Department of the Environment

About us | Contact us | Publications

About us header images - leftAbout us header images - centreAbout us header images - right

Publications archive

Disclaimer

Key departmental publications, e.g. annual reports, budget papers and program guidelines are available in our online archive.

Much of the material listed on these archived web pages has been superseded, or served a particular purpose at a particular time. It may contain references to activities or policies that have no current application. Many archived documents may link to web pages that have moved or no longer exist, or may refer to other documents that are no longer available.

Taxation and the Environment

Environmental Economics Seminar Series
Department of the Environment, Sport and Territories
March 1996
ISBN 0 642 24878 8

Taxes and levies as instruments for environmental policy

Gul Izmir
Director, Economics and Environmental Reporting
NSW Environment Protection Authority

Introduction

In the face of major environmental challenges including such problems as urban smog, diffuse source pollution and eutrophication of rivers, it is becoming increasingly clear that reliance on traditional approaches to regulation alone will not ensure continued environmental improvements or allow regulatory agencies to achieve their missions.

A decade ago, most people saw the solutions to environmental problems lying primarily in command-and-control regulation. In fact, significant progress in environmental protection has been achieved through traditional forms of regulation and there will always be a need for a strong regulatory framework. However, the incremental gains from traditional approaches are decreasing and this suggests that we must move beyond prescriptive, end-of-pipe approaches by increasing our use of innovative technologies and policy instruments.

One of the new directions in environmental policy is wider utilisation of economic analysis and market-based approaches. A focus on the priorities of industry, environmental groups and the community is an essential element of the economic approach to designing environmental programs. Economic instruments provide industry with additional flexibility in determining the best way to reduce their discharges. Firms have financial incentives, such as reduced charges or emission credits they can market, to make greater reductions than are required by regulation and develop more efficient pollution prevention and control technologies. In some cases, this added flexibility also leads to faster achievement of higher standards, as firms who have difficulty in upgrading their processes are given alternative mechanisms to contribute to environmental protection.

Environmental taxes, charges and levies are one major class of economic instruments that could be used for achieving better levels of environmental protection. They constitute a mechanism for putting prices on the use of the environment. As with any other policy tool, their acceptability and effectiveness varies according to the particular environmental problem at hand and the way they are designed and implemented. In this paper the drivers and barriers to implementation of environmental taxes and some design and implementation issues will be discussed, the approach of the NSW EPA to environmental charges and the recent issue of a carbon tax will be reviewed briefly and some broad conclusions as to the future implementation of environmental taxes, charges and levies will be drawn.

Drivers and barriers to implementation

The amount of research done in the area of economic instruments, the numerous reports and papers produced, the various working groups and other policy platforms established for that purpose and the amount of time and resources allocated to this end overseas, and also increasingly so in Australia, are quite impressive (Repetto et al , 1992; OECD 1989, 1991, 1994; US EPA 1992)

The conceptual case for environmental taxes and levies is quite a strong one. However, the extent to which these approaches have been incorporated into the actual regulatory policies has been less than their merits would seem to warrant. In Australia there has been some use of pollution charges within the context of trade waste pricing policies of Sydney Water and Melbourne Water, the waste disposal levy in NSW, and the extractive industry levy to create a fund to rehabilitate disused quarries and the effluent charges for disposal to marine waters in South Australia.

Environmental taxes and levies have been utilised to a greater extent overseas, although the number of applications and their overall acceptance as part of the full array of regulatory tools still falls far behind the levels that would be expected on conceptual grounds (NSW EPA, 1994)

An understanding of the drivers for and barriers to implementation of environmental taxes is essential to ensure that efforts are directed towards developing effective policy tools.

Drivers for implementation

The major appeal of environmental taxes and levies to environmental policy makers is their potential to provide the best environmental outcome at least cost. Actual air and water program costs are often several times higher than the estimated minimum attainable costs. Nearly all studies examining the potential for cost savings conclude that a basic shift to an economic incentive based system is the right path to follow.

An argument usually put forward in favour of environmental taxes and levies is that they can be used to shift the balance of taxation away from taxing 'goods' to taxing 'bads'. In general, labor, income and savings are 'goods' that make the economy productive, while environmental degradation is a 'bad' that reduces overall economic welfare. Thus, a shift in the burden of taxation away from labor, income and savings towards pollution would provide both economic and environmental gains.

