The Introduction of an Environment Tax
and Forecast Simulation of Change in Industrial Structure
Shigemi Ochiai, Ph.D., Eng., President, Jonquil Consulting Inc.
Member of System Dynamic Society
Introduction
Today, just two and a half years before the turn of the century, the earth is in the grip
of environmental pollution. A look back on the origins of environmental pollution
reveals that waste has been gradually accumulating since the beginnings of our planet,
albeit relatively slowly until industrialization grew rapidly during the 19th century.
And as the process of industrialization has gathered pace, so pollution has accelerated,
Environmental pollution primarily refers to: (1) Warming of the earth; (2) Destruction
of the ozone layer; (3) Acid rain; (4) Desertification; (6) Loss of rain forests; (6)
Pollution of the oceans; and (7) An inerease in waste”, The economic losses created
by the environmental pollution afflicting Japan is estimated to have been ¥8 trillion
throughout the 1990s (June 1995 estimate by the Japanese Economie Planning
Agency), equal to 5.7 percent of gross domestic product (green GDP). If the current
trend continues unchecked, Japan will suffer environmental destruction totaling at
Jeast ¥80 trillion over the ten-year period from 1990 to 2000. Given this situation,
new policies must be formulated to build an economic and social system, based on the
recycling of resources, that will impose a Jesser burden on the environment as noted in
the Basic Environmental Act (1), which went into effect in December 1994. However,
before such policies are formulated, the problem of recovering the financial losses
inflicted by environmental destruction will become a major threatening issue. This
paper simulates the changes in industrial structure up to the year 2050 that would be
caused by the introduction of an environment tax, primarily allocated among energy-
related industries, as a means to compensate for the financial losses caused by
environmental destruction. A dynamic system model was developed for this purpose.
1. Processes leading to the introduction of an environment tax
Global environmental issues, notably the warming of the earth, are of great importance to
mankind and must be dealt with urgently. For human beings to achieve sustained growth on an
earth of limited size and resources, an investment of green GDP equal to least five or six percent
of total GDP, appears necessary in order to solve environmental issues. The investment must be
used not only to create new industries and businesses which we might generically term “global
environmental industries,” but it must also influence all industries from the primary to tertiary
sectors. Moreover, changing industry alone is not enough: changes must also take place in the
awareness and habits of consumers. Various measures need to be taken to restore the damaged
environment and to prevent future environmental destruction. Restoration of the damaged
environment would require a national budget of some 8 trillion. Taking the example of carbon
dioxide (CO,) emissions, it takes about ten years for the gas to reach the sky. This means that
regardless of whether we curtail CO, emissions now, gas emitted in the past is already in the
system: Eliminating gas emissions from today would mean a gradual decline in the amount of
the gas in the environment, but environmental destruction, caused by past gas emissions, would
continue for at least the next ten years. Stricter environmental regulations to stop further
deterioration in the environment are planned to combat anticipated environmental destruction.
Legal measures were proposed by the European Union as an environmental audit system and
were introduced in the form of ISO 14000, which Japan introduced on October 20, 1996.
Application of this environmental audit system in developing nations as well as industrially-
advanced countries would help prevent environmental destruction. However, developing
nations will not implement the system for the time being, which is a matter of grave
environmental concern. Funds are thus required to recover from environmental destruction;
however, financial resources drawn only from an energy tax® will be inadequate, so an
environment tax needs to be introduced at an early stage. The seven sectors listed in the
Introduction raise similarly grave issues. However, global warming and acid rain caused by
nitrous oxide and sulfuric oxide emissions from industry have been the focus of environmental
concerns.
