Also, the problem with taxing Cinergy, as the article mentions, is who has suffered from the CO2 may never be compensated. However that being said, the tax revenue could be used to clean up some of the pollution already produced. The article also mentions a merger (with Duke Energy) but fails to mention that if the companies merge they’re going be a dominant player in the energy industry and will be able to influence the regulations set out by the government. The author has overlooked the idea that maybe the only reason Cinergy’s CEO proposes all these ideas is that Cinergy already has a somewhat poor environmental reputation after ‘backing away from a 1.4 billion settlement over alleged violations of the Clean Air Act’. For example, if people are aware that Cinergy is concerned with the environment, they could favor it moreover other power companies. The author fails to mention that by introducing what is known as tradable permits, Cinergy can purchase permits to pollute from firms who find it easier to reduce pollution. Overall the article introduces good ideas, but one must realize the difficulties in assessing the value of the negative externality.



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