## 1. Revenues from Environmentally Related Taxation, 2008

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### Introduction: purpose, scope, and motivation
- Paper provides guidelines for the design of environmental taxes drawn from the literature and applies these recommendations to evaluate actual tax systems across Sweden, Germany, Turkey, and Vietnam.
- Objectives:
  - Illustrate what should be taxed, by how much, at what point in the production chain, and what should not be taxed.
  - Rely on principles of: (1) exploiting emissions-reduction opportunities (welfare gains); (2) balancing across opportunities; (3) minimizing administrative complications.
- Context and motivation:
  - Environmental tax revenues (primarily taxes on motor fuels and vehicles) constitute approximately 3–10 percent of total tax revenues in typical OECD countries.
  - Reform momentum driven by: need for new revenues; acceptance of emissions pricing; potential for swapping environmental taxes for labor taxes; rising concerns about GHG concentrations, urban air quality, and congestion.

### High-level recommended tax design
- Core recommendation:
  - Levy environmental taxes directly on potential damages from the carbon and local pollution content of coal, natural gas, and oil products as these fuels enter the economy.
  - Implement a system of refunds for emissions capture at downstream facilities.
  - Downstream pricing systems can be reasonable alternatives in some cases.
- Motor fuels:
  - Taxes should factor in congestion and accident externalities (and road damages for heavy-truck fuels) until per-mile charges are introduced.
- Revenue use and distribution:
  - Productive use of environmental tax revenues (e.g., to reduce other distortionary taxes) important for containing costs.
  - Prefer compensation schemes (scaling back redundant energy taxes, recycling revenues in tax cuts favoring low-income households, output subsidies for vulnerable firms) over lowering environmental taxes or creating downstream exemptions.

### Pigouvian framework and robustness
- Pigouvian rule:
  - Environmental taxes should equal marginal damages and be levied directly on the source of emissions to induce the efficient emissions reduction (E*).
- Stock vs. flow pollutants:
  - Framework applies to both; for CO2 the marginal damage is the present value of future (worldwide) damages from an extra ton.
- Flat marginal benefit case:
  - For CO2, the marginal benefit curve for one country in one year is essentially flat.
- Robustness to tax imprecision:
  - If the tax is 50 percent above or 50 percent below marginal damages, a large portion (roughly three-quarters) of the welfare gains from the true corrective tax are still achieved.

### Externality measurement: steps and uncertainties
- Key measurement steps for local pollution damages:
  1. Air quality modeling linking emissions to atmospheric concentrations (including secondary pollutants and dispersion factors).
  2. Modeling human health effects and population exposure using dose-response relationships.
  3. Monetizing physical effects using willingness-to-pay evidence (e.g., Value of a Statistical Life).
- Sources of uncertainty (selected VSL values reported in literature):
  - U.S. Department of Transportation used a VSL of $3.5 million in 2004 and later increased this value to $6 million.
  - Muller and Mendelsohn (2009) used VSLs of $2-4 million.
  - National Research Council (2009) used $6 million (in year 2000 dollars).
  - U.S. Environmental Protection Agency used a VSL of $9.1 million for new clean air rules in 2010.
- Spatial heterogeneity:
  - Damages vary across space with local population exposure and dispersion; welfare gains from a uniform national price are considerably larger than additional gains from optimally differentiating prices by region.

### Tax adjustment over time
- Corrective taxes should be adjusted over time in line with growth in marginal environmental damages:
  - Pollution-health effects adjusted with the VSL (which rises with income depending on income elasticity of VSL).
  - For climate change, marginal damages from CO2 emissions rise over time (e.g., with growth in world GDP potentially at risk).

### Tax base and proxy taxes: efficiency trade-offs
- Direct emissions pricing vs. proxy taxes:
  - A tax on a 'proxy' for emissions exploits a narrower range of reduction opportunities and yields smaller emissions reductions and welfare gains.
  - If a proxy tax induces fraction z of emissions reductions relative to an emissions tax, welfare gains under the proxy tax equal fraction z of those under the emissions tax (under linear marginal costs).
- Specific examples and implications:
  - Electricity excise taxes: if under a carbon tax 25 percent of energy-related CO2 reductions come from reduced electricity demand and 75 percent from other sources, excise taxes on electricity consumption might sacrifice around three-quarters of the welfare gains from carbon taxes.
  - Vehicle ownership taxes: if 20 percent of CO2 emissions reduction from a fuel tax came from reduced demand for vehicles and 80 percent from reduced miles per vehicle and fuel-economy improvements, vehicle ownership taxes would achieve only 20 percent of the reductions induced by equivalently scaled fuel taxes.
- Uniformity and harmonization:
  - All emissions sources should be priced at the same rate—pollution content should be charged at the same rate across fuels and end users.
  - Multiple instruments (e.g., ETS + tax) are inefficient unless harmonized; refunds should be provided for allowance purchases to avoid double charging.
  - Taxes should vary continuously in proportion to emissions, avoiding “notches.”

### Administrative complications and coverage trade-offs
- Trade-off:
  - As more diffuse emissions sources are taxed, marginal administration costs rise.
- Examples and approaches:
  - Some non-CO2 GHG sources can be monitored and taxed; others handled via domestic offset provisions where valid reductions can be demonstrated.
  - Forest carbon sequestration via domestic offsets where benefits can be reasonably measured.
- Upstream vs downstream:
  - Recommend upstream levies where feasible to limit collection points and maximize coverage, complemented by downstream refunds for verified capture.
  - Example administrative scale comparison (United States): upstream on refineries, natural gas operators, and coal mines would involve monitoring about 2,000 companies; downstream charging at smokestacks would raise covered firms to about 13,000.

### Key policy recommendations (concise)
- Levy environmental taxes on carbon and local pollution content of coal, natural gas, and oil products at the point they enter the economy, with refunds for verified downstream capture.
- Where feasible, price emissions directly at marginal damages and avoid proxy taxes (electricity use taxes, vehicle ownership taxes) that forgo large fractions of potential welfare gains.
- Align tax rates across fuels and end users to the same pollution-content rate; harmonize instruments (taxes and trading systems) to avoid double charging.
- Adjust taxes over time with growth in marginal damages and VSL changes.
- Use environmental tax revenues productively (e.g., reduce other distortionary taxes); address distributional and competitiveness concerns through compensation mechanisms rather than reduced environmental pricing.
- Prioritize research to refine empirical estimates of local externalities across developed and developing countries.

