How Government Can Use Excise Tax to Reduce Environmental Pollution from Agricultural Chemicals - Coursework Example

REPORT ON HOW GOVERNMENT CAN USE EXCISE TAX TO REDUCE ENVIRONMENTAL POLLUTION FROM AGRICULTURAL CHEMICALS NAME: TABLE OF CONTENTS INTRODUCTION The term pollution denotes the release of a substance or materials in any form to the environment, which has an adverse impact on ecosystem, the health of species, the aesthetic quality of the environment and the ability of the environment to sustain itself in the short term and in the long-term. Pollution may occur through the release of substances or materials from a diffuse source or from a specific point source.1 A good example of diffuse source of pollution is agricultural chemicals such as pesticides. Point sources of pollution include carbon particles (smoke) released in the air from combustion of fuels in industries and car engines among others. Thus, there is need for a holistic approach to pollution prevention which must take consideration the interrelationship between air and biological systems as well as soils and water. The recent measures taken by the Government of Australia have helped to achieve a significant reduction in pollution emanating from exhaust fumes released by vehicles as well as industrial emissions. The government has achieved this benefit partly through introduction of differentiated excise taxes on all types of fuel that burn to produce carbon. The impact of this has been an increase in prices of the types of fuels that release high levels of carbon and other harmful particles in the air, making cleaner sources of fuel more attractive to consumers. This has made the air cleaner as consumers increasingly opt for the cleanest fuel sources for their vehicles and businesses. Though the efforts by the Australian Government to reduce pollution from point sources have achieved remarkable success, pollution emanating from diffuse or non-point sources is still rampant, through agricultural activities.2 Agricultural use of pesticides, inorganic fertilizers and other chemicals is one of the few activities which involve intentional the release of compounds into the environment to kill things such as pests and weed. THE HARMFUL EFFECTS OF AGRICULTURAL CHEMICAL INPUTS Though regulations have been put in place to control the use of agricultural chemicals such as pesticides and inorganic fertilizers, their continued application has increasingly produced unintended consequences to the environment and their harmful effects cannot be ignored. Pesticides, for instance are chemicals which are intended to kill, prevent or repel a particular pest. Pests can include microorganisms such as bacteria and viruses, fungi, mice and other animals or insects. Unfortunately, as Pearce and Koundouri explain, most pesticides have the ability to cause harm even to other species that are not regarded as pests precisely due to the fact that they are designed to be harmful.3 They generally contain toxic substances intended to destroy the insects targeted. When these toxins are swallowed or inhaled by non-pest species, they are not easily broken down or excreted by the body and thus, they accumulate in body tissues. Over time, the concentration of these toxins may become very high, causing destruction to body tissues. This results in health problems and may lead to death.4 On the other hand inorganic fertilizers pollute the environment mainly through run-off water. This happens when rain drops hits crops that have been fertilized and runs off. This water then gets into other water sources and pollutes them. Usually, fertilizers are made of nitrogen or phosphorus and are meant to make soil fertile. When the nitrates or phosphorus released from these fertilizers mix with water, it becomes unhealthy for drinking. In addition, these chemicals stay in the soil and can contaminate water for long time. They sometimes harm the soil and if used in excess, they can make soil infertile and unusable. According to Pearce and Koundouri, fertilizers create environmental hazards by polluting surface and ground water. As a result, they destroy soil components and kill aquatic organisms.5 Agricultural chemicals have adverse effects on human health and are linked to various health problems such as increased levels of cancer, immune system deficiencies and in-born deformities.6 The negative effects are brought about by skin contact when handling the chemicals, inhaling of spray or dust from these chemicals and ingestion through consumption of contaminated water and food. Farm workers are exposed to high levels of risks associated with skin contacts and inhalation as they apply these chemicals to crops. Surface runoff which is contaminated with agricultural chemicals leads to degradation of water and fish rearing grounds. This results into contamination of fish and causes a major problem in rearing grounds that lie downstream of major agricultural areas. The