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The East is Green:

Commentary

The Future of China’s Environmental Regime :


By Matthew Zito, Editor, China Briefing


In the month since China announced the first revisions to its 1989 Environmental Protection Law, the Revised Law‘s implications have been closely studied by policy analysts, media outlets, and foreign investors alike, with signs that this watershed moment in the history of environmental regulation in China may just be the tip of the melting iceberg. With the Revised Law due to enter into effect on January 1, 2015, a growing number of carbon markets dotting the country, and two new environmental tax schemes under discussion, now is a good time to take stock of the complex state of environmental regulations in China, especially their implications for foreign manufacturers.


When it comes to environmental protection, China is a country of extremes. It is at once the world’s biggest polluter and the top global investor in clean energy. And while Premier Li Keqiang has “declared war on pollution,” China will remain reliant on coal for the majority of its electricity until at least 2030. Based on its history of unprecedentedly rapid economic development, China perhaps more than any other nation is caught between the choice of maintaining economic growth and devoting greater attention to environmental initiatives. There is some indication that the latter is finally gaining ground: in October 2013, President Xi Jinping promised to take aim at polluters, even at the cost of lowered economic gains.
By many standards this can’t come soon enough. While the horrendous state of air quality in China’s megacities is well known, recent evidence suggests damage to the country’s soil and water systems is even more grave. Adding to the problem, in 2013 a retired Communist Party official stated that pollution had become the main cause of social unrest in the country. While for the past several decades it has been assumed that private industry could remain largely unaffected by the worsening state of the environment in China, air pollution has become a commonly cited reason in the decisions of several notable China expats to leave the country, thus exerting a growing influence on talent retention for companies operating in China.


Revised Environmental Protection Law


On April 22, the Standing Committee of the National People’s Congress passed a revision to the 1989 Environmental Protection Law. The Revised Law, which contains 70 articles in comparison to only 47 in its predecessor, will take effect on January 1, 2015. Between 2011 and 2014, the Revised Law was debated in three sessions of the National People’s Congress, and submitted to an unprecedented fourth review session in April 2014 before being finalized.


The old Environmental Protection Law had few proponents. Especially in terms of its measures for implementation and penalties, there was a general consensus that the law was woefully lacking. Owing to this, and the relatively weak position of the Environmental Protection Bureau (EPB) vis-á-vis other governmental agencies, there was little hope that the Revised Law would be any more effective at curbing polluters in China. Environmentalists were therefore surprised by provisions included in the final draft of the law which established tougher penalties for polluters and greater powers for public-interest groups.


The inclusion of these measures in the revised law was likely bolstered by some particularly disturbing statistics recently released by the Chinese state media. In the same week that the Revised Law was passed, government reports were issued stating that nearly 60 percent of monitored areas had “very poor” or “relatively poor” underground water quality in 2013, and that about 16.1 percent of the country’s arable land is polluted.


Overall, the Revised Law emphasizes the principles of transparency, accountability, rule of law, and public participation in environmental monitoring. These make it inevitable that the costs of doing business in China for foreign-invested enterprises will go up—whether it be in the form of upgrading manufacturing facilities to comply with new environmental standards, establishing pollution control systems, or via the penalties of non-compliance. As with the law’s predecessor, however, it remains to be seen how stringently these measures will be applied in practice.


•    Fines—One of the biggest changes introduced in the Revised Law is the shift from a system of one-time fines to daily increasing fines for environmental violations. It is widely noted that under the old system, it was often much cheaper for a polluting enterprise to simply pay the fine and continue on in its old ways rather than reform its practices or replace equipment to conform with environmental standards. The new system, however, based on the principle of removing any benefits derived through illegal activity, removes all caps on the fines applicable to polluters.

•    Other Punishments—Overall, the Revised Law establishes heavier punishments for polluting enterprises and government officials connected to pollution incidents. All parties involved in conducting fraudulent or environmentally-damaging activities will bear joint liability. In addition to newly-granted powers for local EPAs to seize assets and ban production at polluting enterprises, up to 15 days of detention may apply to responsible parties in the following situations:
- Enterprises failing to conduct an environmental impact assessment (EIA), refusing to suspend production after being issued a ban, forging monitoring data, or improperly operating a pollution prevention system.
- Central and provincial governments failing to carry out EIAs for economic and technological policies implemented within their respective jurisdictions.
- Enterprises found guilty of discharging pollutants without a permit, or failing to suspend such activities after being issued a ban.

Additionally, local government officials failing to enforce regulations, including issuing bans to polluting enterprises and publicizing certain types of information or found guilty of manipulating data to cover up environmental malfeasance, may be fired or demoted.

•    Transparency—The Revised Law‘s emphasis on transparency is in stark contrast to the previous state of affairs, in which environmental data was considered a state secret and its discussion forbidden by law. Under the Revised Law, polluters must publicly disclose their emissions data, as well as the results of environmental impact assessments, now required for all major project proposals. In an effort to “name and shame” polluting enterprises, the government will also publish a list of violators.

