Tax Shifting And Environmental Economics

The need for tax shifting - lowering income taxes while raising taxes on environmentally destructive activities - in order to get the market to tell the truth has been widely endorsed by economists. The basic idea is to establish a tax that reflects the indirect costs to society of an economic activity. For example, a tax on coal would incorporate the increased health care costs associated with breathing polluted air, the costs of damage from acid rain, and the costs of climate disruption.

Nine countries in Western Europe have already begun the process of tax shifting, known as environmental tax reform. The amount of revenue shifted thus far is small, just a few percent. But enough experience has been gained to know that it works.

Among the activities taxed in Europe are carbon emissions, emissions of heavy metals, and the generation of garbage (so-called landfill taxes). The Nordic countries, led by Sweden, pioneered tax shifting at the beginning of the 1990s. By 1999 a second wave of tax shifting was under way, this one including the larger economies of Germany, France, Italy, and the United Kingdom. Tax shifting does not change the level of taxes, only their composition. One of the better known changes was a four-year plan adopted in Germany in 1999 to shift taxes from labor to energy. By 2001, this had lowered fuel use by 5 percent. A tax on carbon emissions adopted in Finland in 1990 lowered emissions there 7 percent by 1998.

Environmental tax reform is spreading, with the reform process now under way in Denmark, Finland, France, Germany, Italy, the Netherlands, Norway, Sweden, and the United Kingdom. The United States imposed a stiff tax on chlorofluorocarbons to phase them out in accordance with the Montreal Protocol of 1987. At the local level, the city of Victoria, British Columbia, adopted a trash tax of $1.20 per bag of garbage, reducing its daily trash flow 18 percent within one year.

One of the newer taxes gaining in popularity is the so-called congestion tax. City governments are turning to a tax on vehicles picture of urban traffic entering the city, or at least the inner part of the city where traffic congestion is most serious. In London, where the average speed of an automobile was 9 miles per hour - about the same as a horse-drawn carriage - a congestion tax was adopted in early 2003. The $8 charge on all motorists driving into the center of the city between 7am and 6:30pm immediately reduced the number of vehicles by 24 percent, permitting traffic to flow more freely while cutting pollution and noise.

Environmental tax shifting usually brings a double dividend. In reducing taxes on income - in effect, taxes on labor - labor becomes less costly, creating additional jobs while protecting the environment. This was the principal motivation in the German four-year shift of taxes from income to energy. The shift from fossil fuels to more energy-efficient technologies and to renewable sources of energy reduces carbon emissions and represents a shift to more labor-intensive industries. By lowering the air pollution from smokestacks and tailpipes, it also reduces respiratory illnesses, such as asthma and emphysema, and health care costs - a triple dividend.

When it comes to reflecting the value of nature's services, ecologists can, for example, calculate the values of services that a forest in a given location provides. Once picture of logging operation these are determined, they can be incorporated into the price of trees as a stumpage tax of the sort that Bulgaria and Lithuania have adopted. Anyone wishing to cut a tree would have to pay a tax equal to the value of the services provided by that tree. The market would then be telling the truth. The effect of this would be to reduce tree cutting, since forest services may be worth several times as much as the timber, and to encourage wood and paper recycling.

Some 2,500 economists, including eight Nobel Prize winners in economics, have endorsed the concept of tax shifts. Former Harvard economics professor N. Gregory Mankiw, who was nominated to be Chairman of the President's Council of Economic Advisors in early 2003, wrote in Fortune magazine: "Cutting income taxes while increasing gasoline taxes would lead to more rapid economic growth, less traffic congestion, safer roads, and reduced risk of global warming - all without jeopardizing long-term fiscal solvency. This may be the closest thing to a free lunch that economics has to offer." Mankiw could also have added that it would reduce the military expenditures associated with ensuring access to Middle Eastern oil.

The Economist has recognized the advantage of environmental tax shifting and endorses it strongly: "On environmental grounds, never mind energy security, America taxes gasoline too lightly. Better than a one-off increase, a politically more feasible idea, and desirable in its own terms, would be a long-term plan to shift taxes from incomes to emissions of carbon." In Europe and the United States, polls indicate that at least 70 percent of voters support environmental tax reform once it is explained to them.

Subsidies, which are essentially "negative taxes," also must be reformed. Each year the world's taxpayers underwrite $700 billion of subsidies for environmentally destructive activities, picture of oil rig such as burning fossil fuels, over-pumping aquifers, clear-cutting forests, and overfishing. A 1997 Earth Council study, Subsidizing Unsustainable Development, observes that "there is something unbelievable about the world spending hundreds of billions of dollars annually to subsidize its own destruction."

Subsidies are not inherently bad. Many technologies and industries were born of government subsidies. Jet aircraft were developed with military R&D expenditures, leading to modern commercial airliners. The Internet was a result of publicly funded efforts to establish links between computers in government laboratories and research institutes. And the combination of the federal tax incentive and a robust state tax incentive in California gave birth to the modern wind power industry.

But just as there is a need for tax shifting, there is also a need for subsidy shifting. A world facing the prospect of economically disruptive climate change, for example, can no longer justify subsidies to expand the burning of coal and oil. Shifting these subsidies to the development of climate - benign energy sources such as wind power, solar power, and geothermal power is the key to stabilizing the earth's climate. Shifting subsidies from road construction to rail construction could increase mobility in many situations while reducing carbon emissions.

In a troubled world economy facing fiscal deficits at all levels of government, exploiting tax and subsidy shifts with their double and triple dividends can help balance the books and save the environment. Tax and subsidy shifting promise both gains in economic efficiency and reductions in environmental destruction, a win-win situation.

History judges political leaders by whether they respond to the great issues of their time. For today's leaders, that issue is how to deflate the world's bubble economy before it bursts. This bubble threatens the future of everyone, rich and poor alike. It challenges us to restructure the global economy, to build an eco-economy.

The choice is ours - yours and mine. We can stay with business as usual and preside over a global bubble economy that keeps expanding until it bursts, leading to economic decline. Or we can adopt Plan B and be the generation that stabilizes population, eradicates poverty, and stabilizes climate. Historians will record the choice, but it is ours to make

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