Energy and Environmental Taxation: Theory and Practice ... taxation.pdf · Energy and Environmental Taxation: Theory and Practice within the EU An IREF report by Miroslav Zajíček

Energy and Environmental

Taxation: Theory and Practice

within the EU

An IREF report

by

Miroslav Zajíček[1], Pierre Garello[2], Markéta

Grušáková[3], Karel Zeman[4]

Abstract:

Environmental tax reforms have a history of almost two decades and were viewed as a way to the better world the “double-dividend” theory predicted. Much “political capital” has been invested in policies leading to environmental tax reforms on European and national levels from 1992 (the year of the first EU-wide energy and carbon tax proposal) till today. We compare shares of environmental taxes on GDP and overall tax revenues in the EU from 1995 till 2010 to identify the real impact of such efforts. Contrary to rhetoric, we find that environmental taxes importance in fact declined in the last decade in most European countries with very few exceptions (notably Denmark). We also identify reasons for such a surprising development. Among these, rising energy prices (due to other regulatory policies) and introduction of new environmental and economic policies such as tradable permits schemes or feed-in-tariff schemes for promotion of renewable energy sources are the most important.

JEL Classification: H23, H39, D62, Q58

Keywords: Ecotax, Environmental Tax, Externalities, Pigouvian Tax, Redistribution,

Tradable Permits

Energy and Environmental Taxation: Theory and Practice within the EU

IREF 2011IREF 2011IREF 2011IREF 2011

List of Abbreviations:

CO2 Carbon dioxide emissions

EC European Commission

ET(s) Environmental tax(es)

ETR Environmental Tax Reform

ETS Emission Trading Scheme

EU European Union

EU 15 Old Member States

EU 12 New Member States

EU SDS EU Sustainable Development Strategy

ITR Implicit tax rate

GDP Gross Domestic Product

GHGs Greenhouse Gases

OECD Organization for Economic Cooperation and Development

PURPA Public Utility Regulatory Policies Act

RES Renewable energy sources

USA United States of America


1


Environmental Tax

Reforms (ETRs)

gained increasing

political

momentum in the

90s. The asserted

rationale behind

the reform was

labelled in the

political arena and

also sometimes in

economic literature

as “the double

dividend theory”.

The double

dividend theory

was based on the

idea that it is

advantageous for

the economy to

change the

structure of overall

taxation by shifting

the taxation from

taxing "goods"

(work, savings,

investment)

towards taxing

"bads" (such as

pollution,

congestion, and

later carbon).

I. Introduction

Environmental Tax Reforms (ETRs) gained increasing

political momentum in the 90s[5]. Their basic idea was to

shift the tax burden from labour and capital towards the

use of natural resources and of (supposedly)

environmentally harmful activities. These ideas were

clearly stated and summarized in the White Paper on

Growth, Competitiveness and Employment (1993)

published by the European Commission and later

elaborated in a series of documents; the Sustainable

Development Strategy (2001). The asserted rationale

behind the reform was labelled in the political arena and

also sometimes in economic literature as “the double

dividend theory”. The double dividend theory was based on

the idea that it is advantageous for the economy to change

the structure of overall taxation by shifting the taxation

from taxing "goods" (work, savings, investment) towards

taxing "bads" (such as pollution, congestion, and later

carbon).[6] By making such a shift, it was believed that

governments could achieve their environmental goals at no

or minimal costs by simply shifting weights among existing

taxes or by creating new ones. In other words, politicians

came to believe they held the possibility of a “free lunch”

and the prospect of a zero-cost environmental policy

became irresistible. This alone should have raised some

suspicion since there is no such thing as a free lunch in

real life, but surprisingly enough the double dividend

theory received at the time the support of several

prominent experts. To cite just a few: Irwin and Liroff

(1974), Pearce (1991)—he actually introduced the

terminology, Weizsäcker and Jesinghaus (1992) and

Repetto et. al. (1992). However, and not surprisingly,

those claims sparked off an academic debate and some

assumptions of the double dividend theory were soon

undermined (Bovenberg and de Mooij, 1994; Goulder,

1995; Parry, 1994)[7]. Still, the debate is far from over and

in some sense there has been a kind of resurrection of the

“double dividend theory” in past years although with a

slight different emphasis on market instruments such as

emission trading schemes as opposed to direct taxation of

carbon[8].


2


…politicians came

to believe they

held the possibility

of a “free lunch”

and the prospect of

a zero-cost

environmental

policy became

irresistible.

In the first half of

the 90s, the share

of environmental

taxes on total tax

revenues rose by

more than ten

percent.

But the political machine was already grinding. In the first half

of the 90s, the share of environmental taxes on total tax

revenues rose by more than ten percent. Thus, in 1995, one

could easily expect, at least judging from the political rhetoric,

that within a decade or two, the whole tax system which

evolved after World War II would be turned upside down

regardless of academic merits of the double dividend theory. Is

it what we observe today, more than fifteen years later? The

answer is clearly “no”. As we will see, we live in a world that is

completely different from what the proponents of the double

dividend theory suggested; indeed, a world quite similar to the

one we were in the mid 90s–at least from the point of view of

the structure of taxes levied upon us.

The report starts with a short overview of the legal framework

for environmental taxes within the EU, and then continues with

the classification and description of environmental taxes used

currently by EU member states. Then we provide an overview

of the role of environmental taxes from 1995 to 2008 as parts

of the general tax policies both for old member states (EU 15)

and new member states (EU 12) and explore the outcomes of

environmental tax reforms in European countries. In the next

section we explain why the role of environmental taxes

decreased within the last decade. We conclude discussing

whether or not the expectations vested in the introduction of

environmental taxes and environmental tax reforms were

justified.

II. European Legal Framework

Prior to the 2003 Energy taxation directive (see below for

details), the only EU legislation setting minimum levels for the

taxation of energy products was the Mineral Oils Directive

dealing with oil products used for transport or heating and

natural gas used for heating. In 1992 the system for a

harmonized taxation of mineral oils was established via two

directives:

• Directive 92/81/EC (harmonized structure of excise duties

on mineral oils) and

• Directive 92/82/EC (harmonized tax rates of excise duties

on mineral oils).


3


The EC proposed

the first EU-wide

energy and carbon

tax in 1992.

While all Member

States agreed on

the principle of

taxation as an

instrument to

combat climate

change and

politicians

acclaimed the

double dividend

theory, the

negotiations never

resulted in any

agreement.

As has been the case for many pieces of European

legislation, the Directives left room for member states to

adopt different exemptions and tax rate reductions, which

resulted in more than 100 special provisions. The first

proposals to promote the use of environmental taxation

schemes submitted by the European Commission predate

even the publication of the 1993 White paper[9]. The EC

proposed the first EU-wide energy and carbon tax in

1992[10]. While all Member States agreed on the principle

of taxation as an instrument to combat climate change

and politicians acclaimed the double dividend theory, the

negotiations never resulted in any agreement. The

proposal was rejected in 1994[11]. Therefore, the EC

changed tactic and a new scheme was introduced in

1997[12] that was primarily based, not on environmental

considerations, but instead on the strengthening of the

internal market. In the own words of the Commission:

“The aim was now no longer to introduce a new totally

harmonized EU CO2/energy tax but, more pragmatically,

to extend and improve the existing framework for the

Member States taxation of mineral oils to cover all energy

products sold on the Internal Market”[13]. As is clear from

the citation, not only the whole reasoning changed, but

the Commission also changed its approach. Instead of

proposing a new and completely harmonized tax, the

prevailing idea was to harmonize levels and broaden the

bases of taxes already in existence within the member

states. Despite those changes in tactics and approach, the

proposal was still opposed by some countries, notably

Spain. It is only after the introduction of a series of

amendments, changes, of more flexibility for member

states and after the lowering of the minimum rates of

taxation, that the proposal achieved the overall support

from member states. On 27 October 2003, the Council of

Ministers adopted Directive 2003/96/EC designed to

restructure the Community framework for the taxation of

energy products and electricity. In a sense, the Directive

was an overhaul in the history of environmental taxation

in Europe. Till the Directive, the Community coverage was

limited to mineral oil products. But now, the coverage of

the Community framework was widened to include other

energy products such as natural gas, coal, and electricity.

