Environmental Policy

I. Basic Concept Regarding Economic Instruments - B. :Utilization of Economic Instruments in Environmental Policies - Taxes and Charges

I. Basic Concept Regarding Economic Instruments

B. Effectiveness of Economic Instruments in Environmental Policies

1. Effects of Improving the Environment -Theoretical Consideration

Ever since the earliest time after the Oil Crisis, our country, compared to other developed countries, has worked primarily on resource and energy conservation in the industrial sector. On the other hand, the spread of socioeconomic activity of large-scale production, large-scale consumption, and large-scale waste output, have caused population and socioeconomic activity to begin to concentrate in urban areas. The results are environmental problems such as urban lifestyle pollution, increased waste output, and global warming - all issues demanding immediate attention. The primary cause of such problems is the failure to incorporate the cost of using the environment in the mechanism of a market economy. This is due to lack of awareness against the cost to society for taking advantage of the environment in socioeconomic activity, including business activities and everyday life.

The market has a complex mechanism of distributing resources using price as a signal. For example, the rise in prices will increase supply and decrease demand, whereby shortage of assets will be neutralized. The price fluctuation balances out goods and services, but the distribution of goods will not function effectively if there are elements that hamper the correct reflection of prices. It is difficult to reflect social cost caused by burden inflicted on the environment in market transactions, making it difficult for such costs to be reflected properly in the prices of goods and services. By properly reflecting the social cost in the price of goods against the environment, it will be possible to apply the appropriate price from an environmental point of view, thus taking advantage of market mechanics and facilitating the preservation of the environment.

Internalizing the negative external factors of a deteriorating environment that accompany goods and services (social cost) by taking advantage of market transaction through taxation is the function of what is called the Pigouvian Taxation Theory.

The cost to society caused by a deteriorating environment (external diseconomies) should fundamentally be reflected in market prices by having producers of goods and services incorporate these costs into the production costs. However, regarding the various goods and services that put a burden on the environment, it is impossible to internalize the external diseconomies through direct negotiation between the victims and the perpetrators.

Therefore, market prices of such goods and services - which should precisely reflect the cost of external diseconomies - only reflect the cost of raw materials, labor, and capital necessary for the production (private cost) and not the social cost per produced item. This promotes excess production and consumption.

In Figure 1, the intersection point Em of the private supply curve and the demand curve shows the current state, in other words, a state where the external diseconomies are not internalized. Production price and quantity are shown as Pm and Qm, respectively. Efforts should be made to internalize external diseconomies. One way is to match the marginal social cost by adding the price equivalent to the marginal cost of external diseconomies per product to the marginal private cost, this in turn will raise the market value and consequently serve as taxes and charges that restrict production quantity. The cost to be attached is shown as T=Es-Et, shifting the equilibrium point from Em to Es. Under the new equilibrium point, production will be restricted from Qm to Qs and prices will rise from Pm to Ps. Through this, one can tell that the social loss, which was not internalized in market prices (shown as the shadowed area), will decrease.

Regarding environmental policies, it will be necessary to compare the cost of pollution prevention and the advantages gained by such policies when implementing taxation and charges as economic instruments.

Figure1 and Figure2

Similarly, Figure 2 shows a case where a particular company outputs pollutants. The vertical axis is the cost and the horizontal axis is the level of restriction (from complete restriction as origin to 100 percent complete non-restriction). Generally speaking, the larger the pollution, the larger the damage. In other words, the marginal damage cost increases as pollution output increases.

On the graph, the marginal damage cost is shown in the upward-sloping curve to the right. In contrast, the stricter the abatement, the more the cost for abatement. The marginal abatement cost is shown as the downward-sloping curve to the right.

The marginal intersection will be "e," where the additional damage cost and the additional profit from pollution reduction coincide. Therefore, if the output can be controlled to this level, it will be the most desirable outcome in terms of economic efficiency.

From the perspective shown above, it is vital to take advantage of the market mechanism in realizing economic activity that has internalized the social cost and has realized a sustainable society while taking into account consideration of economic efficiency.

