13.2.1.2 Taxes and charges

An emission tax on GHG emissions requires individual emitters to pay a fee, charge or tax^[6] for every tonne of GHG released into the atmosphere.^[7] An emitter must pay this per-unit tax or fee regardless of how much emission reduction is being undertaken.^[8] Each emitter weighs the cost of emissions control against the cost of emitting and paying the tax; the end result is that polluters undertake to implement those emission reductions that are cheaper than paying the tax, but they do not implement those that are more expensive, (IPCC, 1996, Section 11.5.1; IPCC, 2001, Section 6.2.2.2; Kolstad, 2000). Since every emitter faces a uniform tax on emissions per tonne of GHG (if energy, equipment and product markets are perfectly competitive), emitters will undertake the least expensive reductions throughout the economy, thereby equalizing the marginal cost of abatement (a condition for cost-effectiveness). Taxes and charges are commonly levelled on commodities that are closely related to emissions, such as energy or road use.

An emissions tax provides some assurance in terms of the marginal cost of pollution control, but it does not ensure a particular level of emissions. Therefore, it may be necessary to adjust the tax level to meet an internationally agreed emissions commitment (depending on the structure of the international agreement). Over time, an emissions tax needs to be adjusted for changes in external circumstances, such as inflation, technological progress and new emissions sources (Tietenberg, 2000). Fixed emissions charges in the transition economies of Eastern Europe, for example, have been significantly eroded by the high inflation of the past decade (Bluffstone and Larson, 1997). Innovation and invention generally have the opposite effect by reducing the cost of emissions reductions and increasing the level of reductions implemented. If the tax is intended to achieve a given overall emissions limit, the tax rate will need to be increased to offset the impact of new sources (Tietenberg, 2000).

Most environmentally related taxes with implications for GHG emissions in OECD countries are levied on energy products (150 taxes) and on motor vehicles (125 taxes), rather than on CO₂ emission directly. There is also a significant number of waste-related taxes in OECD countries (about 50 taxes in all), levied either on particular products that can cause particular problems for waste management (about 35 taxes) or on various forms of final waste disposal, including those on incineration and/or land-filling (15 taxes in all). A very significant share of all the revenues from environmentally related taxes originates from taxes on motor fuels. Such taxes were introduced in all member countries many decades ago – primarily as a means to raise revenue. Irregardless of the underlying reasoning for their implementation, however, they do impact on the prices (potential) car users are confronted with and thus have important environmental impacts.

However, there is some experience with the direct taxation of CO₂ emissions. The Nordic Council of Ministers (2002) notes that CO₂ emissions in Denmark decreased by 6% during the period 1988–1997 while the economy grew by 20%, but that they also decreased by 5% in a single year – between 1996 and 1997 – when the tax rate was raised. Bruvoll and Larsen (2004) analysed the specific effect of carbon taxes in Norway. Although total emissions did increase, these researchers found a significant reduction in emissions per unit of GDP over the period due to reduced energy intensity, changes in the energy mix and reduced process emissions. The overall effect of the carbon tax was, however, modest, which may be explained by the extensive tax exemptions and relatively inelastic demand in those sectors in which the tax was actually implemented. Cambridge Econometrics (2005) analysed the impacts of the Climate Change Levy in the UK and found that total CO₂ emissions were reduced by 3.1 MtC – or 2.0% – in 2002 and by 3.6 MtC in 2003 compared to the reference case. The reduction is estimated to grow to 3.7 MtC – or 2.3% – in 2010.

To implement a domestic emissions tax, governments must consider a number of issues, such as the level at which the tax should be set, particularly in the case of pre-existing taxes (e.g. taxes which already exist on energy), or other potential distortions (e.g. subsidies to certain industries or fuels). Consideration must also be given to how the tax is used, with such options as whether it goes directly into general government coffers, is used to offset other taxes (i.e. the double-dividend effect), is transferred across national boundaries to an international body, is earmarked for specific abatement projects, such as renewable energy, or is allocated to those most adversely impacted by either the costs of emission reduction or damage from climate change. Another important issue is the point at which the tax is should be levied. A tax on gasoline may be levied at the pump and collected directly from consumers or it may be levied on wholesale gasoline production and collected from oil companies. In either case, the final consumer ultimately pays most of this cost, but the administrative and monitoring costs may differ dramatically in the two cases.

Emission taxes do well in both cost effectiveness and environmental effectiveness. The real obstacles facing the use of emission taxes and charges are distributional and, in some countries, institutional. At the best of times, new taxes are not politically popular. Furthermore, emissions or energy taxes often fall disproportionately on lower income classes, thereby creating negative distributional consequences. In developing countries, institutions may be insufficiently developed for the collection of emission fees from a wide variety of dispersed sources. In many countries, state enterprises play a significant role; such public or quasi-private entities may not respond adequately to the incentive effects of a tax or charge.