Year XXXIV, 1992, Number 3 - Page 211
The European Community’s Proposal for a Carbon Tax
1. In recent years, one major change has come about in the field of environmental policy. While the “first generation” environmental protection measures were overwhelmingly addressed to domestic environmental problems, thus benefiting mainly people living within the borders of a particular country, the world has now assumed a fresh attitude towards the urgency of global problems, in which all mankind, as well as future generations, are involved. It is easy to understand that a further difficulty exists in the case of global problems, since domestic environmental measures are by themselves inadequate.
An efficient policy to tackle global environmental problems can actually be defined according to two very general principles, that seem widely accepted:
– no country is able to cope with global problems by unilateral action, since global problems imply multilateral solutions. In this context we can add that no country has the right to set down the optimal environmental policy for the whole world. This principle sets a limit to unilateral decisions with extra-jurisdictional effects;
– yet, at the same time, in the case of global commons, it must be acknowledged that these do not belong to any particular country or to the present generation, but rather to the world as a whole and to future generations as well.
The solution to this dilemma is rather straightforward. With a world government it would be the task of this institutional body to assume the necessary decisions; and no lower-tier government could claim the power to take unilateral measures, or hinder policy decided at the upper level. But, within a democratic framework, the peoples and governments at the lower level will have the right to take part in the decision-making process.
Since a world government entitled to take decisions in the environmental field for the preservation of global commons does not actually exist, the only practical and reasonable solution is to establish rules for the sustainable management of these common resources through multilateral agreements established within the framework of the United Nations. No country can decide by itself on behalf of all the world, but at the same time no country can hamper the implementation of decisions taken on the basis of a multilateral consensus. Environmental imperialism must be dismissed in both cases.
2. The problem of global warming currently represents one of the main areas of concern for all mankind. CO2 emissions are considered as being the main contributory factor to the greenhouse effect (its share of total GHGs amounts to 61 % according to IPCC estimates), while the atmospheric concentration of carbon dioxide is largely of anthropogenic origin, primarily caused by the burning of fossil fuels. The depletion of tropical rain forests has also become a major reason for the atmospheric concentration of carbon dioxide in the last thirty years, and it is now estimated to be responsible for one third of the emissions caused by the combustion of fossil fuels.
While global warming is a world-wide problem, the main responsibility lies with the industrialised countries. World per capita carbon emissions are 1.13 tons, while this figure is 5.76 for the United States, 2.24 for Japan and 2.28 for the EC. The average for the rest of the world is only 0.40 tons of carbon. In the near future the policy measures needed for limiting carbon dioxide emissions should be implemented especially in the Northern industrialised countries. But it needs to be realised that China’s present total emissions (616 tons) are already more than three times larger than those of Germany (190 tons); while in India they are 1.5 times higher than in Italy. With the expected economic growth of the developing countries, their CO2 emissions could increase dramatically, since their energy use is significantly inefficient.
An effective policy for addressing the global warming problem should therefore provide the right economic incentives to the industrialised countries for increasing energy efficiency and limiting carbon dioxide emissions, but at the same time make provision for adequate incentives to raise energy efficiency in less developed countries as well. The proposal discussed in this paper consequently includes the implementation of a combined energy/carbon tax in the industrialised world and the setting up of a fund for financing technology-transfers towards poor countries, so that energy efficiency can also be raised in the less developed part of the world.
3. Within the European Community, as a first step to limiting greenhouse gases, the joint Energy-Environment Council decided on 29.10.1990 to stabilise Community CO2 emissions by the year 2000 at their 1990 level. While emissions almost stabilised during the period 1970-1985, due to increasing energy prices, in the years 1986-1990 this positive tendency was reversed and emissions grew by 4%. And in a “business as usual” scenario EC CO2 emissions for the period 1990-2000 are likely to grow by 11%. Consequently, a package of measures is needed to reduce the use of fossil fuels and to achieve the stabilisation target.
The Community contribution to global CO2 emissions is only 13%, compared to 23% for the US, 5% for Japan and 25% for Eastern Europe and the former USSR. Unilateral action by the EC would not solve the greenhouse problem, whose nature is global. But in 1993, with the completion of the internal market, the EC will become the biggest economic and commercial entity in the world. As such, the Community seems obliged to take the lead in protecting the environment and the sustainable use of natural resources, in line with the political commitment contained in the declaration “The Environmental Imperative” adopted by the Heads of State and Government at the European Council in Dublin in June 1990. In this way the EC would also play a decisive role of catalyst for the adoption of a Convention on Climate Change at the UNCED Earth Summit in Rio in June 1992.
