Economics for Business

With all benefits there is also a complement of problems. We have already mentioned the problem of where the tax should be set. A problem that then arises once the tax is set is who actually pays the taxes? And who should pay for the taxes? As green taxes are an example of the “polluter pays principle”, this is the principle that states those who cause the pollution should pay the damage costs that go along with it. This can cause large problems with the general public depending on how elastic the market that generates the pollution is elasticity of a market tells how sensitive consumers are to price.

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Elastic markets are very sensitive to price and therefore as price changes the quantity demanded will change by a proportionately larger amount. This generally occurs in a market where there are many substitute goods that consumers can change to: for example if a tax was put on washing powders that contained phosphates the consumers of the powder would simply change brands if the tax resulted in an increase in the price.

Therefore in an elastic market, producers have to pay the brunt of the costs or suffer a fall in consumers. Some commentators claim that the decrease in profits causes industry to put pressure on governments to not adopt a taxing policy as it incurs larger charges than most alternate schemes. The curves in figure 1 show this as profits fall from the whole green area to simply area A as a result of decreased output (D) and tax costs (B+C) when the tax is imposed.

The alternate type of demand curve is an inelastic one where there is not a vast array of alternates for consumers to change to and therefore when a tax is placed on the goods they require and the price increases there is only a small proportionate change in the quantity demanded. This results in a much larger fraction of the tax being paid by consumers because the producers realise that people will be forced to pay the increased price. The final problem occurs on an international level.

If one country imposes an environmental measure on its own industries those industries will then be at a disadvantage to foreign competitors who do not have such measures and therefore have cheaper running costs. This will make domestic goods less attractive to consumers and tip the balance of payments towards imports, reducing the national economy. An example that illustrates what problems can occur with such a tax can be seen in China. In 1979 China experimented with environmental taxes and standards. By the early 1980’s the system was incorporated into law and expanded to cover the whole country.

The amount of revenue gained by the government rapidly increased from 1. 2 billion Yuan in 1986 to 2. 7 billion Yuan in 1993, and after that it seemed the environmental measures had been set and accepted as a good measure much too quickly. This resulted in twenty nine pollutants in wastewater, thirteen pollutants in industrial gases, noise all forms of solid and radioactive waste being subject to a fee. This rapid expansion meant that charge rates were calculated too low and enforcement was not strong enough.

Therefore the taxes were below the marginal costs of pollution control and were not indexed to inflation; this resulted in only a small change in the output of pollution emissions because the polluters did not see the taxes as a large enough threat. Consequently it can be seen that a government should not rush into taxes because if they are not calculated correctly then they will not be taken seriously. The main environmental instrument used in the UK is setting a quantity based standard to which emissions must be below.

Setting a standard is usually made without reference to the value of the goods being produced (MNPB curve – Figure 1) and therefore may not have the desired effect. Generally these standards have a fixed fine that accompanies the standard this type of regulation require a large amount of enforcement, especially if the fine relatively low because if the fine is set below or a small amount above the profit that the firm could make on the extra units produced then they will take the risk because overall they will not make a loss.

This enforcement also increases the total abatement costs to the government because there will be the wages of the enforcers and penalty administration to be paid unlike with a tax, which already has a system set up for enforcement and admin and therefore the costs will be fairly low. Figure 2 shows the comparison between setting a standard and setting a tax. You can see that three firms are being regulated to the same standard, which is set at the pollution abatement S2.

The alternate method to this will be setting a tax at T so that firms 1, 2 and 3 pay a total abatement cost of the area under their marginal abatement curve up to points X, B and Y respectively. Therefore the total abatement cost under the standard, TACst, will be greater than that with the tax, TACtax. As standards are set they do not provide any incentive to lower the pollution emission below that level unlike taxes which lower as the output of a firm lowers.

The other advantages associated with taxes mentioned earlier also may not apply to standards and therefore taxes seem to be an overall preferable solution. The other methods such as permit trading and deposit-refund schemes can not be used on such a large scale as taxes. Pollution permits create a market between plants in an industry for trade of said permits. The benefits of this are that they provide an initial incentive to install cleaner machinery to lower the amount of emissions the firm will need permits for.

But with all markets once they settle to the correct level of permits and emissions there will be no more incentive to lower pollution levels. Also permits can cause pollution black spots where one firm with higher abatement costs has bought a high amount of permits and is therefore still producing the same amount of pollution, therefore not giving an even spread of optimum pollution levels in each plant like with taxes.

This shows that overall taxes can be seen as the best method for reducing pollution. It does have the problem of associated bad press and high amount of initial research required. This is one of the main reasons why taxes have not been implemented to their best capability. The power the tax has does depend on the market it is being implemented on; if the market is highly inelastic then the increase in consumer prices may mean that it is not implemented.

Even though taxes are the best overall method of emission reduction it may not be suited to all industries and therefore all economic incentive instruments should be considered and a mixture used on each industry.


Field, Barry C. Environmental Economics. An introduction, Second edition. Massachusetts, USA: Mc Graw – Hill, 1997. Turner, R. Kerry, David Pearce, and Ian Bateman. Environmental Economics, an elementary introduction. London, England: Harvester Wheatsheaf, 1997 Sloman, John, and Mark Sutcliffe. Economics for Business, Second edition. Harlow, England: Prentice Hall, 2001.