Discussion of the origins, evolution and issues related to enactment of environmental and carbon taxes. Examples of operational environmental and carbon taxes implemented to address environmental pollution.

Economic incentive instruments

In general terms, economic incentive instruments ensure that polluters face direct cost incentives to mitigate emissions at the lowest possible cost. A number of policies and instruments are available to governments to generate the incentives for GHG reduction. Given the limitations of the command and control policy approach discussed above, economists and legal experts have increasingly called for alternative policy measures based on economic incentives.

In the context of setting a price on pollution, two economic incentive instruments are often discussed – namely, taxes and charges, and ETSs. Taxes can set a price for an externality; literature identifies this instrument as an efficient way of internalising costs of environmental harm. Emissions trading can also establish a price on externality. Taxes and emissions trading (including carbon trading) make the polluter pay for externalised harm to the environment, which coincides with the ‘polluter pays principle’.

Environmental taxes

Taxation is one of the most powerful public policy tools that can influence people’s behaviour and economic activities. Taxes can be used to discourage or encourage various economic activities or production/consumption of certain kinds of goods. Especially in the field of environmental policy, taxation is recognised as a major policy instrument which is capable of addressing the externality problem.

The main economic assumption for utilising taxes in environmental policy is to transmit the costs of emissions and other externalities into the prices of the goods and services produced by economic actions. There is no commonly accepted definition of an environmental tax; however, one of the most appealing and broad definitions is offered by the European Environment Agency (EEA). According to the EEA, environmental taxes are generally defined as taxes intended to promote environmental protection and designed to fulfil three main functions:

• First, environmental taxes are cost-covering charges because they force polluters to pay for actual and potential damage caused by their activities.
• Second, environmental taxes provide polluters with incentives to avoid environmentally damaging behaviour because they are required to evaluate the consequences of their hazardous activities.
• Third, environmental taxes provide additional revenue for governments.

Carbon tax

In the context of climate change mitigation where policy makers pursue long-term fundamental behavioural change among a large group, taxes arguably could be more beneficial than direct regulations or other non-price instruments. This is because taxes are capable of addressing the problem of environmental externalities, provide an explicit price of emissions and encourage society to change behaviour to become environmentally responsible.

Readings

1. Roberton C. Williams (2016) Environmental Taxation. Discussion Paper. Resources for the Future. Available at http://www.rff.org/files/document/file/RFF-DP-16-24.pdf
2. EEA. 2005. Market-based Instruments for Environmental Policy in Europe. Technical report 8 [Online]. European Environmental Agency. Available at http://www.eea.europa.eu/publications/technical_report_2005_8