23/08/2006

JURISPRUDENCE OF ENVIRONMENTAL TAXATION

Though it is generally forecasted that national eco-taxes may deteriorate international competitiveness of domestic producers and affect the prices of their traded goods, there is so far little empirical evidence to suggest that differences in environmental standards have had a significant adverse impact on competitiveness. Moreover through tax exemptions, environmental subsidies, border tax adjustments and production and import restrictions governments have successfully dealt with trade concerns.

Almost all countries have introduced environmental taxes to a varying extent as economic instruments increasingly play an important role in formulating a country’s environmental policies. Environmental taxes are defined as monetary rights levied by the state on activities that deteriorate the environment; they are meant to make polluters change their behaviour, thereby increasing collective welfare. Depending upon their design, environmental taxes support the ‘polluter pays principle’ (agents who pollute must pay), under which the costs of pollution prevention and control should be reflected in the price and output of goods and services which cause pollution as a result of their production and/or consumption. Environmental taxes are not meant to pay for these costs but are indeed supposed to deter them. By making polluters pay, an environmental tax does not create new social inequalities, it only points out at existing inequalities in new areas.
It must though be remembered here that environmental taxes are fundamentally different from traditional taxes. They are not primarily designed to be revenue raising instruments, nor are they regulatory taxes in the sense of accomplishing slight changes in individual or firm behaviour. The point of designing an environmentally sound tax system is rather to accomplish deep and structural changes in economic and ecological behaviour of individuals, households or firms; i.e. changes of pattern not of degree.

Implementation of Environmental Taxes
One of the most common policies used to tackle the problem of pollution is through imposing a ‘green tax’ or an environmental tax. Through this mechanism the state imposes a tax on the production or consumption of a product that damages the environment, or on a complimentary product, in an attempt to reduce its production or consumption. Examples of such taxes include leaded petrol tax, tax on electronic products using CFC’s, landfill tax, Carbon tax amongst others. Before implementing environmental taxes the state should very clearly state its environment protection policies and what it seeks to achieve through implementation of such taxes. Like any other tax, environmental taxes are disliked by the industry.
Environmental taxes though offer important advantages such as offering Greater flexibility to polluters who remain free to adapt market signals in a cost-effective manner (e.g. reducing emissions by reducing output, installation of better pollution abatement technology, better production efficiency, or lesser use of polluting substances during production process) as also to reduce the social costs of pollution. Moreover Revenue raised through Eco-taxes can be used effectively to curb further the use of polluting substances by the state and can also be used to reduce other taxes in order to remove economic distortions.
Now suppose that an environmental tax is levied on a consumer good that has harmful environmental effects. This has two distinct effects on the welfare of the consumer. On the one hand he suffers a loss of the real income, since the price of the good that he consumes has gone up and on the other hand tax increases the quality of the environment, which is a gain. In judging the overall distributional impacts of environment tax, one has to take account of both effects. Taxes help in removing distributional income inequalities, that is they ensure that poor do not become poorer and rich, richer. There is a strong argument against imposition of environment taxes as it is apprehended that such taxes will redistribute income from the poor to the rich. However if a state has a progressive tax system, a well developed system of social security and assistance, the distributional argument of imposition of environmental taxes is relatively weak. Though in a country like India, due to the absence of effective social security schemes, a cautious approach is required while formulating any kind of environmental tax policy.
Environmental taxes can be further classified as emission taxes (e.g. on air, water and soil pollution), product taxes (e.g. on petrol and other fuels, vehicles, batteries, plastics, tires etc), input taxes (e.g. on agricultural inputs such as fertilizers and pesticides), other production taxes (CFC’s and halons) and environmental charges for public services delivered (e.g. water and sewage charges, waste disposal charges, transport charges). The Organization for economic co-operation and development (OECD) has drawn attention to the economic and environmental advantages of reinforcing complimentarily fiscal and environmental policies through a comprehensive restructuring of tax systems so as to achieve environmental objectives more efficiently, yet without increasing the overall tax burden [Implementation Strategies for Environmental Taxes (OECD, 1996), 15-17].

