Energy and carbon taxes high on tax policy makers’ agendas

The quest for more sustainable energy and carbon taxation systems is set to gain momentum as both the EU and the OECD have put these issues high on their agenda. The US has recently joined the table, announcing a proposal for the elimination of tax reliefs for the fossil fuel industry (see Fact Sheet: The American Jobs Plan / Made in America Tax Plan). As we explain below, there is a lot to contemplate for those operating in CO2-intensive industries.

The EU perspective: energy taxation and CBAM

As regards carbon and energy taxation, the EU’s efforts are quite advanced. As part of the European Green Deal, the Energy Taxation Directive (ETD) will be reviewed. According to the Commission Work Programme 2021, there will be a proposal published in Q2 2021. In addition to a general clean-up (after all, the ETD has been in force since 2003), the Commission has announced it will review current tax exemptions and reductions which, together with highly divergent national rates, are perceived to constitute fossil fuel subsidies. This also includes aviation and maritime transport which are currently fully exempt from energy taxation. In addition, the revised ETD will include incentives for greenhouse gas (GHG) emission reductions, energy efficiency and the use of alternative fuels.

Another pillar of the European Green Deal is the introduction of a Carbon Border Adjustment Mechanism (CBAM) to complement the EU Emission Trading System (that is also currently under review as part of the European Green Deal). The aim of this mechanism is, essentially, to put a carbon price on imports of certain goods from outside the EU in order to prevent what is referred to as “carbon leakage”. This term describes shifts in economic activities directly or indirectly causing GHG emissions to be moved away from a jurisdiction with CO2 constraints (such as the EU) to another jurisdiction with fewer or no GHG constraints. The CBAM is now at the top of the EU agenda with the European Parliament having adopted a resolution for a WTO compatible CBAM in its plenary session on 10 March 2021. A legislative proposal is expected by July 2021.

While the EU is currently focusing its efforts on energy and carbon taxes, this is clearly just the beginning of their journey towards a more sustainable tax system. In parallel, the EU has recently launched a Roadmap for Communication on business taxation for the 21st century. The aim of this initiative is, after a public consultation, to set out a medium-term vision and actions for business taxation in the EU. This vision is supposed to consider the special role tax policies can and have to play in supporting businesses in their transition to a green(er) Europe and is expected to go way beyond energy and carbon taxation, possibly also resulting in changes in corporate tax and VAT systems.

The OECD initiatives: tax and the environment

Beyond the EU, the OECD is also closely monitoring developments on carbon and energy taxation (see e.g. the reports on Effective Carbon Rates (2018), Taxing Energy Use (2019) and Taxing Energy Use for Sustainable Development (2021)).

With the Covid-19 pandemic highlighting the need for a more resilient economy and society taking into consideration the fact that, according to the 2019 report on Taxing Energy Use, 70 per cent of all CO2 emissions across G20 and OECD countries remain completely untaxed, the OECD secretary-general has included a special focus on tax and the environment in its February 2021 Tax Report to G20 Finance Ministers and Central Bank Governors. Together with the IMF, the OECD intends to provide policymakers with substantive input to support an informed policy dialogue on carbon pricing as well as on a transition to a greener global economy over the coming months. This comes with the announcement of an update to the Effective Carbon Rates report and the first ever G20 Tax Symposium on tax and the environment in July 2021. The OECD, too, is clearly enhancing its efforts to prepare the ground for reinforced policy action on carbon and energy taxation.

Where do we go from here?

What these policy efforts have in common is that they seek to use tax measures to discourage the use of high-emission energy sources. The use of such energy sources may, in turn, become a bigger cost factor across industries, possibly in the near future.

With the EU proposals for a revised ETD and CBAM to be announced in June and July 2021, we may expect changes in legislation as early as in 2022/23, depending on the timeline for transposition where required (as it is has not yet been decided whether the CBAM will be passed as EU directive or EU regulation).