The color of money

The Budget of 2001 announced the government’s intention to consult on the

establishment of a Green Technology Challenge, with the intention of

offering enhanced first year capital allowances for environmental objectives

and innovative technologies.

Businesses write off the cost of capital against taxable profit, normally on

a depreciated balance basis, such that the cost of any investment is offset

against profit over time. Enhanced capital allowances allow businesses to gain

the benefit of this tax relief earlier. In the case of 100 per cent allowances,

the entire cost of an investment

can be offset against taxable profit in the same financial year as the investment

itself. Thus, it is claimed, a cash-flow benefit derives which offers direct

present value to the business. Simple.

Incentives

But why go down the road of incentives at all, given the government’s much-vaunted

shift from the taxation of ‘goods’, to the taxation of ‘bads’, and stated commitment

to the ‘polluter pays principle’?

Andrew Field, HM Treasury: “One of the arguments for incentives is that

they complement or accelerate the effects of environmental taxes, and that’s

certainly the approach that we’ve taken with the climate change levy. The tax

applies to business, but as part of the package there are incentives, through

enhanced capital allowances, for investments in energy-efficient measures which

enable businesses to improve efficiency and thereby reduce exposure to the levy.”

Tax incentives are particularly useful in accelerating the adoption of desired

behaviour when there are specific, i.e. internationally-agreed, targets to be

met. Kyoto, for example.

Financial barriers

Other than social considerations which may make it inequitable, or electorally

hazardous, to tax the polluter, tax incentives serve to overcome barriers; to

incorporate externalities that otherwise are not reflected in prices.

“That is one of the key differences from regulation,” says Field.

“There is no requirement on business to invest, and there is no requirement

for them to do so in a particular way. The business still has the opportunity

to determine the most cost-effective approach, taking account of the fact that

if it invests in certain ways, it benefits from enhanced capital allowances.

Clearly, this measure will then reduce financial barriers to investment, so

if financial barriers are impeding improvement in some areas, this measure will

help.”

The Green Technology Challenge consultation sets out to answer two fundamental

questions. The second is: Which environmental objectives are suited to being

targeted in this way, given: the extent to which there is a market failure,

i.e. an environmental externality or information gap; the extent to which that

failure may be addressed through capital allowances, as opposed to other government

policies; and the effectiveness of offering capital allowances, i.e the extent

to which the policy will deliver real quantifiable environmental improvements

above regulatory standards at minimum cost and encourage further innovation.

The first question is whether the Green Technology Challenge is a good idea

per se. Additional concerns relate to how the scheme could operate and evolve

over time, including the definition of technologies and how – and by whom –

standards are set.

Regulatory ties

Many countries, including many in Europe, in fact already operate similar schemes

where some sort of tax reward is granted for investing in specific environmental

technologies. Whilst State Aid rules will not permit EU Member States to present

tax-breaks where the desired result is already required by law, requirements

set out in forthcoming EU directives are elligible.

The Environmental Ind-ustries Commission (EIC), having long campaigned for

the introduction of fiscal incentives for companies purchasing environmental

technologies, in its response to the Green Technology Challenge, voiced concern

that the ECA scheme may undermine much of the UK pollution control regime. Pointing

out that around 7,000 industrial installations across the UK will soon be required,

under the Integrated Pollution Prevention and Control (IPPC) regime, to use

Best Available Techniques (BAT) to reduce environmental impact, the EIC claims:

“The awarding of an ECA to a particular technology could mean that the

regulatory authorities consider that technology to be sufficiently cost effective

to designate it as BAT for certain installations, where it was not previously

considered to be so. It would undermine the effectiveness of the scheme and

the regulatory regime if the Treasury were then to remove the ECA on the grounds

that the technology was now required by legislation.”

The EIC also recommends that companies be allowed to carry forward unused relief

to future years. For, in the face of a mounting global recession, it would be

well to remember that, in order to offset capital investment against taxable

profit, you first need taxable profit.