The Directive also increased the minimum rates of taxation

for mineral oils and introduced new


5


Table 1 Minimum rates in the Energy taxation directive – motor fuels[16]

Leaded petrol

(€/1,000l)

Unleaded petrol

(€/1,000l)

Gas oil / diesel

(€/1,000l)

Kerosene (€/1,000l)

LPG (€/1,000l)

Natural Gas (€/1,000

kg)

(€/GJ)

Prior to the Directive

337 287 245 245 100 100

Current 421 359 330 330 125 2,6

Table 2 Minimum rates in the Energy taxation directive – heating fuels and

electricity[17]

Gas oil / diesel

(€/1,000l)

Heavy Fuel Oil /

diesel (€/1,000l)

Kerosene (€/1,000l)

LPG (€/1,000l)

Natural Gas

(€/1,000 kg)

(€/GJ)

Coal and Coke

(€/GJ)

Electricity (€/MWh)

Prior to the Directive

18 13 0 0 0 0 0

Current 21 15 0 0 0,3 0,3 1

No substantial development of positive law in the area of energy taxation took place

since the adoption of this Energy Taxation Directive. However, changes will come sooner

or later as indicated in the Green Paper on market-based instruments for environmental

and policy purposes (COM(2007) 140 final). The document provides (at least in theory)

the scope for restructuring the Energy Taxation Directive to better reflect the EU energy

and climate policy and to reflect all other regulatory and economic changes that took

place since the adoption of the Energy Taxation Directive. However, the enthusiasm from

the early 90s for environmental taxes seems to be gone.

III. Classification of environmental taxes

In order to organize the debate properly, it is necessary to define what we understand by

“environmental taxes”. Such taxes can be classified in four categories:

• Energy taxes;


6


Energy taxes are

by far the most

important part of

all environmental

taxes and amount

to approximately

75% of the whole

package.

…most member

states (old and

new alike) derive

more than 90% of

all revenues from

energy taxes from

transport fuel

taxes.

The high share of

taxes derived from

the transport use

of fuels has been

sometimes

attributed to the

structure of the

Energy Tax

Directive

(2003/96/EC) in

which the

minimum rates for

petrol are the

highest among all

energy products

serviced by the

Directive.

However, this

misses the point.

The real question

should be: why are

the minimum rates

for petrol set in the

Directive so high?

• Transport taxes;

• Pollution taxes and

• Resource taxes[18].

Energy taxes are by far the most important part of all

environmental taxes and amount to approximately 75% of

the whole package. Energy taxes include taxes on both

transport and stationary use of energy products (incl.

heating) with transport fuel taxes being predominant. They

are also the oldest ones[19]. However, as usual with energy

taxes, their relative importance varies considerably among

not only states but also energy products and energy uses.

The fuel taxes constitute the biggest part of all energy

taxes. Considering old member states, the relative share of

fuel tax revenue from all energy taxes revenues reaches

more than 90% in Ireland, Greece, Portugal and the UK.

On the other side of the spectrum we find countries where

that share makes for “only” about 50% of all revenues

from energy taxes. This is the case in Denmark, Sweden

and the Netherlands, where the difference can be assigned

mostly to taxes on natural gas and electricity. In new

member states, the situation is more homogeneous.

Almost all new Member states levy about 90% of all

energy taxes on transport fuels with only three exceptions

– Cyprus, Poland and Estonia with about 80% mainly due

to the fact that Poland and Estonia levied taxes on

electricity using rates above the minimum required by the

Directive. The reason for such homogeneity among new

member states is that the Directive 2004/74/EC allowed

for exemptions in minimum tax rates on electricity, natural

gas, and coal for all EU12 countries.

Distinguishing now between transport and non-transport

use of fuel one can see that most member states (old and

new alike) derive more than 90% of all revenues from

energy taxes from transport fuel taxes. The only

exceptions are Romania (with almost 20 % share of non-

transport use fuel taxes), Italy, Sweden, Cyprus (with

about 13 %) and Germany and Denmark (with more than

10 % share of non-transport use fuel taxes) mostly due to

high taxes on gas and fuel oils for heating.


7


After energy taxes,

transport taxes are

second in

importance among

environment taxes

with approximately

25% of the whole

pie.

The high share of taxes derived from the transport use of

fuels has been sometimes attributed to the structure of the

Energy Tax Directive (2003/96/EC) in which the minimum

rates for petrol are the highest among all energy products

serviced by the Directive. However, this misses the point.

The real question should be: why are the minimum rates for

petrol set in the Directive so high? The same question should

apply for gas oil which can be used for both transportation

and non-transportation purposes. The rates for gas oil are

substantially different between its uses – high when used for

transportation purposes, low when used for non-

transportation purposes. Once we assume that the burning

process of the same fuel is about the same regardless of its

use, the only plausible conclusion is that fuel taxes are not

closely connected to their environmental impact.

Only one country in the EU has a share of transport taxes on

energy taxes actually decreasing: Belgium. This is due to the

introduction of the ‘federal contribution on electricity and

natural gas’. A similar change took place in Estonia following

its ETR in 2008 and the related introduction of a tax on

electricity. The more countries introduce and increase taxes

on electricity and natural gas, the lower the share of fuel

taxes will be.

After energy taxes, transport taxes are second in importance

among environment taxes with approximately 25% of the

whole pie. However, there are countries within the EU where

the share of those taxes are substantially bigger than

average. Among these are Cyprus, Malta and Ireland where

transport taxes cover almost a half of all revenues derived

from environmental taxes. Then comes Denmark with a third

of all revenues from environmental taxes to come from

transport taxes.

Pollution and resource taxes are usually marginal and not

very important and usually amount to approximately 5% of

the total. Again, in some countries even these taxes can be

important. An example of it is once more Denmark, where a

third of all revenues from environmental taxes come from

high hydrocarbon tax.


8


… overall shares of

environmental

taxes revenues

have fallen within

the last decade to

2,4 % of GDP and

6,1% of total tax

revenues. This

means, that shares

on total tax

revenues are back

at their levels of

the early 90s. The

fall is noticeable

especially after

2004, which is

quite ironic – just

after the Directive

entered into force.

IV. The results of ETRs in the 90s and 00s

At the beginning of the 90s, it appeared that the role of

energy taxes was set to rise over the coming years. This

development was also supported by the political

momentum with regard to ETRs; a momentum that we

already described earlier. Indeed, data shows that, over

the period 1990-1995, environmental taxes as a share of

total fiscal revenue increased while taxes on personal and

corporate income declined slightly, indicating a modest

shift in tax policy. However, things started to change

from 1995 on. In what follows, we look at the evolution

of the ratio of energy taxes to GDP and to total tax

revenues for both EU 15 (old member states) and EU 12

(new member states). Despite the Directive, results vary

substantially from nation to nation. Still, one can identify

several general patterns that are valid across states.

Environmental taxes usually increased in all countries in

absolute terms. Proceeds from the introduction or

increase of environmental taxes were sometimes (not

always) used to finance cuts on labour tax. And above

all, we find many rate reductions and refund schemes to

protect producers from rising input costs. Also, several

new member states took steps in direction of the ETRs,

notably Slovenia in 1997, the Czech Republic in 2006 and

Estonia in 2008. However, overall shares of

environmental taxes revenues have fallen within the last

decade to 2,4 % of GDP and 6,1% of total tax revenues.

This means, that shares on total tax revenues are back at

their levels of the early 90s. The fall is noticeable

especially after 2004, which is quite ironic – just after the

Directive entered into force. The high-water mark for

environmental taxes was achieved in 1999 when they

peaked with 2,9 % share of GDP and 7% of total tax

revenues. However, within this general picture, there are

big differences among Member States. In what follows

we analyze the data in greater detail. First, development

within EU15 (old member states) will be analyzed before

moving to the study of EU 12 (new member states).

Graph 1 shows shares of environmental taxes with

respect to GDP for EU 15, graph 2 shows the same

variable for EU 12.


9


Graph 1 ET revenues in % of GDP, EU15[20]

Graph 2 ET revenues in % of GDP, EU12[21]


10


In only three EU 15 countries and three EU 12 countries the share of environment tax

revenues is higher in 2008 than it was in 1995. These are Denmark, the Netherlands and

Austria for EU 15 and Estonia[22], Latvia and Poland for EU 12; clearly not the largest

economies of the EU. Denmark actually comes first in terms of share of environmental

taxation relative to GDP, followed by the Netherlands and then Sweden. Among EU 12

countries, the highest level of environmental taxes on GDP is observed in Bulgaria[23]

followed by Slovenia and Hungary on second and third places. Note that to see Denmark

with the highest ratio of environmental taxes revenues to GDP should note entirely come

as a surprise since Denmark is the EU country with the highest level of taxation[24]

relatively to GDP (48,2 % for 2008) followed by Sweden (47,1 % for 2008). At the

opposite end lies Romania with a ratio of tax revenues to GDP at only 28 % and a ratio of

environmental taxes to GDP at only 1,8 %; the second lowest number after Lithuania

with 1,7 %. It is also to be noticed that the overall level of taxation is higher in the EU 15

in comparison with the EU 12[25], which is mirrored by the fact that the level of

environmental taxes on GDP is also lower in EU 12 (2,41 %) compared to EU 15 (2,73

%).

If the share of GDP informs us about the importance of environmental taxes relative to

the size of the economy, this measure however can overstate the role of environmental

taxes in the general fiscal policy of the country. As was just pointed out, a high

environmental tax-to-GDP ratio does not necessarily mean that the country is placing a

higher focus on these types of taxes as opposed to taxing labour or capital, but rather

that we are dealing with a country where the fiscal burden is generally high. To show the

relative (political) importance of environmental taxes to the system one should compare

environmental taxes revenues with total tax revenues. This is what will be done next,

again distinguishing between old and new member states.

