Back Matter

Appendix I. Country Experiences with Environmental Taxes: The Ecotax Leaders

A. Environmental Tax Reform in Denmark

Environmental concerns became the focal point of the tax policy discussions in Denmark around 1990 when Denmark passed an energy action plan with the objective of reducing the level of emissions of CO2 by 20 percent in 2005 compared to the level in 1988 (Helbo Hansen, 1999). Furthermore, Denmark acceded to the EU agreement for emissions in the -year 2000 not to exceed their level in 1990.

The action plan was followed up by three important tax reform initiatives:

1. In 1992-93, a CO2 tax was introduced at a level of about US$17 per ton of CO2, initially only on households, but later extended to industry, followed by a reduction in the taxes on oil and gas. For households, the CO2 tax rate was about 20 percent of the consumer price net of taxes, in addition to the standard energy tax rate of 105 percent of consumer prices net of taxes. For reasons of competitiveness, industry paid only a rate of 10 percent, with reduced rates applied to energy-intensive industries (a degressive rate schedule was introduced with reference to the value added of industrial companies). Because the degressive rate schedule gave only limited incentive effects compared to the average tax burden on a company, the tax provisions were supplemented by a system of voluntary agreements through which eligible enterprises would be refunded all the tax if they carried out energy-saving programs, controlled though an independent audit. The extra revenue raised from this tax (0.2 percent of GDP) was in part used to increase energy saving expenditures, and in part to reductions on the tax on beer and wine (by some observers characterized as an interesting variation of the double dividend).

2. A major green tax reform was to be phased in during 1994-98, the main objective being a substitution of taxation on labor corresponding to about 2.2 percent of GDP (with marginal tax rates on labor to be reduced by 10 percent) by increased ecotaxes and charges on energy, waste, water, and sewage (1.2 percent of GDP), as well as by higher capital income taxes (1 percent of GDP). The overall reform was intended to be revenue neutral through “recycling” of the revenue gain back to industry, through lower social security contributions of employers and investment incentives to induce industrial energy-saving measures. The higher energy taxes initially only applied to consumers, but work was initiated to prepare higher energy taxes on industry as well.

3. This led to the introduction in 1996 of a tax on SO2 emissions of about US$1.7 per kg, as well as a further increase in the CO2 tax on businesses. Particularly the SO2 tax had a radical impact on consumption, since industry with relative ease could move consumption toward low-sulfur fuels. During the whole of this process there was an extensive activity in industry to introduce meters, and to negotiate individual agreements on pollution-reducing „ measures and plans. Considerations are under way to further increase green taxes and to broaden the scope of their use. Energy tax rates were further increased and new ecotaxes introduced during the fall of 1998, including in particular a new tax on nitrogen consumption outside agriculture, which was combined with comprehensive regulatory measures to restrict nitrogen use in agriculture. Interestingly, despite the arguments that regulation involves higher costs than economic instruments such as taxes, Danish farmers strongly opposed the tax route and argued in favor of regulation to reduce nitrogen emissions to the environment.

The overall macroeconomic impact and the impact on overall employment is expected to be modest, although the impact for individual sectors and industries may be quite significant.

B. Environmental Tax Reform in Norway

Since the late 1980s, a strong focus on sustainable development has become a cornerstone of policymaking in Norway (Moe, 1999). In this respect, Norway was clearly among the frontrunners with regard to devising ways to encompass environmental concerns in general economic policies, with the aim of achieving a high level of employment and growth without harming the environment. Today, Norway probably has the most extensive framework for environmental policy of all countries in the world. As just one element of this framework, an annual document annexed to the budget examines the environmental profile of the state budget, identifying all expenditure items that are wholly or partly motivated by environmental policy objectives.

