Chapter 12. Building a New Economy: Shifting Taxes
The need for tax shifting—lowering income taxes while raising levies on environmentally destructive activities—in order to get the market to tell the truth has been widely endorsed by economists. For example, a tax on coal that incorporated the increased health care costs associated with breathing polluted air, the costs of damage from acid rain, and the costs of climate disruption would encourage investment in renewable sources of energy such as wind or geothermal. With this concept in hand, it is a short step to tax shifting. A number of countries in Western Europe are already shifting taxes in a process known there as environmental tax reform, to achieve the environmental goals outlined in preceding chapters. 3
Among the various environmentally damaging activities taxed in Europe are carbon emissions, the generation of garbage (so-called landfill taxes), and the excessive number of cars in cities. A four-year plan adopted in Germany in 1999 systematically shifted taxes from labor to energy. By 2001, this plan had lowered fuel use by 5 percent. It had also accelerated growth in the renewable energy sector, creating some 45,400 jobs by 2003 in the wind industry alone, a number that is projected to rise to 103,000 by 2010. 4
In 2001, Sweden launched a bold new 10-year environmental tax shift designed to convert 30 billion kroner ($3.9 billion) of taxes on income to taxes on environmentally destructive activities. Much of this shift of $1,100 per household is levied on road transport, including substantial hikes in vehicle and fuel taxes. Electricity is also picking up part of the shift. As of 2005, Sweden is running slightly ahead of its 10-year tax-shifting plan, making it the world leader in environmental tax reform. 5
Among the other European countries with strong tax reform efforts are Spain, Italy, Norway, the United Kingdom, and France. There are isolated cases elsewhere. A number of countries, including Malaysia, Thailand, and Turkey, have used a tax on lead emissions to eliminate lead as an additive in gasoline. The United States imposed a stiff tax on chlorofluorocarbons to phase them out in accordance with the Montreal Protocol of 1987 and its subsequent updates. At the municipal level, when Victoria, the capital of British Columbia, adopted a trash tax of $1.20 per bag of garbage in 1992, it reduced its daily trash flow 18 percent within one year. 6
Cities that are being suffocated by cars are using stiff entrance taxes to reduce congestion. First adopted by Singapore some two decades ago, this tax was later introduced by Oslo, Melbourne, and, most recently, London. The London tax of £5, or nearly $9, first enacted in February 2002 by Mayor Ken Livingstone, was raised to £8, more than $14, in July 2005. The resulting revenue will be invested in improving the bus network, which carries 2 million passengers a day. The goal of this congestion tax is a total restructuring of the London transport system to reduce congestion, air pollution, and carbon emissions and to increase mobility. 7
While London and other cities are taxing cars that enter the central city, others are simply imposing a tax on automobile ownership. In Denmark, the tax on the purchase of a new car is larger than the price of the car itself. A new $25,000 car costs the buyer more than $50,000! In 2000, partial rebates were introduced for energy-efficient vehicles. Other governments are moving in this direction. New York Times reporter Howard French writes that Shanghai, which is being suffocated by automobiles, “has raised the fees for car registrations every year since 2000, doubling over that time to about $4,600 per vehicle—more than twice the city’s per capita income.” 8
For some products where the costs to society are large and obvious, pressure is mounting to impose taxes. By far the most dramatic example of this was the agreement negotiated between the tobacco industry and all the state governments in the United States. After numerous state governments launched litigation to force tobacco companies to reimburse them for the Medicare costs of treating smoking-related illnesses, the industry decided to negotiate a package reimbursement, agreeing in November 1998 to pay the 50 state governments some $251 billion—nearly $1,000 for every person in the United States. This landmark agreement was, in effect, a retroactive tax on cigarettes smoked in the past, one designed to cover indirect costs. To pay this enormous bill, companies boosted cigarette prices, further discouraging smoking. 9
A study by the Centers for Disease Control and Prevention (CDC) in the United States calculated the social costs of smoking cigarettes at $7.18 per pack. This not only justifies raising taxes on cigarettes, which claim 4.9 million lives per year worldwide, but it also provides guidelines for how much to raise them. In 2002, a year in which state governments faced fiscal deficits, 21 states in the United States raised cigarette taxes. Perhaps the biggest jump came in New York City, where smokers paid an additional 39¢ in state tax and $1.42 in city tax—a total increase of $1.81 per pack. Since a 10-percent price increase typically reduces smoking by 4 percent, the health benefits of this tax increase should be substantial. 10
If the cost to society of smoking a pack of cigarettes is $7.18, how much is the cost to society of burning a gallon of gasoline? Fortunately, as noted in Chapter 1, the International Center for Technology Assessment has done a detailed analysis, entitled “The Real Price of Gasoline.” The group calculates several indirect costs, including oil industry tax breaks, oil supply protection costs, oil industry subsidies, and health care costs of treating auto exhaust-related respiratory illnesses. The total of these indirect costs centers around $9 per gallon, somewhat higher than the social cost of smoking a pack of cigarettes. Add this external or social cost to the roughly $2 per gallon average price of gasoline in the United States in early 2005, and gas would cost $11 a gallon. These costs are real. Someone bears them. Now that these costs have been calculated, they can be used to set tax rates on gasoline, just as the CDC analysis is being used to raise taxes on cigarettes. 11
