Carbon and energy taxes in Europe

The demand to ‘make the polluter pay’ by putting a price on the amount of carbon dioxide and other greenhouse gases produced has been a major point of discussion and debate across Europe since the mid-1980s.

Jacques Delors spent much of his eight-year period as president of the European Commission arguing for an EU carbon/energy tax. However, he failed to get the member states to agree to introduce one. Taxation measures require unanimity in the Council of Ministers and many member states, including the UK, opposed the Delors proposal on ‘subsidiarity’ grounds – the argument that taxes are for national governments, not the EU. Other member states less politically opposed to EU integration, such as Germany, opposed the Delors proposals because they would have damaged their coal industries. (The two largest German energy utilities, Eon and RWE, both have very large coal operations and are very well-connected with German politicians.) The only EU measure on energy taxation is a required minimum level of taxation, but this is too low to promote energy efficiently significantly. There is no EU carbon taxation. The present commission is talking about trying to introduce one, but some national governments, including the UK’s, have said that they will veto this.

Having failed on a carbon tax, the European Commission tried instead a cap-and-trade approach, the Emissions Trading Scheme (ETS). This was introduced in 2005. It was a start, but has so far delivered few results, mainly because national governments have allocated far too many permits, so the price per tonne of carbon has been far too low to make any real difference. In the future, permits will be auctioned, rather than handed out without payment as they have been in the past, so this should strengthen the ETS.

There has been some progress on carbon and energy taxation in European countries, notably Scandinavia, the Netherlands and Germany. Before the current recession, revenue was used to reduce taxes on income or employment. This was often referred to as an Environmental Tax Reform (ETR) and was done to deliver a ‘double dividend’ – lower levels of pollution and higher employment. However, the total amount raised from all green taxes reached a peak (2.9%) in 1999. By 2008, it had fallen back to 2.4%. Energy taxation, including taxes on transport fuels, makes up about two-thirds of overall environmental taxation.

National carbon and energy taxes

Finland. Finland was the first country to introduce a carbon tax, in 1990. That year, the rate was the equivalent of €1.19 per tonne of CO2. By 2009, this had risen to €20 per tonne. Since 1998, there has been a refund scheme for energy intensive firms, but only those for whom energy taxes would reduce their value added by more than 3.7%. This means that only a small number of industrial facilities can claim the refund.

The Finnish ETR represented 0.2% of GDP.

Netherlands. The Netherlands also first adopted a carbon tax in 1990, but replaced it with a 50/50 carbon/energy tax in 1992. This tax is called the Environmental Tax on Fuels. This mainly affected large energy users, so another carbon/energy tax, the Regulatory Tax on Energy, was introduced in 1996 to target small-scale energy consumers. A tax-free energy allowance (floor) was introduced for both gas and electricity. In 2001, this was replaced by a fixed tax reduction of €142 a year for electricity connection, raised to €181 in 2004. The gas and electricity use of all households and about 95% of all Dutch companies were covered by this tax.

Since 2000, the rate of tax on electricity has been increased by more than the rate of tax on other energy products, as Dutch electricity use was increasing more rapidly than other energy. The carbon element of the energy tax has been largely abandoned, although, from 2000 to 2003, there was a zero-rate for electricity from renewables, on condition that this rate advantage was passed on to consumers who had a special contract for buying green electricity, and waste incinerators paid only half the tax (as half the waste content is assumed to be organic). In 2003, the zero-rate for green electricity was changed to a reduced rate and the waste incineration reduced rate was ended. In 2005, the zero-rate for green electricity was abolished, as the government thought that the subsidies it was offering were enough support for renewables.

In 2004, the Environmental Tax on Fuels and Regulatory Tax on Energy and the excise duty on mineral oils (which included transport fuels) for combined into a single tax. However, a tax on coal remained separate. The rate for electricity was 6.5 cents/kwh for small users to 0.05 cents/kwh for large industrial users. The tax on coal (which provides around a tenth of Dutch energy) was €26 for each tonne of carbon. Revenue was used to reduce personal and corporate income tax and also to offer accelerated depreciation for environmental equipment and energy investments. Some is distributed to households as an Energy Premium.

The Dutch ETR involves around 0.7% of GDP.

