Environmental economic instruments can encourage businesses to be more green, fund environmental improvement and reduce the needs for other taxes By Miroslav Chodak You probably would have a hard time convincing the average citizen that more taxes are actually better for them. Yet this is exactly what some experts imply when speaking about environmental taxes. Through green tax budget reform, it is possible to provide incentives for more efficient use of natural resources while decreasing pollution. And it may also be possible to allow for reducing - or even eliminating - taxes in other areas, such as income tax, social security tax, etc., thereby improving the economy and environment at the same time. This is the main reason why environmental economic instruments, and environmental taxes in particular, receive so much attention in Brussels and at the Organisation for Economic Cooperation and Development (OECD). A report published in October by the Regional Environmental Center for Central and Eastern Europe (REC) found that the countries of this region have become quite adept at using environmental taxes and fees - so called economic instruments - to help control pollution and raise revenues. The report, sponsored by the Danish Environmental Protection Agency, analysed economic instruments in 15 countries of Central and Eastern Europe (CEE) and compared the collected data with the situation in the European Union. It also provided a more detailed analysis of the role of economic instruments in the EU accession process. According to the report, the countries of CEE have taken advantage of the process of economic and legal transition to introduce charges and taxes for environmental purposes. Since 1990, economic reforms and restructuring have helped to reduce the role of pollution-intensive industry in the economy, and investments have been made to tackle existing environmental liabilities and introduce modern technologies. Many countries of the region, led primarily by those most advanced in economic transition, have adjusted existing economic instruments and introduced new ones, with the objective of supporting and promoting environmental improvements. How effective are environmental taxes in the region? While detailed analysis is not available, some specific instruments, such as Polish and Lithuanian air pollution charges, are reported to have contributed to achieving reductions in air pollution. And the recent region-wide dramatic increase in taxes on motor fuels is expected to provide substantial incentives to reduce pollution from the transport sector. But it is important to consider the use of environmental taxes in a wider social context, particularly their possible negative impact in a region where incomes are lower. Take, for instance, the above-mentioned fuel taxes, which were increased substantially to be in line with EU legislation: When comparing these taxes on a basis of purchasing power, it turns out that residents in CEE countries are paying some of the highest motor fuel taxes in Europe, and therefore, the world. Similar concerns exist for the increase of user charges in the water and waste sectors. While these charges can help improve the quality of services, closer analysis finds that, in some cases, household expenditure for water services in CEE approach 10 percent of monthly household income. This cost is a heavy burden on citizens and may have a negative impact on the ability of investors to realise returns on their investments in the water and waste sectors. Thus, developing policy packages and other direct support mechanisms to vulnerable segments of society, as is common in OECD member states, may become increasingly important in the region.   Addressing economic concerns A notable aspect of the use of economic instruments for environmental policy in CEE has been the focus on raising and earmarking revenues from pollution charges for priority expenditures within the environmental field. For this reason, CEE experience differs from the experience in most OECD member countries, where, with some exceptions, environmental taxes generally represent central budget revenues with no explicit link to environmental spending priorities. While such earmarking presents advantages from an environmental financing perspective, it raises other concerns. Earmarking, experts say, has the potential to lead to inefficient allocation of resources and the creation of vested interests that will push for extension of subsidies for longer than may be necessary. The need to maintain steady revenue streams for environmental funds through earmarked pollution charges may have also inhibited the implementation of stricter and more environmentally effective charge rates. Some observers also express concerns over the effect of environmental policy measures on economic competitiveness. But there is no theoretical or practical evidence that environmental taxes in the past have had a negative effect on any country's overall competitiveness. For individual companies, environmental taxation may often act as a signalling mechanism, prompting dynamic changes that have a beneficial impact on economic performance and efficiency in the long run. Along with staying competitive, CEE countries are also concerned about their need to harmonise with EU legislation. This is an expensive process: Recent estimates indicate it will cost between EUR 80 billion and EUR 110 billion for the accession countries to achieve full compliance with EU environmental requirements. The deadlines for compliance that are set by the accession process create a long-term framework in which policymakers can develop policy and spending strategies. The most important roles that economic instruments can play in this process will be in establishing proper pricing and cost-recovery in the water, wastewater and waste sectors and in providing incentives to reduce the need for expensive solutions later. Cost recovery charges will help finance the necessary upgrading of public infrastructure for waste management, a sector more recently recognised as a potentially costly area in CEE. And economic instruments can be adjusted and improved in order to provide more effective incentives, which will allow for the attainment of some directives at least cost. The problems are numerous, but so are the opportunities. There is a major potential to improve the use of economic instruments as cost-recovery and incentive tools to achieve EU compliance in a cost-effective way. If the process is successful, major improvements in the environment should follow. And, who knows? Maybe one day we will not have to pay social and personal income taxes, either. For a free copy of the REC publication, "Environmental Taxes in an Enlarged Europe: An Analysis and Database of Environmental Taxes and Charges in Central and Eastern Europe" send an e-mail to EGal@rec.org. - Miroslav Chodak is a project manager in the REC's Environmental Policy Programme.

Photo: MTI COMMENDABLE BEHAVIOUR: Economic instruments would reward the the Del-Alföldi forestry company in southern Hungary for its green logging practices.