Work of the OECD in the field of environmental taxation Jacques Baveye FPS Finance Workshop on Environmental Fiscal Reform 8 July, 2014

Introduction Joint Meetings of Tax and Environment Experts Twice a year First meeting: 6 May 1999 For this presentation, selection of six topics: Taxing energy use Taxation of diesel for road transport Distributional effects of energy taxes Tax treatment of company cars Tax preferences for environmental goals Interactions between ETS and other overlapping instruments All that follows comes from OECD documents

Taxing Energy Use: A Graphical Analysis Presents for each OECD country: Tax rates in terms of energy content and carbon emissions Reported tax expenditures The size of the relevant tax base An illustration of the revenues raised or foregone The OECD shows substantial difference Both across and within countries In the tax treatment of different forms, uses and users of energy

Taxing Energy Use: A Graphical Analysis Belgium: reported tax expenditures and rebates: Diesel used by trucks, taxis and public buses Fuels used in agriculture LPG used as heating and process fuel No data available for other tax expenditures Natural gas used by energy intensive industries: 60% of industrial consumption of natural gas has been considered energy-intensive use and entitled to an exemption

Taxing Energy Use: A Graphical Analysis Key assumptions for Belgium: Professional diesel represents 15% of total diesel consumption for transport purposes Electricity for residential and commercial use: ≤ 1 kV => EUR 1.9088 per MWh Commercial use also subject to business rate of EUR 3.8597 per MWh Used in industry or energy transformation: > 1 kV => only subject to business rate of EUR 3.8597 per MWh Caveats for Belgium: Several exemptions could not be included in the map (no data available) Source: Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil Fuels 2013 (OECD 2012)

Taxation of diesel for road transport A litre of diesel contains about 10% more energy than a litre of gasoline A litre of diesel produces about 18% more CO2 emissions than a litre of gasoline

Taxation of diesel for road transport The externalities associated with diesel and gasoline use support a higher tax per litre on diesel than on gasoline GHG emissions (i.e., mainly CO2) are higher Level of most harmful air pollutants is generally higher for diesel cars

Taxation of diesel for road transport The other externalities (congestion, accidents, noise and infrastructure costs) are more a function of distance travelled than of fuel volumes Diesel cars drive further on a litre of fuel than comparable gasoline vehicles, due to The greater energy content of diesel fuel per litre The greater efficiency of diesel engines in converting fuel energy into motive energy This also implies a higher tax per litre on diesel

Taxation of diesel for road transport Is the greater fuel efficiency of diesel cars a sound rationale for a tax preference to encourage greater use of diesel cars? No The higher efficiency of diesel cars Is reflected in lower fuel costs over time Is thus internalised into the decisions of the owner Consequently need not be taken into account in fuel taxes NB: the use of road pricing would lower the externalities that should be included in the taxes

The distributional effects of energy taxes Concern that the impact of energy taxes would be regressive, hitting the poor particularly hard = major obstacle to the more widespread use of energy taxation The distributional impact of can be assessed using income or expenditure Households with low transitory income (which are not lifetime poor) Strongly affect the average income of households in lower income deciles Do not affect the average expenditure

The distributional effects of energy taxes Typical households with transitory low income are self-employed, retirees and students New evidence for 10 European OECD countries (excluding Belgium) Based on data from household budget surveys Shows that the distributional impact of energy taxes differs by energy carrier

The distributional effects of energy taxes

The distributional effects of energy taxes On an expenditure basis: Taxes on transport fuels on average tend to be progressive Taxes on heating fuels are slightly regressive Taxes on electricity are more strongly regressive Possible explanations Transport fuels Poorer households do not use a motor vehicle

The distributional effects of energy taxes Possible explanations Heating fuels: poorer households Have less surface area to heat May heat up only to lower temperatures May heat up only part of their house May turn off the heating when not being at home Electricity Some « fixed » amount of electricity is needed Poorer households are likely to own older electric appliances

Company cars Tax systems 25 countries examined Treatment of the benefit associated with use of a company car for personal purposes

