Green approaches: Taxes, not neew laws, are the best way to achieve environmental aims without...

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both the motor vehicle and aerospace industries. If the Government’s commitments to reducing acid rain, carbon emissions and so on are to be believed, we can only expect these figures to increase in the coming decades.

”Although green taxes are unlikely to be an

unemployment panacea, they could play u vital role in getting people

back to work”

BRIEFING

sources are now seen by many people to be pressing issues. A Department of the Environment survey in 1989 revealed that more than a third of respondents considered the environment to be among the most important is-

NEW ECONOMY

GlLES ATKINSON & RICHARD DUBOURG Centre for Social and Economic Research on the

Global Environment (CSERGE) University College London.

Green approache Taxes, not new laws, are the best way to achieve

environmental aims without hurting the ecomony

Such a prospect is met with concern in some circles. Industry and the financial sector, especially, fear environmental regulations will increase costs and reduce profits, growth and employment.

Certainly, if regulation does its job, it might well hit some firms and industries, particu- larly ’dirty’ ones. But it does not follow auto- matically that the economy as a whole will suffer. In fact, increasing attention is being paid to the potential advantage of being in at

sues facing society today. Nearly two thirds declared themselves ‘very worried’ by problems of sewage disposal, water pollution and ozone depletion.

But the fact that economic activity can and does damage the environment is not enough in itself to worry the economist, who knows that in principle such costs can be more than offset by benefits elsewhere. For instance, dumping industrial waste into rivers and the sea might imply cheaper industrial processes

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BRIEFING: GREEN APPROACHES 123

and hence cheaper prices for goods and serv- ices.

The problem comes when we realise that many - in some cases all - of the costs of environmental damage fall not on the polluters but on other individuals, both locally, and sometimes, many thousands of miles away. It is estimated that while almost 3 million ton- nes of sulphur dioxide were emitted by the UK in 1991, only about 35 per cent actually fell on UK soil. Some was carried as far away as Eastern Europe and the former Soviet Union. Even waste discharged to rivers is more likely to affect water users downstream - perhaps anglers or swimmers - than it is the dis- chargers themselves.

Costs borne by people who didn't cause them are known as 'externalities'. They are likely to result in levels of pollution and environmental damage which are too high from a social point of view.

At the limit, the benefits associated with the last quantity of pollution are not sufficient to compensate for the ensuing costs. The socially acceptable limit is reached when the 'economic' benefits associated with procud- ing a little more pollution are outweighed by the costs to the environment. At some point we decide that, although the factory-gate price for making a product usinga dxty proc- ess maybe cheaper than for alternative tech- nology, the long-term environmental damage is more important than the price. A lower level of pollution is recommended. Rarely will a zero level of pollution be justified, however, since the costs of total abatement will probably far outweigh the benefits.

This is a 'market failure' in the sense that the market left to itself does not take account of the environmental 'externals'. The question then becomes how to correct for this market failure and eliminate excessive social costs by reducing environmental degradation.

Two types of regulation have featured most prominently in environmental policy - namely, standards and taxation. The question increasingly being asked is not which of the two approaches will be best for the environ-

ment, but which is likely to be preferred in terms of its economic effects.

Setting standards Regulation to protect the environment typi- cally consists of setting standards for polluting activities to reach a desired level of environmental quality. This 'command and control' approach has, in practice, dominated environmental policy for the past two decades.

Firms are legally obliged to meet require- ments but have some flexibility in how the standards are met. There are three routes they can take.

Switch to less-polluting production in- puts, for example to cleaner energy sources; Invest in pollution abatement equipment - referred to as 'end-of-pipe' or 'add-on' technologies; Change production processes to ones that are less energy or pollution intensive.

The consequences of standards-based environmental controls for economic activity are

Pollution and Abatement Expenditure (PAC) as a % of GDP and Gross Investment (GI) (1989/90)

PACYGDP PACYGI

France 0.9 1.2 Germany 1.6 3.5 Japan 1.3 2.9' Netherlands 1.5 2.3 UK 1.4 na USA 1.5 3.4 [incl.households 1.8 na1

'refers to 1988 na denotes not available

of great interest, especially in the light of the slowdown in growth rates of national output and productivity since the early 1970s.

