What needs to be done, according to the OECD?• Over the medium term, additional revenues from carbon taxes and from the auctioning of tradeable permits may increase the role of environmentally related taxation in government budgets.• The adoption of pollution-abatement measures should be encouraged.• Environmentally related taxes can provide significant incentives for innovation as firms and consumers seek new, cleaner solutions in response to the price put on pollution.• These tax incentives also make it commercially attractive to invest in R&D activities to develop technologies and consumer products with a lighter environmental footprint, either by the polluter or by a third-party innovator.Case studiesThe case studies undertaken by the OECD shed light on how environmentally related taxation can induce innovation.They examined the UK’s climate-change levy on fossil fuels and electricity. The UK levy is charged on taxable supplies to industry, commerce, agriculture, public administration and other services. It is imposed on supplies of electricity, natural gas as supplied by a gas utility, petroleum and hydrocarbon gas in a liquid state, coal and lignite, coke, and semi-coke of coal or lignite and petroleum coke. The levy is applied as a specific rate per nominal unit of energy. There is a separate rate for each category of taxable commodity.The OECD found that firms subject to the full rate of the levy had patented more than firms subject to a reduced rate only one-fifth of the full rate.
Innovation ingredients and IsraelThis gives taxation an advantage over more prescriptive environmental policy instruments, which tend to encourage a focus on end-of-pipe innovation (i.e., innovations reducing the emission of pollution but not the creation of it).The wider context plays a significant role in shaping the innovation outcomes of environmentally related taxation: A country’s intellectual-property rights regime, the system of higher education and cultural norms toward innovation all contribute to a country’s innovation capacity.In an Israeli case study, innovations observed by the OECD in the water sector may result from an innovative culture spanning several decades, in addition to the presence of high water prices and taxes.Making pollution costlySome countries have sought to use the tax system for environmental policy in a number of alternate ways, such as through accelerated depreciation allowances and reduced rates of taxation on environmentally friendly goods. These measures attempt to reduce the cost of “good” actions instead of penalizing “bad” actions, and they can act similar to subsidies.As a drawback, however, they also tend to favor capital- intensive approaches over simpler approaches.Moreover, these are not cost-free initiatives; they necessitate that governments find other sources of funds. Moreover, a firm is unlikely to make an investment with any level of tax credit toward a technology that solely reduces carbon emissions if there is no cost at the outset to emit carbon. Where the technology may also save their firm money (that is, reduce carbon emissions because it increases energy efficiency), only then may an R&D tax credit provide an additional boost and help mitigate the environmental problem.Concluding remarks