Classification of environmental taxes

settled, this is about the only progress that can be noted. The reason for this development is not least that the use of economic instruments is tied in with the wider issue of tax policy at the European level. The EU is a supra-national in- stitution in which the harmonisation of taxes re- quires unanimity among member states, and while common environmental taxes, such as a Europe-wide CO 2 tax, would represent a step forward in the integration process, they have not received unanimous support. The present ef- forts at the EU-level are thus targeted towards improving the conditions for individual member states that wish to take the opportunity of the advantages for environmental policy implemen- tation offered by the use of economic instru- ments, although a proposal for minimum harmonised excise duties on energy has also been put forward. The purpose of this paper is briefly to set out the rationale for environmental taxes, to classify them so that their purpose and motivation can be understood, and to identify the environmen- tal themes towards which they are directed Sec- tion 2. The paper then provides an overview of the national applications of economic instru- ments in industrialised countries. The OECD has produced comprehensive listings of the ap- plication of economic instruments based on sur- veys in 1987 and 1992 OECD, 1989, 1994c, and a further listing in 1997 OECD, 1997a. While this paper updates this information to some extent, using a database recently produced for the European Commission ECDGXI, 1999, it also offers some observations on the acquired implementation experiences with economic in- struments, including where countries have exper- imented with a more general tax shift from labour to resources and pollution and green tax reform Section 3. Tax rates and revenues, where given, are converted into ECU to provide comparability, using ECU exchange rates that existed in 1997, and which are set out in Ap- pendix A. Section 4 addresses the major issues that are raised by the imposition of environmen- tal taxes, including effects on competitiveness and distribution. Section 5 concludes.

2. Classification of environmental taxes

2 . 1 . The rationale for en6ironmental taxes and charges Since the birth of modern environmental policy in the early 1970s, the industrialised countries have endorsed the polluter pays principle. OECD countries embraced the principle in 1972, it was recommended by the Council of Ministers in the European Community’s First Environmental Ac- tion Programme in 1973, and at the intergovern- mental conference in 1985, it was laid down in the Treaty of Rome. Its original intention was to put restrictions on subsidies for environmental protec- tion and to ensure that polluters paid the costs of such protection made necessary by their activities. A wider interpretation, sometimes put on the principle, is that polluters should pay the costs of the environmental damage they cause. Either in- terpretation justifies the appropriate imposition of environmental taxes and charges. A distinction between taxes and charges is drawn in the next section. The basic rationale for the use of taxes and charges in environmental policy is provided by the existence of environmental externalities: impacts on the environment, and perhaps thence on peo- ple, which are side-effects of processes of produc- tion and consumption and which do not enter into the calculations of those responsible for the processes. Where the effects are negative, exter- nalities are costs. By levying a tax or charge on the activity giving rise to the effect, the external cost can be partially or wholly internalised. There is increasing evidence that environmental exter- nalities, in terms of their effects on human health, buildings and ecosystems are now very substan- tial, especially in such areas as transportation, which increases the inefficiency and inequity of not internalising them, and the desirability of doing so. Provided the tax or charge is levied on the cause of the environmental damage for example, on emissions to air, water or land in such a way that a reduction in the cause for example, a reduction in the volume or toxicity of the emis- sion reduces the tax liability, then there will be an incentive for the cause to be reduced. A producer facing an emissions tax will seek to abate the emissions or change to inputs or processes that cause them less or not at all. Such tax as is paid will increase the price of the relevant product, giving consumers the incentive to switch away from it. Moreover, the incentive to reduce the taxed effect is operative at all levels of the effect, unlike with conventional environmental regula- tion, when the improvement incentive ceases to operate once the regulatory standard has been reached. Given that producers and consumers will prob- ably not cease entirely the activities that are being taxed, the taxes and charges will raise revenues. These may be used to address environmental problems directly; or they may be used to sub- sidise producers or consumers to shift to more environmentally-benign activities, providing a sec- ond incentive for environmental improvement; or they may serve to prevent regressive effects from the taxes and charges, by compensating those on low incomes; or they may be applied to other government purposes, allowing, for the same level of government expenditure, other taxes to be reduced. The essential elements of environmental taxes and charges are therefore that: 1. They incorporate the costs of environmental damage into the prices of the goods, services or activities which give rise to them. 2. Thereby they create incentives for producers and consumers to shift away from environ- mentally-damaging behaviour, so reducing the damage. 3. Because each producer faces the same incen- tive, they act to equalise the marginal cost of environmental improvement across the tax base, thereby achieving the improvement at least cost. 4. For producers they may act as a spur to innovation even in the short term. When en- ergy, water and raw materials, as well as solid, liquid or gas emissions become taxed, tax- payers will develop new modes of production, transportation, housing, energy use and gen- eral consumption to reduce their liability. The stimulus to such an ‘ecological modernisation’ is significant both to sustainability and to long run international competitiveness, where to- morrow’s products depend on today’s innovations. 