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THE USE OF ECONOMIC INSTRUMENTS FOR
ENVIRONMENTAL POLICY - A HALF HEARTED AFFAIR
Mikael Skou Andersen

"Command-and-control is comforting to politicians and people: govermnents know what they are asking for, people know what they are getting, companies know what they are supposed to deliver; the only people who do not like it are economists" (The Economist , 2 September 1989).

Summary:

As a key to a more sustainable development the use of economic instruments for environmental policy has been on the agenda for about eight years. Despite of that, a recent OECD survey recorded only a modest increase in their use since the mid-1980s. In pa rticular the Nordic counries have increased their use of economic instruments, but with a few exceptions it has been a somewhat half-hearted affair. Economic imstruments have often been applied on the basis of the principle of the least political resistan ce. Using Wilson's regulation theory (1980), this paper analyses how the costs and benefits of regulations and particular policy-instruments affect the use and design of economic instruments. The outcome has been green taxes that are often fiscally biased , which are too low compared with the externalities they should price and which address the smaller rather than the larger polluters, granting the latter substantial exemptions. However the paper does also shortly suggest a strategy to overcome these defi ciencies, underlining the dynamics and the possible 'double dividend' to be achieved from the use of economic instruments.

1. Introduction

The proposal to impose taxes on pollution is far from new. It was already put forward at the turn of the century by the famous British economist Professor Arthur Cecil Pigou. Reflecting on the famous London fogs, Pigou observed that pollution imposed unco vered costs on third parties which were not included in ordinary market transactions. His proposal was to tax pollution by means of a so-called extemality tax in order to internalise in ordinary market transactions the damages caused by pollution. While P igou was a founder of welfare economics in many ways and thus an important source of inspiration for the subsequent welfare state, the external tax was at his time regarded as a rather academic approach to the control of pollution, and did not gain any pr actical significance (Pigou, 1920; Collard, 1981; Aslanbeigi, 1987).

In the early 1970s the externality tax experienced a revival both in terms of an evolving branch of micro-economic theory that explored the implications of such taxes, but also more practicany as some countries (for instance Japan and the Netherlands) beg an to apply economic instruments in practice (Baumol and Oates, 1975; 1979). In the Scandinavian countries pollution taxation was regarded with scepticisrn, apart from by a few economists. The predominantly social democratic dominated governments and poli cy-makers regarded taxation of pollution as a way in which industries could continue to pollute if only they paid the price. Consequently the policy-instruments employed for environmental policy in the Scandinavian countries were mainly of a traditional r egulatory nature for nearly two decades (Johnson and Brown, 1976; Andersen, 1994a).

It was the Brundtland report which put economic instruments on the agenda again (World Commission, 1987). With its plea for a sustainable development, the Brundtland report recommended the increased use of economic instruments. At the same time the failur es of regulatory policies made policy-makers search for new and more effective policy-instruments. Especially the non-point sources of pollution, such as nitrogen and acid rain, made clear the limits of the command-and-control type of regulations. Economi c instruments were the key to the integration of environmental considerations into other policy-areas, and this integration was the key to a sustainable development.

Since the late 1980s, government reports in many OECD countries have announced an increased use of econormc instruments (Pearce, 1989; VROM, 1989, Lalonde, 1990). In the European Union the fifth action programme for the environment recommends an increased use of environmental taxes, and in 1991 OECD, in accordance with its 1975 'polluter-pays' principle, recommended its member countries to consider the possibilities of introducing more environmental taxes - again (CEC, 1992; OECD, 1991).

These announcements have not been followed by a similar range of action. Although the use of economic instruments (excl. subsidies) has increased in several OECD countries from 1987 to 1994. It has been a rather modest increase when one takes the limited use of economic instruments in 1987 into consideration. The update on the eight countries surveyed in 1987 showed that the number of economic instruments in use had increased by only about 20 new instruments - from about 80 to about 100 (OECD, 1994a: 107) . Although the use in other OECD countries had also been mapped, and more economic instruments have been on the agenda of several governments, the modest increase reflects the political differences related to the introduction of such instruments.

