Examination of Witnesses (Questions 1
- 19)
TUESDAY 23 JANUARY 2007
PROFESSOR PAUL
EKINS
Q1 Chairman: Professor Ekins, welcome
to the Committee. Thank you for taking the time to come and give
evidence to us in the first part of our inquiry into climate change
and the Stern Review. To start off with a general question, what
are your views on the Stern Review? How far has it taken the debate
forward? Given that in July 1997 the Government announced their
intention to reform the tax system to increase incentives to reduce
environmental damage and shift the burden from good to bad, as
they called it, what more could they do to make the fullest possible
use of taxation instruments as a mechanism to achieve their environmental
targets?
Professor Ekins: Chairman, it
is a pleasure to be here and thank you for asking me to come.
I think that the Stern Review took matters forward a very great
deal, especially in a political sense. Those of us who know the
economics literature will probably be aware that most of the arguments
rehearsed in the Stern Review have been out there for some time.
Some of the novelty of the Stern Review was in his choice of emphasis.
He focused first very much on the science of climate change, which
does not always happen when economists look at that subject. He
then focused in the first two chapters very much on the equity
and social justice issues, which again does not always happen.
Yet in my view that is the correct way to start because these
are very important public social as well as economic issues and
it is important to get them on the table. He then worked through
the economics in quite a lot of detail. There has been a fair
bit of controversy about how he arrived at his overall damage
costs, in particular with the use of a discount rate that some
perceived to be too small, and he justified that use. There will
continue to be debate about the right value of such things. I
think that his broad conclusion, which is that the damages from
climate change if allowed to proceed unabated will greatly exceed
the costs of doing something about it and reducing the level of
emissions and therefore the degree of climate change in future,
was absolutely right. I think that his argument that there is
a strong economic case for serious and determined abatement of
emissions internationally is the right one. Broadly, I am in agreement
with that. On the subject of the tax shift, in this country since
1997 the proportion of taxes and GDP that comes from environmental
matters has fallen which, on the face of it, implies that there
has not been a very great movement. Again, I believe that that
statistic gives the right impression of the situation. In my view,
what happened was that the Government started with very good intentions.
The statement of intent on environmental taxation was, though
short, a very innovative document and one which, had it been followed
thought through, would have been something of an international
first. For the first few years the Government seemed to pursue
that agenda quite vigorously, but a combination of events, of
which probably the most important was the fuel duty protests in
2000, caused them to lose political heart. Obviously, it was not
helped in that what seemed to have been cross-party consensus
on that particular tax, namely the fuel duty escalator, broke
down at that time. As you know, that had been introduced by the
Conservatives in 1993. Both parties had broadly backed it until
1999 when the Conservatives changed their policy and it made it
very difficult in the face of the fuel duty protests for the Government
to hold their nerve. Since then the real tax on fuel has fallen.
If one looks at the share of environmental tax in taxation generally
one sees that it peaked in about 1999 and since then has declined
quite substantially.
Q2 Kerry McCarthy: You say that you
broadly agree with Stern's conclusions. Do you agree with his
view that there is about a 1% GDP cost to stabilise greenhouse
gases as against the 5% to 10% potential loss in global GDP if
climate change is allowed to continue?
Professor Ekins: You probably
know that a number like that is derived from fairly complicated—some
would say sophisticated—economic modelling. There is enormous
uncertainty about the way economic models are constructed, the
theoretical bases on which they are founded and the relationships
that they are posited to have. There are very different economic
models which come up with different results. The Stern Review
quotes what is called a meta-analysis of all of these studies
to show that there is a wide range of estimates of GDP impacts
from reducing emissions by 20%, 60% or 70%. Most of those estimates
fall within about 0.5% to 2% of GDP. If one had to pick a single
number that seemed to be representative of those modelling results
1% would be a reasonable choice. Obviously, those economists who
are responsible for and believe in the models that have come up
with higher estimates will say that that is too low. I have looked
at the models and the kinds of modelling of these sorts of issues
that I favour suggest to me that 1% is about right. On that basis,
I agree that that is a reasonable estimate.