1.2. Environment taxes introduced in other nations and coal tax
Environment taxes are already in place in EU member countries and their neighbors, Denmark,
Finland, Norway, Sweden, and the Netherlands. As Japan has not introduced an environment
tax, figures related to energy taxes converted into an environmental tax equivalent were used
instead. Table 1.1 compares environment taxes among these nations®., The table shows that as
Japan imposes no tax on coal, Japan's
total tax rate is less than half of those
Table 1.1 The Introduction Countries of CO, Tax
(1994~1995 year) Unit: $/ CO, Ton)
imposed by most other nations. [esmery | ters [cost | ar [OR Tax other ftnothor | Total
Carbon dioxide emissions will be the frex var | tax
‘ Josmmark issoline ses orae | ao | 10 bes | ono
target of the future environment tax. wrosene fora. fas |sz0 | oo |uag | 2x4
(The increase in energy prices [Diesel 160.1 oo |e | oo | oo 2.8
resulting from the introduction of Joost i539 f OO [5 | oe | oo 25.6
carbon and energy taxes will change [7 7—jeccim lean fod ons [ies pax | 1a
the relative prices in the market Kerosene [350.0 J 141 [iso | 164 | 83.0 17.5
mechanism and therefore change the lee et [ee yes [ine ae ma
F F 2 « |ao ize Joo | oo 2
industrial structure itself.) However, ine
continued improvements in energy ftorvay — fcasolin {76.9 fiosae fiss9 | 00 |ssa.9 | 1,502.6
efficiency will help meet the CO, feces fey | BO pms Ike Yee | oes
oT ; ieset asso. | 0.0 aur faa? | oo 2.9
emission regulations. Other targets I me [oo dove tee ae ine
of these new taxes are listed below.(1)
Nuclear energy (Although it supplies [ri ficin foo foes fee [20 fase PLase
clean energy without CO, emission, Diesel i.8 | a0 |sto }00 | oo 810
an accident in the production of this oat lee Joo [ore fr8 | oo | ust
onergy type would cause tremendous foils dard pasa [ar | ad bat] Tad
damage. Therefore, the use of Kerosene fa6.4 {76.5 {2.8 | 7.8 | o9.9 197.0
nuclear energy must comply with the ese §—fiss.9 fas far | oe | ao La
hi . .
safety standards.)(2) Large-scale ft Hee poe [ae | ae | ao ae
hydraulic power generation (The fia fiosoiin fai fare {oo | ao [us | eas
percentage of energy consumption is Frere: fea [aus | Go | od tice | ais
jase 0 foo |e as
calculated based on the difference i iad oa deo | oo | so nA
between the reduction in the rain
water amount and the available rain
water amount in remote regions.)(3)Water (The increase in the amounts of water and sewerage
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only increases the size of treatment plants. If the current trend continues, these plants will no
longer be able to treat water to the level stipulated before they become incapable of treatment.
Therefore, a minimum consumption will be set, beyond which different tax rates will be imposed
depending on the usage.(4)Commercial fertilizer (The supply of type of fertilizer exceeds demand
for agricultural use. The amounts of nitrate fertilizer recycled on farms should determine the
reduction or increase of taxes based on the recycled amount category.)(5)Land use (tax will be
imposed on land used for construction purposes, based on the efficiency of land use.)(6)Metal and
other raw materials (aimed at providing incentives for reducing the amount of waste through
recycling of metals and other raw materials that do not contain hazardous substances)(7)Solvent
(tax which includes exemption clauses for recycling and collection of solvents)(8)Chlorine and
halogen(9)Hazardous compounds. Among the various feasible measures, a carbon tax appears to
be the most appropriate.
2.Formulation of optimum investment return and environment tax introduction
in the energy industry
Business profitability in the energy industry is assessed by the maximum return obtained from
limited funds applied in a series of flows from imports of crude oil to production and sales of
energy. To quantify these, the investment return V is given by equation (1) proposed by J.
Happel.
V = (1-2){015S, — oR, — Dea U IL} — (2) +6, }L a)
7 i F
Where:(3)
r:tax rate 5; Ex. factory sales price of product I$: Production amount of product, i (annual) 1, Price at which to
accept raw material, j Rj: Amount of raw material, j, required (annual) u: Unit utility price U,:Unit utility price
(anmual)’ 1: Labor costs (annual) L; Number of workers required k: Rate of annual expenditure accompanying the
facility investment ¢,; minimum acceptable rate of return I: Facility costs
Equation (1) above represents the investment return assuming that crude oil prices remain
within a certain price range. The equation can still cover crude oil price fluctuations in the
range of fifty cents to one dollar a barrel. However, equation (1) fails to deal with fluctuations
greater than one dollar. Accordingly, equation (1) becomes equation (2) which averages crude oil
prices by introducing a variable coefficient (critical coefficient).
