Europe's contribution to a balanced carbon world

Ladies and gentlemen

I am grateful to Mr Kovács and to DG Taxud for providing  me the opportunity to share EEA's information and analysis on the role of taxation in helping to create a balanced carbon world.

That is,  a world in which we reverse current trends — cutting the bad carbon released to the atmosphere, and boosting the good carbon stored in biomass.

Achieving that will in turn depend in part on rebalancing the focus of taxation — increasing taxes on economic bads, such as pollution, whilst reducing them on economic goods, such as labour.

I must congratulate DG Taxud.  Under Mr Kovács' leadership this is the second time in two years that you have focused on green taxes. Previously there had been no such interest from this DG during the 13 years  since the EEA's  first report on the effectiveness of green taxes and Ecological Tax Reform (ETR) in 1996.

And I congratulate Sweden — not only for having focused much of their Presidency on the promotion of eco-efficiency but for having pioneered ETR, carbon taxes, and other innovative taxes and charges on pollution, such as those on NOx.
It is perhaps appropriate that it was Sweden that pioneered significant carbon taxes in 1990, given that it was a Swede, Arrhenius, who first sounded the scientific early warning about climate change.  In 1896 he estimated that a doubling of atmospheric CO2 would raise average global temps by about 5 degrees C, which is pretty close to what we now estimate.

We must boost good carbon and cut bad carbon

So, as mentioned, I want to broaden the focus to embrace the good carbon in vegetation, soils and seas, as well as the excess accumulation of CO2 in the atmosphere.

In addition to converting ancient and benign stocks of fossil carbon into a climate warming CO2, 'homo stupidus' has been destroying and overloading the ecosystems that can absorb our excess of carbon. As a result, we now have to contemplate creating artificial carbon capture and storage at huge expense, and with technical uncertainty.

Lord Stern captured the core issue when he described climate change as 'the greatest and widest-ranging market failure ever seen'. In deciding how to generate energy and whether to preserve ecosystems, we continue to be guided by market prices that wholly misrepresent the social and environmental impacts of our choices.

Evidently, there are two sides to this: we need to tax activities that produce negative externalities so that market prices reflect the full economic costs; but we should also pay a fair price for the positive externalities of carbon absorption. The latter should be a key feature of the COP 15 negotiations.

Pricing such externalities is hard but any price will produce some correction and prices can be set to achieve targets

Of course pricing such externalities, both negative and positive, is difficult. One of the first attempts put a cost of some £200,000 on soiled washing in parts of Manchester in the 1890s. It is clear however, that anything north of zero is better than zero, so even the smallest of  taxes on pollution begins to reduce the market failure.

An alternative approach to arriving at an effective tax rate for bad carbon is to set a target for CO2 reductions, such as the 20 % reduction by 2020 for the EU, then work out what tax rate will be needed to achieve that target.

Results from  Anglo-German Foundation (AGF) research, which used two complementary models in Germany and the UK (GINFORS and E3ME),  were presented in London  last week. They found that a carbon tax of around 53–68 Euro per tonne would be needed to achieve the EU's 20 % target.

The substantial tax revenues that would be generated from such a levy — amounting to some 2.2 % of projected EU-27 GDP in 2020 — could be used to lower labour taxes. By boosting employment levels and lowering the incentive for tax evasion, the negative effects on GDP would be offset.

Encouragement comes from the positive experience with both carbon taxes and ETR in Sweden and Germany. The ETR proposed in the research is some three times bigger than the German ETR of 1999–2003, which involved increased energy taxes and reduced labour charges. There the result was the welcome  combination of more jobs and less CO2.

ETR results can be enhanced by directing revenues towards eco-innovation

But, as the AGF research demonstrated, by adding further fiscal measures to the policy package it's possible to achieve even better results. Adding taxes on biomass and minerals and recycling just 10 % of  the total environmental tax revenues to stimulate eco-innovation served to increase materials productivity, and with a lower carbon price.

Whilst ETR is usually presented as a budget neutral option, with increased environmental taxes being balanced by reduced taxes on labour, the urgent need to boost Europe’s eco-innovation of Europe could justify using a small part of the revenues to boost R&D and innovation.

