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The Role of Environmental Taxes in Shaping Sustainable Policies

  • 36 Pages
  • Published On: 12-12-2023
Chapter Two
Criteria for assessing effectiveness of environmental tax

About the chapter

Environmental taxes have been defined as instruments that can be used to adjust revenues in national budgets by increasing the costs of products with negative environmental impact. Environmental tax is based on its incentive effects, and it ensures consistency between rational production and consumption decisions with efficiency of society. It ensures marginal cost of pollution cutbacks remains the same for polluters thereby minimising the aggregate social cost of pollution. One of the outcomes of environmental taxes noted in literature is that these may help generate revenue without deterring market efficiency.

Environmental taxes also serve the purpose of incentivising behavioural change in citizens. An example of this can be found in the EU members’ adoption of environmental taxes and fees through the use of fiscal instruments that are aimed at increasing the environment policy efficiency. For instance, Europe 2020 is EU’s ten-year growth strategy, which focuses on using economic instruments in order to achieve resource efficiency and climate protection. One of its initiatives related to resource efficiency is a 2020 milestone that shifts taxation of labour to environmental taxation with an aim to substantial increase the share of environmental taxes in public revenues. Environment taxes and fees are imposed by the EU Member States within their own states and as per the objectives set by the national governments. Within the EU, four major types of environmental taxes can be identified: Energy taxes; Transport taxes; Pollution taxes; and Resource taxes.

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Another kind of liability is environmental charges, which along with environmental taxes serve as economic or fiscal instruments of environmental policy; charge is different from tax in that it is levied as a way to recover costs. Charges are focused on giving financial incentives for more responsible behaviour towards the environment. Environmental charges are either administrative and user charges. Administrative charges can be control fees, licence fees and registration fees. User charges are payments that are to be made for meeting the costs of collective or public expenses. The distinction and relationship between environmental taxes and charges becomes relevant when seen in context of service. Charges may be implemented where a service is being provided by the government, such as, a water treatment service; whereas tax can be levied even if there is no service being provided. Revenue neutrality is used by governments to make taxes more acceptable. There are three kinds of environmental taxes: cost-covering charges are designed to cover the costs of environmental services that are provided to mitigate the effects of environmental degradation or harms, such as, water treatment; incentive taxes, which are designed to change consumer or producer behaviour; and fiscal environmental taxes, which are designed to raise revenues. However, there could be an overlap between these different types given the characteristics of these taxes. Firstly, cost-covering charges aim at raising revenue from users of the environment so as to cover monitoring or controlling activities’ cost. For instance, user charges are paid for a specific environmental service and earmarked charges are paid not for a specific service but to cover related environmental purposes. Secondly, incentive charges aim to alter environmentally damaging behaviour. Thirdly, fiscal environmental taxes aim to raise government income. For instance, ecological tax reform, an expansion of fiscal taxes, focuses not on income and social contributions, but towards consumption of resources and environmental pollution. All these three taxes, as seen from their features, are not mutually exclusive while they are applied. They aim to raise revenue and at the same time aim to control or monitor activities. Taxes can thus be described as unrequited payments in which benefits are provided by government to taxpayers that may not be in proportion to the payments; whereas charges are paid by individuals for the services that they have received.

This chapter will elaborate on the characteristics of environment tax keeping in view the impact that they cause. This chapter will discuss the purpose of environment tax in terms of ensuring environmental protection; causing healthy economy and creating economic development and involvement. This chapter will particularly attempt to critically assess the different criteria that determine the effectiveness of environment tax.

Criteria for assessing effectiveness of environmental tax

The concept of taxation in context of environment is based on the work of economist Pigou, who proposed the idea of using taxation for correcting negative externalities; in the case of environment, environmental pollution can be taken to be a negative externality. The idea is to invoke corrective taxes to correct the negative externalities. These kinds of corrective taxes are also called as Pigouvian taxation. Negative externality can be defined as a case or situation of harm from production or consumption of some good, to someone other than the buyer or seller of that good. This harm represents a market failure as an external cost that the buyer or seller failed to take into account. The idea of Pigouvian taxation was that unless such a taxation is provided, the market will be unregulated, which will lead to associated negative externality with a high quantity of a good. By imposing taxes on such externality-generating good, there can be a correction. As per the Pigouvian taxation, the tax rate is equalised with the marginal external damage, which is the harm caused to parties other than the buyer and seller. By adding the taxation amount, the external cost is brought into the transaction and this ensures that the buyer pays the marginal social cost of the good. Greenhouse Gases (GHGs) are externality in the sense that there are no full consequences of the costs of actions impose on the entities that produce GHGs. In this regard, an appropriate price on carbon, in the form of taxes, trading or regulation will ensure there is payment of full social cost of their actions. This will make entities move away from high-carbon goods and services, and thereby invest in low-carbon alternatives. According to the basic theory of externalities, economic problem stems from untaxed or unpriced emissions of GHGs as the source. This theory requires a price against emissions, which is the first task of mitigation policy. This task requires introduction of taxes or prices for GHGs. This is to establish a marginal cost against the polluters that is equal to the marginal damage caused by their pollution. This highlights taxes that are based on marginal damages caused by carbon emissions. As such, the appropriate tax would equal the social cost of carbon where the tax equals the marginal abatement cost; one of the methods that is used to determine this social cost of carbon is the DICE model. Charged with this tax, polluter would choose the appropriate level of abatement. However, the element of credibility and predictability of relevant policy would determine the effectiveness considering the long-run nature of many relevant policy decisions.

