Use of taxation in the field of industrial emission in the EU and UK

Use of taxation in the field of industrial emission in the EU and UK

Prof Andersen Mikael Skou explored Europe’s experience with carbon-energy taxation and studied the implications of carbon-energy taxation for CO2 emissions and energy consumption. He observes that carbon-energy taxes expectedly produces a demand effect that reduces the energy demand affected by increase price caused by tax and a substitution effect that replaces carbon fuels with low-carbon or carbon-neutral fuels taxable at lower rates. This may enabled to monitor energy intensity. The paragraphs provided later in this section will explore instruments used in carbon pricing that govern taxation on industrial emission in context to EU and a few of its member states.

Carbon tax and GHG emissions trading system (ETS) are two instruments that could implement carbon pricing. ETS is considered the most cost-effective regulatory approach in order to reduce emissions and to implement reduction options. Tax is set by the government, which sets the rate and specifies sources. The response of the affected source to the tax determines whether the emission reduction is achieved. In case of ETS, the government sets the limit on GHG emissions by the sources specified, and it distributes allowances equivalent to the set limit here.

In EU context, there has been a modest carbon-energy taxes individually applied by its member states. In and around the year 2010, such taxes range from a low and symbolic level particularly most energy-intensive industries up to about 25 euro/ton in Sweden and Finland. The rate differs in Denmark with tax on energy consumed for heating purposes at about 80 euro/ton CO2. One reason could be referred to the observation made by Haites when he studied the experience of carbon taxes and greenhouse gas emissions trading systems. He states that if the share of the total GHG emissions of a particular jurisdiction is improve by subjecting it to tax, it could increase economic efficiency. However, in order to maintain the effectiveness in terms of further emission reduction, the state should regularly adjust the tax rate against the effects of inflation, increase in real income, change in technology and other factors such as change in fossil fuel prices. It could be observed that every jurisdiction will differ in terms of the tax rate due to difference in the factors mentioned. This may prove to difference in taxes applied in different states.

Prof Andersen, thus, highlighted non-existence of a uniform tax applied across the states. He, however, observes that industrial emission tax impacted the fuel consumption with higher tax leading to reduce in consumption. For example, Finland and Sweden experience this with exceeding decline in fuel demand. However, this may not hold true for certain other jurisdictions. Erik Haite cited five studies conducted by Mideksa and Kallbekken Anderson, Anderson, and Bruvoll and Larsen regarding emissions reductions that were achieved by carbon taxes in a few European countries, including Denmark, Norway, Finland, Sweden, Germany, Austria Italy, Slovenia, the Netherlands, and the United Kingdom, for periods prior to 2008. He observed that those studies found carbon taxes produced only small reductions. They were up to 6.5% over several years, and there was continued rise in GHG emissions. For few jurisdictions, carbon tax also created reduction of existing energy taxes. There were extensive tax exemptions for EITE sources, low increment of tax burden on fuels and inelastic demand for fuels in sectors that were subject to the tax. The modest impact of high tax in reduction of emission was also observed in Norway. It implemented a relatively high carbon tax in 1991. The tax rate is counted as one of the highest in the world. Bruvoll and Larsen studied data (1990 – 1999) on CO2 in evaluating carbon tax policy to address CO2 abatement. They employed the methods of divisia index decomposition and applied general equilibrium simulations, which was applied to decompose emission changes, irrespective of existence of the tax or not, with and without the carbon taxes. Their study found that irrespective of the significant price increases for a few fuel, the effect of the tax on emissions was modest. It produced reduction in onshore emissions of only 1.5 percent and the total emissions of 2.3 percent. The further observed that if there was zero tax, total emissions would have increased by 21.1 percent as against the 18.7 percent observed growth. They state that the small effect highlighted here relates to extensive tax exemptions and more or less inelastic demand in sectors that are subject to tax.

UK will remain in the EU Emissions Trading System (ETS) until the end of 2020. ETS affects energy-intensive such as the energy industry and manufacturers. Such businesses must cut emissions, can trade emissions allowances by opening an account in an EU Registry. In regard to trading emission, there are firms that sign Climate Change Levy Agreements, where they can voluntarily participate in an emission trading scheme. Such agreement gives them the chance to be rewarded with emission credits if the firms overcomply with CCLA targets or buy credits to comply. This agreement is one of the trading programmes. The programme could be a Cap & Trade voluntary scheme involving auctioning of incentives to take up absolute targets of abatement. It could be renewable targets trading scheme that rewards firms that over-comply with Renewable Obligation Certificates. These certificates can be convertible into tradable emission permits. Another programme could be energy efficiency trading scheme that rewards firms that over-comply Energy Efficiency Certificates, which are convertible into tradable emission permit.

