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The OECD is also at the forefront of efforts to understand and to help governments respond to new developments governance, the information economy and the challenges of an ageing population. The Organisati provides a setting where governments can compare policy experiences, problems, identify good practice and work to co-ordinate domestic and international policies. The OECD member countries are: Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The European Commission takes part in the work of the OECD. OECD Publishing disseminates widely the results of the Organisation’s statistics gathering and research on economic, social and environmental issues, as well as the conventions, guidelines and standards agreed by its members. ISBN 978-92-64-08762-0 (print) ISBN 978-92-64-08763-7 (PDF) Also available in French: La fiscalité, l’innovation et l’environnement The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. 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The opinions expressed and arguments employed herein do not necessarily reflect the official views of the Organisation or of the governments of its member countries. FOREWORD TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 3 Foreword Today’s environmental challenges demand the concerted efforts of citizens, firms and governments to encourage less pollution and environmental degradation and change existing patterns of demand and supply. The OECD’s Green Growth Strategy (www.oecd.org/greengrowth) aims to inform debate and assist governments’ efforts to develop mutually reinforcing environmental and economic policies – illustrating that “green” and “growth” are compatible. Environmentally related taxes can effectively achieve many environmental goals and their use is widening within OECD countries. But to meet environmental targets at least-cost, we must move beyond current technologies and know-how: innovation is critical. The project leading to this synthesis report explores the benefits of environmentally related taxes that will accrue when higher pollution costs make it economically inviting to invest in the development of new green technologies. A number of case studies have been prepared, some investigating the role of tax design and others looking at ways in which environmentally related taxes can encourage innovation. We can see that environmentally related taxation does induce innovation, with firms responding in positive ways to market signals – developing new products, creating novel means to neutralise pollutants and altering production practices to make them cleaner. To bring about the widest range of innovations, environmentally related taxes must be properly designed, and be predictable to give businesses confidence that the clean technologies they develop today will have a market in the future. Angel Gurría Secretary-General ACKNOWLEDGEMENTS TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 4 Acknowledgements This book is a product of the Joint Meetings of Tax and Environment Experts, a group under the OECD’s Committee on Fiscal Affairs and Environment Policy Committee. Preliminary versions of this publication were presented to this group and participants provided valuable direction, comments and suggestions. In-depth case studies investigating the effectiveness of environmentally related taxation in inducing different types of innovation provided the basis for this publication. These case studies have been undertaken by a range of external experts, whose work provided illuminating conclusions. Summaries of these case studies are provided in the second half of this book. This publication has been prepared by Michael Ash, seconded to the OECD from the Government of Canada, in close co-operation with Nils Axel Braathen, Nick Johnstone, Ivan Haščič and Anthony Cox of the OECD’s Environment Directorate and with Jens Lundsgaard and Stephen Matthews of the OECD’s Centre for Tax Policy and Administration. TABLE OF CONTENTS TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 5 Table of Contents Abbreviations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Chapter 1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1.1. The double market failure: Innovation undersupply and pollution oversupply. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 1.2. Innovation and low-cost, efficient environmental outcomes . . . . . . . . . . . . . . . 23 1.3. The intersection of taxation, innovation and the environment . . . . . . . . . . . . . 27 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Chapter 2. Current Use of Environmentally Related Taxation . . . . . . . . . . . . . . . . . . . . . 31 2.1. Revenues from environmentally related taxation across countries. . . . . . . . . . 32 2.2. Taxes on specific pollutants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2.3. Exemptions and reductions in environmentally related taxation . . . . . . . . . . . 51 2.4. Tradable permits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 2.5. Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Chapter 3. Effectiveness of Environmentally Related Taxation on Innovation. . . . . . . 63 3.1. Measuring innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 3.2. Identifying the benefits and drawbacks of innovation. . . . . . . . . . . . . . . . . . . . . 70 3.3. Case studies of environmentally related taxation and the inducement to innovate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 3.4. Environmentally related taxation and different types of innovation. . . . . . . . . 79 3.5. Innovation degree: Incremental versus breakthrough technologies. . . . . . . . . . 82 3.6. Constraints to innovation in response to environmentally related taxation . . 83 3.7. The adoption and transfer of environmentally related innovation . . . . . . . . . . 87 3.8. Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 Chapter 4. Tax Design Considerations and other Tax-based Instruments . . . . . . . . . . 