V. Moving Forward - Next Steps on Smart Regulation

A. Lessons Learned and Longer Term Challenges

This paper has reviewed both the challenges facing environmental policy-makers and regulators in Canada, as well as the important progress made to date in improving regulatory instruments and processes. Several themes emerge that are worth highlighting.

First, we must continue to expand the toolbox, thereby improving and expanding the policies instruments available to us, particularly with respect to the use of market-based instruments. We need to continue this effort, given the increased pressures confronting regulators.

Second, increased policy complexity demands greater horizontal management of policy issues, and effective co-ordination and co-operation. This applies to the activities of different government departments, different jurisdictions within Canada, and our links to the international community. Once again, our experience shows that Canada has been a leader in this area, but we need to do more. The convergence analysis and framework of the next sections outlines several important strategies to pursue, but this will continue to be an area requiring ongoing innovation and improvement.

Third, we face increasing demands and finite resources. Our science and regulatory capacity needs to be strengthened and managed more efectively. There are new substances, technologies and processes that will need to be assessed and managed with respect to their environmental impacts.

This paper does not provide a comprehensive analysis of all the approaches and instruments to improve environmental regulations. Instead, it identifies three areas of opportunity where we would like to push the envelope with selected exploratory initiatives. These will provide learning opportunities for Environment Canada and our partners in government and the private sector, and can lead to broader regulatory improvements in the longer term.

B. Areas of Opportunity

1. Economic Instruments

In recent years, Environment Canada has been intensifying its efforts to analyse, explore and promote the use of economic instruments and incentives as 'smart', innovative and efficient tools for environmental protection and management. Indeed, this item has been one of the three main elements in the Minister's new approach to environmental protection. We see economic instruments as a key part of our future efforts to improve environmental regulation, providing an important class of tools in our policy toolkit.

There is still a real lack of knowledge about economic instruments. Traditional regulators and the broader public are not familiar with how they work, and need to understand how they can be effective. Some stakeholders still see economic instruments as a "license to pollute". Others are sceptical of the merits of an "additional tax", although in reality, the charge simply reflects some of the real costs of valuable environmental resources. However, many groups and jurisdictions are increasingly enthusiastic about the use of economic instruments in environmental protection.

a) Economic instruments - How and Why

Unlike command and control regulation, economic instruments create direct price (or cost) signals for producers and consumers; prices that reflect scarce environmental resources and the costs of pollution. These prices help decision-makers to recognise the environmental implications of their choices. The power of the market to determine an efficient mix of investment and consumption can then be extended to the environmental aspects of economic activity. Higher relative prices for polluting products and activities affect both consumers' decisions, as well as creating incentives for industry to treat, reduce or eliminate pollution. In some circumstances, economic instruments can be more cost-effective to traditional regulation, allowing a given level of environmental protection to be achieved at a lower cost. This advantage stems from the flexibility to take into account differences in the relative environmental up costs faced by firms.

Economic instruments can also provide a continuing economic incentive for firms to reduce pollution, thereby stimulating innovation in the development and application of new technologies and processes. Moreover, the ongoing incentives with these instruments in some cases will achieve environmental goals more quickly, and can even encourage firms to surpass established standards or targets. This illustrates that when the economic signals are right, choices that are good for the economy converge with those that improve the environment.

A further advantage of economic instruments is that they can involve lower administration costs for both governments and industries than some more traditional approaches. The U.S. tradable permits program for CFCs took only four staff members to run, versus the 33 the EPA had estimated for an equivalent regulatory program, thereby saving the government and taxpayers considerable expense.

Perhaps one of the most practical reasons to use economic incentives and instruments is that they allow incremental progress. For instance, emission charges can be increased gradually. The goal may not be some abstract goal of fully costing environmental impacts, but rather smoothly adjusting relative price signals. This has been the approach largely taken in Europe.

One of the most innovative market-based approaches is to use fiscal policy to encourage better environmental performance. While this can involve the tax system, these instruments are different from ordinary taxes in one major respect. It is possible to use environmental charges in a manner that does not increase the overall burden on taxpayers - i.e. in a "revenue-neutral" manner.