Prof Andersen highlighted certain issues related with ETS. He observes that ETS has created a complex regulatory environment. It has led to existence of both unilateral carbon-energy taxation of member states and EU minimum energy tax rates with trading of grandfathered emission certificates for carbon. Further, he observed that the ETS-cap for a 20 euro/tCO2 has induced increased of carbon price within the range of 4-10 euro/MWh. Carbon-energy taxes ranges between 6-12 euro/MWh for smaller business users in ETR states with predominant fossil fuels use in power generation. This has significant increase the rate for all consumers and highly energy-intensive industries. The issue is that businesses are not compensated for burden imposed due to costs from grandfathered emissions certificates to electricity prices. Muizon and Glachant, however, observed certain positive impact in regard to Climate Change Levy Agreements programme. They observed that tax rebate will serve as a strong incentive to accept ambitious targets. They cited two reference points that reflect the genuine marginal CO2 abatement cost. They are the auction clearing-price and permit price. These two prices must not differ, which means that price paid at the auction must not differ from the price available at the market. These two prices cannot be directly compared as they have different commitments. In case of the auction-clearing price at £53.37, it corresponds to the commitment of the winner of an auction, which is to reduce emissions at regular intervals during a five years period. Thus, for example if a firm wins the bid for 100 tons, it commits to decrease the emissions by 20 tons in the first year, 40 tons in the second, and so on until a reduction level of 100 tons in the fifth year. Altogether, the reduction stands at 300 tons over that time period with the subsidy taxed at 30%. Muizon and Glachant calculated an equivalent auction price that was comparable to permit price by using these two elements. They arrived at £12.4511 per ton of CO2, which is similar to the permit market price.

The EU Emission Trading Scheme is a market-based instrument governing green-house gas emission. The EU Directive (2003/87/EC) is the concerned EU law in this regard. This Directive facilitated the commitment of EU on reduction of GHG emissions through a trading rights scheme. Member states are required to implement this scheme and draw up a National Allocation Plan. The industries covered by the Scheme are power generation, steel, iron, glass, pottery, cement and bricks. The Plan sets a cap on the emission, which is converted into allowances. One allowance equals one tonne of CO2 equivalent. Such allowances are distributed by member states to installations covered by the scheme. Such tradable allowances are usually at 1 tCO2e each) and are distributed equivalent to the limit. Regulated emitters are required to surrender allowances equal to actual emissions. Any exceeding quotas are to be bought by the states. There is also a fine of EUR 100 per excess tones of CO2, as of 2008, during the first 3 three years period. However, certain issues were observed by Bakker in regard to this trading scheme. Firstly, Bakker observed that the EU member states received numerous exemptions. Transport and building representing the largest share of CO2 emission among other sectors are not covered. Member states were entitled to opt out of individual plans. There were large polluting countries, such as Germany, which were left with extra CO2 allowance of 44.1 million tonnes in 2005. Because of surplus in supply, it crashes the price of carbons. This reduces the credibility of the scheme.

The observations made above reiterate the view of Prof Andersen Mikael Skou regarding non-uniform tax being applied across the states. Such non-uniformity was also observed by Böhringer, Koschel and Moslener after they explored the issue of efficiency of taxes. They highlighted the existence of relevant regulation at both the national and EU level. They highlighted the overlapping features between the two legal regimes. Member states have various regulatory instruments that they apply to achieve their climate policy targets. Such state regulation may also cover emission taxes provided for under EU ETS. Such regulation creates the possibility of substantial excess cost. They found that the emission taxes on sectors applied unilateral by the member states and subject to the EU ETS may not be environmentally ineffective. It may increase the overall compliance cost of the EU ETS.

