Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1 - 19)

TUESDAY 23 JANUARY 2007

PROFESSOR PAUL EKINS

  Q1  Chairman: Professor Ekins, welcome to the Committee. Thank you for taking the time to come and give evidence to us in the first part of our inquiry into climate change and the Stern Review. To start off with a general question, what are your views on the Stern Review? How far has it taken the debate forward? Given that in July 1997 the Government announced their intention to reform the tax system to increase incentives to reduce environmental damage and shift the burden from good to bad, as they called it, what more could they do to make the fullest possible use of taxation instruments as a mechanism to achieve their environmental targets?

  Professor Ekins: Chairman, it is a pleasure to be here and thank you for asking me to come. I think that the Stern Review took matters forward a very great deal, especially in a political sense. Those of us who know the economics literature will probably be aware that most of the arguments rehearsed in the Stern Review have been out there for some time. Some of the novelty of the Stern Review was in his choice of emphasis. He focused first very much on the science of climate change, which does not always happen when economists look at that subject. He then focused in the first two chapters very much on the equity and social justice issues, which again does not always happen. Yet in my view that is the correct way to start because these are very important public social as well as economic issues and it is important to get them on the table. He then worked through the economics in quite a lot of detail. There has been a fair bit of controversy about how he arrived at his overall damage costs, in particular with the use of a discount rate that some perceived to be too small, and he justified that use. There will continue to be debate about the right value of such things. I think that his broad conclusion, which is that the damages from climate change if allowed to proceed unabated will greatly exceed the costs of doing something about it and reducing the level of emissions and therefore the degree of climate change in future, was absolutely right. I think that his argument that there is a strong economic case for serious and determined abatement of emissions internationally is the right one. Broadly, I am in agreement with that. On the subject of the tax shift, in this country since 1997 the proportion of taxes and GDP that comes from environmental matters has fallen which, on the face of it, implies that there has not been a very great movement. Again, I believe that that statistic gives the right impression of the situation. In my view, what happened was that the Government started with very good intentions. The statement of intent on environmental taxation was, though short, a very innovative document and one which, had it been followed thought through, would have been something of an international first. For the first few years the Government seemed to pursue that agenda quite vigorously, but a combination of events, of which probably the most important was the fuel duty protests in 2000, caused them to lose political heart. Obviously, it was not helped in that what seemed to have been cross-party consensus on that particular tax, namely the fuel duty escalator, broke down at that time. As you know, that had been introduced by the Conservatives in 1993. Both parties had broadly backed it until 1999 when the Conservatives changed their policy and it made it very difficult in the face of the fuel duty protests for the Government to hold their nerve. Since then the real tax on fuel has fallen. If one looks at the share of environmental tax in taxation generally one sees that it peaked in about 1999 and since then has declined quite substantially.

  Q2  Kerry McCarthy: You say that you broadly agree with Stern's conclusions. Do you agree with his view that there is about a 1% GDP cost to stabilise greenhouse gases as against the 5% to 10% potential loss in global GDP if climate change is allowed to continue?

  Professor Ekins: You probably know that a number like that is derived from fairly complicated—some would say sophisticated—economic modelling. There is enormous uncertainty about the way economic models are constructed, the theoretical bases on which they are founded and the relationships that they are posited to have. There are very different economic models which come up with different results. The Stern Review quotes what is called a meta-analysis of all of these studies to show that there is a wide range of estimates of GDP impacts from reducing emissions by 20%, 60% or 70%. Most of those estimates fall within about 0.5% to 2% of GDP. If one had to pick a single number that seemed to be representative of those modelling results 1% would be a reasonable choice. Obviously, those economists who are responsible for and believe in the models that have come up with higher estimates will say that that is too low. I have looked at the models and the kinds of modelling of these sorts of issues that I favour suggest to me that 1% is about right. On that basis, I agree that that is a reasonable estimate.

