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The Environment Canada Policy Research Seminar SeriesThe Role of Taxation in Environmental Policy
The rationale for using taxes in environmental policy is three-fold. Taxes can be used to "price" harmful effects arising from pollution-causing activities and tax incentives can be used to encourage activities that reduce pollution. The use of taxes is similar in concept to the user-pay principle - in this case tax payments are made for the use of clean air, soil, and water. Taxes can be a superior form of intervention compared to others if certain conditions are met. If they are cost effective, that is if they are able to achieve targest more cheaply. If they encourage the adoption of technology, which may occur with incentives, not just with taxes. They provide a revenue for governments, thus paying for public goods and services of value to Canadians. Environmental taxes also provide what is known as the double dividend: a green dividend form reducing pollution, and a blue dividend from improved efficiency of the tax system. There are also several limitations of using taxes in an environmental context. Emissions cannot be taxed directly, instead, "dirty" goods are taxed as a proxy, though these goods provide other utility to consumers. In an open economy, taxes on production are less effective than taxes on consumption. Also, international co-ordination is necessary if these taxes are to be effective. Dynamic adjustments of such taxes are required to reflect changes in environmental practice. The industrial impacts of environmental taxes must also be considered. Industries most toxic or carbon intensive are resource intensive. These are often concentrated in certain regions or rural areas of Canada. Polluting firms tend to be the smaller businesses with less than 500 employees. In terms of current Canadian policy, the federal fuel excise tax is by far the most significant, accounting for $11 billion annually, or about 3% of federal revenue. There are other, less significant federal excise taxes such as the air conditioner tax, as well as provincial excise taxes on batteries, solvents and car tires, to name a few. In other OECD countries, environmental taxes currently account for between 5 and 10 percent of government revenue. These include carbon taxes in Italy, Switzerland and the Netherlands, road transport and landfill taxes in the UK, and a program of green tax reform in Germany. European countries tend to rely more on environmental taxes as a source of revenue compared to Canada. In Europe, many of these tax reforms are a replacement for payroll taxes, while in the US, environmental taxes such as the Minnesota carbon tax are a replacement of property taxes. Our simple model for optimal taxation involves two types of goods, clean and dirty, and a third good, leisure or labour. Dirty goods result in pollution that reduces consumer welfare. The government can finance expenditures with lump sum taxes or distortionary taxes. Environmental taxes are chosen to maximise consumer welfare. The "First Best" policy is to implement lump sum taxes which can be used to finance public expenditures. Clean goods are not taxes, and the tax on dirty goods is set to raise their price to cover the social costs of pollution. The optimal tax rate, t = MD, where MD is the marginal damage from consumption of the dirty good. Since lump sum taxes are not possible, distortionary taxes are needed to finance government expenditures. The tax rate on the dirty good, therefore is t = MD/P*, where P* is the social cost of raising a dollar of tax revenue (and is most likely greater than 1). The tax rate on dirty goods could be smaller with distortionary taxes. To revisit the concept of the double dividend, if taxes are set optimally in the first place, then a double dividend is not possible. If taxes are not set optimally, then a double dividend is possible with environmental tax. The double dividend occurs if environmental taxes reduce the distortions of the tax system. The reduction in the consumption of dirty goods must increase the tax base of other goods for the double dividend to occur. Further considerations include the fact that taxes are more distortionary in an open economy, leading to smaller environmental tax rates. Environmental taxes could be used to cut the most distortionary taxes (e.g. capital tax). If there is unemployment, then replacing payroll taxes with environmental taxes can make sense, as in the European model. Environmental tax might even make it easier to operate a progressive tax system. There is a need for serious work in Canada to model environmental taxes, with regards to the impact on emissions, the use of revenue (and replacement of other taxes), the social cost of tax revenue, open economy effects, distribution effects and regional / industry effects. BiographyJack M. Mintz has been President and Chief Executive Officer of the C.D. Howe Institute since 1999. He is also Arthur Andersen Professor of Taxation, Joseph L. Rotman School of Management, and Co-Director of the International Tax Program, Institute of International Business, both at the University of Toronto. Dr. Mintz is Editor-in-Chief of International Tax and Public Finance, published by Kluwer Academic Publishers, and an Associate Editor of Contemporary Accounting Research. He serves on the Board of Governors of the National Tax Association in Washington, DC, and on the advisory board of the John Deutsch Institute for the Study of Economic Policy, Queen's University, Kingston, Ontario; he is also a research fellow of CESifo, Munich, Germany. He has published more than 150 books and articles in the fields of public economics and fiscal federalism. Dr. Mintz was Clifford Clark Visiting Economist at the Department of Finance, Ottawa, and Chair of the federal government's Technical Committee on Business Taxation in 1996 and 1997; Associate Dean (Academic) of the Faculty of Management, University of Toronto, 1993-95; a special advisor to the Deputy Minister, Tax Policy Branch, Department of Finance, Ottawa, 1984-86; and Director of the John Deutsch Institute, Queen's University, 1987-89. List of articles and reports by Dr. Jack MintzCompiled in support of an Environment Canada Policy Research Seminar, held in Hull on January 19, 2001.
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