GREEN TAX AND BUDGET REFORM: Principles, European Experience and Wider Relevance A Presentation to the Second Roundtable Workshop ‘Prospects of Green Tax and Budget Reform: Principles and Country Experiences; Revenue Neutrality and Double Dividend’ by Professor Paul Ekins Head of Environment Group Policy Studies Institute December, 2006 BANGKOK

Full Circle 1960s: First general environmental awareness 1970s: Oil crisis – resource depletion 1980s: Local air pollution, sustainable development in late 1980s 1990s: Global change, Earth Summit – climate change, biodiversity 2000 on: The Asian expansion – all of the above On previous development models an exercise in physical impossibility Improve resource productivity or bust

The Imperative In both industrial and industrialising countries Reduce resource flows and associated flows of wastes in industrial countries Reduce emissions of carbon dioxide Reduce other environmental emissions Reduce habitat/biodiversity loss and deforestation Greatly increase resource productivity for resources to be available for global development Fifteen year window of opportunity. This time the challenge is for real.

Market failures Most resources allocated through markets, subject to multiple failures –Environmental impacts escape prices (externalities) –Open access ownership arrangements (fish, forests) –Prices that do not reflect resource scarcity –Inadequate production of public goods Environmental functions (clean air, clean water, biodiversity) Innovation, especially eco-innovation People and businesses are grossly misinformed about their resource use and the environmental impacts of their consumption –Resource prices are too low –Pollution charges are low or non-existent –Public awareness of environmental impacts and of available low- impact technologies is low Yet market efficiency relies on ‘perfect’ information

The Policy Portfolio Market-based (also called economic) instruments, which directly affect the price of the targeted activity – Emissions trading, environmental taxes and charges, deposit-refund systems, subsidies (including the removal of environmentally-harmful subsidies), green purchasing, liability and compensation Environmental Tax Reform (ETR) –Increased revenues for environmental taxes/auctioned emission permits, reduction in other taxes Regulatory instruments, which seek to define legal standards in relation to environmental performance, pressures or outcomes Voluntary (also called negotiated) agreements between governments and producing organisations Information-based instruments (e.g. eco-labels), which may be mandatory or voluntary. Importance of ‘policy packages’

The Importance of Prices OECD (1998) Demand Curve for Electricity Efficiency (Aviel Verbruggen, Energy Policy)

Environmental Tax Reform (ETR)/ Green Tax and Budget Reform EC 1993, Chapter 10: “An insufficient use of labour resources and an excessive use of environmental resources”, leading to the conclusion “If the twin challenge of unemployment/environmental pollution is to be addressed, a trade-off can be envisaged between lower labour costs higher pollution charges”. Green taxes/charges are levied on resource use or polluting environmental emissions Revenues from green taxes (or from reducing environmentally harmful subsidies) allow other taxes to be reduced Green taxes can generate revenues for essential environmental spending (e.g. on infrastructure) that is otherwise difficult to finance

DK: 4.8%

Break-down of tax revenues EU25 GDP (100%) Non-environmental taxes (35%) Environmental taxes (2.8%) Energy taxes (75%) Transport taxes (20%) Pollution and resource taxes (5%) Environmental taxes (100%)

Economic Growth and Environmental Impacts

The Importance of Relative Prices Source: Office for National Statistics

ETRs in Europe Denmark, Finland, Germany, Netherlands, Sweden and UK – all very small; different tax base (energy, CO2, sectors), tax rates, revenue recycling, exemptions; all have exemptions because of competitiveness fears (COMETR) Economic and environmental effects of ETR Green taxes reduce environmental resource use Green taxes achieve efficient resource use and environmental improvement at least cost by promoting –Static efficiency (equal abatement cost) –Dynamic efficiency (incentives for innovation) –Awareness of inefficient resource use –Abatement technologies can lead to new industries Reduction of other distorting taxes reduces net cost of abatement (revenue neutrality) If innovation, awareness, industrial cost reduction, reduced distortions are greater than abatement costs, then environmental improvement can be achieved at net gain to the economy – green economic growth (double dividend)