  Q3  Kerry McCarthy: When one is looking on a global basis at these estimated costs and losses, how easy is it to move from that to doing cost benefit analyses for the UK in terms of bringing in new environmental taxes here?

  Professor Ekins: Any kind of cost benefit analysis of an issue of this kind is fraught with difficulty, and I for one am very glad that Stern did not really attempt it. For a country like the UK the first question one has to ask is: to what extent is this global action and to what extent is it action purely in the UK? If it is the latter obviously global emissions and the damage costs from climate change will fall rather little and the cost to the UK through the effects of competitiveness if the policies are not implemented particularly well could be quite substantial. But if one assumes that there is an international framework in place, that all countries reduce their emissions so that the effects of competitiveness across countries are not pronounced and one looks at the damage costs that Stern projects, particularly the significant risks of catastrophic costs—the single biggest change in the science over the past 10 years since I have been looking at the issue is the way in which scientists now perceive catastrophic costs to be much more possible in the reasonably short term—then it is possible to conclude, as Stern did, that the overall cost of mitigation is much less than the risk of very high damage costs and that the cost benefit analysis, if one could carry it out—Stern did not—would mean a significant return from carbon abatement.

  Q4  Mr Love: If I may carry on logically from what you have just been saying, you said that Stern had estimated a 20% to 60% reduction, but that leaves considerable ambiguity about the cost of adaptation. Do you believe that in this country there is a supportive environment in government and other circles to recognise the costs of adaptation in future?

  Professor Ekins: I think that Stern's perception about the degree to which we need to reduce emissions is much closer to the 60% than 20%. I was quoting that the studies had looked at reductions of between 20% and 60% and come up with different ranges of mitigation costs. Even at 60% emission reductions globally, or at least in developed countries, there will be considerable climate change and we will need to adapt. These adaptation costs are likely to be very different in kind and the public will perceive them very differently. Some of the effects will be direct physical ones on the UK, such as increased flooding and increased cost of home insurance against that risk, if we decide to do it through the private market. I do not think that the public will have a great deal of choice about that. We are already increasing the cost of flood defences against these kinds of events. That is money to be spent by taxpayers which obviously cannot be spent on something else. There will be other much more difficult kinds of costs if there are very wide international effects from climate change. If, for example, some of the low-lying deltas of the world with very large numbers of poor people living in them were to become uninhabitable those people would have to go somewhere else to live. Countries like the UK might be asked to take very large numbers of migrants from something like climate change. I can imagine that that in a sense is not a financial cost because they may be very hard working and in due course add to GDP, but we know that that would be a difficult political issue. In a sense there would be a perception of cost, and for the people displaced from their homes it would be a very real cost that would be very difficult to value in financial terms.

  Q5  Mr Love: You rightly highlight the fact that climate change will probably have much greater impact in the third world than it would in either Europe or the United States. Just looking at the United Kingdom, there is already controversy. The insurance companies are saying regularly to government that they are not putting enough aside for flood protection and therefore they will not insure; or they are not doing enough on coastal erosion. Would there be a benefit to the Government in trying to bring together all the current expenditure to show the public just how much is being spent but, projecting into the future, how much is likely to be needed to be spent on some of the things that you have just been talking about?

  Professor Ekins: Given the problem of climate change and public perception, the fact that it is a very long-term issue which is well outside most people's daily thoughts—indeed, the worst effects will not be felt by us but by our children and grandchildren—and that there are lots of other things which have claims on people's attention, anything that can make these costs real to people, given that they are real costs, is of very great benefit. One of the reasons that the public and people generally are not convinced about climate change is that they do not see it as an immediate issue that is a result of some part of their actions which will impose costs on them and their children in future.

  Q6  Mr Love: An increase in what the Government term environmental taxes has been criticised because the money raised is not used either on mitigation or adaptation. Should we treat environmental taxes in a different way from the ordinary taxation system to highlight just what we are doing in terms of both mitigation and adaptation?