### Problems with tax “notches” and alternatives (Box 2 highlights)
- Notches (discrete brackets) distort vehicle choice, create bunching near bracket thresholds, over-emphasize some behavioral responses, and create tension between revenues and emissions reduction.
- Recommended alternative:
  - Combine a simple, proportional tax on new vehicle prices with a revenue-neutral feebate:
    - Proportional tax on new vehicle prices to meet revenue objectives without distorting vehicle choice.
    - Feebate: fees on fuel-inefficient vehicles proportional to difference from a pivot CO2-per-mile point and rebates for efficient vehicles; pivot set to previous year’s fleet average to approximate revenue neutrality.
- Other notch problems:
  - Firm-level emissions thresholds and discrete fuel pollution notches limit incentives for further abatement and create distortions.
- Complementary instruments:
  - Upstream fuel taxes complemented with downstream rebates for demonstrated emissions reductions (continuous emissions monitoring) encourage abatement technologies.
- Multiple-externality case for passenger vehicle fuel use:
  - Four externalities: CO2 (proportional to fuel combustion), local pollution (reduced less than fuel use due to fuel-economy responses), congestion (per-mile), and accidents (per-mile).
  - In computing corrective fuel taxes, congestion and accident externalities per-mile need conversion to per-unit-of-fuel and scaled back by the fraction of fuel reduction coming from reduced driving.
- Better instruments than fuel taxes:
  - Congestion: electronically-collected per-mile tolls varying by time and location.
  - Accident risk: mileage tolls adjusted for driver and vehicle crash risk.
  - These instruments can substantially reduce the corrective fuel tax needed.

### VAT coverage and interactions with environmental taxes (Box 4 highlights)
- VAT principle:
  - All consumption goods ideally included under VAT; production inputs exempt to avoid production distortions.
  - Under appropriately designed VAT, taxing fuels to account for external costs does not require VAT adjustments.
- Market power and subsidies:
  - Market power may warrant downward adjustment of optimal environmental tax but often of limited practical relevance.
  - Removing subsidies and then taxing externalities is most efficient; if subsidies persist, higher environmental taxes may be warranted on second-best grounds.
- Broader tax distortions and revenue recycling:
  - Two opposing effects in a distorted fiscal system:
    - Positive: recycling environmental tax revenues to reduce distortionary taxes produces efficiency gains.
    - Negative: environmental taxes raise energy prices, reduce real wages and returns to capital, lowering labor supply and capital accumulation.
  - General theoretical finding: optimal environmental tax is below marginal external damage but only moderately so; Pigouvian tax remains a reasonable approximation.
  - Importance: Without revenue recycling, net benefits from emissions taxes are greatly reduced.
- Earmarking:
  - Earmarking revenues is a potential red flag unless spending generates efficiency gains comparable to cutting distortionary taxes.
  - Minor earmarking for production subsidies can improve acceptability without sacrificing too much effectiveness.
- Transition planning:
  - Motor fuel taxes should account for multiple externalities, with planned transition to per-mile charges as capacity develops.
- Distributional and competitiveness measures:
  - Compensation options include scaling back redundant energy taxes, progressive fiscal adjustments, targeted subsidies for clean technologies, temporary production subsidies for trade-exposed industries, and removal of redundant taxes.

### Country cases: Sweden, Germany, Turkey, Vietnam (Box 5 highlights)
- Sweden
  - Early 1990s and early 2000s: Nordic environmental tax reforms combined with reductions in labor taxes.
  - 1991–1992: taxes on oil and natural gas to charge for CO2 and (for oil) SO2; downstream taxes on coal-related SO2 and industrial NOx.
  - Manufacturing exempted from traditional energy taxes and made to pay only 21 percent of CO2 tax rates from 2004 onwards; CO2 tax on fuels used in manufacturing plants covered by EU ETS gradually reduced to 15 percent of statutory rate.
  - SO2 and NOx taxes fixed in nominal terms since 1991, reducing real values by about 35 percent; CO2 tax updated sporadically.
- Germany
  - 1999 reform: gradual increase in transport fuel taxes; new taxes on natural gas, heating fuels, heavy fuel oil, and primarily residential electricity.
  - Reform broadly revenue-neutral: about 85 percent of revenue recycled via equal reductions in employers’ and employees’ payroll taxes; about 13 percent used for budget consolidation; 1 percent earmarked for renewable energy deployment.
  - Substantial tax expenditures for manufacturing and power generation initially 80 percent, later 40 percent; in some cases effective tax near nil.
- Turkey
  - Highest gasoline tax among OECD countries at $0.98 per liter; motive mainly fiscal for consolidation in early 2000s.
  - Taxing vehicle ownership (more inelastic) would be preferable for revenue.
- Vietnam
  - 2004 decision for comprehensive reform; 2008–10 financial crisis may have delayed initiatives.
  - Current fuel taxes: coal taxed at $0.52 per ton; gasoline at about 20 cents per gallon; natural gas not taxed.
  - Environmental Protection Charges on resource extraction are minuscule; significant fuel subsidies to consumers; electricity subsidies scaled to favor poor households.

### Energy system comparisons and illustrative numbers
- Power generation character:
  - Sweden: almost half electricity from hydro, almost 40 percent from nuclear, 9 percent from biofuels.
  - Germany: coal about 45 percent, natural gas 14 percent, nuclear 23 percent, renewables 18 percent.
  - Turkey and Vietnam: reliance on fossil fuels (natural gas, then coal), hydro important: Vietnam 36 percent, Turkey 19 percent.
- Fuel mix and transport indicators:
  - Oil share in total energy consumption: Germany, Sweden, Turkey about 35–45 percent; Vietnam 28 percent.
  - Passenger vehicles per 1000 people in 2010: Vietnam 13; Turkey 131; Sweden 523; Germany 623.
  - Coal accounts for 13–23 percent of final energy consumption in Germany, Turkey, and Vietnam.
  - Natural gas share of final energy consumption: Germany 31 percent; Turkey 26 percent; Sweden minimal; Vietnam 6 percent.
  - Electricity is 12 percent of energy consumption in Vietnam.
  - Renewables share of final energy consumption: Sweden 45 percent; Vietnam 47 percent.
- CO2 damage values used (illustrative):
  - US$23 per ton (U.S. Interagency Working Group on Social Cost of Carbon, updated to 2010 dollars).
  - US$85 per ton (U.K. Department of Energy and Climate Change).
  - Coal is approximately 77 percent more carbon intensive per terajoule than natural gas, and 27 percent more intensive than oil.
- Local air pollution damages for stationary sources (year 2010 central case averages, National Research Council, 2009):
  - SO2: approximately $10,000 per ton.
  - NOx: approximately $2,000 per ton.
  - Primary (fine) particulates: approximately $22,000 per ton.
  - Natural gas: produces no SO2 and NOx intensity about one-fifth of coal; scrubbing can capture around 90 percent of SO2.
- VSL/income adjustment:
  - Real income (PPP) relative to United States: Sweden 82 percent; Germany 77 percent; Turkey 29 percent; Vietnam 7 percent.
  - VSL/income elasticity used: 0.75.
  - Result: damage values per ton are just under half as large in Turkey relative to Germany and Sweden, and about one-sixth as large in Vietnam.

