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Economic Instruments
for the Environment

ECONOMIC INSTRUMENTS FOR ENVIRONMENT

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e have resolved to hand on an ecologically sustainable society

to future generations, a society in which the major environmental problems have been solved. Fifteen environmental
objectives have been established as benchmarks for all environmentrelated development in Sweden. The environment is a concern for
everyone. In many cases voluntary efforts are not sufficient, however,
because it will take too long to attain our objectives. Various environmental instruments have therefore been introduced to encourage people to change their behaviour and lifestyle, thereby speeding up the
transition towards sustainable development.
The tasks of the Swedish EPA include proposing the use of various
environmental instruments. This in turn involves proposing, analysing
and assessing economic instruments, but the Agency also uses legislation, information and communication, as well as spatial planning.

TYPES OF INSTRUMENT
Instruments vary in terms of their purpose
and impact. A combination of instruments
is usually required. Besides economic instruments, there are three types of instrument
used to encourage people to adopt more
environmentally sound behaviour:
legal instruments (laws, rules, ordinances
and regulations);
informative instruments (awareness
raising, knowledge transfer, best practice)
spatial planning (general means of incorporating sustainable development issues
when planning building construction, road,
rail and air transport, and other infrastructure).

LEGAL INSTRUMENTS
Laws, rules and regulations are legal instruments of environmental policy. The Swedish
Environmental Code entered into force in

ISBN 91-620-8221-3.
PRINT: CM Gruppen, Stockholm 2005. DESIGN: Citat AB. TEXT: Britt Hgerhll Aniansson. PHOTOS: Page 1: Bildhuset, 4: Bildhuset,
7: Pressens bild, 9: Maskot, 10: Pressens bild, 12: Etsa, 15: Pressens bild.

ECONOMIC INSTRUMENTS FOR ENVIRONMENT

1999. It is the legislative framework

designed to promote sustainable development and to modernise Swedish environmental laws in keeping with the developments of recent decades. The Code is based
on a number of fundamental principles permeating international environmental protection and resource management. These
include the "precautionary" principle, the
"polluter pays" principle, the "product
choice" principle and principles governing
resource management, natural cycles and
appropriate siting of industrial (and other)
operations and remedial measures.
Like other EU member states, Sweden is
subject to EU legislation and is obliged to
incorporate EU regulations and directives in
its national legislation. Sweden is also a
contracting party to some 40 international
conventions and agreements on environmental protection and resource management.

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Some of these are regional, covering parts of

Europe; others are global. An international
convention becomes legally binding on a
state once it has ratified the agreement and
it has entered into force. Ratification means
incorporating the decisions laid down in the
convention in national legislation by amending or adjusting national laws and policy so
as to meet the objective of the convention.
However, aside from international pressure,
there are no actual sanctions if a country
fails to honour its commitments.

INFORMATION
AS AN INSTRUMENT
Information is used in environmental policy
to influence behaviour and to pave the way
for other, compulsory instruments. Although
necessary, information is not in itself enough
to solve environmental problems; a combination of instruments is usually needed to
achieve results. The recipient of information
is not forced to do any of the things contained
in the information. Even though information
might not directly make people change their
behaviour, it is still essential to increase
knowledge and try to influence attitudes. As
a result, people may more readily accept decisions to increase the cost of certain goods or
services, or to limit freedom of choice. But it
is difficult to determine the extent to which for
example a given information campaign has
changed behaviour and attitudes.
Information is believed to be more effective

when the recipients are involved and can say

what kind of information they want and
need. Demonstrating best practice is one
way of using information to influence
behaviour.

Economic instruments
and environmental quality objectives

SPATIAL PLANNING
The purpose of spatial planning as an environmental instrument is to change factors in
our surroundings to improve the conditions
and prerequisites for environmentally sound
behaviour. According to the Swedish Good
Built Environment environmental quality
objective, by 2010 spatial planning and
building should be based on programmes
and strategies for planning housing, workplaces, services and cultural facilities in a
manner reducing the need for private car
use and promoting the use of environmentally sound and resource-efficient modes of
transport. This will include improving energy
efficiency, making use of renewable energy
resources and promoting the development of
production facilities for district heating,
solar energy, biofuels and wind power. The
National Board of Housing, Building and
Planning and the Swedish Environmental
Protection Agency, have examined methods
and tools for planning and incorporating
environmental quality objectives in spatial
planning.