The Nordic countries have become forerunners in the use of economic instruments (OECD, 1994a: 183). Four Nordic countries have imposed C02-taxes, and a number of other economic instruments have been put into operation (OECD/IEA, 1994). The changed attitud e towards the use of economic instruments in Scandinavia is related to the growing distrust of traditonal regulatory instruments. However, the increased use of green taxes can also be explained by the fiscal crisis of the Scandinavian welfare states. New and more legitimate sources of tax income were needed, as traditional income taxes began to exceed the legitimate 50 per cent level. Both Sweden and Denmark introduced tax reforms in the early 1990s, which substituted income taxes by so-called green taxe s to different degrees. In this process of securing new sources of income for the welfare state, some of the initial principles of envirornmental taxation were lost. This was due partly to the fiscal focus, partly to the decision-making process, in which economic and political interests got a say over the final design of environmental taxes.

This paper will try to explain some of the political factors at work in the process of designing economic regulations. These processes are after all not so different from the processes of the instrument choices.

2. Arguments for Using Economic Instruments

Before discussing the political system and its ability to agree on the use of pollution taxes, it seems appropriate to give a very brief summary of the arguments for using economic instruments (readers familiar with the properties of economic instruments can proceed to the next section immediately).

The top-down approach inherent in command-and-control policies gives the regulated few incentives to improve their performance on their own initiative. The advantage of economic instruments is that they force producers and consumers to take enviromnental concerns into account and to minimise their use - and waste - of energy and other resources as much as possible.

There are two main types of economic instruments: either taxes or traceable pollution permits. There are several variations of each; taxes may, in particular, take the form of either input/resource taxes process taxes, emission taxes or product taxes. Tra deable pollution permits have mainly been used in the US, and are not treated directly in this paper, although they enjoy many of the same advantages as pollution taxes.

The advantages of economic instruments are in particular:

• they do not prescnbe specific technologies or solutions, but leave it to the target groups to decide whether they would prefer to control their output of emissions to change their input of raw materials and energy or to do a mixture of both;

• they are better suited to deal with non-point sources of pollution that cannot be controlled by permits, but where there are proxies to be taxed;
• they ensure that control of pollution takes place where the marginal costs are lowest, thus ensuring substantial cost savings - probably by a factor 2-3;
• contrary to a fixed license they give a constant incentive to reduce emissions, and are as such a much more dynamic instrument;
• because of these dynamics they cause more innovations and force the development of new and cleaner technologies;
• finally economic instruments will generate revenue, sometimes in substantial amounts; revenue which can be used for environmental or other purposes.

Economists have advocated economic instruments as a more or less pure alternative to commond-and-control regulations. In practice economic instruments are employed within a broader mix of regulatory instruments and in an institutional setting that is some what more complex than in the partial analysis. Most importantly, economic instruments are not decided by a single policymaker who controls all information necessary and can anticipate all possible reactions. Economic instruments have to be approved by a political system where the bargaining processes are rather different from the principles that rule blackboard economics.

3. Wilson's Regulation Theory

How do the costs and benefits of public regulations affect the way in which interests are articulated? How can we explain the emergence of environmental regulations? What is the impact on the choice of policy-instruments ofthe costs and benefits of regula tions?

To answer these and other related questions, Wilson's regulation theory (1980) is helpful. Contrary to earlier regulation theories which claimed that public agencies and their regulations were subject to 'capture' by the regulated interests, Wilson introd uced a more sophisticated theory about the costs and benefits of regulations. It deals better with the wave of hew social regulations' - from automobile safety to pollution control - that have emerged since the late 1960s, and which were not demanded by t he regulated parties. Wilson's theory has been sumarised in the two-by-two matrix shown in figure 1. It shows how there are basically four different types of public regulations, according to whether the costs and benefits of regulations are either spread or concentrated.

