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examBoard: Cambridge
examType: IGCSE
lessonTitle: Environmental Taxation
Environmental taxation is a key economic tool used by governments to help manage atmospheric pollution. These taxes aim to make polluters pay for the environmental damage they cause, encouraging them to reduce harmful emissions and adopt cleaner technologies.
Key Definitions:
When factories or vehicles release pollutants into the air, they create what economists call "negative externalities" - costs that affect society but aren't reflected in the market price. Environmental taxes try to fix this by making polluters pay for these external costs, which economists call "internalising the externality".
Environmental taxes can create a "double dividend" - they both reduce pollution AND generate revenue that governments can use for environmental projects or to reduce other taxes. This makes them particularly attractive as a policy tool compared to simple regulations.
Governments use several types of taxes to tackle air pollution. Each type targets different aspects of pollution and can be designed to suit specific environmental goals.
Carbon taxes are charged on the carbon content of fuels. The more carbon a fuel contains, the higher the tax. This encourages businesses and individuals to switch to cleaner energy sources and improve energy efficiency.
A set price (e.g., £20 per tonne of CO₂) is applied to carbon-based fuels. This increases the cost of high-carbon activities, making low-carbon alternatives more attractive.
Simple to understand, provides certainty about the carbon price and gives businesses flexibility in how they reduce emissions.
Can be politically difficult to implement, may affect low-income households disproportionately and requires careful rate-setting to be effective.
While not technically a tax, emissions trading schemes are market-based instruments that work alongside taxation to control pollution. They create a market for emission allowances.
The government sets a cap on total emissions and issues permits up to that amount. Companies must have permits for their emissions. Those who can reduce emissions cheaply sell spare permits to those who find it more expensive, creating a market price for pollution.
Unlike a carbon tax where the price is fixed, in an ETS the price fluctuates based on supply and demand. The cap ensures environmental targets are met, while trading allows emissions reductions to occur where they're cheapest.
Beyond carbon, governments tax other air pollutants that harm human health and the environment.
The UK's Climate Change Levy (CCL) is a tax on energy delivered to non-domestic users. Introduced in 2001, it applies to electricity, gas and solid fuels. Energy-intensive businesses can get discounts through Climate Change Agreements if they meet energy efficiency targets.
Results: The CCL has helped reduce energy demand in the business sector by an estimated 15% compared to what it would have been without the tax. It raises about £2 billion annually for the Treasury while encouraging businesses to invest in energy-efficient technologies.
How well do environmental taxes actually work in reducing atmospheric pollution? The evidence shows mixed but generally positive results.
Sweden's Carbon Tax: Introduced in 1991 at €27 per tonne of CO₂, now around €114 per tonne. CO₂ emissions have fallen by 25% since then, while the economy grew by 75%, showing economic growth can be decoupled from emissions.
UK Landfill Tax: Though not directly targeting air pollution, it has reduced methane emissions (a powerful greenhouse gas) by diverting waste from landfills.
Carbon Leakage: Businesses might relocate to countries with less strict environmental taxes, potentially increasing global emissions.
Regressive Effects: Environmental taxes can hit poorer households harder as they spend a larger proportion of income on energy.
Political Resistance: Introducing new taxes often faces strong opposition, making implementation difficult.
For environmental taxes to work well, they need careful design. Here are key principles that make them more effective:
Using tax revenue to reduce other taxes or support affected groups can increase public acceptance. For example, using carbon tax revenue to reduce income taxes or provide energy efficiency grants.
Applying taxes to imported goods based on their carbon content can prevent carbon leakage and protect domestic industries from unfair competition.
Starting with lower rates and increasing them over time gives businesses and households time to adapt and invest in cleaner alternatives.
The EU ETS is the world's largest carbon market, covering about 40% of EU greenhouse gas emissions. It operates in all EU countries plus Iceland, Liechtenstein and Norway, limiting emissions from approximately 10,000 installations in the power sector and manufacturing industry.
After initial problems with over-allocation of permits and price crashes, reforms have strengthened the system. The price of carbon has risen from around €5 per tonne in 2017 to over €80 in 2022, driving significant emissions reductions in the power sector as coal becomes uneconomical compared to cleaner alternatives.
Environmental taxes are most effective when part of a comprehensive approach to managing atmospheric pollution. They complement other tools like:
The most successful approaches to managing atmospheric pollution use a mix of these tools, with environmental taxation playing a central role in providing economic incentives for cleaner practices.
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