Another fundamental appeal of economic instruments is their potential to drive technological innovation. Conventional regulations do not provide incentives to go beyond the required levels of control. When the focus is on meeting standards, little or no incentive exists for firms to exceed their control targets. Economic instruments, on the other hand, stimulate development of more efficient pollution prevention and control technology. By leading firms to factor environmental costs into their investment decisions, they create powerful incentives to firms for technological innovation and development of cleaner technologies.

The fact that economic instruments can provide a means for faster achievement of higher standards can be another driving factor in their implementation By providing firms who face difficulties in reducing their emissions with an alternative mechanism to contribute to environmental protection, delays in compliance for long periods and requests for extensive 'grace periods' can be minimised.

The emergence of more complex environmental issues that are less amenable to resolution through conventional approaches can be another driving force in wider utilisation of economic instruments. Moves towards integrated pollution control, which requires consideration of discharges to all media simultaneously, will also create a more favourable climate for economic instruments. Schemes such as load-based licensing which set licence fees based on pollutant load emitted can be structured to provide the appropriate signals to firms to examine the overall impacts of their discharges and to avoid inter-media transfers of pollution.

One of the most significant driving forces would be the congruence of interests on the part of the traditional regulators, champions of environmental taxes and the regulated. For example, within the US EPA, although water programs have shown considerable resistance to the use of economic instruments in general, they have been quite favourably disposed towards instruments involving nonpoint sources. This is largely because traditionally nonpoint sources were not regulated and economic instruments provided a way of bringing nonpoint sources under 'regulatory' control.

Barriers to implementation

Probably the greatest barrier to implementation of environmental taxes and levies is the inherent difficulty of changing the status-quo.

Introducing change into any system, gaining support for new ideas and developing a constituency are never easy. If existing legal, administrative and institutional frameworks need to be changed dramatically, that would constitute a major barrier to introduction of new economic instruments. In any case, the burden of proof always seems to be greater on the economic incentive programs than the existing regulatory programs. Generally, there isn't a great deal of enthusiasm on the part of management or staff in environmental agencies. They are either sceptical about these new approaches which have not yet been applied to a large extent, or feel threatened that their existing expertise will lose its value.

There is also the issue of resistance from industry groups or lobbyists who oppose environmental taxes on grounds of the cost burden, or because they are reluctant to allow any major changes to the rules of the game. If environmental taxes and charges are perceived as an additional financial burden on top of the costs associated with pollution abatement to meet regulatory standards, industry concerns are greater. Those concerns are further heightened if industry in competitor countries is not subject to the same charges. A parallel issue is that major industrial establishments have developed considerable expertise in dealing with the current regulatory framework and engaging in strategic behaviour to influence its outcomes. A major change in the regulatory framework could render some of that expertise obsolete and would not be viewed as desirable.

One of the difficulties in developing economic instruments in general is the diversity of skills and expertise required. Multidisciplinary teams consisting of environmental specialists, legal specialists, communication specialists and technical and operational staff as well as economists are needed. Some of the skills can be scarce within traditional command-and-control culture organisations, which makes identification and development of potential applications difficult.

Finally, what is politically feasible determines to a large extent whether and which economic instruments are developed. Environmental taxes and levies are particularly problematic because new taxes are always highly controversial. Even proposals that have a lot of merit from both economic and environmental perspectives will be approached with caution at the political level if they are identified with the 'tax' label. Furthermore, if environmental taxes and levies are viewed as yet another form of general taxation aimed purely at revenue raising, public and political acceptability will not be forthcoming.

Design and implementation issues

It seems a lot more hard work needs to be done to ensure greater penetration of economic instruments and especially environmental taxes and levies into environmental policy formulation. Developing and implementing such schemes involves establishing an interface between the environmental, economic and political interests. It requires a major effort in building a coalition between industry, media, environmentalists, politicians, other interest groups and bureaucrats. The successful programs overseas were successful because there was a congruence of interests or because strategic alliances were carefully sought out, established and nurtured and political issues were dealt with appropriately

An important issue in designing and implementing environmental tax and levy schemes is ascertaining the appropriate level of the tax or the levy. Theoretically, knowledge of the pollution abatement and environmental damage cost curves are required in order to establish the optimal level of environmental quality, discharges and fees. However, in practice neither the pollution abatement costs nor environmental damage are known with any great degree of certainty. In the absence of such knowledge of costs, the setting of the unit fee would involve some trial and error in ascertaining the level that will provide appropriate incentive for firms to reduce their emissions. The fees may also need to take into account variations in the environmental impact of the same pollutant or activity as a result of differences in location or other factors in influencing the sensitivity of the receiving environment.