Notwithstanding the foregoing, must be noted that environmental taxes are not just used to correct externalities, but they are also used to raise revenues that can be used by the government to pay for public goods and to also address distributional goals. In countries like the US, the need to impose environmental taxes has been raised by some commentators to suggest a possible new source of tax revenue. In brief, some of the purposes of environmental tax are to correct negative externalities, such as environmental pollution; regulate market; equalise with the marginal external damage and serve as marginal social cost of the good; and raise revenues for the government to pay for public goods and to also address distributional goal. It has been emphasised that environmental tax can provide ‘double dividend’. According to this hypothesis, “green” tax can control the excessive levels of pollution, and at the same time the overall efficiency of the tax system can be improved through the application of the green tax; this can happen because the government applies a revenue neutral restructuring of the tax system, increasing green taxes in proportion to decreasing traditional taxes thus improving environmental quality and reducing the distortion of tax system, labour cost, and generating higher levels of employment. The double dividend hypothesis is based on two premises. The first premise is that revenue raising taxes will provide the strongest motivation for taxation. The primary goal of such taxes is to raise revenue to provide for defence, public safety, education and research among others. These are goods of collective consumption of the public. The second premise is that market failures can be corrected through the use of the tax. In other words, externality has to be internalised through the tax system. However, OECD argued that this hypothesis does not consider the account that an environmental tax may deform tax bases, or even more bring out already existing distortions, causing adverse effects on economic activities. An example could be the increase in production costs due to environmental tax, which pushes for lower wages or passing of costs on to the consumers. There would be less transparency and no additional government revenues to offset such effects. However, what the government could do is to use part of the revenues to offset these effects, by taking up action such reducing personal and corporate income tax rates and create a tax system less detrimental to economic growth.

Environmental policy has been subjected to much economic analysis because there is a very close nexus between environmental policy and economic analysis. The premise of economic analysis of environmental policy is based on the concept of externality which represents the harmful consequences of economic activities on the environment. The economic context of this externality is found in the environmental policy of green tax or environment tax which seeks to quantify the economic effect of an activity, which is harmful to the environment. The purpose of this exercise is to shift the negative consequences of the activity to the party that is involved in the activity that has led to the externality. By making the environmental policy, the policy maker seeks to create incentives for the firm or the actor causing these externalities to reduce the activity or mitigate its effects on the environment. Environmental policy is able to achieve this objective by either internalising the environmental costs for the polluters, wherein the polluters decide the levels of pollution and pay for it; or by imposing limits on the level of environmental pollution. An assumption behind this theory is that it is increasingly expensive to provide for increasing pollution reduction for smaller environmental gain. Pollution reduction is arguably achieved through introducing pollution control equipment to production processes as against the clean production processes that aim to change production processes in order to stop pollution, which may save money of a firm in longer run. However, the market does not provide the best means of allocating resources, which is further challenged by the presence of externalities. Hence, it could be said that market fails in protecting the environment. The core issue lies in that fact that there is failure to value the environment and in assuming that markets can deal with this issue by incorporating environmental costs into market prices. This does look less than optimal solution.

It is also observed that the environmental policy, which is also reflected in the green tax system adopted by a country, has its ramifications on trade, which is not peculiar to green taxes alone and can also be related to any other form of cost-imposing measure. Nevertheless, the discourse between trade and environment is interlinked because trade has impacts of the environment and the environmental policy also has certain implications for trade. In many contexts, the discourse takes the turn towards a debate on trade versus environment which sees trade policy community face off with environmentalists over the consequences of trade for the environment. In recent times, environmentalists have started giving arguments based in economics to counter the trade policy arguments. They argue that while trade does provide increase in incomes, it also leads to degradation of the environment. This is not good economics because environmental degradation has steep economic costs as well. On the other hand, the ‘environmental Kuznet’s curve’ has been developed to show the relationship between the quality of the environment and the economic development. The curve is a hypothesised relationship and it has indicators that show that environmental degradation worsens with modern economic growth and continues to worsen until average income reaches a certain point. The seminal work by Grossman and Krueger in 1991 showed evidence to prove the connection between the economic growth and environmental quality in the United States. In the United States, the evidence provided by them showed that the environment continued to degrade until per capita incomes reached $ 5000 per year, after which point the quality of the environment started to get better. The argument of the trade policy makers is that as the ‘environmental Kuznet’s curve’ shows, once the per capita income reach a certain point, the environment becomes a priority and the quality of the environment starts to get better.

Its impact on economy

The need for green tax or environment tax is premised on the need for protection of the environment from human activities that are detrimental to it. Dematerialisation is one of the reasons that are given for justifying green taxes and it refers to the decrease in the quantity of resources that are measured in mass and are being used by the economy. There are two aspects between supporters and opponents of green taxes. The supporter refers that green tax could help economic developments by collecting money or fines or damages from people who break the rule while the opponents insist that it will be add more cost in process, so the entrepreneur will increase the costs.

In order to understand the benefit of the green tax to the economy, it is necessary to explore the link between green tax and other taxes; in other words, how far and well do environmental taxes fit within the wider tax system. As discussed earlier, environmental taxes do not merely correct the negative externalities; these taxes can also be useful for collecting revenue and in this lie its major advantage. Therefore, environmental taxes can fit well into the wider tax system of the country. In fact, much of the environmental tax reform or green tax reform that happened in Western Europe and other European nations was also encouraged due to the revenue generating potential of these taxes. As mentioned earlier, the ‘double dividend’ thesis espoused by some writers laid stress on the dual advantages provided by green taxes: first, the benefit of reducing pollution and environmental degradation through taxation; and second, the benefit of increasing revenue through taxes, which could be then used for the collective benefit of the nation.

