UBS HSC Economics Note. Environmental Management Policies. i) Legislation, Regulation and Standards

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1 UBS HSC Economics Note Environmental Management Policies Economics Note 3 Discuss the policies that the Australian Government may use to encourage more sustainable management of the environment Feb Economies that pursue high rates of economic growth tend to experience a deterioration in their natural environment through negative externalities such as pollution and the depletion of natural resource stocks through destructive practices such as deforestation and land degradation. Increasing volumes of natural resources are required to sustain higher rates of global economic growth and the creation of a growing stream of waste products and pollutants (including greenhouse gases) is another consequence of the growth process. Peter Kennedy Head Teacher/ Teaching and Learning at Castle Hill High School The Australian government, like virtually all governments of progressive economies has had to move towards policies that encourage more sustainable use of environmental resources. Embedded in this quest is the pursuit of ecologically sustainable development (ESD) where the key objective of environmental policies is to achieve development that meet the needs of the present without compromising the ability of future generations to meet their own needs. At the heart of the ESD approach to environmental management is the desire to change the nature of economic activity and in particular the threats that conventional economic growth and development processes pose to our natural and cultural environments. In accordance with ESD, decision making processes should effectively integrate long term economic, environmental, social and equitable considerations. The present generation should ensure that the health, diversity and productivity of the environment is maintained or enhanced for the benefit of future generations. The conservation of biological diversity and ecological integrity should be a fundamental consideration in decision making. with improved valuation, pricing and incentive mechanisms promoted in respect to the utilization of environmental resources In order to foster more sustainable management of the environment, the Australian Government must respond to market failure arising from environmentally destructive practices like pollution and resource depletion. There are three main types of strategies used here: Legislation, regulation and standards subsidies and financial assistance economic instruments or market based approaches We will now discuss each of these approaches: i) Legislation, Regulation and Standards Traditionally societies have relied on regulation and legislation to achieve compliance with a particular standard of social or economic behaviour. Governments have attempted to deter market failures such as the pollution of airways and waterways through legislation and regulation enforced by designated authorities or agencies. In

2 the most extreme cases, punitive measures such as fines and even gaol sentences may be applied to the offending parties. For example there is now a tiered structure of offences and penalties for polluting activities in NSW under the Environmental Offences and Penalties Act (1989) where a maximum penalty of $1 million for a corporation and $150,000 or 7 years imprisonment for individual offenders is applied. These policy mechanisms (legislation and regulation) are commonly referred to as command and control instruments and have been preferred by governments because of their directness. For example, firms and even consumers responsible for environmentally damaging practices like pollution or littering are required by law to adhere to an environmental standard or sanctions will be imposed. The responsibility for enforcing command and control policies is usually vested in a delegated government authority or regulatory agency. The legal mechanisms for achieving compliance include ordinances, by-laws and statutes. ii) Subsidies and Financial Assistance Subsidies (payments made by the government to private interests) are used in many countries to encourage more environmentally responsible behaviour on the part of consumers and businesses. The main forms of financial assistance are grants, soft loans and accelerated depreciation. The main function of subsidies is to help businesses and consumers adjust their environmentally threatening behaviour usually during a transition period. Subsidies are usually financed out of treasury funds or though special revenues attained via environmental taxes and charges used to finance special programs earmarked by the government. The purchase of water entitlements from irrigators as part of the Murray Darling Basin management plan and the recently abandoned Cash for Clunkers initiative for encouraging the purchase of new low emission vehicles by consumers are examples of recent Australian government environmental programs encompassing the payment of subsidies or provision of financial assistance. iii) Economic instruments or Market Based Approaches Economic instruments, sometimes referred to as market based approaches or market instruments are designed to provide market signals in the form of a modification of relative prices (e.g. taxation on certain products) and /or a financial transfer (payment of a charge). An important feature of economic instruments is that they leave freedom of choice to economic agents such as polluters, who can select the most advantageous solution, such as either paying a pollution charge or investing in pollution control technology. (a ) Pigovian Taxes The traditional economic instrument suggested for correcting market failure was what has become known as a Pigovian Tax so named after A.C. Pigou whose early work now stands as a landmark in the development of applied welfare economics. The Pigovian tax was typically applied to the case of negative externalities and usually suggested as an approach for correcting the problem of pollution. The main concept here is to tax the polluter according to the external cost he or she imposes on others.