  • Economic instruments based on the above concept have the following advantages over direct regulations.
  • For environmental issues where the burden on the environment stems from a wide range of economic entities, or where the cause of pollution is dispersed, direct regulations have their limits. For means that set restrictive standards, it is difficult to set appropriate target levels for individual companies, industries, and individuals and monitor their implementation, which consequently is costly for the government. Furthermore, this tends to invite further large-scale reduction costs. Meanwhile, economic instruments will enable the appropriate distribution of resources in a least-costly manner to the entire society, as each entity will voluntarily choose the most cost-effective action through the market mechanism.
  • Restrictive measures lack incentive to reduce the amount of pollution that surpasses the level of restriction. On the other hand, economic instruments have the effect of providing a constant incentive where reduction of pollution leads to profit, which consequently has the effect of having a positive long-term influence on technology development.

Other secondary impacts among economic instruments will include added income from taxes and charges.

Polluter-Pays-Principle, which calls for the cost in using the environment due to environmental pollution to be reflected in prices, is being implemented through various restrictions as an important fundamental environmental policy. However, economic instruments also aim to fairly and effectively internalize social costs based on the same principle. Through the advantages of economic instruments, long-term environmental issues are able to be resolved from the very structure of the issues, and are considered effective means to prevent further expected influences on the environment. However, if the cause of local pollution problems and pollutants can be traced to a particular individual, direct restriction can be more effective and reliable than economic instruments. Furthermore, in general, government policies combine various methods where they will complement each other and turn out to be the most appropriate measures available to create the most effective result.

2. Situations in Countries Employing Economic Instruments

The Organization for Economic Cooperation and Development (OECD) has researched its member countries on their use of economic instruments such as taxation, charges, and deposit systems. According to the research, in 1992 the number of cases increased to 202 (25 countries) from the previous 153 (14 countries) in 1987. The research showed a marked increase in the use of taxes and charges on various goods and pollutant output (Table 1). In the eight countries where the research has been extensive, the rate of increase between 1987 and 1993 was about 50 percent. Finland, the Netherlands, Sweden, Norway, and Denmark introduced a CO2 tax in the early 1990s; Switzerland is still considering implementing this tax. Table 2 categorizes the endeavors into types of economic instruments and government policies.

Furthermore, it is reported that taxes and charges levied to clean up and revive the environment, incentive taxes for developing technology to green the earth, charges aimed at increasing the rate of recycling, and other economic instruments are being implemented in individual states in the United States (White Paper on Environment 1996 - Overview). Elsewhere, the countries of Central and Eastern Europe, as well as non-OECD countries in Asia are also increasingly implementing economic instruments (Environment White Paper 1995 - General Introduction).

Economic instruments to preserve the environment in our country include pollution load levy based on air pollution related to the Health Damage Law, special landing fee levied according to the noise levels of airplanes, tax exemption system for low emission vehicles, and charges on collecting and disposing waste material at local municipalities (OECD 1994).

Next, let us take a look at recent trends in CO2 taxes.

  1. Finland
    The energy tax was revised in 1990, for the first time in the world, to impose a tax of 24.5 Finnish markka (approx. 560 yen)/tC on all fossil fuels (i.e. coal, heavy oil, gas oil, natural oil, and peat), excluding energy for automobiles, and at the same time, to increase fuel taxes for automobiles. In 1993, the CO2 tax was raised to 50 Finnish markka. The fuel tax was revised in 1994, and the CO2 tax was changed to a carbon/energy tax that emphasized the amount of carbon included and the energy emitted. In 1995, this tax was revised again and was increased to 141 Finnish markka (approx. 3,200 yen)/tC. (yen rates in parenthesis calculated from US dollar exchange rate vs. world currencies in IMF (International Monetary Fund) as of March 1996)

  2. Netherlands
    In order to finance the increased expenditure from the implementation of the National Environmental Policy Plan (NEPP) in 1990, surcharges on ordinary fuel were increased and a CO2 tax based on carbon dioxide output was incorporated into the tax.
    From July 1992, a new tax against fuel, along with a general fuel surcharge comprised of a 50% energy content and a 50% carbon content as a standard, were incorporated into the environment tax. Specification on the use of tax revenue was abolished and was incorporated into the general account. Given this policy revision, taxation of fuels became a general tax increase.

