3 Experience With Economic Instruments

3.1 European And Japanese Experience With Economic Instruments

European countries use economic instruments to address a wide range of issues, including water pollution; air pollution; climate change; land contamination; waste management; natural resource management; noise; ozone layer protection; energy efficiency; transport; and, land management. While tax-based measures are used extensively, Europe has also gained considerable experience with tradable permit systems, deposit-refund systems, and environmentally-motivated subsidies. 

European countries are particularly advanced in the use of fiscal policy to promote environmentally sustainable behaviour. Although the transport sector accounts for over 90% of total environmentally related taxes, with taxes on petrol, diesel fuel and motor vehicles, European countries apply taxes and fees to address a wide range of environmental issues, including energy (natural gas, coal and electricity consumption and production), packaging materials, waste management, air emissions, water effluent, and non-point water pollution (see Text Box 1).²

Energy use is taxed much more heavily in Europe than in Canada and the U.S. The most significant difference is probably in the much higher European taxes on motor vehicle fuels. These taxes range from almost 0.8 Euros per liter in the U.K. to approximately 0.35 Euros per liter in Greece, compared to federal and provincial taxes equivalent to less than 0.15 Euros per liter in Canada. Most European countries also tax light fuel oil, which is not taxed in Canada. Many European countries have also recently introduced carbon taxes focused on reducing greenhouse gas emissions from the consumption of fossil fuels. Denmark, Finland, Italy, the Netherlands, Norway, Sweden and the U.K. have introduced levies named "carbon-taxes" or "CO2 taxes."³ Similarly, Japan's Ministry of the Environment recently announced a proposal to introduce a new set of taxes on fossil fuels in 2005 with the goal of reducing GHG emissions.

Many European countries have moved beyond the use of tax measures as instruments for addressing discrete environmental issues to a more systematic approach to tax reform. Over the last decade, several OECD countries (Belgium, Denmark, Finland, Iceland, Italy, Japan, the Netherlands, Norway and Sweden) have constituted "green tax commissions" to examine the opportunities for, and implications of, introducing environmentally-related taxes and charges. In a number of cases, these initiatives have focused on opportunities to achieve environmental objectives more efficiently, leading to the application of environmental taxes to a wider range of issues. Some countries have also introduced new environmental taxes as a response to declining tax revenues.⁴ In addition, as Section 3.4 (below) describes, some countries are introducing tax-shifting policies designed to use the revenues from new taxes on pollution or resource extraction to reduce taxes on labour or capital. Denmark, Finland, Germany, Italy, Norway, the Netherlands, Sweden, Switzerland and the UK have all implemented environmentally related taxation with explicit cuts in other distortionary taxation. In the UK, for example, the landfill tax introduced in 1996 was accompanied with a 0.2% reduction in employers' social security contributions. Over half of Italy's carbon tax revenues in 1999 were dedicated to reducing labour costs.

A growing number of European fee-based measures are taking the form of revenue-neutral feebates. A feebate combines: a) a charge based on emission levels or some other measure of environmental risk (such as the quantity of toxic materials incorporated in a product); with b) a partial rebate to facilities that demonstrate prescribed types of environmental improvements (e.g., through the development of a pollution prevention plan, enhanced energy efficiency, etc.). One of the first feebates was Sweden's Nitrogen Tax. The tax revenue collected from power generators is refunded to participants based on the amount of nitrogen oxide produced per unit of energy (a rough surrogate for the facility's production efficiency relative to NOx emissions). In the first year alone, NOx emissions fell by 35%, and investment in abatement technology increased. This system creates a dynamic where heavier polluters transfer resources to lighter polluters.

As the Swedish and other European examples illustrate, the revenue neutral feebate model offers a particularly effective method of attaining a domestic environmental objective (reduced emissions) while minimizing adverse competitiveness impacts and creating incentives for ongoing technological innovation and production efficiency gains. The Swedish example also suggests that a feebate can work within a relatively small market, such as Canada's. Sweden is only one-third the population of Canada, and its economy is also heavily export oriented and based on a similar mix of resource and emerging high tech industries.⁵

In addition to feebates, all OECD countries use a wide range of subsidies to promote environmental objectives. Subsidies are used to create market incentives for the greater use of renewable energy, to improve energy efficiency, to preserve nature / landscape values, to encourage effective and efficient water treatment, to promote specific transportation modes, and to support environmental technology research and development.