Q3 Kerry McCarthy: When one is looking
on a global basis at these estimated costs and losses, how easy
is it to move from that to doing cost benefit analyses for the
UK in terms of bringing in new environmental taxes here?
Professor Ekins: Any kind of cost
benefit analysis of an issue of this kind is fraught with difficulty,
and I for one am very glad that Stern did not really attempt it.
For a country like the UK the first question one has to ask is:
to what extent is this global action and to what extent is it
action purely in the UK? If it is the latter obviously global
emissions and the damage costs from climate change will fall rather
little and the cost to the UK through the effects of competitiveness
if the policies are not implemented particularly well could be
quite substantial. But if one assumes that there is an international
framework in place, that all countries reduce their emissions
so that the effects of competitiveness across countries are not
pronounced and one looks at the damage costs that Stern projects,
particularly the significant risks of catastrophic costs—the
single biggest change in the science over the past 10 years since
I have been looking at the issue is the way in which scientists
now perceive catastrophic costs to be much more possible in the
reasonably short term—then it is possible to conclude, as
Stern did, that the overall cost of mitigation is much less than
the risk of very high damage costs and that the cost benefit analysis,
if one could carry it out—Stern did not—would mean
a significant return from carbon abatement.
Q4 Mr Love: If I may carry on logically
from what you have just been saying, you said that Stern had estimated
a 20% to 60% reduction, but that leaves considerable ambiguity
about the cost of adaptation. Do you believe that in this country
there is a supportive environment in government and other circles
to recognise the costs of adaptation in future?
Professor Ekins: I think that
Stern's perception about the degree to which we need to reduce
emissions is much closer to the 60% than 20%. I was quoting that
the studies had looked at reductions of between 20% and 60% and
come up with different ranges of mitigation costs. Even at 60%
emission reductions globally, or at least in developed countries,
there will be considerable climate change and we will need to
adapt. These adaptation costs are likely to be very different
in kind and the public will perceive them very differently. Some
of the effects will be direct physical ones on the UK, such as
increased flooding and increased cost of home insurance against
that risk, if we decide to do it through the private market. I
do not think that the public will have a great deal of choice
about that. We are already increasing the cost of flood defences
against these kinds of events. That is money to be spent by taxpayers
which obviously cannot be spent on something else. There will
be other much more difficult kinds of costs if there are very
wide international effects from climate change. If, for example,
some of the low-lying deltas of the world with very large numbers
of poor people living in them were to become uninhabitable those
people would have to go somewhere else to live. Countries like
the UK might be asked to take very large numbers of migrants from
something like climate change. I can imagine that that in a sense
is not a financial cost because they may be very hard working
and in due course add to GDP, but we know that that would be a
difficult political issue. In a sense there would be a perception
of cost, and for the people displaced from their homes it would
be a very real cost that would be very difficult to value in financial
terms.
Q5 Mr Love: You rightly highlight
the fact that climate change will probably have much greater impact
in the third world than it would in either Europe or the United
States. Just looking at the United Kingdom, there is already controversy.
The insurance companies are saying regularly to government that
they are not putting enough aside for flood protection and therefore
they will not insure; or they are not doing enough on coastal
erosion. Would there be a benefit to the Government in trying
to bring together all the current expenditure to show the public
just how much is being spent but, projecting into the future,
how much is likely to be needed to be spent on some of the things
that you have just been talking about?
Professor Ekins: Given the problem
of climate change and public perception, the fact that it is a
very long-term issue which is well outside most people's daily
thoughts—indeed, the worst effects will not be felt by us
but by our children and grandchildren—and that there are
lots of other things which have claims on people's attention,
anything that can make these costs real to people, given that
they are real costs, is of very great benefit. One of the reasons
that the public and people generally are not convinced about climate
change is that they do not see it as an immediate issue that is
a result of some part of their actions which will impose costs
on them and their children in future.
