Eco-levies to balance the future

Environmental economics has come of age. From its extremely modest beginnings in the 1960s it is now a core part of any self-respecting economics curriculum in universities, and has a central role in policy-making, not just in most developed countries but in many developing countries as well. Two of its central themes are those of "valuing the environment" and adopting "market-based instruments". The former relates to the measurement of what people are willing to pay to improve theenvironment, the latter to the use of financial incentives, like taxes, to alter the behaviour of polluters and users of natural resources.

The acceptability of these themes varies, however. Expressing value as a willingness to pay is controversial and a substantial critical literature exists denying, in varying degrees, the feasibility and desirability of expressing value in monetary terms. Much of that literature reflects badly on the critics who all too often reveal a shallow understanding of both theory and practice. But there are some legitimate concerns. Adopting financial incentives such as the taxation of pollution and resource depletion - eco-taxes - is a widely accepted complement to environmental policy.

The attractiveness of eco-taxes is that they present the polluter with the choice: pollute and pay, or reduce pollution and avoid paying. This puts the environment into the corporate and household balance sheet just like any other cost. The arguments for doing this are by now extremely well known. Eco-taxation is not a new idea; its intellectual foundations are more than 70 years old if we date the main source to Arthur Pigou's celebrated but extremely dull Economics of Welfare, published in 1920.

The focus now is on the institutional design of such taxes and on the potential they have for transforming the public finances, with taxes on pollution gradually replacing other forms of tax which act as a disincentive to work (such as income tax), or to employ labour (national insurance in the UK). The essays in Timothy O'Riordan's volume largely, and rightly, avoid the theory and focus on practical examples. Jean-Philippe Barde of the OECD in Paris provides a brief masterly survey of just what taxes are in place: Denmark, Finland and the Netherlands already raise between 5 per cent and 7 per cent of all tax revenues from eco-taxes. The role that eco-taxes can play in forcing through the kinds of resource and energy efficiency we will need if the environment is to improve along with living standards, is highlighted by David Gee of the European Environment Agency. And Hans Vos sets out the Netherlands experience in more detail.

With all the discussion about carbon taxes (taxes on the carbon dioxide content of fossil fuels) as a means of controlling the increasingly realistic prospect of global warming, it may not be widely known that Finland, Denmark, Sweden, the Netherlands and Norway already have carbon taxes, generally introduced as part of a tax-reform package. The UK's 1990 white paper on the environment, This Common Inheritance, came as close as any public statement could have in signalling the potential for such a tax here - a politically quite heroic stance at the time, given the privatisation of the electricity industry. Now, in the UK, only the Liberal Democrats have fully grasped the carbon tax concept. Neither of the main parties appears enamoured of it; the Labour party has confused the issue by voting against VAT on domestic fuels, seemingly unaware that if we cannot have a "pure" carbon tax, VAT is better than nothing. Yet without such a tax, it is debatable what any government can do to achieve, by 2010, the target for the UK of a 10 per cent drop in carbon dioxide emissions.

But the UK is making good, if slow progress with eco-taxation. The proper pricing of water abstraction and discharge is not too far off in the future. Paul Herrington's commendable essay reveals the extent to which water metering is having an effect on water demand. Highly significant is the UK landfill tax, a tax on waste going to landfill sites, with the revenues being used to reduce national insurance contributions and, indirectly, to fund environmental trusts. This is the UK's first significant attempt to secure the "double dividend" that quite a few of the essays in O'Riordan's book discuss. As Jane Powell and Amelia Craighill show, the idea is to use the tax to reduce pollution (landfill in this case) and simultaneously use the revenues (perhaps Pounds 400 million a year) to reduce labour taxes, thus stimulating employment.

Reduced pollution and increased employment represent the two dividends. How far there really is a "double dividend" is something academics can quibble about; one might say that if labour taxes are a distortion, why not reduce them anyway? But as a policy development this kind of earmarking is highly significant. Barde's essay shows that the UK is following, not setting the trend, however: other countries have long earmarked some of their taxes this way.

The battle for eco-taxes is, by and large, won. The challenge is to get them into place and to show how they can be designed on top of the existing, often cumbersome environmental regulations already in place. Their major virtue is that they reduce the costs to industry of complying with those regulations, a strategically important feature since industry is all too often successful in arguing that regulation raises industrial costs, reduces international competitiveness and threatens jobs. As Terry Barker shows, eco-taxes have the capacity to achieve exactly the opposite, as close to a "win-win" solution as we are likely to get.

Economic valuation of the environment is enjoying a revival as politicians realise that, whatever its faults, appraisal techniques such as cost-benefit analysis are probably the best thing we have for getting some kind of rationality into decision-making. This no doubt accounts for its new high profile in the European Commission, in the guidelines to the UK Environment Agency, and in its continued role in US regulatory activity. Sometimes advanced as a means of inhibiting regulation (in the belief that most regulations fail a cost-benefit test), it is showing itself to be a true ally for environmental causes.

But cost-benefit can only succeed if efforts to place monetary values on people's preferences for environmental quality succeed. Giles Atkinson and Kirk Hamilton show how these valuation techniques can be used in an exciting way to measure sustainable development. Rather than construct "green" Gross National Product measures they adopt a simple rule: no nation is sustainable if it saves less of its income than is swallowed up in the depreciation on its assets, including its environmental assets. The insights are remarkable. The UK, for example, is seen to have been drifting into unsustainability during the 1980s, due to the policy of consuming energy assets without re-investing the proceeds. Debates about educational standards and underfunded research are one manifestation of this policy of selling the family silver.

On a broader front, Peter Abelson's book is a rapid tour of economic valuation in developing countries. The case studies of water supply, forest function, slum improvement and soil quality, are useful antidotes to the view that, even if such valuation techniques work in the rich world, they surely cannot work in the poor world. Abelson's examples come from Kenya, Nigeria, Bangladesh, India, Bolivia and China. They are admirably summarised and, with the fairly minor caveat about some outdated analysis of carbon dioxide damage - as we know that each tonne of carbon released by fossil fuels does at least $20 worth of damage to the world - this will be a valuable, additional source for those who practise the appraisal of investments and policies in the developing world.

These two books are very welcome newcomers to the environmental economist's library and it is especially gratifying to see the transition from theory and textbooks to practical implementation.

David Pearce is professor of environmental economics, University College London.