ENVIRONMENTAL TAXES IN THE EU: CURRENT ISSUES AND POLICY RECOMMENDATIONS (O.Onike, 2022)

22 min readJul 27, 2023

ENVIRONMENTAL TAXES IN THE EU: CURRENT ISSUES AND POLICY RECOMMENDATIONS (O.Onike, 2022)

Abstract: Today climate reforms are a big issue today. This paper explores the ever- increasing need for increased government commitment to achieving the climate goals. One of the means to this end is through effective and efficient environmental taxes especially within the European Union (‘EU’). The paper looks at the various environmental taxes in the EU, as well as environmental tax policies in the EU like the European Green Deal and its subcomponents and tax incentives. This research reveals a lacuna in the current tax policies of the EU and potential tax policies that can be employed by the EU. It also looks at the pollical barriers to designing and implementing environmental policies. These conclusions were arrived at through an in-dept literary review of existing scholarly works on environmental tax. Lastly, the paper recommends policies such as the use of high-level political platforms to push for pro-environmental tax reforms.

5TH JANUARY 2022

1. Introduction

The climate crisis has necessitated an increase in European Union member states actions towards the green agenda and raised public awareness about the climate situation. This has led to several measures being put in place and consideration for the future. Some of these measures include impact investing, climate finance, environmental taxes etc. This paper focuses on environmental tax and gives a perspective on the current issues relating to environmental taxes in the European Union. This paper also considers different policy options available to tackle these issues as well as recommends a policy that is most effective to be adopted by the European Union and its member states. The paper also makes a lot of reference to the different studies from renowned institutions like the Organization for Economic Cooperation (OECD), which has a sizeable number of its members who are also part of the European Union.

The climate crisis the world faces and by extension the European Union faces today has led to the green tax revolution as highlighted by (Laszlo, 2021). It is important that I highlight for the purpose of this paper that the terms environmental tax and green tax will be used interchangeably but refer to the same thing.

There is an ever-increasing need for decision makers in the European Union to advance the use of environmental taxes to achieve climate change objectives. It is not enough to focus a huge amount of resources on green projects and leave out the option of an environmental tax. As is the case with less emphasis being put on tax policy opportunities. It is advisable to correct the negative externalities that arise from the activities of companies and individuals using a Pigouvian tax approach (Laszlo, 2021).

With the recently concluded COP26 in Glasgow, there certainly is a beam of light distinctly focused on the climate issues facing the EU today. EU countries committed to cut down emissions by at least 55% by 2030 compared to 1990. This is stated in the EU new climate plan called the Nationally Determined Contribution (NDC) (World Research Institute, 2021). To strengthen this commitment towards net-zero emissions and to make up for the credibility gap, the EU has to enact energy transition policies to support renewable energy projects and impact investing, the EU also has to effectively use environmental taxes to achieve the new climate plan. It is also worth of note here that the income generated from environmental taxes can be a key source of funding the EU’s quota of the commitments made by rich countries in 2009 to mobilize $100 billion per annum from 2020 through 2025 to support developing nations in the fight against climate change (World Research Institute, 2021) among several other funding commitments. Environmental taxes — or ecotaxes as used by (Planete-Energies, 2019) — includes taxes on energy, transport, pollution and resources.

People seldom conceive the two words, tax, and environment in the same sentence. This is because government uses taxes to generate revenue for running an economy; government get entangled with environmental issues to protect public interest. However, there is an intersection between the two words, especially with the increased campaign for climate change reforms today.

Environmental taxes can come in many forms, they can serve as a means of revenue generation to the government as we see in the breakdown of the income from taxes generated by EU countries where government imposes a tax on companies whose

activities are proven to have negative effect on the environment and as a means of reward, they can be used by the government as a means to compensate companies that are pro- environment.
For example, the government can generate revenue by taxing oil refining companies who have refused to cut down their carbon emissions — in 2019, the Germany government agreed on a carbon tax for CO2 emissions from oil and gas companies at 25 Euro per tonne, and it is anticipated to increase to 55 Euro per tonne of CO2 emission by 2025 (Traufetter, 2019) — while governments can provide incentives like corporate tax reduction to oil companies that have reduced or committed to transform their production process to reduce carbon emissions.

