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Second Environmental Economics Round Table Proceedings

Convened by Senator Robert Hill, Minister for the Environment and Heritage, Canberra, 5 July 2000
Environmental Economics Research Paper No. 7
Commonwealth of Australia, 2000
ISBN 0 642 19485 8

Economic Instruments and Taxation Measures for Natural Resource Management

The role of Government, the private sector and the community

Neil Byron

 

Main points

Background

While significant progress has been made in recent years to better manage the Australian environment, significant environmental problems are well-known 19.

Public demand for environmental protection and conservation of biodiversity has grown in recent years reflecting factors such as an improved understanding of the significance of species loss (Bennett, Backhouse and Clark 1995) and rising income levels. As well as environmental assets and natural resources being valuable in their own right, many sectors of the economy rely on the use of these resources. Achieving environmental objectives more effectively and using resources more efficiently is good for both the economy and the environment (IC 1997).

There has been increasing focus on using a mix of policy options, and on recognising the need for shared responsibility across governments, resource owners, users and managers, and the community to achieve environmental objectives.

This presentation summarises:

Direct control

Since the establishment of the US Forest Service in the 1890s by Gifford Pinchot, it has been widely presumed that ‘only a far sighted government agency would ever engage in the management and conservation of production forests–the private sector is only an exploiter and destroyer’. The US National Parks Service followed on the same premise–the avaricious private sector could never be trusted to protect and conserve natural values, amenity and wildlife, and so the government had to take ownership of such areas, and be responsible for the direct provision of these environmental services. The same principle was later extended to water resources.

However there is now ample evidence from around the world, and within Australia, that the private sector can and will manage forests, wildlife, priority conservation areas and even water resources, given appropriate institutional structures and property rights 20 and market signals not too distorted by government interventions.

Direct regulation

In the past, where governments have not chosen to exercise direct ownership and management of natural resources, they have generally relied on applying prescriptive regulation to the private sector owner/managers to achieve environmental goals. Prescriptive regulation is relatively inflexible and can provide limited incentive (or even barriers) to the development of innovative solutions to address environmental problems. Regulatory approaches often specify processes and/or equipment that must be used, or specify allowable discharge quantities or how wastes must be treated and disposed. Due to their inflexibility, such regulations can impose high costs on land owners, industry and the community. Prescriptive regulation can also be costly to monitor and enforce, and can be difficult to revise as technology develops and new information becomes available.

The Industry Commission’s Economically Sustainable Land Management (ESLM) report found that prescriptive regulatory approaches are not working well for dealing with natural resource issues and environmental protection. The report (IC 1998, p. 5) noted that ‘regulation has often not recognized the severe practical limits to what can be achieved with prohibition’. The report also found that much regulation is ad hoc and often the only policy response used. Further, regulations have often been set with limited input from those who are required to work under them.

More recent approaches to regulation focus on desired outcomes, rather than prescribing how performance is to be achieved. This allows regulated parties to work out the most cost effective way of achieving desired objectives. Two broad categories of such regulations include performance-based and principles-based regulations (ORR 1997). 21

Economic instruments

Complementing moves towards more flexible direct regulation has been the increased use of economic instruments. Economic or market based instruments are commonly defined as ‘price incentive’ instruments which affect the relative prices of alternative activities. Economic instruments cover a range of measures from relatively simple charges and subsidies to more complex systems involving tradable permits schemes. By changing incentives, appropriately designed economic instruments can encourage conservation and more efficient use of resources and hence limit undesirable environmental impacts.

In contrast to prescriptive regulation, economic instruments do not specify a particular process or technology that may be used but allow decision makers to determine which is the best method in their particular circumstances to meet a desired environmental objective (in this sense, they are similar to performance based regulation). Their main advantage over prescriptive regulation is that they provide consumers and industry with greater flexibility for responding to environmental concerns and they also encourage innovation.

In addition, economic instruments often do not prescribe particular outputs, as do performance based regulations. This flexibility means that, in many cases, economic instruments can provide the least cost solution to environmental problems. Some economic instruments have the added attraction to government of providing a potential source of revenue.

Economic instruments can be classified in a number of ways. One way is to distinguish between economic instruments that focus on assigning prices to environmental and other resources within existing markets, and those which involve the creation of new markets. They can also be classified according to whether or not participation is voluntary.

