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- Analyse the role of taxation in contributing to the solution of environmental problems such as pollution and global warming”
- Explain why it is often claimed that such taxes lead to a “double dividend” and whether these claims are justified- Discuss this statement”
Role of taxation in contributing to the solution of environmental problems such as pollution and global warming
The aspect of tax which relates to the environment is referred to as “Environmental Taxes (ET)”. ET is connected to government’s environmental goals. Such tax is meant to boost positive behavior change for instance in pollution and global warming.
The major advantage of an ET is that it gives room for efficiency in the economy. It serves as an economic tool for the reduction of cost to attain a certain extent of social security.
Benefits of ET
- Restructuring of pollution abatement results to fixed efficiency advantages
ET is capable of curbing costs where such pollution abatement costs differ across entities. Newell & Stavins, (2003) explains how reduced costs through the use of command and control (CAC) regulation can be a lot more than the cost at its minimal achieved via emission tax.
- ET encourages technology development and innovation
Unlike other regulatory policies that set specific limits for compliance with pollution requirements, the ET provides polluters with recurring incentives to enable them reduce their toxic wastes to the barest minimum at an operating cost level. Besides, ET is applicable to all residual emissions, thus, generating incentives for the emergence of new technologies with marginal costs lower than the ET rate.
- ET provides for effective form of abatement
ET tends to attain a more effective form of abatement and considers the diverse costs of individual companies without having to compromise with the companies demand. Unlike, where the CAC tend to rely on the companies to know the cost incurred on abatement which could lead to negotiation between both parties.
Indirectly, such companies have control over the manner in which CAC rules would be established. Therefore, every company is exposed to equal pollution tax rate thereby increasing efficiency of regulatory policies and limiting the risk of granting polluters power on negotiation.
- Mechanism to generate income
Revenue generated via ET has been debated with respect to ET being a double dividend or a benefit. However, ET increases income through tax paid on every unit of pollution.
Demerits of ET
- ET ignores the peculiarity of different geographical pollution
There is likely to be inefficiency via the use of uniform tax rate on unequalled sources of pollution. Hence, a peculiar policy could be required in order to attain a fair system of tax on polluters.
- ET is not suitable for with certain companies form of decision making
Where a Company adopts a system of division of labour (i.e. decentralization), the implication of this is that every area of the firm’s operations would not be considered. The internal structure of a Company is required to such that similar decisions are collectively made such as important decisions on tax liabilities and their choice of technology before ET can encourage responses from polluters.
The difference between the tax and the costs of abatement for companies considering higher pollution abatement should have an equilibrium point. Such considerations might not be significant to the internal structure of the company, thus may also necessitate significant restructuring to the decision-making process of the Company as a whole in order to merger both decisions together.
Restructuring on the otherhand, is expensive and not worth the efforts where such tax involved is low. Companies are likely to ignore lower ET; making other regulatory measures may be more effective in terms of both abatement costs and decision-making costs.
- ET could lead to adverse effects
ET may yield an adverse effect where the polluters (i.e tax payers) react in a negative manner which could be more harmful to the environment. For instance; taxation of toxic waste could lead to a reduction in waste, likewise, it could also encourage illegal activities (e.g. burning/dumping) which could be more costly to the environment.
- ET could have impact on distribution
ET is seen to be regressive in terms of being generally applicable on energy, carbonated contents of fuel, and transportation. Alternatively, a high percentage of low earned household finances are expended on power, cooking gas, and transport.
Consequently, incomes arising from environmental safety could accrue to high earned households who can pay for such public safety. Environmental policy reforms must be careful to use a package of changes that account for and offset these distributional effects.
- ET leads to international competitiveness
Tax on industrial inputs increases manufacturing costs. Where local products compete with foreign products that are not subject to comparable ET, it could lead to competition of local companies.
Claims on ET leading to “double dividend”
With respect to fiscal policies, issues emerge as to the stability as well as the possibility of ET incomes. Particularly, on the erosion arising from polluters behavioural reactions. Generally, incomes generated from taxes are usually influenced by behavioural reactions. ET centered on items with inelastic demand for instance; energy could be less influenced by behavioural reactions than other tax bases.
