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Environmental Taxation Don Fullerton (Texas) Andrew Leicester (IFS) Stephen Smith (UCL)

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Presentation on theme: "Environmental Taxation Don Fullerton (Texas) Andrew Leicester (IFS) Stephen Smith (UCL)"— Presentation transcript:

1 Environmental Taxation Don Fullerton (Texas) Andrew Leicester (IFS) Stephen Smith (UCL)

2 Introduction Key part of policy agenda across OECD New UK taxes on landfill, business energy, aggregates extraction How to minimise cost of meeting major environmental goals? Can environmental tax revenues substitute for other sources of revenue?

3 Approximate UK taxes, 2005 Landfill ~ £18/tonne (£733m) Climate Levy ~ 0.43p/kWh (£744m) Aggregates Levy ~ £1.60/tonne (£326m) Motor fuel ~ 47p/litre (£24b, 5% of tot.rev.) Motor vehicles ~ up to £200/yr London Congestion ~ £8/day (£122m)

4 Outline and key issues Why use market mechanisms in environmental policy? Environmental tax bases in practice Revenues and the double dividend Applications: –Road transport –Energy –Household waste

5 Principles: Choice of instrument Market instrument or regulation? Advantages of taxes: –Static efficiency gains Reallocation of abatement to those with low cost Performance incentives: using technology properly –Dynamic incentives: innovation –Low risk of regulatory capture –Cost-limiting Tax rate as upper limit on per-unit emission cost

6 Principles: Choice of Instrument Limitations of taxes: –Uncertain environmental impact Prefer regulation if threshold effect? –Incompatible with firm decision-making? –Still little direct experience for evaluation –Hard to target emissions directly –Geographical variations in damage –Costly evasion activities –Political economy & distributional effects –Legitimisation of polluting behaviour?

7 Principles: Choice of Instrument Balance of those costs and benefits in selecting instrument Taxes valuable when need to change behaviour across many different production / consumption activities But danger of overly complex tax structure Small taxes may not have much impact

8 Environmental tax design 1. Tax on measured emissions –Direct incentives for abatement –Tax needs to absorb measurement cost –Scale of costs, need to consider: Type of emission (flow, stock) and available measurement technology Number of sources (point-source easier) Integrate measurement with market activities? –Trade-off between incentive targeting (linkage) and administration cost –Do we know the right tax rate for each emission?

9 Environmental tax design 2. Tax on a proxy (emission-related input) –Piggy-back incentives onto existing tax –Can apply to market transactions –Saves administration costs and complexity –How closely is it linked to emissions? Does higher tax lead to some other tax-avoidance? –Examples Advanced disposal fee (paid at the store) Tax on carbon content of fuel Tax on petrol

10 Environmental tax design 3. Multi-Part Instrument –Combine indirect taxes on transactions, to better approximate the ideal emissions tax –Improves the linkage to emissions –Generalizes the Deposit-Refund System A DRS combines a tax on output and a subsidy to recycling, leaving tax only on units not recycled Tax on carbon content of fuels, plus a subsidy for research into carbon scrubbing technology Combine a tax on petrol, subsidy for pollution control equipment, tax on big cars, subsidy for new cars …

11 Environmental Tax Revenue Revenues depend on elasticities of demand and supply Effective incentive tax may therefore see revenues erode over time Revenue effects are hard to anticipate – impact of economic climate? e.g. energy tax: low price elasticity, high income elasticity – need to increase tax rate just to stand still if economy grows

12 Double Dividend Oft-argued as reason to favour tax swap (new green tax revenue to cut other tax) Efficient tax system has equal marginal excess burden from each revenue source Suppose EB is defined to exclude gain from environmental protection Raise environmental tax rate to the point where its marginal EB equals that of other sources – or higher?

