D. Murali and Kumar Shankar Roy

Chennai: Countries such as the Netherlands, Portugal, and Finland have brought in differentiations into their car registration taxes so as to encourage buyers to opt for the ‘cleanest’ car models. Indeed, taking into account congestion, pollution, and the fact that such green tax revenues allow other taxes to be cut – it seems quite a feasible option for the governments across the world. With over 80 per cent people in the world still aspiring to own their cars, mostly in Asia, the next few decades will be challenging for both carmakers as well as the environment-keepers. The stewardship of the natural environment is the responsibility of everyone. But, do we practise what we preach? Speaking on this central theme, Mr David F. Williams of KPMG’s Tax Business School in the UK shares a few thoughts with Business Line. Is the tax important, or the awareness? “The central paradox of environmental taxation is that the more successful it is in changing people’s behaviour, the less revenue it will raise,” he avows. More on the issues that are challenging administrations and what approach could be the best…

Excerpts of the e-mail interaction.

We believe KPMG had brought out a discussion paper on taxation and environment in March this year. How do you summarise it?

The care of the environment has moved over recent decades from a matter of minority interest to a ‘mainline’ issue of widespread concern. The paper proceeds on the assumption that the protection of the environment is a worthy objective. To the extent that assumptions are made on scientific matters, they reflect what appears to be the majority view.

However, the paper suggests that for those who do not share that view points of disagreement may not be as frequent as might have been expected. No taxation measures will affect solar activity, so greenhouse gas emissions; and the influence of taxation measures on them remain relevant factors even to those who see their role in climate change as a subsidiary one. Other measures, such as those to control toxic emissions, are less controversial.

Is defining the environment a problem?

We recognise that there may be situations where taxes on environmentally harmful activities can shade into charges for services, but suggest that establishing a precise definition of ‘tax’ is nevertheless of little importance.

Defining ‘the environment’ is more problematic. In our discussion paper, its meaning was restricted to physical factors; i.e., such matters as climate (including flooding, drought and other effects of global warming), pollution of air, water or soil, loss of amenity and threats to biodiversity.

Environment also extends to the availability and preservation of scarce resources such as fossil fuels, where the issues that arise are often inextricably linked to questions of climate change. Issues of human health are, in general, not considered.

Whose responsibility is the environment?

Arguably, stewardship of the natural environment is the responsibility of everyone. However, there are various factors that make it a particular concern of governments. In the developed world, governments account for a very significant proportion of total economic activity, with the result that simple arithmetic allocates to them a correspondingly high proportion of environmental responsibility.

Governments by their very nature have some responsibility for the actions of the population at large, because they are in a position to influence or regulate these in a way that no other party can.

And the governments have access to relevant economic and scientific data, and the capability to analyse it exhaustively, to an extent that is very rarely the case for taxpayers – apart from the largest companies.

Talking about companies, what is the role supra-national organisations play in this issue?

Most commentators would probably consider that the actions individuals and companies have been prepared to take as a matter of free choice in order to protect the environment have in the main proved to be insufficient.

The actions of governments, by regulation or by the use of economic instruments such as taxation, tend to be more effective precisely because they remove that element of choice – in the sense that compliance with regulations or payment of tax liabilities in accordance with the law are not optional.

So you believe that governments can affect the environment?

In broad terms, there are many ways in which the actions of governments can be used to bring about environmentally-friendly behaviour by the individuals and companies under their jurisdiction: by regulation, by taxation, by systems of emissions trading, by subsidies, by voluntary agreements, and by persuasion or by provision of information. Elements of any or all of these may be combined in the pursuit of particular environmental objectives.

Let’s talk about taxation first. Why tax?

The various purposes for which taxation is imposed by governments are: to raise revenue; to achieve desired behavioural effects; to redistribute wealth and to implement economic policy.

How do you define environmental taxation?

There are many definitions of ‘environmental taxes’ put forward by the European Union, and jointly by the OECD and the European Environment Agency. In our own study, we considered the various ways in which decisions taken by governments as regards taxation – like any other government or commercial decision – may have environmental impacts. The guiding principle, therefore, is that ‘there are no environmental taxes; only taxes with environmental effects’.

Any government will need to raise a certain amount of revenue to meet its spending plans. At first sight, it appears preferable that it should raise this from taxing ‘bads’ rather than ‘goods’; e.g., from environmental levies (taxing undesirable activities such as pollution), rather than from taxes on desirable activities such as labour and saving.

There appears to be, in effect, a rebuttable presumption in favour of environmental taxes. Following this line of argument, some commentators advocate a wholesale ‘shift’ from taxes on labour and capital to environmental taxes. This is sometimes presented as a ‘win-win’ strategy or ‘double dividend’, where the dual objectives of saving the environment and financing the state are achieved at a single blow.

If it’s such a win-win strategy, have the current attitudes of environment taxation changed significantly?