3 The Pigovian tax solution requires the intervention in the market of some government authority to assess and administer the tax. If pollution externalities are widespread or are pervasive to the system, then the activities of government will also have to be extensive reaching down into most aspects of economic activity. To a certain extent this appears to be the case in practice as when we look at the range of tax measures used in modern economies (especially developed economies,) it appears that nearly every economic activity is affected by some type of tax. The range of taxing and charging mechanisms used by OECD countries includes taxes/ charges on waste, water, effluent, noise pollution and products like petrol and cigarettes. Many of these taxes/ charges are simply designed to collect revenue as opposed to correct socially unacceptable practices. This is contrary to the requirements for an efficient system of taxation where incentives are provided for more socially responsible forms of behaviour by consumers and producers. b) Emission Taxes and Charges The product charge or product tax is a commonly used form of tax for correcting market failure. Here a charge is set on either a product or the inputs used to make a product. An example of a tax on a product would be petrol or gasoline tax while a tax on an input could be a resource tax or charge where firms are taxed according to their use of a particular resource, for example a water usage charge. Either way, the charge or tax is expected to reflect the value of environmental services used in production. Resource Rent taxes are another tax instrument favoured by many resource rich countries around the world which can be designed to encourage more sustainable development of environmental resources. For example, Australia has a predominantly state- based system of existing resource taxes and royalties designed to collect a share of the increasing profitability of Australia s expanding resource sector. More recently a new Mineral Resource Rent Tax (MRRT) has been proposed by the Gillard Government which is designed to levy a tax on 30% of the super profits from the mining of iron ore and coal in Australia. Another commonly used economic instrument is the emission charge or pollution tax where payment is made according to the quantity and quality of pollution discharged. A good example here is the carbon tax. A carbon tax is a tax on energy sources which emit carbon dioxide and hence is a pollution tax designed to address a negative externality. The underlying purpose of a carbon tax is to reduce emissions of carbon dioxide and thereby slow global warming. It can be implemented by taxing the burning of fossil fuels coal, petroleum products such as petrol and aviation fuel, and natural gas in proportion to their carbon content. Ideally the emission charge /tax would be set equal to the marginal external cost (MEC) of the pollutant. More realistically, the polluter would be expected to conform to an acceptable standard of environmental quality, e.g. the discharge of X amount of litres of effluent into a local stream per year or a certain level of carbon dioxide into the atmosphere and then, a charge or tax is imposed on additional units of pollution, thereby penalizing the heavier polluting firm. In the case of a carbon tax countries such as Australia have considered a mechanism where a fixed price on each unit of carbon emitted is set and businesses effectively pay a tax on each unit of carbon pollution they are responsible for.

4 (c) Tradeable Permits/Emissions Trading Schemes An alternative to modifying market behaviour by using taxation instruments is to create a market for the negative externality in question. Once a standard for behaviour has been set, for example a maximum level of a particular pollutant being allowed to be released into the atmosphere, it is possible to issue permits to polluters allowing them to discharge only a certain level of the pollutant. A market can then be established for the permits enabling them to be bought or sold. This is commonly referred to as a market for tradeable permits or transferable emission permits. Under this type of system, each firm must have a permit to generate emissions. Each permit specifies exactly how much the firm is allowed to emit. Any firm that generates emissions that are not allowed by permit is subject to substantial monetary sanctions. Permits are allocated among firms, with the number of permits chosen to achieve the desired maximum level of emissions. The permits are marketable- they can be bought and sold. Under the transferable emissions permit approach, a delegated government authority would be responsible for ensuring overall compliance by polluters with the environmental standard. The responsible authority would only supply a certain number of permits. If the authority desires to tighten the pollution standard then they can buy back the permits. By reducing the number of available permits the pollution authority will lower the allowable level of pollution. Tradeable emissions permits create a market for externalities. This market approach is appealing because it enables pollution reduction to be achieved at minimum cost. The theory is that those who can cut back their pollution cheaply do so and sell their surplus permit allocation to those who cannot. The overall effect should be to drive pollution reduction at the lowest cost to the companies involved and potentially to their customers in the form of lower prices. This is one of the main reasons it has become the preferred economic method for combating the problem of global warming and the build up of greenhouse gases in the atmosphere. The carbon tax and emissions trading instruments are at the heart of the Australian Governments current approach to sustainable environmental management. By July 2011 the Gillard Labor Government had managed to gain support by the Greens MPs to establish a fixed price on carbon from July 1, Under this scheme a fixed price on carbon would be imposed for three years before moving to a full emissions trading scheme, despite there being no global agreement on climate change targets. The implementation of a fixed price on carbon (i.e. $23 per tonne) from July 2012 which rises by 5 per cent per year and switches to a flexible price cap- and trade emissions trading scheme in July The carbon price mechanism is designed to cover the energy sector, transport and industrial processes but agriculture was to be excluded through credits attained through a so called Carbon Farming Scheme. While the possibility of catastrophic damage due to climate change is a major concern to all countries of the global economy many developed countries seem dubious to act because of the fear of what is termed carbon leakage. Carbon leakage occurs when one country acts to reduce emissions by raising the cost of carbon pollution to its local producers giving countries that do not act to mitigate (reduce emissions) a trade

5 advantage. This imposes a negative impact on the competitiveness of countries that act to mitigate emissions which may lead to a shift in production from these countries to those which do not impose penalties on carbon polluters. It is often argued that carbon leakages will arise if there is no uniform global emissions tax or equivalently, if there is no free international trade in emissions permits through an international cap and trade emissions trading scheme. The empirical evidence in support of carbon leakage is debatable with some observers arguing that any damage to developed countries from carbon leakage will be small. In conclusion, the path to the sustainable management of environmental resources will require an effective integration between economic and environmental policies. There are numerous complementary tools to achieve this but economic instruments are generally believed to be the most cost effective ones as they are based on market mechanisms. However, while economic instruments can play a key role they need to be part of a comprehensive economic restructuring effort encompassing broader tax reform, welfare reforms along with productivity enhancing industry policies designed to move the Australian economy into a more efficient, less carbon dependent, phase of development.