13 Double Dividend Weak double dividend (Goulder, 1995) –Welfare gain from using green tax revenues to reduce existing distortionary taxes exceeds welfare gain from lump-sum redistribution of revenue –Pollution restriction can create scarcity rents, and welfare is higher if govt can capture those rents via taxes or auctioned permits, to reduce other taxes Strong double dividend –Welfare gain from green tax plus reduction in distortionary tax is positive, even excluding environmental benefits –No regrets policy

14 Double Dividend Environmental taxes themselves distortionary –e.g. energy tax raises consumer prices, reduces the real net wage, and affects labour supply Need to evaluate each reform, case-by-case, in context of existing taxes and enviro policy Must consider proposed use of revenue If a small CAC mandate does not create scarcity rents, it can cut pollution without exacerbating labour supply distortions, equivalent to tax swap Thus, focus on revenues misplaced; key is not to create scarcity rents without capturing them

15 Applications: Road Transport Vehicle standards guarantee emissions reduction but are inflexible, same for all Ideal tax on vehicle emissions would allow choice of cheapest ways to abate (list) Technologically complex at the moment To what extent can existing taxes be used to mimic the ideal?

16 Road Transport In a GE model where heterogeneous agents make different fuel and car choices: –Tax on car type that depends on distance achieves the same outcome as the ideal emissions tax –Or a tax on petrol that depends on the car, but needs chip to identify car type (Fullerton and West, 2002) –Uniform rate on petrol and rates on car types cannot In a computational model, using data on different cars with utility-maximising owners: –Second best set of taxes on petrol, engine size, and vehicle age; obtains 71% of welfare gain of ideal tax –Petrol tax alone can generate 62% of maximum welfare gain (Fullerton and West, 2000)

17 Road Transport Petrol taxes regressive: income elasticity typically low (West, 2004: 0.23) Price elasticity also typically small (-0.67) Regressivity offset by lower rates of car ownership amongst poorest households Use rest of tax/benefit system to compensate low-income motorists? Exemptions for poor reduce effectiveness

18 Applications: Energy Use Ideal tax is on all CO 2 emissions at the household/firm level Direct measurement of individual emissions is not practical Carbon tax on carbon content of fuel – indirect input tax, but good proxy Could tax at time of extraction or time of purchase for final use –primary tax is on fewer numbers, lower admin costs –final use tax omits emissions during extraction

19 Setting a carbon tax rate Rate should equate marginal external damage cost of each fuel But damage from CO 2 depends on stock of emissions – multi-period problem Taxing non-renewable energy sources at constant ad valorem rate has no effect on time profile of resource use –But increasing rate over time might lead to higher energy use and emissions today –Reducing current emissions requires falling rate –Optimal time profile of rate is complex

20 Other issues in carbon tax design How do CO 2 taxes interact with the rest of the tax system? How should they be co-ordinated internationally? –CO 2 damage is a global issue –Is it better to set international targets only, or also to agree on policy (easier to monitor policy implementation?) Can we learn from variation in oil prices about behavioural responses? –Variation in carbon tax rates across energy sources is not the same as impact of oil prices –How to isolate from macroeconomic situation the accompanying high oil prices?

21 Other carbon tax considerations Adjustment costs –Higher if market failure prevents optimal energy use adjustment (e.g. credit market fails w.r.t. energy efficiency measures in homes) Competitiveness –Return revenues to business? –Exempt energy-intensive sectors? (Reduces impact!) –Tariffs on imports from countries with no carbon tax? Distributional –Domestic energy is necessity, carbon tax regressive –Use revenue to transfer to poorer agents? –Are market failures greater for poorer households?

22 Waste management UK 2004/5: around 65% of municipal waste landfilled, 10% incinerated, and 25% recycled Each generates externalities (e.g. methane gas) Domestic waste disposal typically funded by local taxes, not per unit excess waste generated Marginal cost pricing may lead to costly avoidance behaviour (e.g. flytipping) Consider possible welfare gains vs. administrative cost of marginal cost pricing Ideal would be different tax on each type of waste – but higher cost to collect and enforce Almost all studies suggest behavioural response to higher price (reduction in waste generated) very small.

23 External costs of landfill CSERGE (1993) estimates externality at around £7/tonne for active waste and £2/tonne for inert waste, including disamenity cost of landfill sites Estimates used to set initial Landfill Tax rate in 1996 EU Landfill Directive: UK to reduce biodegradable municipal waste to 1/3 of 1995 level by 2020 Landfill Tax rates increased year-on-year since 1999 as a way to help hit that target Medium term objective: £35/tonne for active waste – far above estimated external cost Miranda & Hale (1999) estimate external cost at $7.5 - $73.4 / tonne – lower cost if methane flaring, and large uncertainties over quantity and effect of gases produced


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