Quantifying environmental externalities with a view to internalizing them in the price of products, using different monetization models

Abstract

In this paper, we first conduct an exhaustive literature review on how environmental externalities in a life cycle model could be valued and, through a case study, we check the consistency of the results obtained based on different monetization models. Then we compare the two approaches for internalization of externalities in the price of products: (1) to introduce a corrective tax equal to the externalities and (2) to apply reduced value added tax rates on environmentally friendly goods based on their relatively low externalities compared to less friendly alternatives. A typical product category is selected for the case study, i.e., electrical energy derived from the two distinct primary energy sources, renewable and non-renewable. The results comparing the three monetization methods illustrate that the choice of method used can influence not only the resulting monetary value of the externalities, or marginal social costs, of a single product but also the relative ranking among alternatives in the same product category. Our results also show that internalizing externalities by means of either a corrective tax (approach 1) or a reduced value added tax rate (approach 2) eliminates the price disadvantage of green products like electricity from biomass, making them a preferable choice over cheap conventional ones like coal.