Communication from the Commission to the Council and the European Parliament - Bringing our needs and responsibilities together Integrating environmental issues with economic policy
Date: 2000-09-20
Institutions: European Commission
Subjects: economic growth, environmental impact, environmental protection, pollution control measures, sustainable development

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 20.9.2000
COM(2000) 576 final

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE
EUROPEAN PARLIAMENT

Bringing our needs and responsibilities together-
Integrating environmental issues with economic policy

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE
EUROPEAN PARLIAMENT

BRINGING OUR NEEDS AND RESPONSIBILITIES TOGETHER-
INTEGRATING ENVIRONMENTAL ISSUES WITH ECONOMIC POLICY

1.

INTRODUCTION

The Amsterdam Treaty requires the integration of environmental protection into
Community policies in order to achieve sustainable development1. At its June
1998 meeting in Cardiff, the European Council invited all relevant formations of
the Council, starting with the Transport, Energy and Agriculture Councils, to
establish their own strategies for giving effect to environmental integration and
sustainable development within their respective policy areas. In Cologne in June
1999 the European Council called upon the Council to report to it in 2000 on the
integration of environmental issues and sustainable development in the policy
areas of General Affairs, Economic and Financial Questions, and Fisheries.

This Communication follows the presentation of strategies for integrating the
environmental dimension into the Agriculture, Transport and Energy sectors; the
Development, General Affairs (in particular for trade issues), Industry and
Internal Market Councils are working on strategies for their policy areas.
Building on the Commission’s 1994 Communication on economic growth and
the environment2, it contributes towards the definition of a Community strategy
to improve integration of the environmental and economic dimensions of
sustainable development3. In line with the conclusions of the Lisbon European
Council, the strategy proposes no new process, but rather the use of existing
instruments to achieve gradual but credible progress in integration. These include
Member States’ annual reports on structural reforms and the Broad Economic
Policy Guidelines. The Broad Economic Policy Guidelines should ensure that
consistent policies for integration are proposed across different sectors of the
economy. The ECOFIN Council when preparing the Broad Economic Policy
Guidelines taking account of contributions from other Council formations should
ensure such consistency. The Council’s decisions concerning energy and

1

2

3

“Environmental protection requirements must be
integrated into the definition and
implementation of the Community policies and activities referred to in Article 3, in particular
with a view to promoting sustainable development.” Article 6 of the consolidated version of the
Treaty establishing the European Community; OJ C 340 of 10th November 1997
“Economic Growth and the Environment: Some Implications for Economic Policy Making”;
COM(94)465 of 3 November 1994
At Helsinki in December 1999 the European Council asked the Council to submit to it in June
2001 comprehensive strategies for these sectors. The Commission was also invited to present to
the June 2001 European Council a proposal for a long term strategy dovetailing policies for
economically, socially and ecologically sustainable development. Annex 1 contains a more
detailed discussion of issues relating to the integration of economic and environmental concepts
of sustainability.

2

environmental taxes are also relevant to the integration between environmental
and economic policy measures.

The Communication argues that
there is no inherent contradiction between
economic growth and the maintenance of an acceptable level of environmental
quality. Indeed, economic growth typically enables societies to provide their
members with a cleaner, healthier environment: cholera and dysentery due to
water pollution are not problems faced by developed societies, even when
confronted with natural disasters. Accordingly, the issue should not be seen as
one of economic growth versus
rather of how
improvements in living standards can be accompanied by the safeguarding and
improvement of the quality of the environment. Moreover, improving integration
should be beneficial for both environmental and economic policy. “Greening”
fiscal policy, by removing subsidies to environmentally harmful activities for
example, should enhance economic efficiency. The use of economic instruments,
such as taxes, subsidies or other incentive payments, or tradable emission
permits, will frequently offer a more effective means of achieving environmental
policy objectives than traditional environmental policy instruments such as direct
regulation of polluting activities. Measures to enhance integration will be
simultaneously beneficial for the economy and the environment.

the environment, but

The European Environment Agency has argued that “improved environmental
quality . . . will have to come mostly from changes in economic activity and
socio-economic policies”4. To the extent that our current use and allocation of
resources is not consistent with this goal, moving our economies onto
trajectories which will allow us to meet this objective entails changes in resource
use and allocation. There are essentially two ways of doing this. Either the goods
and services that we consume now must be produced using fewer natural
resources, or we must produce and consume goods and services which use these
resources less intensively. Both of these scenarios imply change. This change is
an essential part of achieving the Lisbon European Council's goal of making the
Community the world's most competitive and dynamic knowledge-based
economy.

2.

WHY INTEGRATION IS INADEQUATE AND WHAT CAN BE DONE ABOUT IT

the reasons why environmental considerations are insufficiently
One of
incorporated in economic policy formulation is that economic policy is –
correctly – essentially concerned with macroeconomic stability and the
functioning of markets. But many environmental problems arise precisely because
there are no markets in environmental goods and services. As well as damaging
the environment, these missing markets give rise to an important source of
economic inefficiencies, or “externalities”.

Externalities lead to a mismatch between private and social costs. But economic
if
efficiency requires that private and social costs be equal at

the margin:

4

“Europe’s Environment: The Second Assessment”; European Environment Agency, 1998

3

If economic agents do not

resources are to be used efficiently, the costs to an individual of using those
resources must be the same as the costs society incurs from the use of the same
resources.
take account of pollution in their
production costs, then they will allocate too many resources to producing goods
and services which cause pollution;
if economic agents are not paid for
environmentally beneficial actions, they will undertake too few of them. In both
cases, society as a whole loses. So measures to improve the integration of
environmental issues into economic decisions should result in less pollution and
improve the functioning of the economy.

Because markets for many environmental goods and services are either missing
or
incomplete, producers and consumers receive misleading price signals.
“Getting the prices right” - action to improve the working of such markets where
they exist, or to create such markets when they do not - should therefore form
part of an effective integration strategy. Several instruments which might be used
to improve integration of environmental and economic policies by creating
markets in environmental goods and services or improving the functioning of
these markets are outlined below. Additional details are in Annex 2.