There are, however, criticisms against the levy of environmental taxes from the perspective of the economics involved in such an issue. More specifically, if the environmental taxes are too low, they will not be able to internalise the environmental damages in market transactions; but if they are too high, they will go on to penalise the market transactions and may therefore, harm economics of the market. Clearly, the need to internalise the negative externalities in the market coincide with the need to allow fiscal health in the market. This leads to economists always searching for the most optimal environmental tax, one that can target externalities without causing harm to the market economy. However, as regard the goal of environmental tax to correct negative externalities, a 2008 study conducted by EEA found adverse results. For instance, the study found that in Italy, there was no evidence to demonstrate the effect of tax on the two regions - Lombardy and Emilia-Romagna - included in the study. Further, the UK showed similar result. The UK did not have any government or industry quantitative data showing any improvement as there were no relevant measures in place. No evidence was found to demonstrate that aggregate tax caused reductions in “noise and vibration, dust and other emissions to air, visual intrusion, loss of amenity and damage to wildlife habitats”. Moreover, the optimal tax is theoretically ‘just right’ but is very challenging to achieve on ground. As such, it can be said that there are both advantages and disadvantages of the environmental taxes, which means that in any taxation and policy related exercise, there will be a balancing act between the two compulsions. International policymakers view green growth and promoting energy efficiency and technologies about clean energy and sustainable development as complementary goals. However, there will be challenges as long as there is global ecosystem degradation and loss. In order to tackle this problem, the gap between global benefits from ecosystems and willingness to pay to maintain and conserve them should be closed. For that to happen, there should be facilities for international financing, payments for ecosystem services, and taxes on financial and currency transactions. Consequently, there should be reform on environmental tax, which is meant to sponsor tax reductions on labour and capital and new revenue generation from taxes on emissions. This will ensure job creation and GDP growth while at the same time there is fall of emissions (double dividend), wherein the more aggressive theory suggests that the efficiency gains from a better tax outweighs costs arising from carbon tax to a great extent.

The effect on the economy from carbon tax may not be to the extent expected. It effect is largely dependent on original tax structure. The effect on the economy from carbon tax may vary from one policy structure to another. There are certain findings that may serve as a caution while imposing carbon tax. Study conducted across Denmark, Finland, Sweden, Netherlands and Norway will provide support to this statement. These countries were the first ones to adopt carbon tax. The study estimate the real mitigation effects of these countries by using the method of difference-in-difference (DID). The results varied. Carbon tax in Finland created significant negative impact on the growth of per capita CO2 emissions. Denmark, Sweden and Netherlands showed are negative impact but not significant. The effects were weakened because of presence of tax exemption policies on certain energy intensive industries. Carbon tax in Norway did not realise its mitigation effects due to rapid growth of energy products that caused substantial increase of CO2 emissions in the oil drilling and the natural gas exploitation sectors. In the UK, the Landfill Tax, 1996 creates charges on businesses and local authorities, which dispose waste using landfill. The revenue from such charge was recycled through reduced employers’ social security contributions. Similarly, the Climate Change Levy (CCL), 2001 levies energy tax on commercial and industrial use of energy, except for household energy. It aims to provide incentives so as to increase energy efficiency as well as reduce consumption of dirty fuels. There is a potential 80% discount from the levy for energy-intensive industries. This creates an incentive to agree targets to improve energy efficiency or reduce emissions by entering into a Climate Change Agreements (CCAs). Besides using to reduce employers’ social security contributions, a fraction of the revenues generated from the taxes is used for special funds. Though the policies are in place, increase in the landfill tax rates since 1996, and that of CCL since 2006 has not been recycled as was supposed to. It further went on to introduce an aggregate tax. This proved useful in that an analysis conducted by HM Treasury revealed that this particular tax could help reduce aggregate sale and encourage an alternative ‘untaxed’ secondary waste materials.

b. Impact on environment protection policy

As observed earlier, if environmental taxes are too high, they will go on to penalise the market transactions and may therefore, harm economics of the market. In this regard, it is also noted that consumers and businesses find it unattractive towards any polluting activity that incurs higher cost resulting from environmental tax. Environment taxes provide consumers and businesses options to determine the least-cost way to reduce environmental damage. Hence, there are subsidies and incentives for environmentally preferable goods or practices. The Bonus/Malus was introduced in France in the year 2008. It was a feebate (a self-financing system of fee and rebate for shifting the costs of externalities onto the market actors responsible) provided on purchase of new cars. It was found that cars that polluted less benefited from a reduction of price up to 1,000 euro, while on the other hand, the most polluting cars were imposed taxation of 2,600 euro. This policy impacted on carbon dioxide emissions. The environmental impact of the policy was negative in the former case, which went to show that feebates served as an efficient tools for reducing CO2 emissions. However, it could also be that there should be a pragmatic classification of products in a sustainable manner. This would permit low VAT category significantly limiting economic costs of the tax reform, while also price reduction for green products limits undesirable distributional consequences. While determining the amount of taxes from emissions reduction from implementing a CO2 tax on industrial sources in Chile, it was found that there is no modification in the use of fuels in industrial sources from taxes up to US$10/ton CO2. If the taxes are between US$10/ton CO2 and US$30/ton CO2, there was rapid reduction of emissions. If they are higher than US$30/ton CO2, the reductions became stagnate. This established that too low or too high taxes can raise revenue but not reduce emissions.

