While green taxes can be an effective tool for promoting environmentally friendly practices and reducing the negative impact of economic activities on the environment, there are several challenges associated with implementing these taxes
Companies around the world are increasingly recognising the importance of ESG principles and are taking action to integrate them into their operations. This is being driven by a variety of factors, including changing consumer preferences, regulatory pressures, and a growing recognition of the benefits of sustainable business practices. Two emerging trends – increasing regulations and the green tax – in the ESG space are under spotlight currently.
Increasing Regulations
As the ESG space continues to become more filled with action, Governments and regulators are introducing policies and regulations aimed at promoting ESG practices. One of the increasingly evident and rapidly emerging trends in the ESG space is the increasing focus on regulation. As the importance of ESG factors has become more widely recognised, governments and regulatory bodies around the world are moving to implement new rules and standards that require companies to disclose more information about their ESG performance. This trend is being driven by a growing recognition of the role that ESG factors can play in driving long-term value creation, as well as concerns about the potential risks associated with ESG-related issues, such as climate change, social inequality, and corporate governance.
For example, the European Union (EU) has introduced a new taxonomy regulation that aims to establish a common language for sustainable finance and to facilitate investment in sustainable assets. The EU’s Sustainable Finance Disclosure Regulation (SFDR) requires financial institutions to disclose how they integrate ESG factors into their investment decisions.
As another example, the US Securities and Exchange Commission (SEC) has taken steps to require companies to disclose more information about their ESG risks and opportunities. Closer home, the Securities and Exchange Board of India (SEBI) introduced new rules that require the top 1,000 listed companies in India to disclose their ESG performance in their annual reports. The disclosure requirements cover a range of ESG factors, including climate change, biodiversity, and social responsibility.
As more governments and regulatory bodies move to implement new ESG-related rules and standards, we expect to see significant changes in the way that companies operate and report on their ESG performance, which will in turn help to drive greater accountability and transparency in the global business community.
Focus on Climate Change
One of the emerging trends in the ESG space is the increased focus on climate change. Climate change is garnering top of the mind recall in the global gestalt as one of the most significant issues facing the world today, and investors are increasingly looking to invest in companies that are addressing this challenge. Many companies are setting ambitious goals to reduce their carbon emissions and are investing in renewable energy and other sustainable practices. One way in which governments are responding to both ESG and climate change concerns is the imposition of green taxes.
Green Taxes
Green tax is a tax that is imposed on activities that are, or are considered to be, harmful to the environment. The purpose of green tax is to encourage individuals and companies to adopt more environmentally friendly practices by making it more expensive to engage in activities that harm the environment.
Green taxes can take different forms. For example, a tax can be levied on carbon emissions from vehicles or factories, on plastic bags or other single-use items, or on products that contain hazardous chemicals. Governments usually plan to use the revenue generated from green taxes to fund environmental projects and initiatives, such as renewable energy development, pollution reduction programmes, and conservation efforts. At least that’s the basis on which such taxes are sought to be imposed.
One of the main arguments in favour of green taxes is that they provide an economic incentive for individuals and companies to reduce their impact on the environment. By making it more expensive to engage in environmentally harmful activities, green taxes encourage individuals and companies to find more sustainable and eco-friendly alternatives. However, opponents of green taxes argue that they can be regressive, meaning that they disproportionately affect low-income individuals and communities, and that they can lead to job losses in industries that are heavily impacted by the taxes.
Carbon Border Tax – the Cross Border Green Tax
Many have suggested adopting a carbon border tax, which would apply a charge on imported goods produced in countries with weaker emissions regulations. A cross-border carbon tax would help make industries and businesses in countries that have higher carbon prices competitive against oversea businesses.
Some countries have already implemented such taxes to discourage imports of products that are harmful to the environment or to incentivise exports of environmentally friendly goods. For example, the EU is implementing a carbon border tax, also known as a carbon border adjustment mechanism (CBAM), which aims to prevent "carbon leakage" by ensuring that imports into the EU face the same carbon pricing as domestic goods.
The CBAM is designed to prevent companies from relocating production to countries with weaker environmental regulations and then exporting those goods back to the EU, thereby avoiding the EU's carbon pricing mechanism. The cross-border carbon tax will place a levy on imports of materials including steel, aluminium, and fertiliser from nations and foreign companies with laxer environmental rules. The CBAM will initially apply to the aforementioned sectors and is expected to be expanded to other sectors in the future.