While environmental legislation in general has a fairly long history in Norway, environmental tax policy moved to the mainstream of policymaking only in the late 1980s. Based on the recommendations of an early environmental tax commission established in 1990, a number of environmental taxes and charges were put in place in subsequent years inter alia with the aim of stabilizing CO2 emissions in the year 2000 at 1989 levels. It was calculated that achieving this ambitious goal would inevitably have negative consequences for employment. The key policy instrument was the co2 tax introduced in 1991 with different rates for different fossil fuels. A number of tax exemptions, mainly for export-oriented manufacturing industries, mean that only about 60 percent of total CO2 emissions are subject to the tax, and only about 20 percent of emissions from manufacturing. The exempt manufacturing sectors—similar to the situation in the other countries with a CO2 tax—are heavily exposed to international competition.

A broad-based second environmental tax commission established in 1994 submitted its report to the government in 1996. A key objective of the commission was to design policies to ensure that the economy can deliver both high employment and a better environment, and the approach adopted was to seek ways to integrate environmental policies and objectives in mainstream macroeconomic policies. Core to the work of the commission were the questions of whether taxes on labor could be relieved and replaced with incentive-based green taxes, and the possible implementation strategies for such a reform in a small open economy. A key issue in this regard was also the cost effectiveness in reducing national CO2 emissions in accordance with the binding commitments reached in Kyoto in December 1997. In this respect, Norway was one of the only five countries that implemented a carbon tax to curb CO2 emissions, which in 1996 accounted for 70 percent of total greenhouse gas emissions in Norway.

Based on fairly extensive empirical research and a large number of simulations, the commission concluded that taxes on labor and on investment are the most distortive at the margin, and that environmental taxes, set correctly, can improve the efficiency of the economy. Substituting the one with the other would represent win-win policies. Despite these clear but theoretical advantages, the commission also pointed to a number of drawbacks of such a policy. For instance, labor taxes in the form of payroll taxes and social security contributions constitute an important and stable revenue source; and structural changes of a nature and range required would lead to opposition from the groups and sectors adversely affected.

The model simulations carried out by the commission, which illustrates the effect of raising green taxes by 1 percent of GDP with a broadly offsetting reduction in payroll taxes, showed a marginally positive effect on key macro variables (disposable income, inflation, employment, and unemployment), combined with significant environmental benefits. On the key question of whether green tax reform may produce a double dividend, the commission points to the theoretical a priori inconclusiveness, but also—through its empirical simulations—seems to underpin the view that a double dividend will, in fact, materialize over the long term, if reforms are correctly designed, although the effects in long term equilibrium may be modest. It should be stressed, though, that in the view of the commission, a double dividend is not a necessary condition for carrying out reforms, as long as the policies benefit the environment without hurting employment, or strengthen employment and the efficiency of the economy in general without affecting the environment negatively.

Empirical research suggests that the CO2 taxes in Norway may have reduced emissions by about 3 to 4 percent in 1991-93. However, the above-mentioned commissions pointed to the need to raise the effectiveness of the carbon tax structure: hence, the exemptions and the weak link between the rates of taxation and the carbon content of products imply that the incentives for reducing carbon emissions are weakest in industries where marginal abatement costs are lowest. The majority of the latter commission, therefore, advocated a rapid change to a carbon tax system without exemptions. A governmental proposal of April 1998, to extend the carbon tax to exempted sectors (with compensations) met fierce opposition in parliament, and was eventually watered down, with the new CO2 taxes coming into effect as of January 1999. Parliament decided in this connection to set up a commission to prepare a national system of tradable emission quotas for mainland processing industries, linked to the Kyoto mechanisms, with a report ready by the end of 1999. According to a Ministry of Finance estimate, the introduction of international emission trading may significantly reduce the annual abatement costs of compliance with the Kyoto targets compared to national solutions, to as much as a third (from 0.6 to 0.2 percent of GDP).