95 4.1. Identifying the appropriate level of the tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 4.2. The extent of the tax base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 4.3. Administering the tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 4.4. Tax-based policy instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 TABLE OF CONTENTS TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 6 4.5. The choice of tax instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122 4.6. Creating a policy package: Combinations of environmental and innovation instruments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 4.7. Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 5. A Guide to Environmentally Related Taxation for Policy Makers 5.1. Why taxes? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136 5.2. Making effective environmentally related taxation . . . . . . . . . . . . . . . . . . . . . . . 138 5.3. Using the revenue generated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 5.4. Overcoming challenges to implementing environmentally related taxes. . . . . 143 5.5. Environmentally related taxes alone are not the answer . . . . . . . . . . . . . . . . . . 147 5.6. Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .148 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 Case Studies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Annex A. Sweden’s Charge on NO x Emissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153 Annex B. Water Pricing in Israel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 Annex C. Cross-country Fuel Taxes and Vehicle Emission Standards. . . . . . . . . . . . . . . 175 Annex D. Switzerland’s Tax on Volatile Organic Compounds . . . . . . . . . . . . . . . . . . . . . . 187 Annex E. R&D and Environmental Investments Tax Credits in Spain . . . . . . . . . . . . . . . 197 Annex F. Korea’s Emission Trading System for NO x and SO x . . . . . . . . . . . . . . . . . . . . . . 209 Annex G. UK Firms’ Innovation Responses to Public Incentives: An Interview-based Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 Annex H. The UK’s Climate Change Levy and Climate Change Agreements: An Econometric Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 Annex I. Japan’s Tax on SO x Emissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239 Tables 2.1. Extent of tax instrument utilisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 2.2. Taxes on chlorinated solvents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 2.3. Pesticide and fertiliser taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 2.4. Full exemptions for agriculture from environmentally related taxes . . . . . . . . . . . 52 2.5. Tax rates on electricity in OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 2.6. Environmental impacts of selected tax reductions/exemptions in the Netherlands. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 4.1. Inducements for innovation by tax instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 4.2. Welfare effects of taxes and R&D subsidies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 A.1. Adoption of NO x mitigation technology in Sweden . . . . . . . . . . . . . . . . . . . . . . . . . . 155 A.2. NO x patent applications across countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156 A.3. Plants subject to the NO x tax: Descriptive statistics. . . . . . . . . . . . . . . . . . . . . . . . . . 157 B.1. Agricultural prices for fresh water in Israel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 B.2. Domestic water prices in Israel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 C.1. Empirical results: Emission abatement technologies. . . . . . . . . . . . . . . . . . . . . . . . . 183 C.2. Empirical results: Input (improved engine design) technologies . . . . . . . . . . . . . . . 184 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 7 C.3. Empirical results: Output technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 D.1. Largest VOC reductions by industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 E.1. Use of reasoned reports in Spain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 E.2. Sequential impact of tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 E.3. R&D&I tax credits and tax credit use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 E.4. Impact of R&D&I tax credit on use of EI credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 E.5. Environmental Investments tax credits and tax credit use. . . . . . . . . . . . . . . . . . . . 202 E.6. Impact of environmental investments tax credit in use of R&D&I tax credit. . . . . 202 E.7. Characteristics of tax credit use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 F.1. Implementation progression of cap-and-trade programme . . . . . . . . . . . . . . . . . . . 210 F.2. Pollution impact of low-NO x burners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 F.3. NO x reduction efficiencies by low-NO x burners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 F.4. Patents by technical field in Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214 G.1. Drivers of innovation and construction of indices . . . . . . . . . . . . . . . . . . . . . . . . . . . 220 G.2. Survey results and energy intensity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221 G.3. Survey results and productivity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 G.4. Survey results and innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 H.1. Rates of the Climate Change Levy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229 H.2. Descriptive statistics by CCA participation status . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 H.3. CCA participation and environmental performance . . . . . . . . . . . . . . . . . . . . . . . . . 233 H.4. CCA participation and innovation performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 I.1. Annual average rate of change of SO x reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247 Figures 1.1. Estimated effects of innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 1.2. Drivers of innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 1.3. Chain-linked model of innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 2.1. Revenues from environmentally related taxation as percentage of GDP . . . . . . . . 