Client regulation: In a classical regulatoty situation the costs of regulation are born by the tax payers, and thus spread, while the benefits, often in terms of subsidies, are concentrated on a smaller group of the constituency. A typical example of clie nt regulation is agricultural policy. Client regulations are usually passed only after extensive negotiations with those concerned, but without much public debate. The general public does not care too much about this year's intervention price for wheat, f or instance, while the farmers care quite a lot, and are likely to negotiate very actively in the decision-making process.

Majority regulation: In the case of majority regulation consensus seeking lasts longer and affects more groups in society. In these cases both the costs of regulations and the benefits are spread, which gives no certain interest groups particularly strong incentives to promote regulations. A good example of majority regulation are the social reforms of the 1930s. It took quite a long time to build up consensus about these reforms.

Interest group regulation: In the case of interest group rezulation both the costs of intervention and the benefrts are concentrated on rather narrow groups, who will have strong incentives to influence the decision-making process, while the general publi c displays little concern. It means that both the costs and the benefits are borne by limited groups, rather than by society as such. Examples of interest group regulations are the regulation of harbour tariffs (state harbours versus municipal harbours) o r railroad tariffs. Wilson also mentions labour market regulations as an example of interest group regulations.

Entrepreneurial regulation: When costs are concentrated and benefits are spread, one would normally not expect regulations to be passed. Those who will benefit from regulations have only very general and therefore limited personal interest in lobbying for them, while those who have to bear the costs will indeed have rather strong incentives to seek to prevent regulahons from being imposed. However, there are several examples of regulations which fall within this sphere such as safety, work place and envir onmental regulations. Indeed it is the existence of these socalled 'new social regulations' that contradict the classical assumption that regulahons are passed only in the interest of the regulated. According to Wilson such regulations depend on the exist ence of 'entrepreneurs', i.e. ideal interests organised for the purpose of such regulations, and who act more or less as 'watch-dogs'. They lobby to place such regulations on the agenda of policymakers and seek to outweigh the influence of groups who have interests in avoiding regulations. Their success depends to a large degree on the support that they can obtain from non-affected third parties, such as the media, influential writers, etc.

One could argue that many environmental regulations offer long-term benefits to the regulated, for instance in terms of a more optimal and efficient resource rnanagement. It is indeed difficult to estimate a priori whether a specific regulation will entai l benefits or costs. According to Wilson it is, however, the costs and benefits as perceived by the regulated that will influence their behaviour during the decision-making process. The most important difference between economics and politics is that wher eas economics is based on the assumption that preferences are given, politics must take into account the efforts made to change preferences (Wilson, 1980: 363).

4. The Impact on the Choice of Policy-Instruments

Entrepreneuial regulations arise only after pressure from policy-entrepreneurs. However, when it comes to the design of policies and in partticular the choice of policy-instruments, those who will have to bear the costs of intervention often have stronger incentives to lobby against particular instruments than do entrepreneurs. So if they cannot prevent a regulation, they will seek to influence the design of regulations and the choice of policy-instruments so as to limit their costs.

The basic asymmetry of interests is paralled by an asymmetry of information. The potentially regulated can provide policy-makers with very specific and detailed information, which cannot be balanced by information from policy-entrepreneurs. Furthermore, o ften policy-entrepreneurs do not care too much about the specific policy-desicion or choice of instrument as long as the general aims agreed upon are in accordance with their demands for regulation.

In the case of environmental policy, the policy-entrepreneurs are mainly concerned that something is done, but they have less interest in the specific design of policies or the choice of instruments. This is mainly a complicated technical and legal issue that is sorted out between officials, experts and the affected interests. More recently evironmental policy-entrepreneurs have displayed increased concern about the choice of policy-instruments, but they still lack vital information. They can demand the u se of more economic instruments, such as a C02-tax but they can only seldom provide policy-makers with information about the way in which it should be designed or about its potential impact. Target groups have such information and since policy-makers need to estimate the possible impacts of a taxation scheme, they depend to a high degree on the informanon provided by the target groups.

