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Is it time for Texas to tax pollution?

During the fourth special session of 2004, Texas legislators focused on finding new sources of revenue to enable school finance reform. Among the many ideas suggested was the establishment of a tax on pollution. Rep. Lon Burnham sponsored House Bill (HB) 35, which proposes taxing electricity generators at a rate of 60 cents for each pound of nitrogen oxide (NOx) released into the air.

This was not the first time such a proposal crossed legislators' desks. In the 75h session (1997), Rep. John Hirschi advanced a much broader proposal. His HB 2479 advocated taxing all regulated emissions from all major industrial facilities. In light of the need for new sources of revenue to reduce property taxes, is now the time to give serious consideration to taxing pollution?

The Theory Behind the Tax

Pollution imposes costs upon society, and some form of environmental regulation is necessary to ensure that pollution-related costs are limited to socially optimal levels. Since the 1920s. (1) economists have endorsed pollution emissions tax0s as one efficient means of constraining pollution to acceptable levels and better reflecting environmental costs in market transactions. Unlike "command and control" approaches to regulation, pollution tax systems provide firms with considerable flexibility in meeting pollution targets. Regulatory approaches involving tradable permits also provide firms with the latitude to devise a least-cost response to pollution objectives. However, these approaches tend to bestow a "right to pollute" upon existing polluters, which can pose a barrier to entry on new industrial facilities. Further, pollution taxes have an attractive "polluters should pay" property of fairness that may be absent from other regulatory strategies.

Taxes on income, revenue, sales, and labor tend to hinder productivity and growth and impose "deadweight losses" on the economy. Many economists see merit in replacing existing taxes on "goods" (the creation of wealth through labor and investment) with taxes on "bads" (e.g., pollution) of "sins" (e.g., alcohol, tobacco, or topless nightclubs). In 1997, more than 2,500 economists, including eight Nobel laureates signed a petition suggesting to policymakers that "carbon taxes or the auction of emissions" be used to curb emissions thought to be responsible for global climate change. (2)

Possible Impacts in Texas

The tax burden associated with any pollution taxes on industrial sources would vary depending upon whether the tax covered all regulated emissions or simply NOx. Either approach would produce a considerable impact on electricity generators (accounting for about 45 percent of NOx emissions and 48 percent of total regulated emissions from major industrial sources in Texas).

In model simulations conducted in the early 1990s, the Center for Energy Studies, University of Texas at Austin, found that if emissions taxes were set to the "social cost of pollution" values that had been adopted by environmental and utility regulators in other states, there would be significant impacts on electric power plant operations in Texas. Increased electricity generation from natural gas-fired power plants would displace that using Rocky Mountain coal. Conservation and renewable energy, projects would be encouraged. The use of Texas lignite would not be affected, unless very high emissions tax rates were imposed. Emissions taxes, at the levels studied, would succeed in reducing air emissions. Tax revenues from power generators alone might approach $600 million per year if the social cost of pollution values approved by the New York Public Service Commission were used as the basis for pollution taxes in Texas. Although the electricity market in Texas has changed greatly over the past decade, many of these results remain plausible.

Imposition of emissions taxes could place some industries in Texas at an economic disadvantage relative to their out-of-state competitors, unless other taxes on industry in Texas are reduced or other states and nations follow our lead. This may be of greatest concern to the state's petroleum refineries and chemical production plants, which compete in international markets, but of lesser concern to the electricity generators, given the state's limited interstate transmission capability.

Roadblocks to Taxing Pollution

So why have Texas policymakers been slow to embrace this idea? For one thing, experts disagree on the social cost of pollution and the "optimal level" for any emissions taxes. Further, firms already "internalize" many of these pollution-related costs through their compliance with existing environmental regulations and programs. The Texas Council for Environmental Quality (TCEQ) already assesses various permit and inspection fees on major industrial sources of pollution. At some point, emissions taxes can adversely affect industrial activity, so it is important that the fees are not increased to excessive levels. Thus, any additional layer of environmental regulation must be carefully crafted.

Replacing property taxes with pollution taxes will likely shift tax burdens away from cleaner industries (e.g., high-tech firms) toward those with higher emissions levels (e.g., electricity generators and chemical production facilities). Many such "smokestack industries" wield considerable political power.

Finally, electricity prices (and perhaps chemicals and petroleum prices) could increase, if other taxes on affected industries were not simultaneously lowered.

Next Steps for Texas

The Joint Select Committee on Public School Finance examined "benefit taxes" on businesses, a broadening of sales taxes, changes to existing taxes, expansion of the state lottery, personal income taxes, and many other proposals, but neglected to consider pollution emissions taxes seriously. The Texas Public Policy Foundation studied sales tax changes and various business taxes extensively. (4) Public Citizen and the Texas Center for Policy Studies note that the TCEQ's present emissions fees contain a "volume discount" feature (i.e., as the amount of pollution increases, the fee declines on a per-ton basis) and that simply removing or reducing this feature would raise significant revenues and send a more appropriate "price signal" to industrial facilities. (5) Indeed, such facilities are assessed fees based on only the first 4,000 tons of pollutants released.

As Texas policymakers continue to seek new revenue sources to enable property tax reform and effective strategies to improve air quality in the metropolitan areas of Texas, taxes upon pollution deserve consideration.


(1). Arthur Cecil Pigou (1920), The Economics of Welfare, London: MacMillan.

(2.) Redefining Progress (1997), The Economists' Statement on Global Climate Change.

(3.) Jay Zarnikau (1992), "Pollution Emissions Taxes: A Proposal for Implementation in Texas," in The Role of Natural Gas in Environmental Policy, Bureau of Business Research, University of Texas at Austin.

(4.) Milton Holloway (April 2004), "An Economic Analysis of Property Tax Relief Funded by a Sales Tax Increase," and (May 2004), "Weighing the Difference: The Evaluation of the Unequal Burden of State Taxes for Texas Business," Texas Public Policy Foundation.

(5.) Public Citizen and Texas Center for Policy Studies (February 2003), Making Polluters Pay: Environmentally Responsible Ways the 78th Legislature Can Raise New State Funds.

Frontier Associates and Visiting Professor

LBJ School of Public Affairs University of Texas at Austin
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Author:Zarnikau, Jay
Publication:Texas Business Review
Geographic Code:1U7TX
Date:Oct 1, 2004
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