The European Commission has announced that it will be revising the Union rules on energy taxation. This comes at a crucial moment for the Member States, who are now coming out of the financial crisis, and will help meet the EU 2020 targets. This revision of the existent energy taxation rules is expected to introduce many benefits from taxation and at the same time support sustainable growth.
Currently, taxation of energy products is harmonized on the EU level only to a certain extent. The Energy Taxation Directive from 2003 set minimum rates for taxes of products used for energy, such as motor and heating fuels. However, these rules are now considered outdated and inconsistent with the Union’s changing goals. Revision of the Directive is aimed at addressing the EU’s higher goals in energy and climate policies, in particular increases in energy efficiency, consumption of more environmentally friendly fuel, and removing distortions in competition within the Single Market.
The Problem
“A fair and transparent energy taxation is needed to reach our energy and climate targets. Our common goal is a more resource-efficient, greener and more competitive EU economy.” -Algirdas Semeta, EU Commissioner for Taxation, Customs Union, Audit and Anti-Fraud.
The energy market in the EU is generally governed by two principles – economic and environmental. Since the effects of the financial crisis are wearing off and the Member States are now facing a new challenge due to a rise in oil prices, a financial incentive to decrease the use of fossil fuels seems necessary. Also, the EU’s aim of obtaining 20% of its energy from renewable sources, having 20% energy efficiency, and decreasing greenhouse gas emissions by 20% before 2020 (the 20-20-20 Strategy), play an important role in revising the Energy Taxation Directive.
From an economic viewpoint, the EU’s current rules for taxation of energy fuels set a minimum rate above which the Member States are allowed to place their own tax rates. This has created obstacles and distortions in the Internal Market because of two economic factors – 1) current minimum rates are based on volume (EUR/1000l) and are set according to the historical rates in each state, and 2) different levels of taxation of certain fuel types has led to market price signals not fulfilling their role. The first factor means that an unfair competition between fuel sources is created and there are tax benefits for some fuel types without justification. For example, coal is currently the least taxed fuel source, and biodiesel is taxed on the same rate as conventional diesel. The second factor has resulted in artificial differences in fuel prices. For example, before taxation, diesel is more expensive than petrol. In most Member States, a lower tax is levied on the former than on the latter, resulting in the fact that the pump price does not reflect the original one.
From the environmental viewpoint, the EU’s current system of taxation does not address the issue of CO2 emissions reduction in any way. In fact, as stated above, some cleaner fuels are taxed at the same rate, or even more heavily, than the polluting fuels they are expected to replace. However, four Member States (Denmark, Ireland, Finland, Sweden) have introduced a so-called ‘carbon tax’ to address this issue by making consumers pay for pollution. Still, these states have very different rates and are not synchronized with rules under the EU Emissions Trading Scheme. This also contributes to distortions in competitiveness within the Internal Market.
Comprehensive Modern Solutions
The aim of the new Energy Taxation Directive is to steer the Union’s way into a low-carbon and energy efficient economy. The values which steer the revision are the need to contribute to sustainable growth, promotion of resource efficiency, and the creation of a greener and more competitive economy. It comes as a result of calls by the European Council of March 2008, and echoes the UNFCCC CoP 16 in Cancun in 2010.
The Commission’s answer is a comprehensive solution to a modern problem. The current minimum tax rate is to be split in two parts. One is to be based on CO2 emissions of the specific energy product and is to be fixed at 20EUR per tonne of CO2. The other concerns the energy content of the fuel and will reflect how much actual energy is generated in Gigajoules (GJ). The minimum tax rate is to be set at 9.6 EUR per GJ for motor fuels and 0.15EUR per GJ for heating fuels.
The single minimum rate for CO2 emissions would harmonize pollution taxation in the whole Union. To complement the ETS, it will apply only to sectors not covered by the scheme by the introduction of a ‘carbon tax’ on sectors such as households, transport, smaller businesses, and agriculture. For example, biofuels, which are currently taxed at the same rate as conventional fuels (due to the ‘per volume’ rule), would be subject to an exemption under the new rules, due to their better CO2 emissions. Logically, renewable energy sources are also exempt from the CO2 element, since they do not produce pollution in the energy-generation process. At the same time, the most polluting fuel – coal – will become the most heavily taxed.
