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Taxes and the Environment: What are green taxes?

Green taxes (also called "environmental taxes" or "pollution taxes") are excise taxes on environmental pollutants or on goods whose use produces such pollutants. Economic theory suggests that taxes on polluting emissions will reduce environmental harm in the least costly manner, by encouraging changes in behavior by those firms and households that can reduce their pollution at the lowest cost. In practice, green taxes-even indirect ones, on proxies for emissions or on related goods-have rarely been imposed. Some examples can be found in Europe, but virtually none in the United States.

  • Pollution can be regarded as a cost of producing goods and services, but one that is borne not by the polluter but instead mostly by others in the form of a damaged environment (in forms ranging from noxious odors to impaired health to changes in climate). A pure environmental tax aims to ensure that polluters face the true cost of their activities by charging them for the damages caused to others.
  • Direct taxes on emissions are economically efficient because they give polluters an incentive to reduce their pollution up to the point where further reduction would cost more than paying the tax, and to do so in the least costly way.
  • Indirect taxes, such as taxes on related goods, or alternative policies, such as mandated technology standards, may not reduce pollution in the least costly way. For example, imposing a higher gasoline tax to reduce the environmental damage from automobile emissions gives drivers no incentive to maintain their cars' pollution control equipment, and mandating pollution control equipment provides no incentive to drive less.
  • Direct emissions taxes are also cost-effective because they ensure that pollution reductions are undertaken by those who can do so most cheaply. Firms that find pollution abatement costly will choose to continue to pollute and pay more tax, while those who find it less costly will cut their pollution rather than pay more tax.
  • Tradable permit schemes are another alternative to emissions taxes, and can be just as cost-effective. These schemes limit the quantity of allowable emissions by issuing a fixed quantity of emissions permits, which polluters may then trade among themselves. The permit price plays a role analogous to a tax: polluters with high costs of reducing their emissions will instead buy permits that let them continue to emit, while those that can cut emissions at lower cost will do so and then sell their unused permits. Tradable permit schemes may have different distributional effects than pollution taxes, however, depending on whether the permits are given away (and to whom, and on what basis) or auctioned off. Examples of such schemes are the acid rain provisions of the U.S. Clean Air Act and the European Union’s Greenhouse Gas Emission Trading Scheme.
  • Subsidies for emissions reductions do not have the same effect as emissions taxes. Subsidies increase the benefits of belonging to the subsidized group and may result in more polluters, each polluting less, with no net decrease in emissions.
  • One proposed green tax that has recently gained favor is a carbon tax. This would impose an excise levy on the carbon-based content of fossil fuels as a means of reducing greenhouse gas emissions that contribute to global warming. Estimates vary widely of the external costs associated with these fuels, whose combustion releases carbon dioxide into the atmosphere. In a recent review of twenty-eight published studies, the median incremental damage estimate was $14 per ton of carbon, but a handful of estimates found damages above $350 per ton.
 
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