9.6 Well-being and environmental taxes

Chapter 6 sees application of the framework for assessing tax measures undertaken by states in their aim for well-being through taxation, as set out in chapter 4, to the well-being aspects of environmental taxes, with the aim to scrutinise practices and to identify recommendations. For purposes of chapter 6, the environment is taken to be the natural world and all that is related to it. The term ‘environmental taxes’ is used here in a broad sense to refer to taxes with a specific base that has a clear negative effect on environment, or which seek to tax certain activities, goods, or services so that environmental costs may be included in the respective price and/or so that producers and consumers are oriented towards activities that better respect the environment.

A number of observations, issues, and recommendations that follow from application of the assessment framework to environmental taxes are briefly outlined below.

As addressed in answer to the first four general questions, it is typically held that states should intervene in the environment, because of associated and otherwise unaddressed market failures as a result of which hardly any market price reflects the true overall cost (including environmental costs and benefits). States have a range of different policy instruments available to do so, including environmental taxes. The impact of environmental conditions on well-being suggests well-being as a factor to consider in the assessment of such environmental policy instruments. Environmental impacts are not only felt now, but also carry over into the future, to affect the well-being of humans, (other) animals, and other species. Furthermore, environmental taxes can for instance have cross-border effects on competitiveness of enterprises that may affect well-being domestically and abroad, and also impact whether or not redistribution from rich to poor occurs, e.g. through targeting international emission reduction at richer regions. That said, the added value of well-being in relation to the environment, above and beyond other matters such as happiness, pleasure, health, wealth, et cetera, is difficult to convincingly establish outside its function as an overarching concept. In practice, it also seems uncommon for taxation to expressly focus on the combination of the environment and well-being. Formulated well-being aims related to the environment often are unspecific and difficult to measure. Information on the implications of the state of nature for human well-being is patchy, with limited data available, substantial knowledge gaps, and poor understanding of linkages. Attempts to address through taxes both environmental and, potentially conflicting, well-being aims may undermine the ability of the tax to achieve either one of those aims, resulting in the recommendation to pursue aims other than environmental via other, complementary policy instruments. A major importance of well-being in matters of environmental taxation may be to ensure that public policy consideration goes beyond economic (welfare) aspects, and that states consider environmental measures and effects not in isolation but in integration, taking into account how different government policies affect each other and ultimately, how such policies impact the way life is going for the individuals concerned. Alternative market-based policy instruments that can contribute to correcting market failures as regards environmental prices are for instance tradable emission rights, or subsidies for pollution reduction. Governments can also use a whole range of non-market environmental instruments, such as command-and-control regulations, state financing, green tech support policies, infrastructure improvement, targeted procurement, information campaigns, or private-public partnerships. Generally, environmental taxes are quite favourably assessed in comparison to regulatory policy instruments, as environmental taxes provide an efficient way to reduce environmental damage that can avoid deadweight losses and that can provide a continuing, dynamic incentive for polluters to reduce their pollution. A downside to environmental taxes is that such taxes, as with any taxes, can have distortive effects that can result in substantial welfare and well-being costs. In some cases regulatory policy instruments will be favoured over environmental taxes, for instance when specifically targeted measures are required to tackle location or source specific environmental damages, or when certainty must be had regarding the quantities of the environmental targets that will be reached. Compared to environmental taxes, subsidies can allow for better targeting, and can alleviate free-rider problems that may occur under broadly set taxes. However, the complexity of targeted subsidies brings with it higher administration and compliance costs. In some situations, a mixture of different policy instruments will be superior.

