Spotlight G20: Tax “Bads” and not “Goods”

Edward B. Barbier

A fundamental problem impeding global economic progress, growth and job creation is that all economies base their tax systems on raising revenues from “goods”, such as income, wealth and employment of labor.  And, perversely, governments rarely tax, and in fact often subsidize, “bads”, such as natural resource use, pollution and financial speculation.

The result is two major distortions in the world economy.  First, investment, innovation and job employment are discouraged, while pollution, environmental degradation, and financial speculation are encouraged.  Second, these perverse incentives perpetuate the “no win” political stalemate over whether additional taxes on income, wealth and labor should be used either to reduce chronic budget deficits or boost public spending and aggregate demand in economies.  As I argue in a recent article in the UN’s sustainable development journal, Natural Resources Forum, this policy failure is also inhibiting the long-run transition to more sustainable and “greener” economies.

The group of twenty of the world’s largest and richest economies, the G20, could therefore make substantial progress in reviving the global economy if they agreed on the following key steps.

First, the G20 should endorse the European Union proposal for a global financial transactions tax (FTT) at the forthcoming G20 summit in Cannes, France in early November 2011.  As I suggest in my Natural Resources Forum article, a very small FTT collected on the sale of financial assets, such as stock, bonds or futures, would have a negligible impact on liquidity or overall financial transactions, but could raise substantial funds globally.  For example, a Gates Foundation report has estimated that even a small tax of 0.10% on equities and 0.05% on bonds could bring in about $48 billion from G20 member states.  A variant of the FTT is a currency transaction tax (CTT), which is a charge applied to any foreign currency exchange transaction.  Foreign exchange transactions totaled US$800 trillion in 2007, which means that a CTT of only 0.05% could raise $400 billion in revenues for global public goods, such as aid to poor economies, climate change mitigation and ecosystem conservation.  Such small tax rates would not deter financial speculation but they would ensure that the global financial sector contributes to a more sustainable and a fairer world economy.

Second, the G20 should follow through on the pledge by its leaders at the 24-25 September 2009 Pittsburgh summit to phase out all fossil fuel subsidies.  As I note in an article in Environmental Innovation and Societal Transitions, fossil fuel consumption subsidies globally amounted to $557 billion in 2008.  Production subsidies accounted for an additional $100 billion.  Together, these subsidies account for roughly 1% of world GDP. Such fossil fuel consumption and production subsidies are an additional market failure preventing improved energy efficiency in economies.  By artificially lowering the cost of using fossil fuels, such subsidies deter consumers and firms from adopting energy efficiency measures that would otherwise be cost-effective in the absence of any subsidies.  Removal of such perverse incentives would therefore boost energy savings substantially.  Phasing out all fossil fuel consumption and production subsidies by 2020 could result in a 5.8% reduction in global primary energy demand and a 6.9% fall in greenhouse gas emissions.

Third, ideally the G20 should adopt environmental pricing policies, whether through cap and trade or taxes, that would ensure that carbon and other pollutants, as well as water and scarce ecological resources, are no longer ‘free’ to use by their economies.  However, as I maintain in my Natural Resources Forum article, at the very least the G20 should agree to implement a global carbon tax on greenhouse (GHG) emissions.  Countries could introduce market penalties on GHG emissions at levels that are equalized across different regions and industries.  The tax would be set low initially and rise steadily over time to reflect the rising damages from global warming.  Estimated revenues from such a scheme could range from $318 to $980 billion by 2015 (in 2005 prices) and $527 to $1,763 billion by 2030.  Again, these revenues could be used to finance global public goods, such as aid to combat poverty, climate change mitigation and ecosystem conservation, or alternatively countries could invest in building their human capital through education, skills development and job training.  Equally, the revenues raised through carbon taxes and other environmental pricing measures could be used to reduce income, payroll and other taxes, or to instigate wholesale tax reform.

If the G20 takes these three steps, not only will the result boost the global economy in the short run but also promote sustainable growth through taxing “bads” rather than “goods”.

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