4. In the case of climate change there is no clear-cut trade-off between regulations and taxation. A comprehensive strategy must give room both to command-and-control and to economic instruments, relying on a mutually reinforcing set of regulatory, voluntary and fiscal measures. Energy efficiency could be promoted through higher energy prices and the imposition of technical standards, while fuel-switching towards the use of less-polluting energy sources could be favoured by energy price increases according to carbon content. In the industrial sector there is a lot of room for voluntary agreements targeted at a reduction of CO2 emissions.
The strategy proposed by the Commission seems capable of reaching the target of stabilising CO2 emissions and to balance the competitive needs of the European economy with environmental requirements. The suggestions for policy involve a variety of measures.
First, possibilities to improve energy efficiency appear to exist in all sectors and for all energy sources. This “no-regret policy” will increase energy security, improve transport systems, limit energy-related air emissions other than CO2 and strengthen the industrial framework. But fuel switching also has a major role to play, especially in the medium and long term, with a much more substantial share of natural gas being used, to the detriment of coal and possibly oil. Finally, an increased use of renewable energy sources must be promoted in order to contribute to reaching the stabilisation target; technical obstacles need to be overcome with R&D programs and the competitiveness of these energy sources needs to be improved.
Regulatory measures are needed to exploit the possible gains in energy efficiency (15-25% with existing techniques), while R&D programs should be developed to promote minimum-emissions power production from fossil sources (including the development of carbon abatement technologies), renewable energy sources and efficient energy use and conservation, including energy-efficient transport systems. Many of the regulatory measures for the power generation industry, transport and household-commercial sectors are already covered by Commission proposals such as the SAVE program, but will need to be strengthened. On the basis of current estimates it appears that these measures will achieve about half the stabilisation target.
5. The proposed set of regulatory measures must be supplemented by fiscal measures. Existing fiscal proposals on the internalisation of the environmental costs into the circulation tax on lorries or on enlarging the use of tax differentiation must be extended to private cars and reinforced. But they are still inadequate to achieve the stabilisation target. A new tax must be introduced on the use of all non-renewable energy sources (including large scale hydro-electric ones). This will provide a signal to the market that the trend of energy prices is upward, and thus influence the behaviour of firms and individuals.
The tax will be consistent with the “polluter pays” principle and has been advocated in many resolutions by the European Parliament. Since CO2 emissions are related to very different fossil fuel uses by a very large number of consumers and businesses, the use of policy instruments based on market mechanisms to provide incentives for the reduction of CO2 emissions will certainly be more cost-effective than relying solely on regulatory measures.
The tax will have an energy component – to be applied to all energy sources – and a component based on the carbon content of each fossil fuel. An energy tax would be more effective in promoting energy efficiency. A carbon tax would provide more specific incentives to reduce CO2 emissions, but would put a relatively higher burden on coal, which is the most secure energy supply. Moreover, it would favour nuclear energy, which has advantages in terms of CO2 reduction, but which leads to its own particular problems (security, waste disposal). Furthermore, the impact of the carbon tax on the industrial competitiveness of member states would differ according to their energy structure.
The Commission proposal is thus in favour of a balanced solution: 50% of the tax being modulated according to energy content; and 50% according to the carbon content of each type of fossil fuel.
6. This energy/carbon tax should be introduced through a Community Directive in order to avoid possible distortions within the internal market; but it ought to be implemented at the national level according to the principle of subsidiarity.
A key characteristic of the tax will be its revenue neutrality. This means that it should not result in any increase in the total tax burden. The tax revenue needs to be offset by fiscal incentives and by tax reductions. This shift of the burden of taxation away from distortionary taxes on companies and individuals and towards taxes on exhaustible resources (that in addition heavily damage the environment when used for combustion), will represent a first step towards shaping a more efficient taxation system (with less deadweight loss) and will prove at the same time to be more compatible with the environment and sustainable development.
Commission and independent estimates show that a tax rate equivalent to $10 per barrel of oil – together with the regulatory measures provided in the package and with complementary national programs could be sufficient to achieve the stabilisation target. But this tax rate will be gradually reached by the year 2000, starting with a rate of $3 on 1.1.1993 and increasing each year by $1. This provision will be needed in order to promote a gradual adaptation of the European economy to the new conditions of the energy market.
The tax will be implemented by the Community only when measures with an analogous financial impact are introduced by other OECD countries. This conditionality clause could be justified as a way to put pressure on the Community’s main trading partners, and especially on the US and Japan, so that similar policies for limiting carbon dioxide emissions are carried out at least at the level of the industrialised world.