Economic instruments within existing markets

Examples of applications of economic instruments within existing markets include taxes and charges, and subsidies and tax concessions. Taxes and charges may simply be regarded as additional ‘prices’ that firms or other decision makers must pay to cover some or all of the costs associated with the pollution or environmental damage. Where taxes and charges have been set appropriately, firms and consumers are able to take into account the costs of environmental damage caused by their decisions. Those firms and consumers that can reduce environmental damage at a cost lower than the levy or charge will do so, while those that cannot will pay the charge or tax, or lower or even cease production altogether. These measures therefore provide incentives for firms and consumers to find innovative and low cost ways to reduce environmental damage.

Subsidies and tax concessions, on the other hand, encourage producers and consumers to undertake activities that the government regards as beneficial to the environment. Some examples of financial/tax incentives to encourage farmers to provide conservation services are discussed in Binning and Young (1997) and Saunders and Binning (1999). Any such incentives need to be carefully targeted to achieve clearly articulated objectives, and avoid perverse secondary incentives. They also need to be monitored to ensure they continue to achieve their objectives.

Economic instruments defining new markets

As the ESLM report pointed out, environmental harm can be caused by a lack of markets or by the existence of markets that function poorly. In many cases, inadequate markets reflect poorly defined property rights. Because property rights for many natural resources are ill-defined, people tend to overuse some resources and undervalue others.

To create markets for environmental services, it is sometimes possible to assign private property or use rights to natural resources or environmental services through mechanisms such as tradable permit schemes. 22 Permits can create a licence for firms to cause some form of environmental degradation up to specified limits. These limits can be set below current levels of degradation. Through trading of permits amongst polluters, the use of a market mechanisms has the potential to achieve any given target reduction at the lowest cost. Firms with relatively high costs of reducing degradation could buy additional permits from those firms that are able to reduce degradation more cheaply, to mutual benefit. Overall, the system relies on financial incentives to ensure that degradation reductions are made by whoever can do so at least cost, and rewards them for doing so, while penalizing those producers who continue to degrade the environment.

Voluntary measures

Some types of economic instruments allow resource users to choose to undertake (or not to undertake) actions rather than being forced to do so in response to a regulatory requirement (such as direct regulation or through the requirement to have a permit or quota to be able to undertake an activity). Segerson and Li (1999) identify two types of voluntary approaches which involve government participation:

One of the main benefits of the use of voluntary approaches is the potential reduction in the cost of meeting environmental standards through increased flexibility and incentives for innovation. However, as regulatory policies become more flexible and efficient, the relative potential savings from voluntary approaches is reduced (Segerson and Li 1999).

Scope for increased application of economic instruments

There are many complexities involved in using economic instruments, and the benefits and costs of specific proposals need to be carefully considered.23 Nonetheless, the ESLM report concluded that there appears to be potential to expand the use of market based instruments to deal with public good conservation.

Indeed, economic instruments have been used by all levels of government in Australia to deal with problems associated with land, water and air degradation. Examples include:

The ESLM report identified the following as areas that could further benefit from the application of economic instruments 24:

Although economic instruments can promote environmentally beneficial outcomes, the choice for policy makers is often not as simple as adopting one option (say a market based approach) over another (say regulation). Each policy option incorporates different characteristics and advantages and disadvantages and thus tradeoffs must often be made. While there is extensive experience with the use of regulations, the use of economic instruments is far less developed.

A range of factors needs to be considered when selecting the most appropriate instrument or combination of instruments to address an environmental problem. These include:

On a case by case basis, policy makers must make tradeoffs between these criteria as one policy option will rarely satisfy all criteria well. The tradeoffs made will depend on which criteria are paramount in any given circumstance. For example, governments may be risk adverse where policy failure is irreversible (such as with species extinction). In these cases, higher costs may be acceptable in order to achieve greater dependability of the outcome. A combination of instruments is often likely to work best and reduce the extent to which one criteria will have to be sacrificed in order to promote others.