The recent expansion in use of emissions trading in the European Union has largely been driven by the EU's Kyoto commitments, and by the failure to achieve consensus on an EU-wide energy/carbon tax. A number of countries have developed national-level emissions trading programs, and an EU Council Directive calls for a pan-European emissions trading system to be initiated in 2005. European jurisdictions have also developed tradable development rights programs for various other issues, including land preservation (e.g. France), transferable quotas for fisheries conservation (e.g. Netherlands), and sector-specific emissions trading programs encompassing a suite of GHG and other air emissions from the sector (e.g. the Danish electricity sector).

As is the case in Canada, European countries have used deposit-refund systems primarily to encourage the return of beverage containers to the point of sale. Recently, however, deposit-refund systems have been used to address increasingly complex issues, such as the reduction in use of CFCs (e.g. Italy); return of vehicles to manufacturers (e.g. Norway); collection of waste oil (e.g. Norway); return of electric bulbs (Austria); and the environmentally sound management of large appliances and electronic goods. Deposit-refund systems are gaining momentum as an effective instrument to achieve environmental objectives, and many of the programs have achieved recovery rates close to 100%. Revenues collected through the deposit system are used to fund the administrative aspects of the program as well as to provide refunds to participants.

A number of jurisdictions in Europe and Asia are exploring opportunities to go beyond simple take-back programs operated through deposit-refund schemes. The objective is to create incentives for producers to redesign their products so as to eliminate the source of the environmental problem. "Design for environment" (or DfE) is an important aspect of pollution prevention, and can include material substitution, toxics use reduction, and design for longevity, reuse and recyclability. Emerging experience with products ranging from carpets to electronics suggests that DfE can provide important opportunities for producers to reduce environmental impacts in innovative ways that reduce costs or enhance market share. Various countries are starting to promote DfE through the use of a range of economic instruments to supplement a basic "take-back" obligation. Taiwan and other Asian countries increasingly are using advance disposal fees or deposit refund schemes that impose differentiated fees or deposits depending on the risk associated with the materials of concern associated with the targeted product. Some European countries are imposing materials taxes to reinforce DfE incentives. Recent work suggests that these incentives could be further enhanced by adapting the feebate model that has been used effectively for percloroethylene, SOx, NOx and various other substances in Europe – the revenues from a materials tax could be distributed either back to individual producers willing to invest in new production technologies or to the recycling sector to further stimulate recycling.⁶ A final option that is being explored with respect to automobile take-back programs in Sweden is to enable individual producers who have paid into a collective take-back scheme to claim partial refunds if they can demonstrate that their vehicles are cheaper to recycle, disassemble or dispose of than the average vehicle that is included in the collective take-back scheme.

3.2 U.S. Experience With Economic Instruments

The U.S. approach has been less systematic than some European countries. The U.S. uses economic instruments to address discrete environmental protection and conservation or resource management issues, rather than as part of an overall strategy that emphasizes tax-shifting and correcting market failures as a relatively integrated set of social, industrial and environmental policy objectives.

Nonetheless, the U.S. has made much more extensive use of economic instruments for environmental protection than Canada. The federal, state and local governments all use fees, charges and taxes for a range of issues.  Although feebates are generally not used, there are a growing number of feebate-like measures for promoting building energy efficiency. For example, the Colorado Renewable Energy Mitigation Program requires that new homes over a certain size have a renewable energy system or pay a $5,000 mitigation fee. A local non-profit administers the funds for projects such as PV solar panels for local schools and a micro-hydro electric power plant. The California 20/20 Rebate Program, created in March of 2001, promotes voluntary energy conservation by offering electric utility customers a 15-20% rebate for reducing their power usage by 20 percent from the previous year. This program helped achieve peak demand savings of 2,600 MW during the peak consumption months of June to September in 2001.⁷

Deposit-refund schemes are prevalent at the state and local levels for promoting the recycling of beverage containers and other consumer products. The U.S. is the leading exponent of marketable permits and other trading programs, with federal, state and municipal level initiatives related to a wide range of pollutants, land use and resource conservation related issues. Performance bonds, liability legislation and information disclosure also form important elements of the overall environmental management toolbox in most US jurisdictions. Incentives and subsidies for reducing pollution or improving the environment include tax benefits, loans, tax-exempt bonds, grants, tax incentives, and preferential procurement programs.

