Brussels' energy taxation revolution

The European Commission has issued proposals that, for the first time, attempt to regulate fuel taxation rates in EU member states, rather than simply setting minimum values. It wants to see motor and heating fuels taxed according to their energy content and CO2 emissions rather than by volume as is the case today. If the proposals are accepted, diesel will in future cost more than petrol, biofuels will become relatively cheaper and LPG and CNG (compressed natural gas) will become more expensive. From the perspective of climate policy and the internal market, the proposals are not unreasonable. The question is, will the member states be willing to bite the Commission's bullet?

'A unique window of opportunity for a new energy taxation directive'

The Commission says the timing of its revised energy taxation directive is perfect. Member states are re-focusing their economic policies on sustainable growth as they exit from the crisis. They are also drawing up strategies to meet a European-wide 20% carbon reduction goal for 2020. The energy taxation proposals can help them with both, the Commission says. They provide member states with an opportunity to raise taxes on climate-unfriendly fuels and shift taxes from labour to consumption.

The Commission’s goal is to have the proposals enter into force in 2013, when the third phase of the EU’s emission trading scheme (ETS) kicks in. The idea is that the revised taxation directive will complement the EU’s carbon trade scheme by introducing a first-ever price on carbon in sectors that have so far been exempt from carbon emission restraints, such as transport and agriculture. Moreover, Brussels has an internal market case for its plans: the Commission wants to put in place a common framework for CO2 taxation as member states such as Denmark, Finland, Ireland and Sweden have started to introduce their own schemes.

None of this will be smooth sailing, however. In fact, the revisions that the Commission has now proposed to the existing 2003 directive were originally due in April 2009, but were repeatedly delayed due to internal wrangling. And, judging from some of the responses so far, this is undoubtedly just a flavour of what’s to come. To complicate matters, new taxation rules must be accepted unanimously by member states rather than by a qualified majority as most other directives. To illustrate the magnitude of the Commission’s challenge, suffice it to say that the original 1992 energy taxation directive took five years to agree on and the first revision in 2003, which forms the basis for today’s directive, no less than six. The European Parliament, incidentally, has no say on tax matters.

‘Tax issues are not easy issues at the Council of Ministers’, admitted EU tax commissioner Algirdas Šemeta on 13 April, the day he launched the proposals. Member states’ diverging concerns typically result in a messy bargaining process that churns out a hodgepodge of special exemptions (derogations in EU-speak) that ultimately leave national policymakers relatively untouched. Traditionally, tax proposals have been opposed by the UK and Ireland purely on sovereignty grounds.

Nevertheless, two versions of the energy taxation directive have been agreed in the past and the Commission now sees a unique window of opportunity for a new directive, as member states are trying to exit from the crisis, pursue green growth, fight climate change and are at the same time desperate to restock the public purse.

Unprecedented

The Commission’s proposals are in many ways far-reaching. Crucially, it is demanding changes to member states’ actual rates of fuel tax, rather than merely setting minimum rates (that are in practice

'Tax issues are not easy issues at the Council of Ministers'

often exceeded). Today, for example, member states are free to tax petrol more than diesel (or the other way round), as long as they respect minimum rates set by the existing energy taxation directive (33€ct/litre for diesel and 35.9€ct/litre for petrol). In future, not only would the minimum rate for diesel be raised (to 35.9€ct/litre in 2013 and 41.2€ct/litre by 2018, while petrol remains unchanged) but diesel would have to cost more than petrol. This is because of a proposed change in how fuels are taxed.

Currently, they are taxed based on volumes consumed. In future, they would be taxed based on their energy content and CO2 emissions. In practice this means diesel should cost 15% more than petrol since it generates more energy and emits more CO2 per litre. Because in most member states petrol costs more than diesel, regardless of at what levels they tax, they would be forced to either raise diesel rates or lower petrol rates to adapt. Quite unprecedented interference from Brussels.... The Commission suggests a ten-year transition period, i.e. until 2023, for the full adjustment to take place.