International implications
A major obstacle to the implementation of environment related taxes is the fear of reduced international competitiveness. Emission taxes, input taxes and other environmental taxes may raise the cost of the products of a polluting firm, and thus politically it may be difficult to impose such taxes in certain areas. National eco-taxes then deteriorate the international competitiveness of domestic producers and affect the prices of their traded goods and services. For instance, a carbon tax would most likely increase the cost of batteries and consumers would then promptly move to cheaper imported batteries from countries that do not impose environment taxes. If carbon is released into the air again through the use of such batteries, then the very purpose of environment tax, to reduce the release of carbon in the atmosphere, is undermined. Though so far there is little empirical evidence to suggest that imposition of environment taxes reduce international competitiveness, there are other ways in which state governments have dealt with these concerns.
a. Tax concessions and exemptions. In the above example the government may decide to offer a tax concession to the industries manufacturing batteries with cleaner products, thereby ensuring that the industries do not suffer from an increase in production costs.
b. Environmental subsidies. The government, in order to facilitate the acceptance and use of new pollution abatement technology, may offer subsidy on such products. Thus if under an environmental tax legislation, polluting firms are required to adopt cleaner technologies, then the government may provide a subsidy on purchase of such abatement technologies and thus ensure that such technology is adopted and used by industries. This shall also lead to a substantial reduction in domestic pollution and also ensures that prices of domestic goods are not much affected by introduction of new pollution abatement technology.
c. Border tax adjustments (BTA’s). A BTA consists of the imposition of a tax on imported products equivalent to a tax borne by like domestic products, and the exemption from taxes on products if they are exported. The effectiveness of BTA’s has been analyzed later in the paper.
d. Production and import restrictions. Through this the government bans import of those products which harm the environment. The ban on trade of such goods requires global efforts to correct cross-border pollution. In the case of the Montreal protocol on the protection of ozone layer, co-operating countries reached an agreement to ban trade of ozone depleting products. Such import restrictions will ensure that domestic producers do not suffer due to increase in the cost of the good as also to ensure that the future generations grow up in a much healthier environment.
The goal of environment taxes is to reduce pollution and to ensure that those who pollute pay the economic and social costs. This is clearly evident from the fact that by and large environment taxes are collected form the use of fuels and the sale of motor vehicles, which form a major source of pollution. In order to provide for a better standard of living for its citizens the government has to impose taxes on environmentally harmful products so as to deter producers and consumers from using them.

Border Tax Adjustments (BTA’s)
Concerns regarding international competitiveness of domestic goods are generally addressed through establishment of a border tax adjustment system. Such system ensures that domestic producers do not suffer from cheap imports, largely from those countries which do not follow the practice of taxing environmentally harmful products.
The 1970 report of the GATT working party on BTA’s defined Border tax adjustments as “any fiscal arrangements which put into effect, in whole or in part, the destination principle (i.e. which enable exported products to be relieved of some or all of the tax charged in the exporting country in respect of similar domestic products sold to consumers on the home market and which enable imported products to be sold to consumers to be charged with some or all of the tax charged in the importing country in respect of similar domestic production”.
There are various kinds of BTA’s, but the simplest and most common amongst them is the “destination system” in which traded goods are subject to taxes of the importing country (destination) and exempt from the taxes of the exporting (origin) country. Thus if transport fuel is trucked from Berlin to Paris then it will be taxed in Paris (destination), at the Paris rate, and will be exempt (completely or partially) from paying tax in Germany.
The BTA system is regulated by GATT rules and unfortunately the interpretation and application of the BTA rules in GATT articles remains unclear with numerous legal issues that need clarifications. Interpretations vary and have been constructed on a case-by-case basis taking into account, inter alia, the product’s end uses in a given market, consumer’s habits and tastes, the product’s properties, nature and quality and the tariff classifications for the products.
Article II:2 (a) authorizes a state to impose taxes on any imported product, equivalent to that borne by a like domestic product. The term ‘like domestic product’ has itself been a subject of much controversy and its definition remains ambiguous. The U.S. experience however establishes the importance of BTA’s in achieving the benefits of environmental taxation. Writing about the U.S. experience with BTA’s Mr. J. Andrew Hoerner (in his working paper International Workshop on Market Based Instruments and International Trade, Amsterdam, March 1998) concludes with four assertions. He states that the tax on embodied inputs is administrable. There has been a controversy surrounding the question whether input products could also be subject to a border tax adjustment. The U.S. experience with Superfund Taxes shows that this kind of a system is possible and administrable. He further concludes by saying that BTA should be avoided if the tax is a trivial percentage of the price and goes to acknowledge the fact that if the tax is a significant percentage of the price, then there will surely be evasion efforts, though such evasion can be kept under control by carefully designing the tax and enforcement structure.
The issue as to what products might be classified as ‘like products’ remains a legal question of treaty interpretation. As has been already mentioned, the definition varies on a case-by-case basis. However the legal debate is heavily influenced by the political and administrative concerns. Concerns about the international competitiveness of polluting industries have been the primary barrier to the adoption of such taxes in many nations. Border tax adjustments allow nations to address the issue of competitiveness while maintaining the environmental incentive. The political considerations would have to weigh in favour of BTA’s if environmental taxes are to be introduced without harming the domestic industry.