There are few exemptions (though, as noted above, the tax rate paid by large energy users is much lower than the rate paid by households). At the start, there was no tax on natural gas used in greenhouses, but the sector signed an agreement to improving its energy efficiency by 65% in the period 1980-2010. From 2000, a small rate of tax was imposed on greenhouses, at the insistence of the European Commission. Other sectors also signed long term agreements, including the energy intensive companies in 1999.

(For more on the Dutch ETR, see The Netherlands’ Tax on Energy: Questions and Answers.)

Sweden. Sweden introduced taxes on CO2 and SO2 in 1991, and one on NOx emissions in 1992. The CO2 tax is the major form of energy taxation in Sweden and has been successively increased since 1991. In 2009, it was over €40/tonne. However, industries are required to pay only 50% of the tax, so, in practice, the Swedish rate is similar to the Finnish one. Also, no tax is applied to fuels used for electricity generation, so the main effect has been on promoting renewable heat (including from peat, which is theoretically renewable, but only over millennia and is actually extremely bad for the climate. Finland removed its CO2 tax from peat in 2005). Some of the revenue was used to fill some of Sweden’s budget deficit, but some to reduce income tax, making this the first major ETR in Europe. Overall, 4.6% of GDP has been involved in this tax shift.

There has been a tax on consumption of electrical power since 1951. This includes electrical power consumed in Sweden, whether it is produced domestically or imported. Industry can avoid electricity tax by participating in the voluntary Programme for Improved Energy Efficiency. Since 1981, recognising the need for more electricity use in Northern Sweden, northern Swedish regions and municipalities have been allowed to levy a reduced rate, which is about a third lower. Norrbotten, Västerbotten and Jämtland regions, as well as some municipalities in Västernorrland, Gävleborg, Dalarna and Värmland regions, use this lower rate.

Denmark. In 1977, Denmark introduced an energy tax on fossil fuels in response to the oil crises. The aim was not environmental, but to reduce the balance of payments deficit resulting from the import of oil products and increase the use of natural gas. The tax depends on the energy content of the fuels and, at first, was only levied on oil-products. In 1982, it was expanded to coal and, in 1996, to gas. Until 1996, all VAT-registered firms were largely exempt from paying energy tax, but since then they have had to pay the tax on energy used for space heating. However, gas, oil and coal used for manufacturing or electricity production are not covered by the energy tax. Firms using more than 15 million kWh a year of electricity do not pay tax on the amount above that level. Electricity used for space heating has a reduced energy tax rate.

In 1992, Denmark also introduced a CO2-tax, dependent on the content of CO2 in the fuel. The highest rate was the equivalent of €13.5/tonne. However, the aim was not to increase the price of fossil fuels, so the energy tax was lowered. Energy-intensive industries were fully exempt from paying CO2 tax. A sulphur tax was introduced in 1996 and a nitrogen tax in 2010.

Denmark imposed a tax freeze from 2001/2002 to 2008. Since 2008, rates have been regulated according to price level increases. Overall, Denmark has the highest rate of energy taxation of any EU country.

In May 2009, a new Danish tax reform was adopted. However, the changes will be introduced no earlier than 2010 and some not until 2013. The reform will include:

  1. A general increase in the energy levies.
  2. A reduction of the lower-limit allowance of the CO2-levy (reduction in the basic tax free allowance of the CO2-tax, not implemented yet).
  3. An increase in the levy on waste put on landfills.
  4. Levies on hazardous waste.
  5. Levies on methane in connection with energy use.
  6. Several initiatives in the area of levies for vehicles.

The Danish tax shift has involved 2.3% of GDP.

Norway. Norway introduced a CO2 tax on mineral oil products in 1991 and this was later extended to all fossil fuels. Different fuels pay different rates: in 2009, the highest rate – mineral oil – was the equivalent of €27/tonne. The fact that Norway is obliged to follow EU rules, despite not being a member, to have free access to the EU market, has complicated matters. From 2003, coal and coke have been exempted from the CO2 tax and, in 2008, the CO2 tax rate for offshore installations was almost halved to reduce “double taxation” after this sector became part of the EU ETS. Norway has given free ETS allowances to gas fired power plants and to district heating.

A tax on sulphur in mineral oil was introduced in 1970. It was the first tax in Norway that had an explicit environmental purpose. A tax on nitrogen emissions was introduced in 2007.

