Market Based Instruments for Climate Protection- A Case Study on Europe

List of tables
List of figures
List of abbreviations

Objectives of the study

Global Emissions Scenario

Review of literature:
Brief sketch of the past studies conducted on Market Based Instruments (MBI)
Pollution Tax
Tradable Permits
Market Barrier Reductions
Govt Subsidies & Incentives
A Framework for government intervention

Theoretical orientation:
Conceptual framework of the study
Operationalization of concepts

Case study on Europe

SWOT Analysis of the Market based Instruments




I am thankful to my mentor, Dr. Subir Bhattacharya, to provide me the opportunity to work on this research thesis, “Market Based Instruments for Climate Protection- A Case Study on Europe” for his tireless support and assistance. My deepest gratitude to him, for guiding and correcting my paper with attention and care, as he went more than the extra mile to guide and support me through this work.

I am also grateful to my family for their unending support & encouragement.

List Of Tables
Table-1: 2008 Emissions Data for selected countries
Table-2: Energy-related Cumulative CO2 Emissions
Table-3: The Use of Subsidies in Environmental Management
Table-4: Alternative Fuel & Vehicle Subsidies in the Ozone Transport Region
Table-5: Environmental taxes in selected European countries
Table-6: Tax rates in some selected East European countries
Table-7: Comparison of minimum tax rates of EC directive 2003 & 1997 proposals
Table-8: Emissions allocations in 2005-07

List Of Figures
Fig.-1: CO2 Emissions Distribution in India
Fig.-2: Framework for government intervention for environmental protection
Fig.-3: Efficient solution to environmental problems
Fig.-4: CO2 Market- price volatility

List of Abbreviations
ADF – Advance Disposal Fees
AFV – Alternative Fuel Vehicle
ALARA – As Low As Reasonably Achievable
BAT – Best Available Technique
BMW – Biodegradable Municipal Waste
BOD – Biological Oxygen Demand
CAC – Command And Control
CARB – California Air Resources Board
CDM – Clean Development Mechanism
CFC – Chlorofluorocarbon
CNG – Compressed Natural Gas
COP – Conference Of Parties
DEFRA – Department for Environment, Food and Rural Affairs
EC – European Commissions
ECE – European Climate Exchange
EPA – Environmental Protection Agency
EU-ETS – European Union’s Emissions Trading System
GBP – Great Britain Pound
GDP – Gross Domestic Product
GHG – Green House Gases
IEA – International Energy Agency
IPPC – Integrated pollution Prevention and Control
IPCC – Intergovernmental Panel on Climatic Change
LATS – Landfill Allowance Trading Scheme
LDC – Least Developed Countries
LULUCF – Land Use Land Use Change & Forestry
MBI – Market Based Instruments
NAP – National Allocations Plan
NEC – National Emissions Ceiling
OECD – Organization of Economic Cooperation & Development
PRN – Packaging Recovery Note
PSR – Performance Standard Rate
R&D – Research and Development
RVP – Ried Vapour Pressure
SEPA – Scottish Environmental Protection Agency
SWOT – Strength Weakness Opportunities Threats
TAC – Total Allowable Catch
TREC – Tradable Renewable Energy Certificate
TSS – Total Suspended Solids
UNFCCC – United Nations Framework Convention Climate Change
VOC – Volatile Organic Compounds
WMO – World Meteorological Organization

1.0 Introduction

The economy and the environment: two parts of a whole. Rapid urbanization and increased industrialization have led to high levels of air, water and land pollution, depletion of non renewable resources and degradation of renewable resources across the globe. In this process, use of power played a vital role. As a consequence, environment got adversely affected. From the point of view of environment, power generation is the major source of pollution. As per the forecast of the International Energy Agency (IEA), without control, total CO2 emissions of the world will increase from 26.11Giga tonnes in 2004to 40.4 Giga tonnes in 2030 of which Power sectors contribution will be 17.7 Giga tonnes. The result of global temp rise to 5deg centigrade will lead to destruction of food, water, eco-system, etc coupled with extreme weather events like Tsunami. Hence, Global communities are taking desperate attempts to device policies for saving the world.

Since pollution control has always been a matter of utmost concern, national governments have intervened in a number of ways to control pollution. Experiences in environmental policy making during the last three decades in both developed and developing countries reveal that every country must choose an enabling legal and administrative system and a mechanism for enforcement of environmental policies. The available policy options range from Command and Control (CAC) which depends on emission standards, as direct instrument and technology standards, as indirect instruments to Market-based Instruments (MBIs) which depends on taxes, marketable permits, as direct instruments and barrier reduction and subsidies, as indirect instruments . The actual mix of policy instruments chosen varies from country to country depending on its goals, stage of development, institutional capabilities and political preferences. However, there appears to be a gradual tilt in favour of MBIs in many countries. The reasons are (i). Command and Control (CAC) system can be extremely costly if poorly designed and administered, (ii) MBIs offer more cost effective ways to achieve environmental objectives, (iii) Enormous Information required for the design and enforcement of Command and Control (CAC) instruments, (iii). Demise of central planning etc. There has been substantial evidence that Command and Control system could not yield the desired results Hufschmidt et al(1983) , Tietenberg(1985).

It is the legacy of Nobel Laureate Ronald Coase (1991) who pointed out that if the assumption of zero transaction cost is maintained, the set of markets can be expanded beyond private goods to include non-market assets. The disputed parties will work out an agreement that is Pareto efficient regardless of the party to whom unilateral property rights are assigned initially. As long as these legal entitlements can be freely exchanged, government intervention is relegated to designate and enforce well-defined property rights. Coase had carried out some complicated research works on this crucial issue and some fundamental problems associated with it like measurement of monetary damages associated with emissions, fate-and-transport system that move emissions through alternative media etc.

Crocker (1966) and Dales (1968) introduced the idea of tradable pollution permits as an alternative to Pigouvian tax for the management of environmental quality. MBIs aim to control pollution by way of crating markets for pollutants where pollutants like SO2 are traded. The system can achieve similar cost-minimizing allocation of control burden as the charge system. Under this system, a “cap” or an allowable level of pollution is allotted to the firms in the form of permits. A comprehensive work on the subject is available in Bhattacharya et. al. (2007). Firms which keep pollution level below their allotted level can sell the surplus permits to others or other facilities. Pollution trading framework was developed in several ways in many countries.