The double dividend theory discussed earlier has shown the positive impact of environment tax that of improving tax efficiency and reduction of emissions, further creating job creation and GDP growth. As such, the advantages of environmental taxes include economic efficiency, environmental effectiveness, raising public revenue, and transparency. Other than that, environmental taxes are employed to address issues including waste disposal, air emissions and water pollution. For instance, the wastewater tax in Denmark evidently showed the environmental effectiveness of the instrument. It largely affected municipal sewage plants, because many industries were exempted from it. Due to this tax, from 1996 to 1998 the discharges of three taxable pollutants, phosphorous, BOD, and nitrogen declined by 20-25%, whereas discharge increase from industries with direct discharges. The country’s wastewater effluent charge and relevant measures undertaken led to reduction of water pollution from the 14 companies that were responsible for 90% of the pollution by 90% in 1969, and by 1980 by a further 20%. However, the positive impact of green tax on environment is also very much dependent on the level of awareness of the public that would make relevant policy viable. Any changes in environmental taxes produce different inter-generational effects. Such effect must be considered while attempting any relevant political decision effecting a country’s population. Thus, while analysing the effect of a green tax reform on economic and intergenerational welfare, a study found that young individuals favoured both an energy-consumption tax and an energy input tax. However, this did not find agreement with the older generations. The support on the reform is therefore dependant on disutility. Another study that identifies such systemic problem is related with China’s newly drafted Environmental Protection Tax Law that focuses on green incentives. This law shifted the focus of government regulation on “taxes on bad activities” from “taxes on good activities”. It expanded the principle of “polluter pays” to cover corporate and individual decisions. However, the study found that China has an existing pollution charge system that is ridden with inappropriate pricing levels and exemptions. The new law also does not provide clarity on this area as well as is found that exemption was provided on pollution sources from wastewater treatment and waste disposal and agriculture, which are the major sources of pollution in China. Furthermore, the study found vagueness in the language of the new law in respect of the interface between tax authorities and environmental officials. These examples suggest the need for environmental awareness to introduce a politically viable green tax reforms.

Any kind of environmental pricing through imposition of taxes provides the consumers and businesses the flexibility to determine the best way of reducing environmental damage. Further, if the environmental tax is well designed, it increases the price of a good or activity that reflects the cost of the environmental harm. Such cost hence covered by market price, ensuring consumers and businesses to consider this cost while making their decisions. Environmentally taxes mainly serve an environmental purpose. It also creates fiscal revenue. Fiscal consolidation limits environmental policy measures in regard to the expenditure side of the budget. It therefore strengthens the need of employing taxes as well as other market-based policy instruments while making environmental policy. However, environment taxes as seen as a way to create review may have implication on welfare cost when the implications of environmental tax reform and public spending policy for growth and welfare, interactions between health, education, and the environment are taken into account, we show that revenue-positive tax reforms combined with a change in the public spending structure may improve long-run growth and welfare. However, this outcome incurs relatively high welfare cost during the transition phase. This is particularly the case when the spending policy favours education spending.

A uniform price on emissions or other negative environmental externalities can provide incentive for behavioural change. However, the fact remains that taxes when they raise revenue, also change behaviour. For instance, the UK Government introduced the Fuel Duty Escalator in 1993, to stem the increase in pollution from road transport, but it was also successful in raising revenue, while reducing demand for petrol, and consequently reducing environmental impact. As a separate challenge, it was reportedly made with public resistance. Further, there must be a large cost involved in formulating the tax and as seen above; taxes are pushed down on consumers as well. If the tax is set too high, firms would find it burdensome to deal with the tax burden. This was explained earlier in that any tax too low or too high taxes can raise revenue but not reduce emissions.

It is also relevant to mention the distributional effects of environmental taxes because through the intervention of the government externalities that escape the cost internalisation may be corrected, but may also affect different households differently as there is varied consumption pattern based on income and demographic composition. Thus, intervention through levies on consumer goods can also lead to more inequality in some cases or reduce inequality in others. An example can be seen in the way higher tax rates on air flights and taxis reduce inequality and increase the environmental quality while lower tax rates on buses, bicycles, and mopeds also reduce inequality and increase environmental quality.

price mechanism a policymaker may correct for externalities that escape the cost internalization in the
consumption pattern varies with income and demographic composition. While correcting for
environmental damage, some levies on consumer goods lead to more inequality, others to less
inequality. This article addresses the issue of distributional effects of environmental taxes. More
specifically, since some modes of transportation are both luxury items and high-polluters and other
modes are necessities and low-polluters we argue that is possible to have favorable environmental and
distributional effects by implementing a differentiated tax system. To demonstrate the emp

The basic criteria that could be summed up from the above discussion in order to assess the effectiveness of environmental tax could be by determining whether environmental tax brings full-cost pricing without having penalised low income groups and without the difficulty to determine optimal level of taxes and fees; and whether it could be easily administered by existing tax agencies and be used to improve environmental quality and to reduce other taxes instead of being used as general revenue.

. Impact on quality of life

This section discusses the impact of environment taxes on the quality of life. Quality of life relates to concepts of living quality, living environment, quality of place, and the evaluation of the residential environment. This is related to health, well-being, and urban physical environment. Quality of life is related to the degree of excellence or satisfaction. A more recent current definition of quality of life is:

“is the extent to which objective human needs are fulfilled in relation to personal or group perceptions of subjective well-being. Human needs are basic needs for subsistence, reproduction, security, affection, etc. SWB is assessed by individuals' or groups' responses to questions about happiness, life satisfaction, utility, or welfare. The relation between specific human needs and perceived satisfaction with each of them can be affected by mental capacity, cultural context, information, education, temperament, and the like, often in quite complex ways.”

