Thursday, March 7, 2013

On China's New Carbon Tax Plan

Last month, Xinhua news service announced (here) that China would introduce a new carbon tax, along with new taxes on conventional polllutants, which has received generally favorable commentary (albeit with questions) from the Common Resources blog of the well-respected think tank Resources for the Future (here) and in the Washington Post (here). A more skeptical voice comes from (here), which doubts that any such tax would have enough of an effect on China's carbon emissions to make a difference for climate change.

In my view, all of the commentary so far misses the main problem with a carbon tax (or any environmental tax) in what is still largely a command economy in China: taxes are market-based instruments that require well-established market institutions to function at all, let alone achieve specified environmental goals. Most especially, for taxes to be effective the enterprises that are subject to them must operate under hard budget constraints, which means that they must have a competitive market-based incentive to minimize costs of production, including internalized pollution costs. Typically, firms operating in command economies operate under soft budget constraints, where production levels rather than profitability are the most important (often the only) measures for firm survival. Key work on this issue (though not focused on environmental problems) was done by the Hungarian economist Janos Kornai. His famous 1986 article on "The Soft Budget Constraint" (here) and his monumental book 1992 book on The Socialist System (Princeton) are must reading.

My own 1998 book, Instituting Environmental Protection: From Red to Green in Poland, is about the failure of environmental protection under socialism in Poland, which during the 1970s created the world's largest system of environmental taxes. Those taxes proved uniformly ineffective in reducing pollution emissions because of a combination of soft-budget constraints and the same kind of regulatory conflicts of interests that persist in China today. In 1970s Poland and in China today, government officials, who are trying to maximize their career prospects, which depend ultimately on meeting production targets, will not allow production to be hampered by pesky environmental taxes. In communist Poland, central planners obsessed with meeting production and economic growth targets simply offset assessed environmental taxes with increased budget allocations for affected firms. Is there any reason to expect different outcomes in China today? If so, someone will have to explain the organizational and/or institutional differences that should lead to a different outcome.

I've just begun a research project on environmental taxation in China with a Chinese PhD student in public finance. Hopefully, our work will illuminate current organizational and institutional impediments to successful environmental taxation (including carbon taxes) in China, and what steps might be taken to minimize those impediments.

In the meantime, the Chinese government already has announced that is backing away from the announced plan to introduce a carbon tax this year.

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