Green Taxes

David Morris, Vice President
Institute for Local Self-Reliance, 1994

In the past 25 years we have substantially increased taxes on labor and modestly increased taxes on income while allowing pollution and resource depletion to remain largely untaxed. The result is that we have created a tax system that encourages resource depletion and discourages investments in machinery and labor. A worldwide discussion is taking place about how to move away from taxing "goods" like investments and employment, that is, activities we would like more of, and toward taxing "bads", like pollution, that we would like to discourage.

Pollution taxes have been embraced by a growing number of mainstream economists and policy makers. Stanford economist Lawrence Goulder calls such taxes "corrective taxes" because they correct the distorting price signals now given to resource depletion. Ex Federal Reserve Chairman Paul Volcker and former Council of Economic Advisors Chairman Martin Feldstein have suggested using a carbon tax to reduce the federal deficit.[1] The Ford Motor Company and the GAP have supported a proposed carbon tax in California that would have replaced a portion of the state's retail sales tax.[2]

Green taxes are not new. In the last 15 years such taxes have been used for two primary purposes:

* to generate revenue to pay for damages created from past pollution and for measures to reduce future pollution

* to change behavior

A third type of green tax discussed below has been gaining visibility. It combines a significant pollution tax with a major restructuring of the tax system to make the overall economy more efficient. This process is called "tax shifting".

Green Taxes Designed to Finance Remediation and Prevention Measures

These taxes are used to generate revenue to pay for the damages and cleanup costs from pollution and to pay for measures to reduce future pollution.

* Minnesota Solid Waste Tax.

In 1989, Minnesota extended the 6.5 percent sales tax to garbage services and in 1990, raised $24.3 million. A portion of this money has been used to finance recycling and waste minimization programs and to provide loans and grants for recycling businesses. Another portion goes to close down polluting landfills.[3] Minnesota also collects a 2 cent per pound tax on toxic chemicals listed on the Toxic Release Inventory.

* California Tobacco Tax.

In 1987, by initiative, Californians approved Proposition 99, The Cigarette and Tobacco Products Surtax. The initiative imposed an additional 25 cent tax over and above the existing tax of 10 cents per pack. It went into effect in January 1989. In 1990 it raised $543 million. These funds are used to finance aggressive public education programs and nicotine addiction treatment programs as well as to pay for health costs associated with tobacco use.[4]

* Iowa Pesticide and Fertilizer Tax.

In 1987 Iowa passed the Groundwater Protection Act which imposes a tax of 1/10th of 1 percent on gross sales for pesticides at the retail level and 1/5th of 1 percent of gross sales on the manufacturers of pesticides. It also imposes a 75 cents per ton tax on nitrogen fertilizer. These three taxes raised $3.2 million in 1993. Thirty five percent, or $1 million went to the Leopold Center for Sustainable Agriculture at Iowa State University to promote economic and environmentally sustainable agriculture.[5]

Green Taxes Designed to Change Behavior

A growing number of green taxes are designed to change behavior. They are often high enough to make it attractive for customers to use more environmentally benign products and practices.

*Quantifying Electricity Generation Environmental Costs.[6]

Almost a dozen state utility regulatory commissions have quantified the environmental costs of electric generation. These environmental costs range from 1.2 to 8.6 cents per kWh, depending on the type of plant and the type of fuel. In all states utilities must include these environmental costs when choosing the least expensive source of additional electricity. In some states, like Wisconsin, utilities must take these externalities into account but do not need to be guided by them in making their final decision regarding investments or purchase contracts.

In 1991, the Minnesota legislature required the Public Utilities Commission(PUC) to include environmental costs when comparing the costs of alternative energy sources. In 1993 the legislature altered the 1991 law and required the PUC to establish interim values by March 1, 1994.[7] In February 1994 the PUC established such values. They embrace a wide range of possible values.

