Taxation, Innovation and the Environment

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13 Oct 2010
9789264087637 (PDF) ;9789264087620(print)

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Solving the world’s environmental problems could take a significant toll on economic growth if only today’s technologies are available. We know that  innovation – the creation and adoption of new cleaner technologies and know-how – provides a means to achieve local and global environmental goals at significantly lower costs. Innovation is also a major driver of economic growth.  

OECD governments are increasingly using environmentally related taxes because they are typically one of the most effective policy tools available. Exploring the relationship between environmentally related taxation and innovation is critical to understanding the full impacts of this policy instrument as well as one potential facet of "green growth." By putting a price on pollution, do environmentally related taxes spur innovation? What types of innovation result? Does the design of the tax play a critical role? What is the effect of this innovation? 

In analysing these questions, this report draws on case studies that cover Japan, Korea, Spain, Sweden, Switzerland, the United Kingdom, Israel and others. It covers a wide set of environmental issues and technologies, as well as the economic and policy contexts. The research methods range from econometric analysis to interviews with business owners and executives. The report also explores the use of environmentally related taxes in OECD countries and outlines considerations for policymakers when implementing these taxes. 

Green growth policies can stimulate economic growth while preventing environmental degradation, biodiversity loss and unsustainable natural resource use. The results from this publication will contribute to the Green Growth Strategy being developed by the OECD as a practical policy package for governments to harness the potential of greener growth.  

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  • Foreword
    Today’s environmental challenges demand the concerted efforts of citizens, firms and governments to encourage less pollution and environmental degradation and change existing patterns of demand and supply. The OECD’s Green Growth Strategy ( aims to inform debate and assist governments’ efforts to develop mutually reinforcing environmental and economic policies – illustrating that "green" and "growth" are compatible.
  • Abbreviations
  • Executive Summary
    The world is facing a host of environmental challenges. Some are confined to local areas and may be the result of a few polluters, such as mercury emissions to air or sewage discharges in watercourses; others occur at the global level and are brought about by millions of different actors, such as with the emissions of greenhouse gases. While these environmental issues can be thought of as negative side-effects of countries’ economic development, it is important to consider as well that as countries grow richer, more dense, and more technically advanced, the desire and ability to confront these challenges grows as well.
  • Introduction
    This chapter introduces why an unregulated market provides too much pollution and too little innovation, the combination of which makes environmentally related innovation doubly undersupplied. It outlines that such innovation is critical for achieving environmental targets cost-effectively. There is discussion of the process of innovation, its drivers and the role of governments and industry. The chapter finishes with a discussion about the role of taxation in correcting these two market failures.
  • Current Use of Environmentally Related Taxation
    This chapter outlines the usage of environmentally related taxation in OECD countries. It begins by exploring the revenues derived from such taxes, their trends and the role that these taxes play in governments’ overall budgets. It goes on to analyse trends in the rates of taxes across countries and how countries are continuing to implement them. The chapter finishes with a discussion on the extent and impact of exemptions and rate reductions within environmentally related taxes.
  • Effectiveness of Environmentally Related Taxation on Innovation
    This chapter analyses the effectiveness of environmentally related taxation to bring about innovation. It begins by discussing the challenges to measure innovation empirically and outlines potential metrics. The chapter then delves into a number of case studies to look for potential linkages, finding mixed evidence. It highlights the different types of innovation that environmentally related taxation does (and does not) induce. Constraints to the effectiveness of taxation to induce innovation are also investigated.
  • Tax Design Considerations and other Tax-based Instruments
    This chapter considers how the design of environmentally related taxes – the level of the tax, the extent of the tax base and the predictability of the rate – influences the ability to induce innovation. It also explores the effect of measures to address political economy considerations. Attention is then turned to other potential tax-based measures, such as accelerated depreciation allowances and R&D tax credits, to address the environmental and innovation challenges. The chapter concludes with a discussion of potential instrument combinations to achieve an optimal outcome.
  • A Guide to Environmentally Related Taxation for Policy Makers
    This chapter provides a broad overview to policy makers about the considerations surrounding environmentally related taxation. Taxes are assessed against other potential policy instruments before turning to fundamental tax design considerations. The chapter also delves into the use of revenues derived from such taxes and the political economy considerations present during implementation. It finishes with a discussion about why taxes should be central to countries’ environmental policy approaches but that taxes alone may not be enough to fully and cost-effectively address the environmental challenges.
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  • Expand / Collapse Hide / Show all Abstracts Case Studies