ne ®
A+ Ot +9,
Where,
@,: Critical coefficient(3) P,,:(1+ €)*,
+ interest(4)
However, the market prices of chemical products and gasoline, for example, which are produced
and released on the market, do not reflect the social expenses per production unit. This means
that as the market prices only reflect the private expenses of the producer (critical expenses),
inclusion of social expenses in the production costs will increase the prices, ultimately pushing up
consumer prices. To limit such increases in the consumer prices and limit the financial burden
on the producer, a measure was proposed by A. C. Pigou in 1918, This incorporates a tax on
chemical products and gasoline imposed per production unit into the private expenses to form
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social expenses, thus increasing the tax-inclusivemarket prices and limiting the amount of
production (amount of consumption). This
measure is called Pigou's tax, and has 4. New Social Curve
been the basis of the environment tax
until today, just before the 21st century. Social Supply Curve
Figure 2.1 shows the mechanism of P,
Pigou's tax. However, when we look at p
the balance between supply and demand ‘ zi
P,
Private Supply Curve
in consumption as well as rapid economic 7a” Paalion with: Prose Unie
growth, the amount of product does not
equal the amount of consumption.
Although the production plant ships
products regularly, these products are
m ‘{— Demand Curve
>
usually stored at sales points. Therefore, QS Qn Products
it appears difficult to limit Q,, shown by P,: Cost P,: Increasing Cost Q,,: Product
Figure 3.1 to Q,. Modifying Figure 2.1 to Q: Cost of Control T: Tax (T=E,- E,)
make it correspond to the current status rm ; .
.2.1 The Relation Bet ACP;
indicates point B, in Figure 2.1 Judging ® satiate
from this actual status, the production Tax and Real Social Curve
amount is given by equation (3)
Qa = Q, @)
As a result, the amount of environmental tax per production unit based on equation (3) becomes:
equation (4)
s (4)
TayxT ®
Where,
W (environment tax introduction coefficient) = 0.01 - 0.05
Therefore, the price increase resulting from introducing the environment tax is between 1/200
and 5/100. Substituting environment tax introduction coefficient, W, of equation (4) into
equation (2) produces equation (5) which represents average investment return, V:
P= LYM + PY aV2t FO Yn 3)
P+ Yat OY
Where,
\,; environment tax introduction coefficient
This means a decrease in the investment return, and also suggests the existence of a new point
E,, which does not correspond to the supply-demand curve shown in the figure. The difference
between E, and Es is expected to be reflected as an increase in price.
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3. Simulation of System Dynamics Model and Simulation Results
3.1 Simulation of System Dynamics Model
Figure 3.1 shows the flow from crude oil to production of each petroleum based fuel, indicating
changes in the industrial structure in
petroleum related fields resulting i aie a
from the . introduction of an sp
environment tax. The level of [ee eS more pe
recycling of waste oils (surplus oil, Fe
waste oil and wash oil) generated by WancgeNE SrEETINONS Pe SOLE
the production of petroleum based | i ai | erase
fuels has become fairly advanced. [ons on, ms
This recycling was incorporated as an creo [> DEWAXINGHYDROFINISHING
element of SD model feedback. A omy SESS || saneon
model of the system dynamics was af PE
constructed based on Figure 3.1 Also, ee
to examine changes in the industrial ~nsonEA Fon
structure, the focus was placed on pig = ect
iron production, which was selected re
from the various production sectors in eet so
the iron and steel industry as it — rau
consumes much energy and makes a Fig.1 Model for Oil Products Flow
significant contribution to GNP.
Figure 3.2 shows the pig iron production flow which is used as the basis for the SD model.
sen 080 > Receptacle —_
+ Y SS
y
Nonmetal Mineral > Pig Iron —> Rolled Steel > Materials, > Metal goods ————- Consumption
ae y
OMA A
Ceramic Mineral A > Electric Mi BO ge EY
a a
ry a cyt
sepa tf | joni Macha a
= Indust Machinery
‘Transportation Machinery / /'
/
Construction Machinery
Fig.3.2 Flow for Iron Products
3.2 Simulation results
Figures 3.3 and 3.4 show forecasts up to the year 2050. These forecasts are based on the
petroleum -fuel production SD model and on the pig-iron production SD model prepared in section
3.1 above, respectively. Figure 3.3 simulates the forecast consumption of petroleum-based fuels
produced from crude oil and expresses the results as forecast crude oil consumption. According to
Figure 3.3, consumption will gradually increase until 2005, Odecrease until 2015, and then
experience a gradual decline until around 2035, followed by a further drop sometime between
2040 and 2050. Figure 3.4 forecasts pig-iron production, which accounts for a significant
proportion of total iron and steel production, based on the amount of energy produced by crude oil.