Then came the relatively new MBIs like market barrier reduction and incentives like subsidy.

However, application of MBIs is still very limited in the world. Among the developed nations, these are extensively applied in Europe. Europe is much ahead compared to other regions. The developing world is almost yet to start. Among the developing world China is ahead.

Objectives of the study
On this back drop, the objectives of the study are stated as follows:
1. A policy framework for government interventions
2. A case study on Europe
3. SWOT analysis of MBIs

Market-based instruments for environmental management are relatively new mechanisms in the international policy context. Their application is still in the embryonic phase. Around the world a variety of MBIs are being tested and applied to different environmental problems. In some instances, putting the theory into practice involves some hurdles and practical difficulties. Consequently, there is debate as to whether the benefits of market-based instruments justify the costs involved in their establishment. There are a range of potential obstacles including: aligning instruments and policy options; concurrent or prior removal of perverse incentives; addressing diffuse, or non-point, source problems; and, ensuring instruments are performance based rather than overly prescriptive.

Recognition and beginnings of a concerted global response to the deterioration of the environment and its implications can be traced to the United Nations Conference on Human Development held in Stockholm in 1972.

Concern on climate change increased through the 1980s, and an Intergovernmental Panel on Climate Change (IPCC) was established by the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP) as a scientific intergovernmental body to provide an assessment of the latest scientific research and its policy implications for mitigation and adaptation.

The 1990s witnessed the growing consolidation of the global response at the international level. At the Rio Summit in 1992, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted.

The first Conference of Parties (COP) to the Convention (UNFCCC), which was held in April 1995, adopted the Berlin Mandate which led to the formulation of Kyoto Protocol in 1997. As per the Kyoto Protocol, industrialised countries (US has not ratified the Kyoto Protocol) have to undertake quantified emission reductions over specified commitment periods. As per the principle of ‘common but differentiated responsibilities and respective capabilities’ of the UNFCCC, industrialised countries listed in “Annex I” of the Protocol have binding commitments to reduce their emissions.

Annex I Parties committed themselves to reducing their overall emissions of six greenhouse gases by at least 5.2 percent below 1990 levels in the period between 2008 and 2012, with specific targets varying from country to country. The Protocol also provided the basis for three mechanisms to assist Annex I Parties in meeting their national targets cost-effectively – an emissions trading system, Joint Implementation (JI) of emissions-reduction projects between Annex I Parties, and a Clean Development Mechanism (CDM) to encourage joint projects between Annex I and Non-Annex I (developing country) Parties.

The Copenhagen conference did lead to the emergence of the “Copenhagen Accord” on climate change, negotiated by a group of countries. The Accord, which could not achieve consensus, was noted by the COP, and later supported by several countries under specific conditions. The Accord reflects a broad political consensus on some of the issues that are relevant to negotiations:
There is an agreement on the broad scientific view that the world must not exceed a 2 degrees Celsius increase in warming on the basis of equity, and in the context of sustainable development.

The developed countries account for two-third of energy consumption and a similar level of CO2 emissions. The energy consumption of developing countries is estimated to rise by 4 to 5 percent over the next 20 years, and emissions would also increase to sustain such a growth in energy consumption. China has seen rapid growth over the last 15 years, and its CO2 emissions have also grown significantly.

CO2 emissions for India are also growing due to accelerated pace of growth and energy consumption. However, the per capita energy consumption and emission in India are still in the mid range for the least developed countries (LDCs). Table-1 depicts population, GDP, CO2 emissions and per-capita emissions of selected countries.

Table-1 : 2008 Emissions data for selected countries

Region/Country Population
(million) GDP
(Billion 2000 US$) CO2 Emissions
MT CO2 Per capita CO2 emissions
World 6609 39493 28962 4.38
China 1327 2623 6071 4.58
Brazil 192 808.95 347 1.80
India 1123 771 1146 1.18
Japan 128 5205 1236 9.68
South Africa 48 178 346 7.27
Thailand 64 173 226 3.54
Turkey 74 372 265 3.59
UK 61 1766 523 8.60
USA 302 11468 5769 19.10
France 64 1506 369 5.81
Germany 82 2065 798 9.71
Russia 141.79 429.55 1593.83 11.24

From the table, it is evident that per-capita emissions in the developed countries are much higher than the developing nations.

Table-2 presents energy related cumulative CO2 emissions. It is observed that emissions by the Annex-I countries increased from 59.3% in 11850-2006 was 74.4%.

Table-2 Energy-related Cumulative CO2 Emissions

Country MT CO2 Percent
1850-2006 1850-2006
World 1150702 100
India 27433 2.4
China 99204 8.6
Brazil 9457 0.8
USA 333747 29.0
Europe 15 252148 21.9
Annex I 856115 74.4
Non-Annex I 281497 24.5
Source: WAI, CAIT Database Accessed on May 4, 2010.)

Fig-1 depicts CO2 emissions distribution in India. It is observed that electricity sector emits about 51% followed by other energy sectors

Fig-1 : CO2 Emissions Distribution in India

In 2007, the total amount of CO2 emitted without Land Use Land Use change and Forestry (LULUCF) was 1398.70 million tons, which accounted for 73.4 percent of the total CO2 emissions. The electricity sector accounted for 51 percent of the total CO2 emissions emitting 715.38 million tons of CO2. About 10 percent of the CO2 emission was from the transport sector (138.86 million tons of CO2). Another 10 percent was from other energy industries (138.15 million tons of CO2). Amongst the other energy industries, 80 percent of the CO2 emissions (or 104.36 million tons of CO2) were from residential, commercial/ institutional, and agriculture/fisheries sectors, indicating the use of fossil fuel for space lighting, cooling, heating, pumping and for engines to run trawlers etc. All the manufacturing industries together accounted for 29 percent of the total CO2emissions (405.86 million tons). Of this 58 percent of the CO2 emissions were together from iron and steel industry and the cement industries (246.88 million tons of CO2).

A review of existing literature is very much important for carrying out any scientific research. It provides the basis for building the foundations as an insight into the system. This chapter is directed to that end and provides a brief sketch of the past studies carried out on marker based instruments world wide other than Europe. Studiers carried out on Europe is dealt in the case study.