These values will be used to compare potential sources of new electric power generation. These values would add .8-1.6 cents per kWh to the price of coal generated electricity. The PUC is presently initiating a contested case hearing to establish permanent environmental values.

Interim Externality Values

*Ontario's Automobile Feebates.[8] The only existing significant feebate program was enacted by the Province of Ontario.[9] Initially the program was a tax on gas guzzlers only, similar to that in existence in the United States. In 1991 the New Democratic Party doubled the existing gas guzzler tax and widened its application. Fierce opposition led to a major revision in June 1991. At that time a $100 rebate for the most fuel efficient cars was added.

The impact of the tax has been inconclusive. Since the tax went into effect in 1991 Ontario customers have been buying smaller, more fuel efficient cars. Sales of fuel efficient cars as a percentage of total car sales had been flat from 1983 to 1990 but then rose from 2.6 percent in 1990 to 5.3 percent in 1991 to 7.4 percent in 1992. However, the recession and the 13 cents per gallon increase in the provincial gasoline tax in July 1991 makes it difficult to evaluate the importance of the energy inefficiency tax itself. Complicating the issue further is the fact that the tax itself comprises less than 1 percent of the sales price of the car and it is not advertised. There is no sticker on the car explaining the tax. Thus it is difficult to maintain that the customer is making a decision based on the tax.[10]

* Minnesota Contaminated Property Tax. Property contaminated by past pollution has a reduced market value and therefore pays lower property taxes. To maintain tax revenues and to provide an incentive to land owners to clean up their property, the Minnesota legislature in 1993 enacted Chapter 375, Article 12. It imposes a contamination fee that is triggered when a reduction in property taxes is awarded due to contamination. The tax is two tiered. If no cleanup plan exists the tax equals the contamination value times the property tax class rate for the property. If a plan is approved the tax equals the contaminated value times 50 percent of the property tax class rate for the property. Once the cleanup is completed the tax disappears.

* Federal Tax on Ozone Depleting Chemicals. In 1989 the U.S. Congress enacted a tax on eight ozone depleting chemicals as part of its Omnibus Budget Reconciliation Act. It extended this tax to 12 additional chemicals and raised the tax on the original 8 chemicals in the National Energy Policy Act of 1992. The Clean Air Act established caps on most chlorofluorocarbons (CFCs), with a phase out occurring around the year 2000. The tax on CFCs was $1.37 a pound in 1990 and 1991, about twice the then current product price. Recycled CFCs were exempted from the tax. The tax was raised in 1990 and again in 1992. The tax rises to $3.10 per pound in 1995 and then rises by 45 cents per pound per year thereafter. The tax is proportional to the chemical's potential for depleting the ozone layer.

Tax on Ozone Depleting Chemicals

Although the concept behind the tax was to encourage the rapid phase out of CFCS, the tax also has generated large amounts of revenue: $360 million in 1990 and over $1 billion in 1994. Andrew Hoerner of the Center for Global Change argues that in the early years the tax and not the cap on production has been the primary driving force for U.S. ozone reduction. A dramatic 290,000 metric ton reduction in CFC 11 equivalence has occurred below the national ceiling.[11]

* Minnesota Groundwater Protection Act. This 1989 law prohibited the use of once-through water systems in the Twin Cities after 2010 and immediately raised the price of using once-through water 200 fold for commercial users and 50 fold for non-profits and schools.[12]

* Air Pollutants Tax. Minnesota has imposed air emissions fees since 1985. The Clean Air Act of 1990 allows states to impose a charge per ton of regulated pollutants in order to finance the regulatory program. The Clean Air Act expressly prohibits fees on carbon monoxide emissions. The Minnesota legislature in l99l authorized such charges to cover "direct and indirect costs...to develop and administer" the program. The Minnesota Pollution Control Agency imposes a uniform charge of $18.92 per ton of emissions on five air pollutants: sulfur dioxide, nitrogen oxide, volatile organic compounds,(VOCs), particulate matter less than ten microns in diameter(PM10), and lead.[13]

There is no emission fee for the 189 pollutants identified as "hazardous air pollutants" by Congress in the 1990 Clean Air Act Amendments. The PCA is examining the possibility of imposing environmental charges on these known air toxics. It is also examining the possibility of imposing variable rates. British Columbia has established variable environmental fees assessed on the basis of potential environmental harm.

