Should environmental taxes be refunded?

Can refunding or earmarking of the revenues help make the taxes more palatable?

There is so much resistance to taxes. Yellow vests, industrial lobbyists and the silent but powerful voters…

Can refunding or earmarking of the revenues help make the taxes more palatable?

Hagem, Hoel and I have very recently, on September 25th, published a paper.

This paper delves into the topic of the widespread resistance to environmental taxation (such as carbon taxes) around the world, and presents a potential fix to this issue. There is strong theoretical support among economists for a “Pigouvian” carbon tax that raises the price of emissions so that they actually include the costs that they incur on the world. In practice however, when such taxes are implemented they are often too low to lead to the intended emission reductions. Reasons for this include the fear of losing competitiveness (job losses), strong lobbying by emitting industries, and resistance to giving money to the state for practical, distributional, pragmatic or ideological reasons. To make taxation politically feasible, a potential solution might be to earmark or refund tax revenues. Previous research supports the idea that refunding environmental tax revenues in various ways can lead to less resistance to taxation. Scandinavia has some interesting schemes for industrial pollutants (NOX) that we have analyzed.

This paper analyses 2 kinds of tax refunding to industries: in proportion to OUTPUT or ABATEMENT.

Refunding in proportion to Output (OBR, which Sweden has for NOx) or in proportion to abatement Expenditure (EBR) – which Norway has. We also model the mixture of both approaches. The paper find that the OBR approach makes a very high pollution tax politically feasible. The EBR policy actually makes a really low pollution tax very effective by using refunds to subsidize abatement. In effect it becomes a combined tax and subsidy. Furthermore, we find that low polluters prefer the OBR system, while high polluters often favor EBR. The mixture of both allows for achievement of both abatement and output reduction targets.

Regulators need different amounts of information depending on the approach. We note that the OBR system needs accurate information on output, which may be susceptible to manipulation. EBR on the other hand, requires information on purchasing costs and costs of the abatement technology. Herein lies opportunities for firms to exploit information asymmetries to extract information rents, which regulators should be wary of. The main take away from this paper is offering an alternative to standard taxation that, while not being technically efficient, can be politically palatable.

(If you are wondering which is better — it turns out to be a bit complex, so read the paper…)