A new emphasis on economic instruments

The Government's second anniversary report on the 1990 White Paper on the environment had little new to offer - other than a resounding commitment to use economic instruments in place of regulation wherever possible.1 But the introduction of few, if any, of the economic instruments which are the Government's top priorities appears to be feasible before 1995.

Enthusiasts for economic instruments must lately have been wondering whether their promised place in environmental policy would ever come. Three years after the Department of the Environment (DoE) issued the Pearce report on environmental economics, and two years after the Government undertook in its White Paper on the environment to pursue "with vigour" the opportunities presented by economic instruments, there is precisely nothing to show for all their endeavours.

Cutting back on regulation
False dawns there may have been, but the second anniversary report is unlikely to be another. The Government's approach was stated clearly in an introduction by Environment Secretary Michael Howard. There will, he says, be "a new presumption in favour of economic instruments rather than regulation as we develop our environmental policies."

In future, the report adds later, the intention will be that "new regulations should be limited to cases where economic instruments to achieve the Government's environmental objectives more effectively are either not available or require regulatory underpinning." The Government also intends to press the European Commission to adopt the same approach, with the caveat that the principle of subsidiarity should apply to any legislative proposals which Brussels puts forward.

The report then goes on to identify the areas in which the Government is already considering the application of economic instruments, and outlines its current thinking on each. First, though, a word about the areas which it does not touch on.

CFC tax
The 1990 White Paper identified several opportunities for introducing economic instruments which now seem to have disappeared from view. Among them were levies on CFCs, waste oil, batteries and tyres. In each case the intention would have been to provide an extra incentive for recycling.

Exactly how far these ideas progressed is not known. The idea of an official tyre levy was probably discarded after the tyre industry introduced its own, somewhat ineffective, "green fee". The DoE is also known to have worked up detailed proposals for a CFC tax. Although this was blocked at some point in the Whitehall machine, it may yet come back as a tax on all ozone-depleting substances. This would embrace the HCFCs, which are likely to remain in commerce until around 2020.

A second issue on which the report fails to touch is the recommendations made by the Advisory Committee on Business and the Environment for tax incentives to promote fuel-efficient vehicles, discourage unnecessary provision and use of company cars, and shift people onto public transport (ENDS Report 212, pp 3-4 ). These amount to a far-reaching package, but the Chancellor can hardly ignore them for a second time in his next Budget without prompting questions as to why the Government bothered to set up the Committee at all.

Thirdly, the report omits to mention a consultation document issued by the Inland Revenue this summer which proposed a change in company car taxation (ENDS Report 211, p 32 ). The present charges based broadly on engine capacity would be replaced by charges based on car list prices. The DoE is understood to be unhappy that the opportunity is not being taken to introduce a system based on fuel efficiency.

Legislative requirements
Several other considerations which are not aired in the report need to be borne in mind in assessing how rapidly the ideas it outlines can be translated into workable economic instruments.

First, if the instrument takes the form of a tax or other measure which falls within the province of the Treasury, it will normally take 18 months to pass through the Treasury's procedures, assuming it does not encounter serious opposition.

Secondly, unless the instrument is one that can be introduced via the Treasury's annual Finance Bill, it cannot be implemented without new legislation. The possible exception is the system of sulphur trading which is being developed by the DoE (see below). It is just conceivable that the DoE could get away with stretching the meaning of section 3(5)(a) of the Environmental Protection Act 1990, which enables the Secretary of State to make plans for the allocation of emission quotas between sources, to accommodate such a system.

An opportunity for the DoE to take new powers to introduce economic instruments will be provided by the Bill to establish the Environment Agency. On the present timetable, this will enter Parliament in November 1993 (see p 25 ). However, those instruments which would probably be administered by the Agency, such as the system of water pollution charges now under consideration, could not be introduced until it was operational. On present plans this will not be until April 1995.

The conclusion appears inescapable that few, if any, economic instruments will be in operation until 1995. This will leave the Government exposed to further criticism from environmentalists, who generally regarded the second anniversary report on the White Paper as being almost devoid of new ideas.

Thirdly, progress in introducing economic instruments will be slow unless they are actively championed across Whitehall. An inter-departmental task force with this remit is believed to be under consideration by the DoE, but the job of convincing other Departments that it is needed remains to be done.

Treasury's role
Fourthly, other Departments will inevitably have their own agendas in responding to any DoE proposals for economic instruments. Potentially formidable obstacles face the DoE, for example, in the Treasury's objectives. Among these are the simplification of the tax system, whereas many of the innovations which the DoE is pursuing would add complexity. Likewise, many of the DoE's ideas are inherently likely to run up against the Treasury's dislike of tax reforms which are aimed at altering the behaviour of individuals and corporate bodies.

These obstacles should not be magnified too greatly. The Treasury is always interested in new sources of revenue, and this may explain recent reports that it has been warming to the proposed EC carbon/energy tax. If the proposal is indeed taken on board by the Treasury, the DoE may find it easier to make the case for other environmental taxes. The drawback is that once the Treasury takes an interest in environmental taxes, it may want to run the underlying policy as well.