### Motor vehicle externalities and illustrative corrective fuel taxes
- Assumptions:
  - Externalities scaled back by 50 percent assuming reduced driving accounts for half of any tax-induced reduction in fuel use.
  - Assumed on-road fuel economy of 30 miles per gallon.
- Illustrative corrective fuel taxes per gallon:
  - Germany: $3.69 per gallon.
  - Sweden: $4.14 per gallon.
  - Turkey: $2.35 per gallon.
  - Vietnam: $0.78 per gallon.
- Note: congestion is the most dominant component of these corrective taxes; figures require local data refinement.

### Statutory motor fuel taxes and comparisons
- Statutory motor fuel taxes (current, reported):
  - Sweden: about $2.90 per gallon.
  - Germany: about $3.30 per gallon.
  - Turkey: about $3.70 per gallon.
  - Vietnam: about $0.20 per gallon.
- Comparison notes:
  - For Germany and Sweden, calculated corrective fuel taxes are somewhat above current statutory rates (but not presented as definitive policy recommendations).
  - For Vietnam, conservative corrective tax estimate is four times the current tax.
  - For Turkey, current fuel taxes may be difficult to justify on externality grounds.

### Other sectoral findings and recommendations
- Coal:
  - Local pollution damages driven by SO2 prior to scrubbing.
  - Sweden: limited welfare gains from coal tax reform (small coal use).
  - Germany: coal tax equivalent from EU ETS insufficient to cover U.S. value for carbon damages and local pollution damages.
  - Turkey: coal not taxed.
  - Vietnam: coal taxed very lightly despite significant damages.
- Natural gas:
  - Damages per gigajoule about one-third to one-half as large as for coal.
  - Recommendation: levelize natural gas tax across end users and set between current household and generator rates.
  - For Turkey and Vietnam: modest taxation of natural gas to cover carbon damages.
- Light fuel oil:
  - Damages intermediate between coal and natural gas; undercharged in nearly all cases except residential consumption in Turkey and Sweden where tax rates are excessively high.
- Redundant taxes and subsidies:
  - Significant excise taxes on household electricity use and vehicle ownership exist; environmental rationale disappears when fuel taxes reach corrective levels.
  - Residential electricity excise taxes per kWh (IEA, 2010): Sweden 3.7 cents per kWh; Germany 2.7 cents per kWh; Turkey 1.2 cents per kWh.
  - Vehicle excise taxes in Sweden, Germany, and Turkey raise revenues equivalent to fuel charges of 33 to 66 cents per gallon (IMF, 2011b).
  - Vietnam subsidizes electricity use; vehicle taxation system opaque.

### Final policy conclusions and research priorities
- General principles:
  - Emissions taxes or cap-and-trade equivalents with allowance auctions should be the centerpiece of greener fiscal policy.
  - Prefer levying taxes upstream in fuel supply chains, with refunds or credits for downstream emissions capture.
  - Compensate low-income households and trade-exposed firms via targeted measures rather than reducing environmental taxes or granting exemptions.
  - Avoid notches and differentiated treatment of identical emissions.
- Specific policy actions:
  - Impose charges for coal, oil products, and natural gas for CO2 and local emissions grounded roughly to damage estimates.
  - Levelize taxes across emissions sources causing the same damage.
  - Scale back redundant energy taxes (electricity excises, vehicle ownership) as environmental rationale wanes.
  - Transition motor vehicle taxation toward time- and location-varying mileage tolls.
  - Introduce or increase taxation on coal in Turkey and Vietnam; levelize natural gas taxation in Germany, Turkey, and Vietnam.
- Research priorities:
  - More sophisticated measurement of pollution and congestion externalities across countries.
  - Refine local data on congestion, accident risks, population exposure, and health vulnerabilities.

*Source: IMF working paper section “1. Revenues from Environmentally Related Taxation, 2008” (provided content).*

### 1. Revenues from Environmentally Related Taxation, 2008 .....................................................5

### 1. Revenues from Environmentally Related Taxation, 2008

### Introduction: purpose and scope
- Paper provides guidelines for the design of environmental taxes drawn from the literature and applies these recommendations to evaluate actual tax systems across several diverse countries.
- Objectives:
  - Illustrate what should be taxed, by how much, at what point in the production chain, and what should not be taxed.
  - Rely on principles of: (1) exploiting emissions-reduction opportunities (welfare gains); (2) balancing across opportunities; (3) minimizing administrative complications.
- Context and motivation:
  - Environmental tax revenues (primarily taxes on motor fuels and vehicles) constitute approximately 3–10 percent of total tax revenues in typical OECD countries.
  - Momentum for environmental tax reform driven by: need for new revenues, acceptance of emissions pricing as effective, potential for swapping environmental taxes for labor taxes to improve competitiveness, and rising concerns about GHG concentrations, urban air quality, and congestion.
- Geographic focus for application:
  - Country cases considered include Sweden, Germany, Turkey, and Vietnam.

### Recommended tax design (high-level)
- Core recommendation:
  - Levy environmental taxes directly on potential damages from the carbon and local pollution content of coal, natural gas, and oil products as these fuels enter the economy.
  - Implement a system of refunds for emissions capture at downstream facilities.
  - Downstream pricing systems can be reasonable alternatives in some cases.
- Motor fuels:
  - Taxes should factor in congestion and accident externalities (and road damages for heavy-truck fuels) until per-mile charges are introduced.
- Revenue use:
  - Productive use of environmental tax revenues (e.g., to reduce other distortionary taxes) important for containing costs.
- Distributional/competitiveness concerns:
  - Prefer compensation schemes (scaling back redundant energy taxes, recycling revenues in tax cuts favoring low-income households, output subsidies for vulnerable firms) over lowering environmental taxes or creating downstream exemptions for favored sectors.