Other countries have also implemented or are considering implementing similar green taxes on cross-border trade. For example, Canada has introduced a tax on certain single-use plastic items that are imported or manufactured in the country. However, implementing such taxes can be complex and controversial, as they can affect international trade relations and may require careful consideration of the World Trade Organization rules.
Challenges to Green Tax and the Cross Border Green Tax
While green taxes can be an effective tool for promoting environmentally friendly practices and reducing the negative impact of economic activities on the environment, there are several challenges associated with implementing these taxes. Some of the larger challenges (in both a local cross border context) are briefly highlighted below.
Political opposition: Green taxes can be politically controversial, particularly if they are seen as increasing the cost of living or reducing economic growth, and on a geo-political basis could face resistance from countries that are beginning to hit their development stride. This can make it difficult to implement and enforce these taxes, particularly if there is significant opposition from industry groups or political parties or countries.
Potentially discriminatory tax impact: Green taxes can be regressive, meaning that they disproportionately affect low-income individuals and communities. This is because poorer households spend a larger proportion of their income on goods and services that are subject to green taxes, such as gasoline or electricity.
At a global level such taxes, and resultant embargos could limit the ability of some developing countries to access environmentally friendly technologies or resources. Developing countries may need to go through the same spike in emissions as the more developed countries did to reach that same stage of development.
For example, despite the various proclamations of the current government in the US pledging to cut US emissions by half by 2030 and reach zero emissions by 2050, as well as executive orders mandating that half of all new US cars be electric by 2030, a notable omission is the failure to include any carbon pricing initiatives or schemes in the US clean energy plan. Therefore, on a cross border basis, the trade implications and country positions on some of these issues remain unresolved.
Trade implications: There are concerns that green taxes can violate WTO rules, particularly those related to non-discrimination and protectionism. For example, if a country imposes a tax on imported goods that is not imposed on domestically produced goods, this could be seen as discriminatory and lead to a trade dispute. When it comes to WTO implications, any green tax that discriminates against foreign goods or producers could be challenged as a violation of WTO rules.
However, if a green tax is applied equally to both domestic and foreign goods, and is designed to address a legitimate environmental concern, it may be considered compatible with WTO rules. In any case, WTO rules allow for the use of environmental measures, including taxes, if they are non-discriminatory and do not create unjustifiable barriers to trade. However, how this will affect countries currently hitting their stride, in development terms, is a question on which there is much heated debate.
Double taxation: There is a risk that green taxes could result in double taxation, meaning that a product is taxed both in the country of origin and in the country of destination. This could create an additional burden for companies and consumers and may make trade more difficult.
Administrative complexity: Green taxes can be difficult to implement and enforce, particularly when it comes to cross-border trade. For example, determining the appropriate level of taxation for imported goods can be challenging, and there may be disputes about the value of the tax or the impact it has on trade. In addition, the ability of an importer to transfer the tax back to the exporter, therefore making trade even less commercially feasible remains a complexity that is yet to be resolved.
Alternatives to Green Tax
As alternatives to the green tax, other economic mechanisms have been suggested such as a cap-and-trade system or emissions trading scheme (ETS). Under the ETS governments would cap the amount of greenhouse gas emissions released into the atmosphere every year based on carbon credits. It was reported that clean energy companies like Tesla earn billions selling their carbon credits to companies like Chevron, General Motors and Toyota. Carbon credits therefore have seen some degree of success in the US. However, these financial incentives might not be deterrent enough to incentivise industries to reduce carbon emissions. In addition, the argument by developing countries that developed countries should shoulder a larger burden for emissions has not yet been fully resolved.
Conclusion
It is exciting to see a proliferation of new ESG-related initiatives, from the development of new sustainable products and services to the implementation of innovative environmental and social programmes. With continued investment and collaboration, there is a real opportunity to build a more sustainable and equitable global economy, one that delivers long-term value for both business and society.
(Kartik Ganapathy is Founding Partner, IndusLaw. The views expressed in this article are the personal views of the author, and do not reflect the views of IndusLaw. )