  Professor Ekins: In general, I do not believe that is desirable. A much stronger argument is to say that governments need revenue and in general it makes sense to raise that revenue from taxing bads rather than goods. In some cases it may be that where there is a case for public expenditure it can make the tax more palatable and politically acceptable to link a particular tax with a particular form of spending, but if that principle became widely established in government all sorts of desirable public expenditure would not find suitable sources of money to finance it. I think that a much better approach is to say that government has a certain revenue requirement and to get it from activities that cause social harm is in general better with other considerations than getting it from other sources. Indeed, that was broadly what the statement of intent on environmental taxation in 1997 said.

  Q7  John Thurso: Both Stern and the Government as well as many sectors of industry regard carbon emission trading schemes as the best way forward to tackle climate change. Do you regard these systems as the best way forward, or do you think it is just a way of looking good and kicking it into the long grass?

  Professor Ekins: As with practically every policy of which I am aware, its goodness depends almost entirely on the detail. There are lots of theoretical arguments—indeed, the Stern Review rehearses a good number of them—about the relative benefits of tax and trading in particular and regulation in other circumstances, but what one sees is that the schemes introduced because of the political pressures of getting any kind of policy brought in at all often bear very little relation to the textbook expositions of these taxes and trading. In principle, as I understand what the Stern Review said—this is broadly what emerges from the academic literature—with a problem like climate change one wants a long-term stabilisation target in terms of emissions, because it is in the long term that they build up in the atmosphere and cause climate change and therefore one wants to put a cap on it. Therefore, in the long term an emissions trading scheme would seem to be an effective way to do that, but in the short term because of the relative shapes of the marginal abatement and damage costs one probably wants to make use of a price mechanism, ie an environmental tax, or in this case ideally a carbon tax. Therefore, one would have a carbon tax adjusted in order to deliver a long-term quantity of emissions trading.

  Q8  John Thurso: In other words, you would almost certainly need both?

  Professor Ekins: Indeed. It would be desirable to think in terms of both. Whether one would need both would depend on the extent to which one found that the policy was effective given all sorts of imperfections operating in the various markets. For me it is a matter of great regret that the proposal of the European Commission in the early 1990s to introduce an EU-wide carbon tax did not capture support at that time. That would have established the principle of a tax early on in the climate change issue. We would have what people knew was a carbon price which did not go up and down with the short-term vagaries of the permit market, as it does at the moment. You are probably aware that as we speak the carbon price is at its lowest level ever, so the people who made investments on the basis of some carbon price even six months ago would be rather disappointed by the performance of those investments. Had we had that kind of price mechanism in place we could have decided then whether as well we needed an emissions trading scheme in order to give some kind of long-term surety about the overall quantities which would be emitted.

  Q9  John Thurso: I want to ask you about the carbon emission scheme in a moment. First, we have received suggestions that carbon trading schemes may be more effective if they are based on the individual; in other words, if individuals have a personal carbon account. They would have either their own carbon allocations which they would sell to business when they did not use it or their own account so that they would purchase carbon every time they took a flight or used something that used energy, or whatever. What do you think of those schemes as a way forward, and what would be the difficulties for government?

  Professor Ekins: I think that the main difficulty is the very considerable difference between the theoretical attraction of such a scheme and its practical implications. If we had a general population that understood what carbon was and was prepared for a system that used carbon as money in its purchases, and if there was an evolving market which allowed individuals easily to make those kinds of transactions so that businesses could get access to the carbon emissions they needed to go about their daily business—we may evolve those institutions and general level of information and awareness—I think that personal carbon trading might have something to commend it. But I believe that we have a long way to go before we get there. Businesses are now much more aware of the issue of carbon trading than they used to be thanks to the EU emissions trading scheme, and I think that is a very good start. Were one to proceed down the route of personal carbon allowances it would be desirable to keep businesses and individuals distinct for the time being so that businesses continued to trade among themselves. Personal carbon allowances would cover the personal use of fossil fuels and perhaps transport and aviation while the business trading schemes continued to be developed. Doubtless you will be aware that the Government have a proposal to introduce a trading scheme for large commercial organisations alongside the EU emissions trading scheme. It seems to me right that bit by bit we gain experience in these rather complicated businesses which effectively create new money, which is what carbon trading represents.

