National Round Table on the Environment and the Economy
Paper for the External Advisory Committee on Smart Regulation (EACSR)

November 30, 2003

NRTEE Mandate

The National Round Table on the Environment and the Economy (NRTEE) was created to "play the role of catalyst in identifying, explaining and promoting, in all sectors of Canadian society and in all regions of Canada, principles and practices of sustainable development." Specifically, the agency identifies issues that have both environmental and economic implications, explores these implications, and attempts to identify actions that will balance economic prosperity with environmental preservation.

At the heart of the NRTEE's work is a commitment to improve the quality of economic and environmental policy development by providing decision makers with the information they need to make reasoned choices on a sustainable future for Canada. The agency seeks to carry out its mandate by:

• advising decision makers and opinion leaders on the best way to integrate environmental and economic considerations into decision making;

• actively seeking input from stakeholders with a vested interest in any particular issue and providing a neutral meeting ground where they can work to resolve issues and overcome barriers to sustainable development;

• analyzing environmental and economic facts to identify changes that will enhance sustainability in Canada; and

• using the products of research, analysis and national consultation to come to a conclusion on the state of the debate on the environment and the economy.

The NRTEE has established a process whereby stakeholders themselves define the environment/economy interface within issues, determine areas of consensus and identify the reasons for disagreement in other areas. The multistakeholder approach, combined with impartiality and neutrality, are the hallmarks of the NRTEE's activities. NRTEE publications address pressing issues that have both environmental and economic implications and which have the potential for advancing sustainable development.

Members of the National Round Table on the Environment and the Economy

The NRTEE is composed of a Chair and up to 24 distinguished Canadians. These individuals are appointed by the Prime Minister as opinion leaders representing a variety of regions and sectors of Canadian society including business, labour, academia, environmental organizations and First Nations. Members of the NRTEE meet as a round table four times a year to review and discuss the ongoing work of the agency, set priorities, and initiate new activities.

Objective

To share the National Round Table on the Environment and the Economy's (NRTEE) experience concerning the use of economic instruments for promoting sustainable development.

1. Overview

Working with stakeholders across the country the National Round Table on the Environment and the Economy (NRTEE), an independent federal agency of the Canadian government, provides practical, objective and neutral recommendations for balancing economic prosperity and environmental preservation. One main area of research for the NRTEE has been the use of economic instruments, particularly fiscal instruments, to promote sustainable development. Our Ecological Fiscal Reform (EFR) program, which is the main research initiative in this area, is designed to enhance the strategic integration of fiscal policy with other policy tools, to address environmental problems in a way that promotes economic efficiency and environmental objectives simultaneously.

The following paper shares the NRTEE's experience concerning the use of economic instruments for promoting sustainable development. The initial section provides background information on EFR and explains its appropriateness as a tool for the challenge of implementing sustainable development. The second section identifies and explores a number of challenges to implementing EFR that have been identified by the NRTEE. The third and final section provides key NRTEE recommendations for advancing an EFR agenda in Canada.

2. Background Information

2.1 Definition of EFR and links to Economic Instruments

The starting point for the NRTEE's Ecological Fiscal Reform program is the assumption that economic instruments, and in particular fiscal instruments, are under-utilized in Canadian public policy. A related issue is our assessment that much policy making occurs along vertical "silos", whereby individual ministries or agencies of the federal system conduct policy making on a limited definition of jurisdiction and authority. The result, in our estimation, is a situation in which public policy is designed to address vertical issues, using a limited array of policy tools (usually, but not exclusively, limited to command-and-control measures). This is a situation that is ill-designed to address many of the complex, interlinked, and dynamic challenges that the federal government is called upon to address. In particular, it does not serve the government's stated objective with respect to promoting sustainable development, which is by definition a "horizontal" issue.

The NRTEE has defined ecological fiscal reform as:

A strategy that redirects a government's taxation and expenditure programs to create an integrated set of incentives to support the shift to sustainable development.