toxins in the fish are transferred to human beings when they consume the contaminated fish. Over the last decade, the rate of usage of different kinds of agricultural chemicals has been increasing rapidly with recent government statistics indicating that Australia spends more than one billion dollars on them annually. According to Broomhall, there are over 4000 chemical industries that produce agricultural chemicals and approximately 3000 veterinary products which are registered by regulatory bodies in Australia.7 This demonstrates the fact that there is a huge number of agricultural chemicals in use. The impact of these chemicals in Australia has been significant. One good example of these is the destruction of the Great Barrier Reef located near the coast of Australia. Effluents comprising of pesticides and sediments from nearby sugar industries surrounding the area have polluted and destroyed wetlands around the reef and which are part of the reef’s ecology. The effluent is believed to encourage growth of sessile algae, killing coral and causing change in energy balance. According to Broomhall, 52% of all phosphorus and 30% of all nitrogen in the central reef system originated from fertilizer run-off from the sugar industries surrounding the area.8 In Western Tasmania, acid run-off has destroyed mountain vegetation and adversely affected aquatic ecosystem. Various studies have linked the extinction of frog species in Western Australia to non-point sources of pollution. Mortimer (as cited in Broomhall) conducted a study to investigate the quantities of pesticides and trace metals in crabs in coastal Queensland.9 The researcher found residues of dieldrin heptachlor epoxide and DDT in all estuaries between Cairns and Brisbane.10 Further, Mortimer noted that dieldrin content at all locations exceeded the national wastewater quality guidelines laid to protect ecosystems.11 Though the use off these chemicals has been banned in Australia, there are still other chemicals in agricultural inputs that are causing pollution. This is evidenced by the dead sections of river systems such as Kings and Queens River.12 In short, the use of agricultural chemicals is a major source of pollution and hence, comprehensive measures of pollution control will need to take this source into account, among other sources. To achieve this objective, it will be necessary for the Australian Government to extend the recent excise-based initiative to agricultural chemicals. HOW AN EXCISE TAX COULD BE INTRODUCED Imposing an excise tax on agricultural chemicals will tend to reduce their application by farmers and consequently, hazards associated with their use will be reduced. The excise taxes should encourage the use of less toxic chemicals and discourage the use of more toxic chemicals. Precisely, the tax system should be structured in such a way that chemical inputs that are most toxic and which are dispersed more readily to the environment should be taxed most. On the other hand, the safest chemicals or fertilizers would go untaxed.13 The excise tax collected could further be used to reduce problems related to pollution among other functions. An excise tax can be implemented in two different ways. First, it can be imposed on the toxic agricultural inputs or materials. In this case, the tax is levied on materials or inputs based on the toxicity level of the constituents. To producers, this will increase the cost of production at each level. The impact of this will be an increase in the cost of the products in the markets. Consequently, the prices of the final products will effectively reflect the environmental costs and farmers will be encouraged to opt for cheaper alternatives – that is agricultural inputs that are less harmful to the environment. This is the best option where the chemicals or effluent cause difficulties for design or implementation and where there is need to minimize administration costs. The other approach involves imposing environmental taxes on effluent, emissions and solid wastes at the point of release to the environment. This is a more direct way of applying a charge on harmful pollutants. It requires the government to develop detailed ‘chemical use accounts’ for each farm. These accounts are then used to record the application of chemical inputs such as inorganic fertilizers and pesticides to crops and soil and to determine the net excess balance. Thereafter, the firm is charged heavily for any excess application of the inputs. In Netherlands, for instance, fertilizers and other chemicals used in agriculture are taxed on excess use based on specific simple ‘mass balance.’14 The impact of this approach is that it creates a link between the tax payable and the environmental resource. However, it involves very high administrative costs to implement. Thus, the government can weigh between the two approaches or implement both. CONSIDERATIONS IN SETTING RATES Pollution taxes place value on