  Q10  John Thurso: For a carbon trading scheme to work there must be a robust market which means that the market must be sufficiently liquid and regulated so it is real and we are not buying and selling carbon that is not there. It also needs a real price. You have already alluded to the drop in price which has rather undermined what is sought to be achieved. Do you think that the EU trading scheme offers these criteria?

  Professor Ekins: I think that for the 40% to 50% of carbon emissions that are within the scheme it could offer those criteria, and it almost entirely depends on the quantity of emission allowances that are permitted to go into the scheme. I believe that the European Commission is absolutely right to take a tough stand, insofar as it is doing so—it is taking a tougher stand than it might otherwise have taken—on the second phase of the national allocation plans submitted, because as submitted there is a very great danger that those plans would not support a robust carbon price and encourage people to make low carbon investments. Indeed, they might encourage people to go on thinking that they could make high carbon investments which would not prove to be a liability in future. As the whole purpose of that scheme looking to the future is to incentivise low carbon investments so we are in a much better position to reduce emissions in the long term, that seems to me to be the key issue. Of the 10 to 15 allocation plans that have been submitted, only one has been passed so far and nine have been rejected. My numbers may not be bang up to date, but it is of that order. I think the Government deserve some credit that it is the UK's scheme which has been passed by the Commission. I think that we have an obligation to argue that other countries should be judged by the Commission to be doing as much to reduce their emissions as they have judged us to be doing.

  Q11  John Thurso: The Treasury hopes eventually to move to a global emissions trading scheme. Given your comments on some of the problems within the European scheme, would that not be a rather difficult thing to foresee in the medium term?

  Professor Ekins: Clearly, it will take time. I think that it easily offers the best hope of some kind of global accommodation with the carbon constraint, and therefore I very much hope that governments everywhere that are convinced of the problems of climate change will pursue it. There are already straws in the wind that suggest how it might develop. The EU scheme is already linked to the mechanisms of the Kyoto protocol that are generating carbon credits. It is obviously very important that the mechanisms for generating carbon credits are robust, and it is probable that those evolved for the clean development mechanism and joint implementation are as robust as they could be. If other countries and perhaps even individual American states such as California evolved their own robust emissions trading schemes that delivered emission reductions in principle there would be no reason why those permits should not become tradable across borders as well. There are all sorts of institutional issues to be resolved, not least what is to be done if states effectively have a kind of money that is internationally tradable but different from that of the federal government as a whole. Those are issues that will still need to be resolved.

  Q12  John Thurso: As you have said, effectively one is creating a kind of currency, or tradable commodity, which is very difficult to quantify in real terms. Therefore, is there not a huge opportunity for fraud?

  Professor Ekins: There certainly is an opportunity for fraud, and a very great deal of effort has been invested in the kind of monitoring and verification mechanisms both in this country and in Europe and to some extent elsewhere in order to try to ensure that that does not happen. In principle, it is quite easy to calculate how much carbon is released when one burns a certain quantity of fossil fuel because it is known how much carbon is in it and all of it will go into the atmosphere. The difficulty arises when one starts to allocate allowances on the basis of estimated base lines. What would have happened if one had not done certain things? The "what would have happened"—the counter-factual—is always an uncertainty and people have vested interests in arguing that base lines are different from what they would have been. That debate that has dogged the whole issue of how one might take into account reductions in deforestation. Mechanisms to deal with these issues have been evolved and I believe that in the European context they are reasonably robust. Easily, the biggest problem with the European scheme is that governments are allocating too many emissions allowances rather than monitoring and verification.