In some cases, these measures are the primary risk management approach. In addition, both the federal and state governments increasingly are using economic instruments to promote participation in programs that promote various "beyond compliance" actions.

Reviewing these numerous programs, a recent U.S. government report, The United States Experience With Economic Incentives For Protecting the Environment, concluded that:

In many cases [economic incentives] are generating health and environmental benefits beyond what is possible with traditional regulations, and sometimes they can be applied in situations where regulations might not be possible at all. ... In general, it is clear that economic incentives do provide the opportunity to achieve any given level of pollution control with substantial cost savings (NCEE, 2001).

3.3 Canadian Experience With Economic Instruments

Canada's limited use of economic instruments has generally followed the U.S. model of discrete, market-based approaches targeted to environmental protection, rather than the revenue-neutral, tax-shifting approach to EFR that is emerging in Europe.

Except for the gasoline excise tax (which arguably is designed to generate revenue rather than to reduce automobile use), the federal government makes almost no use of environmental taxation. Canada generates only about 5% of its total tax revenues from environmentally related taxes and fees. This is in contrast to over 8% in the case of the U.K., over 10% in Norway and over 12% in the case of Netherlands and Korea.⁸ Fuel excise taxes represent the bulk of Canada's environmental tax revenue (about $11 billion annually, representing about 3% of total tax revenue).

By contrast, the federal government does use various tax incentives. It utilized differentiated excise taxes on leaded and unleaded gasoline to accelerate the phase-out of leaded gas, and it continues to provide excise tax exemptions for alternative fuels such as ethanol, measures to "level the playing field" between conventional energy and renewable energy sources, and tax benefits for gifts of ecologically significant land.  It has also used tradeable allowance systems as part of its efforts to eliminate HCFCs and methyl bromide (both ozone depleting substances), and has provided limited support to pilot greenhouse gas trading projects.

The federal government also uses various economic instruments to support resource management objectives. Many of Canada's fisheries resources, for example, are managed through Individual Transferable Quota (ITQ) systems. Under an ITQ system, the federal government establishes a total allowable catch for a specific fishery, and then distributes the quotas to individual entities based on historical catch data. When the season commences, individuals can either sell a portion of their quota, or purchase additional fishing rights.

There are also various federal subsidies designed to support a range of environmental and natural resource management objectives, including increased renewable energy use, soil and water conservation on agricultural lands, effective treatment of municipal wastewater, reforestation, tire recycling, and improved energy efficiency. Subsidies and other program expenditures have included green procurement policies, grants and loans for the research, development, and application of new technologies, and a range of funds to support education and training programs.

Many of the provinces also use various economic instruments. Ontario recently introduced a form of emissions trading designed to reduce emissions of various air pollutants from large coal and oil-fired electricity generators.⁹ The Ontario fuel conservation tax is also the most prominent example of a feebate in Canada. Introduced in 1989, it imposes a fee on gas-guzzlers and provides a rebate to fuel- efficient vehicles. The effect of this program has been negligible, however, as over 90% of the vehicles purchased are subject to a nominal $75 fee, which constitutes less than a third of a percent of the total cost of a typical car.  Furthermore, only one fuel conservation category (6.0L/100km) is eligible for a rebate, creating only limited incentives for consumers to change purchasing behaviour.

Many provinces require some form of insurance or site reclamation deposit as a condition of receiving a permit to operate facilities such as waste disposal sites and new mines. Some provinces require aggregate operators (sand and gravel quarries) to pay an excise tax that helps fund the reclamation of abandoned sites. Alberta has a similar fee and fund for abandoned oil and gas development sites and pipelines.

Most provinces use deposit-refund schemes and advance disposal fees to promote product stewardship and environmentally sound management of various types of solid wastes (see Text Box 2). Various provinces also collect excise taxes related to batteries, solvents, tires, water use, motor vehicle license fees, and forestry preservation. Manitoba is considering whether to impose a tax on home electronics, which would be similar to the fee that is currently applied to tires in the province.