EEA research on ETR to be published shortly shows that, in addition to creating jobs and improving the environment, well designed ETR can significantly boost eco-innovation without creating inequalities. 

But ETR also helps address material productivity…

Recent research from the UK Green Tax Commission, as we heard earlier, confirms that ETR delivers multiple benefits. In addition to those already mentioned, I’d like to mention three other strategic policy issues.

The first is the need to shift the focus of innovation away from labour productivity and towards energy and materials productivity. In a world of 9 billion people seeking OECD standards of living, natural capital, not labour, will be the constraining factor of production. This means that significant taxes will be needed on energy and materials, including water, if we are to stimulate eco-innovation, rather than labour productivity, through price signals.  

The need to refocus the tax base due to ageing populations…

The second policy issue is the ageing population. For much of Europe the source of labour taxes will shrink as a proportion of total population while the lifetime consumption tax base will rise.

As the ratio of workers to pensioners moves from around four now to two by 2050, both the burden sharing between generations and need for stable tax bases will dictate the need to shift some taxes from labour to consumption.

Societies will be forced to adjust their tax bases, so it makes sense to do it in ways that produce the greatest aggregate benefits. 

And the need to reduce national debt (because ETR is more efficient)

The third issue is the current pressing need to raise taxes to meet public expenditure and reduce public debts, and to do so most efficiently.

Taxes on labour and capital create the greatest distortions, costing 2–3 euros in lost output for every 1 euro raised in tax, according to some estimate. Taxes on pollution and on inefficient resource use don’t have such deadweight costs and are less expensive to administer. ETR therefore increases the overall efficiency of the tax system.

It follows that if environmental taxes were to rise from around 7 % of EU tax revenues (which is where they have been stuck for the last 15 years) to around 20 % by 2020 — which is feasible — then the efficiency of the overall tax system would also increase.

ETR shouldn't be limited to carbon and energy taxes

In addition to effective carbon and energy taxes, significant environmental tax revenues could come from levies on wastes, raw materials, dangerous chemicals, and use and disposal of water, which will become increasingly scarce in many parts of Europe.

The success of waste taxes in several EU countries points to the potential for innovation and productivity improvements. In the Netherlands, taxing waste water pollution and recycling revenues helped stimulate clean production. This policy achieved the goal at half the total cost in Denmark, which came late to the idea, having focused initially on investing in waste water treatment plants

(Although, it's worth mentioning that more generally Denmark, like other Scandinavian countries, has helped pioneer ETR.)

Revenues should be maintained if taxes are increased gradually but predictably

The potential fall in tax revenues from successful environmental taxes worries some finance ministers. As with taxes on tobacco, however, rates of taxation on environmental pollution and inefficient resource use would need to rise gradually but predictably, per unit of pollution, or energy used. This would be justified by both increasing public understanding of their negative externalities, as with tobacco and climate change, and by policy targets.

The UK landfill Tax provides a good example of this. The tax increased from around £6 per tonne initially, representing the then best guess at the size of the externality, to the present level of £40 needed to help achieve the EU Landfill Directive targets. 

The distributional impact of ETR need not be iniquitous

As mentioned earlier, the impacts of environmental taxes on the poor have been studied and monitored extensively for 20 years. It is clear that by combining a broader view of equity, which includes environmental justice, and by designing ETR explicitly to address the distributional impacts,  there can be net gains in equity from ETR. 

In conclusion: we need to get serious about ETR

In conclusion, the explicit policy goals and aspirations of the 5th EAP in 1992, and the EU Growth and Competitiveness White Paper of 1993, included internalising externalities and switching taxes from labour to nature. These have not been achieved despite being repeated in subsequent action programmes.  

If we are serious about creating a better balance between the good and the bad carbon then we need a better balance between the taxes on bads and taxes on goods. Politically this is challenging, requiring political will, European leadership, coordination between member states (not least over realistic minimum taxes in the Energy Directive) and above all involving the large majority who will gain from ETR in order to counter the small minorities who will lose in the short term.

This public debate needs to start with the premise put forward by Roosevelt in his US debates on income tax, namely that 'taxes are the price we pay for a civilised society'.