  Q13  Peter Viggers: The Treasury has quite a narrow definition of "environmental taxes" and refers to the climate change levy, the aggregrates levy and landfill tax, whereas the Office for National Statistics uses a much broader definition of "environmental taxes" which includes energy taxes and taxes on road vehicles. The Treasury explains this by saying that it is concentrating on the aims behind the introduction of the taxes, whereas the Office for National Statistics is looking more to the effects of taxation. Do you think the Treasury takes too narrow a view of environmental taxes?

  Professor Ekins: I was not aware that it was as definite as that in terms of definition, but if it is it certainly is too narrow a view. The evolved international consensus as expressed by bodies such as the OECD, which has done an enormous amount of work on environmental taxes and has in a sense standardised what we mean by those taxes and how they should be thought of—it has created a huge international database for environmental taxes—is very much in line with the definition of the Office for National Statistics. That seems to me to be the definition that makes most sense. Where one has a tax on goods or a service that cause a serious environmental effect irrespective of why that tax was introduced, or the historical genealogy of it—for example, fuel duties were introduced well before anybody was thinking hard about environmental matters—that does not seem to be so relevant as the fact that one can use that tax in order to have an environmental benefit. That seems to me to be the relevant definition.

  Q14  Peter Viggers: You refer to the use of the tax for an environmental benefit. Are you implying that there should be hypothecation of the environmental tax?

  Professor Ekins: By no means. It is a simple illustration of the law of demand which is that if one puts up the price people will demand a lesser quantity. That is the way in which classically environmental taxes are perceived to work. Therefore, I am of the opinion that we had much less both local and global air pollution because of the fuel duty escalator in the 1990s than we would otherwise have had. Indeed, there is robust modelling to suggest that emissions from road fuels would have been quite a lot higher had we not had that tax instrument. That seems to me to be the environmental benefit from the tax. One may then decide to spend some of the revenues from that tax or from others on ways further to improve the environment, but that seems to me to be a different decision and effect from the effect of the price mechanism itself.

  Q15  Peter Viggers: How do you rate taxation against regulation in terms of coercing or encouraging people to take appropriate action? You can regulate so that people will not do things or tax them so they are discouraged from doing things. Do you have a view on that broad issue?

  Professor Ekins: I think that a complex society such as ours needs both. Regulation sets standards, and there are some areas of life where standards are important. For example, I am very glad that drinking water is subject to regulation and not taxed on the amount of pollution that can be put into it. On the other hand, there are many environmental issues that respond well to price signals where those physical effects are not absolutely critical and perhaps the cost of abatement is relatively high. We may not know what the cost of abatement is and we can suck it and see, because a tax effectively places a cap on the cost of abatement because no one will spend more to abate when they can simply pay the tax. It has been very interesting to watch the evolution of the debate on the relative merits of these policy instruments. Back in the 1980s the profile of environmental taxes was very low and the way that environmental agencies normally proceeded was through regulation. The literature then started to suggest that in some instances environmental taxes would be a cheaper and more cost-effective and efficient way to proceed. Initially, everyone thought this was a jolly good idea because they could get the regulators off their back, but they then realised that taxes were fairly ineluctable. Once a tax is levied one pays the tax on the full environmental effect, not only on the bit that is above the regulated amount. There has now been a very interesting swing of perceptions against environmental taxes, and certainly governments have found them very difficult to introduce. That means that on the whole we do not have enough of them and in general I would favour the introduction of environmental taxes much more commonly, and in particular for their introduction on an escalating basis. In this country we have had some experiences of tax escalators. The fuel duty escalator and landfill tax escalator are currently in place. In my view they have shown themselves to be remarkably effective.

  Q16  Peter Viggers: Do these need to have a global or perhaps European element, or are we justified in approaching this on a national basis? To what extent must there be an international ingredient?

