Abstract:

Environmental pollution represents a significant cause of morbidity and premature mortality. Nearly seven million people die prematurely around the world each year as a result of air pollution, and hundreds of thousands more die due to unimproved water and sanitation (Lim et al., 2012). The monetized health and productivity damages from air pollution exceed a hundred billion dollars annually in China and the United States (Matus et al., 2012; US EPA, 2011).

In response to the significant impacts of pollution on health, governments traditionally pursued command-and-control regulations. These have delivered significant gains in environmental health, although high costs of regulatory mandates suggest the need for alternative approaches to reducing pollution. This paper focuses on taxes and subsidies as potential means for reducing the health burden from environmental pollution.

Pollution taxes change the business calculus for the sources of pollution (Aldy et al., 2010). Just as higher wages induce firms to invest in labor-saving capital, a pollution tax induces investments that lower pollution. A well-designed tax can ensure that all sources face the same marginal cost of pollution, thereby minimizing the aggregate costs for a given gain in environmental and health quality, and can maximize social welfare by ensuring that the tax equals the marginal benefits of pollution reduction. Raising revenue through a pollution tax could help offset labor and capital taxes, which are distortionary and impose welfare costs as a consequence of raising revenues through these means. Some countries environmentally-related tax revenues comprise 5-10 percent of total tax revenue (OECD, 2011). Taxing fossil fuels in the United States to account for local air pollution and climate change damages would raise revenues equal to about 1.5 percent of GDP (Jorgenson, 2012).

Subsidies in the energy sector can have a profound impact on pollution and health outcomes. Many countries in the developing world subsidize fossil fuels that results in excessive consumption and increased air pollution. Iran’s 2010 subsidy reform illustrates the impact of reducing fossil fuel subsides: fuel prices increases of an order of magnitude reduced carbon dioxide, sulfur dioxide, and nitrogen oxide emissions by 10-20 percent (IMF, 2011). Subsidies for clean energy technologies, by lowering their adoption cost, may displace dirtier sources of energy and produce public health benefits. Subsidizing specific clean energy technologies is typically more costly in aggregate than a pollution tax since it fails to fully exploit the flexibility that a tax offers. For example, a subsidy for an existing set of technologies may not reward innovation like a tax would, nor would it support technologies or process changes that are beyond the scope of the parameters of the subsidy.

The design and implementation of fiscal instruments should account for a variety of realworld considerations. Tax instruments deliver greater certainty for the returns to emission abatement investment, and could drive more abatement and innovation than command-andcontrol regulations or cap-and-trade programs. Such certainty is transparent, which may elicit political opposition since policy-makers typically prefer to impose opaque costs on constituents (Keohane et al., 1998). In some cases, it may be technically or administratively challenging to directly target the pollution externality. For example, India taxes coal as opposed to the more 2 difficult to monitor sulfur dioxide emissions from coal combustion. There are also important interaction effects among multiple policies, such as the prospect of a pollution tax to raise revenue that enables a reduction in labor and capital tax rates. This new revenue source could improve the political palatability of pollution taxes given the fiscal demands in many countries, and a prudent ramping of the policy over time may facilitate broader public support. In countries with subsidized fossil fuel prices, a pollution tax may be ineffective unless the tax can be passed through to consumers. Finally, a pollution tax or fossil fuel subsidy elimination will increase energy prices, and this could raise important distributional questions. Some policy reforms – including the British Columbia carbon tax and the 2005 fossil fuel subsidy reform in Indonesia – have included means-tested unconditional cash transfers to address regressivity concerns.