In this self-contained system, tax revenues from over-consumption are redistributed to investment in efficiency.2

The creation of a special account for the new tax provides further credibility and institutional justification (Joel, 2008). In the United States, for example, a motorboat gas excise tax is earmarked for conservation of aquatic resources, while revenues from a motor fuels excise tax flow directly to highway construction and maintenance (Muller, 2008). This latter case exemplifies the pitfalls of these kinds of schemes. While the use of fuel excise taxes for highway construction and maintenance increases public acceptance of fuel taxes, they are used in a non-environmental manner which actually counteracts the desired disincentive to road transport.

Despite the protests of classical economists, the earmarking of energy and environmental taxes is a common practice in many countries, at least partly due to the political benefits. According to the OECD, one-third of all environmental and energy taxes in place in 2006 were to some degree earmarked (OECD, 2006a) (Table 4).

A compromise between economic efficiency and political economy might be partial earmarking. This makes sense when energy and environmental tax revenues have large fiscal impacts. One compromise would set an indicative cap for earmarking at levels sufficient to fund desired activities (5-20%) while minimising undue distortive effects or efficiency losses (Andersen, 2010).

Table 4

Examples of earmarked energy and environmental taxes

Table 4

Examples of earmarked energy and environmental taxes


Energy/environmental taxes

Type of tax Earmarking


Sales tax on engine .. ... . 3 None displacement


Tax on high-consuming Subsidy for or large appliances low-income EE


■._.,.■ Sustainable Tax on oil production r _ , r Energy Fund


Fines for violation of Energy provisions of the Law on Conservation Energy Conservation Fund


National Energy Automobile registration r . r .

3 Savings Fund


Road congestion pricing and vehicle downtown None access


Surcharge on gasoline Energy and diesel consumption Conservation Fund


Duty levied on imported National Energy air conditioners Savings Fund

United Kingdom

Climate change levy Energy supplier on GHG emissions obligations

United States

Gasoline tax State road repairs

Source: IEA, 2010

Source: IEA, 2010

2. See, for example, a recent report on the best practice in fee-bate schemes for transport: www.theicct.org/2010/04/feebate-best-practices/. It should be noted that the French example does not perfectly illustrate the point. This is because the fuel economy level picked as revenue-neutral was set too high, resulting in a net expenditure of public funds on the scheme. A better design would include a mechanism to constantly adjust either the feebate or the rebate, to maintain net public spending (other than administrative) at zero.

Arguments against earmarking

Arguments against earmarked taxes can be grouped into three categories: (i) fiscal and governance issues; (ii) distributional impacts and equity; and (iii) economic efficiency (Slama, 2005).

Fiscal and governance issues

There is greater flexibility for finance if all revenues are pooled together. Contrary to good fiscal practice, earmarking removes appropriation choices from the legislature or the government ministry. Some feel that earmarking undermines financial discipline and introduces budgetary rigidity in face of competing needs (Slama, 2005; OECD, 2006b; OECD, 2010). There is also concern that the availability of extra-budgetary funds outside the central treasury may result in spending decisions that are susceptible to political influence or that lack transparency.

The income stream of earmarked taxes is separated from the main budget during the allocation process; this can assure a stable revenue stream for a particular activity, but can also be subject to capture by special interests.

The success of earmarking depends largely on the processes in place for stakeholder representation and pluralistic democracy within the government itself. Another consideration is the amount of revenue generated: if small relative to overall government budgets and appropriate to spending needs after accounting for the distortive effects of other legacy fiscal policies, then the adverse effects inherent in earmarking should be manageable.

Distributional impacts and equity issues

Metcalf (2006) and others point out that an environmental tax resembles a commodity tax. Commodity taxes in general tend to be regressive in an annual income framework. Carbon taxes, gasoline taxes, air pollution taxes, and taxes on electricity also tend to be regressive, depending on how heavily lower-income groups rely on targeted energy uses. The impact of environmental taxes on the social welfare of different groups is dependent upon tax incidence as well as the method of revenue dispersal. The redistribution of revenues to provide "safety nets" to adversely affected groups may mitigate regressive impacts of an energy or environmental tax.

Economic efficiency and market distortion

The main efficiency arguments against earmarking include loss of consumer and producer surplus3 and increased distortion of labour and other markets. An example of one problem with rebate programmes is the high incidence of free-riding, where people take advantage of a rebate to make an investment they were already planning. The extent of market distortion depends on many factors, including existing distortions and overall fiscal impact of the tax. Uninformed governments or regulators may add to price and market distortion by being ill-placed to choose the energy-efficiency technologies most needing government support.

Comparing system public benefit charges with earmarked environmental taxes

SPBCs resemble earmarked energy and environmental taxes in certain ways and differ in others (Table 5). Although there tends to be less criticism of SPBCs compared to earmarked environmental taxes in the economics literature, SPBCs are arguably a type of hypothecated energy (gas or electricity) tax.

3. Consumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods. In this case since governments might cause distortions to the market through the picking of technology"winners" resulting in unjustified price rises or decreases, consumer welfare might change.

Assuming this, SPBCs should be subject to the same scrutiny regarding distributional impacts and market distortion as environmental taxes. One fundamental difference between SPBCs and earmarked environmental taxes is that SPBC revenues are collected by energy providers from their customers rather than by governments from taxpayers, and thus do not pass through the public finance system. Since SPBCs are levied on one or just a few energy sources, they may create cross-fuel relative price distortions which could in turn produce inefficiencies or allocation effects. A related difference is jurisdiction: setting the charges and overseeing the collection and disbursement of SPBC funds is usually the responsibility of specialised regulators rather than governments. If the regulator is independent and stakeholders are engaged, this may yield better outcomes than specialised government agencies susceptible to vested interests.

SPBC revenues tend to be fully committed to specific programmes and implementing agencies, with the level of the charge corresponding to the desired funding. Quantitative outcome objectives linked to spending may target resources, market transformation, and/or public benefits or social welfare by lowering overall electricity sales, increasing the market share of energy-efficient appliances, or reducing the energy bills of low-income households. Determining funding (and SPBC) levels using a cost-reflective planning scheme should reduce or at least cap market and price distortions.

Another difference between SPBCs and environmental taxes is the scope of activities on which they are levied and spent. SPBCs are levied on delivered energy from gas or electricity networks, whereas environmental taxes can be much broader and can cover any energy-consuming activity and sector. SBPCs tend to be much more rigid in the way that funds are raised and how they are spent, with the revenue generally being channelled to electricity demand-side management programmes or other electricity-saving activities. In contrast, earmarked environmental tax revenues can be recycled back to a wide range of environmental and energy activities. Because SBPCs apparently provide less fiscal flexibility to governments than earmarked environmental taxes do, the arguments against earmarked environmental taxes relating to fiscal and governance issues and economic efficiency apply even more strongly for SPBCs.

In examining the distributional impacts of SPBCs compared to earmarked environmental taxes, it is really only possible to draw situation- or country-specific conclusions. Without knowledge of the energy use of lower-income groups, it is impossible to draw general conclusions on how regressive an SPBC scheme may be compared with earmarked environmental taxes.

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