It is important to highlight that these revenue and incentive mechanisms used by government are not solely designed for companies, but individuals can also benefit from them as well — for example individuals who purchase electric vehicles and plug-in hybrids are exempt from registration tax in Belgium, Germany even offers purchase grants of up to €9,000 for fully-electric vehicles (Wallbox, 2021). Several EU countries have different similar incentives schemes — a tax credit given to people who buy electric cars. The discussion on tax incentives are broad however this paper discusses it in the following chapters.

2. Environmental Tax in the European Union

When compared to the US, most countries in the EU have a high level of environmental tax, but the US is not the benchmark and therefore the current environmental tax policies

in the EU can be much better than it is today, especially as the EU strives to be a pace- setter in climate reforms. Ab initio, environmental taxes in the EU member states were designed to cater to road construction, sewage systems, water supply and the likes. However, over the course of time, policy makers found it to be a nascent source of revenue and explored it. They found that they could save energy and scarce resources in the process of increasing these taxes revenue. These taxes have grown over time to what it is today, and society has adapted to it (Sterner and Kohlin, 2017).

Within the EU, there is an increasing need for cross-border environmental tax reforms as a response to the cross-border pollution. This is bolstered by the presence of green parties in many EU countries that stand for the green agenda and have strong representation that advocate for the green cause within the political systems of these countries. This radiates a glimmer of hope that increased environmental reforms in the EU will be achieved.

The primary environmental policy strategy used by most EU member states is environmental incentives, environmental taxes, user charges and deposit refund systems. The paper highlights on them in the following pages.
A closer look at OECD data on environmental taxes in use in the European Union, shows that in 2019, the environmental tax revenue was €330.6 billion for the EU27, making up an average of 2.4% of GDP.

The graph below shows this.

Figure 1: Environmental Tax (Total % of GDP) Source: OECD, 2019

In most EU member states, there is no rule for earmarking these revenues for environmental purposes. Interestingly, these tax levels have not changed substantially since 2007. Taxes on pollution, energy, transport, and resources have largely been the same (Laszlo, 2021). This goes to show that pro-environmental policies need to be realigned to raise revenue and more importantly channel the incremental revenues towards environmental purposes. Opportunities to increase tax revenue abound as most EU member states generate a large percentage of environmental tax revenue from energy. Transport taxes are also largely used in many EU countries but a lot more can be generated from transport sector, especially for countries like Estonia that has little or no revenue coming in from transport taxes. A large percentage of EU countries have low

environmental tax revenue for pollution tax too. This point is clearly captured in the figure below.

Figure 2: Environmental Tax (Total/Energy/Transport/Resources/Pollution, % of GDP) Source: OECD, 2019

3. European Green Deal — The role of environmental taxation

The European green deal is a novel approach to growth that uses diverse policy options to transform the EU into a modern, resource efficient and competitive economy, with a pledge to reduce emissions as I earlier highlighted, to make EU the first climate neutral continent by 2050 (European Commission, 2021). The green deal was adopted in December 2019. The European green deal is a perfect opportunity to get it right with the EU’s climate, energy, transport, and resources tax policy.

The European Green Deal was designed to be a green game changer (KPMG, 2021). The EU has not minced words in clearly demonstrating that it wants to be the leading continent in climate reforms and serve as a role model for other nations in this regard. The European Green Deal is financially intensive and will require a lot of resources to implement it, and therefore the EU has hinged the implementation of these plans on the Recovery and Resilience Facility, the Just Transition Mechanism and partly on the NextGenerationEU.

3.1. Recovery and Resilience Facility, Just Transition Mechanism and NextGenerationEU

A closer look at the contents of the Recovery and Resilience Facility (‘RRF’), — which came into force in February 2021– the Just Transition Mechanism (‘JTM’), — which was presented to the European Union Commission in January 2020 and was designed to support a just transition of EU countries to a climate neutral economy and lighted the economic burden of this transition on EU countries — and the NextGenerationEU — an instrument designed to support EU countries post-COVID economic recovery and building a greener, digital and more resilient future — show the plans to generate finance are hinged on borrowing from the capital market (European Commission, 2020). The NextGeneratioEU will specifically be financed by the EU Commission on behalf of the EU, with plans to borrow 800billion through bond issuance. Likewise, the RRF will provide grants and loans to EU member states to the tune of 723.8 billion. While the loans will be paid by member states directly, the grants will be paid by the EU.