Company cars Fiscal cost OECD has developed a benchmark treatment, which represents a neutral tax setting, relatively to cash wage income Benefit assessed by reference to the cost that would be incurred if the employee were to purchase the same benefits (employee-cost approach) The benchmark has two components: a component to reflect the fixed costs of ownership and a component to reflect variable ownership costs

Company cars Standard assumptions about costs and driving patterns: Fixed component: 28% of vehicle value per year Applied to 95% of car list value Variable component: EUR 0.04 for repairs and maintenance Fuel costs, estimated for each country Company cars are driven for 20 000 km per year for personal purposes 10 000 km per year for business purposes Stock of company cars was calculated using data from R.L. Polk Ltd.

Company cars Aggregate taxable benefit under the benchmark treatment compared with aggregate taxable benefit under the current tax settings Calculation of fiscal cost

Company cars

Company cars The difference between the tax system and the benchmark is largely explained by two factors: The capital charge in all countries is significantly lower than the 28% per year assumption used by the benchmark Only 6 countries explicitly include a charge for the number of kilometers driven

Company cars

Company cars Conclusions A considerable amount of tax is currently foregone on company cars as country tax systems do not fully capture the benefit to the employee of company car use While both the capital and distance component are under-captured by the tax system, the distance component is particularly under-captured Most countries do not include a component that varies with distance driven in the calculation of taxable benefit, which is likely to have an environmental impact in giving individuals an incentive to drive more Revisiting company car tax settings can therefore have positive fiscal and environmental impacts

Environmentally motivated tax preferences Variously referred to as tax preferences, tax incentives, tax expenditures, targeted tax relief, tax reductions or tax subsidies Are politically attractive because They provide benefits to a clear set of beneficiaries (which facilitates their lobbying) Their costs in terms of higher taxes tend to be hidden NB: the opposite is true for environmentally related taxes

Environmentally motivated tax preferences Characteristics and preferred practices Tax preferences can address positive externalities Consider subsidies for true positive externalities Tax preferences often attempt to « pick winners » Eligibility should ideally be based on technology-neutral measures rather than use of particular inputs or technology Certain market failures may be best addressed by other policies Credit policies for capital market failures Regulation for principal-agent problems (e.g., stricter building codes in case of split incentives between landlords and tenants) Information for information problems (e.g., energy-labelling) Tax preference can lead to increased pollution (-> rebound effect)

Environmentally motivated tax preferences Preventing windfalls (« free-riding ») from tax preferences is challenging Support should be limited to actions that go beyond a business- as-usual baseline Review criteria regularly Cost of tax preference is often not transparent Issue regular and comprehensive tax expenditure reports Integrate planning and reporting on environmental tax with environmental policies

Environmentally motivated tax preferences More generally: start with the problem, not the solution Consideration of new policies should be supported by a robust analysis of the policy problem, the case for intervention and alternative instruments

Interactions between ETS and other overlapping instruments Cap-and-trade systems are generally combined with other policy instruments addressing the same emission sources… … but doing so will not cause any extra emission reduction – as long as the cap is binding and remains unchanged

Interactions between ETS and other overlapping instruments Impacts in the short run ‘additional’ instrument => further abating effort by some emission sources => reduction in permit prices => increased emissions from some other source(s) included in the trading system

Interactions between ETS and other overlapping instruments As the EU ETS covers CO2 emissions stemming from electricity generation, this affects a long range of ‘additional’ instruments: Instruments that address electricity use (e.g., measures to increase the energy-efficiency of electrical appliances and taxes on electricity use) Instruments that address CO2 emissions caused by electricity generation (e.g., subsidies for renewable energy sources, feed-in tariffs for renewables, and standards for the renewables content in electricity generation) It also affects any other policy instruments that aim to reduce emissions in the industrial sectors covered by the scheme

Interactions between ETS and other overlapping instruments Impacts in the medium to long term « If an additional instrument in practice contributes to reducing the costs of complying with the cap, it could, however, contribute to a stricter cap being set in the future – on the assumption that such considerations are taken into account when future ‘caps’ are set. »

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