C. Environmental Tax Reform in Sweden

The comprehensive tax reform of 1991 signaled a major shift in the emphasis of environmental policies in Sweden, from the previous extensive use of subsidies to achieve environmental objectives, toward the use of taxes as the main economic instrument (Brannlund, 1999). The 1991 reform was in part based on the work of a Commission on Environmental Charges set up as early as in 1988. The overall reform was based on a significant reduction in income taxes, largely offset by a series of new ecotaxes, especially on carbon, sulfur, and nitrogen oxides by a restructuring of energy taxation and by a broadening of the VAT base. The net effect was a 6 percent redistribution of GDP, including about 1 percent related to ecotaxes. A key element in the green tax reform was the introduction as of January 1, 1991 of a CO2 tax on oil, coal, and natural gas. Following a second round of reform in 1993, the manufacturing sector pays only 25 percent of the tax for reasons of competitiveness. The initial intention (but later abolished) was to stabilize CO2 emissions at the 1988 level. It was estimated that environmental and environmentally related taxes in Sweden in 1996 yielded about 3.2 percent of GDP or 6 percent of total tax revenues.

In the spring of 1995, a new commission, the Green Tax Commission, was established to analyze the scope for using taxation to improve environmental quality and at the same time— as a second dividend—achieve a more efficient resource allocation through a reduction in unemployment. The commission was given a very broad terms of reference, including the effect on the environment, employment, industrial competitiveness, and revenue yields. While no specific reform was suggested, the commission offered some principles to guide future policies including a more proactive effort in international fora to combat global and regional environmental problems, and increased efforts regarding research, including in the EU and Nordic contexts. Recommendations also included increased attention to the equity aspects of ecotaxes and the need in general to avoid earmarking. An important conclusion of the Commission’s work is that increase in green taxes cannot be expected to yield revenues of a level, which could finance substantial reductions in labor taxes. Hence, any revenue gains should be allocated carefully and selectively.

The work of the commission also included useful analysis of key questions, mainly based on general equilibrium (GE) models, such as the existence of a double dividend: the final report points to the fact that recent literature (e.g., Oates, 1995) questions the existence of a double dividend with reference to the fact that the green taxes by themselves are distortionary, and that these distortions may well outweigh the benefits of reducing other distortionary taxes such as taxes on labor. The GE-model simulations undertaken by the commission indicate that a tax reform comprising a 100 percent increase of the CO2 tax and a revenue-neutral reduction of labor taxes is likely to have a negative welfare effect on Swedish households, environmental effects excluded. In other words, there is no double dividend. Other interesting results of the analyses carried out by the commission includes simulations of the distributional consequences of the reform showing that CO2 taxes are somewhat regressive.

The Swedish draft budget for 2000 calls for a number of green-tax increases which in part will fund employment measures, including through job skill training.

D. Environmental Tax Reform in the Netherlands

Introduction of green taxes in the Netherlands dates back to 1988 when a new fuel charge replaced a fragmented system of earmarked levies (Zom, 1999). The fuel charge was transformed in 1992 into a general fuel tax with the financing responsibilities for environmental expenditures at the same time being shifted to the general budget. This marked the start of a more comprehensive tax reform effort based on the introduction of green taxes.

By 1996, five distinct environmental taxes had been introduced (tax on the extraction of ground water, tax on waste disposal, fuel tax, tax on uranium, and the regulatory energy tax) with a total yield corresponding to about 1.8 percent of total taxes in that year, subsequently reaching about 2½ percent in 1998.

While an important objective of the first four taxes was to raise revenue, in addition to their obvious environmental policy motives, the regulatory energy tax was somewhat different. The dual objective of this tax was, first, to provide financial incentives for energy conservation and the reduction of CO2 emissions and, second, to enable an efficiency enhancing restructuring of the tax system from direct taxes, particularly on labor toward environmentally related taxes. A special feature of this tax is a volume ceiling on the use of taxable energy which contributes to focus the tax on small users of energy (households and small commercial establishments) which are often thought to be the most difficult group to reach through other policy instruments (such as permits); simultaneously, the tax avoids the adverse effects on international competitiveness that would follow from taxes on large industrial enterprises. The rate and base of the tax is in line with the 1992 proposal for a European Union directive for a CO2/energy tax, with half of the tax base related to carbon content and the other half to energy content.