Economic instruments enjoy a high degree of public support. Polls have showed that pollution taxes are the sort of taxes that people would like to see more of. In november 1991 more than 80 per cent of the Danes were in favour of more green taxes, and eve n after the recent tax reform that introduced a number of new green taxes, more than 50 per cent of those polled were in favour of such instruments. Also among the target groups economic instruments enjoy support. Most industrialists prefer more market-or iented policy-instruments to command-and-control policies, athough they also stress that such instruments should preferably be introduced at a European or global scale.

But there is a very important difference between supporting the use of economic or more rnarket oriented instruments in general, and the attitude towards specific environmental taxes. One could wonder if not the rather strong public support for green taxe s is due to the fact that people somehow expect that the polluters are someone different from themselves - and they find it fair to demand from 'those polluting' that they pay the clean-up costs. Directors of industries may declare themselves in favour of economic instruments, but when it comes to specific taxes, whether on chlorine or on packaging the affected industries are strictly against thern, and have strong incentives to be so.

By the target groups economic policy-instruments are perceived as imposing much higher costs than usual command-and-control types of regulations. The regulated anticipate the pollution tax bills that they have to pay and ask for either normative regulatio ns or voluntary agreements, which are considered less costly.

The efficiency argument that pollution taxes assure that abatement takes place where the marginal costs of abatement are lowest, while norms require equivalent across-the-board measures regardless of differences in costs have not convinced the target grou ps. Neither have more empirical studies that, on the basis of historical data, confrm the difference between the use of economic instruments and the used of norms.

That norms or voluntary agreements may impose rather high costs too is not taken into account. One could speculate whether the target groups expect rules and voluntary agreements to be less strictly applied than economic instruments. Indeed there is a dif ference in the degree of compliance demanded by local environmental officers controlling norms and standards, and the degree of compliance demanded by tax and customs authorities responsible for the collection of green taxes. Environmental regulations are fundamentally different from classical welfare regulations, which are distributive, and which allocate subsidies to specific groups. Environmental regulations require a change in behaviour, and as such they are much more distorting to the regulated than are subsidy schemes or social transfer payments. Thus, the target groups believe that they have strong incentives to lobby against economic instruments and to propose the use of other policy-instruments.

Those in favour of environmental regulations will, on the other hand, be less concemed about the choice of instrument if only the target group complies with the general target. Therefore one can usually persuade them to accept the use of other, but often less effective, instruments.

5. Impact on the Economic Instrument Design

If policy-entrepreneurs still push very hard for the use of economic instruments, the next step for target aroups can be to lobby for exemptions.

In countries where CO2-taxes have been introduced they have been followed by substantial exemptions. Although exemptions and adaptations can hardly be avoided, it is also safe to say that most of the present exemptions are not rationally justified. They a re to a large extent the result of pressures exerted by those subject to taxation. While in Sweden about 25 per cent ofthe CO2-emissions are exempted, it is about 66 per cent in Denmark. This difference reflects the more conflictual decision-making proces s in Denmark, where the CO2-tax was passed by a narrow socalled 'green majority in Parlimnent against the policy of the past government. The green majority was anxious not to create any unexpected side-effects in terms of causing the direct closure of par ticular companies - thus creating the so-called "pastry-master syndrome". Pastry-masters pay relatively much higher CO2-taxes than smoke-stack industries.

The tax rate in itself is a difficult issue and can often become subject to negotiations too. According to conventional economic theory, the pollution tax should reflect the external costs imposed on third parties by market transactions. This ideal approa ch requires meticulous valuation - inded Pigou, as founder of the externality tax, tried to estimate the costs imposed by air pollution in terms of extra laundry costs, additional artificial light and building damages. But as Weizsacker has pointed out, m ost of the present green charges and taxes cover only rather local external costs (Weizsacker, 1989).

Extemalities at the regional or global level are difficult to quantify. Even more disputed is the valuation of extemalities imposed on future generations, ie. intertemporal extemalities - such as climate changes (Brornley, 1990).