  3. Sweden
    In 1991, a CO2 tax of 0.25 Swedish krone (approx. 4 yen)/CO2 kg was levied on fuels as part of a general revision of the energy tax. A sulfur tax was levied on emission of SOx, while the general energy tax was lowered by 50%. In whole, the fossil fuel tax was raised. Meanwhile, a tax reduction was implemented against large-scale energy-consuming industries (cement, paper and pulp, steel, chemical, mining industries, etc.) and in the commercial gardening industry. In 1993, the CO2 tax was revised, which raised the general tax to 0.32 Swedish krone (approx. 5 yen) /CO2 kg, but taxes on industries and fuel used in commercial gardening were lowered to 25% of original, or 0.08 Swedish krone (approx. 1 yen)/CO2 kg, while exempting energy and electricity taxes. Part of the increased tax revenue is used for environmental projects. In 1994, the CO2 tax was raised 4 percent. (yen rates in parenthesis calculated from US dollar exchange rate vs. world currencies in IMF (International Monetary Fund) as of March 1996)

  4. Norway
    A CO2 tax was implemented in 1991 as a measure to restrain CO2 emission. Fuel taxes are based on a combination of basic tax rates and a CO2 tax. For mineral oil, a sulfur tax is charged based on the content of sulfur.
    In 1992, the tax on gasoline and natural gas was raised, and coal and coke were added to the list of taxable items. The CO2 tax was raised gradually until 1995. Regarding energy taxes other than the CO2 tax, the basic energy tax rate on mineral oil was lowered in July 1992, while the energy tax on gasoline was raised to cover for the decrease in tax revenue.

  5. Denmark
    In order to achieve the reduction of CO2 emission and energy consumption, Denmark implemented a CO2 tax in 1992. The framework of the CO2 tax consists levying a CO2 tax and a subsidy scheme that urged a shift to the use of alternative fuels such as natural gas. As a result, the tax burden on heavy oil and light oil remained unchanged, but that of coal and electricity increased. With the tax reform in 1993, energy consumption by industry was exempt from taxation, but due to the discrepancy between the burden on households and that on industry, the law was revised in July 1995 to implement a new energy tax for the industry beginning in 1996. Through this tax and other complementary measures, Denmark cut down on CO2 emission by 5 percent, and plans to raise tax rates by the year 2000.

  6. The Trend for Carbon/Energy Taxes in the European Community (EC) - Currently the European Union (EU)
    In October 1991, the European Community (EC) Committee adopted the "EC strategy on reducing CO2 emission and improving efficient use of energy," which compiled a plan to stabilize the emission of CO2 to the 1990 level by year 2000. In a communication to the Board of Directors, the committee proposed a tax based on the carbon dioxide and energy content of fuel.
    In December 1991, the Joint Board of Environment and Energy Ministers acknowledged the need for taxation in order to stabilize CO2 emission, and ordered the EC Committee to formally come up with a bill by 1992.
    In June 1992, the EC Committee adopted a Board order proposal regarding the implementation of a common carbon dioxide/energy tax, but conflict of interests among the countries at the level of Board of Directors made a common implementation difficult. Thus, the Committee submitted a revised plan in May 1995 with the ultimate goal of implementing a common CO2 /energy tax. However, the period before the year 2000 is considered a transitional period, and the implementation of the tax is left largely to the discretion of each member country. Discussion is still ongoing among the Board of EU Economic and Finance Ministers regarding the common agenda.

There have been reported effects on the environment due to the above economic measures, particularly regarding the levying of taxes and surcharges carried out by OECD countries, showing that the measures are proven not only in theory but also in practice.

Atmosphere pollutant emission charges in France

France established the Agence de la Qualité de l' Air in 1980 to monitor atmospheric pollution and to develop technology to remove atmospheric pollution, and the Government of France was given authority to establish special charges for running this organization. It is reported that during the five years following 1985, total nationwide sulfuric substances were reduced by approximately 8 percent. (Environment Tax - Structure and Form edited by Hiromitsu Ishi, 1993)

The CO2 tax in Norway

The Central Statistics Bureau conducted research on the impact of CO2 tax on energy consumption of static and mobile sources. The research showed a definite effect in reducing the amount of CO2 output. The aforementioned sources constitute 25 percent of overall CO2 output. CO2 output in 1991 through 1993 decreased from 3 to 4 percent in one year due to the CO2 tax. More precisely, the tax was able to withhold 300,000 tons of CO2. (The Effect of the Norwegian CO2 Tax, 1995)