Despite the current limited utilization, some provinces have sufficiently broad legislative authority to considerably expand their use of economic instruments. Alberta's Water Resources Act allows for water charges. To date, the province has used the Act to allocate rights and to authorize a limited system of swaps, but has not yet introduced water charges. B.C.'s new Environmental Management Act is broad enough to allow for the introduction of a range of economic instruments, including modified fee structures based on environmental performance and discharge trading systems (the trading of discharge credits in exchange for reducing discharges below allowable levels).¹⁰ As the Act was only promulgated this year, it is premature to predict the extent to which the province will take advantage of these new authorities.

At the municipal level, Winnipeg's proposed "New Deal" provides an example of how municipal fiscal reform could be designed to include environmental, social and economic objectives. ¹¹  The impetus behind the New Deal was a budget shortfall, and reluctance by the City to increase property taxes. The proposed new tax system would be based on a "consumption tax" model, and would include a sales tax, a city fuel tax (where 100% of the revenues will be put towards public transit expenditures), as well as taxes applied to gas, electricity, and garbage disposal. While other municipalities have introduced pay-per-use services, Winnipeg is the first large municipality in Canada to recommend a fundamentally new tax system.

The Government of Canada and Environment Canada have repeatedly called for the greater use of economic instruments to address environmental issues.¹² Notwithstanding these policy statements, and notwithstanding the examples described above, the Canadian experience with economic instruments is quite limited, and lags many European and other countries. We make minimal use of tax and fee-based measures designed to change behaviour. We have little experience with marketable permit programs, and have made little use of economic instruments focused on changing consumption patterns. We have almost no economic instruments for managing toxic substances, for encouraging design improvements for complex products or for addressing diffuse sources of pollution (other than household waste). 

Commenting on Canada's relatively infrequent use of economic instruments, the OECD's 2000 Economic Survey of Canada concluded that:

... there is a need to increase the use of economic instruments (for instance, charges on toxic emissions and waste, and disposal fees for products containing toxic substances) to reinforce the polluter-pays principle (p. 7).

3.4 Experience With Ecological Fiscal Reform

Over the last decade, several European countries have started to explore and implement various aspects of EFR, which now has significant momentum across Europe. The Scandinavian countries and the Netherlands initiated green tax reforms in the early 1990s, introducing new pollution and fuel taxes and reducing income taxes and social security contributions. Subsequently, Austria, Italy, Germany, Belgium, France and the U.K. have all introduced major tax reform initiatives.

In some cases, these initiatives flowed from commissions established to explore opportunities for environmental taxes. These commissions have varied in their mandate and composition (some have been multistakeholder-based (Norway) while others (e.g., Finland) have involved only government officials). Countries such as Italy and Germany have engaged in various aspects of ecological fiscal reform through direct executive and legislative action, without resorting to green tax commissions.  Regardless of its form, the process of moving towards EFR has always been incremental, often building on prior public consultations. It has also been pragmatic, adjusting or phasing-in green taxes to reduce their adverse competitive impacts and responding to widespread public concerns about the burden of social security taxes. Over time, this cautious approach has both legitimised the use of taxation policy to further environmental goals and, in some countries, established environmental taxes as an important source of government revenue.

Despite extensive experience with market-based instruments, including widespread use of fees, charges and taxes, the United States has not proceeded to the next step to EFR. This is in part because its experience with these instruments has emphasized trading regimes over pollution taxes and because raising taxes, even on the premise of a revenue-neutral tax shift, remains deeply unpopular. Minnesota, Oregon and Vermont have all formally debated EFR without, however, implementing it.

With the exception of Winnipeg's New Deal, Canada's experience with EFR has also been restricted to academic and multi-stakeholder discussions, with few references in the political discourse.  The Program Review exercise in the mid-1990s eliminated many agricultural and energy mega-project subsidies with "perverse" environmental effects. This exercise was driven more by deficit-reduction than environmental objectives as in some cases it also led to the reduction of various environmental programs. In addition, despite these changes, the federal government continues to provide significant fiscal subsidies (primarily in the form of tax incentives) to investments in oil sands and coal mines (CESD, 2000, chapter 3). Canada also has almost no experience with revenue-neutral feebates, or indeed with earmarking of environmental revenues. The NRTEE recently observed that the fact that the revenue from many of the provincial product stewardship instruments is not earmarked for environmental purposes contributes to "public scepticism and resistance to the use of economic instruments for environmental protection" (NRTEE, 2002, p. 9).