Use of tax revenue
Each country decides on the use of environmentally related taxes according to its specific economic, fiscal and environmental situation. Though before discussing how money collected could be spent, we shall first attempt to ascertain as to how much revenue can be generated globally by environmental related taxes. It is only in that context can the use of the revenue collected be studied.
Agnar Sandmo (Norwegian School of Economics and Business Administration) estimates that the potential of Carbon dioxide related taxes globally could be as much as US $ 130 billion a year. At a very modest estimate this figure could be over US $ 30 billion. The significance of the estimates is of course not in the figures they portray but in the indications they give of the order of magnitude. Thus even with modest rates of taxation, assuming that the same rate is applied on all countries, huge revenues are likely to be raised.
Several options are available to state governments as far as use of revenue collected through environmental taxes is concerned. Taxes may be used to alleviate budgetary deficits, contribute to a budget surplus or finance increase in government expenditures. Moreover if some revenues are earmarked for specific purposes, then part of the revenue may be allocated for financing environmentally motivated concerns like improving recycling facilities in the country, reducing dependence upon landfills, setting up more gobar-gas plants in rural areas and financing for research and development to improve the quality of motor fuels used.
Though the best possible use of revenues collected from environmental taxes may be in
financing environmental subsidies. Environmental taxes are always introduced as a
policy and never as a single legislative document. Thus their imposition is accompanied
by a host of other schemes which provide for an early acceptance of such taxes.
Environmental taxes would more or less force the producers to adopt new pollution
abatement technology. The government, through the revenue generated from
environment taxes, can subsidize the cost of such abatement technology. The main
intention behind introduction of environment taxes is to reduce the pollution levels in the state and for this to happen wider use of ‘cleaner’ technology would have to prevail. The government could facilitate the adoption of such technology by subsidizing it with the revenue generated through environment taxes. The state can thus hope to amplify the acceptance of such taxes as also to reduce pollution levels without incurring much public cost.

The problems with environmental taxes
Although environmental taxes are used with increasing frequency by governments around the world as instruments designed to deal with environmental externalities, we must evaluate the difficulties in relying on taxation to correcting for market failure. Many economists argue that explicit pollution taxes create further problems which lead to government failure and little sustainable improvement in environmental conditions. The main problems with the implementation of green taxes are (a) Assigning the right level of taxation: The government cannot accurately value the private benefits and cost of firms let alone put a monetary value on externalities such as the cost to natural habitat and the value of human life. Without accurate information setting the tax at the correct level is virtually impossible. (b) Consumer welfare effects (issues of equity): Taxes reduce output and raise prices, and this might have an adverse effect on consumer welfare. Producers may be able to pass on the tax to the consumers if the demand for the good is inelastic and, as result, the tax may only have a marginal effect in reducing demand and final output taxes on some de-merit goods (for example cigarettes) may have a regressive effect on lower-income consumers and leader to a widening of inequalities in the distribution of income (c) Employment and investment consequences: if pollution taxes are raised in one country, producers may shift production to countries with lower taxes. This will not reduce global pollution, and may create problems such as structural unemployment and a loss of international competitiveness. Similarly higher taxation might lead to a decline in profits and a fall in the volume of investment projects.

Conclusion
The revenue potential for environmental taxes is large. Taxes on carbon and plastic products alone would be enough for meeting various global developmental goals.
It must though be remembered that the main objective of environmental taxes is to reduce pollution and not to generate extra revenues for the state. The state thus has to genuinely impose such taxes so as to enforce the ‘polluter pays principle’ and ensure that cleaner technologies are readily adopted by providing appropriate subsidies to the industries.
In particular it must be mentioned that environmental taxes could be imposed with almost no negative impacts on the fiscal economic situation.
Again it has been strongly argued that imposition of environmental taxes may produce a ‘double dividend’ effect which in essence means that environmental taxes have both merits as instruments of environmental policy and, in addition, the further benefit of tax revenues, allowing other, less-desirable, taxes to be reduced. Taxes on labour income, agricultural products and else may be reduced after the imposition of environmental taxes thereby increasing the labour supply and henceforth leading to a reduction in the rate of unemployment. Similarly agricultural productivity could be increased with a reduction of taxes on agricultural products. Though available literature on the subject suggests that ‘double dividend’ would not necessarily result after imposing ecotaxes, but there is a possibility that with proper enforcement of environmental taxes and policies, a ‘double dividend’ may arise which, apart from benefiting the environment will also increase economic efficiency and industrial productivity.
The issue of border tax adjustments though still is in a nascent stage of evolution but the paper has concluded that imposition of ecotaxes will have to be followed along with BTA systems. The political considerations, it is likely, will not permit an economy to impose ecotaxes without some sort of import restrictions. Analysts have though suggested that clarification be issued to the existing GATT rules on Border tax adjustments so as to facilitate the imposition of ecotaxes.
A cautious approach is required while planning formulation and imposition of ecotaxes as ecotaxes, like any other new tax, have their own set of problems to deal with. Government should set up an expert committee under the auspices of a parliamentary committee to study the scope of ecotaxes in India and its report should be made available to the public. This should be followed by a ministerial council which shall make rules regarding the implementation of ecotaxes and shall also release the statement of objects and reasons as regards the introduction of new ecotax. The revenue thus collected could best be utilized in financing environmental subsidies, though free trade enthusiasts may disagree with me here on imposition of any new subsidy. These subsidies are essential, not because our country has had a history of formulating various subsidies, but because environmental taxes are always a policy decision and have to be implemented as a package, which include collection of taxes on hazardous products as also to subsidize the cost of pollution abatement technologies. Only a wise combination of two will lead to a reduction of pollution and possibly lead to the much debated ‘double dividend’ whereby the entire economy (various other sectors, other than those directly effected through the implementation of ecotaxes) will reap the benefits of ecotaxes.

- Ajit Sharma, Associate, JM Sharma & Co., Advocates & Solicitors. This paper was presented at NICOM 2004 Business Conference organized by Nirma School of Business, Ahmedabad in January 2004. The author can be contacted at ajit@jmsharma.com