agricultural inputs such as fertilizer, hence internalizing part of the costs associated with their impact on the environment. While all the other taxes on these inputs provide the same function, policy objectives may differ. Pollution taxes on agricultural inputs serve primarily to reduce their negative externalities by raising their costs and also providing funding for pollution mitigation programs or creating market signals for consumers. There are various policy design considerations which are associated with setting and implementing pollution taxes on agricultural inputs. One important issue to consider is the impact of the tax rate on consumers. When designing pollution taxes on toxic agricultural inputs, it is vital to give consideration to the impact on low-income households.15 It is very likely that such a tax would disproportionally burden the low-income households. In order to mitigate this concern, it will be important to consider reductions on income tax as well as offering credits to low-income households. Additionally, in setting a tax rate, it will be vital to make a distinction between short-term and long-term objectives and responses. Usually, the short-term response to a given tax rate is likely to be shorter since it will not include the long-term changes that can be beneficial to the environment. This implies that an excise tax that is intended to reduce pollution over a number of years can be more effective at a lower rate than a higher tax rate intended to be applied for just one year. Secondly, as Goulder points out, pollution taxes vary across jurisdictions especially due to their functions.16 A high excise tax on agricultural inputs will provide stronger signals to farmers to change their behaviours while lower rates may not achieve much in changing their behaviours but can provide revenue to support mitigation programs. Hence, the government should make this crucial consideration in setting the level of excise tax on the targeted products. The distribution of revenue collected through the tax is another important factor to consider. Revenues from pollution taxes are usually directed in different ways. For instance, part of the may be directed at pollution mitigation programs, another portion may be used to supplement government budget while another part may be used to support individuals through reduction in income taxes. The choice made by the government in regard to revenue distribution is very crucial in determining the political sustainability of the tax as well as the suitability of a tax rate. Some pollution tax programs return part of the revenue to consumers through other ways such as reduction in income tax. On the other hand, the government may decide to collect tax revenues with a sole intention to use it specifically for its general budget. Though this is generally easier compared to funding mitigation programs, the resultant revenues from the tax would not be economically efficient. For it to be economically efficient, the set tax rate should be equal to the marginal damage caused by the toxic agricultural inputs.17 Furthermore, the government must decide on whether to place the excise tax on downstream or upstream sources of pollution. Applying tax on downstream sources means focusing on the direct source of pollution which in this case implies placing the charges on farmers.18 On the other hand, placing tax on sources upstream refers to imposing tax on the firms producing the inputs such as pesticide and inorganic fertilizer industries. Applying tax on upstream sources provides an administratively effective and efficient method of tax collection while applying tax on downstream sources usually provides a direct signal to consumers. Thus, in designing the pollution tax rate, it will be of utmost importance to determine the potential impacts of downstream versus upstream sources when designing the pollution tax. EXCEPTIONS TO EXCISE TAX In determination of the tax base, there will be need for some exceptions. The government will need to decide which agricultural inputs to place the tax on and the inputs to be exempted. Most commonly, these taxes are placed on toxic chemicals such as pesticides and inorganic fertilizers which have a strong negative toxic or residue effect.19 Thus, pesticides and fertilizers with little or no adverse effect on the environment need to be exempted. This will apply to the producers in case the tax is applied placed upstream and to the farmers where the approach is to place taxes downstream. In Germany for instance, the pollution tax on non-point sources is designed in a way that a high excise tax rate is imposed on industries that produce highly toxic agricultural inputs.20 Producers who meet a certain set standard in regard to the toxic components of their products are exempted. Therefore, exemptions should be placed based on the impact of the substances to the environment. EXPECTED IMPACTS OF THE NEW EXCISE TAX Merits