The functioning of a market for any good or service requires that property rights
in that good or service are well-defined, enforceable, and tradable. In the case of
many environmental products, property rights are not explicitly defined, so
markets for
resolving
externalities which will be effective in certain well-defined circumstances is to
create and assign tradable property rights in those environmental goods and
services.

them cannot develop. Accordingly, one option for

By placing a price on pollution through the imposition of pollution taxes or
charges, governments can reduce or eliminate the gap between the private costs
of the activity which generates the pollution and the costs to society.

In contrast to pollution charges, which fix a price for pollution but leave the
quantity uncertain, tradable emission permits determine the quantity of pollution
and allow market forces to set its price.

Deposit-refund schemes are among the instruments which may be used to
encourage recycling.

Support to undertake activities or provide goods and services which generate
positive environmental effects may be offered by subsidies, or other positive
incentive payments.

Negotiated agreements between industry and public authorities are a hybrid
between market-based instruments and formal regulation. They typically entail
members of an industrial association committing themselves to targets such as
phasing out use of harmful substances, or reductions in their use of energy per
unit of output over a certain time period, in return for promises by government to
refrain from direct regulation or taxation of the sectors concerned.

4

Although not strictly an economic instrument, clear and reliable information can
substantially improve the effectiveness of economic instruments as a means of
integrating environmental concerns with economic policy. Better information
about
the environmental characteristics of goods and services can play an
important part in encouraging and enabling producers and consumers to make
the economic costs to
choices which are environmentally sound and reflect
society of their actions.

3.

MARKET-BASED INSTRUMENTS VERSUS “TRADITIONAL” REGULATION

In contrast to more traditional forms of regulation, economic instruments use
markets to tackle pollution. Whether by influencing prices, or absolute quantities,
or quantities per unit of output, market-based instruments implicitly acknowledge
that firms are different and provide a flexibility that can substantially reduce the
costs of environmental improvements. They are typically superior to more rigid
regulatory instruments in both the short and long run. In the short run, they
enable emission reductions to take place where they are cheapest. Each firm
knows the “value” of its own pollution: faced with a charge per unit of emissions,
a firm will reduce its emissions as long as the cost of doing so is less than the
level of the charge. In the long run, market-based approaches to pollution control
give companies incentives to find cost-effective ways to reduce pollution by
devising new, cleaner production techniques. By reducing the cost of pollution
environmental
abatement,
improvements than would otherwise have been considered economically feasible.

this may allow societies

to achieve greater

This may be relevant for enlargement of the Community to Central and Eastern
Europe. Market-based instruments offer additional possibilities to the candidate
countries to effectively implement EU environmental law in practice. They could
thereby facilitate the achievement of Community environmental standards in a
cost effective way. Moreover, market-based instruments may require fewer
administrative resources to implement. This is an important consideration, given
that public administrations in CEECs are under considerable stress as they adapt
to the rules of a market economy and the requirements of Community
membership. The Community’s development policy should also support
the
introduction of market-based instruments, in particular through its assistance to
structural adjustment and sectoral reform programmes in partner countries.

Conventionally, environmental regulation has created rights to pollute by, for
example, setting limit values which define the maximum amount of pollution
allowed per emitter. Firms have no incentives to outperform whatever standard is
set for them. Increasingly, such regulation has adopted standards differentiated
according to the type of production technology. However, even the most
sophisticated regulations have limited scope to take account of differences in the
ability of individual sources to reduce their emissions. It is extremely difficult to
legislate for the wide variety of firms that exist and the different costs they may
face in switching to cleaner production techniques. By its nature, a regulatory
approach to integrating environmental values in the decisions of individual
to integrate
economic actors
environmental and economic policy objectives are likely to be more successful if

largely ignores market

forces. Attempts

5

they instead acknowledge that market forces are powerful – they are implicated
in many environmental problems – and seek to harness them to achieve
environmental policy aims.

The uncertainty which is a recurring problem for environmental policy-makers
offers another reason to use economic instruments to integrate environmental
policy in economic decision-making. Markets can reveal important information
which would otherwise remain inaccessible. Environmental policy targets should
in principle be set so that the benefit of the environmental improvement at least
matches the costs of achieving it. However, it is often difficult for a regulator to
place a value on a specific environmental amenity or the damage caused by a
particular pollutant, or to find out the exact costs of pollution abatement. The use
improvements
of economic instruments makes the costs of environmental
explicit. Regulation also imposes costs, but they remain hidden, or implicit.

Clearly, economic instruments do not eliminate uncertainties. When introducing
taxes or charges, the quantity of emission reduction that will result is generally
unknown. Equivalently, it is difficult to determine the charge or tax rate which
will ensure an efficient allocation of resources. Similarly, if a ceiling is put on
emission volumes, the cost of sticking to this ceiling under an emissions trading
scheme will not be known in advance. Moreover,
to be effective these
instruments
require well-functioning and competitive markets which are
responsive to price signals. The current focus on structural reforms of the
Community economy should further increase the attractiveness of market-based
instruments. The more markets are competitive, and the more responsive are
supply and demand to changes in relative prices of goods and services, the more
effective will be market-based solutions to environmental problems. However,
uncertainty about prices or quantities should not become an excuse for inertia.
The direction of the desired policy response is clear, even if its precise size is
unknown.

While market-based instruments offer substantial advantages compared to more
traditional options, the choice of policy instrument should be tailored to the
precise environmental problem to be addressed. This may entail using market-
based measures, regulation, negotiated agreements, either separately or
in
combination. Site-specific or regional problems require site-specific or regional
responses. Regulatory instruments are likely to remain particularly suitable to
prevent and combat major hazards in the living and working environment.
Irrespective of the exact form of the policy intervention, care must be taken that
the political process leading to its implementation does not lead to the measure
deviating from its stated objective, whether by accident or design. For example,
regulation which imposes tighter emission standards on new installations than on
existing plants may stifle market entry and hamper competition; negotiated
agreements may achieve little more than “business as usual” outcomes, or may
provide opportunities for anti-competitive behaviour; market-based instruments
such as taxes may serve mainly as revenue-raising devices and have little or no
environmental effect. Whatever approach is adopted, environmental problems
should not be tackled in a way which creates or exacerbates other difficulties.
Moreover, the impact of any policy depends on its effective enforcement.