First, environmental levies can be used to complement other environmental policies, such as "voluntary" programs. For example, in the UK many industries chose to enter into negotiated covenants with the government to reduce GHG emissions, and thus avoided paying a significant portion of the climate change levy.

Second, revenues from environmental charges can be recycled within the affected industries, thereby reducing compliance costs and overall competitiveness impacts. From 1998-2000, Quebec imposed a levy on purchases of the dry- cleaning solvent perchloroethylene (PERC) to create a fund to assist companies to purchase more efficient equipment. In Sweden, a NOx emissions charge was recycled within the affected industries (see side box).

Finally, revenues from environmental taxes (or permit auction fees) can be used to shift the tax burden. Governments can reduce distorting taxes on corporations and labour, thereby promoting investment and job creation, while taxing activities or products that we would like to see diminished, such as air and water pollution.

Several European governments, such as the UK, Denmark, and Germany, have made some initial efforts in environmental tax shifting.

Many international organisations, such as the World Bank, the OECD, IISD, UNEP, and the World Business Council for Sustainable Development, have endorsed greater use of economic instruments, based on a positive assessment of their use around the world. The U.S. EPA currently refers to economic incentives as a key instrument for addressing environmental problems. It reports that at least 40 studies show that economic incentives are more cost- effective than traditional regulations. One EPA study estimates that with widespread use of economic incentives at the federal, state, and local level could reduce environmental expenditures by 25% (US$50M).

b) Economic Instruments - Three Initiatives

(1) Emissions Trading and Climate Change

Canada's Climate Change Plan to reduce greenhouse gasses (GHGs) and meet our Kyoto Protocol obligations includes a major role for emissions trading by large industrial emitters of GHGs. Emissions trading, within a regulatory framework, was included because it is particularly suited to addressing the challenge of GHGs emissions reduction.

Under an emissions trading system, an environmental target is set limiting the maximum release of a pollutant within the relevant jurisdiction(s). The target can require moderate or very significant reductions, depending on the policy goal. Permits to allow this targeted level of releases, and no more, are then created by a governing authority, usually the government that has the authority to control and police the polluters. Firms are then required to have the requisite number of permits corresponding to their level of pollution. A key design feature of any emissions trading system is how to allocate these permits, but once allocated, the system will allow permit holders to buy and sell the permits, i.e. to trade, in a relatively unrestricted manner.

Several factors make emissions trading an attractive instrument. The system is cost-effective and efficient in that those with the lowest costs of reduction will tend to reduce the most, and those facing high costs reduce the least. It also reinforces the polluter-pays principle, in that permit trading will force those who continue to pollute, or increase their emissions, to compensate those who are making the greatest emissions reductions.

The basic theory supporting the use of emissions trading is fairly simple, yet there are many important design issues that need to be properly addressed to achieve the greatest benefits in practice. The final decisions on the form and management of the GHG emissions trading system are now being developed. There are still many complex details to work out, and there will be a need for ongoing .Smart Regulation. to make the system as effective as possible. One conclusion is clear - the very introduction of this major economic instrument represents a significant step forward in the use of smart regulation for environmental protection.

(2) Reducing Sulphur in Fuel Oil

Environment Canada, as well as many other jurisdictions, has been implementing and developing policies and regulations to reduce the sulphur content in various fuels. The burning of fossil fuels which contain sulphur causes environmental and health damage, particularly by contributing to

acid rain and particulate matter in smog. Regulations on sulphur in gasoline have already been put in place, and the regulations on sulphur in diesel recently came into force. However, the management options for sulphur in fuel oils are now being developed.

The National Round Table on the Environment and the Economy (NRTEE) has been examining this issue, and its preliminary work has found that under some circumstances, economic instruments may be lower cost alternatives than regulations. Extending the NRTEE sulphur in heavy fuel oil analysis, Environment Canada is evaluating the feasibility of various management options to reduce sulphur emissions from light and heavy fuel oils, including taxation, tradable permits and traditional regulations

The results of Environment Canada's evaluation will be made available to stakeholders as part of the public consultations on light and heavy fuel oils. The Department also needs to address issues related to instrument design, compliance monitoring and enforcement issues, which would be needed for a more detailed assessment and final recommendation.

