ENVIRONMENTAL TAX REFORMS IN DEVELOPING COUNTRIES

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ENVIRONMENTAL TAX REFORMS IN DEVELOPING
COUNTRIES 

• EFD Annual Meeting, Capetown
• 7 December 2006

Professor A. Markandya. U. Bath and FEEM
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Background

• Environmental taxes are good for the environment
• They are good for the economy cause less
  distortions than normal taxes
• If they are so good, why are they not more
  adopted?
• Well, they are becoming more popular
• And there are concerns about social impacts
• Any change in taxes is difficult

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EFR IN DEVELOPING COUNTRIES

• Increased collection of royalties from the
  extraction of natural resources
• Reductions in environmentally harmful subsidies
• Increases in the taxation of economically and
  socially harmful commodities
• Taxing emissions of pollutants.

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Royalties from extraction of natural resources

• Too often under priced and not enough revenue to
  state.
• Lack of transparency and corruption in awarding
  concessions.
• Increases in charges and greater transparency can
  help fiscally and environmentally

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Royalties from extraction of natural resources
examples of reform

• An increase in royalties on timber concessions in
  Cambodia resulted in much higher revenues, less
  logging and better safeguarding of protected
  areas.
• Increased transparency in awarding contracts in
  Cameroon and better enforcement of forest charges
  resulted in tax recovery rates of over 90
  percent. Fiscal revenues to the state 10 fold.
  Employment rose from 20,000 to 90,000.
• Enforcement of fishing rights/licences and
  introduction of by catch fees in Namibia
  increased government revenues substantially and
  brought about a larger processing industry to the
  country.

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Key Analytical Issues

• What is the right or optimal level of royalty
  from an economic perspective and is the proposed
  change a move toward that optimal level?
• How do the changes impact on employment and on
  the poor and how can these impacts be mitigated?
• What are the environmental impacts of the change
  in taxation?
• What are the revenue gains and what is the
  welfare benefit associated with those gains if
  they permit other taxes to be reduced?

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Reductions in harmful subsidies

• Subsidies cost the government billions.
• Subsidies to gasoline and diesel in developing
  countries were 18 billion in 2002. Sub Saharan
  African countries that subsidized diesel and
  gasoline in 2005 include Angola, Nigeria, Ghana,
  Sudan and Eritrea.
• Benefits of reductions are apparent in many cases
  but vested interests against reductions are
  strong.

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Reductions in harmful subsidies- Examples

• Cancellation of pesticide subsidies in Indonesia
  saved the government 100 million. At the same
  time it did not result in a fall in output of
  rice in fact output increased by 3 million
  tons. Complementing the subsidy was a program of
  IPM which cost about 5 million a year and
  reduced the growing problem of pest resistance.
• Energy subsidy reform in China reduced subsidies
  on coal from 61 percent in 1984 to 11 percent in
  1995. The result has been big savings to the
  state, as well as major improvements in energy
  efficiency and falls in emissions of harmful
  pollutants

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Key Analytical Issues

• What are the revenue savings from the subsidy
  reduction and what is the welfare benefit
  associated with those gains?
• How do the changes impact on the poor and how can
  these impacts be mitigated through better
  targeting of any subsidy that remains?
• What are the environmental impacts of the change
  in taxation in physical and monetary terms?

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Taxing Environmentally/Socially Harmful
Consumption

• Better to tax the emissions themselves but taxes
  on consumption is 2nd best.
• Many old taxes e.g. petrol, alcohol, tobacco
  were not always designed for this purpose but
  have benefits other than revenues raising.
• Mostly taxes are below marginal damage levels.
• Recently a whole new raft of taxes on commodities
  have been introduced tires, batteries etc. to
  cover costs of disposal. Mostly in EU countries
  so far. Plastic Bags in some African countries.

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Key Analytical Issues

• What are the revenue gains from the tax and what
  is the welfare cost associated with the tax?
• What are the benefits of any reduction in other
  taxes permitted by the imposition of these
  commodity taxes?
• How do the changes impact on the poor and how can
  these impacts be mitigated through other fiscal
  reforms?
• What are the environmental impacts of the change
  in taxation in physical and monetary terms?

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Taxing Harmful Pollutants

• Direct classical externality tax.
• Taxes introduced in
• China on air and water emissions
• Colombia on water BOD and suspended solids
• Philippines on water discharges
• Malaysia on palm oil effluent
• South Africa on water effluent (under
  consideration?)
• Tax rates tend to be low
• Taxes are usually earmarked. (Controversial).

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More Recent Literature on EcotaxesWhat Happens
to Revenues?

• Should taxes go to budget or be earmarked for
  environmental programs?
• Pro earmarking argument is that it makes tax
  more acceptable by all parties and can reduce
  impacts on competitiveness
• Main anti earmarkingarguments are (a)
  environmental expenditures should not depend on
  environmental revenues (b) it makes application
  of unified public expenditure principles more
  difficult and reduces macroeconomic flexibility

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Analytical Tools MCPF
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Analytical Tools MCPF
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Analytical Tools MCPF

• With iso elastic demand and supply functions the
  MCPF can be written as

The price elasticity of supply is 1/ß and the
price elasticity of demand is 1/a.
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Analytical Tools MCPF. More Realistic Example
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Analytical Tools MCPF

• Approximation to full set of DWLs from a tax
  change is
• Difficulty is knowing the changes in Qj
• Estimates of MCPF vary a lot by tax. From
  slightly negative to over 2.