6

4.

ENVIRONMENTAL INTEGRATION, GROWTH, COMPETITIVENESS AND SOCIAL
STABILITY

4.1.

Growth and the environment

is not
The relationship between economic growth and the environment
straightforward. Many environmental problems faced by poorer countries result
from too little economic growth. Growth enhances willingness and ability to pay
for a cleaner environment. In contrast, at low income levels, societies do not
have the resources to provide for even basic needs such as sanitation. The World
Bank has estimated that water pollution in developing countries is responsible for
over 2 million deaths each year5. Moreover, this pollution acts to constrain
economic development by, for example, damaging fishing grounds. Pollution
levels in urban areas are several times higher in poorer than in richer countries.
On the other hand, in the absence of targeted policy measures, quantities of
household waste and emissions of greenhouse gases tend to rise with per capita
income: on current trends the Community will not meet its commitments to abate
greenhouse gas emissions under the Kyoto Protocol to the UN Framework
Convention on Climate Change6.

Nevertheless – at least in the short-term – economic growth, whether in the
developed or the developing countries will likely require increased use of natural
resources, and will lead to more pollution. Bringing economies onto a higher
growth path should therefore be accompanied by improved integration of
environmental factors in decisions and behaviour at corporate and at individual
level. While the Community and other developed countries have made progress
in decoupling economic growth from the use of natural resources, much more
needs to be done. For example, the scientific consensus is that emissions of
greenhouse gases must be at least halved from their current levels if potentially
dangerous human-induced climate change is to be averted. But rising levels of
inevitable. They are not
greenhouse gas emissions or of waste are not
preordained consequences of economic growth. Rather, they reflect inadequate
integration of environmental considerations in the decisions of
individual
consumers and producers. As a result, developed countries now face substantial
costs in repairing past environmental degradation. This is due to a failure to value
the environment and the services it provides.

In the view of the Commission, creating competitive markets for environmental
goods and services will frequently be the most effective way of ensuring that we,
as producers or consumers, value the environment appropriately and integrate it
in our everyday decisions.

5

6

“Growth and the Environment” (World Development Report 1992); World Bank; 1992
The Commission’s Green Paper on greenhouse gas emissions trading (COM(2000)87 of 8th
March 2000) discusses how a system of tradable emission permits could help the Community
achieve its target.

7

4.2.

Competitiveness and environment– the international dimension

intrinsically result

Environmental policies do not
in higher aggregate costs.
Rather, and in particular if implemented using economic instruments, they make
costs more apparent. Incorporating the Polluter Pays Principle as an element of
the integration of environmental issues with economic policy alters the burden of
costs between producers and consumers: polluters have to recover the costs of
abatement efforts through higher prices. This contrasts with a situation in which
the costs are not made explicit but nevertheless fall on society through, for
example, higher health-care expenditures.

Both traditional “command and control” environmental regulations and economic
instruments shift costs to enterprises and consumers for pollution abatement
which would otherwise have been borne by others. In addition, they can entail
substantial transfers of funds for emissions that remain unabated. For certain
sectors a large sudden increase in costs could pose substantial problems notably
vis-à-vis foreign competitors. These problems are not insurmountable. There are
a number of ways to address them.

Instruments such as business impact assessment systems can help to establish the
implications for the sectors and enterprises concerned, and ensure that decision
makers are better informed. Though some environmental problems may require
urgent action, there are others where a more gradual approach to integration is
possible. The economy cannot be put on an environmentally sound path
overnight. The risk in taking an incremental, long-term approach is that the
policy goal may be expressed in such general terms or set so far in the future as
to lack credibility. This can be remedied by setting intermediate milestones
against which progress to the ultimate well-defined policy objectives can be
assessed. Provided that it is credible, a gradual approach to integration should be
consistent with the need to achieve a better environment while avoiding a “step-
change” in the conditions in which companies operate. Adopting a high level of
environmental protection as a policy objective should not mean creating large
quantities of “stranded assets” or making large numbers of workers unemployed.
A gradual approach will give firms time to adapt and to develop innovative
approaches to pollution abatement.

A gradual approach to the internalisation of external costs in which all sectors are
treated equally seems preferable to more accelerated implementation if the latter
is accompanied by tax exemptions or rebates for some sectors. This can result in
environmental taxes having perverse effects. Typically, it is the most energy-
intensive or polluting sectors which receive derogations or exemptions. Since
these sectors are frequently also intensive users of capital rather than labour, the
outcome may be bad both for the environment and for employment. Nonetheless,
countries which have introduced emissions taxes have very often accompanied
them with these types of exemptions because of fears that the affected sectors
face technical constraints which would not allow them to adapt quickly to price
changes, and that they as a consequence would lose international competitiveness
leading to widespread job losses.

8

Such concerns should be less important if a coordinated long-term approach to
the environment is undertaken at Community level or even globally. Indeed, in
the absence of coordinated international action, efforts by the Community to
safeguard the environment cannot be fully successful in the longer term. Global
challenges such as climate change and ozone depletion can only ultimately be
International environmental problems such as
conquered by global action.
transboundary water and air pollution can best be tackled by coordinated
international efforts. The Community’s development policy could assist partner
countries to use market-based instruments such as Joint Implementation and the
Clean Development Mechanism of the Kyoto Protocol. This should improve their
overall economic and environmental performance and be a cost-effective way for
the Community to contribute to global environmental objectives.

The overwhelming majority of
the goods and services produced in the
Community are also consumed in the Community. Exports to and imports from
third countries are each equivalent to less than one-tenth of Community GDP. A
large part of this trade is with countries in Central and Eastern Europe which
have applied to join the Community, or with countries which are members of the
European Economic Area. These countries are committed to implementing
legislation in the short- to medium-term. Steady
Community Single Market
progress by the Community towards improved environmental quality in the
framework of the Internal Market should not therefore have major negative
implications for international competitiveness versus these countries.