In context of the UK, EU ETS has covered half of the overall emission in the UK and also three-quarter of industrial emission. EU ETS provides for a cap on emissions across all EU member states. This may limit the value of policy instruments that are applied to the same emission. Thus, in case of a domestic tax on electric consumption, it may increase the price of electricity in the UK. The electric generators in the UK are members of EU ETS. Any reduction in electricity demand because of the increase in price will reduce demands of EU allowances. This may in turn increase the availability of such allowance in other countries. This will, therefore, not produce any effect on overall emission across all member states. This indicates that a policy that increases electricity prices but has a dynamic effect in reducing emission cap can only be seen as creating a positive environment consequence. The purpose of a carbon tax or GHG ETS is to reduce GHG emissions cost effectively. Thus, these instruments should be assessed on the basis of the emission reductions achieved and the cost per tCO2e reduced. Other aspects of the performance of these instruments include low price volatility; price commitment into the future; harmonization of marginal costs across jurisdictions; revenue raised; potential cross-jurisdiction revenue flows and administrative issue. Given this and the situation regarding the UK discussed here, it may find relevance to the observation made by Stuart Adam. He casts a doubt on whether the national policies in the UK have been reviewed in this context. They cited the policy of the Carbon Reduction Commitment. This policy targeted use of energy by only the large non-intensive users of electricity, such as the large retailers and services industries. This may create a cap and trade mechanism, which would eventually reduce the use of electricity in these sectors. Irrespectively, this may not be able to reduce the emission across EU until and unless the ETC cap produces a dynamic effect. Furthermore, they observe that ETS should not be the central plank of the policies in order that a national carbon tax is effective in reducing overall emission. Even though, it may help reduce tax in another member state of the EU. There scenario calls for an assessment of the role of EU ETS targets and national targets in the overall international trade scheme.

Carbon tax in Sweden

Carbon tax is considered the most efficient mitigation instrument based on the market. Sweden is one of the first adopters of carbon tax. Lin and Li explored the effect of this tax on per capita CO2 emissions. They employed a method of difference-in-difference (DID) to make this study.

DID approach is a research design that is used to estimate causal effects of policy interventions and policy, which do not affect everybody in the same way and at the same time. By using DID, Lin and Li did a comprehensive estimate of the real mitigation effects of Sweden with Denmark, the Netherlands, Finland, and Norway. The result indicated that that the effect of carbon tax in Sweden was negative. It was not significant. The reason was that Sweden has tax exemption policies governing certain energy intensive industries. This weakened the mitigation effects of carbon tax. Similar issue was highlighted earlier by Bakker who observed that the EU member states received numerous exemptions. This indicates that unless there is a third factor such as the exemption, carbon tax will lead to reduction in emission. Andersson, in his study, found a significant causal effect of carbon taxes on emissions. He analysed implementation of the carbon tax and a value-added tax on the transport fuel in Sweden. He found that, carbon dioxide emissions declined almost up to 11 percent. Such decline was caused majorly by carbon tax alone. He, however, observed the use of price elasticities to simulate reductions in a policy evaluation of carbon taxes may significantly underestimate the true effect of the taxes. However, the evaluation of the effectiveness of carbon tax on emission reduction is also dependent on assessing it with other alternatives. Such comparative assessment may present a clearer picture to the debate of effectiveness of the carbon tax as against alternative climate policy measures. This is supported by the study observation made by Jagers and Hammar. They cited the example of carbon tax on passenger cars to that effect. They observed that the unpopularity of the Swedish carbon tax on fuels is examined as against the alternative climate policy measures that are designed to decrease carbon emissions emanating from private transport. They stated that the question of popularity is partly determined by the way it is designed in current debated regarding combat of climate change by the society. They stated that there may an increase in the total social cost of combating climate change due to replacement of carbon tax with alternatives measures. Such measures may be subsidised green fuels or expanded public transportation. They emphasised on rationality of informing the public about the costs involved of implementing the policy alternatives. In case, environmental taxes or an increase to the taxes are to be implemented, Jagers and Hammar, therefore, recommended framing them in a different manner to that effect. One way would be to present the taxes attached to those alternatives, together with their financing means, the likely effects on emissions and their respective private and social costs.

Sweden created 15 environmental quality objectives in 1999 to tackle its high CO2 emission. Sweden has the energy and carbon taxes that are closely relevant. The positive effect was on the increase in use of biomass in district heating system and in industry. The carbon tax has managed to create to a lesser extent in its effect on emission. Some of the reasons are lower industrial tax level than that of district heating. Only a small percentage of energy supply was fossil-fuel-based. Tax on fossil fuel was reduced during the 1991 reform. Industrial company incurred fossil fuel tax that was relatively a small fraction of the total cost. As observed by OECD, Sweden employed carbon tax with other taxes. Carbon tax contributed to reducing CO2 emission. It led to alternative of increase biomass use in the heating system, and new innovation. Sweden’ policy included considering a combined factors of energy and resource efficiency and CO2 emission when permits to hazardous activities were considered. This shows the close interaction between energy and carbon taxes. That may be the reason why it is claimed that economic costs of Sweden has hardly been affected by carbon tax. The 2018 general tax rate stood at USD130 per metric ton of CO2. Sweden removed the industry discount as well. Metcalf observed that before the 1991 standard rate, its economy grew at 2.9 annually. After the tax rate was introduced, the GDP between 1991 and 2015 grew at 2.1 percent annually. This demonstrates that carbon tax hardly affected the economy. Its carbon tax contributes to 1.6 percent of the entire tax collection, which stands at 2/3 of 1 percent of GDP. Irrespective of the high carbon tax rate, Sweden managed to use its revenue. Carbon tax has been a part of the broader tax system. Labour taxes were reduced through adopting of higher energy use and carbon tax. Overall, Sweden does not seem to view carbon tax as separate from the overall tax reform measures. They view energy tax and carbon tax with other taxes towards the economic progress. This could be seen in the way they have used revenue from carbon tax towards better economic interests.

