Natural Resource Taxation

Markets are an excellent mechanism for organizing production and distribution, but they aren’t magic. They don’t generate prices ex nihilo.

Market prices are circular. The price of a product depends on the prices of the inputs to its production. The price also depends on the supply and demand for the product, given the prices of other products. Prices depend on prices.

How is this circularity bootstrapped?

In modern societies, prices are bootstrapped in an ad hoc way, without any design or plan. This makes market prices somewhat random. They depend on external conditions in ways that are unclear and unchosen.

Prices are information. They control the physical economy, which consists of the physical production and distribution of products.

Prices determine what is produced, in what quantity it is produced, and how it is produced. A product is produced if it can be sold at a price above the cost of production. The greater the profit (difference between the market price and the cost of production), the greater the incentive to produce the product. This creates an incentive to produce what people want. It also creates an incentive to produce things efficiently, in terms of the monetary cost of production.

Prices also determine how products are distributed. Again, there is a profit motive, but it is a subjective value profit, not a monetary profit. People try to get the most value for their money. This creates an incentive to consume products efficiently. The greater the value of a product, the greater the incentive to purchase it. The greater the price of a product, the lower the incentive to purchase it. People try to satisfy their desires in the most efficient way.

So, prices are very important. Correct prices generate good economic outcomes. Incorrect prices generate bad economic outcomes.

The market mechanism does not guarantee that prices are correct. To correctly optimize the price of a product, the market requires correct prices for other products. The correctness of one price depends on the correctness of other prices. This circularity must be bootstrapped for markets to work.

To judge the correctness of market prices, we must know how they are bootstrapped. To make market prices correct, we must control how they are bootstrapped.

The physical economy is not circular. It has a physical input of natural resources, a physical output of goods and services (economic output), and a physical output of waste. It contains circularities, but it is not circular as a whole. It consumes natural resources, produces various things, and emits waste.

It’s not entirely clear what products constitute economic output. Almost any product can be an input to the production of some other product. Even food, which is necessary for humans to survive, is also necessary for humans to do work, so it can be considered a partial input to production. But some production goes to sustain things that we consider to be “outside” the economy, such as the existence of human beings. Even if we consider all products to be “inside” the economy, it would still require an input of natural resources, and it would still emit waste.

The physical inputs to the economy are easier to identify. They include land, sunlight, plants and animals (such as trees and fish) that are harvested directly from nature, minerals (such as iron and coal), air and water. Air and water are not only used as materials in production processes, they are also used to dump wastes. Clean air and water are turned into dirty air and water by production processes. Land is also used to dump wastes, in a more circumscribed way.

Natural resources are the physical inputs to production that are not produced by the economy. How are they priced?

Land is typically priced by the market, but those prices do not just reflect the value of the land. They also reflect produced capital, such as buildings, and local infrastructure, such as roads and utilities. Land ownership is also typically taxed in ad hoc ways.

Governments often charge ad hoc fees for the extraction of natural resources. For example, a logging company might pay a fee per board-foot of timber cut on public land. To extract fish from the sea, a fisher usually requires a license. A mining company might pay a fee for extracting minerals, but not always. Some natural resources are taxed at the point of final consumption, rather than extraction. (Taxes on fuel are an example.) Often, there is a mix of ad hoc taxes and fees, charged at various points from extraction to final consumption.

Usage of air and water is sometimes free, and sometimes taxed. Typically, there are restrictions on pollution, but no fees for pollution.

Natural resource prices bootstrap market prices.

All prices ultimately depend on the prices of natural resources, which are not entirely determined by the market. To some extent, they are set by government fiat, but in an ad hoc way. They cannot be set by the market, because they are not produced by human labor. They are provided by nature.

I propose that natural resource prices be defined (by the state) in a principled way, based on their utility, scarcity and downstream effects (such as pollution). The state would collect the price of natural resources at the point of use, extraction or degradation. I call this “natural resource taxation”. It would give market prices a rational basis.

Land should be taxed based on the potential uses of the land, and on the state-provided infrastructure in the region. Biological resources, such as lumber and fish, should be taxed based on sustainability and balancing other uses. (Forests are not just a source of lumber. They also provide wildlife habitat, watershed management, recreation, etc.) Mineral resources, such as iron and coal, should be taxed based on their scarcity, long-term value and downstream effects, such as pollution. The use of water (other than rain) should be taxed. Land taxation would take the value of rainfall into account. Air and water pollution should be taxed.

Libertarians might complain that natural resource taxation would require price-setting by government bureaucrats, which is an opportunity for corruption. That is true, but we need to bootstrap prices somehow. Markets aren’t magic. Also, governments already price natural resources in ad hoc ways, which creates greater opportunities for corruption. If natural resources are free, then markets are not bootstrapped, and there is a tragedy of the commons. Currently, we have a mixture of ad hoc pricing and no pricing.

Natural resource taxation would provide a rational foundation for markets. The foundation would be explicit, designed and justified. It would create incentives to use natural resources efficiently and reduce pollution. It would not punish productivity. It would only tax people for the natural resources that they use or consume, not for what they produce with their labor.

Most types of taxation punish productivity. For example, property tax is based on the value of buildings, not just the value of the land. If you improve the buildings on your land, you will pay more property tax. This punishes productivity. Similarly, income tax is based on income earned by labor or investment. If you work hard and well, or invest wisely, you will pay more income tax. Again, this punishes productivity. Consumption taxes also punish productivity, although not directly. All income is eventually used for consumption of some kind. So, a tax on consumption is a tax on income, and thus a tax on production.

There are only two types of taxation that do not punish productivity: a head tax, which is a fixed amount per person, and natural resource taxation. An ideal society would rely exclusively on those types of taxation.

Most existing forms of taxation are complex, ad hoc and create opportunities for corruption and tax evasion. Property tax requires that government bureaucrats assess the market value of property every year. This is ad hoc, it can become corrupt, and it creates uncertainty about future taxation. Income tax requires individuals and companies to keep track of financial minutia, and it creates many opportunities for tax evasion. A simple flat income tax would be relatively easy to assess, but the income tax is very complex in most countries, with many loopholes and subsidies. Sales tax requires businesses to record every sale, and it incentivizes them to not record every sale. Value-added tax is even more complicated, because it requires a full accounting of revenue and the costs of production. Sales and value-added taxes are often ad hoc, and vary from one jurisdiction to another.

Natural resource taxation would be simpler than most existing forms of taxation. It is relatively easy to assess and control the extraction/use of natural resources. The current system taxes every transaction, and (in many cases) requires detailed accounting of production processes. Natural resource taxation would tax only a subset of transactions and processes: the extraction/use of natural resources.

To summarize, natural resource taxation would have the following benefits for society:

• It would place market prices on a rational foundation.
• It would incentivize the efficient use of natural resources and the reduction of pollution.
• Unlike current forms of taxation, it would not punish productivity.
• It would be simpler than current forms of taxation, and thus create fewer opportunities for corruption and tax evasion.