A still wider group of countries – including all the major industrialised economies
– is also taking steps towards protecting the global environment by limiting their
greenhouse gas emissions. Although comprehensive common and co-ordinated
action at the global level or at least at the level of the industrialised countries
would be the optimal solution to tackling global environmental problems, lack of
such co-operation should not trigger a major relocation of economic activities.
Indeed, suggestions that higher levels of environmental protection would cause
large parts of production to relocate outside the Community (and the developed
world in general) take inadequate account of the many benefits of location in the
Community. These include guaranteed access to the single market, generally
well-developed infrastructure, and macroeconomic, political and institutional
stability.

Furthermore, substantial differences in tax structures and levels already exist both
within the Community and between the Community and other industrialised
countries. This suggests that differences in tax structures are not
the only
relevant factor for international investment decisions and accordingly, that the
preservation and improvement of international competitiveness does not have as
a pre-requisite identical structures and levels of taxation or environmental
standards across countries or groups of countries.

For all of these reasons, fears that the pursuit of a high level of environmental
protection will inevitably lead to a deterioration of the Community’s international
competitiveness may be exaggerated. It is nevertheless beyond question that
facilitate the
international cooperation on the widest possible scale will
introduction of policies promoting environmental sustainability and in some

9

respects is a necessary condition for their success. In the absence of such co-
ordination, the Community could examine the feasibility of making border tax
adjustments in a way which would be environmentally and economically sound
and consistent with international trading rules.

4.3.

Environmental integration, the distribution of resources and social stability

There are more fundamental
reasons why arguments that well-designed
environmental policy will lead to a loss of international competitiveness are
misplaced. In fact, such arguments are frequently not about macroeconomic
competitiveness, but about the distribution of resources across the economy.

Indeed, tightening environmental regulation and withdrawing or charging for the
use of explicitly or implicitly assigned rights with respect to natural resources and
the environment has distributional implications, as has the initial allocation of
property rights. Here a balance has to be found between the interests of the
incumbent polluter and those suffering from this pollution and society as a whole.

As already argued, improved integration of environmental factors in economic
policy will enhance economic efficiency. Some sectors currently receive hidden
subsidies through not paying for the environmental degradation or damage to
public health linked to their activities. Some polluting sectors benefit from
explicit subsidies which may have been introduced for short-term social policy
reasons. If these subsidies contribute to additional environmental degradation
they are clearly not consistent with the objective of environmental integration.

The improvement in economic efficiency can be accentuated if resources raised
by environmentally-motivated taxes and charges and saved by the removal of
environmentally-damaging subsidies are returned to the economy through cuts in
other, inefficient taxes. A more efficient economy will be more competitive
internationally, not less.

Over time, placing more value on the environment is likely to mean changes in
the goods and services we produce and consume and how we produce them.
Some sectors will decline and others will expand. Overall, we will benefit by
living and working in healthier societies and more efficient economies.
Environmental policies can have a positive effect on employment, where the
supply of environmental goods and services is more labour-intensive than the
economic activities being replaced7.

Economy-wide measures to improve the skills and adaptability of the labour
force, as recommended by the Employment Guidelines and the Lisbon European
Council, will
facilitate the changes induced by improved integration of
environmental and economic policies. Nevertheless, the possibility of negative
repercussions in some sectors and regions cannot be ruled out. For this reason,
any comprehensive integration strategy must contain objective assessment of its
include
full implications. To alleviate potential difficulties the strategy must

7

cf. “Environmental Policies and Employment”, OECD, 1997

10

appropriate structural measures including retraining and other support for the
if moves to improved environmental
workers in the affected industries,
integration are to remain socially and politically acceptable.

5.

MEASURING INTEGRATION: DEVISING INDICATORS

5.1.

Introduction

The integration strategies under development by other Council formations have
already identified several indicators which have both sectoral and general interest.
Indicators such as energy intensity, and emissions of greenhouse gases and other
pollutants, both in absolute terms and per unit of GDP should be part of any
comprehensive assessment . Rather than duplicating the work of other Council
formations, this section focuses on identifying additional indicators of horizontal
economic policy relevance. The Commission will intensify its efforts to devise a
detailed set of indicators of integration of environmental and economic policies
which will support the structural indicators requested by the Lisbon European
Council. This should help to ensure that environmental factors are an integral
part of structural reforms of the Community economy.

5.2.

Indicators on the use and effectiveness of economic instruments

Section 2 above suggested that creating and improving the functioning of
markets for environmental goods and services offers an effective way to improve
integration of environmental and economic policies. This naturally suggests that
indicators about the use of economic instruments may assist in assessing progress
in integration.

The use of economic instruments has traditionally focussed on influencing prices
through fees and user charges or taxes. Perhaps the simplest and most readily
available indicator of
revenue generated by
this type is the amount of
environmental taxes.

These indicators based on taxation should, if possible, be complemented by
analogous data on the use of fees and charges relating to, for example, water use
and waste collection. Intensified cooperation between environmental, statistical
and fiscal authorities at Member State and Community level will facilitate
comparisons between Member States. This will in turn help to spread information
about effective integration strategies.

Indicators on the use of tradable emission permits and negotiated agreements
should also be established, to provide a more comprehensive picture of the use of
economic instruments as a means of integrating environmental and economic
policies.

Quantitative information on the use of market-based instruments must be
complemented by analysis of their environmental and economic effects. The

11

Commission has undertaken such analysis8, and will continue to do so. This
would help spread information about best practices in Member States and
identify successful and less successful attempts to use markets to integrate
environmental and economic policies.

Box 1: Indicators on the use of environmental taxes

An environmental tax may be defined as “a tax whose tax base is a physical unit (or a proxy of
it) that has a proven specific negative impact on the environment”. This definition stresses the
potential impact of a tax on environmentally-harmful activities, rather than the name given to
the tax or its announced purpose. Starting from this definition Commission Services (Eurostat
and the Taxation and Customs Union Directorate-General),
in co-operation with other
international organisations, has devised a classification of environmental taxes under four
headings. These cover energy taxes (mainly taxes on transport fuels), transport taxes, and
pollution and natural resource taxes.

