APPENDIX 20
Memorandum from Economics for the Environment
Ltd (EFTEC Ltd)
INTRODUCTION: GOVERNMENT
POLICY ON
MARKET BASED
INSTRUMENTS[30]
1. We wholeheartedly support the efforts
made by government to introduce market-based instruments (MBIs)
in an effort to make environmental policy more efficient. In particular,
we support the introduction of environmental taxes on "externalities"
(uncompensated environmental damage to third parties), the use
of tradable permits and quotas, and "hybrid" instruments
that combine these features with so-called "negotiated agreements".
Indeed, one of us is partly responsible for the initial advocacy
of such measures in the United Kingdom[31].
2. However, while it is generally correct
to introduce MBIs, it does not follow that all and any MBI is
justified. Much depends on the form taken by the MBI and the institutional
and economic characteristics of the economic activity that is
targeted by the policy initiative. Indeed, government has itself
rejected MBIs in some contexts precisely because they are not
always efficient when placed in the context of prevailing regulation[32].
Criticism of a particular initiative is not therefore a criticism
of all MBIs. We believe that the proposed aggregates tax has a
number of deficiencies. These are set out below. Our conclusions
depend on particular factual issues being correct. If our assumptions
can be shown to be incorrect, then our conclusions can be challenged.
But we have not seen better evidence than we have assumed here.
THE AGGREGATES
TAX
3. In order to build up our argument we
focus first on the aggregates tax in isolation. We then consider
its role in the overall package of tax plus negotiated agreement.
4. The proposed aggregates tax has its foundation
in environmental economics analysis which indicates that a tax
on the externalities from a given economic activity is an efficient
way of reducing those externalities. The critical point of
an environmental tax is that it can be avoided by undertaking
changes that reduce the source of the externality. For this
to be true, however, the tax must get as close as possible to
the externality itself. For example, if a given product is associated
with particular emissions of pollution, it is the emissions that
should be taxed rather than the product. The exception to this
rule occurs when there is a "one-to-one" relationship
between the product and emissions. As an example, taxing vehicle
fuels is a reasonable approximation of a tax on carbon dioxide
for purposes of climate change policy because there is a specific
relationship between fuel use and CO2 emissions. We acknowledge
that it is often difficult to tax the externality directly and
that real-world policy is often forced to implement less perfect
("second best") solutions. But this does not alter the
fact that second best solutions can often be a very long way from
a desirable solution. Hence the first point we make is that
the aggregates tax is not a tax on the externalities from the
use and transport of aggregates. It is a tax on the product, namely
the tonnage of aggregates.
5. We are very aware that government economists
know the second best nature of the aggregates tax. Product taxes
on their own may not provide an incentive to reduce the externality.
To see this, consider whether the industry, facing a per tonne
tax, has any incentive to reduce the tax by reducing emissions
and disamenity. It has none because changing the level of externality
does not in fact reduce the tax at all. The only action that reduces
the tax is to reduce the quantity of aggregates. The issue is
therefore one of just how efficient or inefficient the actual
proposal is. The main reason for supposing that it is inefficient
is that the demand for aggregates is, on the available evidence,
inelastic[33].
What this means is that the tax on the product will have a comparatively
small effect on the demand for the product. Hence the overall
tonnage of aggregates in the industry is not likely to fall much.
But because the tax is a second-best solution, the main environmental
effect of the tax works through the change in the tonnage. Hence
comparatively small environmental gains would follow if the tax
was implemented on its own. We have seen nothing that would alter
our argument in this respect.
6. To make an inefficient tax more effective
there are several things that can be done. The first is to differentiate
the tax according to the type of product, in this case between
recycled and "virgin" aggregates, and between quarries
in sensitive areas and less sensitive areas. The second is to
hypothecate some of the tax revenues into environmental schemes
that are directed specifically at the externalities. The third
is to use the tax as a threat to the industry so that it "puts
its own house in order". The fourth is to retreat from a
"pure tax" solution and mix the tax with other "command
and control" regulations[34].
7. As far as we understand government policy,
we believe that all these modifications are being proposed or
are under consideration.
8. We understand the tax will not apply
to recycled aggregates, only to virgin aggregates. This should
have some effect on encouraging the use of recycled aggregates
with a consequent reduction in quarrying. But the issue is how
much substitution it would engender. ECOTEC (1999) suggests a
number of reasons why this substitution effect is likely to be
small[35].
The cross-price elasticity of demand appears to be small, total
wastes available are a small proportion of total aggregates use,
and qualities differ[36].
