Basing environmental taxation on opportunity costs

‘The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person’ (Smith, 1971, bk 5, ch.

In order to appreciate the breadth of this statement, consider the example used before in the following way. After the electric power plant has been installed and power supplies have been improved for the region, the wine growers suddenly and unexpectedly experience heavy losses due to the forma­tion of mist in the valley.

An environmentally and ecologically relevant tax needs to be a tax that affects the choice-influencing costs. In designing such a choice-influencing environmental tax, we have to look for the time and locus at which environ­mentally relevant choices are made. Since these choices are not made on any basis of periodicity as a normal tax would require, an incentive needs to be created which triggers the tax. This may sound paradoxical, since a tax is by definition an involuntary payment that for this very reason tends not to be initiated by the entity to be taxed. In the case of environmentally relevant taxes, however, the situation must be different. Neither choice-influencing costs, which are subjective, nor locus and time of decision making are directly or indirectly observable by an outside agency, such as a tax authority.

The objective of the tax is to encourage environmentally and ecologically preferable plant design, production processes and production management, but what this design, these processes and the management will be is known only to the decision makers involved, and only after an appropriate decision­making process has been launched. This implies that the tax involved can only be of the type of an incentive. If that is the case, however, the question arises as to what might constitute the tax base.

As we noted above, partitioning of property rights so as to make different resource use compatible in fact moves the production possibility frontier in a north-eastern direction. The resulting production potential constitutes a source of earnings for the participants, which in itself constitutes a tax base. When a tax authority tries to encourage the creation of a stream of income in order to broaden the tax base, it can grant deductions as an incentive. Such deductions can then form an appropriate lever to encourage environmentally or ecologi­cally desired changes, which cannot be prescribed but can only be triggered by way of incentive. The system then takes on the following form. When a particular project is to be added to an existing ecosystem, as in our case of the power plant, building and operation permits need to be secured as usual. Similarly, financing will be dependent on these permits. Under the present regime, no particular attempt at redefining property rights through multiple negotiations can be expected. The transactions costs required to lead to an optimal repartitioning of property rights in these cases can be assumed to be substantial. It is here that the ecological tax instrument must provide a lever.

An opportunity for renegotiating a partitioning of property rights in order to make different uses of the same resource compatible can be created by providing for a tax incentive on the grounds of ecologically desired improve­ments. If a scheme such as the one outlined above can be presented and shown to lead to substantial savings and/or extended production possibilities, an x year tax credit for the income generated through the scheme can be granted upon certification by an environmental regulatory authority. The tax credit can, in turn, be used as collateral for the outlays needed in order to facilitate implementation of the agreement arrived at. This solution implies that the information needed for the decision of the tax authority is totally forthcoming from the parties involved and, as it needs to be certified by the environmental regulatory authority and does not require any additional infor­mation gathering on the part of the tax authority there is little room for error or misjudgement. The tax credit can easily be implemented within the con­text of current procedures, and the tax base has been broadened by the volume of the income generated (I) through repartitioning of property rights multiplied by (n - x), with n being the time during which taxes can be expected to be levied. The tax base is:

with r being the relevant discount rate.

As we look at Adam Smith’s criteria, we notice that this scheme violates every single aspect of his principle of certainty. The tax incentive is not the same for each taxpayer, as it crucially depends on the specifics of the repartitioning scheme negotiated. Although the tax incentive is not arbitrary, it is certainly not well known in advance. The time at which it becomes effective depends only on the activities of the taxpayers, as does the manner of payment, as even does the quantity to be paid, and none of these is clear and plain in advance. What becomes clear and plain is the tax credit, as this instrument needs to be used as collateral. The tax credit, in turn, drives the implementation of the scheme. If the authorities err in setting the tax credit too low, the scheme will not be launched and the additional increase of the tax base will not be forthcoming. If they set it too high, they still increase the tax base but forgo some tax revenue.

Interestingly enough, the environmental tax as a tax credit satisfies the double dividend criterion. The double dividend even has an institutional realization. The environmental dividend is being certified by the environmen­tal authority and the fiscal dividend is being certified by the tax authority granting the tax credit.