Graph 3 shows shares of environmental taxes with respect to total tax revenues for EU

15, graph 4 does the same for EU 12.


11


Graph 3 ET revenues in % of total taxation, EU15[26]

Graph 4 ET revenues in % of total taxation, EU12[27]


12


… most EU member

states are similar

in their use of

environmental

taxes with only few

outstanding

countries that

diverge from

general patterns,

especially

Denmark, Sweden

and the

Netherlands and

Slovenia and

Bulgaria.

Denmark was the

first country in the

world to implement

a CO2 taxation

scheme, closely

followed by

Sweden in the

early 1990s.

Despite the fact

that EC attempts to

levy the European

carbon tax failed in

1994, some

countries,

including the

Netherlands,

Germany, and the

U.K., soon followed

the Nordic lead.

The countries with positive differences between the

years 1995 and 2008 are: Denmark, the Netherlands,

Austria and Sweden, for the group EU 15, and Estonia,

Latvia, Poland and Slovakia out of the group of EU12.

The shares on total taxation are in both groups almost

the same – 6,67 % for old member states and 6,97 %

for new member states. Interestingly, the order between

both groups is reversed from what we obtained

comparing the tax-to-GDP ratio. This is likely to be due

to the fact that ETs are by their construction more

complicated to evade from than taxes on labour or, even

more surely, on capital. Another complementary

explanation could be that the overall energy intensity is

lower in old member states than in new member states.

This could also explain why lower tax rates in new

member states tend to raise the same amount of

revenues than higher rates in old member states. And it

also may be the rationale behind the passage of two

directives in April 2004 amending the original Directive

2003/96/EC. These are the Directive (2004/74/EC)

giving the possibility for the Czech Republic, Estonia,

Latvia, Lithuania, Hungary, Malta, Poland, Slovenia and

Slovakia to apply temporary exemptions or reductions in

the levels of minimal taxation of energy products, and

the Directive 2004/75/EC that gives the same possibility

to Cyprus. Cyprus, along with Poland, was granted

further exemptions with regard to environmental

taxation in the Treaty of Accession that provided for

transitional arrangements and other special features.

The highest levels of environmental taxes with respect to

total taxation are found in Denmark, the Netherlands

and Ireland. For the new member states it is found in

Bulgaria followed by Poland and Estonia.

From what we have presented so far, it is clear that

most EU member states are similar in their use of

environmental taxes with only few outstanding countries

that diverge from general patterns, especially Denmark,

Sweden and the Netherlands from the pack made of old

member states and Slovenia and Bulgaria from the pack

of the new member states.

Denmark levies three individual taxes framing the

energy taxation mix:

• The energy tax (based on the energy content of the


13


fuel, levied on fossil fuels, oil products, and coal, the only exemption being natural

gas where the energy content is not taken into account),

• The CO2 tax (introduced in 1992 – for details see below), and

• The sulfur tax (introduced in 1996, levied on all fossil fuels with a sulfur content

exceeding 0.05% based on weight).

Denmark was the first country in the world to implement a CO2 taxation scheme, closely

followed by Sweden in the early 1990s[28]. That was the time when the first proposals to

promote the use of environmental taxation schemes and overall European carbon taxes

were submitted by the European Commission (1992 – see above). Despite the fact that

EC attempts to levy the European carbon tax failed in 1994, some countries, including

the Netherlands, Germany, and the U.K., soon followed the Nordic lead. As an example of

such a development we can use data from Denmark – see Table 3.

Table 3 Development of energy and CO2 tax rates for different users and uses[29]

Household and service sector

Industry – heating

Industry – light process

Industry – heavy process

Light Fuel Oil €/1,000 l €/1,000 l €/1,000 l €/1,000 l

1996 239,2 239,2 18,3 1,1

2000 268,3 268,3 24,6 1,1

2007 286,5 286,5 24,6 1,1

Heavy fuel oil €/ton €/ton €/ton €/ton

1996 269 269 21,7 1,3

2000 304,5 304,5 29,2 1,3

2007 324,8 324,8 29,2 1,3

Natural Gas €/1,000 m3 €/1,000 m3 €/1,000 m3 €/1,000 m3

1996 31,3 31,3 14,9 0,9

2000 244,2 244,2 20,1 0,9

2007 305,8 305,8 20,1 0,9

The 1996 tax reform created a rather complex system of energy and carbon tax

differentiation for industry in Denmark[30]. As a part of that system, the industrial

companies can reduce their CO2 tax burden by entering into voluntary agreements with

the government.

The tax on electricity consumption can be used as an example of the energy tax used in

Denmark. Again, the tax on electricity consumption in Denmark belongs to the oldest

taxes of its kind in Europe and in the world. It was first levied on all electricity

consumption in 1977 and has been used ever since. The tax is levied on consumption


14


regardless of where or how electricity is generated (domestically, abroad or conventional

or renewable energy sources). As for the magnitude see the table 4.

Table 4 Energy and CO2 taxes levied on electricity[31]

Heating purposes Other purposes Industry

Electricity €/MWh €/MWh €/MWh

1996 57,8 62,5 8,2

2000 76,6 85,3 13,4

2007 80,8 89,5 8,6

Thus, the tax rate on electricity in Denmark exceeds by up to 100 times the minimum

excise duty stated in the Directive. The same magnitude applies also for Sweden and the

Netherlands (the other two rather exceptional countries as noticed earlier).

However, not even this could explain Denmark’s position as a leader in the area of

environmental taxation. The energy taxes constitute only about 40% of all state

revenues coming from environmental taxes. Together with transport taxes they

constitute about 70 % of the total. Energy and transport taxes alone would make

Denmark number 1 in terms of tax-to-GDP ratio among EU 27, but what makes Denmark

really special are its pollution and resource taxes that contribute the other 30 %. The

difference between EU average composition and Denmark’s is clearly visible on the two

pie diagrams[32].

Graph 5: Comparing the structure of environmental taxes: EU average and

Denmark[33]


15


The per-unit taxes

have some

counter-cyclical

qualities: when the

price of fuel

increases, the

share of the tax in

the overall price

decreases, and vice

versa.

The per-unit taxes

have some

counter-cyclical

qualities: when the

price of fuel

increases, the

share of the tax in

the overall price

decreases, and vice

versa.

As for Slovenia, the irony of the environmental tax reform

lies in the fact that Slovenia used to be number one in

terms of share of environmental taxes on overall tax

revenues (12.2%) and also in terms of tax-to-GDP ratio

among EU 12 (4.5%). This was before accession, in 1997.

With such numbers Slovenia would have ranked second

among EU 27 as far as tax-to-GDP ratio is concerned, and

as number one according to the share of ETs on the tax

revenues. However, as a result of the ETR of 1997, both

tax-to-GDP ratio and the share of ETs on the entire tax

revenues felt substantially from 4.5 % and 12.2% to 3 %

and 8 % respectively.

V. Reasons for the decrease in weight of

environmental taxes

Given the political momentum for ETRs, it is fair to ask what

“went wrong” for environmental taxes. Remember that the

rationale behind the double dividend theory was that the

taxes to be abolished or reduced (taxes on capital and

labour) were distortionary while the taxes to be increased

or introduced (taxes on energy products and other “bads”)

were “virtuous”. It was expected that new taxes on “bads”

would generate health, ecological and other benefits by

lowering consumption of bads, and elimination of old taxes

would generate another set of benefits stemming from the

elimination of losses caused by distortionary effects. There

were even some attempts (mostly on US data) to compute

the magnitude of those dividends with highly favourable

results: "the costs of a carbon tax may be largely and

perhaps even fully offset by taking advantage of its

efficiency value and using the revenues to cut existing taxes

that discourage capital formation or labour supply."[34] It all

looked like a win-win situation. But still, ETRs went “out of

fashion” in the first decade of this century. In this section,

we will suggest plausible reasons for this very unexpected

development. The reasons for the decline of

environmental taxes can be summarized as follows:

•••• The very construction of environmental taxes;

•••• Increasing overall energy efficiency;

•••• Political unpopularity of an increase in

environmental taxation in the era of increasing


16


energy prices; and

•••• Introduction of other policies – namely emission trading schemes,

renewable energy sources subsidies, road charges/tolls etc.

First, environmental taxes are typically imposed on the sale of a given

commodity/service on a per-unit basis. Very few of them are levied ad valorem (unlike

other types of taxes such as VAT). The per-unit taxes have some counter-cyclical

qualities: when the price of fuel increases, the share of the tax in the overall price

decreases, and vice versa. To see the mechanism, it is possible to look at the data of

percentage of taxes in premium unleaded (95RON) gasoline prices compared with the

development of the crude oil price.