3.1 Pollution Tax
The primary experiments with direct pollution taxes in Latin America are water charges. Policies in Brazil, Chile, Colombia, and Mexico, for example, set water charges to reflect use and effluent discharges. Local authorities, though many times constitutionally empowered to assess pollution based water charges, find that institutional constrains and polluter opposition prevent them from properly monitoring pollution and assessing the charges. Colombia managed to implement a moderate exception to this failure. In 1993 it implemented fees related to biological oxygen demand (BOD) and total suspended solids (TSS) levels in water while maintaining a pre-existing minimum effluent standard. A small charge per kilogram of water is assessed that translates to a 5 to 10% increase in a household’s monthly water bill. These charges are reportedly still too low to cover treatment costs for public utilities and collection of fees is sill one third of the total amount charged, but both BOD and TSS have seen moderate declines since the implementation of the program (Ardila S. and Z. Guzman, 2002).

In 1980, Argentina attempted to introduce an industrial effluent discharge fee. The tariff included a fee for discharges within the maximum allowable level and a much higher penalty for discharges above the maximum allowable threshold. The aim was to eventually set the fees at a level equivalent to abatement costs. Environmental groups sued the government on the grounds that the fee system amounted to a license to pollute beyond legal limits. The court declared the decree introducing the fees to be unconstitutional, and the issue remains unresolved in legal terms to this day. It appears that the court regarded the fee as exceeding the powers of the national government to levy taxes because it concluded that the fees could not be justified as a payment for service. (Amsberg, 1995)

The example of emission fees in China, enterprises are allowed to count most fee payments as production costs, therefore fees lower enterprises' tax liabilities in this system (a very important consideration given that tax rates on profits are on the order of 33%). Moreover, 80 % of fee revenue are returned to enterprises and in many cases ends up being used for non-environmental purposes, because local environmental authorities simply do not have the resources or political will to closely enforce that these funds are invested in pollution control, as it is ostensibly alleged. Aware of these problems, in 1988 the state mandated that funds be returned to enterprises in the form of loans rather than grants. However, this rule has not been enforced, as environmental authorities are able to subvert it by exempting enterprises from repaying loans or by simply not enforcing repayment (.Blackman and Harrington, 1999)

Some conventional taxes designed to generate revenue act as indirect taxes on emissions. For example, Mexico taxes older cars but does not set the tax to reflect pollution differences across car vintages. Generally, however, the Latin American public strongly opposes taxes on polluting goods on the grounds that such taxes are regressive and may stunt local economic development.

Tax reform in South Africa has been underpinned by two Commissions of Inquiry into the Tax Structure of the Republic of South Africa; the Margo Commission (1984 to1986) and the Katz Commission (1994 to 1999). These investigations went to considerable efforts to underscore the generally accepted principles of taxation underlying their analyses in accordance with international best practice.

3.2 Emission Tradings
Costa Rica has had a system of tradable offsets since 1995. It has arranged the sale of recognized offsets to both U.S. and Norwegian firms and in return has transferred pastureland into managed forest. Belize, Bolivia, Honduras, Nicaragua and Panama are all developing similar programs (World Bank). Permit system to deal with air emissions are also under consideration in both Peru and Mexico.
The only country in Latin America that has its own tradable permit system in place is. The permit system is for a daily allowable emissions capacity of particulate matter and is coupled with a command and control emissions standard. Since monitoring of plant level emissions does not occur in Chile, these permits are based on current capacity of a plant and the type of fuel used rather than on emissions. These permits are also issued in perpetuity, so that new sources must purchase permits from existing plants already in the system . Since trading started in 1995, most of it has been within firms and not between them . A number of problems with Chile’s tradable permit system stem from institutional deficiencies and poor market design and development. Initial allocations of permits were not well defined and property rights were not well established. Legal uncertainties exist regarding enforcement. High transaction costs and lengthy approval processes for trades and fear on the part of plants that it they sell permits they will not be able to purchase them back when conditions changes have severely limited the number of trades that actually take place. In spite of these problems, introduction of the permit system has resulted in improved compliance with the emissions standard and better air quality for Santiago.

3.3 Market Barrier Reductions
Liability mechanisms to environmental management are simple instruments, which require only that legislation be in place that confers relatively straightforward rights and obligations to resource users (these approaches form a legal umbrella for court cases, which then consider the nature and extent of environmental damages on a case-by-case basis). However, as these approaches are relatively new, they have seen very limited application in the world because legal systems are themselves weak in such countries. A way to overcome such a lack of legal capacity was implemented by Trinidad-and-Tobago, where voluntary liability mechanisms are strongly promoted. Such voluntary systems are informal ones and do not suffer the same problems as their formal counterpart. They can take advantage of social (peer group) pressures are likely to see broader success rates in a small-island context than they would in a larger country.

Voluntary mechanisms are of crucial interest in Trinidad-and-Tobago, as efficient enforcement and regulation in the country are impeded by the fact that the court system is heavily backlogged and constrained by inadequate financial resources. An example of a successful voluntary liability mechanism is provided by the oil sector: in 1990, PetroTrin established a voluntary policy of full compensation for environmental damages. The move was prompted by a number of uncontained well blowouts through the 1980s that damaged local homes, flooded farmers’ fields with oil, and caused a significant public outcry in response to health damages when the company gave no assistance in relocating people to avoid the potentially lethal effects of the spills. After the voluntary policy was implemented, two notable trends happened: (a) blowout prevention devices on wells improved, making spills and leakage less frequent, and (b) when a spill did occur, it was easier to contain the impacts and any damages were readily compensated. An incident in the early 1990s, for example, required rapid evacuation of about 1,000 residents from a village when a blowout occurred; affected people were compensated for dam-aged land and inconvenience, and farms were restored at company expense.

3.4 Govt Subsidies & Incentives
Environmental subsidises in Latin America are more common and often take the form of subsidized credit and tax relief. Brazil redistributes revenue back to states from the state value-added tax in partial accordance with the land use restrictions and conservation provisions in each state. Subsidies to abatement technology have had limited success in inducing proper behaviour due to low enforcement of existing emission standards, and lack of monitoring to ensure proper investment of funds (Huber, R., J. and Seroa, d Motta. 1998).

In USA, various types of subsidies have been used besides federal programmes. Table-1 presents the Use of subsidies in Environmental Management in USA.