### Empirical findings on existing tax systems (summary)
- Observations:
  - Ample room for improvement in leveling tax rates (for the same pollution content) across fuels and end users.
  - Many systems rely substantially on vehicle ownership taxes and excise taxes on electricity consumption that are redundant, from an environmental perspective, with appropriate fuel pricing.
- Research priorities:
  - Refine empirical estimates of major local externalities across a broad range of developed and developing countries.

### Principles of environmental tax design — Pigouvian framework
- Pigouvian rule:
  - Environmental taxes should equal marginal damages and be levied directly on the source of emissions.
  - Corrective tax equal to marginal damages induces the efficient emissions reduction (E* in Figure 2), where marginal benefit (avoided incremental environmental damage) equals marginal abatement costs.
- Stock vs. flow pollutants:
  - Framework applies to both; for CO2 the marginal damage is the present value of future (worldwide) damages from an extra ton, accounting for ocean uptake and delayed temperature adjustment.
- Flat marginal benefit case:
  - For CO2, marginal benefit curve for one country in one year is essentially flat since damages depend on atmospheric stock of GHGs.
  - For major air pollutants, mortality risk may increase roughly in proportion with ambient pollution concentrations over a range.
- Robustness to tax imprecision:
  - Even if the tax is 50 percent above or 50 percent below marginal damages, a large portion (roughly three-quarters) of the welfare gains from the true corrective tax are still achieved.

### Externality measurement (uncertainties)
- Key measurement steps for local pollution damages (Box 1):
  1. Air quality modeling linking emissions to atmospheric concentrations, including secondary pollutants and dispersion factors (wind, geography, stack height).
  2. Modeling human health effects and population exposure (seniors, those with pre-existing conditions) using dose-response relationships.
  3. Monetizing physical effects using willingness-to-pay evidence, e.g., Value of a Statistical Life (VSL).
- Sources of uncertainty:
  - Atmospheric chemistry modeling (secondary pollutant formation) is especially difficult.
  - Disagreement over appropriate VSL values:
    - U.S. Department of Transportation used a VSL of $3.5 million to value road deaths in 2004 and later increased this value to $6 million.
    - Muller and Mendelsohn (2009) used VSLs of $2-4 million.
    - National Research Council (2009) used $6 million (in year 2000 dollars).
    - U.S. Environmental Protection Agency used a VSL of $9.1 million for new clean air rules in 2010.
- Spatial heterogeneity:
  - Damages vary across space with local population exposure and natural dispersion factors.
  - Optimal regional differentiation of emissions prices could yield welfare gains, but welfare gains from a uniform national price (equal to average damages) are considerably larger than additional gains from optimally differentiating prices by region (Muller and Mendelsohn, 2009).
- Conclusion:
  - Given uncertainties, analysis focuses on uniform taxes.

### Tax adjustment over time
- Corrective taxes should be adjusted over time in line with growth in marginal environmental damages:
  - Pollution-health effects should be adjusted with the VSL, which rises with income (depending on income elasticity of VSL).
  - For climate change, marginal damages from CO2 emissions rise over time, for example with growth in the size of (world) GDP potentially at risk.

### Tax base and proxy taxes
- Direct emissions pricing vs. proxy taxes:
  - A tax on a 'proxy' for emissions exploits a narrower range of reduction opportunities than a direct emissions tax; the proxy tax yields a steeper marginal cost curve and smaller emissions reductions and welfare gains.
  - Example: If a proxy tax induces fraction z of emissions reductions relative to an emissions tax, welfare gains under the proxy tax equal fraction z of those under the emissions tax (under linear marginal costs).
- Specific examples:
  - Electricity excise taxes:
    - If under a comprehensive carbon tax 25 percent of energy-related CO2 reductions come from reduced electricity demand and 75 percent from other sources, excise taxes on electricity consumption might sacrifice around three-quarters of the welfare gains from carbon taxes.
  - Vehicle ownership taxes:
    - If 20 percent of CO2 emissions reduction from a fuel tax came from reduced demand for vehicles and 80 percent from reduced miles per vehicle and fuel-economy improvements, vehicle ownership taxes would achieve only 20 percent of the reductions induced by equivalently scaled fuel taxes.
- Policy implication:
  - In the ideal Pigouvian framework, all emissions would be directly priced at marginal damages and proxy taxes (electricity use taxes, vehicle ownership taxes) would be avoided.
- Uniformity:
  - All emissions sources should be priced at the same rate—pollution content should be charged at the same rate across fuels and across end users.
  - Multiple instruments (e.g., ETS + tax) are inefficient unless harmonized. If an EU ETS country adopts a national comprehensive carbon tax, refunds should be provided for ETS allowance purchases to avoid double charging.
  - Taxes should vary continuously in proportion to emissions, avoiding “notches” (see Box 2 in source).

### Administrative complications and coverage trade-offs
- Trade-off between emissions coverage and administrative feasibility:
  - As more diffuse emissions sources are taxed, marginal administration costs rise.
  - Some non-CO2 GHG sources (e.g., vented methane from underground coalmines) can be monitored and taxed; others may be better handled via domestic offset provisions where entities demonstrate valid reductions (e.g., methane capture from livestock waste).
  - Forest carbon sequestration could be integrated via domestic offsets only where carbon benefits can be reasonably measured (satellite imagery, aerial photography, ground-level sampling).
- Refunds and downstream capture:
  - Recommend refunds for emissions capture at downstream facilities as part of a fuel-entry tax system; downstream pricing systems are an alternative where appropriate.

### Key policy recommendations (concise)
- Levy environmental taxes on carbon and local pollution content of coal, natural gas, and oil products at the point they enter the economy, with refunds for verified downstream capture.
- Where feasible, price emissions directly at marginal damages and avoid proxy taxes (electricity use taxes, vehicle ownership taxes) that forgo large fractions of potential welfare gains.
- Align tax rates across fuels and end users to the same pollution-content rate; harmonize instruments (taxes and trading systems) to avoid double charging.
- Adjust taxes over time with growth in marginal damages and VSL changes.
- Use environmental tax revenues productively (e.g., reduce other distortionary taxes); address distributional and competitiveness concerns through compensation mechanisms rather than reduced environmental pricing.
- Prioritize research to refine empirical estimates of local externalities across developed and developing countries.