EFR is a broad approach, using suites of instruments in a reinforcing package, and engaging multiple fiscal policy tools in addition to taxes and tax breaks. EFR involves:

• redirection or introduction of new taxes or tax breaks;

• redirection or introduction of targeted direct expenditures, such as targeted government program expenditures, government procurement, cash subsidies, and grants; and

• other economic instruments, such as tradable permits, permitting charges, and user fees.

By drawing on this broader array of tools, EFR offers greater opportunities to design "win-win" policy packages. The common purpose of these tools is to provide incentives for producers and consumers to alter their decisions and behaviour-either to internalize environmental costs or to reward more sustainable practices.

EFR is meant to be used within a policy package that also includes regulatory, informational, and voluntary tools. The optimal policy mix will be specific to the issue being addressed. The criteria for determining the mix include effectiveness, efficiency, distributional effects, flexibility, and political buy-in. In some cases, command-and-control approaches cannot tackle an environmental issue, and EFR offers a cost-effective and flexible alternative. In these instances, EFR is used on a stand-alone basis. Examples include a "cap and trade" on greenhouse gas emissions, government green power procurement combined with tax incentives for renewable energy development, and the redirection of subsidies for agriculture. In these cases, EFR works best when accompanied by voluntary initiatives and information programs that explain the rationale for it and provide information on sustainable behaviour to respond to the incentive. EFR itself also often requires legislation to provide the legal mandate for operation.

EFR, command-and-control, and voluntary programs can also be designed to reinforce one another, with EFR measures targeting niches missed by other policy tools. For example, EFR can be used to encourage participation in voluntary programs, or it can be used as a support to regulatory initiatives, as in the early 1990s when a differentiated fuel excise tax was used to encourage a shift to unleaded gasoline use in advance of regulations.

2.2 Benefits of EFR in Canada: the NRTEE Analysis

EFR can be a uniquely appropriate tool for addressing sustainable development. This policy field affects many agents in society in complex ways. EFR is an integrative tool, more easily adaptable to the complexity of sustainable development than are other policy tools. It also supports continuous improvement, which underlies the path toward sustainable development.

There is a role for EFR in Canada. This role will vary according to the specific issue being addressed and the other tools also being applied to the issue. EFR is much broader than economic instruments and tax reform, and this very scope is what makes it new. The range of instruments available provides many options and opportunities to assemble suites of instruments that are mutually supportive, provide environmental benefit, and expand the opportunity for voluntary action or to complement regulatory approaches.

EFR offers certain benefits over command-and-control approaches. It is more amenable to a continuous improvement approach. The market signals being sent can be readily adapted-if monitoring identifies a need to alter the signal to reach the desired objective or if the objective itself changes with time. EFR also allows for more flexibility and more equity, because parties can determine their response. It need not be designed around the "lowest common denominator" as regulations must.

EFR also opens up new opportunities, because it can address niches unfilled by other policy tools. For instance, EFR can facilitate reaching targets that have been established under command and control. EFR can also expand the effectiveness of voluntary programs, by offering incentives for participation or by sending new "information" to decision-makers in the form of a price signal.

2.3 The NRTEE: Background and Process

The National Round Table on the Environment and the Economy is a publicly funded, independent federal agency. The mandate of the NRTEE is to play the role of catalyst in identifying, explaining and promoting, in all sectors and in all regions, principles and practices of sustainable development. As sustainable development is a very broad concept, the NRTEE breaks it down into manageable pieces by focusing in on those critical, yet relatively unexplored, areas that lie at the intersection of the environment and the economy.

As an agency that operates at arm's length from government, the NRTEE is able to provide a neutral forum where all of the key stakeholders-decision makers and opinion leaders from government, industry and other sectors-can openly and freely discuss and debate critical issues and work together on finding solutions. Through this work, the NRTEE makes a valuable contribution toward achieving a better balance between the environment and the economy, one that promotes economic prosperity for all Canadians while preserving the environment for the benefit of current and future generations.