Governments and political commentators have taken a significant interest in environmental taxation in recent years, and a substantial literature exists advocating their adoption and extension. Increasing numbers of taxes that may be specifically identified as having an environmental rationale are being imposed in developed economies. However, in the UK, the EU and the OECD countries, environmental taxes as a proportion both of GDP and of total taxation revenues have fallen in recent years.

The possible reasons for the low ‘take-up’ of environmental taxes could be the disparity between expressed interests in environmental tax on the one hand, and the level of tax receipts on the other.

What could be explanations behind the low ‘take-up’?

The explanations being considered are many. One says that there is in fact no advantage in taxing ‘bads’ rather than ‘goods’, and that governments have realised this. Some point out that the disparity is more apparent than real, depending on the vagaries of various definitions of environmental taxes. Others indicate that environmental issues are being addressed in other ways (e.g., by regulation or through emissions trading schemes). Attention is also drawn to the central paradox of environmental taxation – that the more successful it is in changing people’s behaviour, the less revenue it will raise!

How about using green taxes to protect environment?

Yes. Some commentators do suggest that, as a matter of principle, the proceeds of environmental taxes ought to be spent on environmental projects. Some of these advocate a system of formal hypothecation for this purpose. Thus, they may attack governments for lack of commitment to the environment when they have ‘diverted’ environmental taxes to general purposes.

However, if a system is adopted whereby the proceeds of environmental taxes must always be spent on environmental projects, then a closed fiscal environmental system is created which operates in isolation, without interacting with the wider economy of the nation concerned. The question of how a government spends the funds available to it is perhaps best determined, as a separate issue, by the needs its society faces rather than by the source of the funds.

Arguably, the importance of the environment is more fully acknowledged, and more is achieved for its benefit, by a system which both appropriates general revenue to environmental purposes, and expands the role of environmental taxes to the level where they can play a part in financing general expenditure (and thus have an increased behavioural effect).

How have politicians treated the issue?

Environmental taxation is not an issue that divides political opinion along traditional ‘right left’ lines. If, at the risk of oversimplification, right-wing opinion is identified with ‘small state, low-tax’ approaches, and left-wing opinion with ‘tax and spend’ approaches, environmental taxation does not fit automatically into one or the other category.

But shouldn’t the spenders (who cause harm) be taxed?

There is that school of thought. In fact, some of those who advocate environmental taxation do so on the basis of the ‘polluter pays principle’. The theory behind this approach is that tax should be used to ‘internalise the externalities’; i.e., to bring within the polluter’s own cost basis the ‘negative externalities’ associated with its activities, such as the costs of damage to the environment, that are currently borne by the state or by other members of society. Such taxes are sometimes called Pigouvian or Pigovian taxes, after the English economist Arthur C. Pigou (1877-1959) who developed the concept.

Some seek to justify the ‘polluter pays’ principle on the ground of ‘fairness’ or ‘justice’. Arguably, however, a more significant argument than that from equity is that based on the behavioural response. If a polluter must pay via the tax system for his polluting activity, he may be expected to reduce that pollution by whatever courses of action are open to him, using first those means that have the lowest cost and moving on to those with a higher cost. In theory, in a perfect market, this process will continue until the point where the cost of eliminating one additional unit of pollution is equal to the cost of paying tax on that unit. At that point of equilibrium the tax will have both a revenue effect for the state and a behavioural effect for society.

What is the level of pollution at which taxes should be levelled?

The level of pollution at which that point of equilibrium arises will be determined by the rate at which the tax is set. The rationale for setting the rate in such a way that the tax burden equals the negative externalities is that in this way allocative efficiency may be achieved; i.e., economic welfare for the nation as a whole may be maximised.

Such a situation of maximised welfare exists where no one can be made better off without making somebody else at least correspondingly worse off. (This is sometimes referred to as ‘Pareto efficiency’, after the Italian economist Vilfredo Pareto.)

Are there examples of tax measures affecting the environment?

There is no necessary correlation between the visibility and the environmental impact of particular taxes. Our conclusions from the study paper suggest that an attempt might be made to plot these two factors on the axes of a graph, providing a matrix to assist readers in judging the merits of the different approaches outlined in the appendices. A similar approach might also be applied to the total environmental tax stance of different countries.

Tell us about the complexity of environmental issues and behavioural responses.

Even among those who are agreed on the causes of global warming and on the importance of addressing it there may well be differences of view over individual issues, because of the complex way in which human activities combine to affect the environment. The manufacture of energy-saving products may itself be a high-energy process; or reductions in energy use by such products may also reduce cost, thus encouraging consumers to make greater use of them. It is therefore important to make a careful analysis of the full behavioural and environmental effects of any proposed measure.

Protection of the environment is almost universally seen as a desirable policy objective. What is coming in its way?

Probably, a few of its advocates see it as the only objective that governments should pursue. In general, environmental damage is a side-effect of society’s desire to enjoy goods or services that contribute to welfare and well being. The challenge for governments is therefore to devise a way of limiting that damage while minimising the impact on the economically or socially valuable activity that gives rise to it. To some extent this is a test of ingenuity, but it also involves making judgments as to the relative weight to be given to these conflicting aims.

