Environmental Taxes

When tax is imposed on a polluting or environmentally harmful substance or activity, it introduces an economic cost that the polluter will take into account when making the decision on whether or not to carry on the activity or, how it is done or its extent. This applies whether the activity is part of a production process, consumption, or the way waste is disposed of. Harming the environment can be seen as claiming a service from nature. The producer or consumer should bear the full costs of their various input factors so as to ensure that production and consumption is economically justifiable, and that inherent or ensuing costs are not carried over to others. Introducing a well measured tax implies that the relevant external costs are internalized in the decision process.

Environment taxes effectuate the principle that the polluter shall pay.

The OECD, IEA and the European Commission have agreed to define environmentally related taxes as any compulsory, unrequited payment to general government levied on tax-bases deemed to be of particular environmental relevance. The relevant tax-bases include energy products, motor vehicles, waste, measured or estimated emissions, natural resources, etc. Taxes are unrequited in the sense that benefits provided by government to taxpayers are not normally in proportion to their payments.

Requited compulsory payments to the government that are levied more or less in proportion to services provided (e.g. the amount of wastes collected and treated) can be labelled as fees and charges. The term levy covers both taxes and fees/charges.  

According to the OECD (Organisation for Economic Co-operation and Development) 2006 report a database operated in cooperation between OECD and the European Environment Agency (EEA) has entered 375 environmentally related taxes in OECD member countries, plus some 250 environmentally related fees and charges in those countries. Of the taxes, the largest number is levied on energy products (150), on motor vehicles (125), and various forms of waste (50).There is a wide range of environmentally related taxes currently levied in the OECD-countries, among others: water pollution tax, batteries tax, logging tax, tyres tax, beverage container tax, toxic waste levy, tax on plastic bags, aircraft noise tax, tax on groundwater extraction, tax on pesticides, and artificial fertilisers, landfill tax, ozone depletion tax etc. 

Environmentally related taxes are, of course, also levied in other parts of the world; in China a tax on wooden chop sticks was increased this year in order to protect forests. 

The aim and purpose of environmental taxes is to curb or reduce the extent and amount of the use or consumption of harmful substances or activities, or depletion of a resource. When the imposition of the tax is well targeted, it will add to the costs of the subject paying the tax. The adding of costs to a producer within one country or region, that is not imposed on producers outside that country or region, may of course impact on the competitiveness of the local producer. The result may be that a polluting activity is reduced in geographical areas where environmental standards are higher, and increased or taken over by competitors in places with laxer regulatory regimes.

Governments therefore may need to consider a smooth introduction of a new environmental tax over a phasing in period, rather than abruptly imposing tax that dramatically changes the terms of market competition overnight. Other measures may be to exempt certain industries or parts thereof, or to couple the levying of a tax with refund mechanisms or to economically support certain sectors in a transitional period, thus abating the effects of the tax.

Such measures to cushion the effects of a tax will tend to reduce its effectiveness, but may be politically necessary in order to introduce the tax in the first place.

Also, introducing a general environmental related tax may have distributional effects that raise concerns, in particular where such effects are regressive in the sense that they impact more on consumers with low capability to pay and relatively less on the wealthy part of the population. If, for example, a significant levy is introduced on driving motor vehicles in certain urban areas, the levy may be effective in reducing the total amount of traffic but also have the effect that less wealthy households are prevented from driving children to school while it does not affect the well off. In order to mitigate the overall negative economic distributive effects of certain taxes and levies, Governments may need to consider other changes to the tax system to alleviate the tax burden of low income citizens, e.g. by adjusting the lower tax brackets.

Another issue that needs to be addressed is the administrative costs and difficulties. Environmental taxes often can be simple and easy to administer at low costs, but where exemptions and refund mechanisms are applied this may change the picture.

COMBINING ENVIRONMENT TAXES WITH OTHER MEASURES AND INSTRUMENTS

Imposing tax on an activity or substance, of course, is a measure applied to put limits and constraints to something that can be legally carried on, used or consumed. Certain activities and substances are harmful to such a degree that Governments, either on its own initiative or based on international agreements, outright prohibit or ban the activity. Such prohibition can be put in place more or less smoothly over a phasing in period. One well known success story in this regard is the Montreal Protocol on Substances That Deplete the Ozone Layer signed in 1987. The treaty stipulates that the production and consumption of compounds that deplete the ozone in the stratosphere –chlorofluorocarbons (CFCs), halons, carbon tetrachloride and methyl chloroform shall be phased out by 2000 (2005 for methyl chloroform). Although the ban has been largely successful it is not 100% effective as it is not yet universally implemented.

Where a harmful activity or substance is not generally disallowed, its application can be limited by regulation. Typically legislation may allow the activity only to a certain extent by authorisation or permits. In such cases the imposition of environmentally related taxes can be applied as an effective measure in combination with the regulatory measure. 

Direct regulation can also be used as a basis for allocation of tradable permits. Where a cap on an activity is imposed and a tradable permit is issued through auction or allocation in consideration for payment, the effect is similar to that of imposing a tax on the activity.

The probably best known example of a tradable permits system on the international level is the Kyoto Protocol to the United Nations Framework Convention on Climate Change . Countries that ratify the protocol commit to reduce their emissions of carbon dioxide and five other greenhouse gases, or engage in emissions trading if they exceed the set limitations. The emission reduction obligations run through the period 2008-2012. The Protocol has been ratified by more than 160 countries contributing 60% of global greenhouse gas emissions. Negotiations will determine the fate of a future treaty to succeed the current one. The European Union has signed up to the Kyoto Protocol in addition to its member states and has established an EU-wide emissions trading system based on allocated emission targets and quotas.

Environment taxes can also be applied in combination with negotiated agreements, subsidies and labelling and certification systems (informing producers and consumers in order for them to make informed choices).