Empirical studies have attempted to quan- tdy just how much (if any) of the slowdown could be attributed to environmental regulations. One approach is to model simulations of the paths of economic activity and employment with and without environmental safeguards.

124 NEW ECONOMY

The scenario without environmental regulations is referred to as the ‘baseline’ estimate.

For instance, pollutants that cause acid rain are subject to regulation in Europe. The EU Directive on Large Combustion Plants re- quires the control of emissions of sulphur dioxide ( S O 2 ) and nitrogen oxides (NOx) from power stations and industrial boilers in mem- ber states. A Dutch study has simulated the changes in GDP and employment that might result from these statutory lunits, in terms of their deviation from the baseline (that is, in the absence of the directive). The results are shown in the Table below.

Focusing on the UK, we see that between 1988 and 1993 investment in SO2 pollution control equipment required under the directive is estimated to have increased GDP by 0.06 per cent a year, and employment by 0.03 per cent a year. This is one piece of environmental regulation that seems to have been a positive stimulus to employment in the UK.

Investing in pollution control equipment has this effect when the economy is operating below full capacity, and so there are unem-

where in the economy.

Clouds on the horizon However, taking a slightly longer-term view, the table shows that GDP and employment are both expected to decline relative to the baseline - by 0.05 per cent a year between 1994 and 1997.

End-of-pipe technologies add to production costs without any corresponding increase in marketed output. It is usually assumed therefore that as these costs are gradually passed on in the form of higher product prices, the beneficial effects of the initial stimulus are reversed. In addition, the EU directive is a one-off stimulus - at least for existing plants. When demand for pollution abatement equipment begins to diminish, so do the positive impacts on economic activity and employment.

The effects of more general national environmental controls were examined in some detail by the OECD in 1985 (The Macro- economic Impact of Environmental Expendi- tures). Again, warnings of negative effects on

GDP and Employment Impacts of Acid Rain Pollution Control in the European Community

Annual % deviation from baseline levels

Control of so2 Control of NOx 1988-93 1994-97 1988-93 1994-97

UK GDP 0.06 -0.05 0.01 -0.01 Employment 0.03 -0.05 0.01 -0.01

Germany GDP 0.13 -0.06 0.06 0.00 Employment 0.13 -0.1 1 0.05 -0.03

France GDP 0.04 0.03 .... .... Employment 0.03 0.03 .... ....

Italy GDP 0.08 0.03 0.03 0.02 EmploVment 0.02 0.01 0.01 0.01

Source: Pearce (1993) ‘Ecomrnic Values and Natural World Earthscan, London

GDP and jobs were found to be exaggerated. For the six countries surveyed -Austria, Finland, France, the Nether- lands, Noway and the USA - a story emerges that is similar to the one for the UK de- scribed in the table.

Whether detrimental or beneficial overall - and there is some evidence to support the latter - it would appear that the effects of environmental regulation on employment are not large. The main reason for this is the

ployed resources in the economy. Then, spending on pollution abatement does not en- tirely displace other forms of investment. The same applies if the increased demand for labour, needed to manufacture pollution control equipment and also to operate and main- tain the equipment, is not to displace jobs else-

relatively small scale of the expenditures that have been analysed. But since spending on the environment now represents a significant and growing proportion of countries’ GDP, environmental regulation might have greater repercussions for economies than it has had in the past.


For this reason, Jorgenson and Wilcoxen (1990) are less sanguine about the possible effects of US environmental regulation on industrial and vehicle emissions. They have estimated that, by the 1990s, US GDP was 2.5 per cent lower than it would have been in the absence of environmental safeguards.

The reasons for this concern might be the inefficiency of standards-based policies as much as the implementation of environmental policies per se. Economists have long argued that efficient policies must take into account firms' relative costs of reducing their pollution. Uniform standards do not do this - hence most economists' enduring belief in the value of tax-based environmental policy.