But it is also essential to avoid any deterioration of the competitive position in relation to – and the resultant de-location of European firms towards – countries outside the OECD area that implement less stringent environmental standards, in particular for those industrial sectors employing energy-intensive production processes that are heavily traded internationally (steel, chemicals, non-ferrous goods, cement, glass, pulp and paper).
Special fiscal treatment could be provided for, but the affected industries would be obliged to assume a commitment to reduce CO2 emissions voluntarily.
7. The macroeconomic impact of the tax would be negligible, especially due to its revenue neutrality, as well as to its progressive introduction. In the Community as a whole there might be a small reduction in the annual growth rate during the period to the year 2000 (between 0.05 and 0.1) and a temporary increase in the rate of inflation (0.3 to 0.5 per annum). But some member states, where the level of economic growth is actually lagging behind the Community average, must face the difficult task of reducing the growth rate of CO2 emissions during the catching-up process.
The Community has already endorsed a further commitment to relieve the costs of such adjustments through the provision included in the Maastricht Treaty that a Cohesion Fund will be created before December 31st, 1993. According to the Protocol on Economic and Social Cohesion annexed to the Treaty, this Fund will finance projects in the fields of environmental protection and trans-European networks in member states whose per capita income is lower than 90% of the Community average.
8. The revenue from an energy/carbon tax of this type will be significant, amounting to about 20 bn Ecu in 1993 (0.35% of European GDP), at a rate of $3 per barrel of oil. This figure could be employed in three different ways: a) to finance fiscal reductions in the member states in order to balance the negative economic effects that could derive from the implementation of the tax; b) as a new own resource to finance the Community budget (the fifth resource) in order to fill the gap highlighted by the Delors-II package between existing resources and financial needs following the Maastrich agreement; c) to contribute to a world-wide fund for financing technology transfers to the Third-World countries which aim at increasing their energy efficiency.
The first option should be considered within the framework of an environment-friendly type of fiscal reform. Such a reform was implemented in Sweden in 1990-1991, and it involved about 6% of GDP without significantly changing the global size of the budget (equal to 56% of Swedish GDP). About 80% of taxpayers are now charged at a marginal income tax rate of 30% – while at the beginning of the eighties the marginal rate had reached 85% –, which also represents the rate levied on capital income. The following decrease in revenue has been 40% financed through an enlargement of the capital income tax base and an increase in the property tax, and 30% by widening the VAT tax basis and an increase in energy and environmental taxation.
In Sweden, VAT is now also levied on energy products, while a new carbon tax and a sulphur tax have been introduced. As far as the carbon tax is concerned, the tax rate is 250 Kr (34 ECU) per ton of CO2. This tax is actually an excise tax on coal, mineral oils and natural gas, but electricity generation is exempted and the burden is largely reduced on energy-intensive industrial sectors for competitiveness reasons. The sulphur tax is levied on coal and peat when used as fuels, and on mineral oils.
Even if there remain significant limitations to the Swedish fiscal reform, linked to the difficulty of encompassing all energy uses pending an international agreement on the taxation of CO2 emissions, it should be recognised that this reform represents a good example of domestic fiscal reform targeted at enhancing the burden of taxation on the consumption of goods and the use of energy resources, while diminishing the weight of distortionary taxes on income.
Following the Swedish model, the introduction of an energy/carbon tax within the EC could be the first step in the direction of implementing a system of energy taxation at the supernational level. If the EC succeeds in its attempt to reach an agreement on an energy/CO2 tax, this result would be very important for demonstrating that in the field of environmental taxation, transfers of sovereignty from the national to the supernational or world level can be achieved, especially when global commons are at stake and there is strong world-wide pressure from public opinion to address the problem of adequate protection of environmental goods with fiscal instruments.
9. The second possible use of the revenue coming from the energy/carbon tax is to finance the Community budget. The Delors-II package has tried to quantify the financial needs of the Community for the five-year period 1993-1997. An overall increase of expenditure amounting to about 20 bn Ecu is estimated for the end of the period. The political reaction of many member states has been rather negative, since they are already constrained by the need to fulfil financial requirements in order to join the Economic and Monetary Union.
As a way out of this dilemma the revenue of the energy/carbon tax could be used, at least partially, to finance the increase in the size of the Community budget. This will represent effectively a real own resource for the Community, fairly distributed between member states (since the revenue of the tax is very much linked with economic prosperity), and with good automatic stabilisation properties (since energy consumption varies with changes in economic activity without any significant time-lag).
