Environmental and labour taxation

Setting the scene

The 7th EAP calls on the EU and Member States to consider ‘fiscal measures in support of sustainable resource use such as shifting taxation away from labour towards pollution’ (EU, 2013). This briefing presents trends in the shares of environmental and labour taxes in total tax revenues. The reasoning that it is more environmentally and economically sound to tax pollution and resource use than to tax labour is based on the theory that increased taxes on resources should incentivise a reduction in their use. Environmental taxation can allow fiscal consolidation while, at the same time, encouraging restructuring that moves towards a resource-efficient economy (EC, 2011). Reducing taxation on labour can also encourage economic growth and, through targeted investment, can encourage the creation of jobs, for example in the recycling and energy efficiency sectors (EEA, 2013). Increasing environmental taxes and reducing labour taxes while keeping the overall tax burden constant is widely known as environmental fiscal reform.

The Roadmap for a Resource Efficient Europe (EC, 2011) includes a milestone that, by 2020, a major shift of taxation from labour towards the environment will lead to a substantial increase in the share of environmental taxes in government revenues, in line with the best practice of Member States.

Figure 1. Shares of environmental and labour taxes in total revenues from taxes and social contributions, EU

Note: Total revenues from taxes and social contributions exclude imputed social contributions.

For the EU as a whole, there has been no progress over the period examined (2002-2016) (Figure 1). The share of total revenues from taxes on labour has remained at approximately eight times that of revenues from environmental taxes. The revenues from labour taxes relative to environmental taxes were slightly lower in the early years (2002-2006) compared with the rest of the period examined. The revenues from labour taxes relative to environmental taxes increased during the years of the economic downturn (2008 and 2009), decreased slightly immediately after that and remained fairly stable after 2011 (see also EC, 2018).

The years following the 2008 economic downturn offered the opportunity to use environmental fiscal reform to address rising unemployment, i.e. to increase environmental taxes by reducing labour taxes and thereby encourage employment creation. The lack of any progress in such a tax shift at the EU level indicates that this opportunity has not been capitalised upon. This lack of progress comes in spite of renewed interest in environmental fiscal reform, driven by various factors including the push for fiscal consolidation and the growing recognition of the financial burden of certain measures such as fossil fuel subsidies. The recent sharp fall in global oil prices is seen by some as providing an opportunity to reform fiscal measures targeted at the production and consumption of energy from conventional sources (notably fossil fuels), e.g. by reinforcing carbon-pricing mechanisms and revisiting fossil fuel subsidies (IEEP, 2015).

In addition to taxing energy and carbon, pollution and resource taxes offer opportunities to further reduce environmental pollution and improve material resource efficiency (see the Resource efficiency briefing (AIRS_PO2.1, 2018)). Such taxes are still largely unused in the EU, comprising only 3.4 % of revenues from all environmental taxes in 2016, which corresponds to around 0.08 % of gross domestic product (GDP) in the EU (Figure 2). Over recent years, there has been no sign of an increase in the share of pollution and resource taxes in environmental taxes. This is despite an increasing focus on material resources in EU policy, represented, for example, by the 2011 Roadmap to a Resource Efficient Europe (EC, 2011) and the 2015 Circular Economy Package (EC, 2015a). Transport taxes, such as sales taxes on vehicles or annual vehicle taxes, are the second most important category in terms of revenue generation and their share was rather stable between 2003 and 2016. 

Figure 2. Environmental taxes by type, as share of GDP, EU

The lack of progress with environmental fiscal reform may be a result of a number of obstacles in relation to implementing environmental taxation.

In its 2015 review of tax reforms in Member States (EC, 2015b), the European Commission refers to three such key barriers: (1) the potentially regressive nature of environmental taxes and possible associated equity issues; (2) the potentially harmful effect on the competitiveness of the sectors concerned; and (3) the administrative and enforcement costs of raising these taxes. The Commission, nevertheless, offers successful implementation strategies, namely transparency and early engagement with those affected by the tax, gradual implementation of the tax according to a pre-announced schedule and making such tax measures part of a broader policy package designed to achieve the specific environmental objective.

Analysis by the European Commission also suggests that higher energy taxes (a form of environmental taxes), compensated for by a reduction in labour taxation, can, in fact, improve competitiveness (Barrios et al., 2014). However, the administrative and enforcement costs must be in proportion to the political and environmental objectives that the tax aims to achieve. Other studies also suggest that any potentially negative impacts of environmental taxes can be reduced or addressed through the careful design and implementation of tax adjustments (IEEP, 2015).

