Part 1 Introduction

　　During the period from August 97 to August 98, the Working Group on Environmental Economics made studies on the planned projects on the basis of the work done b y the WG during the first phase. These projects are as follows:

　　Green Taxation: theory, international practice and relevance to China

　　Environmental Accounting

　　Economic Instruments for industrial Pollution Control in China

　　Sustainable Agriculture

　　Biodiversity

　　Fisheries

　　The second session of the WG was held in Harbin, Heilongjiang Province, July 199 8, discussing the research results on ablve projects. The main results on Green Taxation and Economic instruments for industrial Pollution Control in China are concluded in part 2 and part 3 of this report.

　　Part 2 Study on Green Taxation: Theory, International Practice and Relevance to China

　　The object of this study is threefold:

　　(a) to review the state of the art in environmental taxation worldwide, both in terms of theory and practice with detailed analysis of the mst promising models, instruments and experience;

　　(b) to review the status and performance of environmental taxation in China, inc luding tecent assessments and proposed improvements by the State Environmental P rotection Adminitration, the World Bank and others;

　　(c) to identify opportunities and assess the potential for expended environmenta l taxation in China, both at the micro level(optimal pricing to ensure efficient resourc use) and at the macro level(fiscal reform to integrate environment and economy).

　　2.1 Rationale for Environmental Taxation

　　Full-cost pricing (marginal opportunity) ofresources, goods servies requires t hat all costs, present and future, intemal (private) and extemal to the users th at are incurred by society during production and consumption are incorporated an d fully covered by the price of the goods or service. Environmental taxes are on e of the princepal economic instruments that are used to effect full-cost prcing : to bring the gap between private and social cost. To do this, the tax should b e set exactly equal to the marginal environmental damage corresponding to the so cially optimal level of pollution. Environmetal taxes can be levied on the pollu tant itself (effluents or emissionstaxes) or on final products associated with e nvironmental extemalities (product taxes).

　　Enviromental taxes, if properlystructured, can become a major thrust of fiscal policyreform. Conventional taxation throughout the world taxes work, income, sa vings, investment, and value added and leaves untaxed (even subsides) leisure an d consumption, resource depletion, and pollution. If a reform of fiscal system t hat would reduce conventional taxes and rplace them withenviromental taxes, so a s to leave the total tax burden unchanged, would probably bring a better environ ment and stimulate economic growth as well( therefor called double dividend).

　　Although there is a rather heated debate as to whether a revenues neutral envi ronmental taxe would actually result in a double divedend,it is agreed that brao d-based envirronmental taxes with incidence on low marginal tax inputs that repl ace revenuses obtained from taxes withhigh marginal tax rates are likely to resu lt in zero or negative cost (benefit) to the economy. While an overnight shift f rom " taxes on value " to " taxes onvice "is unlikely and potentially disruptive , gradual shift towards environmental taxes would be a move in the right directi on. For example, income taxes could be reduced and the lost tax revenues replace d byproduct taxwe on gasosline, chemicals, and other polluted products.

　　2.2 International Experience with Environmental Taxes

　　Teh introduction of environmental taxation especially in the form of energy ta xes has accelerated during the past the years among OECD countries and some deve loping countries, While all OECD countries tax pollution one way or another, tax rates have been low aiming to collect revenues rather than to provide incentive s for changing be havior. The 1990s have witnessed an effort led by the Nordic c ounties and Germany to increase enviromental tax rate in general to more meaning ful leveles, and the introduction of taxes on carbon dioxide, sulfur and nitroge n oxide, etc. The performance of environmental taxes in several European countri es are evaluated and concluded that their environmetal effectiveness was easier to document than their incentive effects(incentives for producers and consumers) .As for resource taxation, some counties, such as the Philippines, get more than half of the rents through successful reforms especially of the forest sector 0p olicies. Indonesia has been particularly successful in capturing rents from petr oleum and mineral extraction.

　　Despite their great potential, both as incentives for improved environmental b ehavior and generators or revenues for finaning sustainable development investme nt, environmental taxes have not expanded as rapidly and as widely as it was hop ed because of the political cost of higher taxes and concerns about their effect on competitiveness and distribution. Another concern has been the institutional and adkministrative requirements of environmental taxes imposed on emissions th at are difficult to monitor.

　　European countries have used tax differentiation and its variants as a transit ional policy to speed up the inplenentation of regulaftion of polluation of poll ution products. These measures have two potential applicabilities to China: (a) a differential VAT (value added tax) between environmentally friendly and unfrie ndly products; (b) a reduction in the annual road tax on cars and an increase in the indirect tax on car fuels.