ECONOMIC INSTRUMENTS FOR THE ENVIRONMENT

Neither companies nor individuals always act consistently or logically

to protect the environment. This may be partly due to the lack of pricing of environmental assets and of environmental damage. As a result,
the price we pay for goods and services does not reflect the actual cost
of consuming them, and so there are insufficient incentives to make
environmentally sound choices. In addition, many people feel no
responsibility for shared utilities such as air, water or biological diversity and are therefore unlikely ever to change their behaviour of their
own accord.
The environment can be priced in many ways as a means of mitigating or preventing environmental impact and damage. We meet a
large number of economic instruments in our working life and as private consumers. Environmental economics is not merely theory; it is
very much a part of our daily lives.
By putting a price on the environment, we gain a clearer picture of
the cost of consuming scarce shared resources. With the help of economic instruments, which influence corporate and personal decisions
and behaviour in the short and long term, it is possible to use the
mechanisms of the market itself to reduce harmful environmental
impact.
The instruments used in Sweden are ultimately intended to achieve
the 15 national environmental quality objectives laid down by Parliament. To achieve these objectives, Sweden is pursuing three action
strategies for More efficient energy use and transport, Non-toxic and
resource-efficient cyclical systems (including an integrated product policy) and Management of land, water and the built environment. Sweden must also meet its commitments under various environmental conventions, e.g. on climate and biodiversity.
The Swedish environmental quality objectives are ambitious and
substantial changes in our patterns of production and consumption
will be needed to achieve them. Unless something is done to accelerate
developments, we are unlikely to achieve the objectives within a reasonable timeframe.
An economic instrument can act either as a carrot or a stick to
steer us towards more environmentally friendly and sustainable
actions. Positive economic instruments provide obvious financial benefits in the form of tax relief, refunds, grants and financial support.
Market-based instruments and voluntary agreements are also becoming increasingly important as environmental economic instruments.

ECONOMIC INSTRUMENTS FOR THE ENVIRONMENT

ENVIRONMENTAL CONDITIONS
FOR A MARKET ECONOMY
In a perfect market economy, scarce
resources are managed by pricing them and
trading in them in such a way that their value is maintained or increased. The product
will command a high price if demand is
high and supply is limited.
Nobody owns air, water or other environmental and natural assets. They are shared,
collective assets belonging to everyone
and to no one. Everyone wants to use them
(free of charge), everyone needs them, but
no one owns them. Since they do not
belong to anyone in particular, these assets
cannot be traded or managed according to
principles governing scarce resources. The
tools needed to prevent assets of this kind
from being squandered or destroyed are
lacking in a free market.
Environmental costs (what economists
call "negative external effects") usually have
to be borne by others than those causing
the environmental damage. Those affected
are not compensated for the loss of common assets. This applies, for example, if
emissions or discharges by one company
cause the operating conditions for other
companies to deteriorate. Another example
is where private consumption by some individuals diminishes the standard of living for
others. The losers cannot prevent the abuse
of the common assets, nor can they be
compensated for their loss with assets of an
equivalent (environmental) value.
Thus, environmental economists agree
on the need to control the free market so as
to manage the environmental problems
caused by overuse or destruction of common assets. The state steps in as owner of
these environmental assets and prices
them. Whoever wants to trade in the market
has to pay a set price for the commodity,
which is no longer available free of charge.

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Typical features of an economic instrument that is effective for

environmental purposes:
it achieves the desired objective as quickly as possible;
it is cost-effective the relevant environmental quality objective is
achieved at the lowest possible cost
the use of the instrument also promotes technical development and
creates a financial incentive for improving production processes and
changing patterns of consumption;
the instrument is simple and inexpensive to administer and monitor.