Denmark Phase – 1998 (targeting the household sector): tax shift 2.3% of GDP; reduced income taxes; taxes on energy, water, wastewater, plastic and paper bags Phase – 2000 (targeting mainly industry): tax shift 0.2% GDP; reduction in employers’ SSCs and energy efficiency subsidies; taxes on energy SO2; complex incidence of energy tax (heating and process distinction) Phase – 2002: tax shift 0.3% GDP; reduction in income and pension taxes; mainly energy taxes (industry only affected for heating)

Finland Industry and households Phase : tax shift 0.2% GDP; overall tax reduction; reduction in income tax, SSCs; increase in CO2 tax and landfill tax Phase : tax shift 0.5% GDP; further reduction of labour taxes; increased environmental taxes and corporate profit tax

Germany Phase – 2003: tax shift 0.9% GDP; reduction in employers’ and employees’ SSCs increase in existing energy taxes and introduction of an electricity tax; disproportionately favourable treatment of industry Phase : increasing heating fuel taxes on natural gas and on heavy fuel oil; removal of environmentally damaging subsidies abandoned because of political opposition.

Netherlands ETR in 1998: tax shift 0.7% of GDP; revenues recycled back to households (reduction in income tax and increase in allowances) and industry (reduction in SSCs) Tax differentiated according to ‘bands’ of consumption (lowest rate for highest consumption) Importance of voluntary agreements

Sweden First ETR in 1991 (first major ETR in Europe): tax shift 4.6% GDP; reduction in personal income taxes and taxes overall; VAT on energy purchases and introduction of SO2 and CO2 tax Second ETR : tax shift around 0.4% GDP; reduction in taxes paid by low and medium wage earners and in taxes overall; increased environmental taxes

United Kingdom Three relatively modest ETRs (affecting businesses not households): 1996 landfill tax, tax shift 0.05% GDP; 2001 Climate Change Levy, tax shift 0.06% GDP, 2002 aggregates tax, tax shift 0.02% GDP; reduction in employers’ SSCs; winners and losers Climate Change Agreements (CCAs) with CCL: energy efficiency improvement targets, 80% tax rate discount for energy- intensive firms

Transforming economic structure Economic instrument (environmental taxes, emissions trading with auctioned permits) Escalators (fuel duty, landfill tax) - resource use, emissions would become progressively (but gradually) more expensive over time (eg 3-5% real per annum) Over time economy would be transformed On experience to date –No evidence of any adverse economic effects –Clear evidence of environmental improvement –Theoretical and evidence-based arguments for their introduction Yet limited reforms largely restricted to North European countries WHY?

Opposition to ETR People and organisations are used to free/cheap environmental resources Business opposition for reasons of competitiveness (although purpose of instrument is to make resource-intensive activities less competitive, and alternatives more competitive, over time) Affected sectors resist decline more strongly than benefiting sectors argue for support Household opposition to lifestyle changes (eg fuel tax protests 2000) Political opposition to tax harmonisation

Definitions of competitiveness EC 2004: “a sustained rise in the standards of living of a nation and as low a level of involuntary unemployment as possible”. OECD 1992: “the degree to which a country can, under free and fair market conditions, produce goods and services which meet the test of international markets, while simultaneously maintaining and expanding the real incomes of its people over the longer term”. Difference between national, sectoral and firm competitiveness

ETR: factors affecting competitiveness Differences in energy costs: energy prices –Exchange rates –Energy import prices –Tariffication –Energy tax rates Revenue-recycling: winners as well as losers –Business taxes (e.g. SSCs, lower business costs) –Labour/capital distortionary taxes: double dividend (increased employment/output), tax interaction effect Innovation in taxed firms (Porter/van der Linde) –Cost-effective energy efficiency measures –X-inefficiencies in use of energy –Innovation-seeking/competitiveness of individual firms Market stimulation/innovation in environmental industries