The NRTEE consists of a membership of distinguished Canadians, supported by a Secretariat. Members are appointed to the NRTEE by the Prime Minister of Canada and represent a broad range of sectors including business, labour, academia, environmental organizations and First Nations, as well as diverse regions across the country. The Secretariat, headed by the President and Chief Executive Officer, provides program management, analytical, communications and administrative services to the NRTEE members and their task forces and committees. Information about the NRTEE and its membership can be found at www.NRTEE-trnee.ca.

NRTEE activities are organized into programs, each overseen by a task force of NRTEE members and representatives from business, government and non-profit organizations.

The responsible task force commissions research, conducts national consultations, reports on agreements and disagreements, and recommends how to promote sustainability. The NRTEE reviews these reports and recommendations before approving them for public release. The NRTEE members meet quarterly to review progress, establish future priorities and start new programs.

2.4 EFR work at the NRTEE

One key means by which the Round Table fulfills its mandate is through its Greening of the Budget Submission - an annual set of recommendations that outline the ways in which the federal government can better integrate economic, social, and environmental considerations into its annual budget. Many of these proposals have been successful: energy efficiency, renewable energy, donations of ecologically sensitive lands, and sustainable development indicators, to name a few. Historically, this work was undertaken by an Economic Instruments Committee of the NRTEE, started in 1994.

In 2000, the NRTEE divided its economic instruments work into two streams. One stream, now titled "Greening the Budget," focuses solely on discrete budget initiatives that derive from recommendations of other NRTEE programs, such as those on non-renewable resource development in the North, brownfield sites, and environmental health. The second stream has become one of the NRTEE's main programs, the Ecological Fiscal Reform (EFR) Program.

The goal of the NRTEE's EFR program is to gain insight into the key challenges and opportunities related to EFR and to explore the potential for EFR in Canada. The first phase of the program included a review of international experience with EFR and three case studies: on agricultural landscapes, cleaner diesel transportation, and substances of concern. This phase was successfully completed with the release of the NRTEE document: Toward a Canadian Agenda for Ecological Fiscal Reform: First Steps.

In April of 2003, a second phase of the program was launched with a focus on the reduction of carbon based emissions from energy. The program's current objective is to 'develop and promote fiscal policy that consistently and systematically reduces energy-based carbon emissions in Canada, both in absolute terms and as a ratio of GDP, without increasing other pollutants. The program will be providing budget recommendations for reaching its objective in time for NRTEE's 2005 Greening of the Budget submission, and will produce a State of the Debate report providing an examination of the role of fiscal policy in climate change and energy policy in early 2005.

The NRTEE's experience has shown EFR to be a uniquely appropriate tool for addressing sustainable development. As such, EFR recommendations have been made in other NRTEE programs including Environmental Quality in Canadian Cities: The Federal Role, Cleaning up the Past and Building the Future: A National Brownfield Redevelopment Strategy for Canada.

3. Challenges to Implementing EFR

Based on its experience, the NRTEE has identified a number of challenges to implementing and operationalizing EFR in Canada.

• Horizontal nature of sustainable development and the integrated policy response (i.e. fiscal, regulatory, and other) it requires;

• Capacity - EFR is a new approach; using it successfully will require leadership, openness, new actors, and new knowledge;

While people have been discussing and applying economic instruments for many years, EFR is a new approach. Using it successfully will require openness to change, the involvement of new actors with new knowledge, and the building of new knowledge among existing actors. Implementation of EFR will require the involvement of, and championing by, senior individuals-from government and the private and non-government sectors-who have sufficient authority to take risks, break down barriers, and mandate the adoption of innovative approaches.

