Carbon pricing can help European countries to raise revenue and reduce their fiscal deficits more effectively than other taxes, according to a new report published today (19 November 2012) by the Grantham Research Institute on Climate Change and the Environment and the Centre for Climate Change Economics and Policy.

The new policy paper by Professor Michael Jacobs and co-authors, on ‘Less pain, more gain: the potential of carbon pricing reduce Europe’s fiscal deficits’, reviews a new analysis by Vivid Economics of the potential impact of energy and carbon taxes, as well as changes to the European Union Emissions Trading System, in several Member States, and finds that they could raise as much revenue as other forms of taxation while having less damaging side-effects on economic growth and reducing greenhouse gas emissions.

The paper concludes: “Many European countries are running high annual fiscal deficits and have high debt liabilities, and are looking at options for raising tax revenues. While energy-carbon taxes have generally been considered to be instruments of environmental rather than fiscal policy, it is time to reconsider that view.”

The analysis indicates that energy and carbon taxes can have a less detrimental effect than labour taxes and other indirect taxes, such as Value Added Tax (VAT), on gross domestic product (GDP) and employment. An illustrative energy tax package for Spain, including an increase in duties on transport fuels, could raise more than 10 billion euros per annum by 2020, while packages for Poland and Hungary could generate annually 5 billion euros and 1 billion euros, respectively.

In addition, tightening the cap within the Emissions Trading System to achieve a 30 per cent reduction in the European Union’s emissions by 2020 compared with 1990 could generate 30 billion euros per annum.

The paper points out that the evidence shows energy and carbon taxes “currently play too small a role in the tax portfolio of many European countries”. It adds: “This evidence is not widely known, which perhaps is why energy-carbon taxes do not fulfil their potential role in fiscal strategy”.

It states: “Unlike the taxation of labour or consumption via VAT, there is an appropriate minimum level of energy taxation. This minimum reflects the costs energy consumption imposes on society. Those costs are primarily proportional to the carbon content of energy (more precisely, its contribution to global warming).”

The paper suggests: “It is crucially important for the future low-carbon competitiveness of the EU to get the taxation of the major fuel types – petrol and diesel – right. Currently, EU countries collect less revenue from diesel than they could, with negative implications for the fiscal balance.”

“The solution is to agree a collective increase in diesel tax rates. Of course, rates which have for so long remained differentiated cannot be raised overnight, because the public would not accept it. Yet, a gradual programme of alignment would be worthwhile for all countries and for each individually.”

The Energy Tax Directive, which is currently being revised by the European Council before being finalised next year, may require higher minimum tax rates to be charged on diesel.

Notes for Editors

  1. The Grantham Research Institute on Climate Change and the Environment was launched at the London School of Economics and Political Science (LSE) in October 2008. It is funded by The Grantham Foundation for the Protection of the Environment.
  2. The Centre for Climate Change Economics and Policy is hosted by the University of Leeds and the London School of Economics and Political Science, and funded by the UK Economic and Social Research Council and Munich Re.
  3. Vivid Economics is a consultancy based in London.
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