Contaminant Fees for Air Emission Permits or Approvals [14]

Contaminant Fees for Effluent Permits or Approvals

[15]

Tax Shifting

Recently the debate about green taxes has included the issue of tax shifting, that is, of using green taxes as a means to restructure national tax systems. This debate is most vigorous and visible in Europe where there are strong environmental political parties and high unemployment. As European President Jacques Delors declared in Copenhagen in June 1993, "Taxation of natural resources allows us to reduce the excessive load on taxing productive labor, thereby increasing Europe's international competitiveness."[16]

In most industrialized countries, the majority of increased taxes in recent years has fallen on labor. There have also been modest increases in taxes on capital while there have been virtually no tax increases on pollution or natural resources depletion.[17] The result, economists argue, is fewer jobs and more pollution. In almost all countries the non-wage cost of labor has increased dramatically since 1970 even while net wages to labor have fallen. For example, gross labor costs in France went from 54 percent to 60 percent while net labor income fell from 37 to 34 percent.[18]

A number of studies have evaluated the macro economic impact of a tax on carbon equal to $100 a ton.[19] Most studies conclude that there would be a 1-3 percent reduction in GNP.[20] However, these studies do not assume offsetting tax reductions elsewhere in the economy nor do they assume that the money raised would be directed toward improving efficiency.

The World Resources Institute argues that current taxes on capital and labor undermine economic efficiency. A tax on capital raises the cost of capital and thus discriminates against technological innovation. A tax on labor raises the cost of labor and thus reduces employment. Displacing these taxes with pollution taxes would improve the productivity of the economy. "Unlike many other sources of federal revenue, a carbon tax would generate overall economic efficiency gains, regardless of how the revenues from the tax are used", says Dower and Repetto.[21]

A high carbon tax coupled with reduced tax rates on income and profits, according to the World Resources Institute, could generate a possible gain of 45-80 cents per dollar of tax shifted.[22] The gain comes not only from improved economic efficiency but from reduced investment in infrastructure and in reduced operating costs due to higher energy efficiency and in reduced environmental damage.

A vigorous discussion is occurring throughout Europe about how to achieve the greatest economic efficiency and equity from tax shifting. Sophisticated models have shown that reducing the personal income tax might stimulate short term spending but has modest long term benefits. A better result might occur by directing the environmental tax revenues to expanding investment tax credits. However, that lowers the cost of new capital investments relative to labor and thus could increase unemployment. Also higher growth could actually increase carbon dioxide emissions. A reduction in payroll taxes could help labor and an increase in investments in energy efficiency and renewables could reduce the linkages between growth and pollution.

The Danish government recently examined the impacts on their economy if they were to increase their carbon dioxide tax by about $25 per ton.[23] The conclusion was that if the revenue generated were returned through income tax reductions there would be a loss in production and a rise in unemployment but if the revenue generated were returned by reducing business' social security reductions employment and production would both rise.

Effects of a $25.50 per ton increase in Denmark's CO2 tax on the Danish Economy

Returned through income tax reductions

Returned through employer social security reductions

A modest form of tax shifting has been suggested by a bill introduced in California by Assemblyman Tom Bates. AB 1725 would have imposed a tax of $3 per ton of carbon dioxide($11 per ton of carbon). This tax would equal the revenue lost by phasing out a .5 percent temporary sales tax. Thus tax revenues to the state would remain the same while the tax shifted from retail business to pollution.