EFR challenges us to think "outside the box"-beyond the current regulatory backdrop, compliance mindset, and fiscal instruments that are familiar and comfortable. Any change is likely to be challenged and resisted by some parties. The introduction of EFR must, therefore, be undertaken as a conscious change-management process. To gain acceptance for EFR, time must be taken to build trust and expand the base of understanding. Forums such as the NRTEE, where people can discuss EFR within a "safe space" and identify shared interests and opportunities, will help to achieve this.

Understanding of the potential for EFR is new to Canada. There is a lack of detailed knowledge among decision makers, stakeholders, and the public about the range of EFR instruments and their operation. There are concerns about feasibility, government revenue implications, additional costs for producers/manufacturers, administrative burdens, and other associated factors. This means there will be a need for change among all actors at the policy development table-a new mix of issue experts, traditional policy experts, and economists and economic instruments experts, who can join together to explore creative new solutions and approaches.

There will be difficulties in simply communicating between new groups of experts and in defining a common vocabulary. One example is the difficulty encountered when discussing the use of any new fiscal instruments in an era when "no new taxes" has become a widespread mantra. Communication and awareness raising are essential, and the timing is ripe for expanded understanding and implementation of EFR incentives.

3.1 Institutional

An expanded use of EFR will be transformative. It will present a challenge for everyone, because it requires the integration of science, economics, and policy design. This demands new forms of horizontal cooperation across government departments, within industry divisions, and among diverse stakeholders. It will also demand the evolution of new skill sets and job profiles among all stakeholders.

Government will face a special challenge. For tax-based EFR instruments, policy responsibility and tool control are split between line departments and the Department of Finance. Consequently, there is a need for cross-departmental cooperation, and confidence among all actors that this co-operation will be given. This is in contrast to traditional tools, such as regulation or voluntary programs, where authority typically resides within the line department. Line departments usually have authority over instruments, such as permit fees, fines, and expenditure programs, with fewer challenges to their use. Using them in an integrated EFR framework may require coordination between two or three levels of government and among departments within one government. Successful use of EFR depends on unprecedented levels of collaboration. This, in turn, highlights the vital importance of institutional support and capacity that inform and empower action on sustainable development across all departments.

3.2 Timing

EFR should not be the driver for establishing environmental objectives and targets-it must not be a "solution in search of a problem." The scientific need to act should be established, and clear policy objectives should be set prior to the consideration of any specific management option or suite of instruments, EFR included. Of course, many issues face competing policy objectives both between federal departments and levels of government.

EFR should be among the mix of policy tools considered from the very start of discussions on management options. The focus should be how to make the overall policy package most cost-efficient and environmentally effective. EFR may have a role to play, either on its own or in combination with other policy instruments, and the final policy package may or may not include EFR instruments. The more the policy framework has been defined, the narrower the potential role for EFR.

3.3 Equity

The development of well-designed, effective EFR instruments depends on the same conditions as the development of any other policy instrument: broad societal support for action, clarity of objective, sufficient time and adequate analytical resources, and open consultations with stakeholders. The process for analysing and developing EFR should be similar to that used for regulation or for voluntary programs. The hurdle should be no higher and no lower.

In working on policy measures that will be implemented through the federal budget, there is a strong temptation to work toward a submission for the immediate budget. This pull to work within the budget cycle leads to 12-month timelines at the most. Such a lead time contrasts sharply with the lead times used in the development of regulatory options (a 36-month period under the Canadian Environmental Protection Act [CEPA]) and most voluntary programs. In order to develop EFR instruments with similar levels of consideration, consultation, and effectiveness to those used in the development of regulatory or voluntary management tools-and in order to go through a similar process of purpose definition, measures analysis, and refinement of design-lead times longer than a traditional budget cycle may be needed.

Because EFR is new and unfamiliar, it may face a higher hurdle than do other policy instruments. There may be a requirement for more analysis and a need to demonstrate stakeholder consensus, effectiveness, and cost-effectiveness at a more stringent level than that demanded of other policy tools. But we already frequently accept the need to take regulatory action in the absence of perfect information or complete consensus. In these circumstances, EFR can be implemented on a continuous improvement model, through the use of pilot projects with clear mechanisms for periodic monitoring, evaluation, and amendment. This "learning by doing" approach can serve to overcome the barriers faced by a new instrument.

