HM Treasury's role and the regulatory
44. The Stern Review highlighted three key areas
for action by the Government:
Climate change is the greatest market failure
the world has ever seen, and it interacts with other market imperfections.
Three elements of policy are required for an effective global
response. The first is the pricing of carbon, implemented through
tax, trading or regulation. The second is policy to support innovation
and the deployment of low-carbon technologies. And the third is
action to remove barriers to energy efficiency, and to inform,
educate and persuade individuals about what they can do to respond
to climate change.
45. Of the three elements suggested by the Stern
Review for action by Government, we believe that the pricing of
carbon and the application of economic tools is clearly the area
where the Treasury is best placed to take the lead, and the use
of such tools by the Treasury was therefore the focus of our inquiry.
Our inquiry did not consider Government policy in support of technological
innovation, or its action to remove barriers to energy efficiency
and influence individuals' responses to climate change (except
via economic tools).
46. One of the key findings of the Stern Review was
that establishing a carbon price, through tax, trading or regulation,
was an essential foundation for climate-change policy.
Environmental taxation is a tax on 'bads'that is, some
undesirable behaviour, such as emission of carbon dioxideand
works by forcing emitters to pay the environmental costs of their
actions. Environmental trading schemes also involve the pricing
of economic 'bads'this time by setting the maximum level
of, in this case, emissions that is tolerable and creating a market
through which emitters can buy and sell permits. Regulation covers
a broad class of measures that prohibit, limit or enforce a particular
behaviour, and carry the threat of punishment for non-compliance.
There are disadvantages and advantages to all three approaches.
Professor Ekins argued that use of the price mechanism was appropriate
in many, but not all, cases:
I think that a complex society such as ours needs
both [taxation and regulation]. Regulation sets standards, and
there are some areas of life where standards are important. For
example, I am very glad that drinking water is subject to regulation
and not taxed on the amount of pollution that can be put into
it. On the other hand, there are many environmental issues that
respond well to price signals where those physical effects are
not absolutely critical and perhaps the cost of abatement is relatively
Once a tax is levied one pays the tax on the full
environmental effect, not only on the bit that is above the regulated
amount. There has now been a very interesting swing of perceptions
against environmental taxes, and certainly governments have found
them very difficult to introduce. That means that on the whole
we do not have enough of them and in general I would favour the
introduction of environmental taxes much more commonly, and in
particular for their introduction on an escalating basis. In this
country we have had some experiences of tax escalators. The fuel
duty escalator and landfill tax escalator are currently in place.
In my view they have shown themselves to be remarkably effective.
47. A variety of policies and tools will be necessary
to counter climate change emissions and public policy cannot afford
to rely solely on emissions trading schemes, or environmental
tax, or regulation. In general, however, we are persuaded that
use of a price mechanism, rather than regulation, is an extremely
effective way to change people's behaviour and, as much as is
possible, the Government should give primary consideration to
the use of economic tools in combating climate change.