These initiatives on the indirect tax side (i.e., consumption taxes) have been supplemented during the 1990s with important reform measures on the direct taxes (i.e., income taxes), primarily through the introduction of tax incentives to promote environmentally friendly investments (free depreciation on environmental investment; tax relief for benefits from green investments; and an energy investment tax credit).

In March 1995, a Green Tax Commission was established in the Netherlands with the purpose of evaluating the practical possibilities for using taxes to improve environmental quality and sustainable economic development. The Commission, which has applied a tax-by-tax approach to its assessment, adopted a list of fairly strict criteria for evaluating potential green tax measures, including: demonstrable environmental benefits; consistency with international law; simplicity of implementation; absence of adverse effects on the economy as a whole; and broad revenue neutrality. In addition, according to the commission, green taxes should not be applied to behavior that should not or cannot be changed to avoid the taxes. Some of the commission’s proposals have already been implemented in practice. The commission’s third and last report dealt with the potential for further greening the Dutch tax system in a long-term perspective, inter alia, by shifting further from direct to indirect taxes.

The Dutch approach to green tax reform is somewhat different in its careful emphasis on “greening” the existing tax system rather than, as the main approach used in most other countries, basing the green tax reforms mainly on the introduction of new types of taxes.

Appendix II. Country Experiences with Tradable Permits Systems

A. The United States Experience

The United States emission-trading program

As an instrument of abatement policy, tradable permits were used for the first time in 1975 by the Environmental Protection Agency (EPA) through its Offset Program for air pollutants. Interestingly, the program arose from an attempt to implement strict emission regulations,. which in many areas could not be met within the timetable or could be met only at substantial opportunity cost in terms of forgone economic growth. By 1975, it had become clear that a number of regions, designated as “nonattainment” regions by the Clean Air Act, would fail to attain the ambient air quality standards by the deadlines mandated in the Act. The Offset program was an attempt by EPA to improve air quality while fostering economic growth as well. The program worked as follows. New firms were allowed to enter nonattainment regions provided that they acquired sufficient emission-reduction credits (representing excess reduction) from other facilities in the region so that total regional emissions would be lower after entry than before. This was accomplished by requiring new sources to secure credits for 120 percent of the emissions they would add, the extra 20 percent being retired as an improvement in air quality.

The program evolved over a number of years and eventually led to the 1986 Emissions Trading Policy Statement, which covers several pollutants such as carbon monoxide, sulfur dioxide, particulates, volatile organic compounds (VOCs) and nitrogen oxides. The program is characterized by several elements. The geographic “netting” or “bubble” element allows trade of emission reductions among different sources within a firm, as long as the combined emissions under the bubble are within the allowable limit. The “offset” element allows firms to trade emission credits between existing and new sources as long as the new emissions are more than offset by a reduction from existing sources. Finally, the “banking” element allows firms to accumulate and store emission-reduction credits for future use or sale. Overall, the program is assessed as successful both in terms of environmental effectiveness and economic efficiency, despite certain weaknesses, which have limited participation and interfirm trading.

The lead-in-gasoline program

Following the path set by the offset program, the government began applying the tradable permits approach more widely. One prominent use involved facilitating the regulatory process for getting lead out of gasoline. Under this program set up in 1982, a fixed number of lead rights (authorizing the use of a fixed amount of lead over the transition period) were allocated to the various refiners. Refiners who did not need their full share of authorized rights (due to early compliance) could sell their rights to other refiners. Refiners had an incentive to eliminate the lead quickly because early reductions freed up rights for sale. Acquiring these credits made it possible for other refiners to comply with the deadline. Designed purely as a means of facilitating the transition to this new regime, the lead-banking program ended as scheduled on December 31, 1987. Two features of the program are noteworthy. First, it resulted in a much easier phaseout of lead than would have traditionally be possible because of the interrefinery flexibility that it offered (Tietenberg, 1998). Second, the program was designed to eliminate a pollutant not merely to place an upper limit on its annual use. In that respect, the program was rather unique.

