Daily Tax Report: International

INSIGHT: Taxing the Environmental Footprint

July 29, 2020, 7:01 AM

If there is anything that the world should have learned from what happened in the last few months it is that certain matters should not, and perhaps cannot, be handled on a country-by-country basis. Environmental matters are a decisive factor in shaping the future and the life on this planet so there should be no doubt that they belong in this group.

The importance of the issue and the urgency that comes with it require all options to be put on the table in the attempt to find a solution. Just as every individual and every business has a role to play, the role that tax systems can play in bringing about change should not be overlooked.

Prior Insights in this series have put together a summary of the main measures introduced in the recent past by a number of countries. The myriad measures introduced by different countries have created a jungle of incentives and punitive charges that is difficult to navigate and the actual impact of which is difficult to assess, especially if looked at on a global basis.

The idea of this Insight is to imagine a way for tax to help, assuming there was the will and the freedom (there should be no doubt that there is the need) to reimagine and simplify tax systems, making the impact on the environment an organic part of the way taxes are calculated.

So far, the two main types of taxes that countries have had at their disposal are value-added/consumption taxes and income taxes. Both types of taxes have been struggling to keep pace with a fast-changing economy and evolving business models. The seemingly endless discussion about the taxation of the digital economy is just an example of the fact that perhaps tax systems that have been developed for an economy that was completely different to today’s are showing signs of distress.

Re-Engineering the Tax System

So why not make an effort to re-engineer tax systems, “thinking out of the box” and question, as an example, if companies (and perhaps individuals) should continue to be predominantly taxed on the amount of income that they generate?

Among many reasons to support this idea, there is the fact that across populations there seems to be an increasing demand to understand the correlation between taxes paid and the reason they are paid, as well as what use governments make of the money that they collect. The latter issue, in particular, should not be underestimated, because one of the main pushes to spontaneous compliance is the understanding of such relationship.

A clear link between taxes and why they are paid helps understanding and acceptance of the tax, and creates more collective participation in pursuing a goal.

Assessing the Environmental Footprint

The “clean up” of the environment, or the treatment of the diseases that come with such massive change to the environment (of which climate change is only one example), are items that will be growing exponentially in the budget of any country; the point could therefore be made that these should become part of the drivers in deciding how much each taxpayer should contribute to the related costs.

In other words, if two taxpayers make exactly the same amount of income before taxes but one of the two has very little impact on the environment and the other one has a huge (negative) impact on the environment, the expense that the government will incur with respect to the impact on the environment of the latter is much greater. Is it fair that the two taxpayers end up paying the same amount of taxes?

If the answer to this question is no, an assessment of the “environmental footprint” of taxpayers and the formulation of a tax system that, in calculating how much money each should contribute to the overall budget of the country, takes into account the “environmental cost” associated with their activities, could be the answer (at least partially) to the amount of taxes paid to the “cost” that derives from business activities.

The assessment of the environmental footprint could be based on the type of products manufactured or services rendered as well as the way the products are manufactured, and the services are rendered.

In fact, it should not be just a matter of what product or service the taxpayer manufactures or renders and the specific impact of such product or service on the environment, but also what kind of decisions the company takes when it comes to how to carry out its activities. Considerations such as whether a business uses electric vehicles over petrol-powered ones, recyclable packaging instead of plastic, or whether it allows employees to work from home, are just a few examples of what this assessment could be based on.

The type of products manufactured or services rendered would likely relate better to the field of indirect taxation, whilst the way products are manufactured and services rendered, being more related to decisions taken by the taxpayer about how to manufacture or deliver the services, would probably apply to direct taxation.

Reformulating the fundamentals of corporate income taxes to transform them into “corporate income and environmental impact taxes” would mean that they could play an amplified role in this process. There are many different ways of doing this, but, purely for an example, let’s think of a traffic-light assessment of businesses as one of the possible solutions. Taxpayers would be awarded a red, yellow or green status with respect to their impact on the environment, and their tax would accordingly be determined through a system of different rates, so that companies which do less harm to the environment (and have a lower social impact and, therefore, use less public money) would be rewarded by paying lower tax.

Role of Taxes in Encouraging Greener Behavior

How to do so in a transparent and reliable way? Companies currently spend a significant amount of money to have external parties verify their financial credentials, the quality of their internal processes, and other matters. Their green credentials should be just as important and measurable. Needless to say, to avoid confusion and opportunistic behavior, it would be necessary to develop generally accepted criteria to assess the environmental footprint of taxpayers and to identify the parties who should perform the valuation.

Indirect taxation could also play a major role. The need to replace highly polluting plastic products with more eco-friendly products is widely recognized. However, what often happens is that the more eco-friendly a product is, the more expensive it is to produce, especially in the short term due to the necessary initial investment in research and development (R&D). Inevitably the cost is passed on to the consumer and these products are therefore less affordable.

If, on one hand, the revised corporate income taxes could partially help, on the other hand, indirect taxes, having an immediate impact on consumers, could also play a major role. A differentiation could be introduced that would see high polluting and low polluting products become subject to different rates.

The most common indirect tax is value-added tax (VAT), but because of the way VAT generally works the impact of different rates would likely be diluted down the chain and, consequently, the desired outcome of making low impact products more competitive would be diluted as well. Excise taxes could arguably be much more effective for this purpose.

In addition, if we consider that many eco-friendly products are designed and manufactured by start-ups, the need to “help” them is even stronger, given the fact that start-ups already face the challenge of finding investment and entering new markets. Allowing them a more favorable tax profile (in the form of reduced income tax rates and/or lower excise taxes on the low polluting products) could therefore be an effective way not only to encourage companies to invest more in R&D in order to make more of these products, but also to lower the cost of the products for consumers (making them more competitive).

The results could be twofold: initiating a race between companies to invent and manufacture new environmentally friendly products and services as well as new manufacturing techniques, and a cost reduction for consumers who are charged a lower price on such items.

In this imaginative exercise what we have attempted to sketch is an idealistic tax system where income taxes are a function of a combination between income and environmental footprint, and products are subject to indirect taxes based on how eco-friendly they are. To bring a healthy touch of realism into this discussion, it must be said that any serious discussion on this theme could only be started if there was unanimous consent on it.

The recent discussions on the taxation of the digital economy have taught us how difficult it is to reach consensus when dealing with tax questions; however, in a different context, what is at stake here is not the redistribution of taxing rights among different countries but the survival of our planet. Is this serious enough to consider it?

Stefano Giuliano is a Partner with CMS Italy.

The author may be contacted at: stefano.giuliano@cms-aacs.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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