Green taxes Long championed by economists, environmental taxes are only now being discussed seriously in policy-making. The theoretical case for them is clear: by levying a charge on activities that damage the environment, not only can the best economic outcome be achieved, it can also be achieved at the lowest cost in terms of economic resources.

Polluters cut back on their pollution so long as the benefits - a lower tax bill - outweigh the costs of extra abatement. Firms that find it relatively cheap to clean up will do so more and pay less tax. Others might take no action, preferring instead just to pay the tax.

Taxes achieve their environmental objective by inducing some firms to abate more than others. Indeed, this is the very reason for their efficiency: taxes recognise that clean-up costs vary significantly from one polluter to another.

Moreover, because polluters pay taxes on all the environmental damage they do, not just on the 'socially excessive' damage, they have a continuous incentive to reduce their total tax bill. They might do this by devising better and cheaper methods of limiting the damage caused by their activities.

But industrialists and politicians often op- pose tax-based environmental policies pre- cisely for this reason. For not only must regu-

lated industries bear the costs of installing abatement equipment, they must also continue to pay taxes on any remaining, 'socially beneficial' levels of damage. And evidence suggests that these transfer can be larger, perhaps by five or ten times, than the resource costs of achieving the environmental objective.

The worry is that these costs will place such a burden on firms and industries that profits, output and employment will all be adversely affected. Firms will go bust, and the desired objective will be achieved at great cost to the economy as a whole, and to certain industries and communities in particular.

Double whammy Few actual examples of tax-based policies exist to put this hypothesis to the test. But a lot of research in Europe and the US has looked into the likely effects of a carbon tax to combat global warming. Attention has tended to concentrate on the potential for a so-called 'double dividend, whereby taxes can improve the environment and help the economy. It would do this through the spending or 'recycling' of the tax revenues. It turns out that whether you get the double dividend would probably hinge on the way revenues were actually recycled in practice.

Barker et al. (1993) have recently modelled the impacts of a carbon/energy tax on the UK economy. The proposal is for a tax of US$3 per barrel of oil equivalent in 1993, rising in real terms to US$10 by 2000. Recycling options considered were a reduction in VAT and a cut in the basic rate of income tax.

Tax revenue predictions suggested that, by 2005, VAT might be reduced to 15.7 per cent from its current 17.5 per cent level. Alterna- tively, income tax might be cut from 25 per cent to around 23 per cent. The result of either recycling option would be to increase GDP marginally over the base case. As a result, unemployment was forecast to fall by an extra 5,000 under the income tax scheme, and by 59 000 with a VAT reduction, results similar to those from other studies. Hence, although

126 NEW ECONOMY

claims of a double dividend might be overdone, so too are fears of economic disaster.

Jorgenson and others are examining the US situation with the benefit of a multi-sectoral econometric model of the US economy since 1947. This model is of the ‘voluntary unemployment’ type which some might argue makes it less suitable for lookmg at effects on long-term, ’structural’ unemployment. Nev- ertheless, their estimates of the adverse economic effects of post-War environmental controls in the US mentioned above contrast quite dramatically with the double-dividend potential of a carbon tax.

Again, the assumed recycling method is critical. If the revenues are recycled as a lump sum via, for instance, a bigger personal tax allowance, then they forecast that with an environmental tax real US GNP in 2020 would be 1.7 per cent lower than without a tax. Recy- cling via a reduction in income tax, however, would result in only a 0.7 per cent fall in 2020 GNP, whle lower corporation taxes would actually raise GNP by 1.1 per cent.

The reason for the difference lies in the way tax rebates affect economic behaviour, and the way they can be used to offset other ’dis- torting’ taxes. Recycling via reductions in income or corporation tax induces workers to supply more labour and encourages compa- nies to employ more staff and to increase investment. There might be even greater incen- tives to increase employment if, say, revenues were used to reduce employers’ national in- surance contributions.

Although, on this evidence, carbon and other environmental taxes are unlikely ever to be an unemployment panacea, they could play a important role as part of a concerted policy of getting people back to work.