Graph 6: Share of taxes in premium unleaded (95RON) gasoline prices and price

of crude oil[35]


17


Second, because environmental taxes are established on a per-unit base, any increase in

overall energy efficiency leads to lower amounts of tax revenues. As evidenced by data

(see graph 7 and graph 8), every EU 27 country has experienced a considerable

improvement in terms of energy efficiency, the effect being stronger for EU 12 than

for old member states. The average improvement in energy efficiency for countries in EU

15 was approximately 23%. It was almost three times higher for EU 12. However, the

energy intensity[37] is still almost three times higher for EU 12 than for EU 15 (445,93 as

opposed to 156,37).

Graph 7 Energy intensity, EU15[38]


18


Graph 8 Energy intensity, EU12[39]

One can then logically expect that the effect of increased energy efficiency will be

stronger in EU 12 than EU 15. However, if anything can be deduced from the data, it is

that the decline in the weight of environmental taxes was a bit larger in EU 15. Why is it

so? To get an idea, one can look at Bulgaria that had the highest improvement in energy

efficiency of all countries studied. Yet, Bulgaria remains one of those countries in which

the weight of environmental taxes actually increased from its 1995 level. It must be that

the effect of higher energy intensity is offset, in reality, by other factors – mainly by the

economic growth itself. When an economy is growing, energy tends to be used

more efficiently per unit of output but the amount of output is growing so fast

that the amount of energy used increases despite all efficiency improvements.

This reasoning lies behind the fact that energy consumption is rising with GDP growth

although admittedly not as fast.

Third, from a political point of view, it is highly unpopular to tax more heavily

consumption goods, which prices are already increasing. Inversely, it is easier to

increase tax rates when the price of the taxed good is decreasing. The data

support this explanation.


19


Graph 9 Tax rates on unleaded gasoline and oil prices 1990 - 2007[40]

As can be clearly seen, the sharp increases in tax rates on gasoline end around 2002,

when prices of oil started to climb to their 2008 peak (reaching 140 USD/barrel).

Clearly, oil and fuel taxes cover just a part of environmental taxation issue, but the same

logic works for other taxes as well. Furthermore, because the price of other energy

products closely correlate to oil price, it is not surprising that the appetite for new tax

and increases in existing taxes on other energy products diminished considerably during

the last decade. Those ETRs that were enacted within that decade could be described as

half-hearted (the Czech Republic, with its environmental tax reform of 2008 and

subsequent development, providing a good illustration). At the height of energy product

prices, some voices within the EU 27 were even heard calling for a cut in energy

taxes[41].

Fourth, it took a long time to get the Energy taxation directive accepted, and by the end

of the negotiations, what survived was a watered down version of the proposal submitted

in 1997 by Mario Monti. It is indeed difficult to compare the final version of the Directive

with the original 1992 proposals for a pan-European carbon tax. The resulting

compromise of 2003 pleased almost no one and in the meantime new pet projects for

“green coalitions” appeared on the agenda. Hence, by the time they were introduced, the

ETRs movement from the 90s had lost its momentum, which explains the surprisingly

quiet development of environmental taxation from 1995 till the present day documented

in the previous sections.


20


Thus, the

combination of

new political pet

projects (EU ETS

and others)[52]

combined with a

sharp increase in

prices of oil, oil

products, natural

gas and electricity

put on hold any

discussion about

environmental tax

reforms – at least

based on

environmental

justifications.

In the EU, the main competing “green” project seems

to be the emission trading scheme for carbon. The

idea of trading emission allowances originated in the

USA where several states adopted such schemes –

not trading permits to emit CO2, but to emit other

pollutants such as SO2[42]. In the run-up to the 1997

Kyoto Protocol Americans injected this idea into the

Kyoto protocol flexible mechanisms (1997) despite

European unwillingness to accept it at the beginning.

One can even say that the EU was a leading sceptic

towards international ETS in Greenhouse Gases

(GHGs). However, as is well known, after few years of

time Europeans had changed their opinion, now

embracing this particular flexible mechanism while

Americans rejected the Kyoto protocol as a whole[43].

Hence, by the end of the 90s, the emission trading

scheme had gained political momentum –except in

the US-- precisely when ETRs lost their momentum.

This seems to be no coincidence.

Accordingly, the EC commissioned several documents

in which it showed a new enthusiasm with respect to

emission trading (as opposed to environmental

taxation) as a main tool to achieve results similar to

those that were targeted in first proposals of the

environmental taxation directive. These include:

• The Green paper on emission trading schemes

(March 2000)[44] and the Green Paper on

market-based instruments for environment and

related policy purposes (March 2007)[45];

• The Sixth Environmental Action Program of the

EU under the name “Environment 2010: Our

Future, Our Choice”. It was published in 2002 as

a joint decision of the

European Parliament and the Council (Nr.

1600/2002/EC)[46];

• Communication from the Commission to the

Council and the European Parliament – Progress

Report on the Sustainable Development

Strategy 2007, COM/2007/0642[47];


21


• White paper – Adapting to climate change: towards a European framework for

action, COM(2009) 147, 1.4.2009.

The 2000 Green paper became a base for the development of the Directive 2003/87/EC

on greenhouse gas emission trading[48]. The Directive 2003/87/EC was passed in October

2003, that is, more or less at the same time as the Energy taxation directive (six months

later to be precise), and its passing was much smoother and faster (instead of 11 years

separating the first proposal from the final directive in the case of the Energy taxation

directive, it took this time only two years to get to a final directive on emission trading

from its first proposal as Communication 581/2001 in October 2001). From its very

beginning the EU ETS (EU energy trading scheme) was supposed to be a corner stone of

the EU climate change abatement policy and a main tool for the EU as a whole (EU 15 at

that time) and individual member states to simultaneously comply with both their

emission reduction commitments under the Kyoto protocol and also their own targets

originating from the Green Paper of 2000. EU ETS started its operation on 1 January

2005 with a pilot phase from 2005–2007[49]. The second phase started in 2008 and will

run until 2012 with the third phase to follow in 2013 for a period of eight years till 2020.

The scheme incorporates about 60% of all CO2 emitters and the scope of the system is

getting broader all the time[50]. The same emitters are also subject to the Energy taxation

directive. In a sense, it means a double taxation of the same set of products which is also

not a plus from a political point of view, since the introduction of the EU ETS had an

immediate impact on electricity prices all over Europe – see graph 10.

Graph 10 The effect of ETS introduction on electricity prices in EEX[51]


22


This target had in

fact three

dimensions:

harmonization

among member

states, among

energy sources and

among different

uses of a given

energy product. On

all counts the

policies introduced

to achieve them

failed.

… the minimum

taxes for gas oil

used as a source of

fuel for

transportation are

about 15 times

higher than the

minimum taxes for

stationary uses of

the same fuel.

Thus, the combination of new political pet projects (EU

ETS and others)[52] combined with a sharp increase in

prices of oil, oil products, natural gas and electricity put on

hold any discussion about environmental tax reforms – at

least based on environmental justifications. If there will be

any attempt to introduce new taxes on energy products or

to increase existing taxes on energy products their main

rationale will be to increase fiscal revenues. In any case,

enthusiasm for ETRs is over and there is no sign of its

revival any time soon.

VI. Official justifications behind ETRs and tax

harmonization and real achievements

Having established that ETRs lost their momentum and

understood why, it is still interesting to see whether they

have achieved at least some of the goals they pledged to

achieve and that also served as a rationale behind the

reforms (albeit on limited scale as we have seen already).

There were several justifications lying behind the

environmental tax reform movement and environmental

tax harmonization:

• Reduction of tax distortions between countries and

products

• Creation of incentives to use energy efficiently

• Compensation for harmful effects of energy

consumption and production

• Reduction of import dependency, higher energy

security

• Reduction of CO2 emissions and support of RES

• Trade-off between taxing energy and labour

It is no place here to come back on the theoretical debate.

As was mentioned earlier, that debate took place in the

first half of the 90s and, in our opinion, is now closed, with

the defeat of the “double dividend” proponents.

Interestingly, ETRs that were passed recently were not

even mentioning the “double dividend” theory. In what

follows we will instead investigate whether the results

actually achieved by the ETRs have been in accordance


23


There is no sign for

a convergence in

taxation of

different energy

products.

…the way

environmental

taxes are

constructed might

give a false

impression of

convergence or

reduction of

distortions.

with justifications and expectations.

Reduction in distortions

This target had in fact three dimensions: harmonization

among member states, among energy sources and among

different uses of a given energy product. On all counts the

policies introduced to achieve them failed. We will go

through these points in reverse order.