3.4 Jurisdictional

Canadian circumstances may pose barriers to EFR or create unique opportunities.

One challenge is the need for coordination and agreement between levels of government, particularly for issues of shared jurisdiction. Responsibilities for issue management may be fragmented from revenue power, creating a barrier to the use of EFR. Federal-provincial differences of opinion about program design and funding requirements may make agreement on EFR packages difficult.

Canada's diversity also makes it challenging to design "one size fits all" EFR approaches. Canada is composed of many regions and provinces/territories with substantial differences in ecosystems, policy contexts, regulatory and fiscal philosophies and approaches, and political cultures. These differences pose a unique challenge to any national EFR initiative. It may be necessary to offer EFR programs within a general framework with a specific objective and to negotiate delivery on a tailored, region-by-region basis.

Another challenge is the size and structure of some Canadian markets. For some commodities, Canada is a small portion of a continental market and, hence, becomes a policy taker, not a policy maker. Where there are only a few actors in the Canadian market and/or a few regional sources of environmental impacts, instruments that have been used widely in the United States, such as trading, are more difficult to use.

Finally, the federal government is very concerned about the precedent set by any new fiscal measure, be it ecological or otherwise. This may become a barrier to innovation on the EFR front.

3.5 Analytical

The European failure to conduct many ex post studies of EFR programs should not be repeated in Canada. Strategic investment in science, economics, and program assessment is required to support EFR initiatives.

At present, there is little baseline data for most environmental issues, insufficient economic information, and little monitoring of results and outcomes. The ability to do economic analysis is often constrained due to a lack of necessary data and a lack of access to the information that does exist. However, lack of data must not be blindly used as an excuse for inaction. Research is needed into what kind of and how much information is necessary for good analysis. It may be useful to study what data are used in the U.S. It is important that both the science and economic aspects be integrated into analysis and assessment of an EFR initiative.

Monitoring, evaluation, and assessment will be essential components in introducing EFR on a continuous-improvement basis, whereby programs are implemented with the clear intent from the outset of evaluating their effectiveness. Monitoring must focus on actual environmental outcomes, as well as economic aspects. These investigations could then be used to adjust or fine-tune programs, so that they are more effective and efficient in achieving their intended targets (e.g., water quality). Unanticipated economic and ecological impacts, positive and otherwise, would also be captured. This may be difficult to do where EFR is only one tool within a suite of measures, including command and control and/or voluntary. In these cases, the analysis should be on the full suite of instruments.

3.6 Understanding economic impacts

The EFR agenda in other jurisdictions has often been implemented along a revenue-neutral model. This approach has been necessary, since reaction to a tax instrument is often hostile, particularly in the North American climate of "no new taxes" and even a wish for tax reductions. This has been reflected in the NRTEE's EFR program, which has, at times, met with difficulties in achieving agreement on new charges and taxes. Expenditure-based programs are more appealing to the public and to stakeholders, but they are harder to sell to governments.

What does this entail for revenue-neutrality in Canadian EFR initiatives? Is it feasible? Revenue-neutrality can be implemented through several approaches, either alone or in combination. It can be done:

• through tax reforms, where any new tax revenue is recycled in such a way that the individual party can be no worse off after taking the desired environmental action;

• through subsidy reforms, where existing subsidy envelopes are redirected in order to fund more ecologically focused initiatives; and

• through expenditure reforms, where new expenditures undertaken in one area lead to a reduced need for expenditures in another.