Competitiveness

A question frequently raised regarding all taxes, including green taxes, is whether they would undermine the competitiveness of domestic industry. This question has been raised with regard to national green taxes in Europe, where countries operate under the Single Europe Treaty which forbids taxing imports within Europe, and with regard to state taxes in the United States, where the Constitution prohibits states from imposing taxes on interstate commerce. Countries and states prefer to introduce green taxes cooperatively, not unilaterally.

Green taxes would not impose a competitive disadvantage if imposed on the household sector or on that portion of the business sector that does not export its products or services. The most significant impact would occur on energy intensive, exporting industries. Muller and Hoerner examined the impact of a $7.50 per ton carbon tax on the most energy intensive industry. They found that at the four digit Standard Industrial Classification(SIC) Code level the heaviest burden would fall on Portland cement manufacturers but cement tends not to trade in international markets and is only slightly traded on the interstate level because of its high transportation costs relative to its modest value. Nitrogenous fertilizers and a few primary metal industries such as aluminum and steel would experience price increases in excess of 0.5 percent.

The authors conclude, "Overall, the competitive impact of a modest state-level carbon tax would appear to be limited to a handful of industries and to be small even for those industries it hits hardest."[24]

To cope with competitiveness issues Europe's carbon taxes either exempt heavy industry or create a two tiered structure for business and households. In 1991 Sweden, for example, introduced a $30 per ton tax on carbon dioxide emissions. Energy intensive industries were exempted. Household and non-manufacturing industries paid rates four times higher on average than mining, manufacturing and agriculture industries.[25]

$7.50 Per Ton Carbon Tax as Percentage of Annual Shipping Value by Industry for Energy Intensive Four Digit SIC Industries.[26]

(based on 1988 shipping and energy use)

* Denmark's Carbon Dioxide Tax. In 1992 Denmark introduced a carbon dioxide tax. The charges are twice as high for households as for businesses: $14.30 per ton of CO2 vs. $7.15. Denmark offers refunds to energy intensive businesses. For firms engaged in export, refunds of the tax are possible depending on the ratio of the tax relative to the value added in production. For industries where the tax amounts to more than 3 percent of the value added, a total tax refund is possible. However, Denmark permits such refunds only if "reasonable" energy efficiency investments are undertaken. These investments must be specified in energy audits carried out by consultants certified by the Danish Energy Agency.[27]

Finland and Denmark also have a cap on the amount of carbon taxes a firm that competes internationally must pay. A carbon tax introduced into the Maryland House of Delegates in 1992 included a tax cap of $250,000 per enterprise regardless of whether the business were engaged in export.

* Sweden's NOx Tax. Since January 1, 1992 Sweden has imposed an environmental charge on NOx emissions from large combustion plants. The fee is $2.18 per pound, measured as NO2. The revenue from the charge is returned to the plants in proportion to their energy production. This refund policy allowed the tax to gain business support yet the refund policy still encourages NOx reductions. The average cost of reducing one kilogram of NOx is $1.20 while the tax is $2.18 per pound.[28]

*Ozone Depleting Chemicals Tax. The U.S. Congress designed the tax on ozone depleting chemicals(ODC) to minimize adverse impacts on U.S. manufacturers. Imports of ODCs are subject to the same tax while any tax paid on exports of such chemicals is rebated. The Internal Revenue Service(IRS) taxes imported goods based the average consumption of ozone depleting chemicals in the manufacture of comparable domestic goods. If the IRS has no comparable product on its list it will tax that product 5 percent.

These measures protected the domestic market from predatory tactics by foreign producers who did not pay the tax and allowed exports to compete on a level playing field in other nations that have not adopted a tax. However, the rebate of the tax on exports eliminates the environmental price signal.

Can a state that imposes a carbon tax on in-state producers also impose the same tax on out-of-state producers? Most states already require companies engaged in interstate commerce to distinguish between in-state and out-of-state sales as part of the process of allocating the firm's total income between the states. A firm could be given a credit in an amount equal to the carbon tax paid times the percentage of all sales which are out-of-state sales. For diversified firms, the credit would have to be calculated by product line so that the tax liability caused by, for example, the in-state production of cement was not reduced as a result of out-of-state sales of software.