If burning fossil fuel causes external effects in terms of

worsening the environment especially in terms of the

production of CO2 (or any other pollutant) then it should

be highly irrelevant where the particular fuel has been

burnt. So, if such environmental considerations were

primary reasons for the reform, then the use of the fuel or

energy product should not matter for the tax levy. Or, to

be more precise, if environmental considerations other

than CO2 emissions were the reason for imposing

environmental taxes then burning of fossil fuels for

industrial uses and big scale electricity/heat production

should be taxed less and not more because big industrial

power plants, power plants of energy companies or big

heating plants for the supply of heat into the district

heating systems (often using cogeneration of heat and

electricity) produce less pollutants per unit of burnt fossil

fuel than distributed energy production in households or

small sites. The reasons are straightforward – higher

temperatures in big producing sites, are more optimized

in terms of operational, thermal and energy efficiency,

developed technology to clean residue of combustion etc.

But this is not the logic followed by existing environmental

taxes. Enough is to look at the Directive to realize that

other considerations were at play while setting minimum

rates for particular types of energy product and particular

use of an energy product. There are striking differences

between taxes imposed on fuels used for transportation

and fuels used for non-transportation purposes, mainly for

heating, and also between taxes imposed on industrial

and domestic use of the same energy product.

For instance, the minimum taxes for gas oil used as a

source of fuel for transportation are about 15 times higher

than the minimum taxes for stationary uses of the same


24


fuel. The reasoning that high taxes on transport fuels can be motivated by the existence

of other negative externalities related to the transport sector (accidents, noise, and

congestion) does not hold water. One would need to argue that other negative

externalities caused by transportation (accidents, noise, and congestion) are 15 times

more costly from a social point of view than externalities from burning of the fuel itself.

Either it is true, then why do we have energy taxes or environmental taxes in the first

place since the associated externality is relatively negligible, or it is not true, and we

must conclude that other considerations are at play (mostly social ones and also the

need to finance the road infrastructure or/and the need to fill the gaps in other

governmental revenues, i.e., fiscal considerations).

Also, there is no sign for a convergence in taxation of different energy products. As a

matter of fact, if such convergence were seriously targeted, one would need first to find a

common denominator over which one can levy the various taxes on different energy

products. But so far, no such common denominator has been offered. It could have been,

for instance, the carbon content of each energy product (if the overall goal is to limit CO2

emissions), but no tax (with the exception of the carbon tax, which is not general and

does not exist in most states) has been constructed on such a basis. Moreover, since

burning a particular fuel has almost the same effect regardless of the place where it is

burnt in Europe, convergence of taxation among energy products requires that taxes be

the same or almost the same everywhere in Europe. As we will see below, there is no

evidence that we are moving in that direction.

If no convergence is observed at the European level, at least one could find convergence-

-according to a common denominator--within some of the member states. The data,

however, does not provide any support for this happening either (see Annex 3).

Before we can present and analyze the data used to study the convergence among

member states, a short and easy statistical digression is in order because the way

environmental taxes are constructed might give a false impression of convergence or

reduction of distortions. If the tax is levied per-unit and the price of the taxed good is

increasing then the share of tax on the total price decreases – for all levels of imposed

tax. Mathematically it appears that different tax rates converge. An example is given

below in a table. The effect is stronger when the share of the tax in the overall price is

smaller.


25


Table 5 Mathematical convergence of different level of tax levied per unit

Price net of tax 10 20 30 40 50 60 70 80 90 100

Price plus tax in percentages (levy = 5)

150% 125% 117% 113% 110% 108% 107% 106% 106% 105%


140% 120% 113% 110% 108% 107% 106% 105% 104% 104%


130% 115% 110% 108% 106% 105% 104% 104% 103% 103%


120% 110% 107% 105% 104% 103% 103% 103% 102% 102%


110% 105% 103% 103% 102% 102% 101% 101% 101% 101%

Average 130% 115% 110% 108% 106% 105% 104% 104% 103% 103%

Standard deviation (SD)

16% 8% 5% 4% 3% 3% 2% 2% 2% 2%

Average/SD 0,122 0,069 0,048 0,037 0,030 0,025 0,022 0,019 0,017 0,015

Graph 11 Mathematical convergence of different level of tax levied per unit


26


Clearly, although the levies have remained the same and no convergence took place, a

careless study can easily conclude to the contrary. The next table shows actual data on

convergence among several types of energy products[53]. Further details are provided in

Annex 1.

Graph 12 Convergence of taxation levels for different energy commodities

among European countries[54]


27


We can see from

the data that no

overall

convergence of

energy taxes has

taken place among

European countries

within the last

decade.

For almost all other

energy products

even divergence

seems to be the

case.

Creation of incentives to use energy more efficiently

True, everything else equal, when the price of a good

increases consumers usually buy less of it. But to reduce

energy consumption by means of taxation is nonetheless

trickier than it seems. Taxing the use of energy products

may or may not achieve such a goal and the net effects of a

tax are in fact very hard to quantify and measure. There are

good reasons behind that.

People tend to react in three ways when, due to taxation,

energy and energy products become more expensive:

• They substitute other products for the taxed ones,

• They lower their use of the taxed products

• They consume less of other products especially when

the price elasticity of the taxed product is low, which is,

at least in the short term, the case for energy and most

energy products.

Contrary to what is often believed, it is possible to substitute

energy with other products – mostly with some kind of

capital goods (for instance more fuel efficient cars[56] or more

insulation). However, there are several effects coming with

this kind of substitution. While using more capital goods as a

substitute for energy someone had to produce these capital

goods and use more energy to produce them. The net effect

is likely to be positive in a sense that less energy is

consumed in total[57]. In any way, when taking into account

the production of the capital good, the global result in terms

of environment and energy consumption is (at best) much

less shining than expected.

Besides, the fiscal policy can lead industries to transfer their

energy intensive production to other countries with more

lenient energy and environmental policies as a way to lower

their overall production costs. Because of these transfers one

might have at home the impression that the policy is working

while this is in fact just a statistical illusion from a global

point of view[58],[59].


28


…although on the

face of it the

higher the costs of

energy the less of

it is used, the truth

is very likely that

the total cost of

saving the energy

via artificially high

prices due to

environmental

taxation will be

much higher than

expected.

Pigou suggested

that a special kind

of tax be

introduced to force

individuals to take

into account the

effects that some

of their actions

have on third

parties.

Substituting capital goods for energy leads not only to higher

costs of capital goods (because of higher demand for capital

and higher cost associated to the production of capital) but

also to higher overall costs, at least if we keep technology

constant. Indeed, if the additional capital good was not used

before the taxation was introduced it must have been

because it was more expensive and other combinations of

capital and other inputs were cheaper; otherwise the

producer would have done it.

Finally, because the overall costs are higher than before,

expenditures on other goods and services have to be

lowered[60].

The same reasoning applies not only to environmental taxes

but also to other measures introduced to promote a more

efficient use of energy such as tax credits for investments in

renewable energy or above-market-value feed-in tariffs for

“renewable electricity”, funding for a smart electric grid,

upgrading government vehicles to be more energy efficient,

subsidizing of insulation, ban on old-fashioned bulbs[61] etc.

Other types of substitutions are likely to occur such as more

energy efficient cars for more secure cars. One way to make

a car more energy efficient is by reducing its weight – so,

under the general direct pressure to produce more efficient

cars in terms of mileage and CO2 emissions and the indirect

pressure caused by high fuel prices in Europe, the cars in

Europe are getting lighter (less steel, narrower metal plates,

no spare wheel etc.) and less secure in terms of life and

health protection of passengers. To put it bluntly, it is not

unlikely that more people die on European streets because

of environmental taxes and other environmental regulations.

Taxing energy use in transportation also leads to less

transportation and therefore less division of labour and lower

overall economic growth[62]. Higher taxes on transportation--

and resulting lower division of labour--are probably one of

several reasons why European economies are not growing as

fast as the US economy. For data comparing US and

European taxes on transport fuel see Annex 2 of this report.


29


This approach

bears close

resemblance to the

polluter-pays-

principle promoted

by the OECD

(OECD, 1972 and

OECD 1992) and

placed as a

cornerstone of EU

environmental

policy.

Hence, although on the face of it the higher the costs of

energy the less of it is used, the truth is very likely that the

total cost of saving the energy via artificially high prices due

to environmental taxation will be much higher than

expected. So much so that the strategy could prove

inefficient – at least from a global viewpoint.

Compensation for harmful effects

To understand this idea brought in support of energy and

environmental taxation, the best is to go back in time – to

Cambridge in the years immediately following World War I.

In 1920, an famous economist by the name of A.C. Pigou

suggested that a special kind of tax be introduced to force

individuals to take into account the effects that some of their

actions have on third parties (today, these effects are known

as “externalities” and Pigou’s suggested solution as the

Pigovian taxes, however Pigou did not use these terms; they

evolved later on after World War II). In Pigou’s terminology,

the effect of the tax is to equalize the private cost of the

action with the cost to society.

Half a century later, Pigou’s idea was given a new impetus

with the work of Baumol and Oates (1971). Although not

identical, the rationales of Pigou and Baumol-Oates were

very close to each other as were the suggested solution: a

uniform tax levied on the polluter or polluting substance.

