Negative Externality in Accounting Theory

ACCOUNTING THEORY
2019

Negative externality
A negative externality is also commonly known as an external cost. It is a monetary impact
faced by a third party arising out of an economic transaction. Any organization, individual,
property owner, or resources that are indirectly impacted are generally the third parties to a
transaction while the producer and customers are respectively the first. Externalities are also
termed as spill over effects. Externalities like carbon emissions from factories arise from
production activities while externalities like water arise from its consumption (Bussolo,
Koettl, & Sinnott, 2015).
Figure 1 Negative externalities
As seen in the graph, the Marginal social cost curve is relatively higher in comparison to the
private marginal cost due to various external costs. At Q1, the socially efficient output is
lower as compared to the market equilibrium output, at Q.
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Negative externality
Externalities are most likely to happen in circumstances where the allocation of property
rights over assets or resources is uncertain or hasn’t taken place like in the case of natural
resources such as oceans (Kehoe et. al, 2013). As oceans are not anyone’s personal property,
therefore, water transportation system might take up the opportunity of polluting the same
without having the slightest of fear of being slapped with a notice from the court (SHJ &
McGrath, 2018). Hernando De Soto being an influential Peruvian economist has highlighted
the significance and the need for the creation of property rights in order to enable in the
development of successful market economies (Klaukka, Staak & Valladares, 2012).
Although individuals and organizations are the participants in the consumption of public
goods yet they are not liable to the cost that is proportionate to consumption. Therefore, there
must be government intervention in order to address the issue by ensuring the production of
public goods is at an optimal level. The intervention of the government will ensure smooth
proceedings and keep the negative externalities at bay. In the absence of government
intervention, there are probabilities for an individual or organization to take a bad decision
regarding neutralizing the balances of costs and benefits (Alan & Robert, 2012). Negative
externalities arise out of commercial behaviours which can be prevented by means of
government intervention only. The contributors to negative externalities are unlikely to take
charge of rectifying the same. This creates the room for additional negative externalities that
further results in market inefficiencies and environmental depletion. Thereby, negative
externalities are a stake for the economy as a whole (Handley & Limao, 2015).
Negative externalities can be dealt with by means of reducing or eliminating the same. It is
vital that the government should devise a mechanism that helps in the combating of
problems. There can be the implementation of various taxes, charges, penalties/fines, and
regulations so as to rectify negative externalities. Individuals or organizations that are
contributing to negative externalities must be slapped with fines or taxes. It is one of the
orthodox methods that will lead to the betterment of society (Henderson, 2015). This will
ultimately make them cautious enough of their activities and they might stop contributing to
negative externalities. For example, emissions from vehicles are one of the significant
contributors to environmental pollution. Therefore, the government has formulated such laws
where the vehicle owners have to pay consumption taxes as per the size of the vehicles
(Klaukka, Staak & Valladares 2016). The large-displacement ones are supposed to pay higher
taxes as compared to the small displacement ones. There are huge benefits arising out of
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Negative externality
regulating such negative externalities. Organizations that are contributors to negative
externalities will rethink of their operational patterns and other activities and shall execute the
same in a manner that reduces or just eliminate the impact on the environment. Once the
government is stern in this regard, it will create an environment where economic benefit can
be observed (Henderson et. al, 2015). If the benefits derived from continuing such activities
that are causing negative externalities are less than the taxes or penalties then there are
probabilities for the individuals or organizations to rather just cease these activities and this
shall ultimately reduce negative externalities. The government can reconstruct the resources
that were depleted as a result of negative externalities from the taxes and penalties collected
from the contributors of the same. The tax collected can be of great use for the government in
cleaning the environment. There are certain issues that can come in the way of the
government while enacting the tax laws pertaining to negative externalities. Hence, through
externalities, the government can reap a huge fund and the same can be used in the normal
course to enhance the economic condition. For example, defining the relationship between
tax level and displacement is one such issue where the enactment of the automobile
consumption tax will harm both social and economic development (D'Alimonte, 2014).
Therefore, the government must pay due attention to the techniques used in order to reduce
the negative externalities so as to control its negative impacts on the development of the
nation. This step will help in the fuller development and will ensure a positive movement.
Figure 2 Negative externalities
There can also be the use of non-economic measures so as to reduce negative
externalities. Like in the case of an individual who is contaminating the public places and
is financially weak to bear the taxes or penalties imposed on him for continuing such
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