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Environmental Tax Reform: EEA study

The European Environment Agency has published a study on environmental tax reform (ETR).  ETR is defined as 'reform of the national tax system where there is a shift of the burden of taxes, for example on labour, to environmentally damaging activities, such as resource use or pollution'. 

ETR comprises two elements. First, it deters environmentally damaging activities by making them more costly. Second, it involves recycling the revenues gained from increased environmental taxes and using them to create positive economic and social outcomes, such as increasing employment and boosting incentives to work. The recycling of revenues is especially important for the acceptability and equity of the tax reforms.

The study points out that ETR can produce (at least) four different types of impacts, each of which may be distributed unequally across society. These comprise the direct consequences of increasing taxes (e.g. higher prices for certain goods); the consequences of recycling (e.g. direct transfers or alleviation of taxes); the broader economic impacts of ETR (e.g. job creation or inflation); and the environmental effects of ETR (e.g. a cleaner environment).

The study is divided into three main parts: first, a review of relevant literature on ETR's theoretical and empirical distribution impacts in Europe; second, a model-based analysis of ETR at the EU‑27 level and third a combining of these two approaches — literature review and modelling — to provide a more detailed analysis of the distribution of an ETR's impacts in Germany.

The modelling exercise analysed the effects of applying ETR to meet the EU target of reducing greenhouse gases by 20 % by 2020. This scenario looked at the effect of taxing emissions, with the revenues used to support innovation and reduce income tax and social security costs. The model showed that the policies would increase employment by more than 1 million jobs, with a small (0.04 %) cost to GDP to achieve the 20% GHG reduction target at EU level.

  • At the European level, the model indicated that fiscal reform would result in financial benefits for almost all socio-economic groups. However, in a few countries the poorest people could see negative effects, as these people spend a higher proportion of their income on energy.
  • The German-focused study finds that increasing the cost of emitting carbon could also have a negative effect on the poorest groups,. However, the the worst-hit parts of society could lose just 1 % of their disposable income in 2020, so, it argues, it would be relatively simple and affordable to compensate the affected groups via targeted benefit transfers.
  • The reduction in social security payments also means labour costs decrease, boosting employment – the model suggests that increasing the price of emitting one tonne of carbon dioxide to €68 by 2020 could create 152 000 additional jobs in Germany.

Overall, the report concludes that:

  • Although ETRs tend to improve incomes across society, they can have mild regressive impacts in that richer households gain more than poorer ones.
  • Care is needed to design ETRs in ways that ensure that certain groups are able to benefit equally.
  • ETR's overall benefits for the economy, environment and society are potentially significant.
  • ETR should therefore be regarded as a key element in the policymaking toolkit for shifting to a green economy.

You can download the study below or read the press release here.

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minute read

16 Jan 2012