The point I seek to highlight here is that in both the RRF, the JTM and the NextGenerationEU mechanisms which are specifically focused on funding and implementing the green revolution in the EU, neither seeks to generate funds from taxation, or seeks the possibility of exploring the additional externalities that will come from green tax reforms. Positive externalities like a reduction in carbon emissions by implementing an EU wide carbon tax system. This goes to highlight the lacuna in potential environmental tax revenue that can be filled up if there is more talk on the effective use of an environmental tax system by the EU. Also, if revenues are generated from taxes directly by these EU countries, then the cost incurred in seeking for loans and interest payments on these loans would be avoided.

Despite the absence of the environmental tax narrative in the RRF and the JTM, the European Green Deal also has the Carbon Border Adjustment Mechanism and the European Union Emissions Trading System which serves as another good opportunity to impact on the EU tax structure while it achieves the EU climate goals. The proposed new Carbon Border Adjustment Mechanism (CBAM) seeks to disincentivize carbonization of imports to Europe while the EU Emissions Trading System (EU ETS) requires setting a cap on carbon emissions by producers and charging a fee on CO2 emission from production that exceed their allotted caps.

These offer a perfect opportunity for the EU to implement tax reforms in this regard to serve as additional disincentives to carbonization of products. The potential revenue generated from such a proposed tax could be used to invest in climate initiatives and pay for loans and grants. This point is buttressed by (Laszlo, 2021) where he highlighted that

the EU Emission Trading System and the Carbon Border Adjustment Mechanism can be used to pay for the bonds issued and loans used to finance the EU rescue package. He further highlighted that the EU ETS and the CBAM can serves as effective means to achieve the climate objectives, but they do not have any weighty effect on the current EU tax structure. To make an already bad case worse, likely novel taxes at the EU level have little to do with environmental goals.

3.2. Energy Taxation Directive (ETD)

Despite the conspicuous absence of note-worthy new environmental tax initiatives at the EU level, the European Green Deal has proposed to revise the Energy Taxation Directive (‘ETD’). The initial Energy Taxation Directive (ETD) 2003/96, lays down the “EU rules of taxation of energy products used as motor fuel or heating fuel and of electricity” (European Commission, 2020). Since its introduction in 2003, there have been several attempts to revise the ETD, but they have all been blocked by the council. This is despite the clear development in the energy sector over this period and the increased need to update it in line with the EU climate commitments like the Paris Agreement of 2015, the EU climate goals and the EU climate financing challenges. In September 2019, the EU Commission published an assessment of the ETD, — this assessment was based on five criteria of effectiveness, efficiency, relevance, coherence, and EU added value — nothing else stood out from this publication except that the EU ETD was no longer significantly aligned with the EU climate objectives. Therefore, the need to revise it.

The proposed updated EU ETD is a revision of the current energy taxes used in the EU, with a focus on harmonizing the taxation of electricity and energy products which are used as fuel for vehicles and for the heating of houses across the EU (KPMG, 2021). This is a laudable initiative, and it will certainly generate additional revenue for EU countries and contribute significantly to achieving climate targets, but irrespective of the upside to it, it is important to call to mind that currently energy taxes are the highest contributors to taxes in the EU as I earlier highlighted. Most EU countries have their highest environmental tax revenue from energy taxes. Therefore, while the ETD is laudable — as it also seeks to incorporate the aviation and maritime industry into the ETD, which will further broaden the tax base — the EU needs to structure new environmental tax directives that focus on transportation, pollution and resources. “One of the biggest impacts of this directive is decreasing the possibility of subsidizing fossil fuels, especially in such sectors as aviation and maritime transport” (KPMG, 2021). The proposed minimum tax rates are highlighted in the table below.