The CO2 tax in Sweden

The Swedish Environmental Protection Agency conducted research on the relation of CO2 output to implementation of CO2 tax. When comparing the CO2 output of 1987 and 1994, the research showed that output decreased by 19 percent overall in private households and industry. In particular, there was a shift towards use of biological fuel from the use of fossil fuel regarding local heating habits. The research indicated that 60 percent of the decreased CO2 output was a result of the CO2 tax, and the remaining 40 percent was due to energy conservation and concentration of local heating. On the other hand, industry does not appear to be responding much to the CO2 tax after the 1993 revision of the energy and CO2 tax (the CO2 tax rate on industrial fuel decreased to 25 percent of ordinary rates, and it also abolished the energy tax). (Utvardering av koldioxidskatten, 1995)

The NOx charge in Sweden

In Sweden, a NOx charge was implemented in 1992 aiming at the early establishment of new NOx emission guidelines by 1995. Under this NOx charge, the government expected a decrease of 20-25 percent over the period of 1990 through 1992. However, the actual decrease was much larger than expected (OECD, 1994). The Swedish Environmental Protection Agency evaluated the decrease in NOx emission and found the actual decrease to be 34 percent over the period of 1990 through 1992, with a further decrease to 54 percent by 1994 (Avgifter, skatter och bidrag med anknytning till miljovard, 1996).

Environmental tax on domestic airplanes in Sweden

Sweden imposed an environmental tax on domestic airplanes in 1989 with the purpose of reducing gas emission from airplanes. The implementation of the tax improved exchange of combustion rooms of airplane engines and reductions in hydrocarbon output of up to 90 percent were reported. (Hiromitsu Ishi, ibid.)

Waste material tax in Denmark

A waste material tax was implemented in Denmark in 1987. The tax was levied on landfill-bound or burnable waste materials based on the quantity of waste, expect for specified items. A secondary impact of the tax was that small-scale waste processing companies that could not meet government standards were forced out of business. Furthermore, the output of waste between 1987 and 1989 decreased by 12 percent, and the amount of recycled goods increased by 7 percent. The definition of waste material broadened after 1990, but the amount of taxable waste material declined more than expected. An unexpected result was an increased use of recycled construction material (as filling material) for building roads. (OECD, 1994)

Tax on plastic carrier bags in Italy

Italy imposed a 200 percent tax on plastic carrier bags based on their market price. The consumption of plastic shopping bags increased 37 percent between 1983 and 1988, but with the implementation of this tax in 1988, its consumption declined by 20-30 percent. (OECD, 1994)

Water effluent charge in Germany

In Germany, water effluent charge was implemented in 1976 with the purpose of providing an incentive to improve the water quality of drainage (actual execution from 1981). The federation ran the charge system, which imposed taxes on COD and heavy metal. There are no quantitative results, but pollution-preventive investment increased drastically in the few years prior the execution of the charge, revealing that the measure had an announcement effect. (OECD, 1994)

Oyster tax in Connecticut, USA

In 1987 in the state of Connecticut, USA, a sales tax on oysters was implemented to promote the revitalization of the natural resource. The revenue was used to improve oyster production and oyster beds. Under this sales tax, the oyster catch tripled, recovering to roughly 700,000 bushels per year. Connecticut became the second largest provider of oysters in the US (Environmental White Paper, 1996)

Examples in Japan

According to interviews conducted by our research panel, the city of Date in Hokkaido began to charge for garbage (charging 60 yen for 40-liter garbage bag and 40 yen for 20-liter bag), subsequently garbage output decreased by 30 percent compared to the period before the garbage surcharge.

3. Impact on the Economy

In order to achieve a socioeconomic system that integrates the environment and the economy as well as taking into consideration the preservation of the environment, taking advantage of economic instruments such as government policy is considered an effective means to keep down costs for the entire society and to enable a long-term transition. In order to make the transition to a sustainable economic society, it becomes necessary to realize a long-term shift where natural resources are utilized in a sustainable manner and resource development - its use, production, investment, technology development, and consumption activity - comes to impose less of a burden on the environment. Economic instruments are believed to contribute to smoothing this transition by taking advantage of the market mechanism.

Meanwhile, short-term impacts on an economy in transition may include changes in economic growth, international competitiveness, trade, employment, and regression, as in the case of other instruments. The Research Panel hearings also showed that economic groups voiced such concern.

Such views are often debated in the context of economic impact when discussing the implementation of a carbon tax as an instrument to protect against global warming.