*Source: IMF working paper section “1. Revenues from Environmentally Related Taxation, 2008” from the provided PDF content.*

### Box 2. The Problems with Tax ‘Notches’

### Box 2. The Problems with Tax ‘Notches’

### Problems with tax “notches” (general findings)
- Tax systems that assign vehicles to discrete brackets by engine size or CO2 per mile and levy different taxes by bracket are not cost effective because they do not provide the same reward for reducing CO2 across various behavioral responses.
- Such systems:
  - Do not strike the right balance between reducing CO2 per mile in small vehicles, reducing CO2 per mile in large vehicles, and shifting demand from large to small vehicles.
  - Place too much of the burden on shifting people into small vehicles and on reducing CO2 for vehicles that are currently slightly above lower tax brackets (Sallee and Slemrod, 2010).
  - Distort vehicle choice by causing a bunching of demand for vehicles with CO2 per mile just sufficient to be in a lower tax bracket.
  - Create a tension between revenue needs and reducing emissions—as sales shares for low-tax, low-CO2-per-mile vehicles rise, revenues fall.

### Policy alternative: proportional tax on new vehicle prices plus a revenue-neutral feebate
- Recommendation:
  - Combine a simple, proportional tax on new vehicle prices with a revenue-neutral “feebate.”
- Roles of the components:
  - Proportional tax on new vehicle prices:
    - Easily set to meet a revenue objective without distorting choices among different vehicles.
  - Feebate:
    - Fees on fuel-inefficient vehicles proportional to the difference between their CO2 per mile and a pivot point of CO2 per mile.
    - Corresponding rebates paid for relatively fuel-efficient vehicles.
    - Provides a cost-effective way to reduce emissions per mile because the same reward per ton is provided, regardless of how the emissions reduction comes about (e.g., Small, 2010).
    - Can be kept (approximately) revenue-neutral by setting the pivot point equal to average CO2 per mile of the previous year’s vehicle fleet.
- Note:
  - Basing the tax on CO2 per mile promotes a broader range of responses for reducing emissions beyond smaller engine size, such as use of lighter materials or reduced cabin size.10

### Other examples of notches and their problems
- Firm-level emissions thresholds:
  - Firms pay tax only if their emissions exceed a threshold level.
  - Exemptions limit emissions coverage and can create distortions like discouraging mergers or firm growth.
- Discrete fuel taxes by embodied pollution per unit:
  - These systems provide no incentives for refiners to further remove impurities once they have achieved a lower tax notch.

### Administrative considerations: upstream vs downstream charging
- Administrative logic:
  - Environmental taxes should often be levied upstream where fuels enter the economy to limit the number of collection points and maximize emissions coverage.
- Example (administrative scale comparison):
  - In the United States, levying a carbon tax upstream on petroleum refineries, natural gas operators, and coal mines would involve monitoring about 2,000 companies.
  - A downstream approach—charging from the smokestack at power generators and major industrial facilities—would raise the number of covered firms to about 13,000 (e.g., Metcalf and Weisbach, 2009).
- Implications:
  - Downstream systems tend to be less comprehensive due to administrative reasons (small-scale emitters often exempt) and political pressure for exemptions.
  - Upstream charging is especially strong when there are many small-scale stationary emitters (e.g., countries with large informal sectors).
  - In cases with limited numbers of emitters (e.g., the U.S. sulfur trading program) pricing downstream can be entirely reasonable.

### Complementing upstream taxes with downstream rebates (examples and rationale)
- Upstream tax systems can be complemented with rebates to promote downstream behavioral responses that further reduce emissions, for example:
  - Adoption of flue gas scrubbing technologies.
  - Coal washing.
  - Adjusting design, temperature, oxygen and moisture content of the combustion chamber to reduce NOx emissions.
- Mechanism:
  - A power plant or manufacturing firm that demonstrates (through installing continuous emissions monitoring technologies) that its emissions out of the smokestack are less than the embodied emissions in its fuel inputs could claim a credit equal to the difference in emissions times the (upstream) emissions price (e.g., on SO2 content).
  - Placing the onus on firms to demonstrate valid emissions reductions (to obtain the refund) provides ongoing incentives to improve emissions monitoring technologies.
- Vehicle tailpipe case:
  - Individual sources of local pollution are too numerous to tax directly.
  - An upstream fuel tax (to encourage better fuel economy and reduce vehicle miles traveled) coupled with emissions regulations on vehicles (to encourage abatement technologies) may approximately mimic the effects of a direct tax on emissions (e.g., Eskeland, 1994).

### Multiple-externality situations: motor fuel taxes for passenger vehicles
- Context:
  - Multiple-externality problems are endemic; in the power sector many pollutants are additive and can be dealt with through charges on fuel use.
  - The transportation sector is a key exception because some externalities vary with fuel consumption (dependent on vehicle mileage and fuel economy) while others vary only with vehicle mileage.
- Four main externalities for passenger vehicle fuel use:
  1. CO2 emissions:
     - Proportional to fuel combustion (leaving aside blending from biofuels).
     - Appropriate fuel tax equals CO2 produced per unit of fuel combustion times the marginal damage from CO2 emissions.
  2. Local pollution emissions:
     - Fuel taxes reduce local pollution emissions, but by less than in proportion to the fuel reduction because some fuel reduction comes from better fuel economy rather than reduced driving.
     - In countries enforcing emissions-per-mile regulations, emissions are not affected by long run fuel economy improvements—manufacturers can cut back on abatement technologies and still meet the same emissions-per-mile standards (e.g., Fischer and others, 2007).
     - Pollution damage estimates need to be multiplied by the fraction of the fuel reduction that comes from reduced driving (as opposed to better fuel economy).
  3. Traffic congestion:
     - Tax-induced reductions in vehicle miles reduce congestion; congestion externalities arise because drivers do not account for their impact on slowing travel times for others.
  4. Traffic accidents:
     - Tax-induced reductions of driving lower the incidence of traffic accidents (externalities include injury risk to pedestrians or third-party property damage).
- Calculation note:
  - In computing corrective taxes, congestion and accident externalities obtained on a per-mile basis need to be expressed per unit of fuel (multiplied by fuel economy) and then scaled back by the fraction of the incremental, tax-induced fuel reduction that comes from reduced driving (Parry and Small, 2005).