Figure 3: Proposed Minimum Tax Rates in the European Union Source: KMPG, 2021

4. Environmental Tax Incentives

On the one hand, there is the environmental tax which not just serves to generate revenue from environmentally destructive activities but also serves as deterrent to companies or individuals engaged in such negative environmental activities by imposing of a tax.
On the other hand, there is the environmental tax incentive which forgoes the revenue from taxes, to serve as a means of encouragement and support to companies and individuals that take steps to engage in or who engage in pro-environmental activities. Köppl and Schratzenstaller (2021) emphasize this by highlighting that environmental tax incentives are designed to favor less environmentally harmful activities and investments at the cost of less revenue from taxation to achieve environmental objectives.

A well-designed environmental tax reform should take environmental tax incentives into consideration. In fact, the ability to design a functional framework for such incentives is key to balancing the scale. Most governments are weary of the negative implications that come from imposing new environmental tax regimes on companies and individuals — these negative implications can arise from a reduction in investments, low employment rates, technology and capital transfers to countries that support environmentally detrimental activities — so they are very cautious in implementing new tax policies. To take care of the negative aspects of implementing new environmental tax policies, EU member states have the option of utilizing environmental tax incentives.

Environmental tax incentives can also be viewed as subsidies. According to the OECD, (2011), “A subsidy is defined as environmentally motivated if it reduces directly or

indirectly the use of something that has a proven, specific negative impact on the environment. Environmentally motivated subsidies consisting of payments from government to producers, or of preferential tax treatments with the objective of influencing the level of production, the price, or the remuneration of the factors of production. Environmentally motivated subsidies could take the form of a VAT exemption or another favorable tax treatment, such as the VAT exemption for electrical vehicles. Other types of environmentally motivated subsidies would be grants or loans totally or partially financing projects or activities aimed at protecting or restoring the environment, nature preservation or conservation of environmental heritage” (OECD, 2011).

From the above definition it is clear how diverse environmentally motivated subsidies are. It is challenging to design and implement such subsidies to suit all the relevant parties. There are several arguments that are put up by pro-environmental and anti-environmental subsidy advocates, as to how these incentives should be designed and implemented. The work by Greene and Braathen (2014) as highlighted in the table below touches on the key findings related to beneficial tax incentives. The authors (Greene and Braathen) most salient points state that tax incentives don’t focus on punitive measure for the negative externalities that arise from environment tax, that adequately implementing them require proper fiscal analysis as it is cost demanding and the lost revenue from the taxes need to be recouped from other government revenue streams, that it cannot be implemented in isolation as it has to be coordinated alongside other government policies and this can make it more difficult to implement.

Figure 4: Overview of Beneficial Findings of Tax Incentives Source: Greene and Braathen, 2014

Environmental tax incentives also have its positive and negative effects. On the positive side, if designed and implemented properly, it could attract the type of. investment the government seeks to attract in line with its climate goals — investments like impact investments and renewable energy projects — as well as raise capital from more sustainable sources like green bonds. It can also serve as a tool to redirect financial strategies to drive

system change. The most glaring negative effect of environmental tax incentives is that it can lead to a reduction in governments revenue. Although the outcomes of implementing environmental tax incentives are difficult to assess, if properly designed and implemented they can achieve the a dual objective of maximizing revenue — especially after cessation of the incentive period — and attaining climate goals.

It is important to also highlight that environmental tax incentives are more diverse across EU member states, as opposed to environmental taxes that are largely revolved around energy, transportation, resources and pollution.
Most tax incentives in the EU are focused on transportation sector as many EU countries have a similar tax incentive that necessitates incentivizing low-emission vehicle purchase. In addition to the earlier example with Belgium and Germany, most tax incentives in the EU are focused on grants for low-emission vehicle purchase and reduced registration fees for low-emission vehicles. Tax incentives for low-carbon vehicles are laudable as research evidence shows that they increased the number of vehicles sold as was the case with the Swedish Green Car Revolution which enacted policy measures that support reduced taxes for cars that emit lower levels of CO2 to the tune of €4,200 for emitting less than 50 grams of CO2 per km and exemption of cars that run on ethanol and gas from fuel taxes. The graph below shows the trend of electronic vehicles purchases in Sweden after the policy was enacted and how the inconsistency in policy implementation affected purchases.

Figure 5: Market Share of New Car Registrations in Sweden Source: Tietge, 2017 (EVs : Electric Vehicles)

The graph above shows how the policy was oversubscribed that the government exhausted it budgetary allocation to the policy, buttressing the point that tax incentives for low-carbon vehicle emission is an effective tool to increasing the sale of low-carbon vehicles. This also calls to mind the need for government to be consistent with its environmental incentive policies as they are crucial to influencing the public reaction to subsequent policies.