This definition identifies subjective and objective human needs. It identifies both personal as well as group perceptions of well-being. Moreover, this definition also identifies the weights that may vary perceptions over a period of time, such as, education, awareness and temperament. This is particularly related to links between quality of life and environment because over a period of time, there has been a shift in perceptions towards the extent to which environment is an important factor in quality of life. Earlier quality of life was measured more in economic terms, but as the environmental deterioration became more apparent, the perception towards quality of life was also impacted by the perceptions of environment. It is important to define quality of life in context of environmental tax research because one of the important links with quality of life is with environment, which also includes the physical environment of the individual. This may also explain the ‘environmental Kuznet’s curve’ discussed above, which shows that as people achieve a certain level of per capita income, the focus shifts towards environment. However, this theory is subjected to various critiques. Under an assessment of its strength, it was found that the impact of trade liberalisation on the environment will arguable differ from country to country. It is dependent on their comparative advantages in pollution-intensive production. It is further arguable dependent on relative factor endowments and environmental regulations of a country. This theory provides estimates that permit impact of trade liberalisation on pollution to depend on a country’s characteristics. The study found that the relationship, according to this theory, between per capita income and emissions is reasonably robust. There was little evidence that suggest that trade patterns significantly determines the inverted-U shape.

There is a direct impact of a local living environment on the health and well-being of the inhabitants. A healthy environment provides mental well-being of people. For instance, access to green spaces is an essential part of quality of life. As such, outdoor air pollution is a main issue directly affecting the quality of people's lives, causing a range of health problems. One of the major themes in the discourse on green taxes or environmental taxes is the link between the taxes and better quality of life. It is to be determined herein how environmental taxes can lead to healthy environment thereby impact quality of life. In this perspective it must be noted that green growth is linked to a better quality of life as it translates to better health and environment for people. Environmental risks and ecological scarcities have a negative impact on human well-being and social equity and are therefore indicators of a poor quality of life. Studies use carbon dioxide emissions as well as greenhouse gas emissions as indicators of environmental degradation. At the same time, it is now considered that greenhouse gas emissions are linked to poor public health and increased diseases. Literature on this issue indicates that the link between taxes and a better quality of life is also explained in economic terms. Some writers argue that if green taxes are to be argued against on the basis of economics, these can also be argued in favour of on the basis of economics. To make this point clearer, the depletion of ozone layer, global warming and climate changes will also have higher economic costs if not contained at this point. These higher economic costs will be in contexts of public health, where the rise of diseases may lead to increased public health costs. Higher economic costs will also be in the context of increased costs for replacing finite sources of energy which are fast depleting or reversing the ill effects of pollution and environmental degradation. In this context, the green taxes will push back the spill over costs to the producer and consumer, which eventually will have the effect of decreasing environmental spillovers. The Netherlands is an example of this, as green taxes here had the effect of reducing heavy metal leaks into lakes and rivers by more than 50 percent.

Less environmental degradation, which is linked to green taxes, is also linked to a better quality of life for people. This is demonstrated by the example of Brazil, where the green taxes form more than 3 percent of the GDP, which is close to the OECD average of 3 percent. At the same time, the quality of life or life satisfaction indicator in Brazil is also close to the average OECD value. In relevance, it must be noted that climate change and other factors threaten environmental stability, which consequently disrupts ecosystems’ capacity to provide goods and services that could be translated to economic benefits, and quality of health for humans. Environmental goods and services are not traded in markets and hence are often not subject to economic valuation and are ignored in policy-making. Such failure becomes a primary cause for environmental degradation and consequent health hazards. The scarcity of market data can lead to misleading decisions, which impact the significance of resources protection. This results in resource depletion and degradation. In this light, it should be noted that economic instruments, including but not limited to include standards and quotas, subsidies and tradable permits and abstraction and pollution taxes, should provide necessary incentives to stakeholders to adopt preventative measures. Taxes, subsidies and quotas, by internalising external costs arising from use of natural resources, can ensure sustainability by setting full cost pricing of the environmental goods and services at the social optimal level. Furthermore, tradable permits systems for pollutants provides for pricing and trading the right to use the environment as a waste sink. Such systems were introduced by the Kyoto protocol with the ain to reduce greenhouse gases emissions in the contracting counties.

d. Impact on Innovation

Environmental challenges vary from local jurisdiction to global jurisdictions. Challenges at the local areas may stem from few polluters causing incidents such as sewage discharges in watercourses; and the global scenario are caused by multiple players, such as greenhouse gases. Given the rising desire to control or solve these issues, environmental innovation plays a critical role to facilitate environmental goals. A popular definition of environmental innovation is that it is such innovation that consists of new or modified processes and techniques or systems and products that are aimed at reducing environmental damage. Environmental innovation can then be likened to any technological or other innovation aimed at reducing the externalities caused by products and processes. These tend to internalise negative environmental impacts of such externalities because of the spill-over impact of such innovations. Environmental policy is related to new innovation and there is now much literature and many studies that reveal the impact of environmental policy in driving innovation. The seminal Porter hypothesis is relevant here as Porter had suggested that:

“Pollution is a manifestation of economic waste and involves unnecessary or incomplete utilisation of resources . . . Reducing pollution is often coincident with improving productivity with which resources are used…properly designed environmental regulation can trigger innovation that may partially or more than fully offset the costs of complying with them”.