Finally, there will inevitably be competition for the revenues raised by economic instruments. Again, it is a fundamental Treasury policy that revenues must not be "hypothecated" - that is, they must go into the general kitty rather than be allocated in advance to some specific purpose. This helps to explain why the DoE wants to take its own powers to introduce economic instruments in an environmental Bill. Without these, it would be in a weaker position to argue that at least some of the revenues raised should be treated, not as tax receipts, but as funds needed to discharge the regulatory authorities' statutory duties in, say, cleaning up old landfills.

One of the central questions which will be posed by industry and environmentalists is whether economic instruments will supplement or replace existing regulations. As befits his background as a lawyer, the Environment Secretary managed to face both ways on the issue when he gave evidence to the House of Commons Environment Committee on 27 October. On the one hand, said Mr Howard, "we have a very extensive regulatory system in place which we have no intention of dismantling." On the other hand, "I don't," he said, "regard every element of the existing regulatory system as sacrosanct."

The four initial candidates for economic instruments are:

  • Water pollution charges: Two studies of experience with water pollution charges in Europe were carried out for the DoE during the 1980s by consultants Environmental Resources Ltd (ERL). A third, formulating proposals for a charging scheme in the UK, was completed this spring. A follow-up consultation paper is to be issued by the DoE shortly.

    ERL's report is believed to have linked its proposed charging scheme to the achievement of water quality goals. In England and Wales, these will be set in statutory water quality objectives which are due to be introduced from 1993. The approach suggested by the report is for the phased introduction of charges over several years, building up from an initial low level until they are equivalent to the cost of treating each discharge.

    Since the level of charges under this scheme would eventually be much higher than those paid under the present system under which the National Rivers Authority recovers the costs of issuing and policing compliance with discharge consents, ERL has suggested that the new charges should be based on actual, rather than consented, discharges.

  • Landfill tax: Another consultant's report for the DoE has assessed the value of a landfill levy in providing extra incentives for recycling and waste minimisation. The Government has promised to announce its conclusions early in 1993.

    A levy of £10 per tonne of waste appears to have been mooted. This would raise a pleasing £1 billion per year for the Treasury. The problem with which the DoE is grappling is that a levy of this magnitude may boost incineration without doing enough to promote recycling.

  • Sulphur trading: This is the only area on which the basis of the DoE's thinking, a report prepared by London Economics, has been made public.2 A consultation paper on the issue has been promised by the end of the year.

    The idea behind a tradable permits scheme is that it should enable an overall emission goal to be met at least cost. At present, only the two electricity generators are permitted to offset higher acid gas emissions from one plant by reducing emissions from another. This allows them to decide what mix of control measures - installing abatement equipment, burning low-sulphur fuel, or building new clean capacity - can achieve their company-specific emission targets at least cost.

    The London Economics study looked at how these arrangements could be built upon by allowing sulphur trading both between the generators, and between the generators and major industrial sources of SO2. It recommended a system of tradable permits under which each firm would receive an annual SO2 allocation based on the quotas they already have under a national plan to reduce SO2 emissions from large combustion plant by 60% between 1980-2003. Free buying and selling of quotas would be allowed with the aim of achieving the emission target at least cost. The study concluded that this would result in annual savings of about £60-80 million across Britain from 2003 onwards.

    A crucial question is how such a system would fit with integrated pollution control, or with pressures for sharper cuts in SO2 emissions so that acid deposition is reduced below the "critical loads" which sensitive ecosystems can tolerate.

    London Economics presented the issues in stark terms. Trade in sulphur permits, it pointed out, would be inhibited by regulatory uncertainty. Hence "in order to exploit market mechanisms, the authorities would have to make firm longterm commitments, and to forego some opportunities to alter the size and shape of the SO2 quotas." In simple terms, SO2 emission targets would have to be frozen, and HM Inspectorate of Pollution could not respond to changes in the "best available techniques not entailing excessive cost" (BATNEEC) by imposing tighter standards on sites emitting SO2.

    The DoE's interest in sulphur trading comes just at the time that HMIP is preparing to issue authorisations for power stations which are expected to require SO2 reductions beyond those specified in the national plan on the grounds that going further is justifiable under the BATNEEC approach. HMIP is expected to insist that only trading of sulphur quotas within these limits would be acceptable; giving the generators a free hand to trade as they wish would not. But even if it wins the argument, the potential for a later conflict between BATNEEC and tradable permits should not be ruled out.

  • Waste recycling and recovery:
    Several options other than a landfill tax for advancing policy in this area have been examined in another report by ERL. They include levying waste collection charges on householders in proportion to their waste generation, deposit/refund systems, and raw material and product charges.

    The Government will need to decide soon what role these will play in contributing to the achievement of its own recycling target for household waste and of the recovery and recycling targets proposed in the draft EC Directive on packaging. It has promised to announce its conclusions early next year.

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