As a percentage of total government revenues from tax and social security contributions, these
taxes have barely increased in importance over the last twenty years, representing a little under
7% of such revenues. Almost all of this is generated by “traditional” taxes such as those on
energy and transport.

However, this gives an overly negative impression. These figures do not show attempts to
differentiate taxes on environmental grounds. For example, while the overall levels of revenues
from fuel excise duties may not have changed much, differentiation between leaded and
unleaded petrol has been successful in persuading motorists to use cleaner fuels. Also, the
amount of revenue raised is a poor guide to environmental impact: an effective environmental
tax will discourage activities which damage the environment. Accordingly, it will reduce its
own tax base, and possibly raise little revenue.

On the other hand, in order to remain environmentally effective over time, these taxes need to
be adjusted regularly to compensate for overall inflation, income growth and fluctuations in the
pre-tax price of the commodity. Indeed, if one really intends to curb or slow the demand for a
polluting commodity or activity its price after taxes should rise faster than income and overall
inflation.

This requires politically difficult discretionary tax changes, unless the tax formula includes an
automatic adjustor.

Accordingly, breaking down the headline revenue data according to the number of taxes, the
products and pollutants taxed, the rates at which they are taxed and the real price after taxes
helps to make the aggregate figure more policy-relevant. Presented as a time series alongside
figures for the volumes of the taxed products and emissions,
this will provide further
information about progress in integrating environmental issues with fiscal policy, and will
show if increased fiscal efforts have been associated with cuts in pollution.

5.3.

Indicators on environmentally-harmful policies and measures

Developing a comprehensive integration strategy also requires indicators relating
to policies which intentionally or unintentionally encourage activities which are
environmentally harmful.

8

See for example “Evaluation of environmental effects of environmental
Commission, 1998; an updated version of this study will be available shortly

taxes”, European

12

Progress in reforming environmentally damaging policies appears to be blocked
in part by a lack of comprehensive information on the extent of these counter-
productive measures. A recent OECD report which sought to identify the scope
for improving the environment by reducing subsidies found that, with some
exceptions, internationally comparable data on support levels was either scarce or
almost non-existent9. Developing agreed indicators on the extent and impact of
these policies could accordingly remove an important obstacle to improving
integration.

5.4.

Indicators about the value of the environment

Although Gross Domestic Product is the most readily available (and therefore
widely used) indicator of economic well-being, it is strictly speaking a measure of
production. From the perspective of environmental integration, GDP data have
two major weaknesses. They do not provide information about potential
scarcities of natural resources which could threaten future economic activity, and
they neglect degradation of environmental quality which could have negative
impacts on human health and well-being. To fill these gaps, considerable effort
has been made to develop “satellite” national accounts and indicators such as
measures of savings and wealth which attempt to capture the impact of depletion
and degradation of natural resources. These aim to complement conventional
economic statistics and extend the range of information available to public
authorities. By identifying the depletion and degradation of environmental
resources associated with different economic activities they can help policy-
makers to take account of the value to society of these resources. Improved
information about the value of environmental resources – including the value of
positive environmental effects generated by some economic activity – can
enhance the consistency and transparency of policy-making by making explicit
the valuations which are implicit in any environmental policy measure.

5.5.

Indicators about “environmental” industries

The process of improving integration of the environment into economic policies
entails changing the focus of policy from environmental problems to the causes
of those problems. This suggests that a classification of environmental activities
into two main sub-categories, one covering pollution prevention and abatement
(integrated technologies and processes), the other relating to repairing pollution
damage and providing environmental services would be useful for monitoring
progress with integration. Information derived from the second sub-category in
particular could be useful in resolving some of the uncertainties in valuing
environmental resources. The amount of money spent on repairing damage and
providing environmental services may serve as a guide to the value placed on the
environment. However, the data which would allow such a classification remain
to be developed at Community level. Accordingly, it will not be possible to
produce these indicators in the short- to medium-term.

9

“Improving the Environment
Conclusions”; Organisation for Economic Co-operation and Development, 1998

through Reducing Subsidies; Part

I: Summary and Policy

13

6.

CONCLUSIONS

The Helsinki European Council requested the Council to submit comprehensive
to the
strategies for environmental integration and sustainable development
European Council in June 2001. It will be important
these
comprehensive strategies propose consistent policies across different sectors. The
contributions from various Council formations to the preparation of the Broad
Economic Policy Guidelines should help to guarantee that a coherent, systematic
approach is taken.

to ensure that

Environmental protection based on increased use of market-based instruments
should be taken into consideration in the preparation of the Broad Economic
Policy Guidelines and recommendations concerning the quality and sustainability
of public finances. Making better use of environmental taxes and charges than is
now the case would contribute to economic efficiency and broaden the tax base.
This would help Member States continue fiscal consolidation while improving the
quality and sustainability of public finances, in line with the Lisbon European
Council conclusions. At the same time, markets to which these instruments are
applied should be made more competitive and more responsive to price signals.

Integration of environmental and economic policies will also be improved by
removing environmentally-damaging subsidies. While there is widespread
agreement that such subsidies exist and are a potentially significant source of
environmental damage, little firm information about their extent and incidence
appears to be available. Using as a model the approach used to identify cases of
harmful tax competition between Member States, the Commission proposes that
the Council should examine the positive and negative environmental impacts of
national taxation systems, taking account of work already being done within the
Community. This review should be as comprehensive as possible, and include
direct and indirect, explicit and implicit, intended and unintended effects of
subsidies, taxes, tax differentiation and tax exemptions or reliefs. The results
would enable Member States to share information about “best practice” in
national fiscal policies, and identify those elements of national systems which
have especially strong environmental effects, both good and bad. This would help
in setting priorities for environmentally sound fiscal reforms.