Q6 Mr Love: An increase in what the
Government term environmental taxes has been criticised because
the money raised is not used either on mitigation or adaptation.
Should we treat environmental taxes in a different way from the
ordinary taxation system to highlight just what we are doing in
terms of both mitigation and adaptation?
Professor Ekins: In general, I
do not believe that is desirable. A much stronger argument is
to say that governments need revenue and in general it makes sense
to raise that revenue from taxing bads rather than goods. In some
cases it may be that where there is a case for public expenditure
it can make the tax more palatable and politically acceptable
to link a particular tax with a particular form of spending, but
if that principle became widely established in government all
sorts of desirable public expenditure would not find suitable
sources of money to finance it. I think that a much better approach
is to say that government has a certain revenue requirement and
to get it from activities that cause social harm is in general
better with other considerations than getting it from other sources.
Indeed, that was broadly what the statement of intent on environmental
taxation in 1997 said.
Q7 John Thurso: Both Stern and the
Government as well as many sectors of industry regard carbon emission
trading schemes as the best way forward to tackle climate change.
Do you regard these systems as the best way forward, or do you
think it is just a way of looking good and kicking it into the
long grass?
Professor Ekins: As with practically
every policy of which I am aware, its goodness depends almost
entirely on the detail. There are lots of theoretical arguments—indeed,
the Stern Review rehearses a good number of them—about the
relative benefits of tax and trading in particular and regulation
in other circumstances, but what one sees is that the schemes
introduced because of the political pressures of getting any kind
of policy brought in at all often bear very little relation to
the textbook expositions of these taxes and trading. In principle,
as I understand what the Stern Review said—this is broadly
what emerges from the academic literature—with a problem
like climate change one wants a long-term stabilisation target
in terms of emissions, because it is in the long term that they
build up in the atmosphere and cause climate change and therefore
one wants to put a cap on it. Therefore, in the long term an emissions
trading scheme would seem to be an effective way to do that, but
in the short term because of the relative shapes of the marginal
abatement and damage costs one probably wants to make use of a
price mechanism, ie an environmental tax, or in this case ideally
a carbon tax. Therefore, one would have a carbon tax adjusted
in order to deliver a long-term quantity of emissions trading.
Q8 John Thurso: In other words, you
would almost certainly need both?
Professor Ekins: Indeed. It would
be desirable to think in terms of both. Whether one would need
both would depend on the extent to which one found that the policy
was effective given all sorts of imperfections operating in the
various markets. For me it is a matter of great regret that the
proposal of the European Commission in the early 1990s to introduce
an EU-wide carbon tax did not capture support at that time. That
would have established the principle of a tax early on in the
climate change issue. We would have what people knew was a carbon
price which did not go up and down with the short-term vagaries
of the permit market, as it does at the moment. You are probably
aware that as we speak the carbon price is at its lowest level
ever, so the people who made investments on the basis of some
carbon price even six months ago would be rather disappointed
by the performance of those investments. Had we had that kind
of price mechanism in place we could have decided then whether
as well we needed an emissions trading scheme in order to give
some kind of long-term surety about the overall quantities which
would be emitted.
Q9 John Thurso: I want to ask you
about the carbon emission scheme in a moment. First, we have received
suggestions that carbon trading schemes may be more effective
if they are based on the individual; in other words, if individuals
have a personal carbon account. They would have either their own
carbon allocations which they would sell to business when they
did not use it or their own account so that they would purchase
carbon every time they took a flight or used something that used
energy, or whatever. What do you think of those schemes as a way
forward, and what would be the difficulties for government?