Administrative feasibility must be taken into account in designing the scheme. If the scheme is too complex, it will lead to excessive administrative costs both for the regulatory authority and industry.

The technical control options that could be adopted by industry in response to the environmental tax or levy would also need to be considered. If the ability of the industry to react to the tax is limited due to unavailability or excessive costs of better control technology, then the tax might not be an effective policy instrument.

Applications of environmental taxes and levies should be targeted to address problems of great community concern and where there is potential for tangible environmental improvements. Priority would need to be given to dealing with pressing environmental issues where most of the gains from traditional forms of regulation have already been achieved and there is a need for a broader approach. Issues such as water quality, urban air quality, land degradation, cumulative impacts and diffuse sources of pollution would probably have high priority within the Australian context. It would be also appropriate to target areas where there is a significant potential for cost-savings and enhancing the effectiveness of regulations.

To be useful tools of environmental policy, environmental taxes, charges and levies need to be developed in recognition of the particular environmental, economic and social circumstances of the country. It is specifics such as the physical location of a range of industries, rainfall and wind patterns, flow regimes of rivers, seasonal variability, labor and capital costs, technological options, community preferences, existing institutional and regulatory frameworks etc. that determine whether a particular tax or levy scheme will be a useful and effective policy tool. All these factors need to be taken into account in identifying and developing potential applications.

The emphasis should be on identifying clearly the benefits for the environment and the industry. The public acceptance of the taxes and levies will be encouraged if real tangible environmental benefits are expected to flow from them. The general community would expect improvements in the quality of their local and regional environments. Industry would expect to avoid additional financial burdens and to achieve greater control regarding the choice of pollution abatement technologies to meet required performance targets.

Any environmental tax or levy scheme would need to be developed in close consultation with all the stakeholders. Stakeholders would need to be given the opportunity of suggesting amendments to the proposed schemes and to be involved in determining its parameters such as the appropriate level of the charge to achieve the desired environmental objectives, appropriate compensation mechanisms etc. In some cases, the proper packaging of the scheme to include subsidies or other compensation mechanisms, phasing-in over a mutually agreed timeframe, and built-in assurances as to the achievement of tangible environmental gains, could improve greatly the acceptability to the various interest groups.

Thus, it would seem that a lot more 'education' and consultation still needs to be undertaken. It is essential to involve all the interest groups in the debate from the start, understand their concerns, address them and foster better appreciation of the ways in which economic incentives can be useful for environmental policy. It is important to frame the debate to identify common ground rather than dwelling on points of contention. For public acceptance, it is essential that the exact nature of any proposed environmental tax or levy is transparent, there are mechanisms in place to ensure review and auditing of outcomes, and those that will pay are aware of its nature.

From a longer-term perspective, it will be important to emphasise that pollution charges do not necessarily mean additional tax burdens for the economy as a whole. The message that governments can reduce taxes that have the effect of discouraging activities such as labor and the generation of capital, while setting up taxes that discourage undesirable behaviour, such as pollution, needs to be much more clearly articulated. It would also need to be supported by actual examples of schemes designed to appropriate level of detail, clearly identifying the groups that will be beneficiaries as well as those that might stand to lose in the short-term, and any proposed transitional arrangements.

The NSW EPA approach

The NSW EPA is undertaking a number of programs and activities to broaden the range of regulatory tools at its disposal for ensuring better environmental protection.

Economic Instruments

The NSW EPA, in conjunction with other government departments, has been investigating the feasibility of introducing a number of economic instruments schemes in the state. Four pilot cases have been selected for investigation:

The preliminary findings of these studies indicated that there would be considerable potential for the application of economic instruments (NSW EPA 1994a, l994b, l994c, l994d).

The findings were presented to industry and community groups through a series of forums. These forums were the first step in exploration and consultation with the community on the potential for economic instruments in environment protection

Following on from the initial feasibility study, a draft operational plan for managing saline discharges into the Hunter River has recently been released. The scheme builds on and complements the existing system of pollution control regulation by allowing mines and power stations to trade discharge credits between themselves and is being implemented as a pilot for a period of one year starting from January 1995.

Again, following on from the initial study, a project to examine the setting up of a 'bubble licence' covering a number of the Sydney Water Corporation sewage treatment plants which discharge to the Hawkesbury-Nepean River has been established.

The NSW EPA is also examining the feasibility of introducing a load-based licensing scheme. Such a scheme would enable the pollution control licensing system to better reflect the impact of pollutant loads on the environment, provide an incentive to industry to reduce discharges to the environment, and lead to a more equitable licensing fee structure.

