A Quick Look At Sweden’s NOx Tax
What is NOx?
NOx is a generic term for nitrogen oxides. The reaction of nitrogen and oxygen in the air during combustion at high temperatures produce NOx. It is a dangerous pollutant and a component of acid rain, which can cause extensive destruction to vegetation and animal life. Sweden is more sensitive to acid rain than most other countries due to granite bedrock covering most of the country. Because of this, precursors to acid rain like nitrogen oxides have been a major political issue for the Swedes since the 1980s.
In 1985, the Swedish Parliament set a goal to reduce the level of 1980s NOx emissions by 30%. In 1988, stationary combustion plants were subjected to individual, non-tradable, emission permits. However, this was not enough to meet their objective and the existing regulatory policy was deemed to be insufficient to meet the target. Thus, in 1991, the NOx tax was introduced. The policy was aimed to increase investment in better abatement technologies and reduce emissions. The management of the tax was assigned to the Swedish Environmental Protection Agency.
Only large combustion plants are required to pay the tax. Initially, a large firm was defined as producing at least 50 GWh of useful energy per year. However, as the policy developed and was successful, these costs have decreased and thus the criteria of being a large firm fell twice. In 1996 plants generating at least 40 GWh of energy per year were included and in 1997 this was lowered further to include firms producing 25 GWh. At present, all stationary combustion plants producing above the energy output limit and are part of the sectors power and heat production, chemical industry, waste incineration, metal manufacturing, pulp and paper, food and wood industry, are subjected to the NOx tax.
Smaller firms are not included because of high metering and abatement costs that were viewed as unreasonable for these smaller plants. Industries that are exempt from the tax are: cement and lime industry, coke production, much of the mining industry, refineries, blast-furnaces, glass and isolation material industry, wood board production, and processing of biofuels. Mobile sources are not included as well.
The charge rate was originally set at SEK 40 per kg NOx. This was based on an estimate of the marginal abatement costs that were predicted to reduce emissions. In 2008, this increased to SEK 50 or EUR 5.5 per kg NOx to re-establish the real value of the tax as to effectively sustain motivation for abatement. The duty is assessed directly on emissions or presumptive emissions. Normally, direct emissions are chosen because it typically brings about lower charges.
The question with taxing pollutants is often, is the policy revenue neutral? For example, every dollar generated from the carbon tax in BC is neutral through reductions in other taxes. Is Sweden’s NOx charge revenue neutral?
By definition, revenue neutral is when the payments received by the government remain virtually unchanged. In other words, the government does not retain most (or any) of the revenues from the tax. If we follow this definition, it can be said that the Swedish NOx charge is revenue neutral.
Incomes are redistributed to the different plants. Only about 0.3% of revenues collected are administration costs and 3% are metering costs. The rest are allocated back to the polluting companies. Refunds are given depending on the amount of useful energy produced. Firms emitting low emissions compared to their energy output are net recipients while high emitting firms are relative to energy output are net payers. This discourages wasting energy by plants and avoids changes in competition.
This implies that the Swedish government earns relatively nothing from the revenues of the NOx tax. It then seems that this charge-refund policy for nitrogen oxides emissions is in fact neutral.
Is the tax rate appropriate though?
The appropriate tax is set where aggregate firms’ marginal abatement costs are equal to the marginal damage caused by emitting NOx. This only works if the Swedish Environmental Protection Agency knew each firm’s abatement costs. Firms have an incentive to understate their abatement costs to lower their expenses under a tax. Sweden has had the tax in place since the early 1990s. If firms are lying they should have gotten caught by now because failing to meet the desired reduction in NOx emissions could easily be fixed by increasing the tax. They have reduced NOx emissions and their history shows that they did raise the tax in 2008 to establish the real value of the tax. Even if it is assumed their estimates for abatement costs are correct, the tax rate still does not seem to be appropriate.
Is it due to the refund system?
One would think that the refund would produce the opposite effect though: it gives firms the incentive to overstate their abatement costs. Assume that the tax successfully pushed a firm to adopt new cost saving abatement technology. Instead of reducing emissions because of this new tech, the refund reduces the incentive of the firm to lower emissions because they can save on reduction costs and get refunded at the same time. However, this is not the case. Their payback scheme rewards firms that can produce high output while emitting low emissions. This then discourages the different plants that adopt new technologies to lie and emit more.
In my opinion, the tax is not set appropriately because the marginal damage being used to set the charge is understated. Remember that many different sectors are exempt from the NOx charge. The tax appears to be set on the damages caused by large stationary firms that can bear the cost. Smaller firms and mobile sources are not subjected to the tax. If the damage caused by their emissions was not taken into consideration when setting the tax, clearly there will be an understated marginal demand curve and the tax is going to be at a lower rate than it should be. To get the appropriate tax they must include all sectors and set the charge according to the marginal abatement and damage of all the groups emitting nitric oxides.
Sweden has been dealing with NOx emissions since the 1980s and has had a NOx charge since the early 90s. The fact that they have reduced emissions suggests that they may have gotten the right system working for them. However, they might want to reevaluate the appropriate level of their tax to include all sectors that emit NOx, especially mobile sources.