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‘The figure reveals a temporary increase in the amount of energy generated in 2005, followed by a
continual downward trend.
TT
SER eon
seta —— —
150000.
120000,
90000
60000
Fig.3.3 Simulation for the Crude Oil Consumption
X1000ton
Fig.3.4 Simulation for the Production of Pig Iron
4. Considerations
(1) Forecast crude oil consumption amount
As is clear from the result of the simulation of section 3.2, the amount of crude oil consumption starts declining
until it reaches a level in 2050 that is approximately 15% less than that in 1997. Factors supporting the results
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{995 2000 2005 2010 2015: 2020 2025 2030 2035 2040 2045. 2050
Year
of this simulation are as follows: The current findings of the advisory committee of the central government
suggest that a 5% environment tax will be introduced in Japan in 2005 to help restore the environment. Prior to
2005 (at the latest, around 2004), when the tax is scheduled to be introduced, a significant increase in the
amount of crude oil imports is predicted. Importers will naturally import crude oil before the environment tax is
introduced and will seek greater profits by adding the environment tax to the imported crude oil when the
environment tax is introduced. In response, the Ministry of International Trade and Industry, as the acting
government agency, will inevitably prohibit the practice of adding environment tax to such crude oil. However,
given the traditional relationship of interdependence between the ministry and industry, policies are likely to be
developed that will actually protect crude oil importers. Following the introduction of the environment tax,
crude oil importers may raise product prices by 15% for reasons of production adjustments and the introduction
of the environment tax, to prevent a loss of revenues resulting from sluggish consumption coupled with the
decline in energy production. The effects of introducing a 5% environment tax on crude oil are different from
those of the 5% consumption tax; final product prices are likely to rise between 15 and 20%. The situation is
therefore expected to repeat that seen in 1975, when the first oil crisis triggered an increase of 20% in consumer
prices (a dramatic consumer price increase). The forty years from 2010 to 2050 will probably see a decline in
crude production resulting from the introduction of environmental regulations. Moreover, Japanese energy
policies are shifting to the increased use of clean energy, specifically, natural gas. Tokyo Gas Co., Ltd. plans to
switch 80% of its energy resources to natural gas by the year 2000, which supports the prediction that crude oil
consumption will decline.
(2) Forecast changes in the industrial structure
‘The level of recycling is fairly advanced in the iron and steel industry. The industry is output fell
significantly following the bursting of the so-called [Bubble Economic. Although production
recovered somewhat from the post-bubble period during the 1990s, dark clouds still hang over
traditional industries requiring large investments, such as iron and steel, heavy electrical
equipment and petrochemicals. The introduction of an environment tax will promote pig-iron
* production to follow the same trend as that forecast for energy consumption. However, future
advances in recycling in the industry should be factored as these are important elements. Based
on the forecast, the Japanese economy is expected to move away from its focus on traditional
industries that require large investments, resulting in a significant change in the industrial
structure. To take the example of iron and steel manufacturers, these producers will have scaled
back approximately 15% by 2010 from their 1997 operations. These industries will, therefore,
face the choice of either cutting back on operations, or shifting the drop in capacity to other
operations. The year 2010 will undoubtedly be a period of major restructuring in Japanese
industry.
References
()OECD 1991 Environmental Committee Meeting at Ministerial Level: An Environmenral
Strategy in the 1990s’
(2)EC 1992 ‘Commission Adopts Proposal on Carbon/Energy Tax’
(3)OECD IEA ‘Energy and Taxes, Second Quarter, 1995,’
(4)Pigou A.C, 1918 ‘The Economics of Welfare, Macmillian, Chapter 9
(®)HPS 1996 ‘Stella-Dynamic Modeling Across the Curriculum’
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