Environmental taxes mean healthier China
David DollarChina Daily  Updated: 2005-10-15 06:57

During its 25 years of reform, China has made impressive progress in the transition to a market economy. Much of the production and distribution in China is managed through the market, and the efficiency of this mechanism is evident in the country's sustained rapid growth.

While the market is good at many things, however, it is not good at everything.

One place in particular where the market breaks down concerns the use of natural resources and the environment, particularly where some important resource is freely available. While China's record of production and gross domestic product (GDP) growth is fantastic, its record of environmental protection is not so good.

Air and road space are good examples of free resources that the market will tend to over-exploit unless the government takes some corrective measures. A number of different approaches to protecting precious resources can be taken, but one of the most effective ones is the use of environmental taxes and prices for natural resources.

The prices of coal and oil in China are, to some extent, market prices in that they reflect the cost of extracting or acquiring these resources. However, coal and oil are different from many other goods in that the burning of fossil fuels has negative consequences on the environment. While the prices of oil and coal in China cover the cost of acquiring them, they do not take into account this environmental damage.

The heavy air pollution in China has serious health consequences and economic costs. The World Bank estimates that air and water pollution together cost China each year about 8-12 per cent of the GDP.

Because the users of energy do not pay these costs themselves, they tend to overuse energy resources.

This is exactly the reason why many countries have imposed energy taxes. China has a tax on petroleum products, but it is very low compared with the United State or Europe.

Taxes on oil and gas are very effective at getting households and firms to use less energy. In China, heating the typical apartment takes twice as much energy as the same apartment in Japan or Europe.

Regarding traffic congestion, putting a higher environmental tax on energy, as discussed above, would help with congestion - especially if some of the money collected is used to finance public transportation, including metros and dedicated bus lanes.

But traffic congestion is not likely to be solved only through higher energy prices. Roads in the city are a scarce resource, and yet it is freely available to everyone.

London recently took an innovative approach to congestion: It introduced a steep fee for any private car that drives into the inner city on a work day. This basically takes a scarce resource - road surface in the inner city - and puts a price on it for users. The result was immediate: Private car use in the inner city dropped sharply; people made more use of buses, metro, taxis, walking, and riding bikes - and consequently, there was much less congestion and a nicer environment for everyone.

Pricing is also effective in tackling the water issue.

China does not have a lot of water available per person. Moreover, the water is not distributed evenly.

Water prices have some similarity to energy prices in China. They are "market prices" in the sense that they cover the cost of getting water from rivers and reservoirs to farms, households, and firms, but the prices generally treat the original water as a free product. As a result, the price of water in China tends to be very low compared to other countries.

Because water is inexpensive, there is not much incentive to recycle it. So, 70 per cent of industrially used water is discharged untreated back into rivers. As a result, all the major river systems in China are seriously polluted.

One measure that would help is to price water more realistically at the source - the river or reservoir - recognizing that it is a scarce resource. This would result in users making more effort to conserve water and to recycle it.

Charging higher taxes and prices for environmental goods that are being over-exploited is an obvious idea that would make China's development more resource-efficient. It is natural then to ask who opposes this idea and who loses from it?

China as a whole should only gain because higher environmental taxes can be offset by lower taxes elsewhere. Unlike a decade ago, China's overall government revenues are now adequate, and there is no urgent need to raise more taxes. So higher environmental taxes could mean lower taxes on, for instance, labour, which would help reduce unemployment.

Poorer regions in China may well gain from higher resource taxation.

In China, the revenues of resource taxes go to the province, and many of the poorer provinces are rich in natural resources. Higher resource taxes would mean that these provinces could generate more revenues, which they could spend on putting more children in school and building better infrastructure.

All of the current owners of cars would be hurt by a tax on petrol that leads to higher prices. But they would also get some benefit if revenue from the taxes is used to improve public transportation and reduce traffic congestion.

In the case of urban water prices, a common concern is that higher prices will hurt the poor. But most of the subsidy from low water prices does not go to the poor. The best way to help the poor is through direct income support so that the poor can buy all of their basic needs.

A final point about opposition to environmental taxes and prices: It is often more popular to introduce price increases gradually.

This can be good policy, but it is smart to announce changes well in advance, even if they are implemented gradually. If the government announces that petrol prices will go up 10 per cent per year for the next five years, people and firms will start planning ahead and buying homes, appliances, machinery, and cars that use less energy.

This is exactly what the government wants.

The author is the World Bank's country director for China.

(China Daily 10/15/2005 page4)

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