Another environmental tax incentive attributed to the transport sector is the car scrapping scheme. It is a tool that is underutilized by many EU countries even though research evidence suggests that it reduces CO2 emission. A research study by OECD called the Car Fleet Renewal Schemes: Environmental and Safety Impact show that car scrapping

schemes in three countries that include Germany and France were effective in reducing CO2 emission cumulatively through 2030. There has been renewed calls especially after the COVID19 economic slowdown by car manufacturers for EU governments to consider reenacting car scrapping schemes to support the revitalization of the sector, but analysts have emphasized that if such schemes must be introduced then there must be green strings attached to them implying that they have to be strictly tied to climate policies. Policies that ensure that when people exchange scrapped cars for money, they use the money to purchase low-emission vehicles. The challenge to enacting the car scrapping scheme in the EU despite it positives, is the cost-effectiveness. The German and French scheme were adjudged to be less cost effective, with the German scheme “less cost-effective in delivering beneficial CO2, NOx and safety outcomes with the benefits quantified here representing only around 25% of the estimated costs” (OECD,2020). The scheme like the one designed in Germany has been criticized for targeting older vehicles that are less used or may not be in use.

There is also the argument for environmental tax incentives for public transportation systems. The authors Köppl and Schratzenstaller (2021) suggest the use of tax exemptions to encourage the use of green public transportation systems, as opposed to using tax subsidies. The argument here is that tax exemptions have few administrative bottlenecks and are easier to design and implement than subsidies schemes. Some EU countries use a reduced VAT rate for public transport services to encourage their use and increase VAT for car that drive though certain areas at certain points in time. In May 2021, France started talks to make it unlawful to drive through the capital city’s historic center without parking

and are considering the use of fines to serves as a deterrent. Although there are several arguments put forward against the use of VAT reductions to encourage public transportation, says that the due to the low elasticity of public demand for commuters’ transport services, cutting VAT rates will have a narrow impact, bearing also in mind that this demand for public transportation is not solely based on the transport cost to the customer, other factors like travel time, income and service quality are important (Paulley et al. 2006). This form of environmental tax incentive however is an effective tool to achieve the climate goal of reducing cars on the road and encouraging the use of bicycles and pedestrians walking.

The discussion of environmental tax incentive in this paper is non exhaustive, however I will lastly add that there are other considerations for these incentives that include incentives to encourage sustainable research and development — even though there is also little empirical evidence to suggest that EU countries are utilizing tax incentives to support environmental research and development — and incentives to support energy efficiency through the use of reduced VAT rates for sustainable electricity products like the reduced VAT rate for thermal insulators used by several EU countries (Köppl and Schratzenstaller, 2021).

Overall, the environmental tax incentives to achieve climate goals may have a blended effects. Therefore, it is most beneficial for EU member states to combine environmental taxes with environmental tax incentives, to achieve its climate objectives.
The discussion on environmental tax incentives should take into consideration the cost and effects, as well as consider all the affected parties for it to be beneficial and effective.

5. The Relegation of Environmental Tax Reforms

When countries come together like they did in Glasgow 2021 to discuss climate change, there is hardly any talk about utilizing environmental tax reforms as a primary tool to achieve set climate objectives. One may wonder what is responsible for this, and while it is difficult to see a clear reason bearing in mind that environmental tax reforms can play a pivotal role to this end, if it is rightly out on the table. Likewise, in the mainstream media campaign for green revolution, there is hardly any talk about greening the tax system in relation (Laszlo, 2021). Moreso with overwhelming evidence to prove the positive correlation between implementing environmental tax and achieving set climate objectives — especially CO2 emissions reduction — and even in relation to other social and economic factors like reducing unemployment. Since it has been long been established that environmental tax works, with a summary of assessment of environmental tax carried out by the European Environmental Agency, (1996) which concluded that the taxes which were evaluated — the paper categorized tax instruments into 4 main categories namely fiscal environmental taxes, incentive charges, user and earmarked cost covering charges — “revealed environmental benefits are were also cost effective, incentive taxes were environmentally effective when the tax is sufficiently high to stimulate abatement measures, Taxes can work over relatively short periods of time (2–4 years), and so compare favorably with other environmental policy tools, though with energy taxes (as with some regulations), they can take 10–15 years to exert substantial incentive effects” (European Environmental Agency, 1996).