Professor Ekins: I think that
the main difficulty is the very considerable difference between
the theoretical attraction of such a scheme and its practical
implications. If we had a general population that understood what
carbon was and was prepared for a system that used carbon as money
in its purchases, and if there was an evolving market which allowed
individuals easily to make those kinds of transactions so that
businesses could get access to the carbon emissions they needed
to go about their daily business—we may evolve those institutions
and general level of information and awareness—I think that
personal carbon trading might have something to commend it. But
I believe that we have a long way to go before we get there. Businesses
are now much more aware of the issue of carbon trading than they
used to be thanks to the EU emissions trading scheme, and I think
that is a very good start. Were one to proceed down the route
of personal carbon allowances it would be desirable to keep businesses
and individuals distinct for the time being so that businesses
continued to trade among themselves. Personal carbon allowances
would cover the personal use of fossil fuels and perhaps transport
and aviation while the business trading schemes continued to be
developed. Doubtless you will be aware that the Government have
a proposal to introduce a trading scheme for large commercial
organisations alongside the EU emissions trading scheme. It seems
to me right that bit by bit we gain experience in these rather
complicated businesses which effectively create new money, which
is what carbon trading represents.
Q10 John Thurso: For a carbon trading
scheme to work there must be a robust market which means that
the market must be sufficiently liquid and regulated so it is
real and we are not buying and selling carbon that is not there.
It also needs a real price. You have already alluded to the drop
in price which has rather undermined what is sought to be achieved.
Do you think that the EU trading scheme offers these criteria?
Professor Ekins: I think that
for the 40% to 50% of carbon emissions that are within the scheme
it could offer those criteria, and it almost entirely depends
on the quantity of emission allowances that are permitted to go
into the scheme. I believe that the European Commission is absolutely
right to take a tough stand, insofar as it is doing so—it
is taking a tougher stand than it might otherwise have taken—on
the second phase of the national allocation plans submitted, because
as submitted there is a very great danger that those plans would
not support a robust carbon price and encourage people to make
low carbon investments. Indeed, they might encourage people to
go on thinking that they could make high carbon investments which
would not prove to be a liability in future. As the whole purpose
of that scheme looking to the future is to incentivise low carbon
investments so we are in a much better position to reduce emissions
in the long term, that seems to me to be the key issue. Of the
10 to 15 allocation plans that have been submitted, only one has
been passed so far and nine have been rejected. My numbers may
not be bang up to date, but it is of that order. I think the Government
deserve some credit that it is the UK's scheme which has been
passed by the Commission. I think that we have an obligation to
argue that other countries should be judged by the Commission
to be doing as much to reduce their emissions as they have judged
us to be doing.
Q11 John Thurso: The Treasury hopes
eventually to move to a global emissions trading scheme. Given
your comments on some of the problems within the European scheme,
would that not be a rather difficult thing to foresee in the medium
term?
Professor Ekins: Clearly, it will
take time. I think that it easily offers the best hope of some
kind of global accommodation with the carbon constraint, and therefore
I very much hope that governments everywhere that are convinced
of the problems of climate change will pursue it. There are already
straws in the wind that suggest how it might develop. The EU scheme
is already linked to the mechanisms of the Kyoto protocol that
are generating carbon credits. It is obviously very important
that the mechanisms for generating carbon credits are robust,
and it is probable that those evolved for the clean development
mechanism and joint implementation are as robust as they could
be. If other countries and perhaps even individual American states
such as California evolved their own robust emissions trading
schemes that delivered emission reductions in principle there
would be no reason why those permits should not become tradable
across borders as well. There are all sorts of institutional issues
to be resolved, not least what is to be done if states effectively
have a kind of money that is internationally tradable but different
from that of the federal government as a whole. Those are issues
that will still need to be resolved.
Q12 John Thurso: As you have said,
effectively one is creating a kind of currency, or tradable commodity,
which is very difficult to quantify in real terms. Therefore,
is there not a huge opportunity for fraud?
Professor Ekins: There certainly
is an opportunity for fraud, and a very great deal of effort has
been invested in the kind of monitoring and verification mechanisms
both in this country and in Europe and to some extent elsewhere
in order to try to ensure that that does not happen. In principle,
it is quite easy to calculate how much carbon is released when
one burns a certain quantity of fossil fuel because it is known
how much carbon is in it and all of it will go into the atmosphere.