The results of preliminary investigations indicate that economic instruments such as taxes and emissions trading (as well as regulations) are feasible instruments for reducing the sulphur in fuel oils, however they all raise some concerns with respect to regional distribution of impacts. Further investigation of economic factors such as elasticities and price of fuel substitutes are needed to determine the relative cost-effectiveness of the different tools. The administrative and transaction costs related to the different instruments need to be assessed, and more background research is needed on the industry structure for the marketing and distribution of fuel oil in Canada.

Environment Canada is thus at an early stage in developing the management options for reducing sulphur in fuel oils in Canada. Whether or not an economic instrument is ultimately part of the package of management instruments chosen, the very fact that they have been given serious consideration represents real progress in our regulatory process.

(3) Toxics Charge

Environment Canada is investigating the possibility of a toxics charge for the management of toxic substances. A differential charge could be assessed against a broad array of substances, where the level of the charge was proportionate to the environmental damage or risk imposed by the substance. A key feature of such a measure is that it could encompass multiple substances - a schedule of charges set according to a categorisation of environmental damage or risk, potentially easing the resources required for substance-by-substance risk management.

Under CEPA 1999, the Minister of the Environment may be expected to declare hundreds of substances as toxic in coming years, due to the need to categorise the entire list of substances currently in use in Canada (the Domestic Substances List). Developing individual management plans for each substance will place an enormous strain on time and resources in Environment Canada. A multiple-substance approach would allow us to manage risk in an effective and efficient way, potentially saving time and resources.

Clearly developing the details of a potential toxics charge will not be a simple, quick task. It will take time, communication and consultations, and more thinking and decisions on design details.

However, a toxics charge has the potential to make a real leap forward in environmental policy and regulation. It could reduce time and administrative burden of individually developing and managing a broad variety of toxic substances, and set prices in the market that will discourage the use of more toxic substances while encouraging substitution of less toxic alternatives. If it is applied to a wide class of substances, it might avoid a real shortcoming of single substance regulation: when measures are taken to reduce one substance, there is no guarantee that firms will not develop, or substitute a more toxic alternative which has yet to be regulated.

Once the analytical work is completed, Environment Canada will assess, in consultation with stakeholders, whether the prospects for a using a toxics charge are promising enough to include as a practical management instrument.

2. Smart Regulation - Administrative and Process Opportunities

Government and business activities depend on good information. Governments require detailed information to develop and implement policies and regulations, for monitoring enforcement, and assessment, and to identify and communicate with stakeholders and regulatees. Yet acquiring timely, accurate, pertinent information can be costly. More information may improve a process, or regulatory instrument, yet we must also consider the time and resources needed to obtain it. In other words, we need to be constantly aware of the administrative and process burdens we impose as part of our regulations and regulatory processes.

We also need to consider who bears the costs of these activities, and whether this allocation is fair and efficient. Government regulations often impose administrative costs on business for information that is of little use to the business, but is desired by the government and the Canadian public. In any circumstances where the costs and the benefits of an activity are borne by different parties, (i.e. costs are externalised), this is cause to look closely at whether the benefits of the activity justify the costs.

Concerns about the overall burden of government regulation, including excessive administrative and process demands, have received significant attention over the last several decades, in Canada and around the world. In response to these pressures, the federal government renewed the federal regulatory process, striving to reduce over-regulation, to increase and improve consultation, and ensure transparency of the process.

a) Reduce Unnecessary Internal Red-Tape

The additional government costs required to provide more checks and balances in the regulatory process will often simply reflect the cost of good governance in a modern democracy. However, there may be cases where the checks and balances have gone too far, and the moderate improvements in the quality of the regulatory results do not justify the additional time and expense.

For instance:

• Should a Regulatory Impact Analysis Statement (RIAS) be required for simply declaring a substance to be toxic under CEPA 1999 Currently this is the case, even though a declaration of toxicity implies no specific action by the government. Further, when the required management plan is developed, a full Regulatory Impact Analysis Statement justifying the intervention (which may be minimal), and considering alternatives, will be prepared.
• How many times is it necessary to go the Special Committee of Council for a given regulatory initiative - is four times necessary or excessive?
• Are we over-consulting on some issues?

