Environment Taxation for Australia

1. Environment Taxation for Australia John Freebairn Melbourne Institute-Treasury Conference Melbourne, June 2009

2. Context for Discussion • Taxes to correct market failures associated with • Pollution external costs • Over-use of common pool resources • Under-supply of public good amenity • Critique of current tax system • Concessions in income and consumption taxes • Selective expenditure taxes (petroleum excise, motor vehicles, stamp duties) • Special taxes on natural resource rents

3. Evaluation Criteria for Environmental Taxes • Efficiency • Correct market failure • Spill-over effects on other tax distortions • Simplicity and costs, or choice of tax base • Market failure means no market for direct measure vs the option of an imperfectly correlated measurable inputs and outputs • Equity and redistribution • Focus on economic not initial incidence • Importance of current position as the base case • Important in instrument comparison and choice • Net revenue • Largely a small by-product

4. Pollution External Cost Correction • Examples include • Atmosphere: GHG emissions, smog • Water: sewage disposal, salination • Land: toxic wastes disposal, loss of amenity • Noise and amenity • Tax as a polluter pays market failure correction • Tax as only one of many corrective instruments

5. Partial Equilibrium Model of Pollution Price or cost per unit of pollution T 0 MAC MEC a Q* Qb Quantity of pollution Market allocation: pollution has zero private cost; quantity Qb Society efficient allocation: reduce quantity to Q*; pollution tax at T = MEC; efficiency gain of ‘a’; costs of pollution-intensive products rise; government revenue gain for tax and auctioned quotas

6. Common Pool Resources(missing market for resource stock) • Examples • Over exploitation of fisheries, underground water • Over use or congestion of transport infrastructure • Tax as a solution • Efficient if T = MEC • Beginning with market as status quo, involves a large transfer from private resource owners/users to government

7. Common Pool Resource MC = MSC Price or cost per unit P* Pb P* - T AC = MPB a MPB = MSB Q* Qb Quantity of fish or cars travelling Market solution: quantity Qb; perceived private cost at Pb Social optimum: quantity at Q*; efficiency gain of area ‘a’. Tax of T would push private cost up to P*, but by < T

8. Challenges with Congestion MarketFailure Correction • Required first-best measures of congestion involves tagging vehicles by location and time. Low cost technology on horizon. • More readily measured associated inputs, eg fuel or vehicle, are not highly correlated with congestion. • City cordons and pricing as an in-between option • Possible strategy: rather than introduce second best measures soon, wait for measurement technology and then a one-off large investment for a close to first best measure of congestion.

9. Public Goods • Examples of resources with alternative public and private good uses • Water for environment vs irrigation and households • Land for nature preservation vs agriculture and forestry • Required reallocation of resource to public good uses to correct market failure will result in a higher price for the reduced quantity of private good uses • Tax will do the job, but it redistributes the scarcity rent to government and away from organised pressure groups • Other instruments, eg grandfather quotas, government purchases, have different redistributions favoured by private interest groups

10. Related Fiscal Policy Issues, and Double Dividend • Environment taxes effectively are an increase in indirect taxes. Mostly, they are passed on as higher consumer prices • Higher cost of living aggravates existing Y, GST and payroll tax distortions to labour market, and/or employees push for compensating wage increases • Unless, revenue gain returned as compensating income tax reductions • Requires a package not unlike 2000 tax reform package involving some GST for Y tax mix change • No double dividend here

11. Other Fiscal Policy Related Issues • The environmental tax internalises a social opportunity cost. So, • A legitimate cost of production income tax deduction. • Include in base for applying GST as part of social cost. • Where the tax alone corrects market failure, there is no need for hypothecated environmental expenditure. • Possible exception where tax and expenditure are part of a second-best package, including a tax levied on upstream or downstream inputs and outputs because of measurement costs of the direct market failure.

12. Current Income Tax Distortions to Environment Decisions • Tax expenditures subsidising private transport • Fringe benefits concessions • Accelerated depreciation • Tax expenditures for primary production • Agriculture • Forestry

13. Current Ad Hoc Taxes on Petroleum Products and Motor Vehicles • Largely an historical collection of easy revenue raisers with many concessions not justified for efficiency, equity or simplicity reasons • An opportunity to reconsider from first principles the tax base and tax rates in terms of specifically designed • user pays fee for government provided road services • pollution tax or taxes • congestion tax

14. Stamp Duties • Turnover tax, over and above the GST, on selected asset transfers, including • Business and residential property • Motor vehicles • Results in distortions to the efficient allocation of the assets between different uses, including some adverse effects on the environment • Can be replaced with less distorting taxes, including • Augmented land tax for property • Higher annual registration fee for vehicles

15. Taxation of Natural Resource Rents • Rents arise from variable quality of deposits and differences in unit production costs • Most States impose a royalty, either fixed or ad valorem • Shifts supply curve upwards • With efficiency loss of too little production • A replacement profit based resource rent tax would • Avoid the production inefficiency loss • Collect as much, or more, revenue as royalties • Example of commonwealth petroleum resource rent tax • Consider extension to other natural resources, such as water, forests, fisheries, to capture some of the projected increase in scarcity rents.

16. Price and unit cost Pw S’ = S + R S Natural Resource With Variable Quality D a c b Q’ Q* Quantity Current royalty system with royalty at rate R: output of Q’; government revenue of ‘b’; investor rent ‘a’. Alternative resource rent tax of share of ‘a + b + c’: output of Q*; comparable or more government revenue and investor rent; efficiency gain of ‘c’.

17. Conclusion • Issues of the taxation of natural resources and the environment have not been on the reform agenda for a long time. • There are opportunities to do better by considering: • Removing distortions in existing taxes influencing decisions about the use of the environment (and elsewhere); and, • Using a special environment tax as one of the available instruments to correct current market failures in environment decisions.