Trading of permits for water pollution control

Tradable permits programs have also been used in the United States to control water pollution. The two most notable cases are: (1) the Wisconsin Fox River water permits for point pollution sources; and (2) the Colorado Dillon Reservoir water permits for nonpoint pollution sources. In 1981, the State of Wisconsin issued discharge permits to 14 paper mills and 4 waste water treatment plants discharging effluents into the Fox River. The permits were issued only for reduction in BOD discharges exceeding the levels required by treatment standards. Trading was allowed to give firms more flexibility in controlling and treating their effluents. Despite estimates of potential cost savings of up to US$7 million per year, only one trade has taken place (Smith and Vos, 1997) under the program. The reason most frequently cited to explain this lack of trade is the oligopolistic structure of the pulp and paper industry and the regulated public utility status of the wastewater treatment plant which limited competition (Panayotou, 1998).

Under the permits trading program between point and nonpoint pollution sources at the Dillon Reservoir in Colorado, point sources are allowed to treat their effluents at less than required (drinking water) standards in exchange for treatment of nonpoint pollution sources. In this case, the point sources are publicly owned sewage treatment plants, and the nonpoint sources are agricultural, recreational, and urban activities. The fact that trading in this system is between the waste treatment facilities and the water authorities implies low transactions costs and hence easier implementation. Despite some estimates of cost savings of approximately US$1 million a year (Hahn and Stavins, 1991), only one point/nonpoint source trade and a few nonpoint source trades have taken place since the program’s inception in 1984. Hahn and Hester (1990) attribute this dearth of trades to the requirement of prior government approval.

The SO2 allowance program

More recently, EPA has employed a tradable permits system to control acid rain. Under the program, SO2 allowances have been allocated freely to existing sources based on baseline fuel use and a specified emission rate; the number of allowances will then be restricted to two phases to assure reduction of 10 million tons in emissions from 1980 levels by the year 2010. To comply with the program, each existing firm must hold allowances equal or greater than their emissions during the year. Allowances can be traded within and between utilities as well as banked for future use. Firms found to produce excess emissions pay a penalty of $2,000 per ton and are required to offset their excess the following year. Except for monitoring compliance, EPA’s involvement in the program was minimal. For this reason, it is said to have worked better than earlier programs. Other reasons often attributed to the program’s success are the existence of monitoring technologies for SO2 and the mandatory requirements for firms to install continuous emission monitors. The first phase of emissions reduction was achieved in 1995 and applied only to the most emission-intensive generative units. Under Phase II of the program (to begin in year 2000), all fossil fuel power plants will be included. So far, the program seems to have worked very well, achieving and exceeding the targeted emission reductions. More than four million tons of allowances were transferred in 1996 between independent plants (Panayotou, 1998).

The post-Montreal CFCs trading system

Through the Montreal Protocol which 24 nations signed in September, 1988, and, later on, the London Conference which 59 nations signed in July 1990, signatory nations agreed to restrict their production and consumption of the chief gases responsible for the depletion of the ozone layer in order to eventually achieve a complete phase out of these gases between the years 2000 and 2005. To implement its responsibilities under the protocols, the United States has chosen to use a transferable permits system. In August 1988, the EPA issued regulations implementing a tradable permits system to achieve the targeted reductions. According to these initial regulations, all major U.S. producers and consumers of the controlled substances were allocated baseline production and consumption allowances using 1986 levels as the basis for proration. Each producer and consumer is allowed 100 percent of this baseline allowance initially, with smaller allowances being granted after predefined deadlines. These allowances are transferable within producer and consumer categories and allowances can be transferred across international borders among signatory nations if the transactions are approved by EPA and results in the appropriate adjustments in the buyer or seller allowances in their respective countries22. Production allowances can be augmented by demonstrating the safe reduction of an equivalent amount of controlled substances by approved means. Some interpollutant trading is even possible within categories of pollutants. All information on trades is confidential, so it is difficult to know how effective this program has been. One estimate suggests that as of September 1993, the traded amount was roughly 10 percent of total permits (Hahn and Stavins, 1991). It was also suggested that by allocating allowances to the major domestic producers of CFCs and halons, EPA created sizable windfall profits (estimated to be in the billions of dollars) for those producers (see Tietenberg, 1998). These windfall profits were then taxed away by the United States Congress.