As each additional step is added to the internal processes of government, the cost to the taxpayer increases, and the nimbleness of government is further eroded. Smart Regulation should therefore ensure that the government itself is not overburdened with excessive red tape - some check and balances may need to be revisited.

The Deputy Minister's Challenge Team on Law-Making and Governance has already addressed the issue of internal red tape. Their recommendations include a need for Privy Council Office to adopt a more principled, results oriented approach, rather than providing specific directives to departments on regulatory efforts. Several recommendations deal with ways to reduce unnecessary steps and duplication in the regulatory process.

b) Opportunities to Streamline External Regulatory Demands

It is now recognised that governments need to justify the regulatory demands and administrative burdens they impose on industry and society. However, even when the benefits from such demands exceed the costs, there may still be significant room for improvement. Our understanding of business processes, and the developments in information and communications technologies, all create new abilities to streamline information requirements and processes to benefit both the regulated and regulators.

Parallel to the transformation of business processes by technology - so called e-commerce - is a restructuring of government processes and systems. The Government On-Line initiative, and other efforts within and across government, are using technology to improve government services. Environment Canada has used the Internet and other technologies to improve our communications with stakeholders, allow electronic filing of information, and save the department and regulated industries time and money. The CEPA registry on Environment Canada's web site is an excellent example of this.

Information and communications technologies allow us to conduct our business more cheaply and quickly. In the private sector, one of the more profound impacts of the technology is how it is changing the structure of business, allowing firms to be more profitable when they merge in some cases, and divest and outsource activities in others. The boundaries of firms and industries are shifting, and there may be similar opportunities for government. What made sense for government to do with older technology, and in an economy with a different structure, may need to adapt in a new context. We need to revisit basic assumptions on what government does, the level of government should be responsible, and how activities can be restructured, in the light of these transformative technologies.

c) Links to Other Smart Regulation Efforts

The use of a broader set of policies and regulatory instruments can also improve administrative procedures. A voluntary instrument, where appropriate, may replace government enforcement

with a alternative accounting mechanisms such as public reporting. The use of economic instruments may allow industries to integrate more easily the requirements of an environmental goal into standard business practices, thereby reducing the administrative burden for industry and government. In other cases, new instruments may demand additional information and administrative procedures, and these additional costs need to be weighed in deciding upon, and implementing, the regulatory instrument.

The 'single window' approach can apply not only between jurisdictions, but also across different federal departments. Improved interdepartmental co-ordination of government interaction with industry and the public not only helps to reduce administrative costs; it also parallels the demand of sustainable development and Smart Regulation to develop policies and regulations in a more co-ordinated manner. Such approaches, however, may not be appropriate in all circumstances, given privacy concerns and the need for compatibility between systems.

d) Improving the Management of Toxic Substances

Environment Canada has developed several strategies and streamlined processes to improve our management of toxic substances under CEPA 1999. For example, developing a proposed risk management strategy prior to consultations will enable Canadians to better understand and discuss issues and options, contributing to more effective, focused public consultations. When possible, we will address multiple substances with a single tool and use 'model or standard' provisions to improve predictability and streamline regulatory development. We will be focussing our efforts on the highest risk sources of toxic substances. We anticipate that only about half of the toxic substances will need to be managed with a regulation, which allows for greater use of the full range of instruments allowed under CEPA, including more flexible tools such as pollution prevention plans. Where it makes sense, we will also use CEPA to set guidelines and work with provinces to implement them through their permit processes.

e) Administrative and Process Opportunities - Next Steps

Environment Canada continues to look for administrative and process improvements, given the rapid and significant developments in this area. It looks forward to recommendations from the External Advisory Committee on these issues. This is an area that concerns all federal government departments and the Privy Council Office, and Environment Canada will work with them to streamline and improve regulatory activities. This work should build on the work and recommendations flowing from the Deputy Minister's Challenge Team.