### Better instruments than fuel taxes for vehicle externalities
- Superior fiscal instruments exist:
  - Traffic congestion is ideally reduced through electronically-collected per-mile tolls on congested roads that rise and fall during rush hours to flatten departure-time distribution and deter driving on busy roads.
  - Accident externalities are best addressed through mileage tolls, ideally adjusted for driver and vehicle crash risk.
- Implication:
  - The corrective fuel tax would be reduced considerably with the introduction of these broader tax instruments.

### Other pre-existing distortions and institutional considerations
- Optimal tax on emissions can differ from marginal environmental damages when there is a second source of market failure from distortions in the output market and the tax leads to a reduction in output.
- Distortions in technology markets and VAT treatment of energy are discussed elsewhere (Boxes 3 and 4) but are not considered in the country evaluation here.
- Institutional distortions can affect the appropriate design and level of environmental taxes.

*Source: Box 2, “The Problems with Tax ‘Notches’.”*

### Box 4. Coverage of Energy under the Value-Added Tax System

### Box 4. Coverage of Energy under the Value-Added Tax System

### VAT coverage and basic principle
- All consumption goods should ideally be included under the coverage of a broader value-added tax (VAT) (or other consumption tax) system to raise revenues in a way that avoids distorting consumer choices.
- Inputs into the production of goods should be exempt from such taxes to avoid distorting production efficiency.
- Examples:
  - VAT-exempt: power generation fuels, electricity used by industry, truck purchases by firms.
  - VAT-included (tax base): residential electricity and fuel use, consumer purchases of cars and gasoline.
- Under an appropriately designed VAT tax, these allocation outcomes occur automatically—no adjustment to the VAT system is required when taxes are applied to fuels to account for their external cost.

### Market power, subsidies, and implications for environmental tax design
- Market power can make output already sub-optimal and could warrant a downward adjustment in the optimal environmental tax, but:
  - This downward adjustment may often be of little practical relevance.
  - Reasons include: energy markets in some studied countries exhibit a fair or growing degree of competition; distortions from market power may not be large; and emissions pricing often induces reductions in emissions intensity more than reductions in overall output (especially in the power sector), limiting compounding distortions.
- Pre-existing price controls or other subsidies can exacerbate excessive production in polluting industries.
  - Removing subsidies and then internalizing environmental externalities via taxes is most efficient.
  - If subsidies are likely to be durable, setting a higher environmental tax to partly offset the subsidy might be warranted on second-best grounds.
- Regulatory constraints (e.g., emissions per kilowatt hour, automobile fuel economy) that remain binding eliminate some behavioral responses to emissions/fuel taxes but do not affect the optimal level of these taxes.

### Broader tax distortions and revenue recycling
- Taxes on labor income and consumption create a wedge between the value marginal product of labor and the marginal opportunity cost of labor supply; environmental taxes that affect labor supply and hours worked interact with these distortions.
- Taxes on firm income from investment and household income from savings create wedges between the value marginal product of capital and the marginal cost of capital; environmental taxes interact with these distortions as well.
- Two opposing effects of environmental taxes in a distorted fiscal system:
  - Positive: Using environmental tax revenues to reduce broader tax distortions (or reduce deficits and thereby the need for higher income taxes) produces efficiency gains which can be large relative to gains from reducing the externality itself.
  - Negative: Environmental taxes raise prices of fuels and electricity, reduce real household wages and the real return on capital, and thereby lower labor supply and capital accumulation over the longer term—mirroring direct taxes on wages and savings/investment.
- General theoretical finding:
  - With qualifications, net impact from shifting taxes off income and onto emissions is to increase costs of pre-existing taxes; gains from recycling revenues are more than offset by efficiency losses in factor markets from higher energy prices.
  - Consequently, the optimal environmental tax is below the marginal external damage, but only moderately so; the Pigouvian tax remains a reasonable, rough approximation.
  - Exceptions exist (e.g., net employment effects can be positive in some cases), but they do not seem applicable for the cases studied.
- Importance of revenue recycling:
  - If emissions tax revenues are not used to increase economic efficiency through cutting distortionary taxes (or funding socially desirable spending), net benefits from emissions taxes are greatly reduced.
  - Without revenue recycling, the case for environmental taxes on cost-effectiveness grounds over regulatory approaches can be substantially undermined.
  - Environmental taxes tend to have bigger impacts on energy prices than regulatory policies because tax revenue is passed through into prices; revenue-recycling benefits are needed to offset added factor tax distortions.

### Earmarking revenues and exceptions
- Earmarking environmental tax revenues for environmentally-related public projects is a potential red flag:
  - Ideally, earmarking should be limited to cases where spending generates efficiency gains comparable to cutting distortionary taxes.
  - Earmarking has an observed tendency to set tax levels to meet revenue needs, which may imply tax rates well below levels needed to correct for externalities.
  - A practical caveat: earmarking may create political pressure for sustaining the environmental tax and improving its initial credibility.
- Possible exception:
  - A minor portion of revenues earmarked as production subsidies for firms affected by the environmental tax can improve acceptability by limiting overall impacts on product prices.
  - This approach need not sacrifice too much effectiveness and cost effectiveness if bulk low-cost emissions reductions come from reducing emissions intensity rather than scale of output.

### Revisiting vehicle and electricity taxes
- Taxes on electricity consumption and vehicle ownership, critiqued on environmental grounds, can make sense on fiscal grounds where broader tax system revenues are limited by exemptions, lack of coverage, and easy evasion.
- Taxation of widely consumed products can be efficient as part of the overall tax system, though ideally such taxes target inelastic bases—potentially at odds with targeting emissions for environmental impact.
- Transition planning: motor fuel taxes should account for a broader range of externalities, with a planned transition to per-mile charges as implementation capability develops.

