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close this bookSteering Business Toward Sustainability (UNU, 1995, 191 pages)
close this folderPart two: Incentives
close this folder8. Ecological tax reform
View the document(introduction...)
View the documentIntroduction: Tax labor and income less, and tax resource throughput more
View the documentAllocation, distribution, and scale
View the documentConsumption and value added
View the documentPolicy implications
View the documentConclusions
View the documentReferences

Introduction: Tax labor and income less, and tax resource throughput more

In the past it has been considered desirable for governments to subsidize resource throughput* to stimulate growth. Thus energy, water, fertilizer, and even deforestation are still frequently subsidized. To its credit the World Bank (1992) has generally opposed these subsidies, but they remain widespread. It is necessary, however, to go beyond removal of explicit financial subsidies to the removal of implicit environmental subsidies as well. By "implicit environmental subsidies" I mean external costs to the community that are not charged to the commodities whose production generates them.

Economists have long advocated internalizing external costs either by calculating and charging Pigouvian taxes (after economist A. C. Pigou, who advocated taxes which when added to marginal private costs make the price equal to marginal social costs), or by Coasian redefinition of property rights (after Ronald Coase, who advocated property rights extensions such that values that used to be public property, and thus not valued in markets, become private property whose values are protected by their new owners). These solutions are elegant in theory, but often quite difficult in practice. A blunter but much more operational instrument would be simply to shift our tax base away from labor and income onto throughput. We have to raise public revenue somehow, and the present system is highly distortionary: by taxing labor and income in the face of high unemployment in nearly all countries, we are discouraging exactly what we want more of. The present signal to firms is to shed labor and substitute more capital and resource throughput to the extent feasible. It would be better to economize on throughput because of the depletion and pollution associated with it, and at the same time to use more labor because of the high social benefits associated with reducing unemployment.

More fundamentally, as we have moved from an "empty" to a "full" world, the remaining natural capital has more and more come to play the role of limiting factor, a role previously played by manmade capital. Our economizing effort must always focus on the limiting factor, according to economic theory. The theory has stayed the same but the identity of the limiting factor has changed. To economize on natural capital we must raise its price relative to man-made capital. We must do this by policy, such as ecological tax reform. There are many reasons why the market will not automatically bring about the needed increase in price on natural capital:

· Natural capital, for example, is the stock of trees in a forest that yields a flow of cut timber, or the population of fish in the sea that yields a flow of caught fish. The annual flow of cut timber and caught fish would be "natural income." Natural capital also provides a flow of natural services such as CO2 absorption, nutrient recycling, regulation of temperature, rainfall runoff, etc. Natural capital is common property, and lack of private ownership means it is unpriced.

· On the source side the running down of natural capital stocks and inventories increases short-run supply and lowers price. If all ranchers decided to liquidate their herds over the next five years and go out of business (in order, say, to invest in chickens), we would not be surprised to see falling beef prices for five years. That will not hold, however, in the sixth year.

· There are possibilities for substitution of abundant resources for scarce ones, within limits not yet reached.

· Externalizing costs of extraction and production keeps resource prices lower than they otherwise would and should be.

· Demand as well as supply affects price, of course, and ruling the demands of many interested parties out of the market keeps prices lower. For example, future generations do not bid in today's markets, and even the present's provision for the future is cut short by the practice of discounting. The survival needs of nonhuman species, like those of future humans, are not expressed in markets.

· Investment by the North in technologies to speedily extract resources in the South results in lower resources prices and a transfer of value from South to North.

· As will be discussed more in the next section, market prices only solve the problem of efficient allocation - and do so only by taking prior solutions to the problems of just distribution and sustainable scale as given. To count on market prices to solve the scale problem is a "category mistake," like trying to drive a screw with a hammer.

There is a growing consensus among a broad range of stake holders in the U.S., and even more so in Europe, concerning the need to reform tax systems to tax "bads" rather than "goods." Taxes have substantive incentive effects which need to be considered and utilized more effectively. The most comprehensive proposed implementation of this idea is coming to be known under the general heading of "ecological tax reform" (von Weizs├Ącker and Jesinghaus 1992, Costanza and Daly 1992, Passell 1992, Repetto et al. 1992, Hawken 1993, Costanza 1994). Earlier discussions of similar schemes were given by Page (1977) who considered a national severance tax, and Daly (1977) who discussed a depletion quota auction which is roughly equivalent.

Shifting the tax base to throughput induces greater throughput efficiency, and internalizes in a gross, blunt manner the externalities from depletion and pollution. True, the exact external costs will not have been precisely calculated and attributed to exactly those activities that caused them, as could theoretically be accomplished with a Pigouvian tax that aims to equate marginal social costs and benefits for each activity. But those calculations and attributions are so difficult and uncertain that insisting on them would be equivalent to a full-employment act for econometricians and bureaucrats, and prolonged unemployment and environmental degradation for everyone else.

Politically the shift toward ecological taxes could be sold under the banner of revenue neutrality. However, the income tax structure should be maintained so as to keep some progressivity in the overall tax structure by taxing very high incomes and subsidizing very low incomes. But the bulk of public revenue would be raised from taxes on throughput, which could be levied at the depletion or pollution end, or both. To minimize disruption, the shift could be carried out gradually by a pre-announced schedule. This shift should be a key part of structural adjustment, but should be pioneered in the North. Indeed, sustainable development itself must be achieved in the North first. It is absurd to expect any sacrifice for sustainability in the South if similar measures have not first been taken in the North. Later we will return to the theme of a North/South bargain as the international context for national policies of ecological tax reform.

The basic goal of ecological tax reform is to limit the throughput of resources to an ecologically sustainable scale and composition relative to the ecosystem, a goal until recently neglected. But the more traditional goal of efficient allocation of resources is also served by this instrument because it raises the tax on bads and lowers the tax on goods - it internalizes externalities in a blunt general way, without getting stuck in the morass of calculating Pigouvian taxes and fretting over secondary general equilibrium consequences. Another economic goal, of distributive equity, is both helped and hindered. The throughput tax is basically a capturing for public purposes of the scarcity rent to natural capital as economic and demographic growth increases its value. Rent is defined as any payment above the minimum necessary supply price for a factor of production. For land the necessary supply price is zero (no one has to produce it), so all payment for land is rent. Some payment for resources is rent. Rent increases with demand for land. Since rent is an unearned surplus there are strong ethical and efficiency reasons for taxing it. A throughput tax is not the same as a rent tax but its incidence will partly fall on rent from unproduced resources extracted from the land. A throughput tax has some of the equity appeal of Henry George's rent tax on land. However, like all consumption taxes, it is regressive. This could be counteracted by retaining the income tax at the extremes - a positive income tax for high incomes, a negative income tax for very low incomes, and a negligible income tax between the extremes. The essential idea is to gradually shift much of the tax burden away from "goods" like income and labor and toward "bads" like ecological damages and consumption of nonrenewable resources. Such a shift would encourage resource-saving technologies, and should simultaneously improve both employment and ecological sustainability.

Of the three major goals of economic policy (sustainable scale, efficient allocation, and just distribution) the ecological tax reform is primarily aimed at the first; contributes positively if non-optimally toward the second; and requires some supplement from an attenuated income tax structure to serve the third. These goals are discussed more fully in the following section.