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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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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 at 10:27

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