Water tax in Denmark

OECD 2019 review states that Denmark exempts most of the companies from water tax. Its policy includes taxing piped water per cubic meter, but excludes taxing water resource. This indicates that companies and industries are offered subsidy through taxation of households. Denmark also follows a water loss tax to create an incentive for water companies to reduce leakage. They do this by taxing the supply plants on minimum of 90 percent of water pumped. Denmark also charges on wastewater governing direct discharges from sources such as industry, households and wastewater plants. This charge is kept proportionate to the load of pollution, and Denmark specifies polluting elements such as nitrogen, phosphorus and other organic material for that purpose. Uniform rate is applied nationwide. Recovery of tax for waste water collection and treatment is a legal requirement in Denmark. A full cost recovery is applicable to water supply too. Denmark follows a high water tax and it has adopted a two part tariff structure. It comprises of a flat fee and also of a charge based on metered consumption.

The water bill is Denmark is broken up in a way that about 50 percent goes to wastewater companies, 30 percent to government taxes and 20 percent towards drinking water facilities. The taxes comprise levies for wastewater and water supply and also VAT. The imposition of taxes on water supply is to aim for reduce water consumption. Water supply and wastewater taxes are of standard rate across the nation. However, water and wastewater tariffs vary differently and are charged by utilities and companies. Such difference in tariff arises due to structural differences in terms of the services provided, such as costs of abstraction, maintenance costs and centralisation of consumers. The tax structure appears to be consumer-based with focus on consumption or load of use of services regarding wastewater disposal. In a study by Jacobsen, Pedersen and Wier on the distributional implications of environmental taxes in Denmark, they explored the distributional effect of taxes in respect to household income, residential location, socio‐economic class and family status. They observed that the tax structure has shifted to consumption‐based taxes from high marginal income tax, particularly environmental taxes. Such shift may create certain distributional impacts not considered in tax policy. They conclude that most of environmental taxes are regressive. Such taxes include green taxes on water, retail containers and CO2 emission.

The way water taxes are structure, in regard to the way Denmark different taxes on water supply, wastewater treatment, and related services may stem from the fact that Denmark adopts corporatism in its exercise of democracy by integrating interest groups in decision-making process. It allows people to be represented by such interest groups in order to exercise the freedom to organise, express and vote a consensual, goal-oriented way. This is reflected in the Danish Environmental Protection Act 1991, Article 11, which requires minister to negotiate “administrative rules with reference to the law with affected businesses and environmental organization, organizations representing counties and municipalities, and relevant state authorities”. To that effect, Oh and Svendsen observed that the ability of participation of interest groups places Denmark to consider overall societal interests. This further enables the use of taxation as the most cost-effective solution in regard to water resource management.