•    Public-Interest Litigation and Whistle-blowing—The Revised Law also widens the channels for initiating public-interest environmental litigation against polluters.  While previously, only a single state-controlled NGO was capable of bringing such suits to court, under the Revised Law, all social organizations registered with a Civil Affairs Bureau above the city level will be able to file lawsuits, provided they have been continuously active for at least 5 years and have no previous record of illegal activity. This is expected to include some 300 environmental groups across China. In keeping with the new law’s atmosphere of increased transparency, individual citizens and citizen groups will be able to anonymously report environmental violators, including both enterprises and government authorities.

•    Environmental Impact Assessments (EIA) and Energy Conservation Assessments—The Revised Law requires two types of environmental assessments be conducted prior to certain types of industrial projects. An EIA is required for all construction projects, including new construction, modifications and renovations, and is a prerequisite to obtaining an operations license. These reports are to be publicly disclosed, and the failure to submit one may result in fines, orders to cease construction and orders to restore the site to its original conditions. ECAs, meanwhile, must be submitted for fixed asset investment projects, with failure to do so resulting in delays to construction or operations. For either type of report, environmental authorities have been granted a number of powers to incentivize enterprises to comply with regulations, including remedial measures (e.g., planting trees, upgrading equipment), tax penalties and punitive prices for utility fees.

•    Other Requirements—Enterprises are also compelled to establish an environmental protection monitoring system, a control system for total emissions of key pollutants and a pollution discharge license, which carries its own additional requirements. Failure to comply with these regulations is punishable by the means described above.

Two New Environmental Taxes


Environmental Tax—Alongside the revised Environmental Protection Law, China’s legislature is currently reviewing a bill for the introduction of an Environmental Tax (ET), titled the Environmental Tax Law. Related measures have been discussed and repeatedly postponed since 2011 — indeed, ET was widely expected to have been included in the 12th Five-Year Plan announced in 2012. Debates have revolved around issues such as which government agency would be charged with collecting the tax and how tax revenue would be used.


Earlier this year, prior to the announced revision to the Environmental Protection Law, the Ministry of Finance announced that China would introduce a set of new taxation policies designed to protect the environment, replacing the “pollutant discharge fees” currently levied on enterprises. It was argued that the advantages of an environmental tax would include a clearer system of managing authorities, more uniform collection rates, and placing the burden of proof on the polluters themselves.


In its current draft, the EP Tax Law consists of 39 articles in 7 chapters and proposes five types of taxable items: air pollutants, water pollutants, solid waste, noise and carbon dioxide. The latter two items would be entirely new to taxation in China, whereas waste disposal charges are currently applied to the former three. At present, it is difficult to assess the influence the Revised Environmental Protection Law will have on deliberations to implement an environmental tax, as the two significantly overlap in their application. As recently as May 2014, the Environmental Tax Law was predicted to enter into effect by late 2015 or early 2016.


Carbon Tax—Adding further complication to China’s environmental regulatory system, as recently as 2013 plans were said to be in the works to introduce a carbon tax to be levied on corporate emissions. As the world’s biggest contributor of greenhouse gases, China faces considerable international pressure to bring down its CO2 emissions, especially in its steel and cement industries. Added pressure comes from meeting the country’s own publicized target of reducing per-unit-of-GDP carbon emissions by 40-45 percent from 2005 levels by 2020.


The introduction of a gradually increasing carbon tax would result in an estimated 19 percent reduction in emissions by 2020 according to some reports, and between RMB 90 and 460 billion in revenue. Critics, however, point to the potential resultant spike in unemployment (as companies scramble to cut costs against declining profits) and local infrastructure costs this would create. During a period of economic uncertainty, Beijing is wary of introducing two new taxes, both of which would target the same polluting enterprises. It now appears likely that ET will take priority over a carbon tax, as China’s attention shifts from combating global warming to dealing with its acute air pollution problem. Nevertheless, Tsinghua University Economist Cao Jing has predicted a carbon tax will be implemented by 2015 at the earliest.


Carbon Markets


While the carbon tax languishes in legislative limbo, cap-and-trade systems are being rolled out across China. In 2013, Shenzhen initiated the first such system (also known as a carbon market or emissions trading scheme), and this was quickly expanded to include six additional pilot regions. To date, the country’s carbon markets can hardly be characterized as booming; however,in May 2014 the China Beijing Environment Exchange recorded a record-high of around two to three trades in carbon allowances per day. This has been primarily attributed to a lack of transparency on how market prices are set and other critical factors for the establishment of true market conditions, such as an absolute carbon cap. As a result, allowance prices have fluctuated between RMB20 in Hubei to RMB130 in Shenzhen. An official closely connected to the development of carbon markets has cited a target of 2020 for the creation of a national carbon market. A review of this proposal is planned for 2015.


From the present standpoint, it is safe to assume that China will press on with an environmental tax, most likely to be announced before the end of 2014 and implemented in 2015. The carbon tax, on the other hand, appears likely to have been shelved for the moment, pending an upswing in the Chinese economy. Meanwhile, both central and local governments have demonstrated their careful endorsement of carbon markets. While China seems committed to the eventual adoption of a unified national market, until this happens, there are likely to be continuing problems based on the above-identified issues.

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email china@dezshira.com or visit www.dezshira.com.