Table-1. The Use of Subsidies in Environmental Management
Brownfields development grants EPA, states Communities, property owners
Cost sharing for land conservation Federal government Property owners
Cost sharing for land conservation Federal, state, and local governments (Land transfer taxes) Property owners
Environmental violation reporting rewards States of New Jersey, California Individuals and organizations
Waste management and recycling grants Federal, state, and local governments (advance disposal fees (ADFs), waste
taxes) Public and private organizations
Unit-based waste collection or reuse payments State governments (ADFs, waste taxes) Businesses
Unit-based payments for the use of alternative fuel vehicles (AFVs) Federal government Public bus systems and small
Municipal sewage treatment plant
construction grants (replaced by loans) Federal and state government Communities
Pollution control loans State governments Small businesses
Brownfields development loans State governments (waste taxes) Property owners
Recycling business loans State governments (ADFs, waste taxes) Businesses
Renewable electricity generation credits Federal governments Businesses
Electric vehicle credits Federal governments Businesses or organizations
Interest exemption of pollution control
investment debt Federal governments Businesses or organizations
Public procurement of recycled products Federal, state, and local governments Recycled products
Public procurement of alternative fuel
Vehicles Federal, state, and local governments Alternative fuel vehicle
Recycled content requirements Private organizations Recycled products
Mandates for the use of alternative fuel
Vehicles Private organizations Alternative fuel vehicle

Provision for tax incentives and loans were introduced. New Jersey offers both tax benefits and loans to encourage brown-field development. Twenty-eight states have offered tax incentives for businesses that recycle used products.

The federal government also subsidizes the purchase of alternative fuel mass transit buses and school buses, state AFV planning, and the purchase of alternative fuel vehicles by small businesses. A number of cities use AFVs in their mass transit systems. Alternative Fuel and Vehicle Subsidies in the Ozone Transport Region were as given below :

(excluding federal mandates) 1995
(in millions of dollars) 2000
(in millions of dollars) 2005
(in millions of dollars)
AFV procurement requirements $0 $153.3-930.5 $719.0-5,875.5
State and local tax incentives 4.3-4.8 (44.8)-12.0 Unknown
Other state and local incentives 2.9-10.5 0.0-4.0 Unknown
TOTAL $7.2-15.3 $108.5-946.5 $719.0-5,875.5
Source: Perkins. September 1995, p. 9.

In Ecuador, taxing mercury in artisanal gold mining is somewhat ineffective because the demand for mercury from artisanal gold miners is quite inelastic, as mercury results in less than 1% f total costs to the miner. Thus, rather than heavily taxing mercury at its point of entry, policy makers in Ecuador have decided to promote the use of retorts to reduce mercury loss in the amalgamation process of artisanal gold mining, through offering an incentive to reduce the costs of the retort to the gold miner on the form of a subsidy. This is an example of subsidizing the cost of appropriate technology for environmental and health benefits. The cost of a retort is about equivalent to 1.5 grams of gold, but will provide a 5-10 percent improvement of capturing gold in the amalgamation process.

3.5 A Policy Framework for Government interventions
Based on the findings of the review of literature a policy framework for government intervention as government is the key facilitator of environment protection is developed. Possible options are explored and a framework is developed as given in Fig-3. The framework involves thorough analysis of different options with special emphasis on cost & benefits; otherwise, policy implementation is likely to be affected or slowed down. Options are to be devised on the basis of optimization of costs so as to achieve maximum adoption. In the process extensive consultations with the stakeholders’ are required and hence, the framework provides provision for stakeholders; consultation. The framework indicates a dynamic process where performance of each policy option is to be reviewed and in case, if some policy options are found not suitable in meeting the desired goals, the whole process should be repeated.

Fig-3 : A Framework for for government intervention for environment protection

4.1 Coceptual Framework of the study
Market Based Instruments (MBIs) are the environmental economics weapons which are now being heavily used to convert the destruction of global climate. MBIs provide the opportunity to incorporate into market signals some or all of the costs that actions of producers or consumers impose on others in the community through environmental damage and use of natural resources(ABARE,2001). Or, if simply put, Market based Instruments (MBIs) are instruments that “encourage behaviour through market signals rather than through explicit directives regarding pollution control levels or methods” (Stavins, 2000)

MBIs can be particularly effective tools for dealing with the four major areas of action of the EU 6th environmental action programme, namely: tackling climate change, preserving nature and biodiversity, protecting environment and human health, and through the sustainable use of resources and management of wastes. They do so by addressing the sources of environmental pollution most relevant to these areas such as:
• Emissions from power stations, industry, cars and aircraft (tradable emission permits, fuel taxes);
• Increasing waste generation by household and other actors (waste disposal taxes, taxes on packaging, incentives for recycling);
• Emissions resulting from agricultural activities (fertilizer and pesticide taxes).

MBIs are designed to achieve the condition of efficient solution to the environmental problem, i.e.,
marginal environmental damage cost = marginal cost of environmental protection (abatement cost) or
the sum of these two costs should be minimized (Fig-2).
Fig-2 : Efficient solution to environmental problem

Market-based instruments (MBIs) span a range of measures and approaches. Fundamentally, they are policy measures that influence outcomes through their effect on costs and profits. In the hands of policymakers, they can affect the operation of established markets or create new ones. They are commonly also referred to as ‘economic’ instruments because they attribute value to assets and directly affect decisions based on considerations of price and income. The MBIs are described below:

4.1.1 Pollution Tax
The emission tax is a near relative of emission trading. While emission trading focuses on the amount of emissions which are allowed in general, the emission tax focuses on the price side of this relation. The tax is set so that, for each unit of pollution emitted, a polluter pays the value of the marginal (additional) external damage (e.g. costs of say, worsened human health, reduced visibility, lower property values, loss of crop yield or biodiversity) caused by that unit of pollution. This is a price based MBI. Pollution tax has the advantages of Polluters try to find the cheapest way to reduce pollution to avoid the emissions tax, The Govt earns revenue from this that can be used to reduce other pollution or reduce other taxes etc. It has the disadvantages like often impossible to tax emissions directly because they are difficult to measure, difficult to define and monetarily value the marginal external damages of a unit of pollution, difficult to enforce since they are often exacted on goods that are not directly bought and sold, measurement and tax emissions may lead to illegal dumping etc.