The Porter hypothesis has since become an important part of the discourse on environmental policy and innovation, although not without controversy or criticism. The criticism against the Porter Hypothesis is that it cannot be used to generalise innovations across the corporate sector or business firms and that in a competitive economy, where innovations can be used to reduce costs and inefficiencies, government intervention in the form of environmental policy nor is needed to drive such innovation. Nevertheless, the Porter Hypothesis has led to a significant amount of research and studies which confirm the hypothesis and signify a link between environmental policy and innovation. An example of such a study can be found in a study based in Germany, which shows that environmental regulation and policy does lead to environmental innovation.As per this study, there is some econometric estimation that can be used to show that innovations in the knowledge capital leads to environmental innovations. To illustrate further, it must be noted that while introducing new products, firms often requires knowledge from other firms. Geographically localised social capital may arguably affect a firm's ability to innovate by using external channels. In a study that covered data on social capital at the regional level, including innovative activities of a sample of 2,413 Italian manufacturing firms from across 21 regions, which controlled a large set of firm and regional characteristics, it was found that being located in a region that shows high level of social capital causes higher propensity to innovate. An area showing high degree of localised social capital complements firms' investments in the area of internal research and development (R&D) and further positively moderates “effectiveness of externally acquired R&D on the propensity to innovate”.

As the innovations in environment are linked to businesses that find innovation offsets the costs of the environmental policy, it can be argued that firms will innovate only when it is profitable for them to innovate. In other words, a firm which finds the costs of innovation exceeds the costs of environmental taxes, may choose not to innovate. On the other hand, the environmental policy will also be created only where the value of the environmental benefits makes the policy viable. This is explained as follows:

“The economic desirability of environmental policy instruments depends on (1) the value of the expected environmental benefits, and (2) the costs at which environmental improvements are achieved. Both the environmental gains and costs depend on technical change, which means that from a dynamic efficiency point of view a relevant criterion for the evaluation of environmental policy is (3) the extent to which it stimulates innovation at the supply side or user side.”

Therefore, both environmental policy as well as innovation depends on the profitability of the schemes. The nature of profitability demand will vary because in terms of innovation profitability will be strictly in economic sense, whereas in environmental policy, profitability will be in the sense of environmental gains and benefits. One of the studies that were conducted to find the impact of environmental policy on innovation was conducted in the context of the Norwegian carbon tax system in the oil industry. The study identified the technological innovations adopted by oil companies operating in the Norwegian Continental Shelf as a response to the carbon tax in Norway with the aim to reduce their carbon intensity. The study found that there was diffusion of available technologies and some incremental process changes also made as a response to the carbon tax. Another study based in Finland, was conducted to explore the impacts of environmental policy instruments on the Pulp and Paper and the marine engine industry of Finland. The study found that there was adoption of environmentally friendlier technologies in these two sectors in Finland but this was the result of diffusion and not innovation. OECD, in its 2011 policy brief on taxation in relevance to innovation and the environment suggested that countries are finding many of the environmental challenges countries daunting. The first factor that may act as deterrent is the environmental remediation costs that depends on the application of existing technologies and know-how. This cost may be off-set by concerned companies’ ability to innovate with the aim to reduce pollution and its effects. However, firms or individuals who churn out innovation cannot alone properly address the challenges. They normally do not pay for the impact that their pollution cause to other. This raises their tendencies to pollute more. Furthermore, there may be discouragement for innovators where they could not reap enough benefit. These factors compound problems related to environmentally related innovation, and undersupply of innovation, due to lesser incentives to adopt innovations caused by absence of a price on pollution. Hence, there is a government’s role to address these externalities and adopt a policy that could imbibe both environmental improvement and concerned IT innovation and development could hold the future.

The issue of the kind of innovation is also important here because innovations can be incremental or radical. Incremental innovations are defined as “minor modifications of existing processes or products”; and radical innovations are defined as “technological discontinuity based on a break with existing competencies and technologies.”Clearly, incremental innovations do not necessarily lead to a major change but merely relates to the modifications to the existing processes whereas radical innovations relate to a complete break from existing processes, which are replaced by completely new processes or products. The literature on the point is varied and shows mixed results on the impact of environmental policy for the innovation of technologies or processes that seek to decrease environmental harm. Some studies confirm the link between environmental policy and innovation, while some other studies fail to show the link. Some studies also show that instead of innovation, environmental policy may lead to diffusion of green technologies. Innovation itself may be incremental or it may be radical. However, it may also be said that there can be factors other than environmental policy that drives environmental innovation. As pointed out earlier in context of a criticism against the Porter hypothesis, firms may innovate not as a response to environmental policy but because it is profitable for them to innovate. However, this cannot take away the role of environmental policies, including environmental taxes of stimulating development and diffusion of new technology. Given that firms and consumers seek new solutions against the price put on pollution, environmental taxes play an important role in the adoption of known pollution abatement measures, and may provide significant incentives for innovation. This is demonstrated with that firms with not enough resources or inclination to undertake their own R&D have adopt technologies due to environmentally related taxes that provide incentives. For instance, Sweden introduced a tax on NOx emissions that dramatically increased adoption of existing abatement technology. The year of introduction saw only 7% of firms adopted abatement technology but it rose to 62% the following year. A commercially viable inventive may bring both polluters and third-party innovators together in investing in R&D to develop environmental technologies and products.