of the new excise regime Introduction of new excise to agricultural chemicals has a variety of positive implications. As noted earlier, the main aim of the excise is to raise the cost of production of agricultural chemicals so that the producers will be catering for some of the negative externalities they are producing. This will help to increase or promote efficiency in allocation of resources. According to Uri, such a move leads to contraction of the level of demand and consequently, a balance is created between level of production/consumption and the amount of pollution created.21 As well, it helps to reduce level of production to the social optimal level. As a result, a more sustainable economy is created in the long-term. If well designed, the excise taxes will encourage innovation and development of new agricultural inputs which will help to reduce dependency on pollutant agricultural chemicals. Further, this may aid in promoting dynamic efficiency in agricultural production. The use of taxes creates strong incentives for research and development of the processes of production of the chemicals and the equipment used to control pollution.22 This leads to innovation of less expensive pollution reduction processes. Another advantage of an excise tax is that it provides incentives for reduction of pollution in an economically efficient manner and at the least cost. Producers of agricultural chemicals are going to seek ways to reduce pollution at the lowest cost. As such, any reduction in the level of pollution that will be achieved will be attained at the least cost to the society.23 Further, as Uri notes, excise taxes can be a good source of revenue to the government.24 While other current taxes such as taxes on income may adversely affect the incentive to work, pollution taxes can be a better source of federal revenue which may benefit the economy. If the pollution tax rates are set at levels that will bring about improvements to the environment, the behavioural effects on citizens generally could be positive. Thus, taking the perspective of resources allocation, raising revenue from pollution taxes might be more preferable to the current sources of revenue. Demerits of the new excise regime Introduction of an excise system has some drawbacks as well. First, the excise increases prices and reduces output. Most likely, this has an unfavourable impact on consumer welfare. One of the drawbacks of using excise tax in regulating pollution is that it is difficult for the government to determine what the optimal tax should be.25 It requires knowledge of the marginal private cost of production as well as the marginal social cost. Another disadvantage of the excise system is that the degree of reduction in pollution resulting from any particular tax rate may be less certain compared to other direct methods of control such as regulations. Nonetheless, taxes have an advantage of cost control over regulations but regulations are preferred where certainty control is required.26 However, with time, the process of collection of taxes will provide useful information that would help in reducing this uncertainty and hence, taxes could be adjusted so as to attain the desired level of pollution. Montgomery and Marcuss (1990) explain that excise system is associated with substantial compliance and administrative costs.27 Introduction of pollution taxes will therefore lead to additional taxes and hence, there will be a rise in the cost of administering the tax system. However, in some circumstances, much of these costs have already been incurred as part of the regulatory process related to agricultural chemicals. In addition, there could be problems in measuring these emissions. This would make the tax system less efficient in reducing pollution. Finally, pollution taxes are likely to affect some regions and industries more than others. Hence, different tax burdens would be imposed on households and businesses. In addition, these taxes would increase the prices of some goods whose production relies more on agricultural chemicals and this would make the tax system to be perceived as being more regressive than the other alternative methods of control. EFFECTIVENESS OF EXCISE TAX ON POLLUTANT AGRICULTURAL INPUTS IN OTHER OECD COUNTRIES There are fairly extensive pollution taxes on agricultural inputs in various countries in different countries. The experience of various Organization for Economic Co-operation and Development (OECD) countries that have applied these taxes indicates that they have played a major role in reducing the use of highly toxic agricultural inputs, particularly pesticides and fertilizers. However, according to the OECD, the price elasticity estimates are generally low.28 This implies that a comparatively little impact that is expected in terms of quantity reductions, unless the excise tax is set at a very high rate. In Austria, a tax was introduced on fertilizer use in 1986 and has