Asia’s two leading economies—Japan and China—are now considering the adoption of carbon taxes. For the last few years, many members of the Japanese Diet have wanted to launch an environmental tax shift, but industry has opposed a carbon tax. China, which is experiencing near-record explosive growth in energy use and carbon emissions, is working on an environmental tax restructuring that will discourage fossil fuel use. Wang Fengchun, an official with the National People’s Congress, says, “Taxation is the most powerful tool available in a market economy in directing a consumer’s buying habits. It is superior to government regulations.” If Chinese policymakers can engineer an environmental tax reform, it will be a landmark development not only for China but for the world. 12
Environmental tax shifting usually brings a double dividend. In reducing taxes on income—in effect, taxes on labor—labor becomes less costly, creating additional jobs while protecting the environment. This was the principal motivation in the German four-year shift of taxes from income to energy. By reducing the air pollution from smokestacks and tailpipes, the incidence of respiratory illnesses, such as asthma and emphysema, is reduced—and thus overall health care costs are as well. 13
With forests, ecologists can calculate the values of services that trees provide. Once these are determined, they can be incorporated into the price of trees as a stumpage tax of the sort that Bulgaria and Lithuania have adopted. Anyone wishing to cut a tree would have to pay a tax equal to the value of the services provided by that tree, such as flood control. The market for lumber would then be telling the ecological truth. The effect of this is to reduce tree cutting and to encourage wood reuse and paper recycling. 14
Tax shifting also helps countries gain the lead in producing new equipment, such as new energy technologies or those used for pollution control. For example, the Danish government’s tax incentives for wind-generated electricity have enabled Denmark, a country of only 5 million people, to become the world’s leading manufacturer of wind turbines. 15
Some 2,500 economists, including eight Nobel Prize winners in economics, have endorsed the concept of tax shifts. Harvard economics professor N. Gregory Mankiw wrote in Fortune magazine: “Cutting income taxes while increasing gasoline taxes would lead to more rapid economic growth, less traffic congestion, safer roads, and reduced risk of global warming—all without jeopardizing long-term fiscal solvency. This may be the closest thing to a free lunch that economics has to offer.” 16
The Economist strongly endorses environmental tax shifting: “On environmental grounds, never mind energy security, America taxes gasoline too lightly. Better than a one-off increase, a politically more feasible idea, and desirable in its own terms, would be a long-term plan to shift taxes from incomes to emissions of carbon.” In Europe and the United States, polls indicate that at least 70 percent of voters support environmental tax reform once it is explained to them. 17
Tradable permits are sometimes a sensible alternative to environmental taxes. Both are economic instruments that can be used to reach environmental goals. The principal difference between them is that with permits, governments set the amount of a given activity that is allowed, such as the harvest from a fishery, and let the market set the price of the permits as they are auctioned off. With environmental taxes, in contrast, the price of the environmentally destructive activity is set by government in the tax rate, and the market determines the amount of the activity that will occur at that price. Both economic instruments can be used to discourage environmentally irresponsible behavior. 18
The decision of when to use which instrument is not always clearcut. Governments have much more experience with environmental taxes than with tradable permits. It is also clear that such taxes work under a wide range of conditions. Still, permits have been used successfully in widely differing situations, ranging from restricting the catch in an Australian fishery to reducing sulfur emissions in the United States.
For example, concerned about the overfishing of its lobster fishery, the government of Australia estimated the sustainable yield of lobsters and then issued permits totaling that amount. Fishers could then bid for these permits. In effect, the government decided how many lobsters could be taken each year and let the market decide how much the permits were worth. Since the permit trading system was adopted in 1986, the fishery has stabilized and appears to be operating on a sustainable basis. 19
Perhaps the most ambitious effort to date to use tradable permits was the U.S. effort to reduce sulfur emissions from power plants by half from 1990 to 2000. The goal was reached in 1995, well ahead of schedule and at a minimal cost. One of the weaknesses of tradable permits is that in some communities emissions might not be reduced at all. 20
Although tradable permits are popular in the business community, permits are administratively more complicated and not as well understood as taxes. Edwin Clark, former senior economist with the White House Council on Environmental Quality, observes that tradable permits “require establishing complex regulatory frameworks, defining the permits, establishing the rules for trades, and preventing people from acting without permits.” In contrast to restructuring taxes, something with which there is wide familiarity, tradable permits are a concept not widely understood by the public, making it more difficult to generate broad public support. 21
3. Redefining Progress, The Economists’ Statement on Climate Change (Oakland, CA: 1997); ECOTEC Research and Consulting, Study on the Economic and Environmental Implications of the Use of Environmental Taxes and Charges in the European Union and its Member States (Brussels: 2001), pp. 24–25; David Malin Roodman, “Environmental Tax Shifts Multiplying,” in Lester R. Brown et al., Vital Signs 2000 (New York: W.W. Norton & Company, 2000), pp. 138–39.