Sharing the burden

The Industry Commission proposed a statutory duty of care for the environment in the ESLM report. This would require anyone who is responsible for the management of land and other natural resources (not just land holders) to take all reasonable and practical steps to avoid harming the environment. A duty of care seeks to have natural resource managers–from small farmers to government agencies–meet the cost of protecting the environment where and when it is expected to be economically efficient to do so from a community perspective. The main effect of ‘reasonable and practical’ is that the requirements for a particular duty holder will vary with the circumstances in each case. This allows a balancing of the risk and severity of the potential harm to the environment with the costs of preventing it.

If the principle of ‘polluter pays’ were adopted, land holders and resource managers would be required to meet the full costs of achieving duty of care requirements. In some circumstances it may be desirable to share the costs, such as when it is not possible or practical to identify the cause of environmental damage; when investment sharing would enable a speedier transition to the attainment of environmental goals and thereby avoid significant (possibly irreversible) losses; or when significant equity issues are involved.

Sharing the costs of environmental management might also be appropriate when environmental objectives exceed what might be required under a duty of care and private sector incentives are not sufficient to elicit the desired behaviour. Indeed, in many areas, loss of biodiversity and land and water degradation requires more than simply avoiding further damage but repairing past damage.

In some cases, private sector incentives may be sufficient. There has been a large increase in the number of private environmental initiatives during the 1990s (Segerson and Li, 1999). There are a number of ways firms may gain through investment in ‘environmental stewardship’. For example, firms may seek to differentiate their products through promotion as being ‘environmentally friendly’ or ‘green’, thus obtaining a larger market share or price premium. Firms might also seek to improve environmental performance to increase their ability to obtain loans and sell equities (Esty, 1997 cited in Segerson and Li) or gain access to particular input and output markets (Tietenberg, 1998 cited in Segerson and Li). Firms might also identify ‘win-win’ opportunities where improved environmental management might result in decreased production costs or improved productivity.

However, in the absence of sufficient private incentives, positive or negative government inducements may be required. Positive inducements can include financial subsidies or cost sharing (see below), while negative inducements can include the explicit or implicit threat of imposition of regulations or taxes if a voluntary approach is not successful in meeting environmental goals (Segerson and Li, 1999). 25

Various cost sharing principles have been proposed by agencies including the Council of Australian Governments (CoAG), the Standing Committee on Agriculture and Resource Management (SCARM) and the Department of Agriculture, Fisheries and Forestry (AFFA). Some agencies include amongst their advocated principles the notion of an environmental duty of care, whilst others suggest a beneficiary pays principle or a trigger for irreversible environmental and/or social harm.

While the Commission does not recommend a particular set of principles for cost sharing, the principles developed by the Victorian State Groundwater Council (see Box 2) represent one approach that may be useful as a reference point in determining cost allocation for private conservation efforts.

Examples where governments have adopted a cost sharing approach include the European Union which developed a series of counter measures such as set-aside and Environmentally Sensitive Area schemes in which farmers were given direct payments in return for adopting environmentally friendly practices (see Latacz-Lohmann 2000). In particular, some of these desired practices involved agricultural ‘extensification’–that is, a reversal of previously excessive intensive farming and a return to more traditional, less environmentally-demanding regimes.

Programs similar to the EU payments programs have also been applied in other countries. In the US, the Soil Bank program ran for several years to assist farmers to turn their land to non-agricultural uses, and promote the development and conservation of natural resources (soil, water, forest, wildlife, and recreational resources) (see Neartica 1999). Under this scheme, payments were made to farmers in return for their conservation practices.

Information and partnerships

The Productivity Commission’s ESD report reinforced the importance of two other key requirements for successful policy responses to environmental concerns: access to reliable information and data; and meaningful involvement of the community and affected groups through partnerships between government, industry and the community (PC 1999).

Reliable information is obviously critical for designing effective responses to environmental problems and for establishing market arrangements. This includes a need, at times, to:

The ESD report found that the information required to formulate and implement policy responses to environmental concerns, is currently inadequate. The report also emphasised that long term research was needed, to generate new understanding about these complex biophysical and socio-economic systems.

Similarly, the ESLM report found that there were significant deficiencies in the generation and dissemination of environmental knowledge and know-how and that this has contributed to the flawed approaches adopted in policies dealing with environmental protection and natural resources. The ESLM report pointed out deficiencies in the quality and coverage of spatial information collected by government, as well as deficiencies in the relevance of the information collected for management decisions at the regional or local level. It made a number of recommendations on how to improve information and research in the environmental area, such as agreed standards to facilitate the aggregation and sharing of data between jurisdictions.