This approach bears close resemblance to the polluter-pays-

principle promoted by the OECD (OECD, 1972 and OECD

1992) and placed as a cornerstone of EU environmental

policy (Treaty of Rome – consolidated version, 2006). Taxes

were also seen as more efficient tool to reduce externalities

than direct regulation (Surrey, 1973). Despite of its success

in academic circles, politicians and policy makers did not

favoured the Pigovian tax for many years. A change finally

occurred with the White paper (1993) and proposed ETRs

that embraced Pigovian taxes overwhelmingly for the first

time. However, there are several obstacles for these taxes to

reach the promised lands of economic nirvana.


30


Taxes do not

entirely destroy

the system; they

pollute it with false

noises that

generate

distortions bigger

than the ones

created by existing

externalities they

were supposed to

mitigate.

…the very reason

why some

economists

supported a

Pigovian tax in the

first place was

precisely that

neither

government nor

anyone else knows

who should be

compensated and

by how much.

This is a real Catch

22 for Pigovian

taxes – they can be

a successful

solution only and

only in situations

where they are not

needed.

Firstly, Pigou (and many others after him till the early 90s)

did not consider the possibility that such taxes could

themselves introduce new distortions in the allocation of

economic resources. However, research done in the 90s

indicated that distortion caused by environmental taxes can

be as important as distortions caused by alternative policy

instruments (such as direct regulation or trading permits).

Pigovian taxes can cause distortions in many ways but the

most important distortions are due to a feature of that tax

that paradoxically is often perceived to be an advantage:

the constant value of the tax rate, at least over a

sufficiently long period of time. The argument for a fix rate

is usually built on predictability of such a tax: Having an

unchanging price for carbon offers a certainty to businesses

and the public. Yet this highly praised feature is also the

biggest problem. For the Pigovian tax to provide ‘the right

incentives’ to economic agents, it has to convey at any

point in time updated and reliable information on the state

of the system (preferences, technologies, resources, cost of

externalities, etc.) But if the tax is set to be constant for a

long time (year or two, or even more) then, even if it were

set correctly at the moment of imposition—an heroic

assumption--, within weeks or months its value will not

longer signal what the economic system would need. It

starts to work as a ‘regulated price’ (a tariff) in the system

– that is, it starts to emit false information (just as the

regulation it was substituted for). Let us remember the fate

of socialism. Socialism was an attempt to stabilize prices for

a long time and it did not work because, by stabilizing

prices it destroyed the only system of information

dissemination available to economic agents[63]. Taxes do

not entirely destroy the system; they pollute it with false

noises that generate distortions bigger than the ones

created by existing externalities they were supposed to

mitigate.


31


…one should bear

in mind the

possibility that the

primary reason for

the existence of

energy taxes (and,

later on,

environmental

taxes) were fiscal

considerations.

…the reason why

taxes were levied

on certain goods

was the low

elasticity of the

demand for and

supply of these

goods.

Secondly, the polluter-pays principle suggests that those

harmed by the polluting activity will be compensated.

Otherwise to whom would the polluter be paying? It even

suggests that the victims of the externality receive

damages that exactly match the harm: Just as one party

to a transaction pays a price to the other party so that the

latter agrees to transfer his/her property rights, the

producer of an externality would pay a tax to get the right

to create that externality. But this is never the case and

will never be. Indeed, the very reason why some

economists supported a Pigovian tax in the first place was

precisely that neither government nor anyone else knows

who should be compensated and by how much. Otherwise

it would have been easy to design other types of remedies

(including individually tailored regulation) or institutions to

tackle the problem. In other words, if the price system

does not work properly in those externality cases it is

precisely because of our (at least temporary) inability to

set up an institutional framework for it to function (a

viable compensation scheme or a system of property

rights). In no way does the Pigovian taxation provide a

solution to this problem. If governments succeeded in

setting the Pigovian tax right and at the same time

succeeded in compensating affected parties correctly, then

no Pigovian tax would ever be needed. The solution would

have been known already otherwise the government

would not be able to succeed. This is a real Catch 22 for

Pigovian taxes – they can be a successful solution only

and only in situations where they are not needed.

Because taxes tackle only the producer’s part of the

problem, not the problem of those affected by the

production, they can change the behaviour of producers of

harm, but not of those who are harmed. Absent any

compensation, the latter will demand for instance stricter

standards regarding the power plant construction. Stricter

standards cost them close to nothing (everybody pays the

cost increments in market prices, not only those who

benefit from the higher standard) but their overall costs

are substantial.


32


Could it be then

that appeals to the

“double-dividend”

theory or to the

polluter-pays

principle be just a

way to put some

descent clothes on

what is nothing

more than the

eternal quest from

our government for

more tax

revenues?

the data offers

quite a different

story from the one

told by proponents

of ETRs, with no

influence of

environmental

taxes whatsoever

on the rise of

energy product

imports.

Thirdly, one should bear in mind the possibility that the

primary reason for the existence of energy taxes (and, later

on, environmental taxes) were fiscal considerations. As early

as 1927, Frank Ramsey set formally some basic principles of

“efficient” indirect taxation (that had long been known from

smart governments), the main principle being to impose

taxes on those goods with the most inelastic supply and

demand. Doing so will minimize the indirect costs of taxation

(what economists call the deadweight loss) since it will

induce little change in allocation of resources. Despite some

additions to the theory by other economists (notably

Mirlees), the principle is surprisingly robust. In other words,

the reason why taxes were levied on certain goods was the

low elasticity of the demand for and supply of these goods.

In the Middle Ages, salt was such a good. Today tobacco,

alcohol or energy products are in that category. But, if

elasticities of supply and demand are low then even high

taxes will not change the behaviour of economic agents

much, contrarily to what proponents of “the double dividend

theory” or “Pigovian taxes” want. Could it be then that

appeals to the “double-dividend” theory or to the polluter-

pays principle be just a way to put some descent clothes on

what is nothing more than the eternal quest from our

government for more tax revenues?

Regardless of any practical or theoretical obstacles to the

proper functioning of a Pigovian taxes, the current policies in

Europe show little care for the theoretical principles set by

Pigou, Baumol and Oates. As already noticed, rates, bases

and scope of taxes are driven by fiscal, political and social

considerations. Environmental taxes discriminate between

users, energy products, uses of the products and member

states. There are myriads of tax rebates, special provisions

and exemptions, all of which complicating the whole system

and dragging it away from any possible theoretical

justification.

Import dependency reduction

The notion of energy dependency has little economic

merit[64], but it is nonetheless interesting to investigate

whether ETRs had any significant impact on the amount of

energy products imported to the EU 27 in the last decade,

that is, whether the policy of imposing environmental taxes

achieved what it was officially designed for. We can look at


33


the data on coal, natural gas and oil and compare the shares of overall imports in overall

consumption at different points in time. Clearly, the data offers quite a different story

from the one told by proponents of ETRs, with no influence of environmental taxes

whatsoever on the rise of energy product imports.

• The share of solid fuel imports (relative to total consumption) was 41% in 2007,

up from 25% in 1997. The share of coal in gross inland energy consumption[65]

has declined over time, from 20 % in 1995 to 18 % in 2007 due to increasing use

of natural gas, mainly in power generation and space heating.

• The share of natural gas imports was 60,3 % in 2007, up from 45,2 % in 1997.

The share of natural gas in gross inland energy consumption has grown over time,

from 21 % in 1995 to 24 % in 2007 due to increasing use of natural gas, mainly

in power generation and space heating.

• The share of crude oil imports was 82,7 % in 2007, up from 76 % in 2000. The

share of crude oil in gross inland energy consumption has decreased over time

from 39 % in 1995 to 36 % in years 2007.

• The overall share of fossil fuels imports on primary energy consumption was 53,1

% in 2007, up from 45 % in 1997.

Graph 13 - 1 Energy dependence of the EU: Net natural gas imports as a % of

primary gas consumption[66]


34


Graph 13 - 2 Energy dependence of the EU: Net crude oil imports as a % of

primary crude oil consumption

Graph 13 - 3 Energy dependence of the EU: Net hard coal imports as a % of

primary solid-fuels consumption


35


Graph 13 - 4 Energy dependence of the EU: Net natural gas, crude oil and hard

coal imports as a % of primary energy consumption

If, there seems to be a slight slow-down in rise of energy dependency after 2006 this is

not very consistent with claimed effects of the ETRs – the slow-down materializes seven

years after the environmental taxes peaked. Moreover, the slow-down seems to be more

a result of high prices of crude oil and natural gas than a result of new energy taxes

imposed on their consumption.

Reduction of CO2 and support of RES

To find out whether there is any influence of energy taxes (and especially environmental

taxes) on environment-friendly sources of energy one can look at the data on the

production of electricity from so called Renewable energy sources (RES)[67].