States’ initiatives

While all of the above programs were initiated and promoted by the federal government, the newest programs have arisen from state initiatives. One of the most ambitious of these programs is California’s RECLAIM program of the South Coast Air Quality Management District of Southern California. This program was initiated in 1992 and covers trading in SO2 and N0X. Tradable permits were issued to 2,700 large polluters in proportion to the pollution emissions they would produce in 1992 at full production capacity. The number of permits issued annually will be reduced 8 percent annually for NOx and 6 percent annually for NOX until the entire region is in full compliance with federal ambient standards. Trading is allowed and encouraged. Several brokerage firms are involved in making markets. The district has estimated savings of at least US$270 million per year over previous programs (Howe, 1994).

Another example is the Ozone Transportation Commission (OTC) initiative to control NOx emissions. In 1994, a group of North-Eastern states participating as members of the OTC, committed themselves to achieving region-wide NOx emission-reduction targets by 1999 and 2003 through a tradable permits system. The NOx budget program is a “cap-and-trade” program that allows large emitters of NO* emissions to trade allowances to meet the emission targets in a cost-effective manner. Since the multistate committees that negotiated the agreements had no statutory authority, a model rule was developed to serve as a template for state laws that must be enacted for each state to participate. Elements covered by the model rule include: program applicability, control period, emission limitations, emission monitoring, record keeping, and electronic reporting equipment. Each state has now the responsibility for developing and adapting state rules that are consistent with the model rule, and a number of states have already done so. The first phase of the program was due to start in May 1999 with an initial cap of 219,000 tons per year per region. This cap will remain in place until 2003, the start of the second phase, when the cap will be reduced to 143,000 tons. The United States experience with tradable permits has stimulated interest in many countries. Yet, there has been rather limited experimentation in other countries either developed or developing, although serious considerations to this effect are being made.

B. Experience in Other Developed Countries

The European experience

The major EU countries have long made extensive use of an array of pollution taxes (as described in the previous section) but have rarely used tradable-permits schemes. The few applications that do exist are briefly mentioned below. In Germany, the air pollution legislation allows the transfer of emission-reduction obligations (offset) but this possibility is reported to have been used in less than 2 percent of the cases (OECD, 1997a). In the Netherlands, power plant bubbles are allowed under an agreement signed between the 12 provinces and the Association of Electric Producers in 1990. In the United Kingdom, provisions for intrafirm bubbles for power plants have been introduced in 1996. While provisions have been introduced for pollution trading in these countries, OECD (1997a) argues that the systems have been applied on a very limited scale.

The Australian and New Zealand case

Tradable permits have been used on a somewhat greater scale in Australia and New Zealand. In Australia, the Murray-Darlin Basin Commission’s program for salinity abatement of agricultural land and river system, began on January 1, 1988, as the “Salinity and Drainage Strategy.” The strategy requires the state governments to desalinate the river Murray so as to reduce salinity by approximately 113 electric currents (EC)23 by 2015. As a reward for such reductions, each state government receives salinity credits and may then choose to allow persons to resalinate the river, by selling or issuing their credits. It is estimated that after credits have been issued, river salinity would improve by approximately 78 EC (Australian Bureau of Industry Economics, 1992).