Even if we follow the more conservative environmental economists and simply neglect the intertemporal externalities and just try to make an accurate estimate of extemalities at the regional or global level it would imply green taxes of a magnitude much di fferent from the one that we know today. But there is no reason to fix a discount rate when calculating the benefit that future generations would have from, for instance, pure groundwater. Fixing a discount rate would imply that the consumption of future generations should be discounted as compared to the consumption of present generations. Intertemporal extemalities are at the core of the problem of a sustainable development. As Pearce (1989) has pointed out, a sustainable development means that the pres ent generation should leave to future generations a stock of natural capital equivalent to what it took over, and sustain its consumption only on the dividend.

Whereas the methods for contingent valuation are still in their infancy, there are alternative approaches to the fixing of environmental taxes in accordance with these criteria. More than 20 years ago, Baumol and Oates (1971) recognised the difficulties a ssociated with contingent valuation and proposed to set targets first instead, and then impose sufficiently high taxes so as to assure the targeted reductions. Such targets can be fixed on the basis of the carrying capacity of the environrnent, and thus r eflect a sustainability criteria.

In the CO2-case it is disputable what the external costs actually are, but the Baurnol and Oates approach would imply CO2-taxes sufficienly high to assure about a 60 per cent reduction of greenhouse gas emissions, so as to stabilise global warming. Even w ithout a closer examination it is safe to express doubts whether any of the Nordic CO2-taxes have reached a level sufficiently high to match this reduction target. The current issue in Denmark is whether a six-doubling of the existing CO2-tax on industrie s should be approved - so as to assure an additional 5 (five) per cent reduction in CO2-emissions.

In most cases pollution taxes are bound to become substantially lower than the external effects imposed on third parties. They are often fixed on the basis of more pragmatic considerarions and in particular to avoid negative side-effects on the competitiv eness of domestic industries. As a result, there is a strong bias towards the taxation of households, rather than of industnes and farmers. Households are a target group poorly organised to lobby for their interests.

But even when attempts are made to establish a link between green taxes and environmental targets, as in the recent Danish effort to introduce complementary environmental taxes on industries it appears that environmental targets are often set in a rather arbitrary way. It remains as such an open question why, for instance, the Danish pesticide plan from l987 requires a 50 per cent reduction of pesticide use, rather than a 30 or 70 per cent reduction. So far, little justification has been presented for thi s target, which appears to be the outcome of a genuine political process.

Wilson's regrulatuon theory explains two phenomena. Firstly, it explains why policy-instruments that are perceived as especially costly, such as economic instruments, are only seldom adopted. And secondly, it explains why economic instruments, when adapte d, are usually biased in the interests of the regulated. In both cases, the reason is the interest and information asymmetries between policy-entrepreneurs and target groups.

6. Bureaucratic Interests

The prediction in Wilson's regulation theory that the benefits of pollution control are so diffuse that policy-entrepreneurs care less about the choice of instrument can be confirmed if we look at the environmental organisations. Economic instruments have not been in great demand by green pressure groups, and they have mainly responded to proposals put forward by others, notably by economists. Actually, economists have been more or less alone in advocating the use of economic instruments since Pigou's day s.

Environmentalists usually regard economic or market-like instruments with great scepticism and prefer standards or fixed guidelines that are perceived as being more environmentany friendly. In the process leading up to the Rio Summit, NGO's were sceptical towards the use of economic instruments. Only in the last two or three years have environmentalists slowly changed their attitude towards economic instruments, which they are prepared to accept if they are followed by extensive supplementary regulations. In this process most of the potentilly administrative and efficiency advantages of economic instruments have been neglected.

Environmentalists have not been the main policy-entrepreneurs behind the increased use of economic instruments in the Scandinavian countries. It is rather fiscal motives that have been the driving force, and one should look to financial and tax ministries rather than to environmental ministries to find the entrepreneurs designing the economic instruments that are being put into operation. For welfare states under fiscal strain, environmental taxes present a substantial asset. Not only are such taxes legit imate in the population, but such taxes can also produce considerable incomes. To a considerable degree, this factor explains the more profound use of pollution taxes in Scandinavia. There has simply been greater fiscal pressure than in many other Europea n countries, allowing pollution taxes to take a more important position.