The NRTEE's work has found that revenue-neutrality exclusively along a tax-shifting model risks being a red herring. There is a role for new taxes within EFR where these are warranted for behavioural purposes; any new tax revenue should be recycled, and the new tax should be clearly linked to the desired environmental objective. However, EFR is broader than tax reform, and expenditure-based programs do have a role, particularly where they can have no impacts on, or reduce, government revenue requirements. What is essential is that the funding and revenue aspects of an EFR initiative be considered and communicated to the public and to stakeholders.

4 Key recommendations moving forward

Based on its experience, the NRTEE has identified a number of key recommendations for moving an EFR agenda forward in Canada.

4.1 Institutional/governance challenges

The NRTEE has seen over and over again in its work that there continues to be a mismatch between the kinds of horizontal thinking and decision-making that is implicit in issues of sustainability, and the basic structures that exist for public policy making in Canada. A coordinated decision-making governance architecture is needed.

4.2 To what types of issues can/should EFR be applied

EFR can be applied to a range of environmental issues and can play a variety of roles within a suite of policy instruments. With creative design, EFR can be part of the policy response to almost any issue. However, EFR seems well suited to environmental issues where:

• flexibility of response from individual actors is acceptable, since each party will determine their own response to the market signal. This means that EFR, used on its own, is not suited to issues for which a minimum threshold performance is required from all actors;

• an end point is difficult to assess or define (as with eco-efficiency), but the direction of progress is known and highly desirable, and EFR can provide incentives for continuous improvement;

• a command-and-control structure is already in place, but there is a desire to support performance beyond compliance, in advance of compliance deadlines, or to support the transition stage of meeting compliance;

• a command-and-control approach is known to be ineffective or impractical,¹ and EFR or voluntary instruments are the only options;

• a voluntary instrument is in place, but there is a need to increase the incentive for participation;

• the intention is to support a transitional stage of performance and behaviour, and it is expected that once this transition has been achieved, a policy instrument will no longer be needed and could be dismantled; and/or

• fundamental, longer-term behavioural change is the objective, and this can be supported by using market signals to change the information on which behavioural decisions are made.

4.3 Components critical to good EFR design

Good EFR design depends on a number of critical components. The NRTEE's case study research suggests that these include (but are not limited to) a thorough knowledge of 1) the state of technology and the genuine opportunities available to mitigate or prevent ecological impacts, 2) the market setting, and 3) the policy context within which EFR instruments would be introduced. Other components include attention to transition strategies, delivery capacity, partnership building, and the use of communication and public awareness programs. Attention must be paid to simplicity of design and administration. Programs may need to be tailored to regional policy contexts and philosophies, which vary greatly across the country.

Success may also depend on engaging affected stakeholders and addressing their practical concerns. Constituencies can be built by demonstrating how people can be better off under EFR approaches than under traditional command-and-control methods.

4.4 Capacity building

There is currently no capacity in Canada, either through a government agency or other organization, to conduct applied research in sustainable economics and to develop tools to measure and manage multiple themes of economic, ecological and social well-being in a holistic fashion. The NRTEE has recommended to the Government of Canada that to develop this capacity, the Government of Canada should task the NRTEE with administering a program to undertake new research and the development and dissemination of practical tools that would build Canadian knowledge in this area. The research should be focused on improved valuation of environmental services, resource uses and losses, full-life-cycle inventory data, eco-profiling and eco-efficiency indicators, and new fiscal policy tools that support both quality of life and economic competitiveness. Pragmatic new tools and methods that could be used by all levels of governments, educational institutions, businesses and communities to integrate economic, ecological and societal measures of well-being into planning, evaluation and reporting activities and procedures would be developed.

¹ For example, a regulation requiring consumers to return pop cans would likely be unenforceable and, hence, ineffective. When the source of the environmental threat is so pervasive and cross-cutting that it is impossible to design a command-and-control approach, as in carbon dioxide emissions from fossil fuel combustion, regulation is ineffective. Regulation may also be impractical for political and social reasons, for example, if the economic burden of compliance must be borne by a lower income or politically powerful group such as the agricultural sector.