Tradable permits systems have also been used both in Australia and New Zealand in a slightly different context, namely, fisheries management.24 Tradable permits (referred to, in the context of fisheries management, as individual transferable quota or ITQ) provide individuals with rights to harvest up to a given quota of the fish stock. The sum of all the quotas is the Total Allowable Catch (TAC) which is also the maximum yield consistent with the survival of the species. These permits are tradable between vessels. They are denominated in tons of catch per fishing year (of the specified fishing stock). Numerous ITQ systems have been used in Australia and abroad. One of the most notable ones, the tripartite (Australia, New Zealand, and Japan) Southern Bluefin Tuna (SBT), failed from two main reasons allegedly: (1) authorities consistently failed to measure the true size of the population stock; and (2) population growth was volatile and unpredictable, thereby placing the stock at risk of over harvesting. A much wider application of tradable quotas is New Zealand’s Quota Management Scheme (QMS). Concern has been raised with regard to its operations because of an apparent failure to reach an adequately stable and unique price for quotas. It was argued that trades had not been active enough to generate sufficient observations for reliable analysis (Australian Bureau of Industry Economics, 1992). Despite this problem, many believe that to this day New Zealand has been the most effective country in imposing this type of system (Panayotou, 1998).

Experience in developing countries

As yet, there has been no survey of the use of MBIs in developing countries comparable to those done for OECD countries. Only two major instances of operational tradable permits were reported in the still limited reviews of the literature on environmental policy in developing countries (O’Connor, 1998, OECD, 1997a, and Panayotou, 1998): in Chile and in Singapore.

Chile’s 20-year experience with tradable water rights

Under Chile’s water policy, individuals are granted freely tradable water use rights which are defined for a fixed quantity per unit of time and are awarded following application by a potential user. A water right is granted provided that it does not impair existing rights and that the ecological requirement of minimum flow has not yet been reached by previous allocations. These rights are granted free of charge and recorded in a national register, the granting authority reserving the rights to restrict water consumption in time of shortage. While owners of consumptive rights (e.g., irrigation mainly) have no specified obligation with regard to quality and quantity of return flows, owners of nonconsumptive rights (e.g., hydropower and recreation) are required to return the same quantity and quality of water. Water rights are freely tradable and the market for water rights is reported to be quite active (Panayotou, 1998).

Singapore’s experience

Singapore’s CFC permits auction scheme began in the late 1980s, after the ratification of the Montreal protocol. Each quarter the national consumption quota was allocated among importers and users, half on the basis of historic consumption (grandfathering) and half through auction. Importers and users were required to register to participate in the bidding process, with each firm specifying the amount of its demand and its bid price. Bids were ranked by price, with the lowest winning bid price (the one just exhausting the stock) serving as the unit permits price. That price was then charged on the full national allotment. Initially, there was a steep increase in permits price, providing users with incentives to adopt conservation measures, substitutes, and alternative technologies. As a result, CFC demand fell sharply. Since the decline in demand depressed the price, the government accelerated the phase-out schedule in an effort to support the price and maintain the incentive for continued demand reductions.

Singapore has also devised a vehicle ownership quota system designed to limit the growth in supply of private automobiles. The Vehicle Quota System (VQS) was introduced in May 1990, following essentially the same principles as the CFC quota system. Under VQS, anyone wishing to own a vehicle (except for buses and emergency vehicles) must have a certificate of entitlement (COE). Those vehicles already registered at the inception of the system were assumed to have a COE (another instance of grandfathering), while anyone wanting to buy a new one is required to bid for a COE in monthly tendered exercises. Each bidder must indicate the amount he or she is willing to pay for the right to own a vehicle in a particular category. Bids are ranked from highest to lowest; each successful bidder pays a COE price equal to the lowest successful bid price. The COE is valid for ten years from the date of registration of the vehicle, after which the COE must be renewed at the prevailing price defined as the 12-month moving average price of the COE in that vehicle category. By mid-1992, the COE price for a standard car had risen by more than 60 percent and represented about one-quarter of the total sale price (Panayotou, 1998).

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1

The authors are staff members of the IMF’s Fiscal Affairs Department. They would like to thank Liam Ebrill, Angelo Faria, and Harald Hirschhofer for useful comments.

2

The Protocol implicitly recognizes that developing countries may need additional time to meet the requirements of the agreement, taking into account potential technical and economic constraints.