　　Studies has shown that if taxes with high marginal rates are chosen to be repl aced byenvironmental taxes that are broad-baesed (e.g. energy taxes) andwhose in cidence falls on factors with low marginal excess tax burden, " double divedend " may result consisting of higher GDP and lower environmental damages. For examp le, Statistics Norway has estimated that raising additional revernes through env ironmental taxes on gasoline, mineral oil or CO2 would result in a negative cost to the economy compared to a high and positive cost for conventonal taxes inclu ding income and value added taxes, It is expected to see more countries introduc ing environmental taxes in the future.

　　2.3 Current Environmental Taxation in China

　　There are three major categories involved in the reform of envirnmental taxation in China: fiscal system, the pollution levy system and user charges.

　　2.3.1 The Fiscal System

　　China's fiscal system has undergone significant changes and reforms in the 1991 0s. The fiscal reforms instituted in 1994 have introduced a taxation system, whi ch is dominated by receipt taxes and income taxes. Taxes in the new fiscal syste m, prmary in tems of environmental relevance are: the excise tax, the value adde d tax, the resource taxes, property taxes (the vehicle and ship use tax), and th e taxes on special conduct on behavior (especiall the tax for griding investment in fixed assets and the City and Town Construction and Maintenance tax). The ex cise tax is imposed on five energy and energy-related products: gasoline, diesel oil, motorcycles and cars, but is does not apply to coal. The resource tax appl ies to seven types of mineral resource, including coal, crude oil and natural ga s, with a low tax rate that have resulted in modest tax revenue and liited effec tiveness as an economic instrument. The excise tax and value added tax provide s cope for environment-based tax differentiation.

　　2.3.2 Pollution Levy System

　　China introduced the pollution levy system in 1979, and has mde great achieveme nts especially in terms of that it raises the environmental awareness of enterpr ises and the level of environmental invesments in pollution rtreatment. However, the levy system suffers from several weaknesses:

　　(a) The low rate of the pollution charge (significantly below the marginal cost of abatement) does not provide incentive for enterprises to treat of reduce poll ution; and its increase has lagged behind the inflation rate;

　　(b) The non-compliance penalty nature of the charge doed not provide on-going in centives for pollution reduction and innovation, while its assessment only on th e density of the pollutant most exceeding the standard, perverse incentives for dilution and pollutant substitution.

　　(c) The economic efficiency of the levy system is further compromised by the lac k of differentation according to the quality of the local environment and the na tural capacity.

　　(d)The charge system is ill suited to and only erratically aplied to the rapidly growing sector of township and village enterprises.

　　(e)The recycling of revenues to charge-paying enterpricses in the form of pollut ion treatment sibsidies reduce the incentive for polluters to change their behav ior.

　　2.3.3 Integrating Environmental Taxes into Fiscal Reform

　　China is undergiong unprecedented reform in at least three in at least three a reas relevant tenviron mental taxation: institutional reform, fiscal reform, and environmental policy reform (especially of the levy system). This is a particul arly opportune time toconsider streamlining the current disparate system of poll ution charges and fees and environment related taxes and integrating them into a n internally consistent and economically efficient environmental taxation system . Despite the apparent appeal of integrating environmental taxes into the fiscal system, environmental taxes are not necessarily compatible with fiscal reforms that aimed to simplify the tax system by reducing the number of taxes and tax ta tes. In order to reconcile environmental taxes with fiscal reform, the following guidelines need to be observed: (a) avoid desiging sophisticated environmental taxes that reflect closily environmental damage (use very broad measures of dama ge); (b) limit the number of new raftes and taxes to a minimum by balancing admi nistrative efficiency againsy economic efficiency; (c) recycle the revenues from environmental taxes to reduce the tax rates of existing distortionary taxes suc h as taxes o labor and cpital.

　　Environmental taxes have significant distribution impacts, which depend on loc al circumstances, location, tin horizon and how the revenues from environmental taxes are spent. These impacts may be addressed through (a) differnetial taxati on (lower taxes on necessities), (b) retraining, compensation of impacts and gra dual implementation, (c) revenue neutrality i.e. commensurate reduction of other taxes with high incidence on the poor and (d) increased progressively elsewhere in the tax system.

　　Part 3 Economic Instruments for Industrial Pollution Control in China

　　3.1 The Existing Situation

　　3.1.1 Macro Policy Cntext

　　Economy-wide policies, both sectoral and macroecnomis, often have significant environmental effects. Some of these policy reforms which usually promote effici ency of reduce prverty, may also be bendficial for the environment, but some may have negativeenvironmentarl effects which call for complementary environmental measures to remedy. In the case of industrial pollution, such environmentally fo cused remedial actions would include both market-based approaches (like Pigouvia n taxes on environmental extemalities, or allocation of pollution rights coupled with marketable permits), as well as non-market methods (such as command-and-co ntrol techniques, or better definition of propery rights).