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    • Annex A. Sweden's Charge on NOx Emissions
      This case study outlines the tax on NOx emissions in Sweden, implemented in 1992. The tax rate is very high compared to other OECD jurisdictions but nearly the full amount is refunded to firms. Through a number of metrics, it was found that the tax did have significant impacts on innovation. Many of these were process innovations that made the firms’ existing operations less pollution intensive, even for firms not adopting capital-based abatement strategies. This case study also includes a theoretical exposition of the impact of the recycling mechanism on the incentives for innovation.
    • Annex B. Water Pricing in Israel
      This case study explores water pricing in Israel in light of the constant pressures over water resources in this semi-arid region. It first looks at the differentiated approaches across industrial, agricultural and household uses, highlighting the fact that pricing reflects use, type of water and varies on quantity. The Israeli experience in conserving water is clearly a success and has been very innovative. A multitude of factors have contributed to this, including water pricing structures, government information campaigns and governments investments in water technologies.
    • Annex C. Cross-country Fuel Taxes and Vehicle Emission Standards
      This case study looks at the effect of emissions regulations, fuel efficiency standards, petrol prices and petrol taxes on innovation in the motor vehicle industry, focusing on the United States, Germany and Japan. The study finds that regulations on emission standards have generally induced innovation in related areas (for example, nitrous oxide emission regulation and innovations in engine design). The effects of petrol prices and petrol taxes on patenting are not as straightforward. Fuel taxes (which can be predicted) had an impact on innovations related to fuel efficiency, whereas petrol prices and fuel efficiency standards did not. However, further analysis of the interplay of taxes and prices highlight some of the empirical issues that result from analysing the innovation impacts of taxation.
    • Annex D. Switzerland's Tax on Volatile Organic Compounds
      This case study looks at the innovation impacts of Switzerland’s tax on volatile organic compounds. Introduced in 2000, the tax covers all emissions of VOCs in Switzerland – both in the production and in the consumption of products containing them. Focusing on three industries, the case study found that innovation did take place by firms. The vast majority of it, however, consisted of incremental innovations and homemade solutions that were not patented. Also highlighted were the barriers that individual firms face to innovating, such as capital equipment sourced from a large manufacturer. The tax on VOCs appears to have also led to significant environmental improvement.
    • Annex E. R&D and Environmental Investments Tax Credits in Spain
      This case study examines the impacts of two tax credits in Spain: one for R&D investments and the other for investments in assets that relate to the environment. The tax credit for environmental investments did not seem to induce innovation, partly due to the fact that the tax credit could be triggered for investments needed to comply with existing environmental policies. On the other hand, the R&D tax credit seemed to support environmental innovation, given the number of firms that made use of the environmental investments deduction after having used the R&D deduction.
    • Annex F. Korea's Emission Trading System for NOx and SOx
      This case study explores Korea’s policies towards NOx and SOx emissions. A capand- trade system was implemented in 2008 and was expanded the following year. Although too early to investigate the environmental and innovation impacts, this instrument builds on previous policies targeted towards the same pollutants. These policies bought about increased patenting but mainly in end-of-pipe technologies.
    • Annex G. UK Firms' Innovation Responses to Public Incentives: An Interview-based Approach
      This case study investigates UK firms and the influence of various policy and market forces on their innovation response. There was a strong correlation between firm-level targets for energy use or greenhouse gas emission targets and R&D (both general and climate change related). Investor and customer pressure also appear to drive process innovation. The effect of the EU ETS was positive for overall innovation but not for climate change related innovation, highlighting the potential issues of predictability of the trading system or the issue of measuring innovation.
    • Annex H. The UK's Climate Change Levy and Climate Change Agreements: An Econometric Approach
      This case study examines the role of the UK’s Climate Change Levy (and associated negotiated Climate Change Agreements with industry) on innovation. Firms with CCAs, who were granted an 80% reduction in the rate of the CCL, tended to be more energy intensive and use more electricity (which was taxed the highest within the levy scheme) than similar firms paying the full rate. Firms paying the full rate did not appear to experience adverse financial or economic effects. Moreover, CCA firms were significantly less likely to innovate than firms paying the full rate, including in areas related to climate change.
    • Annex I. Japan's Tax on SOx Emissions
      This case study examines the Japanese tax on SOx emissions that was implemented in the 1970s to finance compensation to victims of air pollution. The tax rate rose very quickly after its introduction, peaking in 1987, when the system was reformed. Due to the tax, firms undertook significant abatement and adopted existing abatement technologies. However, the design of the tax brought about unpredictability of the tax rate and a lack of credibility of the overall system, ushering in a period of declining patenting in related technologies, despite increasing tax rates.
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