Environment Taxation for

Australia
John Freebairn
Melbourne Institute-Treasury
Conference
Melbourne, June 2009
 Context for Discussion
• Taxes to correct market failures associated with
– Pollution external costs
– Over-use of common pool resources
– Under-supply of public good amenity
• Critique of current tax system
– Concessions in income and consumption taxes
– Selective expenditure taxes (petroleum excise, motor
vehicles, stamp duties)
– Special taxes on natural resource rents
 Evaluation Criteria for
Environmental Taxes
• Efficiency
– Correct market failure
– Spill-over effects on other tax distortions
• Simplicity and costs, or choice of tax base
– Market failure means no market for direct measure vs the option
of an imperfectly correlated measurable inputs and outputs
• Equity and redistribution
– Focus on economic not initial incidence
– Importance of current position as the base case
– Important in instrument comparison and choice
• Net revenue
– Largely a small by-product
 Pollution External Cost Correction
• Examples include
– Atmosphere: GHG emissions, smog
– Water: sewage disposal, salination
– Land: toxic wastes disposal, loss of amenity
– Noise and amenity
• Tax as a polluter pays market failure
correction
• Tax as only one of many corrective
instruments
 Partial Equilibrium Model of Pollution

Price or cost
per unit of
pollution MAC MEC

T a

0
Q* Qb
Quantity of pollution

Market allocation: pollution has zero private cost; quantity Qb

Society efficient allocation: reduce quantity to Q*; pollution tax at

T = MEC; efficiency gain of ‘a’; costs of pollution-intensive products
rise; government revenue gain for tax and auctioned quotas
 Common Pool Resources
(missing market for resource stock)
• Examples
– Over exploitation of fisheries, underground
water
– Over use or congestion of transport
infrastructure
• Tax as a solution
– Efficient if T = MEC
– Beginning with market as status quo, involves
a large transfer from private resource
owners/users to government
 Common Pool Resource

MC = MSC
Price or cost
per unit
AC = MPB

P* a

Pb
P* - T

MPB = MSB

Q* Qb
Quantity of fish or cars travelling
Market solution: quantity Qb; perceived private cost at Pb

Social optimum: quantity at Q*; efficiency gain of area ‘a’. Tax of T would
push private cost up to P*, but by < T
Challenges with Congestion Market
Failure Correction
• Required first-best measures of congestion
involves tagging vehicles by location and time.
Low cost technology on horizon.
• More readily measured associated inputs, eg
fuel or vehicle, are not highly correlated with
congestion.
• City cordons and pricing as an in-between
option
• Possible strategy: rather than introduce second
best measures soon, wait for measurement
technology and then a one-off large investment
for a close to first best measure of congestion.
 Public Goods
• Examples of resources with alternative public and private
good uses
– Water for environment vs irrigation and households
– Land for nature preservation vs agriculture and forestry
• Required reallocation of resource to public good uses to
correct market failure will result in a higher price for the
reduced quantity of private good uses
• Tax will do the job, but it redistributes the scarcity rent to
government and away from organised pressure groups
• Other instruments, eg grandfather quotas, government
purchases, have different redistributions favoured by
private interest groups
 Related Fiscal Policy Issues, and
Double Dividend
• Environment taxes effectively are an increase in
indirect taxes. Mostly, they are passed on as
higher consumer prices
– Higher cost of living aggravates existing Y, GST and
payroll tax distortions to labour market, and/or
employees push for compensating wage increases
– Unless, revenue gain returned as compensating
income tax reductions
– Requires a package not unlike 2000 tax reform
package involving some GST for Y tax mix change
• No double dividend here
Other Fiscal Policy Related Issues
• The environmental tax internalises a social
opportunity cost. So,
– A legitimate cost of production income tax deduction.
– Include in base for applying GST as part of social
cost.
• Where the tax alone corrects market failure,
there is no need for hypothecated environmental
expenditure.
– Possible exception where tax and expenditure are
part of a second-best package, including a tax levied
on upstream or downstream inputs and outputs
because of measurement costs of the direct market
failure.
 Current Income Tax Distortions to
Environment Decisions
• Tax expenditures subsidising private
transport
– Fringe benefits concessions
– Accelerated depreciation
• Tax expenditures for primary production
– Agriculture
– Forestry
 Current Ad Hoc Taxes on
Petroleum Products and Motor
Vehicles
• Largely an historical collection of easy revenue
raisers with many concessions not justified for
efficiency, equity or simplicity reasons
• An opportunity to reconsider from first principles
the tax base and tax rates in terms of specifically
designed
– user pays fee for government provided road services
– pollution tax or taxes
– congestion tax
 Stamp Duties
• Turnover tax, over and above the GST, on
selected asset transfers, including
– Business and residential property
– Motor vehicles
• Results in distortions to the efficient allocation of
the assets between different uses, including
some adverse effects on the environment
• Can be replaced with less distorting taxes,
including
– Augmented land tax for property
– Higher annual registration fee for vehicles
Taxation of Natural Resource Rents
• Rents arise from variable quality of deposits and
differences in unit production costs
• Most States impose a royalty, either fixed or ad valorem
– Shifts supply curve upwards
– With efficiency loss of too little production
• A replacement profit based resource rent tax would
– Avoid the production inefficiency loss
– Collect as much, or more, revenue as royalties
– Example of commonwealth petroleum resource rent tax
• Consider extension to other natural resources, such as
water, forests, fisheries, to capture some of the projected
increase in scarcity rents.
 Natural Resource With Variable Quality
Price and S’ = S + R
unit cost
S
Pw D
a c
b

Q’ Q*
Quantity

Current royalty system with royalty at rate R: output of Q’; government

revenue of ‘b’; investor rent ‘a’.

Alternative resource rent tax of share of ‘a + b + c’: output of Q*;

comparable or more government revenue and investor rent; efficiency
gain of ‘c’.
 Conclusion
• Issues of the taxation of natural resources and
the environment have not been on the reform
agenda for a long time.
• There are opportunities to do better by
considering:
– Removing distortions in existing taxes influencing
decisions about the use of the environment (and
elsewhere); and,
– Using a special environment tax as one of the
available instruments to correct current market
failures in environment decisions.