The second element is more complex and has to do with how efficient the fuel source is. When it comes to energy consumption, the efficiency of the source is more important than the volume and would create a level playing field for all fuel types. For example, the current distortions in the price of petrol and diesel will come to and end. Currently, diesel is taxed at lower rates than petrol in all Member States (except the UK), despite the fact that it has a higher energy content (more energy is generated per liter). This has led to the price of diesel being lower at the pump than petrol, which has created artificially high demand for the product, also in spite of its shortage in the EU. Under the new rules, a neutral taxation method will be applied and a more realistic final price will be the result. In essence, this will contribute to the removal of distortions in the market.
A combination of the two elements will be used to determine the final rate of the tax. The EU will still set the minimum for each product and Member States would remain free to set their own rates above that. This approach has been dominant since 1993 because of a compromise solution which gives the Member States some flexibility due to their different budgetary needs.
Where is the Catch?
The changes to the Energy Taxation Directive will apply to all fuels at the point of consumption. Essentially, when a person tanks-up their car at a gas station, both components of the new tax system will apply. When it comes to electricity though, neither component applies, since there is no CO2 produced or energy generated at the end of the chain. However, the electricity sector is subject to the ETS and therefore falls under the rules of that system. Also, when it comes to nuclear power, the new rules do not apply due to the same rule. And yet, small-scale electric installations falling outside the ETS would be taxed under the revised rules.
However, the environmental component of the revisions are set to impact household budgets. Currently, 10% of CO2 emissions come from the residential sector because of fuel used for heating etc. The new rules recognize that the family purse will come under attack, and propose that there should be solid safety nets and accompanying social measures, especially for low-income households. Currently, only the UK has defined the concept of ‘energy poverty’ as occurring when a family spends more than 10% of their income on energy. Yet, no such definition has been accepted on the EU level, and the regulation of this aspect is left to each individual Member State. The Commission has proposed that the revenue from the new tax could be ‘recycled’ to compensate households through lump-sum social payments, as is already the case in the states who have introduced a CO2 tax. How effective this will be in other Member States is uncertain. It is clear that heating will remain the main problem, since each state depends on different sources for warming its residential areas (gas, wood, coal etc.) and the differentiation between fuel types will result in diverse tax rates. Certainly, individuals would have to reconsider the way they keep warm during the winter.
Furthermore, the new Directive includes a long transition period for the Member States to adapt to the new rules. Most notably, nine states (Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia) will have until 2020 to implement the CO2 component of the new tax rules, due to their generally lower income level. The basis of this idea remains vague, since fuel prices are already considered too high in these countries and the current minimum levels have come under scrutiny from national governments for placing them at an economic disadvantage. For example, Bulgaria’s petrol and diesel prices have been criticized recently for being extremely high for the population’s average income, even though the country has the lowest rates in the EU.
Considering alternative fuels, the current rules tend to favor liquefied petroleum gas (LPG) and compressed natural gas (CNG) due to their fairly new position in the market. As such, a transition period of 12 years is given for these fuel types, during which they can continue to enjoy beneficial treatment and allow them to reach a level of equal competition with traditional fuels. Whether such preferential treatments will cause distortions in the market is a question left unanswered. Yet, with oil prices on the rise, these alternative fuel types are looking increasingly more attractive to the consumer, even without the new taxation rules.
Also, two other sectors will continue to benefit from the revised Directive. The tax rates related to agriculture will remain lower, although they will depend on the environmental objectives that are supposed to ensure this sector’s contribution to saving energy. Less convincingly, the new proposal will not apply to aviation and maritime transport because of existing international obligations and the risk of competitive distortions. However, aviation is set to enter into the ETS in the near future and will have to comply with rules similar to those in the new Directive. The issue of maritime transport remains shrouded in mystery.
From Principle to Reality
For now, the new proposal revises the rules for fuel taxation as the Commission sees fit. It is up to the Council of the EU and the European Parliament to discuss and amend as they wish. Expectations are such that the Directive will be accepted and put into force as of 2013. The Commission sees this as ideal, since it would coincide with the ETS’s third working phase (2013-2020).
However, this will not mean that the new rules will apply directly. The phase-in period which allows the Member States to adjust their tax systems to the new rules is still unknown (the Commission estimates that it might take until 2023), but national administrators, as well as businesses, would expect sufficient time for implementation. Taking this into account, as well as the transition periods mentioned above, it could take a long time before we see taxation playing a role in the EU’s green economy initiative.
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