It is worth noting that the minimum rates, while often hypothetical especially for petrol, are not without significance either. Small strategically placed countries like Luxembourg have kept diesel rates close to the minimum for years to entice truck drivers to fill up at their pumps – and collect the associated tax revenues. Luxembourgers earn €1,500 per capita per year from this, estimates environmentalist group T&E, which specialises in transport issues. Meanwhile, the country’s low tax rates constrain its neighbours’ tax decisions. If the new directive would be enacted, countries like Germany and the UK would profit from higher tax earnings, because they would lose less revenue to fuel tax havens like Luxembourg. The relevance of minimum levels is enhanced because under the new proposals member states would no longer be allowed to grant special exemptions to certain sectors, as they have in the past.

Steep increase

In concrete terms, under the proposals the energy content tax of transport fuels will be gradually increased to reach €9.6/GJ by 2018, while that for heating fuels will be €0.15/GJ from 2013. The CO2 component will be the same for all fuels: €20 per tonne from 2013, to resemble the carbon price in the EU ETS.

When it comes to explaining what the energy taxation directive will and will not cover, it makes sense to remember that one of its primary goals is to introduce a carbon price in the sectors that are not currently covered by the ETS, i.e. transport, services, agriculture and households (which together cover about 50% of

Readjusting the petrol versus diesel balance in Europe makes sense from the oil industry's perspective
European emissions). It therefore explicitly excludes power stations and other industrial installations which fall under the ETS from the CO2 component of the tax. The electricity sector will continue to pay the energy content part at today’s rates. In practice, outside of the transport sector, the main fuel affected by the proposals will be coal for heating. The new way of calculating fuel taxes means a steep minimum rate increase for coal, which today is taxed the least, even though it causes the highest emissions.

One other major consequence of the new formula for calculating fuel taxes is that it would enable biofuels to compete on a level playing field with fossil fuels. At present, biofuels are treated in the same way as diesel and petrol in EU legislation, i.e. based on volume. Under the proposed revision, their lower energy content would be recognised and they would be exempt from the CO2 element of the tax if they meet sustainability criteria set by the EU’s renewable energy directive.

Fuel efficiency

Predictably, the draft directive has met with mixed reactions. It seems unlikely the Commission could have issued its proposals without the unspoken consent of the European oil industry. As it is, refineries association Europia has welcomed the plans. This is not surprising, as the industry is critical of Europe’s diesel deficit and petrol surplus. It says: ‘favourable taxation of diesel over gasoline has boosted demand for diesel, reduced that for gasoline and created a significant imbalance in European supply which has increased EU’s dependence on [diesel] imports from and [petrol] exports to third countries.’ These imports often come from Russia and the exports are to increasingly competitive markets. Thus, readjusting the petrol versus diesel balance in Europe makes sense from the oil industry’s perspective.

Other positive reactions have emanated from renewable fuel associations such as ethanol industry body ePURE and European biomass association Aebiom. ePURE said it would end the ‘systematic discrimination’ of biofuels and was ‘absolutely necessary to cement the EU’s climate and energy objectives’.

In contrast, the Natural and Bio Gas Vehicle Association (NGVA) expressed dismay at the proposals, saying they would bury its hopes of boosting its market share. Currently, member states that promote compressed natural gas (CNG) or liquid petroleum gas (LPG) often apply very low levels of taxation. Under the new proposals, these fuels would be taxed like other fuels, according to their energy content and CO2 emissions, losing the special derogations they often enjoy today. The minimum tax rates would be quadrupled from today to 2018.

European Commissioner of Taxation Algirdas Šemeta (photo: European Union)
Strong criticism has also come from the International Automobile Federation (FIA). ‘Diesel has been consistently encouraged over the past decade due to its better fuel efficiency’, said Jacob Bangsgaard, director general FIA Region I, which represents some 36 million motorists. ‘It makes no sense to now penalise those consumers who have chosen this technology.’ Many consumers have paid more up front for diesel cars because they have been ‘led to believe diesel will mean lower running costs’ over the long term, says Bangsgaard.

“Green” transport group T&E dismissed car manufacturers’ concerns that the proposals would kill off the diesel car market in Europe. In some countries such as the UK, diesel is taxed at the same level as petrol and diesel cars still represent 50% of new cars sold, the group points out. According to T&E, factors other than the price of diesel, such as sales taxes, annual vehicle taxes and company car taxation are more important in deciding what car to buy.