36


Graph 14 Renewable energy primary production: biomass, hydro, geothermal,

wind and solar energy (1000 toe)[68]

As we have already established, the importance of Environmental Taxes (ETs) started to

decrease significantly after 1999 (as expressed by the ITR on energy line in the graph –

for details see below). But the rise in the production of energy from RES started in most

countries much later on, after 2005. The only exception from the rule is Germany.

Hence, there is no evidence of any connection between the production of energy from

RES and environmental taxes. However, there is a simple explanation to the rise of RES

in recent years: direct subsidies and feed-in tariffs promoting the production from RES

regardless of any environmental taxation of conventional sources. Environmental taxes

might help, but they are insignificant in comparison with other measures.


37


…there is no

evidence of any

connection

between the

production of

energy from

Renewable energy

sources (RES )and

environmental

taxes.

It is in Germany

that RES have

enjoyed the

highest subsidies

and for the longest

period of time. It is

therefore no

coincidence that

the rise of RES was

the biggest and

earliest there and

that Germany grew

into the world’s

biggest market for

wind and

photovoltaic

power.

It is in Germany that RES have enjoyed the highest

subsidies and for the longest period of time. It is

therefore no coincidence that the rise of RES was the

biggest and earliest there and that Germany grew into

the world’s biggest market for wind and photovoltaic

power.[69] The introduction of RES into the German

energy mix started with the “Law on feeding electricity

from renewable resources into the public grid”

(Stromeinspeisungsgesetz[70]) adopted in 1990. The law

established that renewable generators had the right to

connect to the grid, and stated how much they were to

be paid for their renewable generation in the form of a

feed-in tariff. The resulting increase of installed capacity

exceeded even the optimistic expectations of “green

energy” promoters. Whereas only 60 MW in wind power

were installed in 1990, by 2000 this number rose to

6113 MW. Spain and Denmark introduced similar

legislations in the 1990s. Other countries followed suit

later on using similar schemes. Two other important

events happened at the beginning of the new century to

spur the development of RES and to escalate costs. First,

The Renewable Energy Sources Act of Germany

(Erneuerbare-Energien-Gesetz or EEG) was passed in

2000 as a replacement for Stromeinspeisungsgesetz.

This act introduced all elements of modern European RES

promotion scheme, namely: feed-in tariffs fixed for 15 or

20 years differentiated by individual RES types. The

results were staggering and catapulted Germany to the

biggest RES market in the world. The share of RES

electricity in Germany increased from 6.3 percent in

2000 to about 16.1 percent in 2009 with 45 GW of

installed capacity in RES. The other important element

was the decision by the European Court of Justice on 13

March 2001 in case C-379/98, PreussenElektra AG v.

Schleswag AG. The Court found that the

Stromeinspeisungsgesetz (with its guaranteed minimum

prices for RES electricity from RES) does not constitute a

state aid. The Court furthermore ruled that this law,

applicable only to renewable energy produced in

Germany, was compatible with the Community rules on

free movement of goods and services[71].

Finally, what about the impact of ETs on CO2 emissions?

With almost no impact on the production and

consumption of energy products, there could have been


40


tolls, direct subsidies) that came rapidly to be preferred to energy taxes to achieve what

energy taxes were supposed to achieve. Moreover, it was shown that environmental

taxes achieve almost none of their stipulated goals.

It would be a speculation to try to predict the future development with regard to

environmental taxes especially in the current budget situation of most developed

economies with public finance deficit looming. But our hunch is that, although our public

decision makers will keep it as an element of their rhetoric, they will not count on it so

much.


41


------------------------------------------- [1] Miroslav Zajíček is a director of the Laboratory of Experimental Economics (lee.vse.cz) and the Senior

Research Fellow of the Liberalni Institute, Prague (www.libinst.cz). He also lectures at the University of

Economics in Prague and at the Charles University in Prague. His major fields of specialization are energy

economics, industrial organization and experimental economics. Contact: miroslav.zajicek(at)vse.cz

[2] Pierre Garello is Professor of economics at Aix-Marseille University, CERGAM and Director of Research for IREF

[3] Markéta Grušáková is a student at the University of Economics, Prague.

[4] Karel Zeman is Assistant professor at the University of Economics, Prague, Department of Economic and Social Policy.

[5] To be precise, we need to admit that the first instances of the use of energy taxes to promote some environmental goals were changes in the tax regime of gasoline in Europe. It was redesigned in the 80s in such a way that unleaded gasoline was favored. The later was granted a tax rebate based on environmental considerations with regard to the lead’s harmful effects. [6] To be precise, there are two versions of the “double dividend theory” – the strong version and the weak version. The strong version asserts that, by shifting the tax burden from taxing labor and capital to taxes on “bads” such as energy products, the country can achieve both of its environmental goals (lowering the levels of CO2 emissions or/and emissions of other pollutants) at no, minimal or even zero costs in terms of GDP growth and overall welfare. The weak version of the theory states that “by using revenues from the environmental tax to finance reductions in marginal rates of an existing distortionary tax, one achieves cost savings relative to the case where the tax revenues are returned to taxpayers in lump-sum fashion” (Goulder, 1995b). This claim has no political importance or appeal whatsoever, so it was not discussed very often and is of little interest. Hence, it will not be discussed in this report. To be complete, Goulder (1995b) also considered an intermediate form of the double dividend theory stating that “it is possible to find a distortionary tax such that the revenue-neutral substitution of the environmental tax for this tax involves a zero or negative gross cost”.

[7] The double-dividend-type of thinking is widespread even among economists although some of them use it only implicitly. Consider the paper by Harvard economist Jeffrey Miron: “The Case Against the Fiscal Stimulus” on realclearmarkets.com/blog criticizing Obama’s stimulus package for inefficiency and ineffectiveness and suggesting in a comment dealing with the part of the package promoting more efficient use of energy the following: “Rather than trying to promote energy efficiency with slow acting and ineffective energy programs, the right approach is higher energy taxes, which directly raise the price of energy and discourage its use. … The right way to reduce energy use and stimulate the economy, therefore, is to increase energy taxes while lowering other taxes enough to offset the higher energy taxes and provide the desired amount of stimulus.” Another example of the same reasoning can be found in Milne (2003). [8] A good example of this resurrection is Stern (2006). [9] See also Boeshertz and Rosenstock (2003)

[10] The tax was proposed to be revenue-neutral and based half on carbon content and half on energy value. It, in fact, broadened the tax base to non-carbon energy sources such as nuclear power and hydropower (European Commission, 1992). [11] It may be interesting to note that at the same time the Clinton administration attempted to introduce federal energy tax based on the energy content – a sort of environmental tax close to the carbon tax but using a different common denominator. There was also a different justification for such a tax – the tax was proposed as a measure to lower the federal budget deficit. After the proposal was rejected in 1993, the administration came back to a more traditional source of income – the fuel tax on gasoline that was substantially increased from 1994 on and the proceeds of which were used partially to fill general needs of the budget as opposed to previous practice of using money raised by this tax to cover exclusively expenses on highways construction and maintenance (US Treasury, 2003).


42


[12] This proposal was sometimes named “the Monti proposal” after Mario Monti the then Commissioner for Taxation. [13] Commission (1997).

[14] One of the main reasons behind the slow progress in development of the Energy taxation Directive was the then-EC’s unanimity requirement on taxation issues. In 2001, a revision of the unanimity rule for certain tax issues was proposed in order to impose the qualified majority vote based on the “enhanced co-operation” mechanism. The rule was introduced by the Amsterdam Treaty and later developed by the Nice Treaty. It entered into effect on February 1, 2003. [15] For details see Kolk (2005) [16] Source: Directive 2003/96/EC [17] Source: Directive 2003/96/EC

[18] This classification is based on the practice used by Eurostat, see also Taxation trends in the European Union, Eurostat 2010. [19] The oldest energy tax in Europe was introduced in the UK. The name used for taxes on fuels has been usually “hydrocarbon oil duty” in the UK. The petrol duty was introduced there in 1909, at a rate of 3d (£0.013) per UK gallon – again as another source of revenue. In 1919 petrol duty was abolished and replaced with vehicle taxation, and the “tax disc” based on horsepower was introduced. In 1928 the Government decided to once again charge duty on fuel, at a new rate of 4d (£0.017) per UK gallon. [20] Source of data: Eurostat [21] Source of data: Eurostat

[22] Estonia levied other environmental taxes on its citizens in 2009 and 2010. In 2009 the excise duty on fuel increased by 10 – 127 %. In 2010 there has been another increase of the excise duty on fuel by 5 – 64 % combined with the increase of the excise duty on electricity by 40 %. These increases will mean almost an additional 1% of GDP to be channeled to the governmental coffers.

[23] The position of Bulgaria seems to be cemented in 2010 by the increase of excise duties on electricity (for industrial needs). The same applies also for Denmark which increased the energy taxes – except petrol and diesel – on business and households by 15 % in 2010.