Will industry and jobs go elsewhere? Unilateral action to tackle environmental problems will, according to some people, dis- advantage our trading position vis-h-vis the rest of the world. For example, the need to import pollution control equipment might cause a temporary deterioration in the bal-

ance of payments. More importantly, concern has also been expressed about the possi- bility of regulation leading to inflation at home, causing domestic firms to become un- competitive and lose out on world markets. As some would have it, policy-makers have traded off environmental quality for international competitiveness.

Yet the loss of competitiveness is certainly not a foregone conclusion and will largely de- pend on the extent to which demand is affected by higher prices. In fact, little evidence exists that countries have seriously impaired their international competitiveness by at- tempting to improve environmental quality - unilaterally or otherwise.

We also hear a lot about firms faced with environmental regulation simply locating elsewhere. Industry and jobs, it is said, will go to countries that are willing to accept lower environmental standards - so-called pollution havens.

Again, in reality such fears have not been borne out. Costs of compliance with domestic regulations are only one of many things af- fecting a firm’s location decision. Leonard (1988) found that industries choosing to relo- cate have tended to be those facing stagnant markets for obsolete or hazardous products.

Leonard also suggests that many countries have found a development strategy based on low environmental standards to have mixed blessings. On balance it may even have dele- terious effects. There is probably a greater advantage to specialising in pollution control technologies, given the international growth in demand for these products. Such trends look set to continue. In this case, environmental standards and taxes might provide a valuable impetus to gains in international competitiveness through ’first-mover’ advan- tages.

What‘s the damage? Discussion of the impacts of environment policy tends to focus on their contribution to changes in easily recognisable measures. Positive effects on output, gross investment


and employment are taken to indicate that environmental policies are good, whereas negative effects indicate that they are bad. Yet it is all too easy to lose sight of the wider costs and benefits of environmental policy.

There are three broad classes of benefits from environmental policies. Improvements in air quality might mean buildings need cleaning and repairing less often. In this case the environmental benefits are ’cost reducing’. ’Output increasing’ benefits might occur when crop yields rise as a result of lower ozone concentrations, or when workers take less sick leave because of pollution-related illnesses.

These two are tangible benefits of environmental policy that are reflected in the level of GDP. Since they are only indirectly measured, however, national accounts do not attribute them to environmental improvements. They are also extremely difficult to model. As such they can all too easily be overlooked.

But even if cost reducing and output increasing benefits were adequately identi- fied, measures such as GDP would still be poor indicators

success of policies to improve the environment.

Policies for the environment, policies for jobs

The debate about environmental policies is increasingly in terms of whether the macroe- conomic effects are beneficial or costly. But this is to neglect their real purpose: to correct market failure and thereby improve the environment.

Traditionally, economists have concen- trated on the efficiency of the different policy instruments in achieving environmental ob- jectives. Taxation has usually been the preferred approach and this result stands. But as environmental policies become more exten- sive and more macro focused, there is a growing need to widen the debate to include other,

“although claims of a double

dividend might be overdone, so too are fears of economic

disaster” of the full fruits of environ-

non-economic effects. There is some evidence to suggest that taxes are better in these respects too.

Except in those cases where environmental regulation acts as a competitive spur, however, polluting firms and industries will

mental improvement. GDP is an aggregate of marketed transactions within an economy. For the most part, transactions that do not have a market price are excluded from national accounts by definition.

Hence, the third class of environmental policy benefits -which might be termed ’welfare increasing‘ - can be completely invisible in existing measures of welfare. Yet it is pre- cisely these non-marketed effects, such as the value of reduced health risks, improved rec- reation or general amenity, that must be of primary interest when evaluating the benefits of environmental policy. The number of people affected can be very large, so the total benefit can be significant. Ignoring them could seriously underestimate the value and

rarely welcome it with open arms. Even if regulation benefits both the environment and macroeconomy, there will probably still need to be structural changes in patterns of production and employment in ’dirty’ industries.

Environmental regulation might at times play a useful role in supplementing tradi- tional measures to generate employment. But it will often need to be accompanied by such measures, lest the impacts on ‘polluter-de- pendent’ regions and communities be too harsh.

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