Harsh criticism

On the day of the Commission’s proposals, T&E presented a study showing that average road fuel taxes in Europe have declined by 10€ct/litre in real terms since 1999. If taxes had been corrected for

'Diesel has been consistently encouraged over the past decade due to its better fuel efficiency. It makes no sense to now penalise those consumers who have chosen this technology'
inflation and the revenues used to lower labour taxes, 350,000 jobs would have been saved, oil imports would have been cut by €11bn and CO2 emissions from road transport would have been 6% lower, according to T&E. Fuel tax revenues also plunged by 16% over the last decade, the group notes. T&E director Jos Dings said the study makes a clear case for fuel tax increases.

The group hailed as highly significant the proposals’ plan to automatically adjust the energy content component of the tax for inflation every three years. (By contrast, the CO2 component can only be revised by fresh unanimous agreement from member states.) The link to inflation is significant, since of the 10€ct/litre fall over the last decade, two-thirds were due to inflation and the remainder to the shift from petrol to diesel (making up two-thirds of consumption today from half ten years ago), Dings said.

T&E reserved harsh criticism however, for the Commission’s decision not to end a ban on taxing international aviation and shipping fuels. ‘If the EU really wants to cut transport emissions by 60% by 2050, it is going to have to wake up to the fact that it can no longer let ships and planes operate in a tax-free parallel universe’, said Dings. A commission official said they had looked at lifting the ban ‘with sympathy’ but decided it would weaken their position in ongoing international negotiations to control airlines’ carbon emissions.

How the directive will be implemented, depends a lot on how the member states will use the exemptions available to them. Nine countries are allowed to postpone the introduction of the CO2 component of a tax on heating fuels until 2020: Bulgaria, Estonia, Hungary, Lithuania, Latvia, Poland, Romania, Slovakia and the Czech Republic.

Other exemptions are open to all member states. All would be permitted to fully exempt households from the tax on heating fuels, for example, regardless of the fuel used. They could also choose to exempt the agricultural sector from the energy content part of the tax if the sector deploys “equivalent” energy efficiency measures – to be defined by member states. The European Commission will analyse whether agriculture should also be eligible for a tax credit envisaged for small electricity and industrial installations that fall outside the scope of the ETS but are at risk of carbon leakage. Diesel used in off-road machines will continue to benefit from being taxed at heating rather than motor fuel rates.

Uncertainty

It is difficult to estimate the climate impact of the energy taxation proposals. The Commission admits as much, in large part because it remains up to member states to set actual levels of taxation, even if they will need to respect the new methodology. The Commission’s most likely scenario suggests that savings until 2020 could be 20 million tonnes of CO2 (or 7% of the total emission reduction effort required from sectors not covered under the ETS). Not a very impressive number. Most of the reductions are expected to come from the transport sector.

Different stakeholders take opposing views on what the Commission’s proposals are likely to mean for the environment. The FIA points out that diesel engines are at least a fifth more efficient than petrol engines and concludes that the Commission’s proposals are ‘ill-judged, given the EU’s ambitious targets for reducing CO2 emissions in the transport sector’. Car manufacturers say cheap diesel is necessary to spur sales of more efficient diesel cars and help the industry keep down average CO2 emission per kilometre in its car fleets.

By contrast, green group T&E, as we have seen, argues that the petrol-diesel tax relation does not affect diesel car sales. In addition, it argues that cheaper diesel makes people buy heavier (and thereby relatively less efficient) cars and drive them more. According to T&E, the petrol engine is also cheaper and easier to improve than the diesel engine.

Aside from all the uncertainties above, there remains of course the biggest one of all: will the proposal be adopted by member states? The draft directive has been a long time coming and makes some radical

'If the EU really wants to cut transport emissions by 60% by 2050, it is going to have to wake up to the fact that it can no longer let ships and planes operate in a tax-free parallel universe'
suggestions. But it does have certain attractions. As the Commission notes, member states are looking to raise money while trying to leave the economic crisis behind and stimulating green growth. They also have to meet emission reduction targets by 2020 that the economic recovery will make harder, not easier, to reach. With the EU ETS taking care of the power sector and industrial emissions, transport has been the biggest source of climate worry for policymakers. It is this sector the energy taxation directive is above all designed to address.

In addition, there is much to be said for European coordination of transport fuel taxation, since fuels can be bought in one country and used in another. One day, the EU may shift towards the US system of taxation, which is based on where the fuel is used rather than bought, but until then the European project, whether from the internal market or climate perspective, argues for the current proposals to be at least given serious consideration.