Introduction
The economically well-developed countries mostly have large industrial base (except some like UK, which outsource) with high consumption of fossil fuels and carbon producing power plants. (OECD, 1996) In these countries, the byproducts of manufact-uring industries and the consumer goods themselves are the cause of pollution. The developed countries also have a well-developed tax structure and compliance mechanisms. The National taxes consist of taxes on goods and services and personal incomes and some form of environmental taxation exists in these countries. (OECD, 1999, fig.1) In this essay, we will examine the case for taxing the environmental bads, in a developed country, and using them to replace the existing taxes. We will also examine the practical difficulties in carrying out such a tax shift.
Fig.1: Environmental Taxes as GDP percentage in developed countries
What is a ‘Tax Shift?’
The Environmental tax shift involves altering of whole or part of the national taxes towards goods, services and activities, which inflict a societal cost, because of their harmful environmental consequences. People and companies pay the costs of this harmful activity, instead of imposing them on other people and the future generations. The tax burden is thus shifted from economic activities and onto pollution. The revenue generated from those taxes contributes to the overall tax effort. (Durning, 1998)
1. Rationale for shift towards taxation of environmental ‘bads’
1.1 Taxing the externalities (Internalization of Externalities)
In a market, the marginal value to consumer must equal to the marginal cost of production for the producer at any given set of prices. This is true for perfect market conditions and leads to pareto-optimality. However, in actual conditions the production and consumption lead to ‘externalities,’ which disturb the pareto-optimality. (Sandmo, 2003) The market prices do not take cognizance of the harmful effects of non-renewable natural resources, effluents, consumer waste and water pollution and their costs remain ‘externalized’. (Kirgis, 1972) Environmental taxation helps to devise the prices that reveal true economic costs and ‘internalize ’the ‘externalities’ through a Pigouvian tax. (Whalley 1998) Thus, environmental taxes by internalizing the economic costs help to correct the imbalance in market prices.
1.2 The double dividend
The developed countries have high Tax to GDP ratio and a large percentage of taxes are collected through taxes on personal incomes and goods and services. (Eissa and Blundell, 2000) These taxes distort the behaviour of the people resulting in ‘dead weight loss of taxation.’ For example, taxes on labour potentially discourage employment. Using this rationale, taxing pollution would make the polluting activity less attractive. Introducing environmental taxes will ‘improve the environment, reduce the dead weight costs and increase elasticity of the tax system.’ (Eissa and Blundell, 2000, p.2) This was elaborated as ‘double-dividend hypothesis’ by Terkla (1984), Lee and Misiolek (1986) and Oates (1993) who state that, in a partial equilibrium framework, a pollution tax not only improves the environment (first dividend), but also generates public funds such that the excess burden of other taxes can be reduced (second dividend).
1.3 Revenue Recycling
Environmental tax shift can reduce taxes on employment and investment. Hoerner (2000) studied if all the revenue from environmental taxes can lower either labor taxes, capital taxes, or a combination of the two. He found that a substantial majority of U.S. industry (73 to 80 percent by value, employing 78 to 92 percent of U.S. workers) would be net beneficiaries of a tax shift. He found that for economic efficiency, revenues accruing from environmental taxes could be used to reduce other, pre-existing distortionary taxes. Thus, implementation of environmental tax shift will improve the ability of government to recycle taxes to finance a reduction in the existing taxes. This approach called ‘revenue recycling.’ is a well-established result in environmental economics and it maximizes gains in economic efficiency. (Sanstad and Wolff, 2000, p.1)
1.4 Increase eco-efficiency and competitiveness
The levy of environmental taxes will promote innovation into new technologies and processes to meet the need for fuel, energy, chemicals, paper and other such products. These innovations will then move the economy towards the ‘eco-efficient’ use of energy and resources (Taylor, 2003) by ‘raising the price of nature.’ (Weizsäcker and Jesinghaus 1992)
Further, tax promoted innovations will help improve ‘competitiveness’ of the businesses. These self-generated innovations will make the businesses less vulnerable to the increased risks due to mounting environmental legislation. The proactive adoption of new technology and approaches would reduce the cost of technology development and adoption for the businesses. (Taylor, 2003, p.14) Thus, the environmental taxes will provide ‘dynamic efficiency’ gains to the economy. (OECD, 1996, p.12)
1.5 Match market costs and social costs
In practice, the market prices do not reflect social costs and the industry and individuals overuse the resources and ‘continue to do what makes sense for them individually, though it makes little sense for others or for society in general.’(Wolff, 2000, p.41) The mismatch between market prices and social costs results in pollution and waste. The Environmental taxes are based on the ‘Polluter pays principle’ (EEA, 1996) and add a social cost on the industry or the consumer creating that pollution. The environmental taxes rationalize the ‘distribution of externalities’ (EEA, 1996) by making the person who is causing the externality to pay for the externality. This helps to maximize economic welfare. Environmental taxes are market-based mechanisms as opposed to regulation, which is a command and control approach. Taylor (2003, fig2) contends that market mechanisms act better in controlling the environment than the command and control approaches.
