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Monday, March 29, 2004

Environment tax can work

On Nov. 18 the Japan Federation of Economic Organizations (Nippon Keidanren) issued a statement opposing a proposed environment tax. Keidanren noted that it had set its own fiscal 2010 targets for reducing carbon-dioxide emissions generated by the industrial and energy-conversion sectors below 1990 levels, and was pushing a voluntary program to achieve the goal.

Keidanren said the tax proposed by the environment ministry had five problems. Let me comment on the alleged problems point by point:

First, Keidanren said, the tax would dampen economic recovery and stifle industrial activities.

Imposing a new tax on fossil fuels would no doubt push up the prices of most products, since the costs of using or generating electric power are reflected in the production, distribution and sale of most products. If income were unchanged, real consumer spending would clearly decrease. So if the government kept revenues from the tax in its coffers, the tax would slow economic recovery.

If the government, however, used the tax revenues on measures to fight global warming, it could stimulate spending that would more than offset a fall in consumer spending. If a tax of 3,000 yen per ton of carbon were levied on fossil fuels, new tax revenues would amount to about 1 trillion yen. Automobile taxes could be cut on fuel-efficient vehicles, and power companies could double the price they pay to purchase surplus solar power from businesses and homes from the present 25 yen per kilowatt-hour, thus encouraging use of solar cells. The government could make up the 25 yen difference from the new tax revenues.

Furthermore, light railway transit (LRT) systems -- or modern streetcars -- could be introduced in Kyoto and other cities, using road-specific construction funds. Effective use of new tax revenues to cut CO2 emissions would spur motorists to shift to more fuel-efficient cars and create new demand for solar cells as well as LRT construction and trains. This would boost the gross national product.

An income-tax cut to counter the effects of the added carbon tax could be implemented. Net disposable income would rise, contributing to an increase in consumer spending. Differences between income reductions due to the new tax and gains in disposable income would be negligible.

The above-mentioned scenario applies to a closed economy, excluding trade. The story would be different for an open economy, including trade, which brings us to the next point.

Second, Keidanren said, the tax could accelerate Japan's de-industrialization trend while aggravating global warming.

The tax would no doubt hurt the competitiveness of export-oriented domestic manufacturing industries, such as steel, that use large amounts of fossil fuel. However, opposition to the environment tax on this ground is illogical, since relief measures are possible.

Taxes could be refunded on steel exports on the basis of CO2 emissions per unit reported, and then levied on steel imports under a similar formula. This system would prevent the tax from crimping steelmaking. Moreover, coking coal used by steel, ceramic, paper-pulp and other industries that consume large amounts of energy could be exempted from the tax.

There is no denying that the introduction of the tax would accelerate the shift of Japanese production bases to overseas locations. Therefore, Nippon Keidanren claims that the tax would aggravate global warming because environmental restrictions are lax in developing countries. However, the clean development mechanism -- by which a country that achieves CO2 emission abatement in developing countries through investment may count the reduction as its own -- would mitigate the problem.

Third, Nippon Keidanren argued, energy taxes are already too high, with a low price elasticity for energy demand; thus the environment tax would not have much effect in curbing CO2 emissions.

Few people would immediately cut down on driving or switch to public transport following a gasoline price hike related to the introduction of the environment tax. Although the short-term price elasticity for gasoline demand is admittedly low, medium-term (five to six years) elasticity is not. Consumers would gradually switch to more fuel-efficient cars. In the longer term, elasticity is even greater, since automakers will be motivated to develop more fuel-efficient cars.

Fourth, Nippon Keidanren said, voluntary efforts should be encouraged and effective means should be developed to reduce CO2 emissions.

To be sure, CO2 emissions from households and offices grew at tremendous rates for some years, while those from industries declined. From the mid-1980s to the mid-1990s, air conditioners and other consumer-electronic products that used large amounts of energy, even in standby mode, were common. Larger automobiles also become more popular. As a result, CO2 emissions from homes and offices and the transport sector sharply increased. Now, though, demand for these products appears to have been satisfied for the most part.

Automobile and home electric-appliance manufacturers are obligated to make more energy-efficient products under the energy-saving law. Replacement of energy-guzzling equipment is likely to lead to a steady decrease in CO2 emissions from homes and the transport sector.

Introduction of the environment tax will motivate households and transport sector to cut emissions. Emissions from the industrial sector are on a downtrend, reflecting changes in Japan's industrial structure -- especially the retrenchment of industrial-material makers -- as well as the effects of Japan's prolonged economic slump.

Fifth, Nippon Keidanren said, a new emission-control framework requiring all countries to join is necessary.

The U.S. withdrawal from the Kyoto Protocol is indeed regrettable. Still, careful discussions should be conducted from the standpoint of fairness on whether developing countries, whose emissions are only one-fifth of those from developed countries, should be required to take part in the second phase (2013-17) of the protocol and how they should do so.

Takamitsu Sawa, professor of economics at Kyoto University, is also the director of the university's Institute of Economic Research.

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