The increased use of market-based instruments should be reflected in reports on
economic reforms of product and capital markets. As recommended in the 2000
Broad Economic Policy Guidelines, the Ecofin Council could demonstrate its
own credentials as an agent of environmental integration by rapidly adopting the
Commission’s energy tax proposal in a form which does not compromise its
environmental effectiveness.

issues which are

A coordinated approach within the Community to implementing the polluter pays
principle – whether by taxation or other market-based instruments – will help to
address
the heading of
“competitiveness”, even if - as suggested in section 4 above - this is a misnomer,
since macroeconomic competitiveness should be enhanced by moves towards
better integration of environmental concerns. Where taxes or charges are the
appropriate means of improving integration, they should start at low rates and be

commonly grouped under

14

progressively increased, allowing firms to adapt to the new set of prices and find
innovative solutions to pollution abatement and control. This contrasts with
current practice in individual Member States, which tend to start with relatively
high tax rates but grant lengthy exemptions or rebates for the larger polluters.
Apart from the fact that this may turn out to be environmentally irrational, it also
risks damaging the Single Market and falling foul of Community State Aid
legislation. Again, a coordinated approach at Community level may help to
enhance the credibility of
introducing effective pollution taxes gradually.
Establishing a minimum Community framework could also help those Member
States which wish to move faster in integrating environmental concerns but fear
that autonomous action would lead to a loss of competitiveness. The
Commission’s proposal
to the Intergovernmental Conference that qualified
majority voting be used for environmental taxation is aimed at easing the creation
of such a framework10.

Based on the above, the Commission suggests that the following should form the
essential elements of a Community strategy for improving the integration of
environmental issues with economic policy:

• the Community should adopt a transparent, gradual, credible approach to
environmental integration, based on efficient target setting, derived from a
comprehensive analysis of the available scientific and technical data,
the
environmental conditions in the various regions of the Community, and the
potential costs and benefits of action or lack of action

• integration of environmental issues with economic policy must be consistent
with the strategy for sustainable development which the European Council
intends to adopt in June 2001

• examination of the environmental impacts of economic activity and regulation
should be integrated into the process of multilateral surveillance of structural
reform, as should be the way environmental policies impact on the economic
reform process (level of regulation, functioning of markets)

• the Broad Economic Policy Guidelines should fully incorporate the objectives
of environmental integration, making use of a reliable set of indicators to be
developed

• reviews of the quality and sustainability of public finances should take
particular account of the contribution of taxation and expenditure polices to
environmental integration and should contain an assessment of the efficiency
of economic instruments in achieving their environmental objectives

• improved integration of environmental issues into economic policy should
make increased use of an appropriate mix of market-based instruments and

10

“Supplementary contribution of the Commission to the Intergovernmental Conference on
institutional reforms: qualified majority voting for Single Market aspects in the taxation and
social security fields”, COM(2000) 114 final of 14 March 2000

15

regulation; this should include the removal of subsidies which are harmful to
the environment and should take account of analyses by the Commission and
other bodies of the environmental and economic effectiveness of market-based
instruments.

This approach should help to ensure that the Community achieves growth which
is economically and environmentally sustainable.

16

Annex 1
Concepts of Sustainability

The words “sustainable development” mean different
things to different people. A
macroeconomist may see the concept in terms of the relationship between the rate of
increase in Gross Domestic Product, the inflation rate, the fiscal accounts, and the balance
of payments. This is essentially a short- to medium-term definition of sustainability. It
neglects broader considerations. These include the long-term viability of the ecological
systems on which much economic activity depends, and whether the distribution of the
growth in income is giving rise to inequalities between rich and poor which threaten social
cohesion.

An environmental activist will in contrast regard sustainable development as being about
issues such as global warming and the preservation of biodiversity. Economic or social
side effects of environmental policies may receive little consideration. Definitions of
environmental sustainability are often expressed in quite general terms. This may make it
difficult to translate them directly into workable policy prescriptions.

Perhaps the most often cited and widely accepted definition of sustainable development
comes from the World Commission on Environment and Development (the “Brundtland
Commission”)11. It defined sustainable development as development which “meets the
needs of the present without compromising the ability of future generations to meet their
own needs”. This definition needs to be given substance to make it useful for policy
makers.

While we cannot know the needs of future generations, it seems unreasonable to assume
that they should be any less than our current needs. That is, as a minimum we should aim
at ensuring that in meeting our needs, we do not prevent future generations from enjoying
at least
the same “standard of living” as we do. What are the implications of this
objective?

Each generation meets its needs by making use of the resources available to it to produce
goods and services which it can consume. In addition, some of the available resources
may be used to create new resources which will be available to produce goods and
services for consumption in the future. This provides a first criterion which may be applied
when assessing the sustainability of economic policy: is the supply of resources which we
are leaving to future generations sufficient to enable them to meet their needs? To put the
same question in slightly different terms, what constraints does this sustainability criterion
place on how we use the resources available to us?

Three different types of resources are the inputs for producing goods and services: human
capital, natural capital and physical capital. Some goods and services may be produced
using a variety of techniques. That is, the proportions of human, natural or physical capital
used in their production may vary. However, the observation that different categories of
resources may be substituted for one another when using them to produce goods and
services needs to be qualified. Natural and physical resources are not perfect substitutes.
That is, natural resources generate some services which simply cannot be produced by

11

“Our Common Future”; World Commission on Environment and Development; 1987

17

other means, and without which we could not survive. Two implications follow from the
observation that natural and physical resources are substitutes, but not perfect substitutes.

The fact that there is some room for substitution between natural and physical resources
implies that sustainability gives some degree of freedom to the current generation as
regards the use it makes of the natural and physical resources available to it. It is not
necessary that we pass on to our successors exactly the same quantity and quality of each
type of natural and physical resources which were available to us. Rather it requires that
the aggregate of these resources available for use by future generations, together with
their human resources, be able to generate goods and services which will enable future
generations to meet their needs at least as well as the current generation.

As well as substituting between resources, societies may also substitute goods and
services for one another – they may choose to consume different types of goods and
services in different quantities. Thus, sustainability does not require that
the same
distribution of goods and services be available to future generations. What matters is that
the range of goods and services be such as to enable future generations to achieve the
same level of well being as the current generation.