Income generation of ET perceived to be double dividend
Oates (1991) and Pearce (1991) observed that ET could lead to double dividend. It is the likelihood that an ET may result in environmental development as well as generating income for the reduction of investment tax, tax on labour supply, and tax on consumption.
Oates’ and Pearce’ observation affects two types of policy decisions as follows:
- Decisions on revenue generation: Arguments against conventional tax
- Decisions on pollution regulator: Arguments against mechanisms that do not generate income (quotas)
Arguments against conventional tax
Proponents of this argument explain that almost all taxes encourage unwanted behavioural changes that could lead to a decrease in the supply of labour thereby creating “excess burden (additional liability)”. This means that taxes decreases individual wellbeing than the tax liability.
Growth in conventional taxes would increase distortionary prices, by an amount known as marginal excess burden. With respect to prevailing taxes, empirical estimates of these marginal distortionary prices are significant.
Bovenberg and Goulder (2002) assessed several estimates e.g in Ballard et al (1985), and they observed that marginal excess burden is 20–50 cents for every more dollar of tax income.
On the other hand, ET encourages wanted behavioural changes which in turn curbs emissions. In such situation, using ET would obviously appear desirable rather than conventional taxes.
The double dividend theory asserts that ET would offer two benefits: it would offer the benefit of welfare by solving the issue of pollution, while ET revenue would allow for government reduction in wages tax, and consequently, increase net wages, labour supply, and reduce safety cost.
Based on the foregoing, ET is likely to be mostly appreciated where series of behavioural changes are required across a huge size of manufacturing and consumption events. Direct regulation cost could be expensive while in some situations, prohibited. Also, where there exist diverse non-regulatory activities, the public may benefit by converting such harmful actions in a cost-effective way.
Sometimes, ET might not work well, while an outright prohibition may be considerably at ease to administer than a tax rate requiring sufficient measurement. The benefits in oversophisticated tax structures are marginal through tax variances showing the ecological features of products with slight environmental importance.
A tax structure that is complex tends to be expensive to administer. The tax limits between high and low tax rates products are exposed to public uneconomical litigation and erosion. Besides, inadequate tax benefits may attain slight modification in behaviour. Again, companies are not likely to consider tax benefits in deciding on environmental technology where such benefit cannot defend the costs of restructuring.
Alternatively, a second dividend is not likely to manifest if the first dividend from environmental benefit is still in existence. The first dividend must be set aside to enable the second dividend develop a tax structure. Asides, the environmental concerns, a certain amount of income could generate efficiently through an exact optimum tax rates on diverse products.
Where; a product is taxed at a lower optimum rate, and such product is related with uncontrolled pollution, certainly, an increase in the rate could lead to two dividends (i.e environmental gain and a more efficient tax structure).
Where; the product is taxed at exactly its optimum rate, therefore, a rise in the rate may result in environmental gain.
Where; there is a pollution control, and then an increase in the tax on this good may not even provide an environmental dividend.
Where; the product has been taxed at a rate higher than optimal, a rise in the ET might reduce welfare. Therefore, the likelihood of a double dividend cannot be overruled; the rate must consider the circumstances.
Tax systems have been planned to reduce additional liability without considering the environmental effects of such tax systems. Welfare would normally develop via shifting the balance of revenue generation to more dependence on ET from the environmental dividend only.
Therefore, tax system is further resourceful where ET are adopted rather than when ignored. However, such development can only last to a certain extent. As the ET rate is improved, the cost of a additional liability on behavioural changes increases, to the extent that it surpasses the additional
Arguments against mechanisms that do not generate income (quotas)
Another argument on the double dividend affects the concerns on the type of green tax policy mechanism. Where; policy deploys ET which is an income generating instrument, does such income offer a more effective fiscal policy, when likened to the use of a comparable non-income generating instrument?
