Pollution taxes?

By Eric Crampton 02/07/2015 1


The Environmental Defence Society wants a shift to taxing pollution. It sounds fine in principle, but there may be a few problems in practice.

For some things, like GHG emissions, where the negative effect is global rather than localised, it’s both simpler and harder. Taxation is simpler because you don’t have to worry about local circumstances: a tonne of CO2 emitted anywhere has the same cost. So the price per tonne should be the same everywhere. But it’s harder because, if only a couple of countries impose carbon pricing, you can wind up with perverse outcomes like production shifting from relatively clean countries imposing a tax to relatively dirty ones that don’t. Optimal policy is then harder to figure out. New Zealand should be a part of any comprehensive international taxation or trading regime. But absent one, we may do better with tech investments into pastoral emission abatement.

For others, like water drawing rights, the right policy is pretty obvious, but it could be a bit complicated to set up in practice. John Raffensperger, formerly of the University of Canterbury’s operations research group, wrote a series of papers (here, here, and here) showing how to do it. You need to know a fair bit about the underlying hydrology. But if you know that, you can set up a smart market in which farmers bid for drawing rights at different drawing nodes, and the system weighs up the effects of drawing at different points. Unfortunately, Canterbury’s Management department killed the operations research group as part of budget cuts and the usual depressing university politics, so there isn’t really anybody around pushing this kind of solution any more. Raffensperger’s now at the RAND Corporation.

Going beyond that, into things like nutrient runoff, nitrates and the like – that gets a bit harder again. Like water drawing, the effects will be highly location specific and will depend critically not only on what other neighbours are up to but also on what downstream water uses are. But it’s easy to meter how much water is drawn from a river or aquifer. Metering nutrient runoff is harder. Agreeing on downstream usages is much harder – and especially around option value. And, because there is no single effect across the country, you could never run it as a straight pollution tax and expect decent outcomes. Finally, from a public choice perspective, we have to worry about those who’d set tax rates to maintain every river as a potential drinking water source rather than recognising that they can vary in value.

The EDS proposal was summarised by Jamie Morton at the Herald, drawing from discussion at Pure Advantage.

How the Environmental Defence Society’s proposal would work

  • The tax would be based on land area and the intensity of its use as identified from high-resolution satellite imagery and land title information.
  • It would put a price on all the major environmental impacts of intensive land uses, including biodiversity loss, greenhouse gas production, accelerated runoff and pollution from nutrients, sediment, fecal coliforms and toxins.
  • Low intensity land uses that supply largely natural ecosystem services would earn a rebate at a per-hectare rate commensurate with opportunity and management costs borne by the landowner and the value of those services to society.
  • Different parts of a single property would therefore be subject to different per-hectare tax rates based on the cover on, and use of, each part.
  • A landowner could minimise tax liability by confining the most environmentally intensive uses to small areas and improving the state and legal protection of natural areas.
  • Revenue raised could fund increased conservation and environmental management, climate change mitigation or other general government expenditure. Similarly rebates could be spent at the landowners discretion on conservation or other priorities.

EDS suggests that the tax could both improve environmental outcomes and reduce reliance on more damaging taxes.

While I like the idea of subsidising land uses that provide national benefit rather than compelling such use, the tax scheme here seems to be trying to serve too many purposes at once. You’d first have to set a baseline level of environmental intensity against which other uses would be compared for tax or subsidy. That baseline plus sharpness of tax/subsidy gradient would determine whether the scheme were revenue neutral, revenue-raising, or impose net cost on the budget. Ideally, you’d set the gradient to internalise the externalities, not to achieve any particular revenue-raising target. And any subsidy should be far more based on the value of those services than on costs of production. Whatever money comes out of it should be a side-effect.

I’m also really not sure how you could judge this based on high resolution satellite imagery. Again, any tax or subsidy would have to depend not only on your own use but also the neighbourhood. Imagery could capture much that’s correlated with the variables of interest, but wouldn’t directly measure it. If I’ve run a better water treatment plant on my milking shed and you’ve not, could the satellite pictures tell the difference? If we’re both then taxed on an average, what does that do to your willingness to invest in better kit?

It’s all the kind of thing that I wish could work, but has a lot of technical difficulties even if we assume that the system would be run sensibly. Once we think about the very likely politicisation of the scheme – it gets more worrying.

Morton quoted me as follows:

Dr Eric Crampton, head of research at the New Zealand Institute, said that in principle, taxes on pollution were far better than taxes on income so long as they were set properly – but this was very hard to do.
A land use-based tax could be unfair if a farmer who used better practices to reduce nutrient runoff and faecal coliform – which were invisible to satellites – was made to pay the same rates as a neighbour who had not.
“Second, the environmental cost of activity on any one piece of land depends a lot on what else is going on in the area – setting a tax and subsidy scheme to account for that does not seem simple.”
Environment Minister Dr Nick Smith has not reviewed or received any advice on the concept, but he also said the approach could be flawed.

We’re the NZ Initiative, not the Institute, but it’s all good.


One Response to “Pollution taxes?”

  • Nice to see some engagement but your response seems to be predicated on two unexplained assumptions. First, your baseline for assessment is some ideal in which externalities are perfectly internalised. Surely the correct baseline for comparison is the current system in which landowners consume ecosystem services for free and provide them without reward leading to very much less environmental maintenance than is socially optimal. You need to explain why some unachievable ideal is a better baseline for evaluation of the EDS proposal than our present reality.

    Second you assert, again without explanation, that an environmental consumption tax should internalise externalities and not aim to achieve other goals such as revenue. “Whatever money comes out of it should be a side effect”. That seems very strange to me. It certainly is not consistent with alcohol and tobacco tax or with ACC. Surely there are other perfectly valid goals for such a tax, such as (1) broadening the tax base to include currently untaxed capital assets (i.e. land), (2) making the tax system fairer by shifting a some of the burden off wage and salary earners and onto land-based businesses, (3) enhancing economic growth by reducing growth limiting taxes (income, company and arguably GST), (4) raising additional revenue to help pay for some rather large looming costs of climate change mitigation and adaptation and (5) creating a novel institution to bring divergent public, private and government interests in the environment toward alignment. Surely the ideal tax is one that finds a ‘socially optimal’ balance across these and other goals. That said, what is truly socially optimal is unknowable. Therefore that ‘balance’ would inevitably be determined politically, just as it has always been for every other tax. I don’t see why that would be such a terrible thing given that the ‘ideal’ is an unattainable mirage. However, I can see that the political power of landowners is such that that they may well manage to ensure their land-based wealth continues to be taxed at a much lower rate than other forms of wealth so that the environmental consumption tax would be no more useful than our emissions trading scheme.

    You also say that the tax would be unfair if the data used to categorise land were unable to differentiate good from bad farming practice. Well, first, what tax is truly fair? None that I know of! Straw men aside, I see no reason other than administrative expense why nitrogen data from the OVERSEER model could not be used to further differentiate farmland in order to differentially reward or charge good and poor practice. More generally, high-resolution differentiation is possible with regularly updated property level field data but getting those data and managing it adds administrative and compliance cost. Presumably there is an optimal tradeoff between differentiation and administrative cost that should be identifiable with appropriate modelling.

    I’d like to see some serious macro-economic and micro-economic modelling of several versions of the environmental consumption tax to see what its social and economic costs & benefits might be.