This concept of sustainability closely corresponds to a definition which is often referred to
as the “weak sustainability” criterion.
In such a framework, a policy aiming at
sustainability would have to strike the right balance between the accumulation and
depletion of economic, social and environmental assets. Alternative definitions of
sustainability include:

–

–

“Strong sustainability”: this stresses the importance of natural capital, on the
grounds that it provides services which cannot be replaced or provided by other
means;

“Environmental sustainability”: this requires preserving the physical flows of
goods and services from natural resources.

The differences between these and other concepts of sustainability essentially relate to the
degree to which natural and physical capital can be regarded as substitutes for each other.
However, these differences should not distract from the large degree of overlap which
exists between competing concepts of sustainability. All agree that our use of natural
resources cannot be unlimited. The environment has a finite capacity to absorb the waste
by-products of economic activity. Development of Community policy towards
sustainability should not be delayed by arcane discussions about what exactly the limits
are.

18

Sustainability as a practical policy principle

Consider the construction of a hydroelectric power station. This entails replacing natural
resources with physical resources, and changes the type of services available for society. Instead
of the services generated by the “original” landscape, which may have included fishing, or
tourism services, society now has the use of the electricity generated by the power station.
These services may or may not be adequate to compensate for the services they replace. It is
impossible to say what relative value society will place on these sets of services in every case.
Yet this determines whether building the power station is consistent with the concept of
sustainable development. If the electricity is more valuable, then the power station is consistent
with sustainability; otherwise it is not. The important point is that replacing natural by physical
capital may be consistent with sustainability.

In contrast, climate change is an issue where consideration of the sustainability criterion does
give a clear direction to policy. There is widespread scientific consensus that
increased
atmospheric concentrations of greenhouse gases as a result of human activity – mainly carbon
dioxide from burning fossil fuels – risk changing the earth’s climate in unpredictable but
potentially highly disruptive ways. In other words, our current levels of use of fossil fuels and of
the atmosphere as a dumping ground for the carbon dioxide they produce are unsustainable.
That is, our current behaviour risks compromising the ability of future generations to meet their
needs. Accordingly, under the terms of the Kyoto Protocol to the United Nations Framework
Convention on Climate Change, the industrialised nations have agreed to start reducing their
emissions of greenhouse gases in order to move towards a sustainable development path.

The risks that climate change will seriously damage the welfare of the current generation are
generally agreed to be quite small: a cost-benefit analysis which only took account of benefits
directly received by the current generation would almost certainly conclude that action to
prevent climate change was not justified. The fact that progress is nonetheless being made
towards addressing the issue is a practical example of the integration of environmental
considerations with economic policy making, and shows that the sustainability criterion can
have real-world policy implications.

Integrating environmental considerations with economic policy making via the sustainability
criterion may or may not yield workable policy prescriptions in every case. We may be unable
to arrive at a satisfactory operational definition of sustainability which will determine decision-
making always and everywhere. Frequently, the decision whether a particular development is
or is not consistent with sustainability will be a matter of judgement. However, incorporation of
the sustainability criterion into decision-making provides the outline of an analytic framework
in which these judgements can be made, in awareness of the consequences of decisions taken
now for the welfare of future generations.

19

Annex 2
Economic Instruments for Environmental Integration

On the basis that a key reason environmental issues are insufficiently integrated with
economic policy is because markets for many environmental goods and services are either
missing or incomplete, section 2 of this Communication identified a number of market-
based instruments with the potential
to improve integration of environmental and
economic policies. This Annex provides some additional detail.

Property rights

Environmental externalities arise because of inadequate or missing markets for
environmental goods and services. The definition and allocation of tradable
property rights creates a market,
thereby internalising the externality. This
ensures that social and private costs are equalised, and leads to an economically
efficient outcome.

The question of whether polluters or victims receive the property rights has some
important implications for equity – for the question of who owns society’s
resources. If the polluters receive the property rights, they are paid to reduce
their pollution; if the members of society get the rights, then the polluters pay
them for the right to pollute. Integrating environmental issues into economic
the Polluter Pays principle will have profound
policy by application of
implications. Not only is the Polluter Pays principle a sound basis for
environmental policy, it can also lead to efficient and equitable economic policy,
and contribute to social cohesion.

Although assigning property rights to an environmental asset – either to the
victims of pollution or to the polluters – may be all that governments need to do
to enable environmental problems to be resolved in an economically efficient
manner, many environmental questions are not amenable to such a “pure” market
solution.

Many forms of air pollution, for example, are caused by thousands of sources and
affect millions of people. In such circumstances, it is impossible for any individual
to precisely identify the source of the pollution that affects him or her. It is also
unlikely that it is in the interest of any one individual to take action against any
source of pollution, because this pollution will also affect many others: the costs
of taking action will be borne by the individual, but the benefits will be felt by
several. In these circumstances, each person has an incentive to “free-ride” on the
efforts of others. Thus, assigning property rights will not on its own be sufficient
to lead to an economically efficient outcome. If a right to pollute is assigned to
firms, individuals are unlikely to be able to organise themselves to collectively
pay firms to reduce pollution; if a right to clean air is assigned to citizens, firms
will find it prohibitively expensive to purchase part of this right from its
individual owners.

Faced with this situation, a government which does nothing implicitly subsidises
polluting activities and places no constraint on the level of pollution. On the other
hand, assigning property rights explicitly to either the polluters or the victims of

20

pollution will be equally ineffective. However, given that
the pollution is
environmentally undesirable and economically inefficient some form of public
intervention is needed to protect society’s interests. To put the issue in the
context of an integrated approach to sustainable development, the challenge is
how the environmental objective of reduced pollution can best be integrated with
economic policy objectives of maintaining levels of output and employment
which will enable the needs of the population to be met, consistent with the goal
of social sustainability.

Charges, tradable permits, subsidies and other incentive payments

they can nevertheless use market

When governments cannot create functioning markets by attributing property
forces to improve or maintain
rights,
environmental quality by levying charges or offering payments. These put a price
on environmental resources. They thereby make progress towards internalising
the environmental externality by bringing private and social costs closer together.
The fact that it will almost always be impossible to determine precisely the cost
of the damage caused by pollution or the benefit provided by an environmental
service in any particular case does not invalidate the economic and environmental
arguments in favour of making polluters pay and of compensating service
providers.

