Experience over the last decades has proven that environmentally related taxes can be effective and efficient instruments for environmental policy. They introduce a price signal that helps ensure that polluters take into account the costs of pollution on the environment when they make production and consumption decisions.

Experience over the last decades has proven that environmentally related taxes can be effective and efficient instruments for environmental policy. The environmental effectiveness and economic efficiency of the environmentally related taxes applied in OECD member countries could, however, be improved further if existing exemptions and other special provisions included in the taxes were scaled back, and if the tax rates were better aligned with the magnitude of the negative environmental impacts to be addressed.

All OECD member countries apply several environmentally related taxes – according to the definition agreed between OECD, IEA and the European Commission (see Box 2.1). A database operated in co-operation between OECD and the European Environment Agency (EEA) currently details about 375 such taxes in OECD member countries – plus some 250 environmentally related fees and charges in the same countries.

While the theoretical advantages (especially the static and dynamic efficiency) of environmental taxes are well known, ex post data on environmental effectiveness are still relatively scarce – although price elasticity estimates are available for many energy products. There are several reasons for this.

As underlined in OECD (2001a), a major obstacle to the implementation of environmentally related taxes in certain cases is the fear of reduced international competitiveness in the most affected economic sectors. This concern is not only for economic but also for environmental reasons. In general, from an economic point of view, when introducing of environmentally related taxes increases domestic production costs of internationally traded goods, domestic production generally would be expected to decline – exports become less attractive and imports more – at least in the short run, implying job losses and other adjustments in the national economy.

This chapter examines the extent to which the GATT/WTO rules permit the use of bordertax adjustments (BTAs) to address potential competitiveness issues arising from the implementation of environmentally related taxes. It addresses the extent to which inputs which are embedded or used in the production of goods, such as energy, are eligible for border tax adjustments.

While economists have set out the desirable features of market based instruments for environmental policy, those theoretical perceptions are rarely met in practice. Since governments cannot design and implement policy measures without taking account of political realities, there will usually be a disparity between theory and practice. First, while economists may concentrate on “optimal” instrument design serving one overriding goal – economic efficiency –, political reality may demand that other goals, which are not necessarily consistent with each other, also play a part in practical design and implementation.

In addition to the issue of loss of competitiveness, the issue of income distribution is often raised when environmentally related taxes are discussed. Policy makers implementing such taxes are often faced with the challenge that some taxes are regressive (progressive) in the way that the budget share of the taxed product tends to be higher (lower) for households with relatively low total household expenditure.

It is possible to design a number of economic instruments for environmental policy with relatively low administrative costs, both for public authorities and the affected firms or households. For example, taxes on petroleum products are levied on a limited number of petroleum refineries and depots, and should hence be relatively simple to administer and enforce. For example, the administrative costs of the ecological tax reform in Germany are estimated to comprise only 0.13% of the additional revenues raised, according to Deutscher Bundestag (2002). This was said to be very low, for example compared to the administrative costs of the income tax in Germany.

The “acceptance” of an environmentally related tax among the public at large seems to be related to the degree of awareness of the environmental problem the instrument is to address. For example, littering of the environment by plastic bags was a much-focussed issue in public debate in Ireland prior to the introduction of the levy on plastic bags. In Switzerland there had for many years been significant focus on the nuisance caused by cross-alpine heavy-vehicle transport, prior to the introduction of the distance-based road fee for heavy-goods vehicles in 2001.

Environmentally related taxes are seldom used in isolation to address a particular environmental problem. Most often they are used in combination with one or more other instrument categories, like direct regulations, subsidies, labelling systems, negotiated agreements, etc. OECD has for some time been studying the impacts on environmental effectiveness and economic efficiency of the fact that such instrument mixes are employed – instead of only one instrument being used per target set. Central to the work is how the different instruments interact in practice. This chapter presents some examples of instrument mixes used and highlights some of the main findings made in this work.