Zero eutrophication

Tax on nitrogen in artificial

fertilizers

Environmental grants for measures

to combat nitrogen leaching, and for
the creation of protection zones

Good-quality Groundwater

A Balanced Marine
Environment

Water pollution charge

Grants for disposal of oil waste

from ships

Flourishing Lakes and Rural settlements

Streams
and fisheries charge

Funding for fisheries management

Thriving Wetlands

Environmental grants for creation

and management of wetlands
in agricultural areas

Sustainable Forests

Environmental grants for investments

to increase the ecological value of
forests

A Varied Agricultural
Landscape

Environmental grants for conservation

of grazing pastures and natural hay
meadows; valuable habitats and
cultural heritage in agricultural areas;
endangered breeds of domestic
animals; a varied and open agricultural
landscape; organic production; environmentally sound cultivation of kidney
beans (on the island of land) and
sugar beet (on the island of Gotland).
Investment grants for agricultural,
horticultural and reindeer enterprises.
Funding for adjustment and development in rural areas

A Magnificent
Mountain Landscape

Funding for preventive measures and

compensation for injuries to reindeer.
Funding for preventive measures and
compensation for injuries to other
animals
Grants for management of reindeer
enclosures

A Good Built
Environment

Tax on natural gravel

Landfill tax
Municipal waste disposal
charges
Producer responsibility for
packaging, waste paper for
recycling, and cars
Car-scrapping charge

Grants for measures to reduce radon

in private homes
Investment grants for ecological
building
Car-scrapping premium
Deposit (refund) system for drink
containers (consumer benefit from
producer responsibility for packaging)
Local climate investment programmes
(Klimp)

EXAMPLES OF ECONOMIC INSTRUMENTS USED TO ACHIEVE

ENVIRONMENTAL QUALITY OBJECTIVES

Environmental
quality objective

Economic instruments involving

costs for those concerned

Economic instruments subsidising or

reducing costs for those concerned

Reduced Climate
Impact

Energy tax
Carbon dioxide tax
Tax shift (higher taxes on
energy and use of private cars)
Carbon dioxide differential
vehicle tax
Road charge for heavy-duty
vehicles
Rail track charges
Electricity certificates
Emissions trading

Carbon dioxide differential vehicle tax

Exemption from tax on biogas motor
fuels
Energy system conversion
programme
Local climate investment programme.
Local ecologically sustainable development investment programmes
Electricity certificates

Clean Air

Parking fees
Environmental classification of
petrol and diesel
Differential taxation of petrol
and diesel

Environmental classification of petrol

and diesel
Differential taxation of petrol and diesel
Subsidised public transport
Lower tax on alkylate-blended petrol

Natural Acidification Sulphur tax

Only
Nitrogen oxides charge

Funding for liming of lakes and watercourses

Environmental differentiation of shipping lane and harbour duties

A Non-Toxic
Environment

Pesticides tax
Batteries charge
Tax on cadmium in artificial
fertilizers
Producer responsibility for car
tyres
Producer responsibility for endof-life electrical and electronic
products

Differential taxation of petrol

A Protective Ozone
Layer

Environmental sanction charge

(fine)

A Safe Radiation
Environment

Tax on thermal effect of nuclear

reactors
Charge to fund disposal of certain radioactive waste
Funding of future expenditure
on spent nuclear fuels

ECONOMIC INSTRUMENTS FOR THE ENVIRONMENT

Exemption from tax on biogas motor fuels is an example of

an economic instrument that help achieve the environmental
goal Reduced Climate Impact.

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TYPES OF ECONOMIC INSTRUMENT