The basis of load-based licensing lies in the concept of effluent charges. The aim is to set licence fees to more closely reflect the pollutant loads being discharged to the environment, both in terms of concentration and volume. Effluent charges may cover pollutants discharged to air, water and land.

The load-based licensing scheme will enable industry to have more control over the methods used to comply with environmental regulation. Firms will have a financial incentive to undertake pollution abatement measures, since this will result in lower licence fees.

The EPA is aiming to develop a practical scheme which provides an incentive to reduce pollution levels and a more equitable basis for setting fees. The scheme is being developed in consultation with industry and other stakeholders. A range of possible fee structures have been considered. The fee could be applied to the total emissions for each firm. Alternatively, the fee may apply only to emissions above a certain threshold or there might be a multi-tiered fee structure where different levels of fee apply between different thresholds. The threshold emissions could be based on levels currently achievable through best practice, desired targets based on environmental values, or targets set in some other manner for specific groups of industries.

The fee structure selected in consultation with the stakeholders was a two-tiered fee structure, with an upper threshold based on best practice and a lower threshold based on environmental values. Also, the fees will take into account variations due to different locations or other factors in the environmental impact of similar activities emitting similar pollutants. Factors reflecting the sensitivity of the receiving environment will be incorporated into the calculation of fees.

Licence holders will be encouraged to undertake monitoring and to submit emissions data to the EPA. Large point sources could be required to sample and monitor emissions. Where no emissions data is made available, table based coefficients, based on activity type, will need to be used by the EPA to determine emissions levels.

In developing practical schemes for load-based licensing, the EPA will undertake an extensive consultation program to ensure that stakeholders are well-informed of the likely implications of the scheme, that legitimate concerns are addressed, and that suggested improvements are given due consideration. One such consultative workshop has already been held for industry representatives. The suggestions coming out of the workshop will be considered for incorporation into the scheme.

The carbon tax

Concern about the risks of climate change as a result of enhanced greenhouse effect has stimulated considerable research into policies to reduce greenhouse gas emissions. One of the policy instruments that has been investigated worldwide and has recently been considered in Australia is a carbon tax.

The theoretical basis for a carbon tax is quite straightforward. A carbon tax would raise the price of energy relative to other goods. Producers and consumers would respond by producing and buying fewer energy intensive goods. Thus the tax would influence all downstream energy choices of producers and consumers towards more energy efficient and less energy intensive products and activities, and hence lead to reductions in emissions.

The ideal tax rate would be set at the point there benefits of the last ton of emissions reductions equal the cost of eliminating that ton of emissions. However, this ideal tax rate is very difficult to calculate, as the scientific understanding of benefits and methods of valuing these in dollar terms are subject to considerable uncertainty. A wide range of figures is cited in the international literature for the appropriate level of a carbon tax. The low end of this range is around $50/tonne of carbon ($13/tonne of CO 2), which is considerably higher than the levels debated in Australia. Thus, a levy/tax set at the level of $l.25/tonne of CO2 would be too low to achieve any significant reductions in emissions in Australia and less so globally and would have only ended up being a revenue raising measure with dubious environmental gains. This would only serve to heighten the scepticism and distrust felt towards economic instruments rather than providing an impetus for the wider utilisation of economic instruments.

The impacts on the overall level of economic activity depend very much on the way the scheme is designed. If the proceeds from a carbon tax are used to reduce the price of using capital and labor, they could potentially improve economic performance. If however, they are used to reduce personal income taxes, they fail to improve economic productivity.

However, an important consideration here is the feasibility and likelihood of achieving a fundamental change in the taxation system and the steps that would need to be taken to ensure such a change. It would seem that this would require considerable analysis and extensive consultation with business, trade and consumer groups.

In terms of distributional consequences, under a carbon tax coal dependent industries would lose while industries that provide low carbon services such as communications, information services and financial services would stand to gain. Thus, carbon taxes have a potential to redistribute Australia's wealth across the states and regions. States and regions with the most energy-intensive industrial bases may be put at an economic disadvantage relative to others.

From an international perspective, Australian industry would stand to lose more than industries in other countries of the world. This is because Australian industry is energy intensive, coal has a decisive cost advantage and substitution possibilities among alternative energy sources are limited.

In dealing with greenhouse gas emissions, a specific carbon tax is only one of a number of possible options. Another option would be a 'quota' or a 'trading' scheme. Ideally, such a scheme would be implemented at the international level.