In terms of community involvement, both the ESD and the ESLM reports emphasized that addressing environmental problems requires action from government, industry and the community working together.

Governments have a role in coordinating environmental policies and in developing mechanisms that provide opportunities for community and industry involvement in decision making processes. On the other hand, the community and industry have important roles to play in providing local knowledge and perspectives (at low cost). Importantly, the involvement of the community and industry promotes ownership of problems and solutions by devolving responsibility and authority. This can increase community commitment. Inclusive and open processes can also promote trust and encourage transparency and accountability of decision making. The ESD report found that successes in promoting ESD outcomes often involved a high degree of involvement by stakeholders and other interested parties.

Conclusions

The promotion of sound environmental management can be seen as the shared responsibility of governments, land owners/managers, industry and the community as a whole. The issues of environmental conservation have far reaching implications that test the skills of policy makers in defining and prioritising problems and then devising appropriate equitable solutions.

The use of economic instruments to pursue environmental goals has increased in recent years. However there remains scope to use them further, particularly in combination with other measures.

While economic instruments are not a panacea for dealing with environmental concerns, they can significantly contribute to the promotion of sound environmental management and conservation. This, and the efficient use of natural resources, is not only good for both the environment and the economy, but also essential to national wellbeing and prosperity in the longer term.

Policy options designed to encourage land owners and farmers to change land use practices include the use of direct payments for their production of (environmental) public goods, tax concessions and acquisition subsidies. Such programs should be set at levels that are sustainable over the long term. Consideration should be given to the development of broad principles for sharing the cost of conservation. Other options that should be considered include information and education programs and removal of disincentives or impediments to achieving environmental goals.

Improved accountability and reporting of environmental conservation measures would enable governments to assess the extent to which specific conservation goals are being achieved. Performance indicators need to be developed, and any public funding for conservation measures should (like regulatory instruments) be carefully targeted to achieve specific agreed outcomes.

Box 2 Cost sharing principles for Victorian groundwater

Principle 1

All parties (groundwater users and non-users) have a duty of care to ensure that they do not damage the natural resource base. They should be responsible for the cost of any damage incurred as a result of their actions.

Principle 2

When it is not possible to identify causes of damage then the primary beneficiaries should pay. Contributions from secondary beneficiaries (also known as indirect beneficiaries) will be negotiated with the primary beneficiaries where appropriate.

Principle 3

Government contributes primarily for activities which produce public benefits. Users, both existing and future, are expected to pay for activities which provide private benefit (for the purposes of these principles 'private benefits' are defined as those received by groundwater users and 'public benefits' as benefits which accrue to society as a whole). Government may agree to contribute to groundwater management activities that produce private benefits as the cumulative up-take of these activities provides significant public benefit. In this instance the Government's cost share would be a result of negotiations with the primary beneficiaries.

Principle 4

Government will only share in the cost of managing existing groundwater management problems. It will not address groundwater management problems caused from new development. That is the responsibility of the new developers. Government will however provide a framework for new development.

Principle 5

Before Government will contribute to any groundwater management activity, that activity must be technically sound and the benefits justify the costs.

Principle 6

Government meets the cost of natural resource management activities such as State-wide planning, State-wide resource assessment, and research and investigation where they are crucial to sustainable resource management and where the market forces fail to ensure their provision. In instances where these activities are not of State-wide importance, the activity must be part of a government accepted management plan.

Principle 7

Government is required … to make sure that water resources are conserved and properly managed for sustainable use for the benefit of present and future Victorians. In some instances where damage has occurred to the groundwater resource, and is continuing to occur, it may not be possible to immediately recover the cost of remedial action from the polluters or direct beneficiaries. In such instances, Government may intervene in order to ensure that the groundwater resource is conserved and properly managed.

Source: Victorian State Groundwater Council, April 1997.

 

References

Bennett, A., Backhouse, G. and Clark, T. 1995, People and Nature Conservation, Surrey Beatty and Sons, Sydney.

Binning, C. and Young, M. 1997, Motivating People: Using Management Agreements to Conserve Remnant Vegetation, National Research and Development Program on Rehabilitation, Management and Conservation of Remnant Vegetation, Research Report 1, Environment Australia, Canberra.