　　In particular, price reforms in the energy sector in China are likely to have a strongly postive impact on the environment. Water resource pricing also still needs reform and would have benefits in terms of both the quantity and quality o f water. On the whole, structrual reform in the Chiese industrial sector is like ly to strengthen the policy context for the environment.

　　A wide range of econcmic instruments can be used in environment management, an d some of them are used in China. The key to policy formulation must be to ident ify packages of instruments that can complement each other. In China, the links between economic policy and environmental concern are probably stronger at a mac ro level than a micro one. It is at the micro level the implementation of econom ic-environmental policy that the greatest reforms and enhancement are neede.

　　3.2.1 Industry and the Environment

　　Analysis of the industrial sector and its impacts on the environment has three key conclusions.

　　The environmental performance of larger enterprses is tending to improve. Poll ution intensity in this sector is declining, and some discharges, such as indust rial wastewater and soot have declined substantially in absolute terms since 198 9.

　　The environment performance of the TVIE (township and village industrial enter prise) is declining in both absolute and relative terms. The TVIE sector has gro wn fast-employment in the esctors increasing at around 5% per year since 1989, a nd out-put increasing even more rapidly (43.9% per year form 1989 to 1994 in cur rent price terms);however, environmental emissions have increased over the same period at 3.4% pa (SO2) and 30.8% pa (solid waste generated). Exiting policy ins truments for this sector are clearly failing to deliver.

　　Industru is not the only sector with polluting discharges and certainly not th e only sector with severe impacts on ambient environmental concentrations. Other pollution's, such as municipal wastewater discharges, emissions from domestic sto vest, small industries and vehicle are playing an increasingly large role in poor urban environmental quality.

　　3.1.3 Weakness in the System

　　Investment in environmental protection overall has failed to keep pace, at a m Arco level, with gross fixed capital formation in the country. In fact, environm ental investment has declined steadily from 3% of total fixed investment in 1990 to 1.8% by 1995. Under the technology renewal fund 7% of new investment should be earmarked for the environment, but in practice the share used for environment al protection is around 2-3%.

　　The pollution levy system has contributed substantially to environment improve ment in China. However, it still has weakness in terms of structure, implement ion and institution in thesystem, the structural weakness is the fact that the c hare islevied only on discharges in exceedance of standards; in terms of implem entation, the charge rate fails to keep pace with inflation, and the coverage in the TVIE sector is extremely weak; at the institutional level, the main problem is that since EPBs are founded from fines for non compliance with the pollution levey, there is some scope for abuse for abues of the system.

　　The Total Amount Countrol(TAC) has been introduced by the government in recogn ition of the continuing deterioration of environmental quality and the realizati on that even if concentrations of discharges are controlled environmental qualit y can get worse. While in theory TAC has some advantages it has considerable dif ficulties, such as that in the initial allocation of emissions, it's extremely d ata intensive, and the high administratively demanding.

　　3.2 Recommenations on Core Policy

　　3.2.1 The Pollution Leroy System

　　Levy charges on pollutin emissions, not just that in excedance. This has two m ajor advantages. First it is more economically efficient since most emissions im pose some extemality at a level the standard as well as above it. Second, this r ecommendation would reduce the need for measurement.

　　Extend the effctive conerage of the pollution levy across all scales of indust ry, but maintain a low charge rate. While at a theoretical level it would be des irable to levy charges based on some combination of the marginal damage cost and marginal abatement cost, it woud be more practicable to extend the effctive cov erage of pollution levy system across all industrial establishments, whether lar ge scale enterprises, SOE, TVIE or SME, but retain for now a low rate of charge. Research has suggested that there is a positive impact form the charge, even th rough it is below the marginal atbatement cost at the sesired level of enission. All emitters should be included-municipal wastewater treatment plants, power st ation, local heatin and heating system from institutions such as colleges or hos pitals. The actual level of charge can ot course be in creased over time.

　　·Differentiate the charge structure for lagre enterprises and the rest. The pol lution levy could be structured in two tiers: the first tier that deal with larg e enterprises, would follow the current pattern,but would be levied on all pullu llating discharges and on all the pollution substances. The second tier would be muc simplified with standard charge rates based on emission coefficients for ea ch industry sector, based on the annual registrations made by industries with th e industrial aagencies in charges where industries are required to register and state their expected output.

　　· Structure the charge for lager enterprises to offer very clear incentives for improved environmental performance. For example, if an enterprise makes a commi tment to reduce emission by a given point in time, then the charge rate would be reduced until the work is completed, and on completion would be fully refunded to the enterprise. In addition, there could be some modifications to the applica tion and administration of the revenues. For example, EPBs should introduce admi nistrative cost recovery charges that explicitly reflect the cost incurred in ca rrying out various regulatory functions.

