Panorama
 
 
 
   
 
 

CARBON-ENERGY TAXATION CONTRIBUTED TO ECONOMIC GROWTH

Environmental Panorama
International
March of 2007

 

19 March 2007 - By Mikael Skou Andersen - When taxes are introduced on energy and CO2 emissions, and the income is used to reduce other taxes, a positive effect is achieved both for the environment and for the economy. Economists from Cambridge Econometrics have, in an EU research project coordinated by the National Environmental Research Institute, University of Aarhus, shown that the ’double dividend’ theory can no longer be rejected in practice. In five EU countries, CO2 and energy taxation over the last 17 years has made a small but positive contribution to economic growth of up to 0.5 per cent, at the same time as CO2 emissions have been reduced.

Taxes on energy and CO2 emissions from fossil fuels can be an effective tool in addressing the climate problem, and without negative effects for a country’s competitiveness – that is so long as the taxes do not simply go into the public purse, but are used to reduce other distortionary taxes and charges. This is the conclusion of the largest to date international study of the effects of CO2 and energy taxation in European economies. The results of the study are being presented at a workshop for specialists following the Sustainable Taxation conference in the EU Commission’s headquarters in Brussels , 19-20 March.

EUR 25 billion a year
The theory that a ’double dividend’, meaning a positive effect both for the environment and for the economy, can arise from environmental taxation was put forward by the late professor in environmental economics, David Pearce, London, in 11000[1].

17 years ago, Finland was the first country to introduce taxes on CO2. Later, Sweden , Denmark , Holland , Germany and UK followed suit with tax reforms that shifted taxation from labour to pollution. Over the years, CO2 and energy taxes have gradually been raised, so that taxes of more than EUR 25 billion a year have been shifted.

Where economic models are usually used to produce forecasts and projections, in this research project the economists have been able to work with historic data. The research team consists of partners from five countries and is coordinated by the National Environmental Institute (NERI), University of Aarhus . We have spent two years collecting and processing detailed data for energy use, tax payments, energy prices, fuel choice and CO2 emissions. The large amount of data has been processed in the empirical time-series estimated, disaggregated econometric Energy-Environment-Economy model for Europe (E3ME), developed by Cambridge Econometrics. It is one of the most detailed and realistic in the world when it comes to the analysis of the energy sector and trade between EU Member States. Using advanced econometric techniques, the effects of CO2 and energy taxation have been separated out from the underlying trends.

Replacing taxation on labour with that on carbon-energy has resulted in economic growth
The analysis shows that, even though the taxes implemented have been relatively modest, they have, in the countries examined, contributed to a reduction in the emissions of greenhouse gases of between 1.5 and 6 per cent, in 2004. In 2012, at which point Kyoto targets should be met, the effect will comprise a contribution to the reduction of up to 7 per cent below the outcome without the tax reform. From an economic perspective, the tax reform has on the whole produced a modest but significant, positive effect on economic growth. There are sectors which lose under the reform, but there are also others which gain, and overall there has been an economic advantage for five of the six countries studied. In UK the reform has been neutral, but here the scale of the tax rates levied has been modest and it is also the most recent environmental tax reform.

The effect of green tax reform (ETR) on economic growth. The effect is measured as the difference between the baseline and the reference case. Slovenia has not introduced green tax reform, but has adjusted energy taxes in the industrial sector according to CO2-content. Source: Cambridge Econometrics.

The positive contribution to economic growth arises because carbon-energy taxation leads to more efficient use of energy while at the same time wage costs are lowered. It also leads to improved competitiveness for energy-efficient businesses and for the development of new products which also can be exported. Taxation of petrol shifts demand to other products and products of a more domestic nature.

The analyses point, moreover, to a difference in outcomes according to whether it is the energy price which is increased or the energy tax. First and foremost this is due to the fact that the revenue from a tax remains in the public purse and can be used to lower other taxes. Furthermore domestic taxes do not affect the prices of imported raw materials and intermediate goods. This is an important result for the discussion amongst policy makers on how use of taxes as an instrument in climate policy can be combined without adverse effects on competitiveness.

Taxes both in the transport sector and industry contribute to the positive result. However, in industry the tax burden continues to be modest. (Energy costs in the UK (upper) and Denmark (lower graph) as a share of the value of production in six energy-intensive sectors showing the share relating to the CO2 tax – before revenue recycling).

Special arrangements are not emphasised
Simply obtaining an overview of the actual tax rates and the many exemptions for energy-intensive industries has presented a difficult task. Countries do not make a point of emphasising the special arrangements which are to be found. Also energy prices normally differ for large users in relation to those for small companies. With a database which contains sector-specific energy prices and taxes, we have created an improved basis for future analyses. The Energy Tax Directive will be reviewed in 2007. Not least in light of expected climate changes and the EU’s ambition, as expressed at the March 2007 Summit , to reduce the emissions of greenhouse gases by 20-30 per cent by 2020, greater attention is expected to be focused on energy taxation.

The research is part of an EU research project under the ‘Scientific Support to Policies’ initiative of the EU’s 6th Framework.
Terry Barker and Sudhir Junankar, Cambridge Econometrics
Programme for the EU Commission’s conference ‘Sustainable Taxation’
Report and project website: www.dmu.dk/COMETR
[1] PEARCE, D.W. 1991. The role of carbon taxes in adjusting to global warming. Economic Journal, 101,938-948

 
 

Source: Denmark's Ministry of the Environment (http://www.mst.dk/homepage/)
(http://www.mim.dk/eng/News/)
(http://www.dmu.dk/International/News/)
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