4.1.2 Emission Trading
Emission trading is one of the flexible mechanisms of the Kyoto-Protocol and shall therefore play an important role in reaching international climate targets. One important point why emission trading was chosen to help reaching the Kyoto-Targets is that, like taxes, it allows emissions to be reduced where it is cheapest for the economy, i.e., it is cost-effective (Dales, 1968 and Montgomery 1972). But unlike taxes, it does not involve transfers from the private sector to the government.

The basic setup is that a regulator setsA permit system allows policy makers to set the quantity of allowable emissions. Permits are distributed or auctioned, generally to firms, and represent the right to pollute some set amt of pollution. Firms then buy and sell permits. Firms then buy and sell permits to each other as needed. The market-clearing price is established through this buying and selling, and if the Govt chooses the optimal level of pollution, will be the same amount as the emissions tax. This is a right based MBI. This MBI has the advantages like a firm can reduce pollution to avoid the cost of purchasing permits, they do not require a policy-maker to measure the marginal external damages of a unit of pollution, they allow policy makers to determine with certainty, the level of pollution that will result etc. ITt has disadvantages like , since the Govt sets the quantity of pollution, there is some degree of uncertainty regarding price. If abatement measurement and permit purchases are much more expensive than expected, they can have large and costly effects on particular industries, permits can be interpreted as giving firms a licence to pollute, particularly when permits are allocated to firms for free, transaction costs to complete a trade may be high. Significant search costs or strategic behaviour could seriously inhibit the permit trading that would normally ensure the least-cost outcome etc.

4.1.3 Market Barrier Reductions
This is relatively new MBI. Removal of legal, regulatory and other barriers to market activities in regard to environment and internalization of externalities to achieve gains from environment protection. There are several types of barrier reductions, e.g., creating markets with measures which facilitate voluntary exchange of rights, liability rule, information programmes etc. This MBI is increasing used in the industralised nations as a method that puts a mandatory requirement on the firms to provide government and people with the information on pollution and abatement activities. This attempts to minimize inefficiencies in regulation associated with asymmetric information where the firm has better information on what and how much it pollutes than the government (Tietenberg and Wheeler, 2001). This is Market friction MBI. Advantages of this MBI are like barrier reduction strategies contribute to better overall performance of the planning system, they provide an important opportunity to revise existing planning schemes to enable more diverse housing forms within existing areas. On the other hand it has legal hurdles

4.1.4 Govt Subsidies & Incentives
This is a very effective system as environmental damages can be substantially controlled by removing / reforming subsidies. A subsidy per unit establishes incentives for emission reductions identical to tax per unit for pollution. As opposed to pollution taxes, subsidies can be used as rewards for reduction of pollution savings (Austin, 1999). Reducing / removing subsidies may induce people to invest more on energy / resource saving technology. For example, full cost pricing of irrigation water supply would remove subsidies and is likely to induce farmers to invest more in water-saving technology resulting in a reduction in raising water wastes and salinity (Hamilton et al, 2002). In many cases, subsidies encourage activities that involve significant environmental benefits, e.g., recycling of waste. This MBI is widely used and effective in supporting more rapid diffusion of clean technologies such as catalytic converter, low CO2 vehicles, etc. Nevertheless, there is a catch. This MBI distorts firms’ long-run economic incentives as subsidy adds to the firms’ revenue and hence, in many a case firms may enter the industry or appear dirty to qualify for subsidy. This may result in a situation where individual firms decrease pollution but the overall level of pollution actually increases (Baumol and Oates, 1988). This is market reform based MBI. Subsidies are often funded by the fees charged on environmentally harmful products or activities.

4.2 Operationalization of the concepts
Advance Disposal Fees (ADF) on consumer products generate revenues that subsidize the otherwise unprofitable activity of disposing of specific products after they have been used.

Alternative Fuel Vehicle (AFV) is a vehicle that runs on a fuel other than "traditional" petroleum fuels (petrol or diesel); and also refers to any technology of powering an engine that does not involve solely petroleum (e.g. electric car, hybrid electric vehicles, solar powered). Because of a combination of factors, such as environmental concerns, high oil prices and the potential for peak oil, development of cleaner alternative fuels and advanced power systems for vehicles has become a high priority for many governments and vehicle manufacturers around the world. The United States Department of Energy officially recognizes this list of alternative fuels:
• Alcohols - ethanol and methanol.
• Compressed natural gas (CNG) - natural gas under high pressure.
• Electricity - stored in batteries.
• Hydrogen - a very special type of gas.
• Liquefied natural gas (LNG) - natural gas that is very, very cold.
• Liquefied petroleum gas (LPG) (also called propane) - hydrocarbon gases under low pressure.
• Liquids made from coal - gasoline and diesel fuel that doesn't come from petroleum.
• Biodiesel - a lot like diesel fuel, but made from plant oil or animal fat.
Biodegradable Municipal Waste (BMW) is the fraction of Municipal Waste that will degrade within a landfill, giving rise to landfill gas emissions, primarily methane. It includes, amongst other materials, food waste, green waste, paper and cardboard.

Biological Oxygen Demand (BOD) is one of the most common measures of pollutant organic material in water. BOD indicates the amount of putrescible organic matter present in water. Therefore, a low BOD is an indicator of good quality water, while a high BOD indicates polluted water.

Clean Development Mechanism (CDM) is one of the “flexibility” mechanisms defined in the Kyoto Protocol (IPCC, 2007). It is defined in Article 12 of the Protocol, and is intended to meet two objectives:
(1) to assist parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the United Nations Framework Convention on Climate Change (UNFCCC), which is to prevent dangerous climate change
(2) to assist parties included in Annex I in achieving compliance with their quantified emission limitation and reduction commitments (greenhouse gas (GHG) emission caps).

Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living; although this can be problematic because GDP per capita is not a measure of personal income.

Green House Gas (GHG) is a gas in an atmosphere that absorbs and emits radiation within the thermal infrared range. This process is the fundamental cause of the greenhouse effect. The primary greenhouse gases in the Earth’s atmosphere are water vapour, CO2, methane, nitrous oxide, and ozone.

Landfill Allowance Trading Scheme (LATS) is an initiative by the UK government, through DEFRA to help reduce the amount of biodegradable municipal waste (BMW) sent to landfill.

National Allocations Plans (NAPs) are a calculation of an “overall cap on the total emissions allowed from all the installations covered by the EU ETS” by member states which are submitted to the EC and approved before being allocated to industries by the member states.