Indicators of competitiveness Costs (compare via exchange rates): –Unit costs –Labour costs (but high incomes desirable) –Energy costs (might decline if greater efficiency) –Energy prices Market share (sectoral) Trend productivity Real exchange rate value Non-price factors (firms): productivity growth, delivery times, quality, after-sales service, financial arrangements, technological innovation, investment, institutional/structural environment COMETR project using these indicators: sectoral competitiveness effects have been very small or indiscernible

The Climate Change Agreements (CCAs) 44 agreements negotiated with different industrial sectors 80% rebate of Climate Change Levy (CCL) in return for delivery of negotiated carbon reduction targets (mainly specific energy consumption, SEC) Targets negotiated as compromise between BAU and ACE (all cost-effective reductions) carbon emissions, as modelled by ETSU (FES) First results of CCAs (to end 2002) reported in April 2003 Targets renegotiated after first results

SEC Evolution Scenarios versus BAU 2000 SectorBAU 2010ACE 2010Potential Meat-1%-11%-10% Paper-14%-37%-27% Chemicals-6%-27%-22% Glass-6%-21%-16% Cement-5%-15%-11% Steel-5%-13%-8% Foundries-8%-16%-9% Aluminium-4%-20%-17% Non-ferrous metals-8%-28%-22%

2002 Results Against Targets The 2002 result failed to meet the 2002 target for 5 sectors (but emissions trading) The 2002 results met the target for –2002 in 4 sectors –2004 in 7 sectors –2006 in 6 sectors –2008 in 3 sectors –2010 in 15 sectors The targets were not particularly demanding; there were more opportunities for cost-effective abatement than the sectors had claimed

CCA – Performance (1) Chemical Industries Association -20% versus 1998 (TP2 2004) -17% versus BAU (TP2 2004)

CCA – Performance (2) British Glass -11% versus 1999 (TP2 2004) -5% versus BAU (TP2 2004)

Conclusions on CCAs Over-achievement of targets – substantial cost- effective efficiency opportunities in industry, ‘awareness effect’ of CCAs because of substantial tax-related incentive (CCL was necessary). Great majority of CCA targets not demanding – asymmetry of information (managers achieved cost-effective reductions they had claimed did not exist) With tax alone a given carbon reduction is cheaper to achieve without rebates BUT ‘Awareness effect’ means that CCL + CCAs may have outperformed a no-rebate CCL both environmentally and economically

Possible Strategy for Future Environmental Taxes on Business Propose tax high enough to trigger an ‘awareness effect’ In return for environmental improvements, offer a rebate large enough (highly affected sectors) to achieve serious business engagement Set targets (likely to be unchallenging because of information asymmetry) Monitor achievement against targets

National Industrial Symbiosis Programme (NISP: DEFRA-funded programme from landfill tax receipts, £6m in ; 3,500 company members Business model: –Regional business-led Programme Advisory Groups –Regional synergy workshops –Sophisticated central database to match resource and waste wants/offers –Close relationship with Resource Efficiency Knowledge Transfer Network –Tracking and feedback of outcomes (from April 2005): Reductions: 1.1 mt waste from landfill; 1.3 mtCO2; 1.1 mt water; 423kt hazardous waste; 1.9mt virgin materials Money: £47m cost savings; £40m new investment; £40m additional sales Significant employment (300 jobs saved, 300 created) and training (1,000) Estimates can reduce business landfill waste by 50% (35mt) Landfill tax escalator is key (£3 pa increase to £35 per tonne; now £18 pt) Recognises the reality of information failure and creates appropriate institutions and incentives to remedy this

Conclusions In market economies any kind of fundamental reform is nearly impossible if it is working against market signals Over reliance on regulation/VAs will be costly and, probably, ineffective (the diffuse users and polluters problem) Price mechanism is the essential mechanism for resource reduction Price signals increase the impact of other instruments, such as information and voluntary agreements ETR not only works with market signals, it achieves environmental improvement at least abatement cost and with most chance of economic benefit Green taxes can also provide financial resources to reduce other taxes or for sustainable infrastructure The policy experience for radical resource reduction is available – so far the political will is not