May all our tax rises be green

The next government could have all the extra revenue it needs and improve the environment at the same time, argues Nicholas Schoon

March, 2002, and Tony Blair is about to announce the election date. Labour has a narrow poll lead. His justification for a new mandate is keeping income taxes down and the economy in reasonable health while allowing moderate but real expansion in health care, education and public transport.

Five years earlier this rosy scenario seemed inconceivable. Pundits said Labour's 1997 campaign tax pledges surely had to be lies. But they weren't. Neither income tax, national insurance nor VAT have been raised since then. But in 2002 new or increased "green" taxes, which barely had a mention during the 1997 campaign, are raising an extra pounds 16bn a year.

The money, equivalent to 12p in the pound on income tax, was badly needed for the key public services the voters demanded. One year's real growth of 3 per cent in the NHS (the bare minimum needed to cope with rising demand) costs pounds 1.5bn. But there are downsides. Farmers infuriated by the fertiliser and pesticide taxes have gridlocked central London with tractors. The recent closure of an oil refinery in an unemployment blackspot is blamed on ecotaxation. The real price of petrol has risen 50 per cent in five years and Tory hoardings shout about Labour's "great green rip- off".

But the ecotaxation reforms have slashed pollution and are estimated to have created nearly 100,000 jobs - a further huge help to the public finances. They have helped Britain to build the low-energy, minimum-material industries of the future. A decisive shift in motoring taxation in favour of high-fuel-efficiency cars, combined with the UK's strong international competitiveness, has prompted two of the big six manufacturers to plan production lines for ultra-light, 70 miles per gallon cars.

Could this happen? It seems highly unlikely here and now in 1997. This year Gordon Brown, the shadow chancellor, said: "Work is something to be rewarded through the tax system, whereas environmental pollution is something that should be discouraged." But he and other leading Labour figures have grave doubts about ecotaxation reform, especially about making fuel more expensive.

Before trying to help them, let us summarise the ecotaxation story so far. Environmental taxes make the companies and/or consumers causing pollution pay for the costs they impose on society as a whole - such as the extra health-care charges due to bad air quality. It is impossible to work out exactly what these costs are but imposing some level of tax on pollution signifies society's disapproval, causes noxious and toxic emissions to be cut and diverts resources into less polluting enterprises. Some or all of the tax revenue can be used to encourage non-polluting alternatives or environmental repair work. Furthermore, taxes and incentives are a better way of making industry cut pollution than are regulations and emission limits, because they allow business greater freedom of action.

Green tax reform encourages companies to innovate for a global future which, in an increasingly crowded and resource-depleted world, will belong to high-efficiency, low-waste enterprises. And if most of the money raised by the new taxes is used to cut the costs of employment then ecotaxation will create new jobs. This is the conclusion of several studies that used computer models to project how ecotax reform would effect the UK economy. The latest, by the left-leaning Institute of Public Policy Research using Cambridge Econometrics' model, found that a particular package of green taxes introduced now could raise pounds 10bn a year in 2000 and create 252,000 extra jobs by then, two-thirds of them full-time, if the extra revenue was used to cut employers' National Insurance Contributions (NICs).

The real economy is too complex for us to know how many jobs would be created by various green tax reforms. In the short term jobs would be shed by companies harmed by them. Many, perhaps most, of the new jobs created in the longer term by lowered employment taxes would be low-pay, low-skill ones. It seems a safe bet that provided the taxes are not draconian and are carefully planned and the revenues are used correctly the economic bad cannot outweigh the good, while the environment must gain.

That is why Sweden, Norway, Denmark and the Netherlands have introduced ecotax reforms, while Britain has begun to follow. In 1987 higher duty was placed on leaded than unleaded petrol to boost sales of the latter. Since then we have had 8 per cent VAT imposed on domestic fuel, duty on road fuels rising by 5 per cent a year and the introduction of a pounds 7 a tonne tax on garbage dumping.

Were the Tories to win power we might have more; the party's separate "green" manifesto promises consultation on a water pollution tax. The Liberal Democrats are real enthusiasts. They have pledged to slash the price of a tax disc for cars with engines below 1600cc from pounds 145 to pounds 10 in order to boost the market for smaller, more fuel-efficient cars. A 4p-a-litre increase in fuel duty would make up for the lost revenues. The third party is also proposing a carbon tax on fossil fuels to cut emissions of climate-changing carbon dioxide gas. The revenue raised would be used to cut VAT and reduce employers' NICs.

But Labour is silent, apart from emphatically ruling out a carbon tax and pledging to cut VAT on energy to 5 per cent when gas and electricity prices are already falling. This would encourage comfortably-off people to use energy less carefully, causing more pollution. Gas and electricity are already cheap - their real price (once inflation has been accounted for, and after taking VAT into account) is cheaper than at any time in the last 17 years

Labour's big problem with ecotaxes is that they are regressive; it sees them as taking from the poor while allowing the rich to carry on polluting. If you make swingeing increases in the cost of petrol or introduce road pricing, the motorists hurt most are low-income ones. Tax the coal, oil and gas we burn in our homes, cars, power stations and industries and you thereby cut their use and curb air pollutants which cause smog and ill health, along with acid rain and climate change. But you also hurt low-income families with young children and poor pensioners. The worst- off fifth of households spend 12 per cent of their budget on fuel, the richest fifth just 4 per cent.

There are, however, ways of dealing with this unfairness. In the Netherlands, for example, there is a carbon tax but every household is given a basic, tax-free allowance of domestic energy per annum. You could drastically beef up the Government's low-key programme for insulating the homes of the fuel-poor. This is something Labour is already committed to, using money raised by its windfall tax on the utilities. Or you could pump some of the revenues raised by fossil-fuel taxes into the benefits system to compensate those hardest hit.

There are a few golden rules for harmonious ecotaxation reform. Explain exactly what environmental goal you are trying to achieve. Earmark the revenue for something which has widespread support, such as cutting employment taxes or improving public transport. Give advance warning of your intentions, consult widely and be prepared to make changes. Use at least some of the money raised to help people or industry cope with the tax while they are curbing pollution and waste.

The Conservative government failed to follow these rules in trying to raise VAT on domestic fuel from zero to 17.5 per cent in two years. It ran into a serious Parliamentary rebellion and only got 8 per cent. When it came to its next ecotax, the garbage-dumping levy introduced last October, it had learned all the lessons. The money this will raise, some pounds 400m a year, has been earmarked for a small cut in employers' NICs (encouraging job creation) and for schemes which cut waste and improve old dump sites (helping the environment).

Any government that follows these rules will still encounter intensive lobbying from companies and interest groups hurt by ecotaxes. And of course environmental taxes are no public sector finance panacea. The more successful they are at curbing pollution, the less money they raise for government. But ecotax reform is a great opportunity there for the taking. One of the best things Gordon Brown could do in his first couple of months as Chancellor would be to set up an ecotax commission tasked to make recommendations by the year's end. It ought to include business people, trade unionists, representatives of low-income groups and local councils as well the economists and environmentalists who have made most of the running on ecotaxation so far. Environmental tax reforms could be introduced without injustice and with public support. But the party most likely to govern hasn't even started trying.