Costs for individuals and companies
Taxes and charges are traditional levies.
They entail extra cost for a specific activity
or for an individual, and make environmentally unfriendly production or consumption
more costly. The terms "tax" and "charge" are
often confused. A tax is general income for
the national treasury - tax revenues go to the
state. Money paid as charges should be earmarked for a specific purpose and should, in
one form or another, be reimbursed to the
payers. There is a considerable difference
between viewing a levy as general revenue
for the state or as a payment that will be
refunded to the payer. Another major difference is that only the legislature (Parliament)
can impose or adjust taxes. An environmental charge can be decided by the Government or by public authorities.
Environmental taxes and charges are used
to steer resource use in the desired direction. The idea is to have the cost reflected in
the price, to influence the choices made by
consumers and producers (direct influence).
If tax collected is used to finance environmental efforts, such as information or collection or recycling systems, it is a case of
indirect influence.
Most of the environmental taxes and
charges in Sweden are levied on the energy
and transport sectors. These include an
energy tax, a carbon dioxide tax on fuels, a
sulphur tax, and an energy tax levied on consumption of electrical power. There are also
fuel taxes, vehicle taxes and road charges.
Tax relief, allowances and subsidies
for companies and individuals
Tax relief (lower taxes, tax allowances).
Tax exemption (no tax at all).
Deposits and refunds.
State or municipal subsidies (funding and
support).
The purpose of using environmental taxes
and charges is to encourage more environmentally friendly behaviour. Many other
taxes and subsidies of various kinds (funding
or support) have also been introduced to
encourage companies and individuals to
make the "right" choices with regard to
production, operations and consumption.
Encouragement may be in the form of state
or municipal investment support (for buildings, equipment, structures and systems).
Support and subsidies may also be available
for work to prevent environmental deterioration or to restore landscapes or habitats (eg,
nature conservation, measures to reduce

nitrogen leaching, liming of acidified

waters).
Transition programmes and investment
grants are other forms of support to ease the
transition to a more sustainable society.
Examples of this in Sweden are the transition programme for energy systems, local climate investment programmes (KLIMP) and
local investment programmes for sustainable
development (LIP), as well as investment
grants for green building.
Where there are lower or no taxes, the
price of the environmentally sounder product
or service will be lower or at least no higher
than the price of the equivalent more environmentally harmful product or service. For
example, Sweden levies no carbon dioxide
tax on combustion of biofuels, nor is there
any tax on biomass motor fuels. Similarly,
the tax on alkylate-blended petrol for boat
engines is lower than that on regular fuels.
Deposit and refund systems are rarely
used as economic instruments in Sweden.
However, a deposit is refunded when drink
containers (plastic bottles and aluminium
cans) are returned to the store. There is also
a premium for scrapping automobiles (a
charge on purchase, a premium when the
vehicle is scrapped). The drink container
deposit and the car-scrapping premium are
part of the Swedish producer responsibility
system.
The use of subsidies can fail, however,
and may actually lead to increasing environmental problems. Consequently, the removal
or change of environmentally damaging subsidies is also a way of encouraging more
environmentally friendly behaviour.

with the help of market trade. A "ceiling" is

set for the maximum carbon dioxide emissions allowed from one or a number of
plants. Each plant is allotted a certain number of emission rights, each one conferring
the right to emit one tonne of carbon dioxide. If a given plant emits more than it is
allowed, additional allowances must be purchased from another plant with a surplus of
allowances. Companies with high costs for
emission reduction will purchase allowances
from companies that can reduce their emissions at a lower cost. Companies emitting
less than they are allowed to can save
allowances for later or sell them to other
companies.
The aim of electricity certificates is to
increase the proportion of electricity generated in Sweden from renewable energy
sources (solar, wind, hydropower and biofuels). It usually costs more to produce electricity from renewable sources than from fos-

sil fuels. Plants producing electricity from

renewable energy sources used to receive
state grants, but 2003 saw the introduction
of a system based on quotas and trade in
electricity certificates. Producers receive
certificates for electricity produced from
renewable energy sources and consumers
must purchase a certain number of certificates in relation to their annual consumption. The mandatory quota of certificates
that consumers must purchase will increase
annually until the year 2010. The revenue
received by the producer from sale of certificates is intended to cover the additional cost
of production. The lower the production
cost, the larger the profit for the producer.
The aim is to produce electricity from renewable energy sources more efficiently. The
more efficient production is in the long run,
the better electricity from renewable sources
will be able to compete with traditional electricity production.

