Ecological Tax Reform

Report for the New Zealand Ministry for the Environment.

Where used effectively, ecological taxes have the potential to make appropriate environmental decisions an automatic part of every economic decision. They are flexible to different needs and changing conditions. They induce people to use their own information and ideas about how to reduce pollution most effectively. At the same time they raise revenue that can replace distortionary taxation on income and capital. They are a valuable part of the environmental regulation toolbox and although they are not appropriate for addressing all environmental problems they are probably currently underutilised and worthy of more investigation. 

An active academic literature has explored the possibility that eco-taxes are not only good for the environment but might also improve the tax system. The conclusion is emerging that because of ‘tax interactions’ this latter result is only true where the existing tax system is grossly distorted and eco-taxes provide an opportunity for much needed reform. Despite this, raising revenue where there are no additional distortions from doing so is certainly good. For example, if we use regulation to cost-effectively reduce pollution we will create the same distortions whatever approach we use. We should therefore use an approach that raises revenue. Eco-taxes should however only be used where the environmental benefits alone justify the regulation.