[24] By the taxation level we understand the sum of taxes and social security contributions. General overall taxation level in the EU, taken as a whole, amounts to 39.3 % in the GDP-weighted average, which means that the EU is generally a high taxing area compared to other important economic areas in the world – USA, Japan and also China. [25] The first seven positions in ranking according to the overall tax-to-GDP ratio are occupied by the old member states. There are only few exceptions – Spain, Ireland and Greece with tax-to-GDP ratios among the lowest within the EU. However, this is likely to change as a result of financial crises and debt crises that plague these three countries severely. Despite all efforts the data does not suggest any convergence in terms of overall taxation policies within the EU. Overall, eleven member states have tax-to-GDP ratio below 35%. [26] Source of data: Eurostat [27] Source of data: Eurostat

[28] Denmark and Sweden were also among the first countries in Europe to levy energy taxes. They levied taxes on transport fuels, such as gasoline, as early as 1917 and 1924 respectively being second after the UK which introduced them in 1909. Sweden later instituted energy taxes on other non-transport energy products like


43


mineral oils and coal beginning in 1957 (by coincidence in the year of the creation of the European Communities). Of course, the justification of these taxes was not environmental, but fiscal.

[29] Speck (2007)

[30] In Denmark, all VAT registered companies had been exempt from virtually all energy tax burdens before the 1996 tax reform.

[31] Speck (2007) [32] Data source: Eurostat 2010. [33] Similar distribution applies also for the Netherlands with about 50 % of energy taxes, 35 % of transport taxes and 15 % of pollution and resource taxes. [34] Shackelton et al. (1992) [35] Source of data: International Energy Agency [36] Another kind of indexation was in place in Britain between 1993 and 1999. It was labeled as a Fuel Price Escalator and led to significant rises in the cost of fuel for consumers. We can see from the graph 6 that at the beginning of 2001, just after the Fuel Price Escalator ceased to be used, the share of taxes in premium unleaded (95RON) gasoline price was the highest in EU 27.

[37] Energy intensity is measured as the ratio between gross energy consumption and GDP for a given calendar year in a given country. [38] Source of data: Eurostat [39] Source of data: Eurostat [40] Source of data: Eurostat, IEA, OPEC [41] Oil Bulletin (2008). [42] The most successful system of this kind is the one that allows trading emission permits of SO2, based on the Acid Rain Program stemming from the Clean Air Act of 1990. The goal of the scheme was to achieve a drop of SO2 emissions in the magnitude of 50% from 1980 to 2010. The first year when overall limits on SO2 emissions were binding was the year 1995. The market operator of the whole scheme has been the Environmental protection agency (EPA). Another example from the USA is the Chicago Emission Reduction Market System from 1997 which enabled the

trade of permits to emit volatile organic compounds (VOC). The system was enlarged in 2000 to cover more

counties around Chicago.

[43] One possible reason for the acceptance of emission trading scheme in Europe is that environmental trading schemes already existed in Europe, even before 1997. They just were not labeled as trading schemes. An example of such trading schemes was based on the Regulation 3093/94/EEC. It gave the possibility for businesses to trade pollutants injurious to the ozone layer. The whole system is pretty cumbersome (all trades have to be reported to the Commission) and the overall goal is different (the ultimate goal is to eradicate these pollutant altogether – unlike CO2 emissions), but the principle is the same. [44] ETS Green Paper, (COM 87/2000), European Commission 8 March 2000. [45] Green Paper on market-based instruments for environment and related policy purposes (COM 140/2007), European Commission, 28 March 2007.


44


[46] This document was the first of all action programs to be passed according to the procedure in pursuant of article 175 of the Treaty. Meaning that, unlike previous action programs (1973 – The 1st Environmental Action Program, 1977 – The 2nd Environmental Action Program, 1982 – The 3rd Environmental Action Program, 1987 – the 4th Environmental Action Program, 1993 – The 5th Environmental Action Program), this program includes binding legal norms. The climate change abatement is among priorities of the Sixth Action program and the emission-trading scheme is explicitly mentioned as a tool to achieve such a goal. [47] In this document energy taxation is barely mentioned and when mentioned it is mostly in connection with taxing of transportation: “In March 2007, the Commission adopted a Green Paper on the use of market-based instruments for environment and energy related policy purposes and in the course of 2008 the Commission will review the Energy Taxation Directive and start to examine how to identify and phase-out environmentally harmful subsidies. The Commission proposed legislation to re-structure passenger car taxation and to coordinate taxation of unleaded petrol and gas oil used as motor fuel.” [48] More precisely it became a basis for the proposal of the framework directive for GHG ET within the European Community (COM 581/2001) that became the basis for the Directive 2003/87/EC. [49] See also Parker (2006) [50] For instance, in January 2008 Norway, Iceland, and Lichtenstein joined the EU ETS. Also, starting with the third trading period (2013 – 2020), airlines will be included into the system. [51] Data source: EEX and computation of authors [52] There are also other projects we did not cover in this report with the similar effect such as the EU ETS on environmental taxation and these are introduction of electronic toll systems for using highways and roads and/or introducing congestion charges in some cities (namely London).

[53] Data lines in graph 12 are constructed as a standard deviation over weighted average of percentages of taxes in prices of particular energy product in particular European countries. [54] Data source: International Energy Agency and computations of authors. [55] With the exception of Denmark – see above for details. [56] It means not only higher mileage but also a different type of technology altogether – e.g. the use of the LPG, CNG, hybrid systems or electricity-only cars.

[57] However, it might not be the case, esp. when capital good used for substitution had been produced in the area with substantially lower energy taxation. [58] A good example of this „energy use export“ is the development of cement production in Turkey that became the world’s largest cement exporter, partially because of environmental regulations within the EU and the proximity of Turkey to European markets. [59] See also Speck et al. (2006) who claim to find that the introduction of carbon taxes on the industrial sector decreased CO2 emissions. The study deals with Denmark, Finland, Norway and Sweden; countries that introduced carbon taxes at the beginning of the 90s – for more details on Denmark see also supra in this report above. But such claims do not consider the possibility of “exporting” carbon-intensive technologies. [60] For economists, this is a simple corollary of the basic Slutsky equation under the assumption that demand for the goods in question (here, energy) is not elastic in price; which is a plausible assumption in case of demand for energy and energy products – at least in the short run. [61] The insanity of the ban became visible when a German entrepreneur circumvented the ban by selling old bulbs as “heating spheres” – with immediate success. The “spheres” were produced in… China.


45


[62] There is a huge literature connecting the division of labour with economic growth, starting from Smith (1776), and leading to Paul Krugman’s contributions to new economic geography and new trade theory, see Krugman (1980) or Paul Romer’s and Michael Kremer’s contribution to the growth theory, see Romer (1986), Kremer (1993). [63] Hayek (1945) [64] Much more important to achieving energy security is the state of the infrastructure, not the level of prices or the level of share of imports. It is also necessary to ask who is actually dependent on whom, since both – the seller and the buyer – are interdependent. The weaker side in this “tug of war” is the one with lesser or more costly outside options – the one with less diversified economy in this case. Most of those that sell energy products to Europe (Russia, Libya, Nigeria, Middle East nations) depend more on European money than Europe depends on their oil or natural gas.

[65] Gross inland energy consumption is defined as „the energy inputs to the economy, calculated by adding total domestic energy production plus energy imports minus energy exports, plus net withdrawals from existing stocks.“ (European Environment Agency) [66] Data source: Eurostat, ENER12 Net Energy Import Dependency, European Environment Agency, 2009

[67] There is no generally accepted definition of the „renewable energy source“. However, to simplify things one can define it as an energy source that is legally awarded such a label. [68] Data source: Eurostat. Toe stands for ‘tonne of oil equivalent’.

[69] On this, see Doumax (2010) and Zajíček, Zeman (2010). [70] Peter Salje: Stromeinspeisungsgesetz. Gesetz über die Einspeisung von Strom aus erneuerbaren Energien in das öffentliche Netz. Kommentar. Carl Heymanns, Köln, Berlin, Bonn, München 1999, ISBN 3-452-24158-0. [71] European Court of Justice, 13 March 2001,Case C-379/98, PreussenElektra Aktiengesellschaft v. Schleswag Ak tiengesellschaft [72] The tax burden on labour consists of personal income taxes and social security contributions. In general, the taxes on labour are tremendously high in Europe. Implicit tax rate on labour averages about 34% of GDP in EU 27. [73] For methodology of computing ITR see Eurostat (2010). Eurostat computations of ITR are also used in this report. [74] Source: Commission service

[75] Source of data for Annex 1: Energy Prices and Taxes, Quarterly Statistics, Second Quarter 2010, IEA Statistics. [76] Data source: Speck (2007), Eurostat, IEA. [77] Data source: Speck (2007), Eurostat, IEA. [78] Source of data: US Treasury, AAA, CBO. Car penetration is defined as a percentage of number of cars on the whole population or alternatively as a number of cars per thousand people.

[79] Source of data for Annex 3: Energy Prices and Taxes, Quarterly Statistics, Second Quarter 2010, IEA Statistics.


46


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