3

For example, the limit agreed to by the United States implies a reduction by about one-third compared to the estimated level of CO2 emissions at the end of the next decade in the absence of such measures.

4

Tietenberg (1985), in a review of several studies, found that the potential magnitudes of these cost savings range from 50 to 90 percent. More recent studies by O’Ryan (1996) and Klaassen (1996) show quite similar results.

5

In this case, there are two sources of market failure that need to be addressed, namely, pollution externalities and market power characterized by a level of output that is less than optimal. Any instruments to correct for the environmental externality will encourage firms to reduce emissions. And to the extent that emission reductions are accompanied by reductions in output, the second type of market failure (e.g., suboptimal output levels) will be exacerbated and hence some welfare losses will occur. This risk is reduced when emissions reductions can be achieved through other means (end-of-pipe treatment, and the like).

6

This sum collapses to the familiar Pigouvian tax if the industry is competitive, and it will equal zero if, as Buchanan suggests, the two effects cancel each other.

7

In the case of an oligopoly for instance (see Ebert, 1992), the derivation of the second best fee would depend on the behavioral assumptions about the firms, but would essentially incorporate the same trade-off between the concerns of market power and excessive pollution.

8

This approach seems particularly warranted when inputs and/or outputs are assumed to be closely correlated with emissions.

9

At a conceptual level, a system of marketable permits for input is conceivable (See Helfand, 1999). However, in practice such systems have never been used since it is extremely difficult to determine the levels of aggregate inputs use necessary to achieve a specified level of total emissions. Developing a system of marketable permits in input markets, then, will not clearly achieve a specified pollution level without a great deal of information on the part of the regulator.

10

In most permit systems implemented to this date, permits were distributed free of charge and hence did not generate revenue for the government (this will be discussed in greater detail in the next section).

11

As will be discussed in the next section, one of the main obstacles to implementing new environmental taxes is the possible loss of international competitiveness, as illustrated by the EU example.

12

To address this problem, the OECD in cooperation with other institutions is working on a statistical framework, which in time will provide a clearer picture of the level and structure of environmental taxation in developed countries. In the same context, the OECD has also established a comprehensive database with information on environmentally related taxes in its member countries (OECD, 1999a).

13

In practice, the concept of a true Pigouvian tax set optimally such that it equals the marginal damages of emissions is rarely applicable, given that regulators are unlikely to have the information needed to set such a tax (see Section II).

14

In September 1999, for example, the Environment Committee of the European Parliament passed a draft resolution on climate change containing a harmonized ecotax plan in which the 15 EU countries can opt in or out.

15

The Protocol will not enter into force until ratified by countries accounting for at least 55 percent of so-called Annex 1 emissions, and by at least 55 countries. Eight countries have ratified so far, but none of the Annex 1 countries. The institutions and procedures for monitoring and reporting of noncompliance are yet to be established.

16

Developing countries are not subjected to binding targets under the Protocol, and only a few of these countries have voluntarily adopted emission targets similar to those of the developed countries.

17

The costs are also estimated to increase over time, and will reach 1½ percent of GDP in 2050 if emissions are to be maintained at the level embodied in the Protocol.

18

“Effective” rates of taxation could be measured as the ratio between actual green tax yield collected and the potential tax base (that is, including what is currently exempt). Data deficiencies have prevented the calculation of effective rates.

19

These lessons are drawn for the most part from the proceedings of an OECD workshop held in Paris in September 1998, on the theme: “Domestic Tradable Permit Systems for Environmental Protection: Issues and Challenges.”

20

Hot spots are very high concentrations of pollution in particular locations; tradable permits could contribute to the formation of such hot spots if they allowed more clustering of emissions in vulnerable areas.

21

In some instances, the combined emissions from small emitters may turn out to be more significant than those of the larger emitters.

22

Very few cases of such international trades have been reported to this date.

23

Electric currents are a standard measure of salinity and are used in calculating the number of salinity credits available for trade.

24

Other countries such as Canada, Iceland, the Netherlands, and the United States have experimented with such programs, but on a much smaller scale.