　　3.2.2 pollution Discharge Permits and Total Amount Control (TAC)

　　·The full introduction of TAC in China is excessively demanding from the admini strative point of view, but if it is introduced with insufficient information an d inadequate institutional structure, it could have very little impact on enviro nmental performance in general.

　　·TAC offers a potentially powerful policy tool to addres the issue of acid emis sions from long distance acid deposition and water pollution in well-defined wat er bodies. This TAC and emission trading could be effectively introduced for con trolling emissions to the "3 lakes" (Lake Tai, Dianchi and Lake Chao) and the "2 regions" - the acid rain and SO2 pollution control areas.

　　·For the wide application of TAC, a longer time frame should be contemplated to ensure that the quantitative controls take into account the impacts of emission s and all emissions are brought into the quantitative framework.

　　3.3 Other Enabling Policies

　　·Financing environmental investment

　　The fund from the Three Synchronizations and the TRR (Technology Renewal & Renov ation) should increase to a target proportion of the total investment, and its i nvestment should has some flexibility in order to balance the emphasis on end of pope pollution a batement and better proces management or waste minimization te chniques. The funds should be used as loans for environmental investment. In add ition to pollution abatement, loans should be available for the introduction of cleaner technology, for support of training nd management programs; loans should also be made available to TVIEs.

　　·Integration of economic analysis with environmental planning

　　The capability in environmental economics and the application of economic think to environment concens need to be strengthened and allowed to support environmen tal policy formulation. The role of economics is also improtant in the wider app lication of cost benefit analysis to policies and to problems. It is necessary t o integrate the Ministry of Agriculture and their responsibility for TVIEs into environmental managment in the same way as SEPA/EPBs are working with Ministry of Industry and Tecnical Co-operation.

　　· Increased focus on environmental management of TVIEs

　　This dynamic sector must be brought into the framework of environmental manageme nt. Traditional command and control instruments hae failed to address the proble ms associated with this sector, and it is important that the application of econ omic instrument is applied. Pollution charges may well be the most straightforwa rd. Research and analyis dased on case study are essential in order to devise ef fective mechanisms for improving environmetal management in TVIEs.

　　· Emphasis on supporting policies

　　The incentive structure propoed above-the reform of the pollution levy system an d of financing througn the revenues raised-would help to suport the use of compl ementary policy tools such as information and disclosure, cleaner production, wa ste minimisation, etc. Cost recovery charging for shared waste treatment is obvi ously important for smalland medium-size enterprises.

　　Part 4 Other Projects and Policy Recommendation

　　·Fisheries. In view of the result of case study on Sustainable Usage of Fisheri e at Fujian Seacoast Area, it is concluded that over-fishing is a very serious r oblem in China, The main reason is that the user charges on fishery resource are significantly below the real marginal user cost. So the establishment of user c hare system on fishery and levy higher user charges on unusual fishes will be o ne of the practical measures to protect fishery resource.

　　·On projects of Sustainable Agriculture, Biodiversity, Environmental Accounting , etc, te WG ha made cooperative research efforts with other WGs, such as Sustai nable Agriculture, Biodviersity, Energy, Clean Production, and these WGs have ma de their contribution to the projects.

　　Part 5 Next Year' Working Plan

　　It is agreed that durig the next year, major emphasis will be on the following t opics:

　　·Environmental Taxation. This will be built upon the work now being completed o n Green Taxation and Economic Instruments for Industrial Pollution Control in China. Specific items to be included will be:

　　(a) International comparison of different environmental policy instruments;

　　(b) A special review of international experience of tradable permits, and a stud y of existing tradable permit schemes in China and their relevance for possible application not only to polution but also fisheries, grasslands, water, etc;

　　(c) A study of ways to reform the existing pollution levy system. This component will aim at making recommendations about how to integrate environental taxation into overall fiscal policy, with concern not only for efficiency but also its d istribution consequeces;

　　(d) Impacts of green taxation in China, using a macroeconomic model;

　　9e) Research on the MOC of CO2 emission control in China.

　　·Crasslands. This study will be a complement to the on-going study on sustainab le rice production, and, as in that sutdy, also be based upon the use of MOC pri cing analysis.

　　·In addition to the above, on going studies n biodiversity and sustaniable agri culture will be completed. By the time of the next working groupp meeting, we sh ould be in a position to start preparing a synthesis document of our work done s o far, with explicit policy recommendations that can be presented to the full Co uncil later in 1999. However, because of its more speculative nature, the green accounting work at both national and firm levels, will probably not be included in this document.