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

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environment taxation for australia

Environment Taxation for Australia

John Freebairn

Melbourne Institute-Treasury Conference

Melbourne, June 2009

context for discussion
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
evaluation criteria for environmental taxes
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
pollution external cost correction
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

Partial Equilibrium Model of Pollution

Price or cost

per unit of






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

common pool resources missing market for resource stock
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
Common Pool Resource


Price or cost

per unit



P* - T




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

challenges with congestion market failure correction
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.
public goods
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
related fiscal policy issues and double dividend
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
other fiscal policy related issues
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.
current income tax distortions to environment decisions
Current Income Tax Distortions to Environment Decisions
  • Tax expenditures subsidising private transport
    • Fringe benefits concessions
    • Accelerated depreciation
  • Tax expenditures for primary production
    • Agriculture
    • Forestry
current ad hoc taxes on petroleum products and motor vehicles
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
stamp duties
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
taxation of natural resource rents
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.

Price and

unit cost


S’ = S + R


Natural Resource With Variable Quality





Q’ Q*


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’.

  • 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.