### Distributional concerns and competitiveness
- Distributional impacts:
  - Environmental taxes could undermine distributional objectives where lower-income households have disproportionately large budget shares for energy goods; this is context dependent.
  - Distributional effects can be assessed by models distinguishing income groups with social welfare weights, though the choice of weights is arbitrary.
  - Compensation approaches:
    - Scale back other energy taxes when introducing environmental taxes to limit overall price impacts.
    - Reduce redundant excise taxes on electricity use and vehicle ownership if fuels and emissions are adequately taxed.
    - Make offsetting progressive adjustments to the broader fiscal system (example: using allowance-auction revenues to finance higher personal income tax thresholds).
    - Subsidize household adoption of clean alternative technologies (e.g., solar water heaters, heat insulation).
- Competitiveness:
  - Environmental taxes raise competitiveness concerns for energy-intensive firms competing globally (e.g., aluminum, cement, steel).
  - Mitigation approaches:
    - Harmonize environmental taxes across countries for global pollutants like CO2.
    - Remove redundant taxes (e.g., on electricity) to neutralize energy price effects.
    - Provide temporary production subsidies for exposed industries or subsidies for adoption of energy-efficient technologies (just sufficient to neutralize higher energy input price burdens).
    - Consider border tax adjustments, though these are complex to design and their compatibility with free-trade treaties is uncertain.
  - Prefer compensation via subsidies or technology support rather than exempting politically powerful downstream firms from environmental taxes.

### Summary policy recommendations (as presented)
- Taxes on fossil fuels for stationary sources:
  - Charge for CO2 and local pollutants with tax refunds for downstream emissions capture and no exceptions or preferential rates for specific fuels or end users.
  - To avoid double pricing, grant a tax refund for allowance purchases by entities covered by the EU ETS.
- Taxes on motor fuels:
  - Account for a broader range of externalities.
  - Plan a transition to per-mile charges as implementation capability develops.
- Scale back on environmental grounds:
  - Taxes/subsidies for hydro and other renewables, electricity, and vehicle ownership should be scaled back.
- Nuclear:
  - Taxation of nuclear seems appropriate, but the efficient level appears beyond quantification.

*Source: Box 4. Coverage of Energy under the Value-Added Tax System (provided content).*

### Box 5. Environmental Tax Reforms in Sweden, Germany, Turkey, and Vietnam

### Box 5. Environmental Tax Reforms in Sweden, Germany, Turkey, and Vietnam

### Country case summaries: reforms, features, and outcomes
- Sweden
  - Early 1990s and early 2000s: led Nordic environmental tax reforms as part of broader tax-shifting that strengthened indirect taxes (particularly the VAT) and environmental taxes, and reduced taxes on labor.
  - 1991–1992: added taxes on oil and natural gas to charge for CO2 and (for oil) SO2; downstream taxes on coal-related SO2 and industrial sources of NOx.
  - Compensating reductions in traditional energy excises (mainly on motor fuels and other oil products).
  - 1993 adjustment: manufacturing exempted from traditional energy taxes and made to pay only 21 percent of CO2 tax rates from 2004 onwards.
  - CO2 tax on fuels used in manufacturing plants covered by the EU ETS gradually reduced to 15 percent of the statutory rate.
  - Electricity generators fully exempt from all corrective taxes except the SO2 tax.
  - Note: SO2 and NOx taxes fixed in nominal terms since 1991, reducing real values by about 35 percent; CO2 tax updated sporadically rather than annually.

- Germany
  - 1999 comprehensive environmental tax reform: (a) gradual increase in taxes on transport fuels; (b) new taxes on natural gas, heating fuels, heavy fuel oil, and primarily residential electricity consumption.
  - Reform broadly revenue-neutral: about 85 percent of revenue recycled via equal reductions in employers’ and employees’ payroll taxes; about 13 percent used for budget consolidation; 1 percent earmarked for renewable energy deployment.
  - Public dissatisfaction led to tax rates falling in real terms subsequently.
  - Considerable tax expenditures on energy products (other than transportation fuels) granted to manufacturing and power generation: initially 80 percent, later reduced to 40 percent.
  - Manufacturing firms eligible (with restrictions) for direct refunds if extra tax burden exceeded payroll tax relief; in some cases effective tax rate reduced to close to nil.
  - No downstream rebates for scrubbing technologies; scrubbing technologies mandated.

- Turkey
  - Outlier: despite low per capita GDP among OECD countries, highest gasoline tax among OECD countries at $0.98 per liter.
  - High gasoline tax explains why Turkey ranks at the top of OECD countries in revenue from environmentally-related taxes.
  - Main motive: fiscal—revenues needed for fiscal consolidation in the early 2000s; fuel taxes relatively difficult to evade compared with personal income tax system.
  - Policy note: taxing vehicle ownership (more inelastic) would be preferable from a revenue-raising perspective.

- Vietnam
  - 2004 decision that comprehensive environmental tax reform required, partly prompted by increasing public awareness of pollution; 2008–10 financial crisis may have delayed initiative.
  - Current fuel taxes: coal taxed at $0.52 per ton; gasoline at about 20 cents per gallon; natural gas not taxed.
  - Environmental Protection Charges on resource extraction are minuscule.
  - Significant fuel subsidies to consumers (IEA 2011).
  - Electricity subsidies scaled progressively to favor poor households (targeted transfers would be more efficient).

### Comparing energy systems and consumption patterns
- Power generation characteristics
  - Sweden: almost half of electricity produced by hydro, almost 40 percent by nuclear, and 9 percent from biofuels; oil generation phased out; ban on new nuclear lifted in 2011.
  - Germany: coal about 45 percent of power generation; natural gas 14 percent; nuclear 23 percent; renewables 18 percent. About half of coal is lignite (domestic); remainder hard coal (two-thirds imported). Domestic hard coal subsidies set to phase out by 2018; lignite subsidies persist. Plans to phase out nuclear by 2022 imply expansion of renewables and transitory expansion of natural gas.
  - Turkey and Vietnam: no large-scale nuclear; reliance on fossil fuels primarily natural gas, then coal, and small oil amounts. Hydro important: 36 percent of generation in Vietnam and 19 percent in Turkey.

- Fuel mix in total energy consumption (selected figures)
  - Oil share: Germany, Sweden, Turkey about 35–45 percent; Vietnam 28 percent.
  - Passenger vehicles per 1000 people in 2010: Vietnam 13; Turkey 131; Sweden 523; Germany 623.
  - Coal accounts for 13–23 percent of final energy consumption in Germany, Turkey, and Vietnam.
  - Natural gas share of final energy consumption: Germany 31 percent; Turkey 26 percent; Sweden minimal (heating from electricity and biomass); Vietnam 6 percent.
  - Electricity is 12 percent of energy consumption in Vietnam.
  - Renewables share of final energy consumption: Sweden 45 percent; Vietnam 47 percent (large contribution from direct fuel wood and agricultural residue).