Organization of Economic Cooperation & Development (OECD) is an international economic organisation of 34 countries founded in 1961 to stimulate economic progress and world trade. It is a forum of countries committed to democracy and the market economy, providing a platform to compare policy experiences, seek answers to common problems, identify good practices, and co-ordinate domestic and international policies of its members.

Packaging Recovery Note (PRN) is a type of document that provides evidence that waste packaging material has been recycled into a new product. It forms a key part of the Producer Responsibility Obligations (Packaging Waste) Regulations 2007 which covers Great Britain.

Strength Weakness Opportunities Threats (SWOT) analysis is a strategic planning method used to evaluate the Strengths, Weakness, Opportunities & Threats involved in a project. It involves specifying the objective of the project and identifying the internal and external factors that are favourable and unfavourable to achieve that objective.

Total Suspended Solids (TSS) is a water quality measurement. This parameter was at one time called non-filterable residue (NFR), a term that refers to the identical measurement: the dry-weight of particles trapped by a filter, typically of a specified pore size.

Volatile Organic Compounds (VOCs) are organic chemicals that have a high vapor pressure at ordinary, room-temperature conditions. Their high vapor pressure results from a low boiling point, which causes large numbers of molecules to evaporate or sublimate from the liquid or solid form of the compound and enter the surrounding air. An example is formaldehyde, with a boiling point of –19 °C (–2 °F), slowly exiting paint and getting into the air.

Title : Market based Instruments : The European Experience

MBIs are applied in many countries across the globe. Cross-country experiences show that the objectives of using MBIs are more or less similar. European countries have extensive use this instrument. In Europe, the use of MBIs gained ground since the mid-1990s, mainly in the areas of taxes and tradable permits. Comprehensive systems of air and water charges are in place in many countries though the rates are kept low mainly because of peoples’ ability and willingness to pay. Several developments are taking place with regard to taxing the polluting commodities. Within EU-15, the Scandinavian countries and the Netherlands which were the initiator of environmental tax reforms, Germany and U K have made substantial progress since the late 1990s. The use of environmental taxes and charges have widened since 1996 with more taxes on CO2, SO2, raw materials, waste disposal. Emission trading has also become a very important instrument with the adoption of EU Emission Trading Directive for reducing CO2 emissions, its transposition into national laws and formulation of the National Emissions Allocation Plan. The trading system started operating since January, 2005.A range of other instruments are under the planning stage. The use of MBIs are likely to increase further as part of wider initiative on environmental policy reforms.

5.1 Pollution Tax
In Europe, the definition of “environmental taxes” is jointly developed by the European Commission (EC) and Organization of Economic Co-operation and Development (OECD). Several taxes are imposed in Europe. CO2 tax is imposed in many member countries. It was first levied in Finland in 1990 followed by Denmark, Germany, Netherlands, Norway, Poland Sweden, Slovania and UK. Estonia introduced a charge on CO2 in 2000. A levy on NOx is in place in Denmark, France, Norway, Sweden and Switzerland. A multi-pollution tax system for air pollution is imposed in many member countries such as Chezchch Republic, Estonia, Latvia, Poland, Bulgaria, Romania etc. Switzerland has a tax on Volatile Organic Compounds (VOC). There are taxes on a wide range of polluting products such as batteries (in Belgium, Bulgaria, Denmark, Italy, Sweden etc.), plastic bag (in Denmark, Italy, Ireland etc.), disposable baggage containers (Belgium, Denmark, Estonia, Finland, Latvia, Poland, Sweden etc.), tyres (in Bulgaria, Denmark, Finland, Latvia, Sweden etc.) lubricant oil (in Finland, Italy, Latvia, Sweden et.), chlorofluorocarbons (CFC) (in Latvia, , Denmark etc.). There are waste taxes (landfill tax) in many member countries. Hazardous waste taxes are levied in Belgium, Denmark, Finland, France, Germany, Poland etc. Besides these, there are taxes in place for water pollution, fisheries, agricultural inputs etc. Table-1 presents environmental taxes in selected European countries.

Table-1 : Environmental taxes in selected European countries

Country Tax / Tax shift
Finland 1990-97 Energy tax, CO2 tax and landfill tax This tax was not revenue neutral as the increase in revenue was not directly linked to income tax cuts
Sweden 1991, tax shifting programme (2001-10) Environmental and energy tax including CO2 and SO2 taxes A total Euro 3.3 billion was to be shifted by the end of 2010
Denmark 1993, 1995 and 1998 1993 : increase in existing tax on fossil fuels, electricity and waste and new taxes on piped water, waste water and carrier bags.

Increase in energy taxes (but industry is reimbursed when entering voluntary agreements). A new tax on SO2 and natural gas.

Increase in energy tax by 15-25%
The revenue loss was partly offset by the increase in energy taxes

Major part of the revenue generated for energy taxes were used for investment in energy-saving measures

1998 : Loss from income tax of DKK 10 billion was offset by revenue gain of DKK 6 billion
Netherlands 1996, 2001 Energy and CO2 tax. Tax on water and waste disposal. The revenue were used to provide social benefits to people through budget.
UK 1996



Energy / CO2 emissions under Climate Change Levy (CCL)
1996 : Revenue was used for a reduction of 0.2% of employers NIC from 10.2% to 10%

Revenues were used for reduction of 0.3% of employers NIC
Norway 1999 CO2 and SO2 taxes and energy tax -
Germany 1999-2003 Energy (mineral oils, natural gas and electricity) Revenues used for reduction in 1.7% of employers’ and employees’ pension contribution
Russia 2001 Energy tax Revenue used to offset reduction in income taxes
Austria 2004 Energy tax The tax was not revenue neutral
Sources : European Environment Agency (EEA) Technical Report (2005)

Tax rates in some selected East European countries is given in Table-2. It is observed that the rates have significant inter-country variations. The reasons may be different industrial structure, different climatic conditions etc.

