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The Two Sides of Green: Money and the Environment

Can taxes on environmentally harmful activities actually promote economic growth prospects?

May 10, 2006

Can taxes on environmentally harmful activities actually promote economic growth prospects?

The purpose of this tax shifting, as it is practiced in Europe, is to incorporate the environmental costs of products and services into the market price — and to help the market tell the environment truth. This rewards environmentally responsible behavior such as reducing energy use.

Among the various environmentally damaging activities taxed in Europe are coal burning, gasoline use, the generation of garbage (so-called landfill taxes), the discharge of toxic waste and the excessive number of cars entering cities.

Germany and Sweden are the leaders among the countries in Western Europe that are shifting taxes in a process known there as environmental tax reform. A four-year plan adopted in Germany in 1999 systematically shifted taxes from labor to energy.

By 2001, this plan had lowered fuel use by 5%. It had also accelerated growth in the renewable energy sector, creating some 45,400 jobs by 2003 in the wind industry alone. That number is projected to rise to 103,000 by 2010.

In 2001, Sweden launched a bold 10-year environmental tax shift designed to convert 30 billion kroner ($3.9 billion) of taxes from income to environmentally destructive activities. Much of this shift of $1,100 per household is levied on cars and trucks, including substantial hikes in vehicle and fuel taxes.

Electricity is also being taxed more heavily. This tax restructuring is an integral part of Sweden’s plan to be oil free by 2025. Among the other European countries with strong tax reform efforts are Spain, Italy, Norway, the United Kingdom and France.

There are isolated cases of using taxes to discourage environmentally destructive activities elsewhere. The United States imposed a stiff tax on chlorofluorocarbons to phase them out in accordance with the Montreal Protocol of 1987 and its subsequent updates.

When Victoria, the capital of British Columbia, adopted a trash tax of $1.20 per bag of garbage, the city reduced its daily trash flow 18% within one year.

Cities that are being suffocated by cars are using stiff entrance taxes to reduce congestion. First adopted by Singapore some two decades ago, this tax was later introduced by Oslo, Melbourne and most recently London.

The London tax of £5 — or nearly $9 per visit — first enacted in February 2002 by Mayor Ken Livingstone, was raised to £8, more than $14, in July 2005. The resulting revenue is being used to improve the bus network, which carries 2 million passengers daily.

The goal of this congestion tax is a restructuring of the London transport system to increase mobility and decrease congestion, air pollution, and carbon emissions. While some cities are taxing cars that enter the central city, others are simply imposing a tax on automobile ownership.

New York Times reporter Howard French writes that Shanghai, which is approaching traffic gridlock, “has raised the fees for car registrations every year since 2000, doubling over that time to about $4,600 per vehicle — more than twice the city’s per capita income.” In Denmark, the steep tax on an energy-inefficient new car doubles the price of the car.

An excellent model for calculating indirect costs is a 2001 analysis by the U.S Centers for Disease Control and Prevention (CDC), which calculated the social costs of smoking cigarettes at $7.18 per pack.

This not only justifies raising taxes on cigarettes, which claim 4.9 million lives per year worldwide (more than all other air pollutants combined), but it also provides guidelines for how much to raise them. In 2002, 21 U.S. states raised cigarette taxes. Perhaps the biggest jump came in New York City, where smokers paid an additional 39 cents in state tax and $1.42 in city tax — a total increase of $1.81 per pack.

If the cost to society of smoking a pack of cigarettes is $7.18, how much is the cost to society of burning a gallon of gasoline? Fortunately, the International Center for Technology Assessment has done a detailed analysis, entitled “The Real Price of Gasoline.”

The group calculates several indirect costs, including oil industry tax breaks, oil supply protection costs, oil industry subsidies and health care costs of treating auto exhaust-related respiratory illnesses. The total of these indirect costs centers around $9 per gallon, somewhat higher than those of smoking a pack of cigarettes.

Add these external costs to the average price of gasoline in the United States — just over $2 per gallon in 2005 — and gas would cost $11 a gallon. For Americans, this is shockingly high. But it is not that much higher than the $7 per gallon that Dutch motorists paid briefly in late 2005 — or the $6 per gallon that British, German, French and Italian drivers now regularly pay for gasoline.

Asia’s two leading economies — Japan and China — are now considering the adoption of carbon taxes. For the last few years, many members of the Japanese Diet have wanted to launch an environmental tax shift, but industry has opposed it. China is working on an environmental tax restructuring that will discourage fossil fuel use.

According to Wang Fengchun, an official with the National People’s Congress, “Taxation is the most powerful tool available in a market economy in directing a consumer’s buying habits. It is superior to government regulations.”

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. Reducing the air pollution from smokestacks and tailpipes reduces the incidence of respiratory illnesses, such as asthma and emphysema — and thus overall health care costs.

Some 2,500 economists, including eight Nobel Prize winners in economics, have endorsed the concept of tax shifts. Harvard economics professor N. Gregory Mankiw wrote in Fortune: “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.”

Accounting systems that do not tell the truth can be costly. Faulty corporate accounting systems that leave costs off the books have driven some of the world’s largest corporations into bankruptcy.

The risk with our faulty global economic accounting system is that it so distorts the economy that it could one day lead to economic decline and collapse. If we can get the market to tell the truth, then the world can avoid being blindsided by faulty accounting systems that lead to bankruptcy.