### Externality assessment: illustrative damage values and methodology
- CO2 damage values used (illustrative)
  - US$23 per ton (U.S. Interagency Working Group on Social Cost of Carbon, updated to 2010 dollars).
  - US$85 per ton (U.K. Department of Energy and Climate Change) corresponding to rapid stabilization shadow price.
  - Coal is approximately 77 percent more carbon intensive per terajoule than natural gas, and 27 percent more intensive than oil.

- Local air pollution damages for stationary sources (National Research Council, 2009; year 2010 central case averages)
  - SO2: approximately $10,000 per ton.
  - NOx: approximately $2,000 per ton.
  - Primary (fine) particulates: approximately $22,000 per ton.
  - Note: natural gas produces no SO2 and NOx intensity about one-fifth of coal; damages prior to downstream scrubbing (scrubbing can capture around 90 percent of SO2).

- Value of statistical life (VSL) adjustment
  - Real income (PPP) relative to United States: Sweden 82 percent; Germany 77 percent; Turkey 29 percent; Vietnam 7 percent.
  - VSL/income elasticity used: 0.75.
  - Result: damage values per ton are just under half as large in Turkey relative to Germany and Sweden, and about one-sixth as large in Vietnam.

- Motor vehicle externalities and illustrative corrective fuel taxes
  - Base estimates for Germany updated to 2010 from Mailbach and others (2008); transferred to other countries with per capita income adjustment.
  - Externalities scaled back by 50 percent assuming reduced driving accounts for half of any tax-induced reduction in fuel use.
  - Assumed on-road fuel economy of 30 miles per gallon.
  - Illustrative corrective fuel taxes per gallon:
    - Germany: $3.69 per gallon.
    - Sweden: $4.14 per gallon.
    - Turkey: $2.35 per gallon.
    - Vietnam: $0.78 per gallon.
  - Congestion is the most dominant component of these corrective taxes in each case.
  - Caution: figures need local data refinement (congestion, accident risks).

### Tax rates, coverage, and evaluation of environmental tax systems
- Statutory motor fuel taxes (current)
  - Sweden: about $2.90 per gallon.
  - Germany: about $3.30 per gallon.
  - Turkey: about $3.70 per gallon.
  - Vietnam: about $0.20 per gallon.
- Comparison to illustrative corrective taxes
  - For Germany and Sweden, calculated corrective fuel taxes are somewhat above current statutory rates (but not necessarily a policy recommendation to raise rates given rudimentary calculations).
  - For Vietnam, conservative corrective tax estimate is four times the current tax.
  - For Turkey, current fuel taxes may be difficult to justify on externality grounds.

- Coal
  - Local pollution damages especially driven by SO2 (prior to scrubbing).
  - Sweden: coal use small across end users; limited welfare gains from coal tax reform.
  - Germany: substantial coal use by power generators; coal tax equivalent from EU ETS insufficient to cover U.S. value for carbon damages and local pollution damages.
  - Turkey: coal not taxed.
  - Vietnam: coal taxed very lightly despite significant local and global damages and rising coal use.

- Natural gas
  - Total environmental damages per gigajoule about one-third to one-half as large as for coal.
  - Local pollution damages smaller than carbon damages for natural gas.
  - Germany: substantial tax on residential natural gas consumption (larger than local pollution damages plus U.S. government carbon damage), but power-sector gas undercharged.
  - Recommendation: levelize natural gas tax across end users and set between current household and generator rates.
  - Recommendation for Turkey and Vietnam: modest taxation of natural gas to cover carbon damages.

- Light fuel oil
  - Damages intermediate between coal and natural gas (higher carbon and NOx intensity than natural gas).
  - Light fuel oil undercharged for externalities in nearly all cases, except residential consumption in Turkey and Sweden where tax rates are excessively high (consumption significant only in Turkey).

- Redundant taxes and subsidies
  - Significant excise taxes on electricity use at household level and on vehicle ownership exist in many cases; environmental rationale disappears when fuel taxes reach corrective levels.
  - Residential electricity excise taxes per kWh (IEA, 2010): Sweden 3.7 cents per kWh; Germany 2.7 cents per kWh; Turkey 1.2 cents per kWh.
  - Vehicle excise taxes in Sweden, Germany, and Turkey raise revenues equivalent to fuel charges of 33 to 66 cents per gallon (IMF, 2011b).
  - Vietnam subsidizes electricity use (IEA, 2011); vehicle taxation system opaque.

- Revenue use
  - Revenue use appears efficient in terms of accrual to the Treasury.
  - Sweden and Germany: environmental tax revenues used to fund reductions in labor taxes.
  - Caveat: NOx tax revenues in Sweden funded a production subsidy in trade-exposed industries, resulting in some efficiency loss.

### Policy recommendations and conclusions
- General principles
  - Well-designed fiscal policies (emissions taxes or cap-and-trade equivalents with allowance auctions) should be the centerpiece of promoting greener economies.
  - Prefer levying taxes upstream in the fossil fuel supply chain, with refunds or credits for downstream emissions capture.
  - Prefer compensating adversely affected low-income households and trade-exposed firms via targeted measures rather than setting environmental taxes below Pigouvian levels or granting exemptions.
  - Avoid tax design pitfalls: notches and differentiated treatment of the same emissions across different fuels or end users.

- Specific recommendations
  - Impose a set of charges for coal, oil products, and natural gas for potential releases of CO2 and local emissions, grounded roughly to respective damage estimates.
  - Levelize taxes across emissions sources causing the same damage and better align taxes with external damages.
  - Scale back redundant energy taxes (e.g., excises on electricity, vehicle ownership) as environmental rationale wanes when corrective fuel taxes are implemented.
  - For motor vehicles: transition away from heavy taxation of fuels and vehicles toward charges varying with miles driven on busy roads (time-varying mileage tolls).
  - For natural gas in Germany, Turkey, and Vietnam: levelize and modestly increase taxation where undercharging exists to cover carbon damages.
  - For coal in Turkey and Vietnam: introduce or increase taxation to better reflect local and global pollution damages.

- Research priorities
  - More sophisticated work needed on measuring pollution and congestion externalities for different countries.
  - Refine local data sources on congestion, accident risks, population exposure, health vulnerabilities, and other country-specific factors.

*Italic: Source — Box 5. Environmental Tax Reforms in Sweden, Germany, Turkey, and Vietnam (extracted from the provided IMF content).*

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*Content derived from the file: _wp12180 - References*

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