Germany. Germany began its ETR is 1999. Existing energy taxes, particularly on transport fuels, were increased and a new electricity tax introduced. The government pre-announced that the electricity tax and petrol and diesel taxes would increase every year: this was done every year from 1999 to 2003. Most of the revenue was used to reduce employer and employee social security contributions, though a small proportion was used to support renewables and renovate existing buildings to make them more energy efficient. Renewable energy generation is exempt from the electricity tax. Highly efficient, combined heat and power plants pay a lower rate of tax and gas power plants are exempted for five years after first generation.

This tax shift amounted to about 0.6% of GDP. The proportion of government revenue coming from green taxes increased by a third from 1999 to 2003. However, since 2003, it has gone back down to almost the pre-reform proportion. Therefore, Germany now gets less of its revenue from green taxes than the EU-27 average.

In addition, the impact of the German ETR has been significantly reduced by three factors:

  • The tax rates are low. For example, the tax rate for electricity consumed by industrial consumers was 1.2 cents/kWh in 1999. This was increased every year until 2003, but reached only 2.05 cents/kWh.
  • There are numerous exemptions and reduced rates. Very large consumers are exempt to maintain their competitiveness. Businesses that paid more than 20% more in the new green taxes than they saved in lower social security contributions were reimbursed by the federal government: in full until 2003, 60% of increased costs since then. Industry and agriculture paid only 20% of the regular tax rate until 2003; since then they have paid 60%.
  • Germany does not have a carbon tax, only energy and electricity taxes. Renewables are exempt from the electricity tax and good quality combined heat and power (CHP) pays a lower rate. However, there is no formal link between tax rate and carbon content. Most strikingly, brown coal and hard coal, which are very high in carbon content, are exempt from the energy tax.

(For more on Germany’s ETR, see Eco Logic: Effects of Germany’s Ecological Tax Reforms on the Environment, Employment and Technological Innovation.)

UK. The UK introduced a climate change levy in 2001 on the use of energy in the industry, commerce and public sectors. Domestic energy was excluded, partly because of the serious problem of fuel poverty in the UK and partly because the Labour government wished to avoid the political problems that had beset the previous Conservative government when they imposed VAT on domestic fuel. The revenue from the climate change levy was used to reduce employers’ national insurance contributions (as the revenue from the Conservatives’ landfill tax had been), with a small proportion used to provide support for energy efficiency and renewable energy.

Despite its name, the climate change levy is not a carbon tax – the same rates are payable on coal, gas and nuclear electricity, though CHP and renewables pay lower rates. This was because the Labour Party was not prepared to alienate its supporters in the coal industry. (This example suggests that taxation is also subject to potential regulatory capture.) The coalition government, which is not close to the coal industry, says that it will turn the Climate Change Levy into a carbon tax.

Rates are low: 0.15p/kWh for gas 0.44p/kWh ($0.0087) for electricity and 0.12p ($0.0024) for any other taxable commodity. There are various exemptions including for electricity generated from new renewable energy and fuel used for “good quality” CHP.

This tax shift represented only 0.06% of UK GDP. The main impact of the climate change levy has been the focus companies’ attention on energy efficiency. Many sectors entered into agreements to improve energy efficiency and therefore pay a lower rate of tax.

Switzerland. Switzerland introduced a CO2 tax in heating fuels in 2008. The rate was set at €7.5 per tonne of CO2, with an automatic escalator to increase rates if CO2 reduction targets are not met. Revenue will be returned to households through the benefits system.

Effectiveness of energy and carbon taxes

Of course, it is difficult to be certain about the impact of a tax among all the other policies, industrial trends and wider political and economic developments. However, reliable assessments show that green taxes can be effective. A good summary is in a paper by Stefan Speck for the Green Fiscal Commission (see ETR in Europe: experience to date). This says that:

  • Finland’s carbon and energy tax has meant that carbon emissions have been 7% lower than they would have been without the tax.
  • Norway’s carbon tax has led to a reduction of 21% in CO2 emissions from power plants. The tax is said to have reduced total Norwegian carbon emissions by 2%. Carbon emissions for each unit of GDP have reduced 12%;
  • Denmark’s carbon and energy taxes have reduced emissions from affected sectors by 6%.
  • In Sweden, emissions would have been 20% higher than 1990 levels without the carbon and energy tax.
  • The Netherlands’ emissions are 3.5% lower than they would have been without the carbon and energy tax.
  • Germany’s CO2 emissions were 2 to 3% lower by 2005 than they would have been without the carbon and energy tax.
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