Market-based economic instruments

charges with a potential profit
Emissions trading.
Electricity certificates (green certificates).
Emissions trading is one way for EU countries to fulfil the commitment made by the
union as a whole to reduce emissions of
greenhouse gases in line with the Kyoto Protocol of the Convention on Climate Change.
Initially, trade will take place during the
period 2005 2007 and will only apply to
carbon dioxide emissions from energy plants
and energy-intensive industrial plants such
as oil refineries, coke ovens, iron and steel
works, and factories making cement, glass,
lime, brick, ceramics, pulp and paper.
The idea of emissions trading is to reduce
emissions in as cost-effective a manner as
possible. Hence, emissions are regulated

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Promoting sustainable development

The use of economic instruments is very much on the international
agenda. Agenda 21 (1992) urges the nations of the world to increase
their use of economic instruments to promote sustainable development.
A decade later, the Plan of Implementation adopted by the World Summit on Sustainable Development stated that action should be taken at
all levels to "continue to promote the internalisation of environmental
costs and the use of economic instruments, taking into account the
approach that the polluter should, in principle, bear the costs of pollution, with due regard to the public interest and without distorting international trade and investment". The OECD, too, has advised member
states to increase the use of environmental taxes and charges. As part of
the European Union environmental policy, the need to use economic
instruments is emphasised in the Sixth Community Environmental
Action Programme, and the European Parliament has requested the
possible introduction of environmental taxes at community level.

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ECONOMIC INSTRUMENTS FOR THE ENVIRONMENT

INTERNATIONAL
Agenda 21, the global action programme for
sustainable development (adopted by the
1992 UN Conference on Environment and
Development), Chapter 4 on changing consumption patterns, says on moving towards
environmentally sound pricing that without the stimulus of prices and market signals that make clear to producers and consumers the environmental costs of the
consumption of energy, materials and natural resources and the generation of wastes,
significant changes in consumption and production patterns seem unlikely to occur in
the near future. Some progress has been
made in the use of appropriate economic
instruments to influence consumer behaviour. These instruments include environmental charges and taxes, deposit/refund
systems, etc. This process should be
encouraged in the light of country-specific
conditions. The section on integrating environment and development in decision-making stresses that an effective legal and regulatory framework needs to be provided,
although most of the recommendations concern the need to use economic instruments.
As for new forms of funding efforts for sustainable development, countries should
identify new ways of raising money to pursue
sustainable development, including the use
of economic and fiscal instruments and the
possibility of trade in permits. A decade later, the Plan of Implementation adopted by
the World Summit on Sustainable Development once again emphasised the need for
economic instruments.
Under the OECD (Organisation for Economic Co-operation and Development) sustainable development strategy, sustainable
development is the overall goal of the OECD
and its members. Economic instruments
should be used to a larger extent and environmental costs should be internalised in
the price of natural resources. The OECD
Environmental Performance Review of Sweden (2004) notes that Swedens achievements over the past decade include an
increased use of economic instruments and

that Sweden is therefore seen as a world

leader in the field. However, the OECD considers the level of taxation to be too low to
exert sufficient influence. The shift towards
green taxes is also considered interesting,
but again the OECD notes that several of the
taxes are too low for the purpose.
Regarding the means of pursuing the
aims and objectives of the European Union,
the Sixth EU Environmental Action Programme emphasises the need for the
promotion of sustainable production and
consumption patterns by effective implementation of the principles to internalise the
negative as well as the positive impacts on
the environment through the use of a blend
of instruments, including market based and
economic instruments. This includes
encouraging reforms of subsidies that have
considerable negative effects on the environment and are incompatible with sustainable development, inter alia, by establishing, by the mid-term review, a list of criteria
allowing such environmentally negative subsidies to be recorded, with a view to gradually eliminating them. EU member states
should also analyse the environmental efficiency of tradable environmental permits as
a generic instrument and of emissions trading with a view to promoting and implementing their use where feasible. However,
despite a commendable desire to make use
of economic instruments, the EU as a whole
has not yet been very successful in this
respect.
In cooperation with the European Commission, the OECD and the European Environment Agency have developed a database
on the use of market-based instruments for
environmental policy and natural resource
management. It includes data on environmentally-related taxes, fees and charges,
environmentally-motivated subsidies, tradable permit systems, and deposit-refund
systems in all EEA member states. It also
includes examples of voluntary agreements
in the field of environmental economics.