This does not imply that the pollution taxes introduced are void, nor that they do not have any regulatory impact. But the fiscal entrepreneurs have caused a certain bias in the design of economic instruments. To understand this bias one needs to understa nd the interests of the various ministries usually involved in the designing of economic instruments.

Finance ministries prefer environmental taxes that produce a relatively stable and predictable income, and thus not taxes which are too effective in decreasing pollution (and income). Finance ministries do not like the idea about earmarking the revenue fo r environmental purposes, since it would hamper their budget control. Finance ministries are also worried about the effects of environmental taxes on the balance of payments and thus on industrial competitiveness. They are therefore attentive to industria l allegations about the impact of such taxes, and more likely to impose pollution taxes on households. Finally, fmance ministries are concerned about a too sudden and dramatic introduction of new environmental taxes since it is relatively impossible to pr edict their impacts in the classical econometric models used. The Weizsacker proposal to reduce income taxes for an eight-doubling of energy taxes would be quite a nightmare for any finance ministry since such a sudden shift in the tax base would erode it s capacity to analyze the national economy.

Tax ministries prefer administrative simplicity and feasibility. While many environmental problems are complex and require a creative tax design that might not even produce an income, tax ministries prefer simple taxes that can be imposed and collected at points easy to identify and control. They are therefore suspicious of the long lists of environmental taxes that would be necessary to control the diverse number of pollution sources. When enviromnental ministries have produced complex and inventive tax schemes, tax rmnistries have often turned them down arguing that they could collect the same amount of revenue in a much simpler way! Furthermore, tax rnmistries often think that they have built a carefully balanced tax system over many years, and having reached this stage of perfection they do, from the point of view of taxation, not see the need for changes - a view that finds support in conventional taxation theories. They are suspicious of the gradual introduction of environmental taxes that often ref lect particular environmental events or the need for specific revenues, and they require a logical and more systematic design of environmental taxes.

The interests of environmental rninistries must be mentioned as well, although their interests are somewhat more in line with the externality taxation principles. Environmental ministries are keen on reaching the environmental targets set, but the use of economic imstruments as regulatory means is in their view just one method of assuring implementation. Traditionally, environmental ministries have not cared much about the costs of intervention. Getting control of revenues from economic instruments presen ts an alternative, and often equally attractive, approach. If such instruments can be used to increase the budget of the environmental ministry, it will have more funding for its remaining pollution control programmes. Furthermore, the use of economic ins truments serves to raise the significance and power of environmental mimstries within governments. They increase the bargaining power of the environmental ministries in relations to the traditionally more powerfull economic ministries. In sum, if the most optimal pollution taxes cannnot be passer for instance because of opposition from finance and tax ministries or from target groups, environmental ministries can still see their interest in going along with less efficient measures.

Despite these rather negative remarks about the impact of bureaucratic interests, it is worth remembering that the interests of the treasury may also help promote environmental taxes. In the European Union (the former European Community) the Directorate-G eneral for Taxation has been among the supporters of the CO2-tax, since such taxes at the European level fit very well into the agenda of the Directorate-General - an ultimate harmonisation of all taxes. Unfortunately it is also this perspective that has triggered UK opposition.

7. The Role of Environmental Economists

Until the late 1980s economists were quite alone in advocating the use of economic imstruments - in a way they still are. Although environmental economists are eager to see economic instruments applied, they are seldom good advisors when it comes to the a ctual design of such instruments. They have too little information, and therefore their possible role as policy-entrepreneurs is often limited.

