Microeconomics - AS Government Failure

 Writing skills - AS Level        Example 1

In 2019 the price of a litre of diesel was 65% higher in Thailand than in Malaysia. Th price difference was because of higher taxation on diesel in Thailand. This led to illegal smuggling. For example, on one night, Thai authorities seized 300000 litres of diesel that was illegally imported from Malaysia.

Evaluate possible causes of government failure in the market of your choice. (source – Edexcel IAL Economics 2021)

Possible answer – 

From the case study above, it is quite apparent that, the effort of the Thailand government to curb the use of diesel or to increase their tax revenue has not worked well as the use of diesel within the country is continued illegally without paying the tax. This means, lower tax revenue for the Government at the same time no significant decrease in use of diesel directing to policy failure leading to government failure. Let me present my understating on the government failure below.

Government failure means the costs of a government policy to intervene and improve the market outcome are greater than the benefits of the policy leading to a net welfare loss.

From the case study we can see, Thai people were paying 65% more tax on diesel than Malaysians because of the higher tax imposed by the Thai Government. This must have caused inconvenience for Thai people and forced them to buy imported diesel illegally from Malaysia. This illegal import of 300000 litres of diesel caught in one night is the manifestation of the government failure. 

Let me discuss the reasons why the higher taxation by the Thai government led to government failure. 

Information gaps - It is possible that the Thai government did not have the perfect information to decide on the exact size of the tax that could help them to achieve their objective. Possibly, due to this reason, the size of the tax they have imposed on diesel was greater than the size that was needed to achieve their objective without any unintended consequences. This must have led the quantity demanded and supplied of diesel in the country to be low leading to less market activities and underutilization of resources. If the government tax revenues collected from the diesel was less than the value of the loss of benefits to the society powered by low market activities, then, this could be considered as government failure.

Unintended consequences - When the Thai government imposed the tax on diesel, they must have thought that their policy could either lead to increase in tax revenues or it could lead to an improvement of the market outcome without considering that their policy might lead to an increase in smuggling of diesel from Malaysia. This is an unintended consequences of the policy, which might have greater impact on the economy. If the value of the illegal transactions are greater than the tax revenue collected by the government then, this could be considered as a policy failure leading to government failure. 

Excessive administration costs - as there is a huge amount of smuggling taking place to avoid paying the tax, this means, Thai government needs to set up new department or use more resources to watch over the illegal smuggling and then catch the perpetrators. If the costs to reduce the illegal smuggling is greater than the tax revenues collected, then, this will be considered as a policy failure leading to government failure. 

Incentive to involved in illegal activity -  Though the quantity of diesel demanded in Thailand was low in open market due to higher prices led by the tax, but, that does not mean people did not need diesel. As diesel is an essential commodity to fulfill the energy needs for any modern economy, people would always look for buying diesel at a lower prices from any market, regardless of open market or black market. This would cause a greater incentive for some black market diesel sellers to involve in illegal search for cheaper diesel.  As the return on the selling diesel illegally is very large, so sellers would not hesitate to involve in diesel smuggling. This incentive to smuggle diesel may become a pattern leading to a platform for organized crime. This may cause huge costs on the society compared to the tax revenues collected by the government. As a result, there may have government failure. 

However, the decision of the government to impose tax on diesel may not be a government failure. Let me explain those positive sides of the government tax policy below.

Though we assumed that government may not have the perfect information to know the exact size of the tax leading to a sharp reduce in market activities or there may not have any significant impact, well! That may not be completely true. This is because, government has got various departments that collect data from the market regularly. This means, they may have good idea about the size of the tax that they need to impose on diesel either to collect greater amount of revenues or to improve the market outcome.  There is no evidence reflected from the case study that could justify that the higher tax was a result of information gaps. It is possible that the Thai government has imposed the higher tax knowing the effects before hand and ready to take actions accordingly. 

Secondly, the presumption of higher administration costs may not be true completely. This is because, the departments that look after the tax collection and its effects are always there to perform their duties regardless of the diesel tax imposed or not. The new tax would just be an additional duty for the departments and nothing else. As a result, there may not have any excessive administration costs at all or the additional costs may not be that much that could super impose the tax revenues. 

Thirdly, the presumption made on the tax on diesel as an incentive to involve in illegal activities, may not be a true fact, as such activities do exist in any society regardless of the government tax on anything. The tax on diesel could just be an another opportunity to practice their existence. So the black market activities can not be considered as an unintended consequences of the government tax on diesel, as such activities are quite common among the people in many countries particularly developing countries.

Fourthly, even if we consider that the higher tax has led to people involving in black market activities but it is not something that can be compared with organized crime. This is because the Thai police have reflected their abilities by catching the perpetrators whenever they were involved in black market activities. This is evident from the case study where it is mentioned that the Thai Police has caught 300000 liters of diesel on one night.  As a result, the value of the black market transactions or the costs of such black market activities on the society may not be greater than the tax revenues or the benefits received from the policy. This means no government failure.

Fifth, the black market activities may not expand to a level where it can reach to an organized crime. This is because of the strict laws and punishments to the people who involve in illegal import of diesel. As a result, it is likely that the tax imposition on diesel may not have unintended consequences as much as it was presumed. So there may not have any government failure at all.

In conclusion, I must say, whether the government decision to impose tax on diesel is a government failure or not, that depends on the factors discussed above. If the effects of factors discussed above lead to greater costs than the government revenues or the benefits that they were expecting from the policy then it would be considered as a government failure. If the benefits are greater than the costs, then it may be considered as a government success.