3. International Convergence Opportunities

As noted earlier, several international economic and environmental trends linked to globalisation pose challenges and opportunities for effective management of the Canadian, and global, environment. These linkages create strong and logical pressures for co-ordinated action. Indeed, many in industry are calling for regulatory harmonisation on the environment. There may also be good public policy reasons, such as creating a level playing field, in support of harmonised systems. However, there are also many that are legitimately concerned about widespread harmonisation with U.S. and global environmental standards.

Environmental conditions may differ and require tailored policies and instruments. Different broader social and legal contexts may point towards distinct approaches. More fundamentally, values with respect to approaches and endpoints may also diverge. Many are concerned that harmonisation implies adopting the lowest common environmental standard, and will impede efforts to improve environmental stewardship in Canada. Finally, many have strong feelings about sovereignty, which they believe could be compromised by one-sided, unidirectional shifts toward U.S. standards and instruments.

The analysis of the pros and cons of harmonisation is too complex to be fully presented here. However, the increasing environmental and economic linkages between Canada and U.S. open up new challenges and opportunities. One immediate strategy is for Canada is to identify the "win-win" scenarios in the Canada-U.S. context where we can improve environmental performance and lever strategic business benefits.

Generally, Canada's environmental management regime is more flexible, less complex and costly than that the U.S. system. Where the U.S regimes sets higher levels of performance than Canada, we may be able to match the U.S. levels, but in a more flexible and efficient way. Our environmental management regime could be a "competitive advantage" for Canada.

This matching of environmental performance levels is the essence of the concept of "convergence". Environment Canada defines international convergence as a performance-based approach where Canada could match higher levels of environmental performance in other countries and develop its own efficient and flexible instruments to achieve that level of performance.

Convergence is broader and more flexible than harmonisation or adopting the requirements of other countries. In some cases, close harmonisation may be the right policy choice. In other cases, matching overall U.S. or international performance levels with flexibility to design 'made in Canada' instruments to achieve them could make more sense.

The challenge is to ensure that whatever approach we take to improving environmental performance in Canada, it is designed with Canadian environmental objectives in mind and recognises the system of shared federal-provincial environmental governance.

Environment Canada has identified a number of strategic Canada-U.S. convergence opportunities.

a) Convergence Analytical Framework:

This is a tool (see side-box) which Environment Canada has developed to work collaboratively with industry, provinces and other stakeholders to tease out opportunities where matching higher levels of U.S. environmental performance could improve environmental and business performance. Environment Canada developed this framework as part of an exploratory initiative on Canada-U.S. convergence and is interested in undertaking case studies using the framework. Initial discussions are underway with provincial governments and with a number of industry associations.

b) Reducing VOCs in Consumer and Commercial Products:

Environment Canada is working with provincial governments and consulting with stakeholders on a strategy to reduce VOCs in consumer and commercial products. Environment Canada is proposing an approach based on convergence with the U.S. This convergence approach recognises the integrated nature of the North American marketplace for many of these products and will take advantage of the wealth of analysis and information available in the U.S. at the national, regional and state levels.

VI. Conclusion

Environmental policy-makers and regulators face mounting pressures and demands driven by science and technology, globalisation, changing public attitudes and economic integration. Yet we have also developed a wide array of principles and approaches that will stand us in good stead in meeting these demands. Sustainable development, pollution prevention, the ecosystem approach, and the precautionary principle reflect our basic understanding of how to develop smart environmental regulation.

We have also identified the practical characteristics of sound environmental regulatory instruments and processes. Better instruments will be effective, proportionate and appropriate, cost-effective, performance-based, adequately enforced, etc. Effective regulatory processes must be open, transparent, and incorporate sound research and effective consultation.

Environment Canada's experiences with environmental regulation illustrate that many of these characteristics have been applied successfully. The examples provided illustrate both the development and implementation of better regulatory instruments, as well as improved regulatory processes.

Despite the importance of the guiding principles, defining characteristics and hands-on experience, developing Smart Regulation remains a challenge. It is never a mechanical exercise, and demands both judicious analysis and a sophisticated touch. Over the long-term, Environment Canada must take the approach of continuous learning, monitoring trends, researching and developing new approaches, and assessing best practices. More immediately, we have has identified three areas where concrete action is needed: improving administrative efficiency, increasing use of economic instruments, and addressing international convergence.