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Reductions in Environmental Burdens

• These can be estimated from changes in output and
  changes in emissions. Values of damage per ton
  are available now for a number of countries for
  air and water pollutants.
• The difficult part is estimating the reduction in
  emissions from a tax. This needs data on
  production technologies in different sectors.

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Distributional Effects of EFR

• Living standards surveys provide a lot of
  baseline data that can be used.
• Estimates of the loss of real income from a tax
  change on good i can be estimated as

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CGE Models

• Many sectors. Many parameters. Aim is to find a
  set of prices that clear all markets. These
  prices change as taxes change.
• Need data on
• I-O matrix (25 sector up to 200 sectors)
• Household expenditures by sector
• Household demand functions and export demand
  functions
• Technologies for each sector
• Exogenous inputs

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CGE Models

• Models for environmental analysis have a
  production block, a consumption block, a trade
  block and an environment block.
• On the environmental side CGE can analyze a range
  of policy instruments taxes, emissions permits,
  limits on emissions.
• Outputs will include
•  Output by sector and total output (GDP)
•  Employment by sector and in total
•  Consumer prices and consumer real incomes
•  Changes in incomes of different groups

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CGE Models

• CGE models are complex and data intensive.
• They require information on a whole host of
  parameters (200 typical) up-to-date input
  output matrices and on social accountng matrices
  that gives data on household consumption etc.
• This makes it difficult to construct such models
  in a credible way.
• Nevertheless data have been collected and models
  have been estimated for several African countries
  (Cameroon, Ethiopia are a couple of examples).
• Where models are available it is possible to
  modify them to take account of the environmental
  dimension, although this will take some time and
  resources.

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Using CGE Models. How/When A Carbon/Energy Tax
Can Create Employment?

• When firms switch away from energy to labour
• Effect is greater when elasticity of substitution
  between energy and labour is high
• And when elasticity of substitution between
  energy and capital is low
• When the carbon tax is recycled through a
  reduction in other taxes.
• Effect is greater when present taxes are
  distorted
• And when the the recycling is via reductions in
  high labour taxes.

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How/When A Carbon Tax Can Create Employment

• The economy has unemployment in the first place.
• Effect is greater when reduced labour taxes,
  which increase demand for labour, are not offset
  by increased wage demands
• The unemployment is not structural and the
  labour market can respond to increased demand.
• The economy may not have unemployment but labour
  supply may be responsive to increased real wages.

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How/When A Carbon Tax Can Create Employment

• The employment effect will be greater when
• Capital is not very mobile internationally (if it
  is, carbon tax cannot be absorbed by capital and
  has to be borne by labour, reducing employment
  effect)
• Non-working households are significant in number,
  so carbon tax can be passed on to them and less
  is borne by workers
• The country has enough international market power
  to raise prices of carbon intensive goods without
  causing a fall in production and therefore a fall
  in labour demand.

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A Simpler CGE Model

• There are 8 goods, one of which is leisure.
• The demand for these goods respects the
  conditions of a rational consumer
• Supplies of goods are perfectly elastic.
• The welfare change as a result of a tax can be
  approximated by

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Basic Data
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Further Basic Data
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Results of a 5 Inc. in Pet. Tax
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Pet. Tax Labor Tax Reduction that Leaves Revenue
Const.
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Further Models That Can Be Analysed

• A reduction in the subsidy on an environmentally
  damaging activity. Same as the analysis
  presented, except that the tax in question would
  be negative.
• A tax on emissions from a particular activity.
  This is more difficult and requires modelling the
  supply side of the economy. The tax will result
  in a change in the inputs to the production
  process, which in turn will change prices and, in
  so far as taxes are ad valorem, it will change
  tax rates. The impacts of the tax changes can be
  analysed once the changes in the price and taxes
  have been worked out.

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Further Models That Can Be Analysed
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Why Do All This When We Have CGE?

• The partial assessment allows for more detail in
  determining parameters and in modelling
  responses. The CGE model sets a straitjacket
  that restricts the inclusion of important
  material that may be ad hoc, but is important for
  the analysis
• It is easier to track the reasons for certain
  impacts and results in a partial model than it is
  in a full CGE model.
• It is easier to implement and needs less time
  that setting up a full CGE model

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Conclusions

• Experience in some of countries indicated that
  there are benefits to be gained from EFR.
• But rarely has anyone checked rigorously whether
  these tax reforms increased welfare.
• Here we provide some tools for the analysis of
  welfare effects, combining economic welfare
  calculations with those of the environmental
  gains and the social impacts.
• The choice between them will depend very much on
  the data, time and resources available.

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• Thank You!