5. They raise revenues which can be used for a variety of purposes, some of which improve the environment or give further incentives to do so. Alternatively the revenues may be used to reduce labour taxation with the objective of increasing employment, or to correct undesir- able distributional effects. 2 . 2 . Classifying en6ironmental taxes and charges Classifying environmental taxes is rather a com- plex task, due to both the different forms they can take and the different functions they can perform. The following classification distinguishes between the incentive and revenue-raising functions of a tax, and between the main uses to which the revenues can be put. 2 . 2 . 1 . Cost-co6ering charges Ironically the earliest experience of environ- mental taxes actually arose from the implementa- tion of traditional regulatory environmental policy. Regulating emissions to land or water costs money. In accordance with the polluter pays principle, it seemed appropriate that the regula- tion should be paid for by those being regulated. Hence the first category of environmental taxes and charges, still important today, is that of cost- covering charges, whereby those making use of the environment contribute to or cover the cost of monitoring or controlling that use. Cost-covering charges can be of two types: user charges, where the charge is paid for a specific environmental service for example, treating the waste-water, disposing of the waste of the charge- payer, or covering the administrative costs of regulation; and earmarked charges, where the revenue from the charge is spent on related envi- ronmental purposes but not in the form of a specific service to the charge-payer for example, general water treatment or land remediation. The level of a cost-covering charge is determined by the service it is intended to deliver or the other purposes to which its revenues will be put. 2 . 2 . 2 . Incenti6e taxes An environmental tax may be levied purely with the intention of changing environmentally damaging behaviour, and without any intention to raise revenues. Such a tax may be termed an incentive tax. The level of an incentive tax can be set by one of two considerations. Where both the cost of the environmental damage, and the eco- nomic benefit deriving from it, per unit of the cause of damage i.e. the marginal damage cost and the marginal benefit can be reliably calcu- lated, then the tax should be set at the level at which the marginal cost and benefit are equal. The tax will then be the optimal tax. This might be termed the optimal approach to incentive taxes. Where it is not possible to estimate the marginal damage cost, or the numbers generated are too uncertain, then the tax can be used as an instrument, probably one among others, to achieve environmental objectives set according to other criteria for example, environmental sustain- ability or the precautionary principle. In contrast to the optimal approach, this may be termed the instrumental approach to incentive taxes in the literature this has been termed the ‘standard pric- ing’ approach, following the paper which first described it, Baumol and Oates, 1971. 2 . 2 . 3 . Re6enue-raising taxes It may be that a tax will change, and be in- tended to change, behaviour but will still yield substantial revenues over and above those re- quired for related environmental regulation i.e. the tax is not a cost-covering charge. Such rev- enues may be desirable to government in them- selves; or they may be the means of bringing about a desired tax shift away from fiscal reliance on, for example, high marginal rates of income tax or high non-wage labour taxes on employers. Environmental taxes, the principal purpose of which is to raise significant revenues, are here termed revenue-raising taxes. Clearly these three types of environmental tax are not mutually exclusive: a cost-covering charge may have incentive effects, as may a revenue- raising tax, or the revenues from a revenue-raising tax may be partially used for related environmen- tal purposes. But there is a two-fold reason for classifying environmental taxes and charges into these three types. First, the classification clarifies the main objective of a tax, over and above the general objective of all environmental taxes, that of environmental improvement. These objectives may not be entirely consistent. For example, a charge that covers the cost of related environmen- tal policy may not be at a sufficient level, or may not be designed, to have an incentive effect. An incentive tax may be so successful at changing behaviour that it ends up raising substantially less revenue than was anticipated the Swedish SO 2 tax fell into this category, see EF, 1996, pp. 114, OECD, 1997b, pp. 30. Secondly, the intention behind a particular kind of tax will, to a large extent, determine the level at which it should be set. A cost-covering charge needs to cover the costs of related environmental regulations, but no more. An incentive tax needs to be set at the appropriate optimal or instrumen- tal level. As to the required level of revenue- raising taxes, they obviously need to be set such that they will generate the desired quantity of revenue. It is therefore important, both for the choice of what is to be taxed and at what level that, the objective of the tax according to this classification is determined in advance. 2 . 