Most, but not all, environmental economists have no background in the natural sciences, and often they know too little about the complex nature of the environmental problems to be addressed and 'internalised' by means of the pollution tax. For instance, t his has led environmental economists to advocate a fertiliser-tax on nitrogen-input - a typical textbook example of a pollution tax. On the basis of scientific evidence, there are good reasons to believe, however, that an input-output tax (based on a nitr ogen-balance) would be more efficient since it improves the incentive to utilise manure (leaching from manure is higher than from fertlisers) (Hansen, 1991).

Environmental economics is first of all a theoretical discipline, and the strict conditions in partial equilibrium economics are not likely to apply in practice. Even though Baumol and Oates maintain that environmental economics was not meant to be 'theor y for the same of theory', they treat economic instruments in a partial analysis, without taking, institutional or environmental aspects into account. The pollution tax was meant to be a complete alternative to command-and-control regulations.

Most environmental economists have few ideas about the possible interplay between economic instruments and other regulations. As a result, economic instruments are often added 'at the margin' of other regulations. In this way several policy-instruments ar e used to address the same issues, and the administrative advantages of economic instruments are not achieved. In some cases the interplay may even be counterproductive, neutralising the incentives accruing from economic imstruments.

8. Impact and Bias

Economic instruments may be on the agenda of many governments, but as the above mentioned factors indicate, it is a difficult exercise to reach agreement on green taxes that are effective in controlling pollution. The fact that a potentially effective pol icy-instrument is designed or used poorly, could lead to negative conclusions about its use. This paper argues, however, that we need to understand better the processes at work in order to escape such pitfalls

Economic instruments are after all a potentially very dynamic instrument. Even if such instruments have been applied differently from textbook principles and with a certain bias in their design, we already know about several experiences where economic ins truments have been a superior way in which to deal with excess environmental loads.

The Japanese SO2-levy introduced in 1974 was designed mainly to raise funds from smoke-stack industries to pensions for officially recognised pollution victims. The rate of the levy was fixed in accordance with the need for revenue, and initially the levy was rather low. However, the levy was extremely effective in reducing SO2-emissions so that 10 years later Japan had the lowest SO2-emissions per capita in the industrialised countries (Tsuru and Weidner, 1985; Imura, 1989).

Denmark's energy taxes have been introduced partly to protect the sale of natural gas from the North Sea and partly to generate revenue for the treasury. Industies have been exempted, but households have been subject to the highest implicit CO2-taxation w ithin OECD. Combined with other policy-instrnments, notably research programmes and subsidies for insulation of buildings, this led to a 45 per cent decrease in the use of energy for heating from 1972 to 1989 (Energy ministeriet, 1990; Andersen, 1994c).

The Dutch water quality charges were introduced in accordance with a century-old tradition for user payment in water management, with only very vague ideas about their impact on discharges. Still, from their introduction in 1971 they led to a national red uction of about 80 per cent in organic discharges over a 10-year period (Bressers, 1988; Schuurman 1988). Similiar, although not quite as impressive results were achieved in France, where a comparable system was introduced (Andersen, 1994a).

Experiences like these and others are evidence that economic instruments can be quite powerful and dynamic tools, although there is also evidence of environmental taxes with little or no impact on behaviour. On the basis of existing reviews of environment al taxes in different countries. it seems as if there are more examples of poorly designed economic instruments, than of successfull ones.

The most important design failures that occur are:

• economic instruments are not used to address the most significant environmental problems, but are applied incidentally according to the principle of the lowest political resistance;

• there is a fiscal bias in the use of green taxes so that there is more focus on the revenue generated than on environmental effectiveness;
• the rates of green taxes are not set so as to match the true environmental costs or to assure specific environmental targets, and are generally much too low;
• the largest polluters are granted precarious exemptions, while smaller enterprises and households are taxed relatively higher (the pastry-master syndrome).

The half-hearted use of economic instruments may in the longer run endanger the existig public support for a policy-instrument which could give an important contribution to a more cost-effective environmental policy, and which has been regarded as the key to a sustainable development by the World Commission.

9. How Can the Use of Economic Instruments Be Improved?

If we return to Wilson's regulation theory, we may get some hints about how to use economic instruments in a better way.