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From selective taxes to

management by objectives
Environmental economic instruments in Sweden have been practically
synonymous with taxes and charges since the 1970s. The bulk of
Swedish environmental taxes and charges have been levied on the energy and transport sectors.
The tax burden is shifting, however, from selective taxes to marketbased environmental instruments, allowing the market a freer rein. The
principle governing market-based instruments (e.g. electricity certificates
and emissions trading) is the same as for many recent EC Directives. A
specific objective is set for all parties to achieve, but it is up to the actors
in the market to decide how to go about accomplishing the goal. In a
free market, actors will select the most cost-effective ways of implementing necessary measures. There will also be incentives for manufacturers
to develop new technologies or new production processes that may
prove profitable in the long term.

mental quality objectives and the action strategies. Initially, most of the
green tax increases targeted the energy sector (electricity and heating),
but the main focus is now on carbon dioxide emissions from transport.
The Swedish Environmental Protection Agency has stressed that a substantial proportion of this shift towards green taxes should be linked
to the action strategies for More efficient energy use and transport. In
practice this means raising taxes on fuel and imposing a mileage tax on
heavy-duty trucks.
There is a growing need to focus on the environmental impact of a
product throughout its life cycle. Hence, economic instruments targeting the production process could be a future role for green taxes. In the
future, taxes and charges might also be used as economic instruments
to reduce the use of dangerous substances and chemicals.

Paying more for the environment

and less for employment
Green tax reform is another environmental economic instrument.
Shifting the tax burden means that higher revenues from environmental taxes are used to offset a reduction in taxes on labour (or other distorting taxes). The effect of a green tax reform is not to increase taxes
overall, but to redistribute tax revenues within a given
framework, and to use taxation more specifically as an
instrument of environmental control. The purpose of redistributing money is to promote environmentally sound activities and choices. Higher environmental taxes will result in a
better environment (environmental benefit). In addition,
they may benefit society by reducing unemployment (efficiency benefit).
The Swedish Government plans a green tax reform
of SEK 30 billion between 2001 and 2010, based on what
needs to be accomplished to achieve the national environ-

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Signs of a better environment?

The use of economic instruments has generally been an effective means
of implementing Swedish environmental policy. Most of the environmental taxes and charges have had the intended effect, and in several
cases they have also contributed to technical development. The tax on
sulphur has helped Sweden to fulfil its emission targets for sulphur.
The nitrogen oxides charge has sharply reduced emissions from solid
fuel combustion plants. Differentiation of the tax on petrol and diesel
has brought about a rapid changeover to more environmentally friendly fuels.
There may be a conflict between the various reasons for introducing environmental taxes in the traditional sense. It must be decided
whether the main reason is to maintain a stable, long-term source of
tax revenue for the state, or whether environmental taxes are to be
used as a way of influencing patterns of consumption so as to reduce
environmental impact. If an environmental tax has a marked effect on
behaviour, it will counteract the revenue purpose the more effectively
the tax changes patterns of consumption, the less "mistakes" will be
made by the consumers and the lower the overall tax revenues will be.
What, then, are the signs of a better environment as a result of
using economic instruments? Since it is difficult to measure the actual
effects of individual instruments, there is no simple answer to this
question. In many cases, however, people experience the effects of
environmental economic instruments as beneficial to themselves as
individuals. Tax relief, refunds and various grants and subsidies have
given people a reason to change their own behaviour and also to maintain their new habits. By changing their own behaviour, they can also
avoid environmental taxes and thereby reduce their expenses.

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The Swedish Environmental Protection Agency (EPA) is a central environmental authority under the Swedish Government. The task of the Swedish
EPA is to develop, implement and monitor achievement of environmental
protection and policy. This includes proposing the use of various environmental instruments. This in turn involves proposing, analysing and assessing economic instruments, but the Agency also uses legislation, information and communication, as well as spatial planning. However, this
brochure focuses on economic instruments used as tools of Swedish
environmental policy.
Read more about the work on economic instruments at the Swedish EPAs
website www.naturvardsverket.se

www.naturvardsverket.se

The Swedish Environmental Protection Agency

SE-106 48 Stockholm
Visitors address: Blekholmsterrassen 36
Tel: +46 8 698 10 00, fax: +46 8 20 29 25
Order:
E-mail: natur@cm.se, tel: +46 8 505 933 40
Internet: www.naturvardsverket.se/bokhandeln