been implemented since then.29 Initially, the rate was intended to help in control of excess production of crops. But the rate of tax per a kilogram of fertilizer was increased in 1987 and was set at 15% and has been applied since then.30 The main aim of the increment was to assist in control of pollution associated with fertilizer use. As a result, the consumption of artificial fertilizers has subsequently declined. Similarly, in Norway, there has been a general tax of 15% on fertilizers and a differentiated tax on pesticides since 1990.31 The tax rates have played a significant role in reducing the application of fertilizers and highly toxic pesticides as well as in signalling the significance of the issue. Consequently, there is minimal use of toxic inputs and a reduced rate of environmental pollution. There is a higher tax rate on these inputs in Sweden, at 20%. This is in addition to tax levied on toxic components of the inputs. For instance, a maximum of 10% tax is levied on highly toxic nitrogen and phosphate fertilizers per kilogram. Less toxic fertilizers are charged at a lower rate. In Netherland and Denmark, there are regulations on the amount of fertilizers and pesticides that can be applied per hectare in each farm and a very high tax is levied for non-compliance.32 In both countries, the introduction of the tax has caused huge achievements in reduction of pollution resulting from use of fertilizers and pesticides. In short, if well managed, a tax system can help to reduce the impact of agricultural inputs on the environment. CONCLUSION Agricultural chemical inputs affect the environment depending on their chemical composition, how, they are used, where they are used and how often they are used. Devising an excise tax to be applied on agricultural chemical inputs may not be a very easy task, but this can be achieved through introduction of an excise tax which should be differentiated based on the toxic constituents of the product. Thus, the government should come up with a tax rate which would aim to reduce the absolute quantities of use of the highly toxic chemicals and which will encourage substitution with less harmful products. However, the government should be cautious in enhancing tax differentiation. This is because when one product is taxed, leading to an increase in its price, consumers will substitute it with other substances, yet the alternatives might cause even greater damages. Thus, the government should come up with an excise tax system which will group different products based on some expected measure of damage to the environment. In view of this, the tax system should be based on the estimated marginal costs of reduction of highly toxic agricultural chemicals products rather than relying solely on the estimated damage costs. To enhance the effectiveness of the excise tax, it will be vital to ensure that it is backed by regulations on how the tax is applied. REFERENCES Broomhall, S. (2010) ‘Frogs in an affluent society,’ Viewed 10, November 2011 from, http://frogsaustralia.net.au/documents/doc_1_fes_v1.pdf Chang-Gil, K. & Stoecker, A. (2006) ‘Economic effects of environmental taxation on chemical fertilizers in South Korea,’ Journal of Rural Development, vol. 30, No. 2, pp. 1-18. Goulder, L. H. (1998) ‘Environmental policy making in a second-best setting,’ Journal of Applied Economics Vol. 1, No. 2, pp. 279-328. Dower, R. C. (1997) Frontiers of sustainability: Environmentally sound agriculture, forestry, transportation, and power production, Island Press, New York. Lutz, E. & World Bank (1998) Agriculture and the environment: Perspectives on sustainable rural development, World Bank Publications. Organisation for Economic Co-operation and Development (OECD) (1993) Agricultural and environmental policy integration: Recent progress and new directions, OECD Publishing. Organization for Economic Co-operation and Development (OECD) (1999) Environmental taxes: Recent developments in China and OECD countries, OECD Publishing, Paris Organisation for Economic Co-operation and Development (OECD) (2008) Environmental performance of agriculture in OECD countries since 1990, OECD Publishing. Pearce, D. & Koundouri, P. (2003) ‘Fertilizer and Pesticide Taxes for Controlling Non-point Agricultural Pollution,’ Viewed 10, November 2011 from, http://siteresources.worldbank.org/INTWRD/903845-1112344347411/20424145/31203ARDenoteWRMEIPearceKoundouri.pdf Prideaux, B. & Cooper, M. (2009), River Tourism, CABI, Massachusetts. Uri, N D (2006) Agriculture and the Environment, Nova Publishers, New Delhi. Montgomery, W. D. & Marcuss, R. D. (March 7, 1990). “Statement before the Committee on Ways and Means U.S. House of Representatives,” viewed 12 November 2011, from http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CB8QFjAA&url=http%3A%2F%2Fwww.cbo.gov%2Fdoc.cfm%3Findex%3D7964&ei=9pm-Tq2UDoaGhQfB0aieBA&usg=AFQjCNHDkbA4-5q5MyTnngud9FJArRfMzQ&sig2=54QOROCpOsCiLqVmbg_zyw Read More