Table-2 : Tax rates is some selected East European countries (Euro/t)

Country (Year) Air Pollution Water Effluent
SO2 NO2 Nitrates (NO3) Phosphates BOD

Russia (2001) 1.2 1.6 0.9 39.9 2.7
Romania (2002) 6.9 27.8 6.9
Estonia (2003) 6.1 13.9 236 377 250 (BOD 7)
Latvia (2003) 20.3 20.3 47 47 47 (COD)
Ukraine (2001) 11.1 11.1 0.7 (2001)
8.8 (2003) 5.8 (2001)
7 (2003) 2.9 (2001)
3.5 (2003)
Molodova (2001) 34.3 35.1 0.1 7.8 0.6
Source : Baltic Environment Forum (BEF) (2003) & OECD (2003)

Table-3 depicts a comparison of minimum tax rates of EC directive 2003 and the 1997 proposals. It is interesting to note that in all the cases, the rates as per the “2003 directive”, valid from 1.1.2004 and 1.1.2010, are less than the 1997 proposals. This indicates that government was quite careful about the ability and willingness to pay the polluters and in fixing the tax rates. In fact, this is not tax but taxing fuels to discourage excessive use of the fuels that will generate pollutants.

Table-3 : Comparison of minimum tax rates of EC directive 2003 and the 1997 proposals.

Item Minimum rates proposal 1997 Minimum rates (Directive) 2003
Valid from 1.1.2002 Valid from 1.1.2004 Valid from 1.1.2010
Transport fuels
Petrol (Euro / 1000 l) 500 421 421
HSD (Euro /1000 l) 393 302 330
LPG (Euro/1000 kg) 224 125 125
Natural gas (Euor/Gj) 4.5 2.6 2.6
Heating fuels
LDO (Euro/100 l) 26 21 21
Kerosine (Euro/100 l) 25 0 0
LPG (Euro/100 kg) 34 0 0
Natural gas (Euro/Gj) 0.7 0.15*
Coal & coke (Euro/Gj) 0.7 0.5*
Fuels used for industrial & commercial purposes
Diesel (Euro/1000 l) Nil 21 21
Natural gas (Euro/Gj) Nil 0.3 0.3
Note - * : Business, ** : Non business such as household,
Source : Kwon (2003) and Ernst & Young (2004)

EU member states with CO2 based car taxation policies are on the rise with No.of states=11 in 2007 to 17 in 2010.
Tax CO2 Energy Energy Energy
Implementation Jan 1st, 2013 Jan 1st, 2013 Jan 1st, 2015 Jan 1st, 2018
Petrol 20 Euro/t 9.6 Euro/GJ 9.6 Euro/GJ 9.6 Euro/GJ
Diesel 20 Euro/t 8.2 Euro/GJ 8.6 Euro/GJ 9.6 Euro/GJ
LPG 20 Euro/t 1.5 Euro/GJ 5.5 Euro/GJ 9.6 Euro/GJ
Natural Gas 20 Euro/t 1.5 Euro/GJ 5.5 Euro/GJ 9.6 Euro/GJ

5.2 Emission trading

First comprehensive review of potential for emission trading in Europe is provided by Klaassen (1997). But emission trading came in large scale to the policy makers of Europe only after signing the Kyoto Protocol in 1997.

Inn the early period, some countries like the Netherlands, Sweden and UK have created tradable renewable energy certificates (TREC) or “green certificates” by which the utilities were allowed to meet the obligations (or, the permissible pollution limit) by purchasing certificates from other producers of electricity output from renewable sources. European experience indicate that the system is more costly than other instruments like carbon tax. Controversies were on. Finally the compact emission trading framework came into shape under the European Union’s Emissions Trading System (EU-ETS).

EU-ETS is a milestone of EU’s effort for meeting the obligation under Kyoto Protocol. It covers 11,500 energy intensive facilities across the member countries. The trading programme does not cover non-CO2 green house gases (GHG) which account for about 20% of EU’s total GHG emissions. The first trading period began in January, 2005. The second and third period scheduled to begin in 2008 and 2013 respectively. The EU does not have much experience in emissions trading and started by a “learning-by-doing” approach. Implementation of EU-ETS mainly centered around the “National Allocation Plans” (NAP). Each member country must submit a NAP with allocation scheme under ETS including individual allocations to each affected units. The NAPs are assessed by the EC to determine compliance with the 11 criteria (12 for the second period) given in the emissions trading directive . For the first period EC approved most the NAPs by the end of 2004.

For the period 2005-07, EU-ETS would like to get some experience in emissions trading with some emissions target. Table-4 depicts the emissions allocations for 2005-07. For the first period, 21 countries have been allocated an annual average of 1.8 billion allowances and have kept 73.4 million allowances for allocation to new sources or for auction.
Table-4 : Emissions allocations in 2005-07
(in Mt)
Member state Annual Average allocation* Annual Average allocation for new sources or for auctions**
Austria 33 0.33
Belgium 560 2.6
Chezch Republic 969 0.35
Denmark 31 2.5
Estonia 19 0.19
Finland 45 0.86
France 150 4.9
Germany 495 3.9
Greece 71 3.3
Hungary 30 1.4
Ireland 19 3.1
Italy 208 15.6
Latvia 4 0.51
Lithuania 12 0.8
Netherlands 86 2.5
Portugal 37 1.3
Slovak Republic 30 0.78
Slovania 8.6 0.67
Spain 162 13.2
Sweden 23 0.68
U K 209 15.5
TOTAL 1829 73.4
Note : * Allowances allocated to the existing units at the start of
the scheme.
** Allowances not allotted to, the existing units but put aside for new entrants and auctioning (in the cases of Denmark, Hungary, Ireland and Lithuania)

EU-ETS traded around 360 million tones of CO2 in 2005 (Point Carbon, 2006). According to Point Carbon’s data base, the trading generated 7.218 billion Euro where brokers were responsible for 57% of the volume, exchange markets did 15% and the rest 28% from bilateral trade. Of the exchange market volume, the European Climate Exchange (ECE) had the largest share (63%), followed by Nord Pool (24%), Powernext (7.9%) and others (5.1%). The average price for an allowance was Euro 19.9. For the brokered and exchanged, the average price of an allowance was Euro 20.6 while for bilateral exchange, the average price was Euro 18.2. It is important to note that the “allowance price” always remained volatile (Fig-2). Fuel price is the major causal variable in the ETS. A “Point Carbon study” indicates that 79% of the variation in allowance prices were explained by the variation in fuel prices (for electric power) while 23% variation is explained by the weather. This linkage between the allowance prices and power market is obvious as power sector carried out maximum trades in 2005 and hence, had significant influence in the allowance price movements.