In view of the difficulties of implementing a world wide quota scheme, a variant of the tradeable quota idea, Joint Implementation Schemes, are being considered in international policy circles as a more practical option. This involves some countries helping to finance the cost of emission reductions in other parts of the world, where achieving emission reductions is less costly. Such an approach could possibly be contemplated across Australia to achieve targeted reductions in CO 2 emissions in the least costly way for the Australian economy as a whole.

Climate change and greenhouse gas emissions are global problems and their solutions need to be developed within an international context. For example, the OECD estimates that removal of energy subsidies in developing countries has the potential to reduce CO 2 emissions by 20 per cent by 2050. From a global perspective that would be the most effective action. Australia's contribution to global greenhouse emissions is only an estimated 1.4 per cent. Without complementary action by other countries, a unilateral carbon tax could end up adversely affecting the Australian economy with no significant global environmental gain.

In developing schemes for meeting their obligations under the FCCC, it appears that most countries are concentrating on or promoting options that are favourable or at least more acceptable given their specific economic circumstances. Those European countries whose economies do not depend on coal, where hydro power on nuclear power is abundant and with low population growth are implementing carbon taxes, while they are not favouring schemes which give credits for greenhouse sinks. Although a common European Union carbon/energy tax has been on the agenda for more than 2.5 years, agreement has not been able to be reached on a mutually acceptable scheme. Countries like the US with energy-intensive economies are concentrating on offset or joint implementation schemes. In the United States, attempts at implementing a carbon tax were made in the early days of the Clinton administration, but were not successful in the face of strong opposition from coal based industry. Developing countries are requesting establishment of global funds to help them tackle their greenhouse emissions.

Within such a context, it would be essential for Australia to devise or support schemes that would lead to greatest reductions in global greenhouse gas emissions with the least impact on its own economy. A unilateral carbon tax does not fulfil this objective.

Conclusions

There is increasing awareness of the potential for utilising taxes and levies as instruments of environmental policy, as well as considerable opposition to their use in certain circumstances. The way forward would be widening the debate on environmental taxes and levies to involve the various interest groups, encourage exchange of views and develop strategic alliances that will work towards identification of potential applications that will be effective in addressing some of the pressing environmental problems we face today.

Environmental management agencies will always face the prospect of making decisions in the face of uncertainties. In order to arrive at the best decisions, they need to take a synoptic view of situations, and seek to evaluate all relevant factors - social, economic, technical, health, as well as environmental, when formulating strategies. In dealing with these complex set of policy issues, a mix of instruments is likely to be required. The challenge will be to incorporate environmental taxes, charges and levies into an integrated environmental policy making process that draws on the strengths of the individual policy measures available.

In many instances economic instruments can be powerful complements to direct regulation. Recent developments at various political levels have been in the direction of making wider use of these approaches and exploring the potential for their application in a range of environmental policy issues. A wider use of carefully developed economic incentives can lead to more effective environmental protection, both in terms of attaining environmental goals and in doing so with considerable cost savings.

References

NSW EPA (1994). Pollution Charge Systems : An Information Paper, Environmental Economics Series. NSW EPA, Chatswood.

NSW EPA (l994a) . Using Economic Instruments to Control Pollution in the Hawkesbury-Nepean, Environmental Economics Series. NSW EPA, Chatswood.

NSW EPA (1994b). Using Economic Instruments to Control Salinity in the Hunter River, Environmental Economics Series. NSW EPA, Chatswood.

NSW EPA (l994c) . Using Economic Instruments to Control Vehicle Emissions, Environmental Economics Series. NSW EPA, Chatswood.

NSW EPA (1994d) . Using Economic Instruments to Control Pollution from Stationary Sources, Environmental Economics Series. NSW EPA, Chatswood.

OECD (1989) . Economic Instruments for Environmental Protection. OECD, Paris.

OECD (1991) . Guidelines for the Application of Economic Instruments in Environmental Policy, Environmental Committee Meeting at Ministerial Level, 30-31 January, Background Paper No. 1. OECD, Paris.

OECD (1994), Managing the Environment in OECD Countries: The Role of Economic Instruments. OECD, Paris.

Repetto, Robert, Downer, Roger C., Jenkins, Robin and Jacqueline Geoghegan (1992). Green Fees: How a Tax Shift Can Works for the Environment and the Economy. World Resource Institute.

US EPA (1992) . The United States Experience with Economic Incentives to Control Environmental Pollution, Office of Policy Analysis, Washington DC.

Department of the Environment, Sport and Territories Logo