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I was thinking about how online gambling could cause numerous governments to face a reduction in tax revenue from conventional gambling, upon which taxes do apply in most countries.

If governments do face such a loss in tax revenue, would such a loss in tax revenue be considered a negative externality?

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No, "loss" of tax revenue is absolutely not an externality A. because it is not a "loss" and B. because the government is not a 3rd party to this - its a 2nd party. To elaborate on A, just like if you decide to buy Reeboks instead of Nikes from now on, that's not an actual "loss" to Nike, its just the lack of a continued gain. To elaborate on B, if you decide to buy less consumer goods and instead buy more stocks, this is not an externality to sales tax because sales taxes are part of the contract of the sale - they're already internalized.

An externality is an affect on a 3rd party not involved in the relevant transaction and also not transmitted through the price system. That last part means that one company taking business from another is not an externality. Same goes for taxes. It is expected that most taxes will cause people to change their behavior in an attempt to avoid that tax to some degree. That is all that's happening.

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In my view yes, it would be considered an externality. An externality is said to occur when a production or consumption decision of an individual has an unintended consequence on the consumption or production of someone else.

The analysis of externalities usually does not include governments, considering only production and consumption, but one can think of the government as a firm that produces public goods like law and order and national defense.

In that case the decision of the individual to use online gambling rather than conventional gambling has an unintended effect on the production possibilities for the government. Now that the government has less revenues, it can produce less public goods.

When a person goes for online gambling rather than conventional gambling they do not intend to reduce the overall provision of public goods, they just went for online gambling because it was more convenient/cheaper etc.

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    $\begingroup$ This is a broad definition of externality because it does not limit the type of link between decision and consequence. I'm not sure there is one correct definition but some would limit it to situations where the link is physical or technological (eg smoke affecting neighbouring laundry) and exclude those where the link is monetary (eg Baumol & Oates' definition - see here. Under such a narrower definition an effect via reduction in tax revenue would not be an externality. $\endgroup$
    – Adam Bailey
    Sep 11, 2019 at 10:27
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    $\begingroup$ If you adopt this broad view of externality then anytime consumer chooses cheaper product he or she creates externality because state earn less money this definition would make the term almost meaningless $\endgroup$
    – 1muflon1 ♦
    Nov 13, 2019 at 2:08
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Yes. There's a concept whose precise term escapes me at the moment, but an example is when income taxes rise, leading to reduced consumption and reduced revenue from consumption taxes.

Contrary to the above, this analysis frequently occurs in regulatory economics (at least, at the academic level - by all accounts, policy makers seem unaware of the concept. ;) )

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    $\begingroup$ If so then all interactions are externalities and the term loses meaning. If I reduce my product price and customers switch supplier is this an externality inflicted on my competitors?. For 'externality' to have then I think we need to limit to cases mediated other than through the market/tax changes. . It is not clear that a tax rate reduction is a value loss - just a value transfer. Wheras if I burn stubble and fill the city with smoke I have creted a value loss. $\endgroup$
    – Duke Bouvier
    Nov 10, 2019 at 13:05
  • $\begingroup$ Externalities are just costs/benefits that don't explicitly appear in the deciding agent's optimization problem. They are often, but not always, expressed through interactions with control variables. Nothing about this is problematic. I'm not sure your distinction makes sense given the well-established literature around Pigouvian taxes as a means to internalize externalities. You're right that a lot of things can potentially be "externalities", and we typically reserve discussion to externalities in the context of co-ordination problems (e.g., pollution). But it needn't be so. $\endgroup$
    – heh
    Nov 11, 2019 at 20:48

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