33 2.2. Revenues from environmentally related taxation as percentage of total tax revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 2.3. Composition of environmentally related tax revenues in the OECD . . . . . . . . . . . . 36 2.4. Composition of environmentally related tax revenues by country . . . . . . . . . . . . . 37 2.5. Tax rates on motor fuel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.6. Real changes in tax rates on petrol . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 2.7. One-off motor vehicle taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 2.8. CO 2 component of one-off taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 2.9. Implicit carbon price and motor vehicle taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 2.10. Total CO 2 components of motor vehicle taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 2.11. Tax rates on light fuel oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 2.12. Taxes on NO x emissions to air. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 2.13. Tax rates on landfill. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 3.1. Direct government share of total R&D expenditures . . . . . . . . . . . . . . . . . . . . . . . . . 65 3.2. Environmental R&D expenditures in total government R&D allocations . . . . . . . . 66 3.3. Energy R&D expenditures in total government R&D expenditures . . . . . . . . . . . . . 67 3.4. Environmental impacts and economic externalities of innovations . . . . . . . . . . . . 72 3.5. Types of environmentally related innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 4.1. Innovation impacts with taxation and tradable permits. . . . . . . . . . . . . . . . . . . . . . 100 [...]... (and therefore effective) impact on the firm: there is no price on the use or destruction of the environment Clearly, taxation can insert itself here Taxes, especially excise taxes, can put an explicit price on the environment and therefore should lead to some induced innovation because taxation changes the rate of return to the investor In the absence of taxation, the TAXATION, INNOVATION AND THE ENVIRONMENT. .. including in other fields and by different actors And the innovations themselves can be used by a wide range of actors, within the firm, within the sector and beyond TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 25 1 INTRODUCTION The interrelationships and drivers described in Figures 1.2 and 1.3 interact with a wide range of forces which shape and direct the rate and direction of innovation A... The innovation process There are three parts to innovation – the creation and development of the innovation, the adoption (or diffusion) of the innovation within an economy, and, finally, the transfer of the innovation between economies Looking at how these work and interest is discussed below In addition, the OECD has developed an innovation strategy (OECD, 2010) to look broadly at the issues of innovation. .. The actual creation of innovation is not as straightforward as Figure 1.2 suggests, however Each stage of the innovation process has an impact on other stages, both for the innovation itself and for other innovations The interrelationships between the knowledge base, the creation process and the development process create a “chain-linked” model of 24 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010... of these issues 16 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 Taxation, Innovation and the Environment © OECD 2010 Chapter 1 Introduction This chapter introduces why an unregulated market provides too much pollution and too little innovation, the combination of which makes environmentally related innovation doubly undersupplied It outlines that such innovation is critical for achieving environmental... benefit of the innovation Thus, the rate of return to the firm (that is, the private rate of return) would be the same as the rate of return to the entire economy (that is, the social rate of return, which includes that to the inventor) as the firm was able to capture all the benefits However, first there are market imperfections that hamper the ability for innovation to be developed and for the inventor... For these reasons, other approaches to (either alone or in combination with) environmentally related taxation are sometimes more effective 22 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 1.2 Innovation and low-cost, efficient environmental outcomes New developments and breakthroughs can have the ability to dramatically lower the costs of achieving environmental goals or achieving strong environmental... some innovations to reach their full potential or usefulness, there must be a network of others users of the same innovation The first Facebook (or telephone, for that matter) user likely realised this: value of social networking sites, for example, relies on the number of other persons using the technology as well 26 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 1 INTRODUCTION One of the largest... addition, they would be able to fully reap all the monopoly benefits that would come from their invention Again, the real world does not afford such conditions and therefore there is an undersupply of innovation These market constraints coupled with knowledge spillover effects reduce potential returns from innovation When the environment and innovation are taken together, Jaffe et al (2005) contend that environmental... Change in the DICE Model of Global Warming”, Journal of Environmental Economics and Management, No 48, pp 742–768 Stoneman, Paul (2001), The Economics of Technology Diffusion, Blackwell, Oxford 30 TAXATION, INNOVATION AND THE ENVIRONMENT © OECD 2010 Taxation, Innovation and the Environment © OECD 2010 Chapter 2 Current Use of Environmentally Related Taxation* This chapter outlines the usage of environmentally . 18 1.2. Innovation and low-cost, efficient environmental outcomes . . . . . . . . . . . . . . . 23 1.3. The intersection of taxation, innovation and the environment. countries. Taxes and other environmental policy instruments can complement each other Well-designed taxes put a clear price on the damage to the environment and therefore