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1. Prof Andersen Mikael Skou, ‘Europe’s experience with carbon-energy taxation’ (2010) 3(2) SAPI EN. S. Surveys and Perspectives Integrating Environment and Society.
2. Erik Haites, ‘Carbon taxes and greenhouse gas emissions trading systems: what have we learned?’ (2018) 18(8) Climate policy 955-966.
3. Ibid
4. Prof Andersen Mikael Skou, ‘Europe’s experience with carbon-energy taxation’ (2010) 3(2) SAPI EN. S. Surveys and Perspectives Integrating Environment and Society.
5. Erik Haites, ‘Carbon taxes and greenhouse gas emissions trading systems: what have we learned?’ (2018) 18(8) Climate policy 955-966.
6. Prof Andersen Mikael Skou, ‘Europe’s experience with carbon-energy taxation’ (2010) 3(2) SAPI EN. S. Surveys and Perspectives Integrating Environment and Society.
7. Torben Mideksa and Steffen Kallbekken, ‘The environmental effectiveness of carbon taxes’ (undated, post-2011) Oslo: CICERO Center for International Climate and Environmental Research.
8. Prof Andersen and Mikael Skou, ‘Europe’s experience with carbon-energy taxation’ (2010) 3(2) SAPI EN. S. Surveys and Perspectives Integrating Environment and Society.
9. J Andersson, ‘Cars, carbon taxes and CO2 emissions’ (2017) (Working Paper No. 212) Grantham Research Institute on Climate Change and the Environment, London.
10. Annegrete Bruvoll and Bodil Merethe Larsen, ‘Greenhouse gas emissions-do carbon taxes work’ (2003) 32(4) Energy Policy 493–505.
11. Erik Haites, ‘Carbon taxes and greenhouse gas emissions trading systems: what have we learned?’ (2018) 18(8) Climate policy 955-966.
12. Annegrete Bruvoll and Bodil Merethe Larsen, ‘Greenhouse gas emissions-do carbon taxes work’ (2003) 32(4) Energy Policy 493–505.
13. GOV.UK, ‘Environmental taxes, reliefs and schemes for businesses’ accessed 7 October 2020 .
14. Gildas De Muizon and Matthieu Glachant, ‘The UK Climate Change Levy Agreements: Combining negotiated agreements with tax and emission trading’ in A Baranzin and P Thalmann (eds.), Voluntary Approaches to Climate Protection: An Economic Assessment of Private-Public Partnership (Edward Elgar 2004).
15. Prof Andersen Mikael Skou, ‘Europe’s experience with carbon-energy taxation’ (2010) 3(2) SAPI EN. S. Surveys and Perspectives Integrating Environment and Society.
16. Gildas De Muizon and Matthieu Glachant, ‘The UK Climate Change Levy Agreements: Combining negotiated agreements with tax and emission trading’ in A Baranzin and P Thalmann (eds.), Voluntary Approaches to Climate Protection: An Economic Assessment of Private-Public Partnership (Edward Elgar 2004).
17. Sonja Butzengeiger, The EU Emissions Trading Scheme (Taylor & Francis 2018).
18. Gildas De Muizon and Matthieu Glachant, ‘The UK Climate Change Levy Agreements: Combining negotiated agreements with tax and emission trading’ in A Baranzin and P Thalmann (eds.), Voluntary Approaches to Climate Protection: An Economic Assessment of Private-Public Partnership (Edward Elgar 2004).
19. Anuschka Bakker, Tax and the Environment: A World of Possibilities (IBFD 2009).
20. Clement Metivier, Clément Bultheel and Sébastien Postic, ‘Global carbon account 2018’ (2018) Institute for Climate Economics. Retrieved from https://www. i4ce. org/download/global-carbon-account-2018.
21. Anuschka Bakker, Tax and the Environment: A World of Possibilities (IBFD 2009).
22. Ibid
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24. Stuart Adam, Tax By Design: The Mirrlees Review (Oxford University Press 2011).
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26. Stuart Adam, Tax By Design: The Mirrlees Review (Oxford University Press 2011).
27. Boqiang Lin and Xuehui Li, ‘The effect of carbon tax on per capita CO2 emissions’ (2011) 39(9) Energy policy -5146.
28. Michael Lechner, The estimation of causal effects by difference-in-difference methods (Now 2011).
29. Boqiang Lin and Xuehui Li, ‘The effect of carbon tax on per capita CO2 emissions’ (2011) 39(9) Energy policy -5146.
30. Anuschka Bakker, Tax and the Environment: A World of Possibilities (IBFD 2009).
31. Julius J. Andersson, ‘Carbon Taxes and CO 2 Emissions: Sweden as a Case Study’ (2019) 11(4) American Economic Journal: Economic Policy 1-30.
32. OECD, OECD Environmental Performance Reviews: Denmark (OECD 2019).
33. OECD, OECD Studies on Water Groundwater Allocation: Managing Growing Pressures on Quantity and Quality (OECD 2017).
34. Klinge Jacobsen, Henrik, Katja Birr‐Pedersen and Mette Wier, ‘Distributional implications of environmental taxation in Denmark’ (2003) 24(4) Fiscal Studies 477-499.
35. Christina Oh and Gert Tinggaard Svendsen, ‘Command-And-Control or Taxation? The Cases of Water Regulation in California and Denmark’ (2015) 4(2) Environmental Management and Sustainable Development 141-151.