Fig.2: Effect of Environmental Taxes in pollution control
1.6 Complying with Kyoto protocol
Taxation is never popular and there is always an outcry against new taxes. The environmental taxes are not entirely new taxes. Some form of environmental taxation such as energy tax, tax on CO2 and SO2 emissions, landfill tax, fuel escalator surcharge are already in existence in several developed countries.(Poterba, 1993) Most developed countries are signatories to the Kyoto Protocol, (UNO, 1998) which envisages trading in carbon to pay for the pollutants. The government is under obligation to enforce the carbon tax on the polluters. In addition, the government has to devise a mechanism to collect taxes through distribution of tax permits to meet its national tax obligation. This opportunity can be utilized for a wider tax shift and introduction of environmental taxes to replace the existing taxes.
1.7 Additional revenue for environmental improvement
It is likely that even after the levy of environmental taxes, the producers and consumers will probably not stop pollution causing activities. Taxes on these will help raise revenues that may also be used to subsidise producers or consumers to shift to more environment friendly activities. This would be an additional source of funds for environmental improvement. (Clinch et. al., 2004)
2. Problems in shift towards environmental taxation
2.1Double dividend and burden shifting
Goulder (1994) compared the effects of an energy tax in a scenario where revenue was recycled through future tax cuts. Goulder (1995) also studied the effects of a carbon tax, offset by reductions in period-by-period marginal tax rates. He only found “weak” double-dividend effect of reductions in economic losses from energy or carbon taxes by means of using revenues to reduce other, distortionary taxes. In none of these cases, however, did Goulder find a double dividend outcome in which economic losses were completely offset by this mechanism. (Sanstad and Wolff, 2000, p.15, 16) Thus, the utility of the double dividend argument has to be clearly established (Oates, 1995, p.918) and therefore it may not be possible to have burden shifting through environmental taxation.
2.2 Competitiveness
The proponents of environmental taxes state that the taxes would make the businesses competitive by making them ‘eco-efficient.’ However, environmental taxation may result in loss of competitiveness. A developed country operates in the international market. If environmental taxes are adopted by the country but its trading partners do not do so, this will increase the cost of production and result in loss of international competitiveness. (Clinch and Dunne, 2004)To avoid payment of environmental taxes some companies may even relocate production and emissions to other countries. Such significant shifts would adversely affect the economy, jobs and result in loss of taxes. (Clinch et. al., 2004)
2.3 Trust in the government to use taxes effectively
Even though there is great concern about environment in the developed countries, yet people normally perceive that environmental taxes will be an additional burden. They were suspicious that the revenues will actually be used to ‘reduce other taxes or fund hypothecated expenditure.’ (Dresner et al., 2004, p.936) The people have little faith in their politicians and governments to do a tax shift in an efficient and transparent manner. This would be one of the major impediments, which the government will face in implementing the tax shift. The government will have to prove itself to be ‘capable and committed’ to use the environmental tax revenue to reduce labour taxes rather than ‘it just disappearing into a black hole.’ (Clinch and Dunne, 2004)
2.4 Increased costs for the poor
The producers facing the burden of environmental taxes may shift the increase in cost increases to consumers in shape of higher prices. This may increase the prices of fuel, gas and heating for the poor sections of the society who are large consumers of these products and are sensitive to pricing mechanisms. Further, they will not be benefiting from the reductions in the labour taxes, as they are normally not liable to pay labour taxes. (Ekins and Dresner, 2004) and (Dresner et. al., 2004) Thus, equity issue is involved in the imposition of environmental taxes and they may prove to be regressive for the vulnerable members of the society.
2.5 Harmful to certain industries
The environmental taxes will adversely affect certain industries. Fossil fuel industries energy-intensive industries as mining, bulk metals, cement, steel, nitrogenous fertilizers, chemicals and ceramics would experience substantial price increases due to increased taxes. These industries are important part of the economy employ large work force. (Kasa, 1999) Any major price increases or reduction in their sales would have an adverse impact on the economy. Closure of these industries may increase unemployment.
2.6 Adverse impacts on environment
Imposition of environmental taxes may result in illegal disposal of the waste due to high disposal costs as imposition of tax on nickel-cadmium rechargeable batteries in Denmark resulted in their illegal disposal. (Devas, 2007) Imposition of taxes may in shift of industry to areas, which have a higher cost for example the fossil fuel based power plants may move towards nuclear power, which has even greater environmental risk. The process of reducing pollution will lead the move to recycle waste, which in itself consumes a large amount of energy. (Devas, 2007)
2.7 Limitations of environmental taxation
Environmental taxes are powerful tools but there are limitations to their use. Taxes can only be levied if we can measure the externality. There are ‘externalities’ that are not possible to measure or where measuring the externality is expensive or intrusive. (Durning, 1998) Taxes cannot help to clean up the existing mess. Taxes may not be able to protect picturesque coasts and other scenic and important zones from development for which regulation and other forms of controls are needed.