Another factor that limits changes to the relative levels of taxes is the high level of political attention that is generated by any changes to a country’s tax system. This can make any changes difficult and will tend to slow the pace of change. The political difficulties of modifying the fiscal system are reflected in a recent study by the European Commission, which assessed the environmental fiscal reform potential of the EU for different scenarios of political acceptance in various Member States (EC, 2016).

The absence of policies promoting a shift of the tax base from labour to environmentally damaging goods and practices over past years, and the lack of plans by the vast majority of Member States to implement these changes, make it unlikely that the 2020 objective will be met.

Country level information

When comparing the levels of environmental taxation across European countries, differences should be analysed with caution. For example, low revenues from environmental taxes can result from relatively low environmental tax rates, or from modified behavioural patterns resulting from high tax rates. On the other hand, higher levels of environmental tax revenues in a country could result from low tax rates that incentivise non-residents to purchase taxed products from the other side of a border (as is the case for petrol or diesel) (Eurostat, 2018).

Figure 3. Shares of environmental and labour taxes in total revenues from taxes and social contributions

Figure 3 illustrates the large differences among countries in the shares of both labour and environmental taxation in the total revenues from taxes and social contributions. In 2016, the labour tax shares ranged from 34 % in Bulgaria to 58.3 % in Sweden, while the environmental tax shares ranged from 4.6 % in Luxembourg to 11.7 % in Latvia.

In 2016, in only two EU Member States (Latvia and Slovenia) was the share of total revenues from taxes and social contributions made up of environmental taxes greater than 10 %.

Nine EU Member States shifted taxation away from labour and towards the environment between 2003 and 2016 (Bulgaria, Estonia, Greece, Hungary, Italy, Latvia, Poland, Romania and Slovenia). Six Member States moved in the opposite direction (Cyprus, Ireland, Luxembourg, Portugal, Slovakia and Spain) as well as Norway; however, some of these changes were quite small. 

The 2015 review of tax reforms in Member States by the European Commission (EC, 2015b) identified a group consisting of approximately one third of EU Member States where there is particular scope for improving the design of environmental taxes. Suggested ways forward include restructuring vehicle taxation, indexing environmental taxes to inflation and adjusting fuel excise duties to reflect the carbon and energy content of different fuels.  

Outlook beyond 2020

A recent report by the European Commission analysed the extent to which environmental taxes could be increased, based on good practice (EC, 2016). This report found that environmental taxes could increase across the EU from an average of 2.5 % in 2013 to 3.6 % of GDP by 2030. Countries reported that politically feasible increases in environmental taxes, especially energy taxes, are lower than estimated optimal rates. However, this gap reduces as one looks further into the future. The report concluded that while, in the short term, the good-practice scenario is viewed as challenging, over the long term nearly all the suggested modifications to the national tax systems can be viewed as politically feasible.

The fiscal outlook in Europe has heightened political interest in the potential of environmental fiscal reforms. Longer term developments, including demographic changes and technological breakthroughs on energy and transport in the transition to a low-carbon, green economy, will contribute to the erosion of the current tax bases in European countries. These expected trends challenge the overall basis of current thinking on tax shifts. Much more work needs to be done on the design of resilient, long-term tax systems in Europe in the face of such systemic challenges (EEA, 2016).

Environmental taxes are defined as taxes whose tax base is a physical unit (or proxy of it) of something that has a proven, specific negative impact on the environment. Current environmental tax revenues stem from four types of taxes: energy taxes, transport taxes, pollution taxes and resource taxes.

Taxes on labour are defined as all personal income taxes, payroll taxes and the social contributions of employees and employers that are levied on labour income (both employed and non-employed).

Since 2013, Eurostat has collected data on environmental taxes by economic activity at a detailed level under Regulation (EU) No 691/2011 on European environmental economic accounts. The methodological basis is outlined in the Eurostat publication ‘Environmental taxes — A statistical guide’ (Eurostat, 2013). In addition, Eurostat uses information in the National Tax Lists (NTL), supplied by EU Member States within the European System of Accounts transmission programme, to compile the data on total environmental taxes and their major categories. The NTL data are available sooner than the detailed data on environmental taxes collected under Regulation (EU) No 691/2011 and are fully in line with key macroeconomic indicators. In order to ensure coherence between the two reporting systems, small adjustments are made by Eurostat.