Firstly, we need to reconsider the client policies. Before new economic instruments are introduced, we need to reconsider existing economic instruments, in particular subsidies. Run-off from agriculture has not so much been caused by uncontrolled market f orces as by agricultural policies and their drive towards increased productrvity. Tax breaks for commuters tend to increase the separation between dwellings and work places. Market failures have a complement in state failures (Janicke, 1990; Anderserr, 19 94a).

Secondly, we need to make the target groups reconsider their perceptions of costs and benefits. The efficiency of economic instruments offers a potential double dividend that could be shared with the target groups. The comparison between the Dutch use of economic instruments and the Danish command-and-control policy for water pollution control shows how Dutch industries have reduced pollution much more effectively in the years between Stockhohm and Rio, and at considerably lower costs, than their Danish c ompetitors (Andersen, 1994a). We need more empirical evidence to show the target groups the potential benefits of economic instruments, also for them, preferably through comparative evaluations of economic instruments. Changed perceptions would move envir onmental policies into the matrix where both costs and benefits are spread (e.g. the type of majority regulation that requires some years to build up consensus).

Thirdly, we need to consider the possible impact on cornpetitiveness better. It is not possible to neglect that domestically applied pollution taxes can bring competitiveness and jobs in danger. But rather than with a defensive stance and a withdrawl of t ax proposals this issue needs to be addressed in a more offensive way. Taking into account that most environmental taxes are too modest to reflect the true external costs, the solution consists in full or partial earmarking of the revenue for the target g roups and the measures they will take to adapt themselves to the new prices. In this process it is necessary to build institutions that can provide the target groups with know-how about how to respond most cost-effectively to the new prices.

The difficulty related to such an approach can be seen quite clear in the present Danish efforts (Finansministeriet, 1994) that have followed this path, which could also be labelled a 'divide-and-rule' approach. If the goverurnent offers the target groups to return revenues and also offers them influence on the design of the earmarking mechanism, they will have difficulties in negotiating jointly. Rather, each sector or interest group will have an interest in an earrnarking scheme that benefits itself at the expense of the joint scheme. For this reason the Federation of Danish Industries has refused to participate in negotiations about the earmarking or refund schemes.

Fourthly, governments will have to cease speculating in the revenues they can obtain from environmental taxes. The bureaucratic interests of fiscal and tax rmnistries are counter-productive from the point of view of economic instruments. Energy taxes can produce a considerable revenue stream for the treasury, but for the remaining spectrum of environmental taxes, revenues should be reserved for environmental measures by the target groups (not for increasing budgets of environmental ministries).

Finally, environmental taxes need a more coherent design. Rather than incidental taxes on batteries, plastic bags and water taps, the use of economic instruments should be related to a more sufficient life-cycle analysis. The most damaging waste streams s hould be identified, and taxes should be applied on the basis of material balance accounts. It is the loss of resources and raw materials, not their tumover, that needs to be taxed, although this particular aspect requires further investigation and discus sion.

10. Perspectives and Concluding Remarks

It is deliberate that the intemational aspects of using economic instruments have not been addressed in this paper, which has focused on the use of economic instruments in a domestic context. Although game theory has taught us something about free-rider p roblems, the complexities of joint policy-making at the intemational level are not very well-understood. Global environmental problems definitely require globally coordinated responses, but I would argue that they do not necessarily require the use of exa ctly the same instruments. Economic instruments are mainly a more efficient way of achieving specific targets, and are as such also applicable at the level of specific regions or countries.

The most disappointing has been the lacking ability of the European Union to reach agreement on a CO2-tax. At the European level mechanisms similiar to those in the domestic debate are at play, and multinational companies have lobbied against the proposed CO2-directive. The UK is not the only imediment to concerted action as other member states, notably France and Spain, have given the UK a more or less tacit backing. In the light of this development, it could have less impact than expected if the so-call ed forerunner countries would turn their use of economic instruments into a half-hearted affair, despite the prospect of an ecological modernisation of industries offered by them.

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