4. Roodman, op. cit. note 3; German Federal Environment Ministry, Environmental Effects of the Ecological Tax Reform (Bonn: 2002); Donald W. Aitken, “Germany Launches Its Transition: How One of the Most Advanced Industrial Nations Is Moving to 100 Percent Energy from Renewable Sources,” Solar Today, March/April 2005, pp. 26–29.
5. Ministry of Finance, Sweden, “The Budget for 2005: A Commitment to More Jobs and Increased Welfare,” press release (Stockholm: 20 September 2004); Ministry of Finance, Sweden, “Taxation and the Environment,” press release (Stockholm: 25 May 2005); household size from Target Group Index, “Household Size,” Global TGI Barometer (Miami: 2005); population from United Nations, World Population Prospects: The 2004 Revision (New York: 2005).
6. Andrew Hoerner and Benoît Bosquet, Environmental Tax Reform: The European Experience (Washington, DC: Center for a Sustainable Economy, 2001); European Environment Agency (EEA), Environmental Taxes: Recent Developments in Tools for Integration, Environmental Issues Series No. 18 (Copenhagen: 2000); U.S. chlorofluorocarbon tax from Elizabeth Cook, Ozone Protection in the United States: Elements of Success (Washington, DC: World Resources Institute, 1996); city of Victoria from David Malin Roodman, “Environmental Taxes Spread,” in Lester R. Brown et al., Vital Signs 1996 (New York: W.W. Norton & Company, 1996), pp. 114–15.
7. Tom Miles, “London Drivers to Pay UK’s First Congestion Tax,” Reuters, 28 February 2002; Randy Kennedy, “The Day the Traffic Disappeared,” New York Times Magazine, 20 April 2003, pp. 42–45; Sarah Blaskovich, “London Hikes Congestion Charge to Force More Cars off the Streets,” Associated Press, 3 July 2005.
8. World Energy Council, Energy Efficiency Policies and Indicators (London: 2001), Annex 1; Howard W. French, “A City’s Traffic Plans Are Snarled by China’s Car Culture,” New York Times, 12 July 2005.
9. U.S. Department of Agriculture, Economic Research Service, “Cigarette Price Increase Follows Tobacco Pact,” Agricultural Outlook, January–February 1999.
10. Centers for Disease Control and Prevention, “Annual Smoking-Attributable Mortality, Years of Potential Life Lost, and Economic Costs—United States, 1995–1999,” Morbidity and Mortality Weekly Report, 12 April 2002; Campaign for Tobacco-Free Kids et al., Show Us the Money: A Report on the States’ Allocation of the Tobacco Settlement Dollars (Washington, DC: 2003); New York from Jodi Wilgoren, “Facing New Costs, Some Smokers Say ‘Enough,’” New York Times, 17 July 2002; cigarette death toll from World Health Organization, World Health Report 2002 (Geneva: 2002), p. 10.
11. International Center for Technology Assessment, The Real Price of Gasoline, Report No. 3 (Washington, DC: 1998), p. 34; U.S. Department of Energy (DOE), Energy Information Administration (EIA), This Week in Petroleum (Washington, DC: various issues).
12. Mick Corliss, “Carbon Tax Stuck in Detour to Kyoto,” Japan Times, 17 January 2002; “China Studying Energy Conservation Taxes,” Asia Times, 22 April 2005.
13. Peter P. Wrany and Kai Schlegelmilch, “The Ecological Tax Reform in Germany,” prepared for the UN/OECD Workshop on Enhancing the Environment by Reforming Energy Prices, Pruhonice, Czech Republic, 14–16 June 2000.
14. OECD, European Commission, and EEA, Environmentally Related Taxes Database, at www.oecd.org/env/tax-database, updated 13 May 2003.
15. “BTM Predicts Continued Growth for Wind Industry,” in Soren Krohn, Wind Energy Policy in Denmark: Status 2002 (Copenhagen: Danish Wind Energy Association, 2002), p. 8.
16. N. Gregory Mankiw, “Gas Tax Now!” Fortune, 24 May 1999, pp. 60–64.
17. “Addicted to Oil,” The Economist, 15 December 2001; environmental tax support from David Malin Roodman, The Natural Wealth of Nations (New York: W.W. Norton & Company, 1998), p. 243.
18. Roodman, op. cit. note 17, pp. 15–27.
19. Australia in John Tierney, “A Tale of Two Fisheries,” New York Times Magazine, 27 August 2000; South Australian Southern Zone Rock Lobster Fishery Management Committee, Southern Zone Rock
Lobster Annual Report 2003–2004 (Adelaide, South Australia: May 2005), pp. 2–5.
20. Richard Schmalensee et al., “An Interim Evaluation of Sulfur Dioxide Emissions Trading,” in Robert N. Stavins, ed., Economics of the Environment (New York: W.W. Norton & Company, 2000), pp. 455–71.
21. Edwin Clark, letter to author, 25 July 2001.
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