Although Canada has not had a green tax commission, both the federal and the B.C. governments sponsored analogous multi-stakeholder processes in the 1990s, although neither process had any significant impact on fiscal policies. The National Round Table on the Environment and the Economy has provided regular advice to the federal government on green taxes, and recently championed a version of EFR that pairs the systematic reduction of environmentally perverse subsidies with the use of multiple fiscal and other policy tools (NRTEE, 2002). Similarly, for the past three years, the Green Budget Coalition – representing 17 of Canada's most prominent environmental NGOs – has undertaken an intensive lobbying effort focused on a mix of "strategic reinvestments" in environmental measures and the initial elements of a long-term ecological fiscal reform agenda.¹³

² For more information on the use of environmental taxes, see the OECD's Environmentally Related Taxes database: http://www.oecd.org/ env/policies/taxes/index.htm.

³ Although these taxes often cover new, fossil-based tax-bases, and although the tax rates to some extent vary according to the carbon content of those fuels that are taxed, the levies are not pure carbon taxes. In particular, numerous exemptions and rebates are applied, reflecting various non-environmental policy objectives, such as concern for sectoral competitiveness or income distribution.

⁴ Anderson (1996) argues, for example, that the introduction of many environmental taxes by Nordic countries in the 1990s was primarily a response to declining tax revenues. Rather than increasing income tax rates – which in some cases were already close to 50% - some Nordic governments chose to introduce new "green" taxes. The primary objective of many of the new taxes was to raise revenues to support broad social programs; environmental objectives were complementary, but not the primary objective. Nonetheless, taxes on specific air emissions and energy consumption have helped improve air quality and industrial efficiency.

⁵ A report by two U.S. NGOs concluded that a scheme similar to Sweden's NO_x feebate could be applied in the North American market provided there is a substantial regulatory threat (Wolf 2000).

⁶ Palmer, Karen and Margaret Oates, 1999. "Extended Producer Responsibility: An Economic Assessment of Alternative Policies," Resources For The Future Discussion Paper

⁷ For more information on the California 20/20 Rebate Program, see: www.flexyourpower.ca.gov/state/fyp/fyp_homepage.jsp

⁸ For more information on the use of environmental taxes, see the OECD's Environmentally Related Taxes database: http://www.oecd.org/ env/policies/taxes/index.htm.

⁹ For more information on Ontario's new emissions trading program, see the Ontario Ministry of the Environment web site at www.ene.gov.on.ca/envision/air/etr/

¹⁰ A review of B.C.'s Environmental Management Act can be found at www.hgelaw.com/lawupdate/polluted-convoluted.htm

¹¹ For more information on Winnipeg's New Deal, see: www.winnipeg.ca/interhom/mayors_office/newdeal/TheNewDeal.stm

¹² Commitments to enhance the use of economic instruments for environmental issues include:

• The first item in the 1992 Treasury Board Secretariat Guidelines on Competitiveness And The Design Of Regulations states that "where feasible, regulatory programs should make use of market mechanisms to achieve their objectives."
• Responsive Regulation in Canada, the Treasury Board Secretariat's 1993 Reply to the Report on Regulations and Competitiveness, states that regulatory programs will make "greater use of new forms of regulation, including economic incentives."
• The "Management, Administration and Policy Business Line" of Environment Canada's 2001/2002 DPR included a strategic focus to "Provide leadership in the development and promotion of economic instruments as policy tools for environmental management."
• In his address to the Globe 2000 Opening Plenary (March 2000) "The Environmental Challenge in the 21^st Century," Minister of Environment David Anderson stated: "... perhaps the most important element [of the new environmental architecture] is an expanded and more sophisticated use of market-based and incentive mechanisms.... It is time to get serious about aligning economic signals and financial rewards with environmental goals."

¹³ For more information on the Green Budget Coalition, see: www.greenbudget.ca