Cornwell, A., Travis, J. and Gunasekera, D. 1997, Framework For Greenhouse Emission Trading in Australia, Industry Commission Staff Research Paper, AGPS, Canberra.

DASET 1992a (Department of the Arts, Sport, Environment and Territories) 1992, National Strategy for Ecologically Sustainable Development, Canberra, December.

DASET 1992b (Department of the Arts, Sport, Environment and Territories) 1992, Intergovernmental Agreement on the Environment, Canberra, May.

Dore, M. and Mount, T. (eds.) 1999, Global Environmental Economics: Equity and Limits to Markets, Blackwell, UK.

IC (Industry Commission) 1997, Role of Economic Instruments in Managing the Environment, Staff Research Paper, Industry Commission, Melbourne.

IC (Industry Commission) 1998, A Full Repairing Lease: Inquiry into Ecologically Sustainable Land Management, Report No. 60, AGPS, Canberra.

Latacz-Lohmann U. 2000, ‘European agri-environmental policy facing the 21st. century’, invited paper session on Agri-Environmental Policies Around the World: Past Trends and Prospects, Australian Agricultural and Resource Economics Society Annual Conference 2000, Sydney.

Neartica 1999, United Stated Code Title 7–Agriculture: Chapter 45–Soil Bank Program, http://www.nearctica.com/environ/elaw/ 7misc/soil.htm.

OECD 1989, Economic Instruments for Environmental Protection, Paris.

ORR (Office of Regulation Review) 1997, A Guide to Regulation, AGPS, Canberra.

PC (Productivity Commission) 1999, Implementation of Ecologically Sustainable Development by Commonwealth Departments and Agencies, Draft Report.

Saunders, D. and Binning, C. 1999, Philanthropy: Sustaining the Land, CSIRO Briefing Paper, Canberra.

Segerson, K. and Li, Na 1999, ‘Voluntary approaches to environmental protection’, in ‘The International Yearbook of Environmental and Resource Economics 1999/2000: A Survey of Current Issues’, Hank Folmer and Tom Tietenberg (eds), Edward Elgar Publishing Ltd, Cheltenham, UK.

Tietenberg, T. 1992, Environmental and Natural Resource Economics, Harper Collins, New York, 3rd edition.

Victorian State Groundwater Council 1997, Groundwater: Groundwater Management Structure and Cost Sharing Arrangements, Victoria, April.

Footnotes

19 Dryland salinity has emerged as a major problem in many parts of Australia’s productive farm lands. Significant problems of land degradation, including soil acidification, soil structure decline and soil erosion are also wide spread. Increased demand for water is placing pressure on the environment of inland surface waters, and overuse of groundwater resources are also contributing to land and water degradation.

20 An example where private forestry is limited by institutional structures is British Columbia, Canada, where provincial legislation decrees that all forest land must be owned by the State.

21 Under performance based regulations specific performance objectives need to be achieved, such as specified percentage reductions in salinity levels in water run-offs from farms. Such regulations can be useful when objectives can be easily quantified and measured. Principles-based regulations can allow even greater flexibility by specifying objectives to be sought in more general terms with reference to the underlying objectives of policy intervention, such as a duty of care to contribute to maintaining off-site water quality.

22 Tradeable permits have been used for the emission of SO2 in the United States and for trading salinity in the Hunter River catchment in New South Wales. Tradeable emission permits are being explored as a possible response to Australian’s greenhouse gas reduction commitments (see Cornwell, Travis, and Gunasekera 1997).

23 Further discussion of these issues may be found in IC (1997); OECD (1989); Tietenberg (1992); and Dore and Mount (1999).

24 The National Strategy for Ecologically Sustainable Development (DASET 1992a) and the Intergovernmental Agreement on the Environment (DASET 1992b) both specifically encourage the use of economic instruments for managing the environment.

25 Segerson and Li caution, however, that the use of subsidies can raise questions not only about the budgetary implications but also the potential for unintended market distortions. They note that other forms of positive inducement, such as technical assistance, access to expedited permitting or regulatory procedures reduce the costs of compliance and generally do not involve the same kinds of costs and efficiency losses associated with subsidies.