Taxing Pollution Instead of Employment: Greenhouse Gas Abatement through Fiscal Policy in the UK

Abstract

Fiscal changes designed to achieve the two objectives of reductions in greenhouse gas emissions and increases in employment are explored using a large-scale energy-environment-economy model of the UK, the Cambridge Multisectoral Dynamic Model (MDM). Two options are considered in detail: the road fuel duty escalator, introduced in the March 1993 Budget, and the CEC's proposed carbon/energy tax; revenues for each tax are recycled via reductions in employers' NIC calculated to keep the ratio of the PSBR to GDP at base scenario rates. The changes are introduced in 1996 and standardised so that each reduces CO2 emissions by some 21 mtC by 2005. The escalator is shown to raise far more revenue per mtC reduced and so NIC charges can be reduced much more than under the carbon/energy tax option. A detailed analysis is made of the effects on industrial costs of the carbon/energy tax option; the effects on competitiveness, measured as the effects on the balance of payments under a fixed exchange rate regime, are found to be negligible, even with a unilateral tax. Both options appear to provide substantial environmental net benefits as well as economic gains. However, each option has its strengths and weaknesses and a combination may allow the UK to reach the Toronto target of a 20% cut in CO2 emissions below 1988 levels by 2005.