Suppose the government decides to raise the gasoline tax as a way to reduce air

Question

Suppose the government decides to raise the gasoline tax as a way to reduce air pollution and traffic congestion to their optimal levels. Which of the following describes why corrective taxes, such as the gasoline tax, are unlike most other taxes? Corrective taxes alter incentives, whereas other taxes typically do not. Corrective taxes bring the allocation of resources closer to the social optimum and, thus, improve economic efficiency. Other taxes get passed on from businesses to consumers, whereas corrective taxes do not. Other taxes are typically used to cover general spending, but funds from corrective taxes can be used only to alleviate pollution.

Explanation / Answer

B) corrective taxes bring the allocation of resources closer to the social optimum, and thus improve economic efficiency

Think, for example, the alluminium market. Imagine that this market is in equilibrium, with no government regulation. In this equilibrium point, we have Q* and P*, price and quantities where demand equals supply. If we think only in this particular market, we find that the quantity Q* is optimal. However, we must think about externalities, and how they affect the entire society. We know that the alluminium industry yields pollution. This pollution is a negative externality affecting people that are not even participating in this particular market. So, if we consider the whole society, the original quantity Q* may not be optimal. Maybe, we would like to reduce this Q* to a new quantity Q** where the pollution is lower, and the whole society is in a better position. The pigouvian taxes, in this sense, will force the industry to reduce its production, thus reducing the equilibrium quantity suplied from Q* to Q**. Then we conclude that it will bring the allocation of resources closer to the social optimum and, thus, improve economic efficiency (In terms of social benefits)

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