Internalising either positive or negative effect on the third party, also known as internalizing the externalities, is an attempt to deal with the externalities by bringing an external cost or benefit into the price system. The main problems with internalising is a relative difficulty of calculating an approximal ‘value’ of the externalities as well as taking into account all the possible externalities, which is quite difficult and requires a lot of analysis.
Transport industries create a market failure in considerable amounts. In particular, there are many externalities related to petrol, both positive and negative. The most obvious one is pollution, because cars run on petrol produce a lot of exhaust fumes, which harm the nature and people’s health. Closing our eyes on out coming global problems such as global warming, there are still many other related problems. Worsening health of people who live in big and medium size cities means that more money is needed to be spent on National Health Insurance. More money spent on the health of citizens means that something else on the list of government to spent money on would be sacrificed, for example, educational sphere, hence it is an opportunity cost. On the other hand, petrol runs most of the transport in the world, which enables to freely trade all over the world. Through transport petrol provides an opportunity to develop businesses, international relationships, increasing living standards over the world, not to mention moving towards higher levels of productivity every day, etc. The transport system itself provides an infinite number of positive externalities as well as negative externalities. If we consider only the externalities from motor vehicle transport, it would still have an enormous impact on people and the nature. The fact that there are 426 motor vehicles per 1000 people in the UK clearly shows - this is a quite serious issue for the United Kingdom. Traffic congestion is already a big problem in cities such as London, Manchester and Birmingham.
If a tax is put on petrol prices, first thing that should be considered is not whether it will be effective in dealing with externalities but the size of the tax. We should remember that the demand for transport is a derived demand, which means that it depends upon the final output produced. Therefore, many industries are highly dependent on transport, hence, on the petrol and its price, as well as just citizens of the country using private vehicles. If the tax is relatively high, many people would still buy petrol, as the demand for petrol is highly inelastic, though some people would switch to public transport, such as buses and trains. Those transport companies are likely to raise ticket prices as well, as the demand for public transport is likely to raise and also because of the increased cost of running the motor vehicles. Freight transport companies are likely to increase the price as well, which may lead to a reduction of supply in a number of industries. Sole traders and small transport companies even can go bankrupt because of the suddenly raised costs and fallen demand. Will the money collected from the taxation internalize the externalities? Not likely. Traffic congestion will still be an issue in the big cities, as the taxation is not likely to bring a huge reduction in the number of cars used – big transport companies may expand and more buses and freight transports will fill the roads, while the number of private cars will still be bigger that the maximum capacity of the roads. In addition to that, the money raised from taxation is not going to reduce the pollution. However, the people who would have to switch to public transport may become less productive because they would still have to spend time in traffic jams and also because of waiting for buses, possible stress from overcrowded public transport, so the growth of overall human productivity is likely to become slower or even negative. Obviously, a big tax on petrol will not be able to cover up all the costs and benefits. Even if that money would be spent on improving the infrastructure or environmental situation, the country may not be able to handle the consequences of an unnecessary big raise in petrol prices. Hypothecation, redirecting the tax revenue on particular purposes, would have simplified the process of internatianolising externalities, but still wouldn’t have given any impressive results.
On the other hand, a small raise in price is not likely to scare off the users of motor vehicle cars, as this is almost an essential good for a modern British person. Freight and passenger companies are likely to deal with the rise in costs by a small increase in the price for their services. Hence, demand patterns are not likely to be changed by a small tax imposed on the price of petrol. A small raise in price of petrol is not likely to have big affects on the numbers of motor vehicles cars used, even though that the revenue from this taxation is likely to be very high, but still not enough to even be close to covering up external costs and benefits.
However, there are other ways of internationalising externalities created by transport industries. For instance, road pricings or congestion charges, direct charges for the use of a road space, could be used. This would reduce the number of vehicles on the roads and also bring some revenue to the government, which could be spent on reducing the negative effects – preventing from all kinds of pollution like noise pollution, air pollution etc. Another example would be subsidizing in order to encourage greater use of public transport, which would also reduce the number of vehicles on the road and therefore reduce the amounts of pollution.
Overall, petrol tax, whenever it’s a high tax or a low tax, would bring the government much more revenue, which means increased government spending. This would lead to improvements in infrastructure and reducing the externalities, but not completely. The value of all the externalities brought by the transport industry just cannot be included in a petrol price simply because it cannot be calculated completely.