Since this is the case there is the need to overcome the political barriers to achieving environmental tax reforms, to achieve this we must firstly address the perceptions that influence political disposition towards the reforms. These perceptions include the impact on employment, which I alluded to earlier in this paper, the impact on already established national taxes and those of the European Union, the impact on the lower class of society who may be affected more by environmental tax reforms, the impact on revenue that it will come with reduction in government revenue and this will be difficult to augment and the impact on other existing regulations and cultural norms which such reforms may erode. Also, when these reforms are not evenly enacted on the EU wide level, politicians at the country level are faced with the fear that companies to whom these reforms are not beneficial will move to other countries that are willing to accommodate them. This can serve as a major disincentive to politicians. Therefore Odendahl (2020) calls for a bold green tax reform that is linked to a tax compensation and incentive system and financial assistance to firms and households to adjust, at both the country level and EU regional level. The author further highlights that true green tax reforms can be politically problematic, and as with every political issues that has powerful losers it requires a stronger political will. To address the challenges, policymakers should enact green reform policies like tax cuts and increased spending that offset the new environmental tax.

The COVID19 pandemic was a major distraction from the conversation on climate issues, but now that EU economies are resurging and are adapting to live and function as best as possible with the virus, the conversation must be shifted back to the issue at hand, and environmental tax reforms must be put back on the drawing board.

6. Policy Recommendation

After all, said and done about the climate crisis, one would expect that the attitude of governments, people and corporations would be drastically changed towards pro- environmental disposition. Despite this we still see that after the COVID-19 pandemic of 2020, government and corporations are keen on a quick recovery. They want to bolster production activities and set the economy and businesses back on an upward trajectory, without much recourse to harmful effects on the environment. But “as long as climate crisis on voters and consumers do not change public attitudes, a radical turnaround cannot be expected” (Laszlo, 2021). The foremost recommended policy is to embrace reforms through a pro-environmental tax regime that must start from the high-level political platforms.
Another policy recommendation is that car scrapping schemes that serve as a form of environmental tax incentives should be designed with a focus on car that are in use, as opposed to cars that are passed a certain number of years — for example in Germany it is designed for cars that are older than 15 years — without recourse to the functionality of the vehicle. This implies that there are little climate objectives tied to these schemes and they should be explored.
Government must employ a mix of environmental taxes with incentives. There is clear evidence also to support the statement that to make the most of an environmental tax policy, there is the need to have a mix of climate policies, environmental taxes and environmental tax incentives. For example, a policy designed to complement an increase

in fuel tax with tax rebate for purchasing electric vehicles, led to an increase in the number

of electric vehicles purchased (Köppl and Schratzenstaller, 2021).
• EU member states should design and implement environmental tax incentives on other

areas of environmental tax, not just on transport sector. As highlighted earlier, most of the tax incentives in place now are focused on the transport sector, paying less attention to energy and resources.

7. Conclusion

There is the need for a radical approach to environmental tax reforms. Decades ago, the discussion on climate change was twisted by parties that would be affected by environmental reforms using the media as their primary tool to dish pour false narratives especially with little scientific evidence at the time to prove otherwise. Now, with the availability of proven scientific evidence to support the climate change agenda and the physical evidence we see daily with increased climate events like wildfires, floods, earthquakes, and the likes, it is overwhelmingly clear that climate change is our reality we must deal with. The challenge now is acting fast and being proactive, if we still have that leverage, by enacting sustainable reforms and increasing environmental taxes — if the EU can get this right, it will serve as a beacon for the rest of the world — to cut down on CO2 emissions, enacting modern tax incentives, redesigning fiscal projections in line with environmental tax reforms, and evenly enact these policies at both country and regional level to ensure that it remains costly and uneconomical for environmentally unfriendly

activities to continue without reforming operations, across the EU. Environmental tax reforms should be allowed to play a pivotal role in this struggle.

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Written by Onyekachi Anthony Onike