3. Practical difficulties in making the ‘Tax Shift’
3.1 Predictability of Revenue
An environmental tax shift policy to substitute revenue by reducing existing taxes requires a very accurate system to predict the revenue from the environmental taxes. The revenue from environmental taxes will be unpredictable as it will depend on the change in the prices of goods and services because of the tax. This in turn will depend upon sensitivity of producers and consumers to price increase. (Taylor, 2003) In cases of a significant response to environmental taxes, the revenues will decline. This rate of decline may be difficult to estimate and this will any make reduction in existing taxes unpredictable. (Broadway, 2003) Continual adjustment of tax rates may then be necessary to maintain revenue neutrality. This may have high administrative costs.
3.2 Difficulty in fixing actual cost
The imposition of the environmental taxes will have difficulty in defining the ‘true’ present and future economic costs of the resources used as well as the damage caused to the environment and human health at every stage of production, processing, distribution, consumption and disposal. Similarly, it would not be practically possible to estimate the present level of pollution caused by the existing pollutant. Consequently, it will be difficult to decide on the baseline level of pollution and to measure if pollution has decreased or increased because of taxation. The environmental taxes probably will be decided in a lump sum, adhoc manner and they may not accurately reflect the cost of the externality. (Robertson, 1996)
3.3 Deciding between different taxes
Several type environmental taxes can be levied. These can be carbon tax, sulphur charge, toxic waste charge, water pollution charge, battery charge, household waste charge, noise pollution tax, landfill tax and many more. The government would have to decide on the method of taxes, if they will be cost covering or incentivising or revenue generating. The government would also have to decide if few or all these taxes have to be implemented. A large number of taxes or taxable items would result in public outcry and imposition difficulties. (Clinch et. al., 2004) and (Ekins and Dresner, 2004)
3.4 Administering the tax
While looking at the question of the environmental taxation we have also to examine the issue of administrating this tax. Is the tax easy to administer and enforce? Is it easy for taxpayers to comply with the tax? Is it easy to evade? The taxes may be easy to collect if levied close to the source of pollution, however if they are applied throughout the economy, they may be difficult to collection and may lead to evasion. (Hassett and Metcalf, 2000) The government will need to develop an institutional framework for tax administration, which will estimate the level of pollution, levy taxes, collect taxes and then redistribute these taxes to development finance. The will require extensive training in tax administration and detection of evasion of new taxes.
3.5 Governmental structure
A strong environment friendly government is needed to implement environmental tax shift. In a developed country, the composition of the parliament, presence or absence of coalition government and relative strength of the green parties will determine the shift towards environmental taxation. Further, the internal structure of government may be a possible obstacle to introduction of environmental tax. The Finance ministry may not agree to ‘hypothecate its tax policy’ to the ministry of Environment, who would want to ‘score for environmental performance.’ (Clinch et. al., 2004)
3.6 Opposition to taxes
There may be large-scale opposition from people on imposition of taxes on items, which have little demand elasticity for example in Britain levy of ‘fuel charge escalator’ met with strong resistance. (Ekins and Dresner, 2004, p.34) Similarly the environmental taxes aim at the energy-intensive companies in chemical, metallurgical, pulp and paper sectors and petroleum & gas refineries. Historically they have been played an important role in the economy. They also employ large number of people. They are politically well connected and are vocal in the business confederations. (Kasa, 1999) Anything affecting their competitiveness or effecting employment will have significant political implications and would adversely influence any levy of environmental taxes.
3.7 Macroeconomic conditions
The possibility of increasing the demand for labour via the reduction of labour taxes will largely depend upon the macroeconomic and labour market conditions in the country. If the country is having high unemployment figures, tax shift, which provides incentives to the workers, will become more attractive. However, it will be hard to introduce environmental taxes if the real earnings of the people are falling, as environmental taxes would then result in net increase in costs. (Clinch et. al., 2004)The people may not see the point in lowering the taxes on employment and increasing the taxes on the consumables as fuel, gas, electricity and heating. It may seem pointless to shift money from one place to another.
3.8 Gradual Implementation
The immediate total tax shift towards ‘environmental taxes’ is not possible. At present the nature and amount of tax receipts is uncertain. The governments also need a time to gain experience in implementing and enforcing these taxes. It would also ensure that existing revenues are gradually replaced and not abruptly cut off. A phase-in would give governments time to fine-tune the tax system. A phase-in would also give reformers time to guard against a potential weakness of environmental taxes. (Taylor, 2003) People and companies also need time to pursue practices, which lower the pollution. Thus, gradual transition towards these taxes, over several years, is only possible.
Conclusion
The environmental taxes provide an economic opportunity of rationalizing market costs of polluting goods. They also provide an opportunity for revenue generation but environmental taxes are unfamiliar tools of public finance. The revenue generation from environmental taxes is uncertain. Further, they will have a major impact on the industry, which may lead to strong opposition to their implementation. The government will have to make an important trade-off between environmental taxes and the potential loss of international competitiveness to countries that impose lower or no environmental taxes. The tax structure would also need careful design to have a phasing mechanism. The recycling of environmental revenues to replace the existing taxes would need formats for efficient functioning. The adverse impact on vulnerable sections of society would also need careful tax design. The environmental taxes at present do not yield significant revenue. Although they appear to provide a very potent and effective form of taxation, yet it is uncertain as to what extent they would be able to replace the existing taxes.
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