  Professor Ekins: At the moment there cannot be an international ingredient because even with a body like the European Union tax policy remains very firmly at national level, and any prospect of the 27 countries agreeing that it should be anywhere else is pretty remote. One has to evaluate this at national level. For a problem like global carbon emissions it would be highly desirable to have a global carbon tax. Similarly, if one had a proxy for that it would be highly desirable to tax aviation fuel at a global level, but there are all sorts of international dissents on that and, in the case of aviation fuel, treaties that prevent it from happening. I think that governments must evaluate these things at national level and in doing so they must be aware of factors such as possible effects on competitiveness. But governments must raise revenue from something and practically anything that it taxes in terms of an input into production, such as labour, may well introduce an effect on competitiveness. Indeed, we have very great debate about the cost of social security systems when they are funded by taxes on employers, for example. I believe there is very great scope for a tax shift within that general sector and removing some of the taxes that have competitiveness effects on labour and putting them on bads like pollution. That was something that people like me thought might be happening on quite a wide scale as a result of the statement of intent, and indeed did happen on quite a small scale when the climate change levy was introduced. Generally, I thought that that was a good thing.

  Q17  Mr Breed: I take you back to what you said right at the beginning of your evidence about the proportion of environmental taxation as against total tax revenues. We know that there has been a reduction over a period if time. It is currently at the lowest level it has been over the past 10 years. Is that due solely to abandonment of the fuel duty escalator or are there other contributory factors?

  Professor Ekins: It is due more or less entirely not only to the abandonment of the fuel duty escalator but the failure to update fuel duties in line with inflation in each year since 2000. I think they have been uprated in line with inflation twice. One was the most recent Pre-Budget Report. That has very largely resulted in that effect because the great majority of environmental taxes currently come from energy and transport-related taxes. That is the major change in taxation.

  Q18  Mr Breed: Bearing in mind what you have just said, you seem to indicate that were there a wider spectrum of environmental taxation in other areas rather than just the fuel duty escalator the effects observed over the past 10 years or so might not have been the same?

  Professor Ekins: That would obviously be the case. If one introduced more environmental taxes that had a relatively broad tax base one would expect to get more revenues from them. In environmental taxes it is important to distinguish those which are purely designed to change behaviour, and indeed at the limit might change it to such an extent that they generated no revenues at all. One might think of the plastic bags tax in Ireland in that context. The use of plastic bags has, I understand, fallen by over 90%. Therefore, that tax is not raising a very great deal of revenue. One distinguishes those taxes from other taxes such as those on fuel where there is certainly a demand effect. People use less fuel than they would otherwise use, but certainly demand does not drop like a stone and it remains an enduring revenue base. Energy is certainly the clearest example of that, but there are others. One can imagine, for example, that however high the aggregates tax one would still want to use some aggregates and the revenues that one gets from such a tax are the price times quantity. If one raised the price, unless the quantity fell by an equivalent amount—in other words, the elasticity is one, but most elasticities are less than one—one would increase the revenue, even if demand fell somewhat.

  Q19  Mr Breed: When we are considering the success or otherwise of the Government's environmental policies as a whole how legitimate is it to focus almost solely on the proportion of environmental taxation against total revenues rather than widen the whole aspect to a significant extent?

  Professor Ekins: I certainly would not want to focus solely on that. I am aware of the Treasury's argument that this is a bad indicator and should not really be used because if environmental taxes were effective one would have the behaviour changes and one could therefore have a reduction in tax revenues. That is true for some environmental taxes and, therefore, one needs to look behind the indicator and see what is driving it. In the case of the UK, what has driven that indicator over the past five or six years is not the fact that people's behaviour is changing to such an extent that revenue is falling but the fact that the tax rate has been lowered in real terms and that is why one gets less revenue. That argument in that particular instance is not the case. One cannot put that forward as a reason why the tax shift does not appear to have taken place.


 
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