If the relevant elasticity is small, the tax will have little
effect in encouraging substitution.
9. We are not clear if it is the intention
to apply a different tax rate to quarries in national parks than
outside national parks. Such a differentiated tax would have a
justification because the externalities in national parks are
very much higher than outside national parks[37].
An alternative to a differentiated tax would be to tighten planning
restrictions in national parks, but if this is the intention then
it is not clear why the elaborate structure of an aggregates tax
is needed in the first place.
10. Given the precedent of the landfill
tax, and the proposals for the Climate Change Levy, we would suppose
that some hypothecation of aggregates tax revenues into externality-reducing
schemes is also under consideration. To our knowledge, however,
there has been little research that attempts to evaluate the environmental
effectiveness of this particular form of hypothecation. We see
no objection in principle to the idea of hypothecating revenues
for environmental initiatives—indeed we can think of good
reasons why it should be encouraged in principle—but it
should be incumbent on those who advocate the tax to show that
this is a socially efficient use of tax revenues.
11. The "threat" of a tax is perhaps
the most powerful reason for supposing that the modified approach
will work. If demand for aggregates is inelastic the effect of
a tax is to transfer substantial resources from the industry to
the government. To avoid this, the industry should therefore be
prepared to implement its own measures to persuade government
to reduce the tax. Fairly obviously, any such measure can secure
its goal provided the industry has a credible programme to "beat
the tax". The problem we drew attention to in our earlier
report is that threats need to establish reasonable targets for
the industry to beat the tax[38].
It seems to us that there is only one logical comparison: industry
must do at least as well, and ideally better than the tax in reducing
the externality. We have seen some of the exchanges between DETR
and the QPA and we note some confusion over exactly what it is
that the industry is expected to do. For example, it seems clear
that, at one stage, the industry was being asked to secure externality
reductions against the benchmark of the total estimated externality
from the industry of some £250-300 million[39].
This is not the correct comparison. Not only should all the externality
not be eliminated[40],
but there can be no logical argument why industry should achieve
far more than the tax would achieve. Otherwise the point of introducing
the tax in the first place seems to be lost. One response might
be to argue that the tax is known to be inefficient of itself
but that, because it has the effect of transferring significant
resources from the industry to government, it is nonetheless a
powerful incentive for the industry to produce a radical programme
for externality reduction. Again, for the threat to be credible,
government must be prepared to introduce the tax. It seems to
us to be a rather perverse threat that rests for its credibility
on the introduction of an environmentally inefficient tax. Of
course, if the tax can be shown to be environmentally efficient,
this conclusion would not follow. But we are not convinced that
the tax would be efficient.
12. If the aim is to mix the tax with command
and control measures such as tighter land use controls, then,
as noted above, it raises the question of why the tax is being
introduced in the first place.
How much externality reduction should the industry
achieve?
13. We think the only logical and fair comparison
of alternatives is in terms of what each would achieve. Industry
should therefore do better than the tax would have done if it
was the sole instrument of policy. In our earlier report we estimated
what we think the tax would achieve by calculating the reduction
in demand for aggregates based on the ECOTEC estimates of demand
elasticities. We did not take account of effects on the use of
recycled aggregates, but, for the reasons stated above, we are
not persuaded that these will be significant. We suggest that
the tax would secure perhaps a 5 per cent reduction in the overall
externality[41].
Our highest estimate was about 11 per cent and our lowest 2 per
cent.
14. We conclude that industry must do better
than approximately a 5 per cent reduction in the overall money
value of the externality.
Can the aggregates industry achieve this target?
15. We do not know if the aggregates industry
can achieve a target reduction in the externalities of some 5
per cent. It is for the industry to convince government that it
can. But we can offer some guidelines. We can ask whether industry
in general can achieve this kind of target through the introduction
of various environmental measures. One problem is that there are
few quantitative assessments of the achievements of environmental
management schemes (EMASs). Given their extensive use we find
this surprising, but one explanation may be that they are too
recent to have been evaluated. We suspect, however, that another
reason is that they are seen as ends in themselves, ie that once
a management scheme is implemented this is seen as fulfilling
the goal of environmental achievement. Since this most clearly
cannot be assumed, our original report tried to focus on self-regulation
and voluntary agreements (essentially the old name for negotiated
agreements) where there was some quantitative information. We
found that a reasonable number of such EMASs had quantitative
targets and that these were often in terms of more than 5 per
cent reductions in air emissions and water discharges.