3 . En6ironmental taxes in relation to en6ironmental problems In the European Environment Agency’s EEA Report for the Review of the European Commis- sion’s Fifth Environmental Action Programme EEA, 1995, the EEA’s key conclusion was: ‘Without accelerated policies, pressures on the environment will continue to exceed human health standards and the often limited carrying capacity of the environment. Actions taken to date will not lead to full integration of environ- mental considerations into economic sectors or to sustainable development’ EEA, 1995, pp. 1. A further conclusion was that ‘the efficiency issue i.e., maximising the environmental benefits and minimising the economic costs is hardly ad- dressed’ EEA, 1995, pp. 2 in current approaches to environmental policy. The rationale behind environmental taxes sug- gests that they have a potentially important role to play in both economy-environment policy inte- gration, by seeking to incorporate environmental costs into prices, and in achieving cost-effective- ness in environmental policy, by equalising mar- ginal abatement costs across polluters, as noted earlier. It has also been seen that the revenues accruing from environmental taxes can be used to make environmental improvements beyond their incentive effects, or to achieve other goals of public policy while allowing other taxes to be reduced. Environmental problems are inter-related. Of- ten a single pollutant will contribute to several different environmental problems. Reducing this pollutant is therefore likely to ameliorate several problems, although the effects from combinations of pollutants can be complex and no automatic relationship of this kind can be assumed. The EC’s Fifth Environmental Action Programme grouped key environmental concerns into envi- ronmental themes. In reviewing the Fifth Envi- ronmental Action Programme, the EEA Report assessed environmental progress, and the key EU environmental measures, against these themes EEA, 1995, Chapter 4, pp. 45 – 116, and Ap- pendix A, pp. 145 – 147. It is interesting also to see how the main environmental taxes and charges which have been introduced relate to these environmental themes, which are climate change, ozone depletion, acidification, air pollu- tion and quality, waste management, urban issues, inland water resources, coastal zones and marine waters, risk management, soil quality, nature and biodiversity. Specific taxes are described in more detail in the next section, but Table 1 illustrates in a general way some of the multiple effects which can be expected from a range of environmental taxes. 2 . 3 . 1 . Carbonenergyfuel taxes The principal environmental motivation behind the introduction of carbonenergyfuel taxes has been the desire to control CO 2 emissions, the main greenhouse gas responsible for global warm- ing and climate change. In mitigating climate change, these taxes also reduce environmental risks and threats to ecosystems. Reduced fossil fuel use also leads to the reduction in polluting emissions apart from CO 2 , such as SO 2 , NO x , particulates and volatile organic compounds, Table 1 Multiple impacts of some environmental taxes Waste tax Tax difference on unleaded CFC tax Surplus manure PRIVATE Carbonenergy NO x SO 2 tax tax petrol fuel tax Climate change ’ b ’ ’’ a ’ ’ ’’ Ozone depletion ’ ’’ Acidification ’’ Air pollution ’ ’’ ’ quality ’’ Waste manage- ment ’ Urban issues ’ ’ ’ ’’ ’ Inland waters ’ ’ Coastalmarine ’ waters ’ ’ Risk manage- ’ ment Soil quality ’ ’ ’ ’ ’ ’ Naturebiodiver- sity a ’’, the main target of the environmental tax. b ’, other environmental themes where the tax is likely to have an effect. which between them contribute to acidification, poor air quality, especially in urban areas, and eutrophication of inland waters. Because of the multiple environmental externalities caused by burning fossil fuels, they are a principal target of environmental taxation, with the significant ex- ception of aviation fuel and international marine fuel. There are increasing calls that these fuels too should be taxed, on an internationally harmonised basis. 2 . 3 . 2 . NO x SO 2 tax It can be seen from Table 1 that even single pollutants like NO x and SO 2 are implicated in a number of environmental problems, including acidification, poor air quality, again particularly in cities, eutrophication of inland waters and ef- fects on ecosystems. 2 . 3 . 3 . Waste tax Waste taxes seek to promote more effective, sustainable waste management through a reduc- tion in the amount of waste going to landfill and increased recycling and waste reduction. By re- ducing the amount of landfilled waste, they will reduce the emission from landfill sites of methane, a greenhouse gas contributing to climate change; they will reduce the amount of pollutants leaching into groundwater; and they will reduce the noise, smell and loss of amenity that frequently occur around landfill sites. If the tax leads to reductions in incinerated as well as landfilled waste, concerns about possible toxic pollution from incinerators for example, from dioxins will be allayed as well. 2 . 3 . 4 . Surplus manure tax Surplus manure derives from intensively farmed livestock, and its main environmental impact is the pollution of inland waters. Thence it affects coastal waters. Ecosystems are also affected in both fresh and marine environments. Surplus ma- nure also has negative effects on soil quality. Farm animals are major emitters of the green- house gas methane, so that taxing surplus manure may be expected to have a positive if small effect on this cause of climate change. 2 . 3 . 5 . Tax differential on unleaded petrol This tax differential is mainly aimed at improv- ing air quality by reducing lead levels, which is principally a concern in urban areas. However, reducing lead emissions from motor cars will also reduce lead pollution of soil and water. Because the effects of lead pollution are still subject to substantial uncertainty, reducing it will also di- minish the risks associated with that uncertainty. 2 . 3 . 6 . CFC tax This tax is mainly aimed at the problem of ozone depletion with its consequences for human health. It therefore contributes to managing the risk involved in ozone depletion, not least with regard to possible effects on ecosystems. CFCs are also a greenhouse gas. Broadly, the level of an environmental tax should reflect the severity of the environmental problem to which it is directed. The fact that an environmental tax can have beneficial effects on a number of environmental problems should be taken into account when the rate of the tax is being set.

3. Current tendencies and practices