The difficulty arises when one starts to allocate allowances on
the basis of estimated base lines. What would have happened if
one had not done certain things? The "what would have happened"—the
counter-factual—is always an uncertainty and people have
vested interests in arguing that base lines are different from
what they would have been. That debate that has dogged the whole
issue of how one might take into account reductions in deforestation.
Mechanisms to deal with these issues have been evolved and I believe
that in the European context they are reasonably robust. Easily,
the biggest problem with the European scheme is that governments
are allocating too many emissions allowances rather than monitoring
and verification.
Q13 Peter Viggers: The Treasury has
quite a narrow definition of "environmental taxes" and
refers to the climate change levy, the aggregrates levy and landfill
tax, whereas the Office for National Statistics uses a much broader
definition of "environmental taxes" which includes energy
taxes and taxes on road vehicles. The Treasury explains this by
saying that it is concentrating on the aims behind the introduction
of the taxes, whereas the Office for National Statistics is looking
more to the effects of taxation. Do you think the Treasury takes
too narrow a view of environmental taxes?
Professor Ekins: I was not aware
that it was as definite as that in terms of definition, but if
it is it certainly is too narrow a view. The evolved international
consensus as expressed by bodies such as the OECD, which has done
an enormous amount of work on environmental taxes and has in a
sense standardised what we mean by those taxes and how they should
be thought of—it has created a huge international database
for environmental taxes—is very much in line with the definition
of the Office for National Statistics. That seems to me to be
the definition that makes most sense. Where one has a tax on goods
or a service that cause a serious environmental effect irrespective
of why that tax was introduced, or the historical genealogy of
it—for example, fuel duties were introduced well before
anybody was thinking hard about environmental matters—that
does not seem to be so relevant as the fact that one can use that
tax in order to have an environmental benefit. That seems to me
to be the relevant definition.
Q14 Peter Viggers: You refer to the
use of the tax for an environmental benefit. Are you implying
that there should be hypothecation of the environmental tax?
Professor Ekins: By no means.
It is a simple illustration of the law of demand which is that
if one puts up the price people will demand a lesser quantity.
That is the way in which classically environmental taxes are perceived
to work. Therefore, I am of the opinion that we had much less
both local and global air pollution because of the fuel duty escalator
in the 1990s than we would otherwise have had. Indeed, there is
robust modelling to suggest that emissions from road fuels would
have been quite a lot higher had we not had that tax instrument.
That seems to me to be the environmental benefit from the tax.
One may then decide to spend some of the revenues from that tax
or from others on ways further to improve the environment, but
that seems to me to be a different decision and effect from the
effect of the price mechanism itself.
Q15 Peter Viggers: How do you rate
taxation against regulation in terms of coercing or encouraging
people to take appropriate action? You can regulate so that people
will not do things or tax them so they are discouraged from doing
things. Do you have a view on that broad issue?
Professor Ekins: I think that
a complex society such as ours needs both. 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 high. We may not know what the cost of abatement
is and we can suck it and see, because a tax effectively places
a cap on the cost of abatement because no one will spend more
to abate when they can simply pay the tax. It has been very interesting
to watch the evolution of the debate on the relative merits of
these policy instruments. Back in the 1980s the profile of environmental
taxes was very low and the way that environmental agencies normally
proceeded was through regulation. The literature then started
to suggest that in some instances environmental taxes would be
a cheaper and more cost-effective and efficient way to proceed.
Initially, everyone thought this was a jolly good idea because
they could get the regulators off their back, but they then realised
that taxes were fairly ineluctable. 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.
Q16 Peter Viggers: Do these need
to have a global or perhaps European element, or are we justified
in approaching this on a national basis? To what extent must there
be an international ingredient?