16. The final issue, then, is whether the
aggregates industry has a credible package of measures in its
"New Deal" to convince government that it could secure
reasonable externality reduction targets. We have not seen recent
exchanges between QPA and government but earlier exchanges clearly
indicated that government does not believe the industry has a
sufficiently aggressive package of measures. Unfortunately, as
noted above, we are not clear what the yardstick of achievement
is meant to be—elimination of all the total externality
(which would, in our view, be absurd) or some percentage of it,
and if so what that percentage is. We cannot say if the 5 per
cent target is achievable, but we can say that, as far as the
limited data permit, we believe other industries are achieving
that kind of target (even though those targets are not articulated
as reductions in externality per se). There may be reasons for
supposing the aggregates industry is "different" to
other industries but, as noted above, we do not have the qualifications
for making those judgements. We did survey a number of quarrying
companies and we noted in our earlier report that the industry
could not be classified as being in the forefront of environmental
achievement. But if this is true it does indicate that it should
be comparatively easy to make inroads into emissions and disamenity
concerns, at least in terms of technological solutions. We did
note that, on the basis of the industry proposals then before
government[42]
and on the basis of what we regarded as the criteria for the likely
success of self-regulation, a number of further actions would
be needed to make the New Deal successful. Most importantly, these
included clearer quantitative targets and the design of more incentives
for management and workers to comply with the self-regulation
targets.
17. The aggregates industry proposes an
"internal tax" of 10p/tonne and we understand from QPA
that this continues to be one source of significant disagreement
between the industry and government. If the 10p/tonne figure is
meant to "mimic" the tax that government would impose,
then it is clearly below the 34p/tonne average (for crushed rock)
for non-national park areas, and well below the £2 per tonne
for sand and gravel. The argument then is that it does not matter
who imposes the tax—government or industry—since the
effect should be the same. But the issue is again what is being
compared with what. If we are right, and industry has to do better
than the government tax would have done on its own, then the 10p
internal charge may be sufficient to meet the target. It depends
on the "productivity" of the internal tax and on the
overall effectiveness of the "New Deal". Effectively,
the government's position appears to be different to this. It
appears to be saying the industry must raise as much revenue as
the government's tax would raise (or somewhere near it) because
the government revenues could have been hypothecated to externality
reduction. Hence the internal tax revenues must be just as high
because, ex hypothesi, they will be allocated to externality reduction.
Are all environmental taxes bad?
18. We indicated at the outset that we support
government initiatives on environmental taxation and on other
market-based instruments. How is it possible to express this general
support whilst criticising the aggregates tax? First, general
support carries with it no logical implication that a tax should
be supported regardless of its context or design. Second, we are
not alone among environmental economists in arguing that this
particular context is not the best one for an environmental tax[43].
Third, we think there are some differences between this tax and
other taxes.
19. To illustrate our third point above
we can compare the aggregates tax with the landfill tax. Both
taxes have been informed by careful studies of the externalities
involved. Both are "product" based in the sense that
the landfill tax is charged per tonne of waste and the aggregates
tax per tonne of aggregates. Both taxes have the potential to
be differentiated according to the externality. Thus, the landfill
tax is differentiated between organic and inert waste and the
aggregates tax could be differentiated between national parks
and other sites. The landfill tax can be avoided by not sending
waste to landfill at all, ie by recycling or source reduction.
The aggregates tax has a similar potential incentive: by not producing
aggregates or by using recycled materials, the tax is avoided.
What limited evidence there is suggests that the relevant elasticities
of demand are also low for landfill (perhaps lower). The difference,
we think, is in the potential for self-regulation in the aggregates
industry compared to self-regulation affecting the flow of waste
to landfill. In aggregates the negotiated agreement is with one
industry organisation, although we accept that there are quarrying
corporations outside of QPA. It is less clear who the parties
to a negotiated agreement on landfill waste would be. Separate
agreements would be necessary for industrial landfill waste (about
45 per cent of the total going to landfill), households (17 per
cent), construction and demolition (15 per cent), the commercial/retail
sector (14 per cent) and the rest (about 9 per cent). In short,
we see the rationale for a landfill tax despite the fact that
it has some of the adverse features of the aggregates tax.
CONCLUSIONS
20. We are not convinced that the aggregates
tax is a well designed tax, though we see the logic in some of
the government's arguments so far as they have been made public.