This means that environmental protection, whether by taxation or other means, is ‘the art of the possible’. Thus while it might be desirable from an environmental point of view to eliminate car use altogether, governments may well be content simply to reduce it somewhat or to encourage car owners to transfer some of their journeys to public transport – even though either of these alternatives has a remaining environmental cost.

Your paper speaks of ‘joined-up thinking’…

Arguably, a successful environmental policy cannot be operated on a piecemeal basis.

Governments need to consider the combined effects of all the environmental measures that they take, whether in the areas of regulation, taxation, carbon trading, or persuasion. This will involve an assessment of which of these approaches, or which combination of approaches, is most appropriate to particular issues. It will also involve an assessment of the environmental effects of measures that are not specifically conceived of in environmental terms, such as aspects of housing or social policy.

No environmental taxes, just taxes with environmental effects. Is it what you are trying to get at?

Not exactly. I will explain. With all government policies, the effects of tax measures must be assessed, inter alia, from an environmental viewpoint. It is not sufficient to think in terms of specific ‘environmental taxes’; arguably all taxes have some effect on behaviour, and all behaviour has some effect on the environment. In particular, governments may wish to analyse the complex interactions within existing tax systems, whereby many taxes on environmentally harmful activities, such as the UK’s petroleum revenue tax and fuel duties, are allowed as costs in calculating profits liable to other taxes with the result that their impact is both reduced and made more difficult to assess.

But does taxation act as a compulsory deterrent?

Taxation serves more than one function. Not only is it one element of a government’s environmental policy, but it also has major roles in raising revenue to finance public expenditure and in contributing to general economic policy. To a lesser extent it may also play a role in implementing social policy. Environmental factors cannot, therefore, be permitted to be the only influence on decisions in this area; the other functions of taxation will need to be given appropriate weight in reaching a balanced taxation policy.

Does it explain the tension between revenue collection and environmental impact?

The place that taxation holds at the intersection of these different areas of government policy gives it a special significance; any misjudgement made in utilising taxes for environmental purposes may have consequences far beyond the environmental sphere, and any decisions taken for economic or social reasons may have an unexpected environmental impact. In particular, where taxes are imposed on environmentally harmful goods or services there may be a tension between the state’s desire to collect more tax, and its desire to see behaviour change (which will mean collecting less tax).

What do statistics show?

The tension that we talked about (above) may also make it difficult to assess the significance of published statistics on revenue collected from environmental taxes. Even once allowance is made for variations of definition, increases in revenue may indicate, on the one hand, the successful use of environmental taxation as a policy choice by governments or, on the other, the increasing prevalence of environmentally unfriendly behaviour. Equally, reductions in revenue may indicate that taxation measures have successfully changed behaviour, that governments are not committed to the principle of environmental protection, or that environmental issues are being addressed in other ways; for example by regulation or emissions trading schemes.

A lot of talk has been going on the regressivity of environmental taxes. The theory is the effective tax rate decreases as the amount to which the rate is applied increases. What’s your take on this?

In general, environmentally motivated taxes are designed to deter consumption. Many therefore apply directly to expenditure. Even where they take the form of taxes on the income of energy producers or of manufacturers, they will normally have the effect of increasing prices to consumers. Such taxes on expenditure will tend to be regressive, and this will often be considered undesirable for reasons of social policy. In this case governments may choose to redress the situation by means of compensating decisions on welfare spending or on the progressivity (where the tax rate increases as the amount to which the rate is applied increases) of income-based taxation. The scope for such decisions may be limited, however, and changes to income taxation may run counter to the general principle of shifting taxation away from economic ‘goods’ to environmental ‘bads’. There may therefore be significant limits on the extent to which a wholesale shift to environmentally-based taxation is practical in the light of social and political constraints.

Some charges on environmentally damaging behaviour, such as those for road use or for entering congestion zones, may become so closely linked to the extent of the service received that they amount to commercial fees rather than taxes. Whether this is a good or a bad thing will be a matter of opinion, but governments may wish to take account of the regressive nature of such charges in any decisions that they make.

So at the end of it, what approach do governments take? The one with the carrot or the stick...

Arguably reliefs can never hold as significant a place in the environmental tax armoury as charges. In part this is because environmentally-friendly alternatives do not exist for all harmful actions; much of the emphasis must therefore simply be on reducing the extent of such actions rather than on substituting others.

In addition, it may be easier to deter taxpayers from environmentally harmful behaviour than to attract them to beneficial behaviour, because it is often easier for a deterrent to gain ‘purchase’ than it is for an incentive; there is more economic activity for it to ‘bite on’. In addition, and perhaps most significantly, tax charges are much more compatible than reliefs with the revenue-raising function of tax.

The use of taxation to protect the environment is a complex undertaking, with a number of inherent difficulties. This does not mean that the project should not be pursued; rather that it should only be undertaken on the basis of careful analysis and research.

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