Carbon Taxation in Europe: Expanding the EU Carbon Price

The current pricing mechanism for carbon in the EU, the EU emissions trading system, only covers 40 percent of emissions. Carbon taxation currently plays no role. The Commission has recently proposed to revise the energy tax system in the EU to include a carbon tax component. This paper evaluates the Commission proposal and considers the possible expansion of the EU carbon pricing base either by expanding emissions trading to cover more sectors or by enacting a carbon tax. It concludes that there are strong arguments for expanding the carbon pricing base, as suggested by the Commission. Nevertheless, expanding the base should done through a unified system, such as expanding the coverage of the emissions trading system or enacting an economywide carbon tax rather than through having side-by-side taxes and trading, as in the Commission proposal. † Walter J. Blum Professor, The University of Chicago Law School; Senior Fellow, The Computation Institute, The University of Chicago and Argonne National Laboratory. E-mail: [email protected]. This paper was supported by the European Tax Policy Forum. I thank Anu Bradford and Christian Egenhofer for comments. The EU has set an ambitious goal of reducing greenhouse gas emissions by 20 percent below 1990 levels by 2020. To achieve these reductions, the EU has put in place a portfolio of policies. The centerpiece is an emissions trading system, the EU ETS. The ETS requires large industrial plants to buy and sell permits to release carbon dioxide into the atmosphere, with the number of permits declining over time to meet specified emissions goals for the covered sectors. The ETS covers only 40 percent of greenhouse gas emissions, however. It does not include key polluting sectors such as households, most commercial facilities, transport, and agriculture. Emissions from these sectors are instead subject to command-and-control regulations, such as fuel economy standards for transport and efficiency codes for buildings. Carbon taxation does not yet play a role in the EU emissions reductions strategy. Since the early 1990s, there have been several attempts to introduce a unitary carbon tax across all EU member states. These attempts failed. Member states objected to ceding taxing authority to Brussels and were concerned about the economic impact of carbon taxation. Instead, in 2003, the Commission enacted the Energy Tax Directive. The ETD focuses on improving the functioning of the internal market by imposing common and low rates of tax on fuel uses of energy, such as transport and heating, and on electricity. Rates are not related to carbon dioxide emissions (and would be too low in any event) and the base does not cover many large sources of emissions. In April 2011, the Commission proposed to modify the ETD so that it includes an explicit carbon tax. The Commission argued that the existing structure, with a carbon price covering only 40 percent of emissions, will make it difficult for the EU to reach its ambitious carbon reduction goals. Moreover, the existing structure covers some sectors twice and others not at all, creating inefficiencies. The Commission concluded that it is time to revisit the ETD to make it better align with the EU’s climate policy. The proposed revision divides the ETD into two components: an explicit carbon tax based on the carbon content of fuels and a separate tax on energy use based on the caloric content of fuels. The carbon component would cover most uses of fossil fuels not already part of the ETS. In doing so, it would expand the carbon-pricing base to around 80 percent of EU emissions. The rate would be €20/ton of CO2 as of 2013. The Commission’s proposal provides an opportunity to rethink the role of carbon taxation in the EU. The standard objection to an EU carbon tax is that it cannot overcome 1 Commission, ‘20 20 by 2020: Europe's climate change opportunity’ (Communication) COM (2008) 30 final. 2 The major sectors in the ETS are large combustion installations such as power generation facilities, mineral installations, and pulp and paper production. It excludes transport, households, and agriculture. 3 Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for the taxation of energy products and electricity [2003] OJ L 283/51.