Taxing the production and consumption of products, processes and activities that cause ecological damage, proportional to that damage. Discriminating against environmentally-unfriendly products through imposition of levies.
Environmental fiscal reform involves the progressive replacement of traditional fiscal charges with targeted charges designed to make the economic actors compensate for all the costs generated by their activities, in particular for the environment and health costs. Environmental fiscal reform offers the double dividend of positive effects on both the economy and the environment. On the one hand, the traditional charges (taxes on income, labour, consumption, etc.) act as brakes on economic activity in general, and reducing them therefore fosters such activity. On the other hand, environmental taxes are an incentive to economic actors to make more efficient use of natural resources and to develop environmentally and health-friendly patterns of production and consumption.
Environmentalists are proposing a "tax shift" to redirect tax incentives. The goal is to give people and companies positive incentives to avoid taxation. Taxes would be judged on their real contribution to the economy, in terms of job creation and productivity growth, equity for the people paying them, and resource conservation.
Conventional taxation systems throughout the world tax work, income, savings, and value added and leave untaxed (or even subsidized) leisure and consumption, resource depletion, and pollution. The implied reduced incentives for work, savings, investment and conservation, and increased incentives for leisure, consumption, resource depletion and environmental degradation, result in more environmental degradation than would have been the case had incentives been the reverse.
A reform of the fiscal system that would reduce conventional taxes and replace them with environmental taxes – so as to leave the total tax burden unchanged – would bring the economy closer to sustainable development by stimulating economic growth and resource conservation and discouraging resource depletion and environmental pollution. A revenue-neutral fiscal reform would save government expenditures on environmental regulation and pollution abatement and it would indirectly advance the objectives of Agenda 21.
While an overnight shift from "taxes on value" to "taxes on vice" is unlikely and potentially disruptive, a gradual shift towards environmental taxes would be a move in the right direction. Experiences suggests that although the amounts of taxes or charges may vary from country to country, they may be adjusted over time to move society closer towards a pattern of production and consumption deemed to better reflect the full range of the costs, including the costs to the society and to future generations.
Over 70 years ago, A C Pigou suggested that governments should impose taxes on activities that involve external social costs. In the case of gasoline, for example, where the social cost is the contribution, albeit slight, of its combustion to air pollution, the Pigouvian tax would equal that part of the marginal social cost which is not included in the production price – the external marginal cost. The advantages are twofold: reduction in pollution is achieved automatically at least cost; and the revenue collected can be added to general revenue and used to make overall reductions in tax rates or to purchase public goods. The concept of a Pigouvian tax is simple, but in practice it may be difficult to implement due to imperfect information and monitoring costs.
One alternative to a pure Pigouvian tax is to levy excise taxes on outputs and inputs closely associated with the pollution-causing activity. Governments may already have in place an indirect tax system on goods and services, and taxable outputs and inputs usually are readily monitored as part of raising public revenue. This policy would be as good as taxing the pollution-causing activity if the latter occurs in fixed proportions with the taxable output or input. This might, however, be too blunt an instrument. For example, taxing gasoline consumption with the objective of reducing pollution provides no incentive to purchase catalytic converters, which may be the least-cost way of abating the pollution.
In between excise taxes on inputs and outputs and taxes or charges on the polluting effluent or emissions themselves are "content" taxes, which are levied on the amount of a particular component in a commodity. The best known example is the "carbon tax" levied by Finland and some other Scandinavian countries, which tax the carbon contained in some fossil fuels. Other examples are taxes on the sulphur content of fuel, or on their thermal content (the "BTU tax"). The advantage of a content tax is that it avoids the difficulty of monitoring the actual emission, while at the s ame time provide an incentive for switching to less polluting technology ( e.g. by changing from coal to gas).
Ecological taxes operate to produce marginal rates of substitution in preferences between environmental goods and material wealth. Ideally, the application of an economic instrument should result in the equivalent of an optimal "Pigouvian tax" (tax that equates the marginal social benefit of reducing the externality to the marginal cost of achieving the reduction). In practice determining the optimal level of such taxes is impossible because of difficulties encountered in defining the product to be taxed, the valuation and the cost calculations.
The science and art of setting environmental taxes is relatively new. Because there are regional differences in the supply of environmental goods and services, in principle ecological tax rates would take into account differences in environmental resource scarcity throughout the world. However, uneven tax rates could distort international competition, imposing extra adjustment costs on the domestic economy of the country in which the tax is higher, and especially the energy-intensive sectors. There is also the question of reallocation or redistribution of the revenues, including the notion of earmarking for environmental purposes.
In 1991, Sweden was the first country to initiate environmental fiscal reform. Others, such as Denmark, the United Kingdom and now France, are following at different paces. Research carried out on this subject area (e.g. by the Organisation for Economic Co-operation and Development (OECD)) is extensive.
Ecological taxes have their main effect through the market: they change relative prices and as such they give a direct incentive to the consumer to alter consumption practices in favour of non-ecotaxed alternatives. Even when there are no alternatives available, ecotaxes have a clear advantage over imposing standards because they stimulate innovation. Market competition induces the polluter (producer and consumers) to search actively for new methods to lower his tax burden. Environmental taxes thus make it possible to mobilize the great potential that research and development offers in favour of the environment.
Ecological tax reform would increase the price of resources and concomitantly reduce the cost of labour.
The challenge to the real integration of environment and trade policies is that the trade system offers positive incentives for those who care for the environment and negative ones for those who do not. Therefore, the international fiscal community needs to decide to what degree those environmental differences differences can be used as an element in the competitive position of countries and regions, but not as a pretext for what is really protectionism.
Problems often arise because one instrument (the ecological tax) is used to obtain several goals whose relationship is insufficiently understood beforehand. For example, if the prime objective of an ecotax on drink containers is to limit solid waste production, then recycling and reuse options should be judged on their relative effectiveness and efficiency with respect to attainment of this goal, and only this goal. Adding another goal of, say, optimal materials recycling, confounds the attainment of the first goal. So generally, efforts to render a global strategy for ecotaxes based on a multitude of environmental criteria and irrespective of non-environmental criteria (such as price elasticity or wealth) will almost certainly fail.
Environmental taxes are often seen as a licence to pollute, particularly if adaptation costs are high and the elasticity of demand is low.
Ecological taxes can easily become ineffective and politically unacceptable when in contradiction to other parts of the regulatory framework. This applies both within a country (e.g. when linked to a value-added tax or excise duty), and between countries where no border controls exists, as in the European Union (EU customers are free to shop within the common market so direct import of non-taxed products for personal use is always possible).
Many applications of ecotaxes advocated by local industry contain one or more hidden market barriers favouring them over their foreign competitors. On the other hand, local producers protest when foreign competitors are not subjected to the same stringent standards that are imposed on them, complaining of ecological dumping.
Ecological taxes are discriminatory because the assessment of environmental damage is always imperfect and subjective; also because of the possibility of exemptions, for example on the use of pesticides by farmers but not individual households.
Ecotaxes infringe the principle of consumer sovereignty.
Environmental taxes create opportunities for circumventing the law -- private persons may choose to buy directly from the producer or service provider thus avoiding the ecotax.