Wednesday, February 20th, 2013...5:52 pm

What Would China’s Carbon Tax Regime Look Like

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My Twitter stream is bubbling with excitement about China’s introduction of carbon tax: Quartz, Think Progress, etc. all reported on the Xinhua report, but the larger context is missing and the key questions about the implementation are not answered.

 

  • It’s an environmental tax, not a carbon tax

The first thing I want to clarify is that calling it a “carbon tax” would be a gross misnomer, because for a long time to come, the majority of the tax collected from this would still be from what used to be called “pollution discharge fees”, not from taxing carbon emissions. It’s a change in form, but still a significant one, and here is why:

When pollution discharge only triggers a “fee”, local government habitually using this fee reduction or even elimination as an incentive for industries to settle into their jurisdiction and generate GDP. Since the fee is administrative, not legal, industries can easily evade the fee by building a close relationship with the local government, without running into legal issues. A conversion of that “fee” to “tax” would place legal responsibilities on the companies.

The tax on carbon would in fact be puny. The Xinhua report noted that previous MOF expert suggestion for the carbon tax was 10 yuan (US $1.5) per ton of carbon dioxide in 2012, with gradual increase to 50 yuan ($7.9) per ton by 2020.

 

  • The distortion of price signals in China’s fiscal system is the main reason for the low-quality economic growth and structural imbalance

Enough has been said about the imbalance in China’s growth model: at the macro level, it takes form in over-reliance on investment and exports to stimulate economic growth, while domestic consumption is inadequate (only 35% of GDP); at the micro level, it’s long-term reliance on limited added value, low labor cost, over-consumption of energy, resources, and the environment, and a lack of homegrown brands, technology and innovation, etc. etc. The main reason for the low-quality and imbalanced economic growth is the distortion of price signals in China’s fiscal system. For instance, the low interest rate lead to over-investment and excessive capacity.  The artificially low resource and environmental cost lead to the overuse and severe environmental degradation.

China now burns as much coal as the entire rest of the world combined, a whopping 3.8 billion tons in 2011, but what most reports miss is that the tax on coal in China is merely 2-3 yuan (US $0.4) per ton, and 8 yuan (US $1.27) per ton for charred coal, even though the price of coal has increased to several hundreds of yuan per ton.

The point of a carbon tax, be in China or elsewhere, is to set the price signal straight. We tax income; we tax property; we tax goods and services — all the things we want more of, so wouldn’t it be logic to actually tax the thing we want less of: pollution?

My environmental law professor Jody Freeman, who served as Counselor for Energy and Climate Change in the Obama White House before coming back to Harvard, told us that she used to say two words to almost everyone she met at the White House – “carbon tax”, and they would look at her as if she was crazy. This needs to be changed. If the giant climate rally in DC this past Sunday is any indication, that is we need a sensible policy to address the reality and challenges of climate change now. And in the case of China, I think starting with adjusting the distorted price signals, while giving due consideration to the widening income gaps and social injustices, is essential.

 

  • Implementation: A tax regime reform that incorporates environmental tax

As previously stated, this environmental tax is mainly converted from pollution discharge fees. Previously, pollution discharge was inspected by and the fee was charged by environmental protection bureaus. The environmental tax, however, is collected by the tax bureau according to the amount of pollution discharged by factories, and that amount is corroborated by the environmental protection bureau. That is to say, the environmental protection bureau becomes an agency that collects statistics for tax purposes.

In 2012, Hubei Province started collecting environmental tax within 100-kilometer periphery of the capital city Huhan, after a test run at Huangshi city. 10% of Hubei’s environmental tax goes to the central government, 15% to the provincial government and 75% goes to the municipal and county government, with the exception of thermal power stations with above 300MW capacity – 10% of their environmental tax goes to the central government and 90% to the provincial government.

The revenue from Hubei’s environmental tax goes to a special “environmental protection fund” that invests in de-sulfur and de-nitrate efforts, supports environmental projects, the prevention of local pollution, and the development of environmental technologies. Hubei government also stated that projects in these field are eligible for loan interest subsidies.

On a national level, the tax regime envisioned by the Ministry of Finance would be that the provincial government’s revenue mainly comprised of turnover tax (which includes environmental tax) and income tax, municipal and county government’s revenue mainly comprised of property tax, and subsidized by action tax (such as tax on large scale entertainment) and special purpose taxes. Since the mid-1990s, the central government strengthened vertical control, and adopted “tiaotiao” management in a number of systems including the tax system. This means that local tax bureaus are directly managed and supervised by the tax institutions of a higher level. Though they have working relations with the government at the same level, they are not managed by the local government. Jia Chen, senior official at Ministry of Finance, noted that under the tax reform, provincial government would be given proper tax management authority, despite the centralized tax system, in order to nurture local tax sources.

I should note that the proportion of environmental tax in the overall revenue of any level of government would be tiny, as is the pollution discharge fee portion of the revenue mix now. Local governments would continue to come up ways to give industries tax rebates and subsidies to attract them to their own jurisdictions, so the effect of the environmental tax or the carbon tax on the industries would be negligible. Standardizing fees into a tax is a step in the right direction. China can use a price on carbon, and environmental issues in general, as a starting point to address the price distortions that are stifling its long-term growth.

 

 

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