Market Mechanisms

Traditionally, so-called market mechanisms (i.e. taxes and subsidies) have been seen as an alternative, perhaps even a competitor, to regulations. Debate over whether regulations or market-based instruments are the most appropriate means of ensuring environmental protection have been protracted and fierce. Regulations are usually seen as a more direct means of intervening to ensure environmental protection. Taxes and subsidies are often regarded as a more flexible way of encouraging improved environmental performance in a market economy. In reality, of course, it is inevitable that both regulations and financial incentives will be needed to implement and encourage the necessary changes. And in fact, the introduction of liability frameworks represents a blurring of the distinction between the two kinds of instruments. A regulatory framework imposes the liabilities. But they are enforced both through economic penalties for damage and through the payment of insurance premiums against future liability claims.

Whatever the relative advantages and disadvantages, there are certain reasons to suppose that the financial mechanism of environmental taxation is a strong candidate for consideration as an appropriate policy option. I first raised the issue of environmental externalities in Chapter 6. In particular, it was pointed out there that material prices are maintained at an uneconomically low level. Essentially, these prices are determined purely by the economic costs of extracting materials from the ground. In reality, this is a misleading basis for materials pricing because it does not include the external social and environmental costs associated with extraction, processing, and dissipation into the environment. Neither does this price basis make any compensation to the future for the depletion of scarce natural resources. So materials are generally priced below what might be considered economically optimal from society's point of view.

In the light of this, there is obviously a need to find ways of internalising external costs. That is, we need to try and ensure that the prices we pay for materials and material products include the costs of environmental damage and resource depletion which are associated with using and consuming those materials. There are a number of different ways in which this internalisation can be achieved. Both regulations and market mechanisms can be used. But one of the most obvious ways of internalising external costs is by using taxes.

In the ideal scenario,3 the tax we apply to a particular material use or emission would reflect exactly the environmental cost associated with using or emitting that material. In practice, this ideal is difficult—if not impossible—to realise because of the problem of placing precise economic values on environmental functions (Plate 6).

Plate 6 How much for my penguin?—What is the value of a pristine environment? Source: The Environmental Picture Library/© John Arnould

Plate 6 How much for my penguin?—What is the value of a pristine environment? Source: The Environmental Picture Library/© John Arnould

I have already commented on this difficulty in Chapter 6. In any case, the exact level of tax applied will, in reality, be influenced by a number of different factors, some of them political and institutional rather than purely scientific or economic. In this book, I am deliberately going to avoid making precise stipulations about these different factors. But I have also pointed out that failing to make any adjustments in price reduces the incentive to avoid polluting emissions. We could certainly argue, therefore, that our taxation system should be designed to reflect the fact that environmental damages result from material use and emission. And as the following section illustrates, there are significant advantages to be gained from an environmentally conscious reformulation of that system.

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