Perhaps the single most powerful instrument for redirecting national economies toward environmental sustainability is taxation. Taxing products and activities that pollute, deplete or otherwise degrade natural systems is a way of ensuring that environmental costs are taken into account in private decisions, whether to commute by car or bicycle, for example, or to generate electricity from coal or sunlight. Each individual producer or consumer decides how to adjust to the higher costs: a tax on air emissions would lead some factories to add pollution controls, some to change their production processes, and others to redesign products so as to generate less waste. By raising a large proportion of revenue from such "green" taxes and reducing income taxes or others to compensate, governments can help move economies swiftly onto a sustainable track.
Taxes are appealing because they offer an efficient way of correcting for the market's failure to value environmental services. If the atmosphere is a free repository for waste products, industries will pollute heavily, and society at large will bear the costs in terms of health care, lost agricultural output, and climate change. Similarly, if farmers pay nothing for using nearby waterways to carry off pesticide residues, they will use more of these chemicals that society would want, and rural people will pay the price in contaminated drinking water.
So far, most governments trying to correct such market failures have turned to regulatory standards, dictating what measures must be taken to meet environmental goals. This approach has measurably improved the environment in many cases, and is especially important where there is little room for error, such as disposing of high-level radioactive waste or safeguarding an endangered species. But it has often turned out to be a costly and cumbersome way of bringing about widespread change. Taxes can help meet broad environmental goals efficiently, since they adjust prices and then let the market do the rest.
Source: State of the World 1991, Worldwatch Institute.