Hamish McRae: Why laggards should copy the leaders on environment policy

There is an awful lot of 'good housekeeping' that countries could take on board
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It is economic summit time again. The walls round Genoa are being manned to repel the boarders. The environmental protesters are unfurling their anti-American placards. And people with a genuine concern about the environment are wondering why governments do not pay more attention to the serious economic research on environmental problems that is available.

Some of the best work on sustainable economic development is being done by the OECD in Paris, founded after the Second World War to try and help governments of the industrial world co-ordinate economic policy. At the moment, governments are enormously concerned about environment policy and the OECD has a working party on sustainable development to help members lift their environmental game.

I have just been looking at one of the papers* and it is astounding how much environmental policies vary between countries, and consequently how much progress could be made by laggards adopting the leaders' policies. Grand issues such as climate change and carbon emissions get the publicity and understandably so, but there is an awful lot of simple "good housekeeping" measures that countries could take without needing an international agreement to prod them into action.

Take a look at the graph here. It shows the level of tax on diesel and petrol in the six largest economies. The most obvious point is that the US and UK are the oddities: the US for its cheap fuel and ourselves for our expensive stuff. The UK is interesting because 15 years ago it was much more "normal": both France and Italy had much more expensive petrol than we did. We have used fuel prices as an environmental weapon much more aggressively than any other country.

But there is another message. Most countries in the middle band tax diesel at much lower rates than petrol. That is on the intuitive reasoning that diesel vehicles are more economical so their use should be promoted. But, as the OECD paper points out, "a litre of diesel almost always pollutes more than the same quantity of petrol".

There is another anomaly. Fuel for many forms of road use is taxed at lower rates or given exemption – public transport for example. Diesel burnt by a bus pollutes just as much as diesel burnt in a car; and buses degrade roads just as much as other traffic. In short, fuel taxes "are often deliberately set in ways that appear to undermine the environmental incentives".

Many countries still subsidise coal production, thereby encouraging the use of dirty coal rather than cleaner alternatives. Canada managed to wipe out fish stocks in the north-west Atlantic (helped a bit by foreign fishing) by a regional policy that subsidised the expansion of the fleet. It then made matters worse by an unemployment benefits system that subsidised people working in fisheries, even if those people were part-timers. Bit of an own goal there.

A similarly misguided policy operates in Denmark. Cement use is subsidised by lower tax rates and cement is a particular gobbler of energy.

There are many other examples of policies designed to achieve one thing actually having unexpected costs. A simple example: speed bumps designed to calm traffic (though not passengers or drivers) increase pollution and energy use because the internal combustion engine is much more efficient when running at a steady speed than it is when it has to accelerate.

There are lots of things that can be done to encourage more sensible policies. At the moment many new projects are subject to an assessment of their environmental impact. But policies are not often tested in the same way. Cost-benefit analysis has long been used to help assess projects, but is an imperfect technique that could be improved.

The general view of the OECD is that the best way of cutting environmental costs is to use the market: a tax on an industry that loads cost on to others (for example by polluting the air or water around its factories) must make sense.

There are two main objections to this: competitiveness and income distribution. Do you tax one of your own industries that happens to be a heavy user of energy when other countries don't tax theirs? And what do you do when an environmental tax places a larger burden on the poor than on the rich?

The general view of the OECD is that in practice a country's or an industry's competitiveness is not greatly changed by environmental taxation or regulation – despite the views of the lobby groups. In any case there are ways of alleviating any loss of competitiveness: a temporary tax rebate to be removed when other countries follow suit.

As for the distribution of income, there are other ways of offsetting the effects of a new tax so that people who are hard hit have some other form of compensation. But sometimes you don't want to give too much compensation: putting up tobacco taxation is an example. Poorer people spend a higher proportion of their income on tobacco than the rich. But many societies (including the UK) have decided that this is acceptable for the greater good of cutting smoking. The fact that much of Continental Europe takes a rather different view does rather complicate matters though, as the customs at Dover know.

This is an area where God dwells in the detail. The particular design of environmental taxes matters enormously. The big point, surely, is that countries can learn from each other. There are grand global issues, of which climate change is really the most important, that are too big for any one government. But, meanwhile, sensible governments can make a lot of progress on their own.

*Encouraging Environmentally Sustainable Growth: Experience in OECD Countries. Paul O'Brien and Ann Vourc'h , OECD, 2001.