But by taxing the product rather than the externality, the government
tax risks not being effective. If it exists as a threat rather
than an actual tax, the threat of an ineffective tax seems to
us to bring its credibility as part of government policy into
some question. We accept that its effectiveness is improved by
differentiating between recycled aggregates and virgin aggregates,
and that revenues from the tax could be used to beneficial effect
in reducing externalities. But we feel that the evidence for supposing
these effects to be significant should be produced so that everyone
can evaluate the argument. We are mainly concerned with determining
what the "playing field" is for the tax: we remain unclear
as to what the target is that the industry has to set itself.
We think the only logical target is that the industry should do
better than the tax. We cannot, and do not, speak for the industry
but we estimate that something like a 5 per cent reduction in
the externality is the relevant benchmark. Whether that benchmark
is achievable is not for us to judge. We do point to the evidence,
such as it is, that it has been secured by other industries which
have a better record of compliance and environmental achievement.
The consequent "environmental slack" in aggregates is
therefore greater and environmental gains should be easier to
achieve. We are not convinced that industry's "own tax"
of 10p/tonne can be compared directly with the estimate of monetary
externality from a tonne of aggregates once the context becomes
one of "doing better" than the government tax would
have done on its own. Ultimately, the issue may be one of belief
about compliance, ie whether government believes industry. It
is unclear to us why that cannot be tested by monitoring the progress
of self-regulation in terms of setting quantitative targets for
emissions and disamenity. We pointed to the need for such agreements
to have clear quantified environmental targets and incentive systems
in place. As far as we are aware, this has not been the setting
for the negotiated agreement in the aggregates case.
December 1999
30 This evidence has been prepared by Professor David
Pearce, Department of Economics, University College London and
Senior Adviser to EFTEC Ltd, and Ms Tannis Hett of EFTEC Ltd.
It draws on our earlier work for the Quarry Products Association-The
Economic Benefits of Environmental Training and Awareness Programmes
in the Aggregates Industry, QPA, 1999. The modifications reflect
changes that have taken place since we wrote that report and/or
clarifications about the intentions of the tax. Back
31
See D W Pearce et al, Blueprint for a Green Economy, Earthscan,
London, 1989, and the subsequent volumes in that series. Back
32
For example, government has actively investigated charging systems
for water pollution but has recently decided that they should
not be introduced. Back
33
This is one of the assumptions that is important to our argument.
We have not investigated the elasticity ourselves and the assumption
that it is small is derived from work by ECOTEC, Environmental
Effectiveness of a Tax on the Supply of Aggregates, Report
to the QPA, 1999. We have not seen anything to suggest the elasticity
is anything other than small, though we share most experts' concern
that the short and long-run elasticities should have a different
relationship than that elicited by ECOTEC. We are also aware that
ECOTEC share that concern. But it does not follow from these concerns
that the elasticities are bigger than ECOTEC's estimates. Back
34
Command and control regulations tend to focus on setting standards
of behaviour or prescribing technologies that may be used or attenuating
rights (eg land use planning controls). Back
35
ECOTEC, Environmental Effectiveness of a Tax on the Supply
of Aggregates, Report to the QPA, 1999. Back
36
A cross price elasticity shows the effect on demand for virgin
aggregates of changing the price of recycled aggregates. In this
case, the price of virgin materials rises because of the tax whilst
that of recycled products stays the same, so the relative price
of virgin materials rises. We should be clear, however, that we
have not attempted to estimate this cross price elasticity and
ECOTEC's argument rests on their estimate of the "own"
price elasticity being small. Back
37
The London Economics study estimates that the 633 hard rock quarries
outside the national parks have externalities of £0.34 per
tonne and that quarries in national parks have externalities of
£10.52 per tonne. Back
38
EFTEC, The Economic Benefits of Environmental Training and
Awareness Programmes in the Aggregates Industry, Report to
QPA, 1999. Back
39
The sources are detailed in EFTEC, The Economic Benefits of
Environmental Training and Awareness Programmes in the Aggregates
Industry, Report to QPA, 1999. Back
40
This is because there is a certain amount of damage that is "optimal"
in economic terms. This occurs when the costs of reducing the
damage are greater than the value of the damage done. Back
41
This is £15-£32 million compared to what we estimate
the total externality to be, namely £340-£470 million.
Note that our estimate of the externality includes transportation
externalities which were not included in the valuation study carried
out by London Economics. In other words, our rough estimate is
considerably higher than the London Economics externality estimate
by some £50-180 million. Back
42
Our report to QPA was written in July 1999. Back
43
Ken Willis and Guy Garrod of Newcastle University have drawn
a similar conclusion on the aggregates tax. See K Willis and G
Garrod, Externalities from extraction of aggregates: regulation
by tax or land use controls, Resources Policy, 25, 1999,
pp77-86. Back
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