From a consequential normative perspective, and in order to properly assess the well-being impact of environmental taxes in answer to questions 5 and 6, the net effect of both government taxing and spending in the matter should be taken into account. For example, environmental taxes may, when viewed in isolation, have a regressive impact, in that they may disproportionally impact low-income households that generally spend a relatively large share of their income on polluting items, while resulting environmental gains are also to the benefit of high-income households. However, recycling of environmental tax revenues can subsequently mitigate these regressive effects. Reinforcing or counteracting effects of other policy instruments must also be taken into account, especially in case of overlapping or conflicting objectives or instruments, as a result of which well-being losses can arise. As to who ultimately bears environmental taxes, and whose well-being is ultimately affected by those taxes, it is not always easy to make the polluter pay. Polluting activities can be relocated to no or low-taxed countries, or environmental taxes can result in increased prices for inelastic goods and are in that way on-charged to consumers, resulting in relatively high burdens for low-income consumers. Environmental tax expenditures (or in other words, environmental tax incentives) effectively have all taxpayers pay in order to induce pollution reduction. Positive well-being effects of environmental ‘gains’ will not be limited to one specific group, as such environmental gains can be expected to spread through positive externalities to positively affect the well-being of many. In order to properly determine and substantiate net effects on well-being of environmental taxes, assessments should take account of exacerbating or offsetting effects of all relevant distortions in combination with the environmental tax, such as already existing taxes, other instruments, externalities, and other market failures, as well as of the systemic changes that can ripple through society as a result of environmental policies. And while there is no single way in which environmental taxes should be designed, implemented or evaluated, a number of issues and recommendations that concern the effectiveness and efficiency of environmental taxes are identified in chapter 6. While properly assessing the effectiveness and efficiency of environmental taxes may be challenging, it is important that such assessment does take place, and focuses also on the broader societal impact. Assessments of environmental taxes should not only be done on beforehand, but should also be done after implementation, to provide for regular monitoring and evaluation of the effectiveness and efficiency of the measure at hand. As ex post evaluations of environmental taxes are rather scarce in practice, a recommendation is to build regular and proper evaluation into the process of designing and implementing environmental taxes. Considering that environmental taxes need to provide certainty, predictability, and continuity over long periods in order to effectively stimulate investment and innovation that will help tackle environmental issues, this pleads against frequent or irregular changes to environmental taxes. At the same time, environmental taxes need to be sufficiently flexible and dynamic to change with new technologies and unexpected opportunities, and with economic or environmental developments.

From a deontological normative perspective, applied in questions 7 and 8, there are again different ways in which international, supranational, and national bodies of rules or laws impose restrictions on environmental taxes, such as WTO and EU rules, for example regarding territorial ring-fencing of the polluter pays principle. States need to verify and substantiate whether their environmental taxes are in conformity with such applicable laws and regulations. Environmental taxes can furthermore create conflicts with autonomy, equality, simplicity, and certainty, or with other principles that underlie tax systems. These potential cases of conflict need to be addressed by states using environmental taxes, whether or not in the sphere of well-being. The required level of flexibility to adjust environmental taxes may also here attract efforts of special interest groups to try to influence future regulations. In addition, such flexibility may induce delegation to executive authorities, potentially at odds with requirements of legality and representation. States need to assess and manage such risks posed by environmental taxes to political processes.

Finally, from a virtue ethics normative perspective as addressed in answering questions 9 and 10, environmental taxes can be used to stimulate certain character traits that can be considered virtuous (such as having the polluter pay) or to discourage vicious action (such as polluting, free riding, harmful competition, or evasive behaviour). States should assess and indicate which character traits are stimulated by their environmental taxes, to enable a discussion on the desirability thereof. In general, public support for environmental taxes (and especially for application of the polluter pays principle) seems to be favourable. Such public support may reduce in case of, for instance, regressive effects, in case of conflicts with the polluter pays principle, or in case of non-transparent use of the funds following from such environmental taxes. Where this is the case, governments need to carefully consider their course of action, and the behavioural impact thereof. The drafting and scoping of environmental taxes determine whether such taxes encourage competition for existing well-being (e.g. in the case of harmful tax competition, or where the ‘gains’ of pollution victims are compensated by well-being losses of polluters), or bring about additional well-being. This is a matter for states to assess and indicate.