Tradable emission permits offer a potentially attractive market-based means of
implementing environmental objectives when an absolute quantity of pollution is
the policy target12. However, they will not be a suitable instrument in every such
case. If the pollutant in question gives rise to environmental “hot spots”, then
other forms of pollution reduction should be pursued. If the cost of measuring
emissions from individual sources is expensive relative to the cost of pollution
abatement, and if it is not possible to monitor the use of some input which is
closely correlated with emissions, then tradable emission permits will not offer a
cost-effective approach.

In terms of the impact on the environment,
it makes little difference in
competitive markets whether the permits are sold (“auctioned”) or given away
(“grandfathered”) – in either case, the quantity of permits is known and limited,
and it is this which provides the environmental benefit. Both, grandfathering the
permits and auctioning achieve internalisation of external costs – a necessary
condition for economic efficiency. However, auctioning has the advantage that
the revenue raised from the sale of tradable emission permits can – and should –
be used by governments to reduce distortionary taxes elsewhere in the economy,
thereby giving a further boost to overall efficiency.

From an economic perspective, subsidies or other incentive payments to “clean”
activities or for switching to such technologies are in principle equal to charges

12

For this reason, the Commission has recently suggested that tradable emission permits could
“form part of a coherent framework of common and co-ordinated policies and measures for
reducing greenhouse gas emissions and implementing the Kyoto commitments” (Green Paper on
greenhouse gas emissions trading within the European Union ; COM(2000)87 of 8 March 2000).

21

or taxes on “dirty” activities as a means of achieving environmental policy
objectives as both remove or reduce the difference between private and social
costs of the polluting activity. However, this indifference holds only if raising the
revenues to finance these payments does not introduce an additional distortion
somewhere else in the economy..

Paying for a reduction in negative externalities rather than charging for negative
externalities raises questions of income distribution in general, and more specific
the issue of the distortion of competition in the Single Market13. From an
environmental policy perspective, such payments do not respect the Polluter Pays
they can help to stimulate the diffusion of new
principle. Nonetheless,
environmentally-benign technologies or activities,
is
impossible or difficult to apply the Polluter Pays principle. The risk in such a
“second best” approach is that recipients of the subsidies may become dependent
on them, making it difficult
to remove them even when they have no
environmental or economic justification.

in particular when it

Negotiated agreements

In its 1996 Communication on Environmental Agreements14, the Commission
observed these agreements “can bring about effective measures in advance of
legislation and thus reduce the volume of regulatory and administrative actions”.

Compared with legislation which may prescribe uniform standards or use of a
technology, negotiated agreements leave industry with greater
particular
flexibility in reaching the agreed environmental
targets. This encourages
innovation to reduce compliance costs. To be successful these agreements must
set well-defined, quantified objectives which can be monitored. Publication of
agreements helps to ensure their credibility and transparency, and should avoid
negotiations which do little more than validate “business as usual” scenarios.

The environmental effectiveness of negotiated agreements
in achieving
reductions in pollution over and above those which would have occurred is
difficult
its activities than the
regulator.

to assess since industry knows more about

Realistically, such agreements can only be negotiated with sectors where there is
a strong industry association which represents all or almost all the firms in the
sector and is authorised to negotiate on their behalf. Moreover, a sectoral
approach may lead to inconsistent
thereby
introducing additional distortions into the economy. This may lead to a situation
in which the burden of pollution reduction falls unduly on smaller enterprises in
developing sectors, and households.

treatment of similar problems,

13

14

The “Community guidelines on state aid for environmental protection” (OJ C72 of 10 March
1994) give guidance as to the types of aid which may be compatible with Single Market rules
Communication from the Commission to the Council and the European Parliament on
Environmental Agreements; COM(96)561 of 27 November 1996

22

In some situations negotiated environmental agreements may be a more effective
regulation. Depending on the
means of
circumstances negotiated environmental
a useful
could be
complement to market-based instruments.

reducing pollution than direct

agreements

Information

The role of information in enabling the efficient functioning of markets is easily
overlooked. Too often, information available to consumers and producers about
the environmental impacts of different goods and services is either missing or
incomplete, or is presented in a form which does not facilitate informed choices.
low-energy light bulbs, while costing more to buy than
For example,
incandescent bulbs, have considerably lower running costs to
conventional
deliver the same amount of light and last much longer. Without knowing how
much of their electricity bill is due to lighting, how are consumers to decide if
buying low-energy lighting is a good deal? Similarly, energy labelling of domestic
appliances which only identifies differences in energy consumption does not
readily allow consumers to judge whether the higher purchase price of an
appliance with lower running costs is justified in comparison with one which is
cheaper to buy but dearer to run.

The effectiveness of clear, reliable information can be enhanced when it
is
combined with price signals which incorporate the environmental costs and
benefits of different goods and services. Indeed, such price signals can lessen the
need for regulations obliging the provision of consumer information. In the wake
of the first oil price shock, fuel consumption performance became an important
selling point for car manufacturers. While many of the figures claimed were
unlikely to be widely replicated by actual driving conditions, the spontaneous
emergence of such material shows the role that price signals can play in
improving consumer information. The prominence given to information about
fuel consumption in the 1970s and 1980s, when fuel prices were relatively high,
contrasts with the situation in the late 1990s, when low fuel prices led the
Council and European Parliament to adopt a directive requiring the display of
fuel consumption data15. Because fuel had become a less important part of the
total costs of car ownership, it had less influence on consumers’ choices.

Better information can also help firms – particularly SMEs - to choose less
polluting methods of production. Farmers may benefit from better information
about how to achieve acceptable crop yields while using less nitrogenous
fertilisers. Energy audits, for example, may enable firms to improve their
competitiveness by reducing their energy use per unit of output produced, while
simultaneously reducing emissions of greenhouse gases and other pollutants.

15

Directive 1999/94/EC of the European Parliament and of the Council of 13 December 1999
relating to the availability of consumer information on fuel economy and CO2 emissions in
respect of the marketing of new passenger cars; OJ L12 of 18 January 2000

23