Fig-2 : CO2 Market : price volatility

5.3 Market barrier reductions

In this area, nothing much is evident except for application of the liability rules. Environmental liabilities are different from environmental compliance. While liability is caused by “part action” of somebody else, compliances are for “future actions controlled by environmental legislation. Cost of decontamination of soil done by a “part” party amounts to environmental liability of the new land buyer, - hence, insurance and extensive survey. Liability for environmental damage could be on the basis of the principle of ‘polluter pays’. The most notable development, in regard to environmental liability in Europe, occurred in March, 2004 when EC approved the long-awaited directive on liability for damage to environment. The directive entered into force in 30th March, 2004 with formal compliance requirement by 30th April, 2007. By this time period, all EU member countries must adopt legislation specifying liability for environmental damages. However, some measures on liability for environmental damage were adopted by many countries during the 1990s also.

In Finland, environmental liability is covered by three main acts : (i) the Act on Compensation for Environmental Damage (1993) which covers pollution of air, water, noise, vibration, radiation, etc. and the cost of compensation is measured as the cost of prevention of the of the damage caused by the polluter, (ii) the Environmental Damage Insurance Act (1998) for setting up of a compensation fund that guarantees full compensation of the damage in cases where the liable party is insolvent or not identified, and (iii) Environmental Protection Act (2000) which seeks compulsory insurance for contaminated soil and ground water. In Spain, the oil tanker “Prestige” laden with 77,000 tonnes of heavy fuel oil, broke into two off the coast of Galicia spilling substantial quantity of oil. The ship owner’s insurer paid a hefty compensation of Euro 22 million. In France, during 2004, there were 6908 claims due to the incident of oil tanker “Erika” that took place in 1999. A total Euro 207 million compensation was claimed. In Belgium, there is a law for safeguarding marine environment based on several liability concepts. Restoration or monetary compensation is required in case any damage occours. Germany has a law, implemented in 2005, based on liability for protection of ecosystem and landscapes. Efforts are going on at various level in Europe to come out with several liability measures for environment protection.

5.4 Government subsidies and incentives
In this area also only a little progress has been made in Europe. In Europe, the reform of environmental subsidies is a hot subject among the decision makers. OECD has been developing a framework on environmental subsidies. As per EU Environmental Technologies Action Plan, EC will work with the member countries, using the OECD methodology as far as possible, to identify the most significant subsidies that have negative effects on environment. However, environmental subsidies are available in many countries of Europe. But, need of the hour is to device at least two approaches : one, on subsidies which can be used in short-run to address market failure and the other one, reform of environmentally harmful subsidies.

In France, subsidies are available to encourage technology diffusion or new techniques, open and develop the market for cleaner vehicles etc. For example, for light vehicles there are subsidies with a maximum Euro 1500 per vehicle. There is also support of electric vehicles with a maximum of Euro 225 per vehicle. Netherlands has a provision of subsidies on energy-efficient cars. In 2002, the lowest-emissions cars (leveled “A”) received subsidy of Euro 1000 while cars leveled “B” received a subsidy of Euro 500 . The Municipal Transport Authority of Amsterdam (GVB) is taking part in a programme (EU funded Euro 18.5 million grant) for development of fuel-cell vehicles. The local authority GVB is testing fuel-cell buses in the northern part of the city with the support of a local environment agency Shell Hydrogen and the cost of the project is Euro 6 million. Luxembourg has similar programmes to stimulate purchase of low-CO2 emitting cars . The Swedish government subsidized the installation of NOx abatement technologies as a part of differentiated dues schemes – it is ‘differentiated fairway dues’. The scheme had a new design in 2005 with greater environmental differentiation for NOx and sulphur content. Norway has also schemes on NOx abatement. UK’s Energy Saving Trust launched the “Power Shift Programme” in 1996. The programme offers grants for purchase of clean-fuelled vehicles which included vehicle running on CNG & LNG, LPG and electricity.

Based on the European experience of use of MBIs, the following SWOT analysis has been carried out e :

All four strategies that have been presented in this study show a potential for addressing climate change. Emission trading has a clear goal concerning the reduction of emissions as the overall cap of allowed emissions is set at the beginning. Environmentalists may favor emission trading from a purely ecological viewpoint, because with help of the cap it is possible to control the total amount of emissions. Controlling the amount of emissions is more difficult using an emission tax. In this case the regulator has to have information about marginal abatement costs of the individual companies and the whole economy. This information is hardly known, so that the optimal tax rate to achieve a certain target has to be set in a trial and error process which would be hard to implement from a political side of view. Because there appears to be much evidence that the marginal cost curve is steeper than the marginal benefit curve in the context of climate change, efficiency considerations favor taxes (Weitzman, 1974). Importantly, MBIs are all cost-effective, but they vary with respect to ecological effectiveness, financial impacts, dynamic aspects, and political feasibility. Probing deeper, it is recognizes that the drivers of all three Schumpeterian phases of technological progress – invention, innovation, and diffusion – are incentives. Promoting clean energy just alone with good will most likely is not going to be enough as long as fossil energy is cheaper. Therefore using taxes or trading to make fossil energy more expansive is a good way to set an incentive that will help developing cleaner technology much quicker than
it would happen without such a financial incentive. That financial incentive can be given
precisely by using taxes and tradable permits. Perhaps a useful complement to emission taxes and emission permits are subsidies and quantity-based tools that promote technological progress. There is hardly any analysis on optimal emission taxes and permits is available for the subsidies-approach.

Environmental policy, in particular such long-term policy as that related to climate change, has to struggle with the significant uncertainty surrounding benefits, costs, and available technologies. Environmental effects of technologies in development can be estimated but not predicted for sure. From the experience of such diverse areas as weather forecasts, horserace betting, macroeconomic variables, and elections, “prediction markets” – i.e., markets where assets are traded whose value depends on the probability that a certain event happens – can play a powerful role in providing effective advice. In particular, they can aggregate information well, often more accurately than experts can. European Union is expected to implement such a market.

MBI are definitely useful instruments for environment protection. Each MBI has distinct advantages and disadvantages. In some cases it is seen that some objectives of one MBI are in conflict with some objectives of another MBI. The SWOT analysis gives clear signal to this and hence, it seems justified that a combination of MBIs is more effective in achieving the overall goal of environment protection.

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