This change could be very important from a political point of view. Its implementation would obviously strengthen the need to promote further institutional reform of the EC, increasing the powers of democratic control by the European Parliament; since it is unthinkable to give the power to manage large tax resources to the Commission without simultaneously recognising the power of a democratically elected body to check (together with the Council, where the member states are represented) the behaviour of the Executive.
The creation of a fifth resource for the EC budget has been suggested by a group of experts convened by the Commission to revise the MacDougall Report on the problems of public finance within the Community ahead of Economic and Monetary Union.
The recognition of the power of autonomous taxation by the EC would also comply with one basic rule of fiscal federalism, which requires that the institutions that share the power to decide expenditure the two branches of the budgetary authority within the EC, the Parliament and the Council, on the basis of a formal proposal by the Commission should also be responsible for providing the financial means needed to cover such expenditure.
10. A third possible use of the revenue from the energy/carbon tax is to finance a world fund, created in Rio within the framework of the Convention on Climate Change, to finance transfers of resources and especially transfers of technology to enhance energy efficiency in less developed countries. This is a decisive pre-requisite for the successful implementation of a world-wide policy for controlling global warming.
A proposal along these lines has been put forward recently by the Italian Minister for the Environment, suggesting the implementation within the EC of an energy/carbon tax of $3 per barrel of oil, whose revenue could be distributed in the following way: 60% to member states’ Exchequers, earmarked for subsidies to investments promoting energy efficiency; 20% to the Community budget; and 20%, to Eastern European and Third-World countries.
An International Fund for Atmospheric Stabilisation has been proposed, with redistributive purposes, by Hirofumi Uzawa of the Japan Academy and Niigata University. A certain portion of the net receipts that each national government will collect through the implementation of a carbon tax would be allocated, through the Fund, to developing countries according to their per capita GDP levels.
Another interesting proposal has been put forward by two Canadians, B. Yang and A. Rosenfeld, during an OECD workshop on tradeable emissions permits. They propose to create a technology-transfer fund to improve energy efficiency in developing countries. The annual funding responsibilities – called tradeable warming credits (TWCs) – could be distributed initially among OECD members according to the carbon content of the fossil fuels used by each country in a baseline year. These TWCs would be tradeable between OECD governments only. A higher excess charge will be set for any OECD country exceeding the TWCs it can acquire under its allocation and any trading purchases from other OECD countries.
The TWC strategy leaves the choice of policies within each country entirely open for that country’s government. If the excess charge is sufficiently high, there will be a strong incentive for each OECD country to enact policies to reduce energy-related CO2 emissions below its annual TWC allocation. Gradually the tradeable warming credits system could be extended to the rest of the world.
The Commission has recently supported the proposal put forward by the Argentinian and Brazilian governments for a global carbon tax equivalent to $1 per barrel of oil, the proceeds of which would go to developing countries to help them install energy-efficient and environmentally friendly technology. With such a tax, revenue amounting to between $21.5 and $25.5 bn could be raised. If such a proposal could be accepted in Rio, it would be a very important step forward towards an effective global environmental policy and would represent at the same time the first achievement in the field of world-wide taxation.
11. The problem of global warming can be successfully tackled only through policy measures carried out at the world level. There is now a widespread consensus that the most cost-effective way to address this problem is to implement a world-wide energy/carbon tax with a uniform rate since, in this case, the reduction of CO2 emissions will take place to a larger extent where the abatement costs are lower. Part of the revenue coming from this tax should be redistributed towards less developed countries to promote energy efficiency improvements and to avoid this policy having any negative impact on their possibilities for growth.
The world still seems to be far away from this first-best solution, since some countries in the industrialised world – and chiefly the United States – do not presently support the proposal of a tax on the use of energy. But it would be politically crucial if the EC were to go to Rio having decided on the implementation of an energy/carbon tax so as to use world public opinion to challenge the countries that are unwilling to follow this path. The EC should also spell out its firm commitment to giving up part of the revenue coming from the energy/carbon tax to a world fund entrusted with the task of providing financial and technology transfers towards less developed countries.
This solution would certainly be a second-best, but could still represent a powerful step forward towards the definition of an effective policy for tackling the problem of global warming.
From the above remarks it is possible to draw the conclusion that at the world level an institution is needed to manage the resources necessary for funding the financial and technology transfers to less developed countries. Since this is a pre-requisite for a successful world-wide policy for curbing the emissions of greenhouse gases, and since there is strong political pressure to control global warming, the environmental tax proposals seem to represent the right approach to induce states to give up a part of their sovereignty in favour of a world institution. In other words, it seems that the fiscal question, linked to the solution of urgent global environmental problems, may play a leading role at the world level in providing a first step towards the political unification of mankind.