Excess burden disregards every environmental advantage. Therefore, ET could have negative additional liability in a case where environmental benefit is part of the excess burden. Such meaning could jeopardize double counting.
Ordinarily, an anti-trust regulator restricts companies from conspiring, monopolizing, limiting production, increasing costs, and yielding returns. However, the environmental regulators basically need companies to limit production. The policy gives room for an entrance barrier, since new companies must obtain quotas for trading in such market.
Double dividend and its weak form/ strong form/ irrelevant analysis
As earlier stated, the first dividend which is an outcome of environmental regulations is an environmental benefit. While the second dividend occurs when there is an additional efficient tax system in place.
Goulder (1995), explains a weak form of double dividend to be a case; where there is a rise in the welfare advantage via ET incomes for the reduction of distorted taxes rather than refunding the tax incomes back to the tax payers (polluters) in a lump sum.
Weak form of double dividend further emerges through auctioned certificates, rather than grandfathered permits, in a case where the auction wages is utilized for the reduction of misleading taxes on labour supply.
Goulder (1995), further explains that the weak form of double dividend is a known fact since it is well known that when a tax on lump sum is exchanged for a distorted tax, there would be positive cost of welfare which forms part of the typical meaning of distortion. While choosing amongst environmental policy mechanisms, the implication will be that ceteris paribus, a considerable premium ought to be placed on selecting mechanisms which does not generate scarce rents and abandon them in the hands of private individuals. If inadequate rents are identified, via taxes then government may adopt the scarce rents to decrease the existing distorted tax rates. Significant costs are incurred if the possible incomes from ET are given up.
Goulder (1995) explains that strong double dividend is the case where increasing ET and decreasing distorted tax does not only have environmental gain (that is first dividend), but also decreases the overall taxed distorted cost. Where, a strong double dividend arises, the implication is that the ET reforms possess negative gross costs (including; welfare costs of behavioural variations and excluding environmental benefits).
The double dividend opinions portrays the importance of tax and its environmental regulations concurrently. Bovenberg and Goulder ( 2002), explains that the amount of dividends, though, is irrelevant. Provided tax and environmental regulation developments are combined appropriately, what is of upmost importance is whether the net outcome is positive or negative on welfare as a whole.
- Ballard, C., Shoven, J., and Whalley, J. (1985), General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States: American Economic Review, 75, 128–38.
- Bovenberg, A. L. and R. A. de Mooij (1994), Environmental Levies and Distortionary Taxation: American Economic Review, 84-94(4), 1085-89.
- Bovenberg, A. L., and Cnossen, S. (1995), Public Economics and the Environment in an Imperfect World, Dordrecht: Kluwer Academic Publishers.
- Chloe. S (2012), Press release: Definition of environmental tax published, website: https://www.gov.uk/government/news/definition-of-environmental-tax-published accessed on 23 February 2014.
- Goulder, L. H (1995), Environmental Taxation and the Double Dividend: A Reader’s Guide, International Tax and Public Finance 2, 157-184.
- Goulder, L. H., I. W. H. Parry and D. Burtraw (1997), Revenue-Raising vs. Other
Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax
Distortions, Rand Journal of Economics 28, 708-731.
- Goulder, L. H. (2002), Environmental Taxation and Regulation, in Auerbach, A. J. and Feldstein, M. (eds.), Handbook of Public Economics, Vol. 3, Amsterdam: North Holland Elsevier.
- Helfand, G., Berck, P., and Maull, T. (2003), The Theory of Pollution Policy, in Mäler, K.-G., and Vincent, J. R. (eds.), Handbook of Environmental Economics, 1, Amsterdam, North Holland Elsevier.
- McManus, P. (2009), Environmental Regulation, Australia: Elsevier Limited, website: http://en.wikipedia.org/wiki/Command_and_control_regulation accessed on 23 February 2014.
- Tullock, G. (1967), Excess Benefit, Water Resources Research 3, 643-644.
 Command and Control (CAC) Regulation can be defined as “the direct regulation of an industry or activity by legislation that states what is permitted and what is illegal”.