Assuming that such a tax could be imposed at a reasonable cost, do states have the Constitutional authority to do so? Muller and Hoerner have explored some of the legal precedents.[29] Recent decisions by the General Agreement on Tariffs and Trade(GATT) may pose an obstacle to imposing environmental taxes on imports. A recent GATT panel decision ruled that the U.S. violated GATT by banning the import of tuna caught by fishing techniques that slaughter dolphins. The panel concluded that the U.S. Congress could impose environmental standards on its own fishing fleets but could not impose such standards on foreign fishing fleets. Such a decision would appear to be relevant to any environmental tax imposed on foreign production techniques.[30]

Equity

Although there are many kinds of environmental taxes, carbon taxes have gained the most attention. One reason is that they are directly related to the amount of carbon dioxide emissions, which in turn its directly related to greenhouse gas emissions and global warming. Energy taxes do not tend to discriminate between fuels.[31]

A $10 per ton carbon tax would have a significant impact on the price of coal but a very nominal impact on the price of electricity or gasoline. A $100 per ton carbon tax would more than double the price of coal while increasing the price of gasoline by 20 percent and the price of electricity by about 50 percent.

Price Impact of Carbon Taxes

Any form of pollution tax is regressive. It falls more heavily on low income households. Poor households spend more than 15 percent of their income on energy while households earning over $50,000 a year spend less than 3 percent.

For purposes of illustration, a $6 per ton tax on carbon would translate into an increased tax of $43.12 per low income household in Minnesota.

Impact of a $6 Per Ton Carbon Tax on Low Income Households

These estimates are based on statewide averages and may be high. One third of low income households, for example, do not own cars and thus their gasoline consumption would be lower than that given above. Low income households tend to use less electricity than the average household The electricity figure assumes coal fired electricity, but 40 percent of Minnesota's electricity is generated by non coal fuel sources.

One way to deal with the inequities resulting from an across the board carbon tax would be to return a significant portion of the revenue to the low income community for energy efficiency. Assuming 514,000 low income households in Minnesota, the amount generated by a $6 per ton carbon tax from low income households throughout Minnesota would be $22.16 million. If 50 percent of the carbon tax revenues were used for energy conservation programs it would amount to $75 million. Thus the low income community as a whole would receive an annual net benefit of about $53 million. If 15 percent of the carbon tax revenues were used for low income conservation programs it would constitute a hold harmless or break even program for low income community.

For those who take advantage of the program, the benefit would be greater because the money would lower energy use over 10-25 years depending on the energy conservation investment. A $2,000 investment per household would reduce heat, electricity and water expenditures by $100-200 per year or more. As these savings are realized, the impact of the carbon tax is proportionately lowered too.

As of 1991 low income energy efficiency programs in Minnesota were serving about 20,000 homes per year, although by far the largest amount of spending was used for the 10,000 homes served by the weatherization program. At current rates, the weatherization program would need 50 years to serve all low income households. To date low income energy efficiency programs have found it difficult to even keep up with the increased number of households in need.

Assuming a $2,000 investment per home, the $75 million from the carbon tax would serve an additional 37,500 homes per year. In addition to existing low income programs, this would allow the entire low income household population to be served within about 10 years.

Two recently proposed state carbon taxes have specifically targeted a certain percentage be used for low income energy efficiency programs. In January 1992 a $3.75 per ton carbon tax was introduced in the Maryland Senate. It would have raised $100 million a year. Twenty one million dollars of those revenues were targeted for low income weatherization and energy assistance programs.

In April 1992 Minnesota State Senator Steve Morse introduced the Sustainable Energy Transition Act. The $6 per ton tax would have raised about $150 million a year. About 15 percent of this was targeted to low income energy programs.[37]