Implementation of a carbon tax requires taxation at a high level. Our country has also conducted research using various economic models to examine the negative impact on economic growth. Many of these economic models use the years surrounding 1990, when the "Action Program to Arrest Global Warming" was adopted, and the year 2000 and after, which are set as goals for stabilizing CO2 emission, as standards for calculation. Depending on the method of implementation and standard of taxation used for the CO2 tax, these models show a 0.01 percent to 0.5 percent decrease in economic growth, with some exceptions, based on a real economic growth rate of 3.5 percent which was set as the standard following the "Five-year Action Plan for a Livable Country" (approved by the Cabinet in June 1992). (Second Report of the Committee on Economic System to Address Global Warming, Table 3, 1994).

While these are not problems unique under the implementation of economic instruments, impact on international competitiveness and trade are also often debated in the context of environmental taxes and charges, particularly the carbon tax. There are arguments that competitive strength in the international arena declines and industries move overseas as a result of economic instruments, particularly the carbon tax. But real competitiveness is influenced not only by various regulations and tax systems but also by a combination of various factors such as political stability, labor force, wage standards, access to raw materials and markets, and how social capital is organized in the country (OECD, 1996a). Therefore, it is inappropriate to discuss the influence on international competition by singling out environmental taxes and surcharges.

In relation to international competitiveness, there is concern that with the implementation of environmental taxes and charges, industries may move overseas where environmental regulations are less severe. In the case of the carbon tax, production in countries that do not implement a carbon tax may increase, causing increased consumption of fossil fuels in other countries due to a reduction in international prices of fossil fuels, thereby causing increased pollution emission in other countries. However, the impact of environmental taxes and charges on competitive strength, trade, and leakage are issues affected by various factors and cannot be fully predicted at the current time (OECD, 1996a).

The above argument holds for regulatory instruments and other government policies as well. The various research results have not shown positive proof that current regulations and criteria have influenced competitive strength. The OECD Environment Policy Committee at the Ministerial Level (February 1996) was also unable to find significant influence of economic policies on competition, trade, and shifts in industries based on experience up to now. Furthermore, much of the environmental taxes and charges had low tax rates and did not show any noticeable international effects (OECD 1996a). If a carbon tax of much larger scale were implemented, such debate is bound to arise, but research results will show discrepancies depending on the scale of the tax and how many countries participate in the endeavor.

The impact of environmental taxes and charges is also affected by the foreign exchange rate, and there remains room for relieving further influences using border tax adjustments on goods. This involves exempting taxes for exported goods and taxing imported goods, thereby giving fair treatment to both. The method will be discussed in more detail in Section II item 5.

Furthermore, environmental taxes and charges not only reduce the burden on the environment, but also serve as an added source of revenue whereby one can expect "a double dividend" in the way of increased employment standards, improved GDP, and the promoting of social welfare. Some examples of this can be seen in the OECD Report, 1996a.

According to calculations by the EC, the economic impact of increased tax revenue from a suggested carbon/energy tax of $10/barrel, in terms of alleviated burden of employees through social welfare payments, amounts to a 0.4 percent increase in GDP in the short term and 1 percent in the medium term (7 years). The unemployment rate showed a decrease of 0.3 percent in the first year and 0.9 percent in the short term. The Hermes Macroeconomics Model of Standard used by France, Germany, Italy, and England showed a 0.1 percent decrease in GDP in the medium term, but a 0.5 percent increase in employment opportunities.

It is difficult to specify the overall impact of the double dividend on society as a whole, and its evaluation differs from country to country. The term, "a double dividend" is also used in different ways depending on research methods. "A double dividend" may result in improved environmental benefits, employment opportunities, welfare benefits, GDP, as well as reducing the distortions of other taxes.

With the implementation of environmental taxes and charges, there is concern that regression may occur where low-income families are forced to take on more burden than high-income families. However, it is inappropriate to argue about regression from the perspective of only one type of tax. A similar effect is possible for regulatory instruments that do not depend on taxes or charges as one incorporates the cost corresponding to the regulation. Because there has been no complete study of environmental policies concerning sharing of the burden among different sectors, it is preferable that more research be done on this subject (OECD, 1996b). It should also be noted that the lower social strata are forced to take on the burden even when the environment worsens.

While economic instruments guarantee various impacts on the economy, it is possible to mitigate the impact by appropriately combining economic instruments with other government policies.

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