Although there could be positive result, there are certain challenges in determining the positive impact of environmentally related taxation on innovation. Firstly, it is the approach to determine or measure innovation. Common approaches may include assessing the R&D resources or IP generated from the firm’s innovation. However, the cost burden of environmentally related taxation may not adversely affect firms’ financial capacity to undertake innovation-related activities. This was seen in an OECD’s case study conducted on United Kingdom’s Climate Change Levy on fossil fuels and electricity. The case study found that firms that were subjected to the full rate of the levy developed more patents than those subjected to a reduced rate. As such, all environmentally related taxation may not lead to innovation. There are factors that need to be taken into consideration in a wider perspective so as to shape innovation outcomes of such taxation. These factors may include but not limited to a country’s intellectual property rights regime, cultural norms towards innovation, and system of higher education. For instance, Israeli has an innovative culture spanning several decades. As such, innovations in water sector may result from such culture and from the presence of high water prices and taxes. Another OECD’s case study consisted of a cross-country examination of the innovation on impacts of petrol prices and taxes, regulations and standards on motor vehicles. The case study found linkages: firstly, between emission regulations and related patents; and secondly, between fuel taxes and fuel efficiency patents. Some of the reasons behind non-clarity on the links between innovation and environmentally related taxation are: limited scope of use of environmentally related taxation for wide-ranging analysis; higher difficulty in investigating innovation effects of environmentally related taxation; prescriptive regulatory approaches to environmental policy; non-optimal design of environmentally related taxes that deters abatement activities, investment decisions and innovation efforts; and generally limited data availability that poses difficulty in isolating effect of taxation.

e. Impact on low-income groups

It is observed that one of the major political barriers against the introduction of environmental taxes is the perceived impacts on low-income groups, who may pay proportionally more than the rich. One of the distributional effects of environmental taxes is how a large share of income of low-income households is spent on electricity, transportation and heating fuels. There are distributional effects of environmental taxation which need to be considered and addressed so that instead of fostering inequality, taxes can reduce inequality while also helping to reduce the environmental costs of human activities. Hence, taxes should consider their impact on groups such as low-income households and therefore, environmental taxes need to be as broad as possible, with provisions to address differential impacts to preserve the incentive effect.

A 2004 report of a research conducted in the UK may possibly elaborate further on the above perspective. The report covered the possible impacts of environmental taxes on households that were of different range of incomes in respect to energy use, water use, transport and generation of waste. The report found that use of energy, water and waste disposal services, and cars by low-income households was not proportionate to their income. This indicated that imposing a flat-rate tax would be regressive. Even a compensation scheme along with the tax or charge might not be able to deal with this issue as the use of environmental resources might vary within a given income group. Therefore, certain low-income households might end up as net losers. The report states that taxes and charges might cause reduction of consumption of the environmental resource by some people, which might further reduce the extent and the number of the net losing, low-income households.

Tariff or charging design or a targeted compensation scheme may solve the regressivity problem. However, the tendency of consumption of key environmental resources to be widely distributed about the mean in a given income group may place some low income households as net losers from any charging-plus-compensation scheme or even most low-income households may end up as significant gainers. The main point is that the number and extent of net losing low-income households could be greatly reduced when households change their behaviour against charging by reducing consumption of an environmental resource in question. Where such reduction causes real hardship, but it is easy to identify the affected households, there could possibly be further special arrangements to provide relief. In case it is harder to identify households, which are affected in large number, the underlying cause of the hardship could here be tackled with prior to using pricing as a policy instrument. But it should also be noted that charging alone cannot be the adequate policy instrument by itself. There is a need for a range of other policy measures that could provide alternative services or infrastructure, increase capacity, or tackle barriers against more environmentally conserving behaviour. This however does not imply that there could be a cost effective way of addressing environmental issues without using environmental taxes and charges, which should be designed to avoid unintended social consequences.

3. Overall Assessment of the Criteria

It is a general concern among policy makers that environmental improvements should be achieved at minimum overall cost. Most popular opinion is that this could be achieved by imposing environmental taxes and charges. Such taxes and charges should not be regressive as seen earlier and should have equal distributional effect. However, such an approach may pose significant constraint on introducing, implementing or enforcing environmental taxes and charges. Moreover, certain other effects of environmental tax which are not intended may also arise. This could be gathered from the study conducted by European Environment Agency (EEA) in 2008. It covered Czech Republic, Italy, Sweden, the United Kingdom, and Northern Ireland. The study analysed the effect of the tax in relation to the national objectives, including reduction of environmental externalities; preservation of the landscape; and reduction in demand for aggregates and encouraging recycling. The study found varied results. Czech Republic has complex administrative process for example its administration of reserved versus unreserved sites. The study found a potential extra complexity in the event of a new proposal for ecological tax formula. Italy expected that introducing of tax would improve quality of information related to monitoring extraction activity. However, the study found uncertainty on whether revenue created from tax is exclusively used for environmental purposes. In Sweden, the tax did not reflect regional variation in gravel scarcity. There was an increased transport and energy use after crushed rock substituted gravel and it required more energy per tonne extracted. This led to penalising the North where gravel is not scarce. In the UK, the study found that secondary aggregate waste materials such as shale, china sand, and waste slate that are claimed not to be subjected to tax were transported over longer distances. This led to reported stockpiles of aggregate waste material on site, which impacted the landscape. Further, Northern Ireland also experienced a cross border aggregate materials trade distortion, as there was no tax in Ireland. The foregoing events show that environmental tax structure could lead to certain uncertain effects that distort national objectives, which is not peculiar to taxes alone and may also be seen in other instruments as well.

