A Proposal to Levy Taxes on Polluting Inputs and Outputs

Project Team: Dr.Raja J. Chelliah, Dr. U.Sankar, Dr. Paul P Appasamy, Dr. Rita Pandey Consultants: Mr. B.C. Rastogi, Ms. M. Karpagam, Dr. S. Jeyaraj, Dr. Vinish Kathuria, Dr. Joseph Thomas, Dr. S. Renganarayanan, Dr. R. Sethumadhavan, Mr. Sacchidananda Mukherjee

Time Period: 2003 -2004

Project Summary:

Environmental pollution is a negative externality. It arises when consumption or production decision of one individual effects the consumption and production decisions of other individuals.  The externality problem can be solved by regulatory approach or economic approach or a mix of both approaches. Command and control (CAC) regulation gives little flexibility to polluters to find least cost methods of pollution prevention and control. It can be justified when the perceived harm from an activity is very high as in production/use of highly hazardous materials or when the assimilative capacity of a region has reached a threshold level or an irreversible ecological damage would result. The precautionary principle justifies CAC regulations. Economic Instrument (EI) is any instrument that gives wide range of options to polluters to achieve specified levels of environmental quality at least cost. A tax on polluting output equal to its marginal social damage signals producers and consumers about the social damage of the activity. Creation of markets for pollutants, eco-rating and public disclosures on the extent of environmental compliance can create market/community pressures for compliance and also reduce transaction costs in finding solutions.  The pollution control regime prevailing in most countries belong to any one of these or a mix of the three types: (a) standards and regulation, (b) standards and charges, and (c) standards and permits.  There is consensus among economists that CAC regulation does not minimize aggregate compliance costs. Its enforcement is ineffective when penalties for non-compliance with the regulations are unrelated to the compliance costs.  Many international agencies have argued the case for use of EIs. The OECD accepted the 'polluter pays' principle in 1972. The World Commission on Environment and Development stressed the need for merging economics and environment in decision making. Agenda 21 of the Rio conference stressed the need for integration of environmental costs into economic activities and to include, wherever appropriate, the use of market principles in the framing of economic policies.  The domestic policy support for EIs is also growing. The Tax Reforms Committee (1992) recommended that excise taxes could be a useful instrument in dealing with externalities in the form of social costs. The Supreme Court has accepted the 'polluter pays' principle a part of the basic environmental law of the land. The MoEF Policy Statement for Abatement of Pollution, 1992 recommends 'new approaches for considering market choices to give industries and consumers clear signals about the cost of using environment and natural resources. It appointed a Task Force to evaluate MBIs for industrial pollution abatement in 1995. It organized an international workshop on EIs in cooperation with the World Bank and CII to appraise the industry about the experiences of developing countries on industrial pollution control. The MoEF Task Force on EIs has recommended the introduction of taxes on inputs and outputs of polluting industries. There are no legal or institutional obstacles to the introduction of taxes on inputs and outputs of polluting industries. Introduction of pollution charges may require an amendment to the Environment Protection Act. Also we need the capacity for measuring and monitoring emissions. The advantages of the environmental taxes/charges are that they not only help in achieving improving environmental quality but also generate additional revenues which could be used for environmental improvement. For non-point pollution, particularly pollution occurring at the consumption stage, a tax on input/output is an ideal instrument for controlling pollution. For point sources, we have to devise taxes/charges with rebates/refunds for units complying with the regulations.  International experience in the introduction of the taxes reveals mixed results. For successful implementation, we need legal and institutional capacity, political support, and involvement of the stakeholders. Issues in the design of the taxes are evaluation of the trade-offs between environmental and other goals, choice of the tax base, consideration of existing distortions in prices and taxes, the basis for determination of the tax rates, phasing of the taxes, incentives for compliance and ear-marking of funds for environmental protection.  This proposal covers coal, automobiles, petroleum, phosphate based detergents, chlorine in paper and pulp and rayon industries and pesticides.