Professor Ekins: At the moment
there cannot be an international ingredient because even with
a body like the European Union tax policy remains very firmly
at national level, and any prospect of the 27 countries agreeing
that it should be anywhere else is pretty remote. One has to evaluate
this at national level. For a problem like global carbon emissions
it would be highly desirable to have a global carbon tax. Similarly,
if one had a proxy for that it would be highly desirable to tax
aviation fuel at a global level, but there are all sorts of international
dissents on that and, in the case of aviation fuel, treaties that
prevent it from happening. I think that governments must evaluate
these things at national level and in doing so they must be aware
of factors such as possible effects on competitiveness. But governments
must raise revenue from something and practically anything that
it taxes in terms of an input into production, such as labour,
may well introduce an effect on competitiveness. Indeed, we have
very great debate about the cost of social security systems when
they are funded by taxes on employers, for example. I believe
there is very great scope for a tax shift within that general
sector and removing some of the taxes that have competitiveness
effects on labour and putting them on bads like pollution. That
was something that people like me thought might be happening on
quite a wide scale as a result of the statement of intent, and
indeed did happen on quite a small scale when the climate change
levy was introduced. Generally, I thought that that was a good
thing.
Q17 Mr Breed: I take you back to
what you said right at the beginning of your evidence about the
proportion of environmental taxation as against total tax revenues.
We know that there has been a reduction over a period if time.
It is currently at the lowest level it has been over the past
10 years. Is that due solely to abandonment of the fuel duty escalator
or are there other contributory factors?
Professor Ekins: It is due more
or less entirely not only to the abandonment of the fuel duty
escalator but the failure to update fuel duties in line with inflation
in each year since 2000. I think they have been uprated in line
with inflation twice. One was the most recent Pre-Budget Report.
That has very largely resulted in that effect because the great
majority of environmental taxes currently come from energy and
transport-related taxes. That is the major change in taxation.
Q18 Mr Breed: Bearing in mind what
you have just said, you seem to indicate that were there a wider
spectrum of environmental taxation in other areas rather than
just the fuel duty escalator the effects observed over the past
10 years or so might not have been the same?
Professor Ekins: That would obviously
be the case. If one introduced more environmental taxes that had
a relatively broad tax base one would expect to get more revenues
from them. In environmental taxes it is important to distinguish
those which are purely designed to change behaviour, and indeed
at the limit might change it to such an extent that they generated
no revenues at all. One might think of the plastic bags tax in
Ireland in that context. The use of plastic bags has, I understand,
fallen by over 90%. Therefore, that tax is not raising a very
great deal of revenue. One distinguishes those taxes from other
taxes such as those on fuel where there is certainly a demand
effect. People use less fuel than they would otherwise use, but
certainly demand does not drop like a stone and it remains an
enduring revenue base. Energy is certainly the clearest example
of that, but there are others. One can imagine, for example, that
however high the aggregates tax one would still want to use some
aggregates and the revenues that one gets from such a tax are
the price times quantity. If one raised the price, unless the
quantity fell by an equivalent amount—in other words, the
elasticity is one, but most elasticities are less than one—one
would increase the revenue, even if demand fell somewhat.
Q19 Mr Breed: When we are considering
the success or otherwise of the Government's environmental policies
as a whole how legitimate is it to focus almost solely on the
proportion of environmental taxation against total revenues rather
than widen the whole aspect to a significant extent?
Professor Ekins: I certainly would
not want to focus solely on that. I am aware of the Treasury's
argument that this is a bad indicator and should not really be
used because if environmental taxes were effective one would have
the behaviour changes and one could therefore have a reduction
in tax revenues. That is true for some environmental taxes and,
therefore, one needs to look behind the indicator and see what
is driving it. In the case of the UK, what has driven that indicator
over the past five or six years is not the fact that people's
behaviour is changing to such an extent that revenue is falling
but the fact that the tax rate has been lowered in real terms
and that is why one gets less revenue. That argument in that particular
instance is not the case. One cannot put that forward as a reason
why the tax shift does not appear to have taken place.
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