The problems related to environment arise when there is a discrepancy between the actual level of environmental quality and society’s preferred level. As discussed in this chapter, there are different types of environmental policies and no single policy is appropriate for all environmental problems. For example, approaches that address distributed effects of taxation, or lead to double dividend, may be considered. There are some basic criteria needed to evaluate effectiveness and appropriateness of a policy: achieve efficient and cost-effective reductions in pollution; fairness; incentives for better solutions; enforceability; and compatibility with certain moral precepts. A policy is cost effective when it gives the maximum environmental improvement possible for the resources used, or achieves a given amount of environmental improvement by using the least possible cost. Effectiveness of a policy depends on cost-effective emission reductions and maximum improvement for the resources spent. This, however, opens up the problem that for a cost-ineffective policy in that, policy-making decisions would be taken based on higher than needed aggregate abatement cost and hence set less restrictive targets concerning desired amounts of emission reductions. As such, fairness, or equity should be used as an important criterion. Fairness or equity normally calls for equal distribution of burdens and benefits of environmental protection among all polluters and all members of the public. This sense of fairness achieves increasing sensitivity when a strong sense of unfairness is caused by systematic suffering of environmental risk by certain communities higher than others. This goes against the very notion of equality. In that sense, environmental laws have provisions rendering equal treatment to regulated parties that are similarly situated. For instance, the US Clean Water Act provides for treatment of facilities of a similar type similarly. Due to this notion of fairness, stiff opposition could be found against regulation specifically affecting or targeting a particular industry, particularly when that industry appears to be singled out. Notwithstanding the foregoing, this concept of fairness is often laden with issues in that there is arguably no consensus on how much weightage each of efficiency and equity carrier. It could be argued on one side that the pervasiveness of environmental degradation requires society to focus primarily on efficient policies that create the maximum impact against resources spent. On the other hand, it is argued that efficient policies should be avoided if they have significant regressive impact. In all, some weightage should be given to distributional considerations while selecting environmental policies. It may also be fair to consider that a strong incentive for private entities should also be considered a crucial criterion for evaluating any environmental policy. Decisions of private entities, including firms and consumers, actually determine the extent and level of environmental impacts. The incentives that they are offered determine the approach of reduction of the impacts. Such incentives determine their innovative ways of reducing impacts of environment as well as stimulate relevant progress in technology. If the focus is on abatement cost and damage functions, lower marginal abatement cost entails cheaper approach of reduction in emissions and hence higher levels of environmental quality. Technological innovation shifts the marginal abatement cost function downward.

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Notwithstanding the criteria of cost effectiveness, fairness, or the criterion of not to be regressive, the criterion of what people judge about what is right or wrong occupies a strong place in determining the effectiveness of environmental taxes. It influences the way they look at environmental policies. For instance is the choice between effluent taxes and effluent subsidies. They both provide economic incentives, and may reduce pollution per source by the same amount. From effectiveness perspective, subsidies would be arguably better as polluters may arguably respond quicker with higher level of willingness to a subsidy program. They may give preference to subsidies rather than an approach that would cost them a lot of money. Subsidies may be more effective in enforcing policies aimed for clean environment. However, attitudes about the environment may be highly polarised. A study conducted in the US covering both liberal and conservative environmentalists found that liberals, but not conservatives, view environment from moral perspective terms (where focus is on the moral or rhetorical views on environmental regulation rather than economic), which provides a partial explanation about the relation that exists between political ideology and environmental attitudes. The study further found that contemporary environmental discourse is largely subjected to moral concerns around harm and care. This is deeply followed by liberals than by conservatives. The study, however, found that difference between liberals’ and conservatives’ environmental attitudes are largely eliminated if pro-environmental rhetoric is framed in terms of moral value of purity. Moralisation holds a key in causing polarisation on environmental attitudes and therefore the study suggested that if environmental discourse is reframed in different moral terms, it could reduce the gap between liberals and conservatives regarding environmental concern. Apart from the polarisation of attitudes, another notion that downgrades the concept of subsidy as a means to get clean environment is the rationale of payment of full social cost of polluters’ actions. Subsidies may be argued to come in a shape of rewards for the polluters for ceasing pollution that they caused. In terms of morality, this behaviour of polluting goes against moral values. In this light, it should be noted that there should be mechanism to enforce policies that ensures placing major burden of polluters. There is a greater chance that polluters may not comply with regulations, in which case policies and regulations need enforcement through the ways of monitoring, negotiations for compliance, and legal redress. The variance in the level of enforcement easiness, ranging from normal to specific enforcement mechanisms and costs, may call for two main steps in enforcement. Firstly, Monitoring aims to measure the performance of polluters while comparing it with the legal requirements. Secondly, Sanctioning aims to bring to justice those who are found through Monitoring to violate law. Notwithstanding these measures, the deficiency in judicial administration, for instance time and effort, and concrete laws in the face of multiple violators poses a burden on the legal system in bringing all violators to justice. Furthermore, violators being reluctant participants may devote resources against the sanctions; taking advantage of legal lacunas to delay legal redressal processes and increasing cost and consuming time of the court. As such, there are imperfect sanctions associated with challenges and costly conflicts. It is also found that courts are more reluctant to apply higher penalties. Closing down or levying hefty penalties may threaten economic livelihoods of large section of population. From the face of it, there is complexity attached to the sanctioning process. The issue is further aggravated by the enforcement costs, which pose budget constraints on public agencies. Thus, such costs become critical to the effectiveness of environmental quality programs. To round up the discussion, it would be worth noting down that OECD Environmental Strategy has identified five inter-connected objectives, which may increase cost-effectiveness and operations of environmental policies:

“Maintaining the integrity of ecosystems through the efficient management of natural resources; De-coupling environmental pressures from economic growth; Improving information for decision-making by using indicators to measure progress; Enhancing the quality of life: The social and environmental interface; and Improving governance and co-operation: Global environmental interdependence.”

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