Covid-19: an accelerator for sustainable taxation?

Alongside the dramatic loss of life, the Covid-19 pandemic has caused a recession unseen in Europe since World War II, leading to unprecedented economic contractions of varying degrees across the EU, skyrocketing government deficits and massive increases in sovereign debts. Shortly after EU governments were starting to see the light at the end of the tunnel of the Financial crisis, public finances are again in need of additional income sources that do not hamper the economic growth and competitiveness that the EU needs.

The European Green Deal put forth by the European Commission to tackle the climate and biodiversity crisis has also set a target for the EU to become carbon neutral by 2050. This necessary target will require a complete redesign of the European economy, including of the different economic instruments employed by governments, including taxation.

What if governments were to raise revenues while promoting sustainable economic growth? What if we were to shift taxes from labour to sustainable taxation?

Green taxation has proven to be a very useful economic instrument to simultaneously advance environmental protection and support the decarbonization of the economy. European regulations define an environmental tax as ‘a tax whose tax base is a physical unit (or a proxy of it) of something that has a proven, specific negative impact on the environment, and which is defined in the European System of Accounts (ESA) as a tax’.

[Con la colaboración de Red Eléctrica de España]

These taxes aim to influence the behaviour of economic operators (e.g. a company) by punishing harmful behaviour to the environment under the ‘polluter pays’ principle. The tax amount reflects the negative externalities, that is the costs (impacts) caused by a producer that is not financially incurred by that producer, created by such behaviour. Besides representing additional funding to public finances, these taxes steer companies and consumers to channel their efforts towards innovative solutions to reduce impacts on the environment, with the incentive of avoiding the tax burden. For instance, let us assume a company pays 100,000 euros a year in environmental taxes with its current production process. If the coming year the company sees its tax burden increase up to 150,000 euros, it will start carrying out a cost-benefit analysis to consider investing in cleaner technologies that will allow it to reduce its tax burden.

EU governments collected EUR 324.6 billion in environmental taxes in 2018. This represented 2.4% of the EU’s gross domestic product (GDP) and 6% of EU total government revenue from taxes and social contributions.

However, overall EU fiscal policy in the aftermath of the financial crisis has not favoured green taxation but in fact has lost an opportunity to use potential additional revenues derived from it. Revenues from environmental taxation in the EU have grown over the years. In 2002, revenues from environmental taxes were around 107 billion euros less than in 2018, but contrary to what could be expected, the share value of environmental taxes in the EU’s GDP has contracted from 2.5% in the beginning of 2002 to the 2018 figure of 2.4%. Similarly, the percentage of environmental taxes over total taxes and social contributions dropped in the same period from 6.6% to 6%.

In this regard, there are significant differences among Member States. If we look at the environmental tax revenue-to-GDP ratios, they ranged in 2018 from 1.6 % in Ireland or the 1.8% in Spain to the 3.7 % in Greece. Concerning the share of environmental taxes in total taxes and social contributions, the figures also varied significantly across the EU Member States, with Latvia reporting the largest share (at 10.9 %) and Luxembourg the lowest (4.4 %). The figure remained low as well for Spain, accounting for 5.2%.

A 2016 study from the Institute for European Environmental Policy (IEEP) for the European Commission assessed the potential benefits associated with higher levels of environmental taxation in the 28 EU countries of the time. It was estimated that the EU could raise €208 billion in additional revenue by 2030 and €222 billion by 2035 through suggested reforms, equivalent to 1.05% of combined GDP. The environmental benefits associated with reforms could amount to a value of €13.7 billion in 2030. Such potential additional income sources could potentially contribute to healthier public finances in the EU Member States and provide the needed fiscal manoeuvre to face the challenges of the future while correcting environmental externalities.

The EU has limited competences on taxation, and this is unlikely to change in the short-medium term, as this touches the very core of national sovereignty and would imply a reform of the Treaties. Nevertheless, a year ago the sole mention of any sort of debt mutualisation would be enough for northern Europe to walk out the door, and now the European Commission is able to raise money in the international financial markets. The pandemic, coupled with the Green Deal ambitions, has created a window of opportunity for reforming and strengthening environmental taxation in the EU. The EU should venture to open this debate and work towards closing the gap among Member States on the matter.

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The expansion of green taxation would effectively contribute to achieving climate neutrality, protecting the environment all while alleviating public finances. However, we cannot overlook that environmental taxes have sometimes been introduced in ways that are seen as regressive, that is more harmful for the welfare of low-income households than for the richest ones. For instance, a tax increase on diesel of 3 cents per litter will decrease proportionally more the income of a modest household living in the outskirts of a big European capital, than the income of a wealthy citizen living in the city centre of the same city. These inequalities will have to be addressed.

Be that as it may, raising environmental taxes does not necessarily translate into more fiscal pressure. If the rise in environmental taxes would be compensated with a reduction of conventional labour taxes, unsustainable behaviours would be punished while companies could benefit from increased levels of competitiveness and this could be translated in an increase of employment levels. In addition, the regressive nature of certain environmental taxes can be addressed depending on how government spends the revenues derived from them.

Overall, greater use of well-designed environmental taxes in the EU has the potential to contribute decisively to the 2050 climate neutrality goal, to a more liveable environment for all citizens, to healthier public accounts and to an overall more sustainable economic growth.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of any other organization)

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