Taxation as a regulatory tool: Lessons from environmental taxes in Europe

Introduction Governments have always used taxation to regulate their citizens' behavior, from the Babylonian divorce tax of 2350 B.C. (Burg, 2004) to the latest child tax credits. The regulatory tax receiving the most attention from scholars, activists, and policymakers these days is a tax on pollution. Ever since A.C. Pigou argued that some market exchanges produce externalities that are not captured in the exchange itself, pollution has been the classic example of a market externality, and recently a carbon tax has been proposed as an alternative to the more popular cap-and-trade method of controlling pollution. Cap and trade, critics argue, causes excessive price volatility, cannot adjust for swings in the business cycle, and too easily captured by special interests. Taxation, on the other hand, is more flexible and less bureaucratic. Environmental taxes seem to be a benefit for all: They would reduce the negative outcome of bad pollution; they would generate revenue that could be used to reduce other taxes (a “double dividend”), or to offset the regressivity of the tax; and they would contribute to energy independence. Although at the national level American policymakers seem more interested in cap-and-trade, interest in green taxes is intense in many countries, and several American states have adopted them. But do green taxes work? Environmental taxes have been in place in several countries since the early 1990s, but the experience is mixed.