In Germany, energy-intensive companies in the manufacturing sector receive a refund of 90 per cent of their energy and electricity taxes, even though the Federal Environment Agency has esti-mated that this subsidy almost completely neutralizes the environmental tax. These exemptions were due to be phased out in 2012, but were extended to 2020. Energy management systems have been made compulsory, as have annual energy savings of 1.3 per cent from 2012 to 2015 and 1.35 per cent for 2016. Annual energy savings between 1991 and 2009 have been well above the planned rates of 1.3 per cent and 1.35 per cent. Thus, these rules and associated subsi-dies are not compelling anything. Instead large potentials for efficiency and pollution reduction remain untapped in Germany’s energy-intensive industries.
Sources: Andersen and Ekins (2009); Roland Berger (2011); BMWi (2013); UBA (2016).
The United Kingdom has a different problem. The major concern regarding energy and carbon taxa-tion in the UK is not industry, but the affordability of heating for private households. Badly insulated houses and a relatively cool climate result in fuel poverty. Policymakers thus shy away from taxing heating fuels. Hence, the UK applied a climate change levy, which was imposed on industry only, not on private households. However, ener-gy-intensive industries also managed to receive substantial reductions to protect their compet-itiveness. Consumption-dependent thresholds for the reductions led to an unequal distribution of the burden of the levy, favouring energy-inten-sive and mostly large businesses over small and medium-sized enterprises.
These examples illustrate how tax reductions produce negative effects. First of all, when the environmental damage caused by an actor, such as energy consumption, is the basis for granting tax reductions, those who damage most receive the highest benefits. They will then be the last to adapt their behaviour towards protecting the environment. Only proper pricing will ensure and promote an efficient allocation of resources across sectors over the longer term. The argu-ment of carbon leakage–industries relocating to low-tax countries–applies only to a small group of industries that have both high energy costs and strong international competition. Among those sectors could be lime, cement, iron, steel, alumin-ium, refined petroleum, fertilisers and nitrogen,
starches, pulp and paper and basic chemicals (Dröge et al. 2009). However, as mentioned above, the OECD could not find substantial evidence of this behaviour (Arlinghaus 2015).
Exemptions and reductions are also unattrac-tive for administraunattrac-tive and political reasons.
Each exemption and special treatment of a tax increases its complexity, and therefore its admin-istrative costs, and opens the door to rent-seeking behaviour. Accurately discriminating between those who should be eligible for a tax exemption and those who are not, based on defined criteria, is complicated. Offering a lower tax rate to indus-tries that qualify, according to specific indica-tors of how their international competitiveness is threatened, often compels firms to shift their behaviour to fulfil these criteria, rather than to increase efficiencies or reduce pollution. This distorts markets in unpredictable ways.
If reductions are provided nonetheless, they should at least be combined with compensa-tory measures, such as negotiated agreements, concrete investment commitments or, prefera-bly, mandatory energy management and auditing requirements.
109
Pricing Environmental Resources and Pollutants and The Competitiveness of National Industries
3.3. LINKING REDUCED TAX RATES TO NEGOTIATED AGREEMENTS
Negotiated agreements with industry might also be a way to safeguard environmental action when industries are exempt from environmental taxes for competitiveness reasons. For example, industries and their associations can commit to target-oriented action, forestalling regulatory legislation and other instruments such as envi-ronmental taxation. Sometimes referred to as voluntary agreements, that term does not capture the true nature of most negotiated agreements since they usually result from the threat of bind-ing requirements (Héritier and Lehmkuhl 2008).
Reliable evaluations of negotiated agreements are still scarce, in contrast to other instruments, such as taxes. This may be due to their relative novelty in the policy arena. Complicating the analysis further, often targets are not quantified or, if they are, important parameters such as the baseline are unclear.
Very few negotiated approaches have been tried in combination with environmental taxation. Hence, there are not many conclusions to be drawn. Swit-zerland had negotiated an environmental agree-ment regarding heating emissions combined with the taxation of heating fuels. It was agreed and noted in the CO2 law that if emissions do not decrease according to fixed interim targets, the tax rate would be increased. After the emissions had not decreased sufficiently in 2014, the govern-ment increased the CO2 levy by almost 25 per cent in 2016 (BAFU 2016). Hence, in the end, this agreement has only postponed implementation of effective instruments and delayed effective emis-sion reductions and green investments.
Another example occurred in Germany, where a negotiated environmental agreement was connected to tax reductions for the manufac-turing industry. When the tax reductions were granted, there was no initial specification of substantial and concrete compensatory meas-ures that industry should take–only a rather vague mention of general industry contributions to achieving emission reductions. Even this vague formulation was not voluntary, but resulted from the threat of otherwise stricter energy taxation.
After the introduction of the tax reductions, the German government faced pertinent questions from the European Commission about how to ensure industry’s contribution to climate targets despite reduced incentives. This led to the spec-ification of the non-binding target in the nego-tiated agreement to reduce emissions by 20 per
cent. The agreed baseline of 1987, which was later changed to 1990, allowed industry to benefit from the emission reductions resulting from the German reunification and, more specifically, the modernisation of Eastern German industry. Due to these influences, emissions decreased by about 15 per cent between 1987 and 1993, thus signifi-cantly reducing the level of ambition of indus-try’s commitment to decrease emissions in any substantive sense (Böcher 1996: 193).
Different industrial sectors of Germany’s economy are still benefiting from the energy and electric-ity tax reductions in the order of EUR 7.6 billion per year, according to the subsidy report of the Government (BMF 2015: 17). As well, industry benefits from reduced social security contribu-tions. The European emissions trading scheme further supports avoiding cuts while complying with its environmental agreement by providing the option of buying permits instead of pursu-ing actual emission reductions by each firm.
Hence, industry is supported substantially by the combined policy package.
3.4. LINKING REDUCED TAX RATES TO ENERGY MANAGEMENT REQUIREMENTS
When negotiated agreements are not considered binding enough, environmental tax reductions can also be linked to mandatory requirements, such as installing energy management systems.
They contribute to overcoming the potential dilemma between providing direction and the competitiveness of industries. Though tax rates and incentives are reduced, industry takes concrete action to reduce emissions.
The aim of energy management requirements is to support the identification and implementation of profitable energy saving potentials. They typi-cally comprise two major elements:
◼ The introduction of a comprehensive data monitoring system to establish how much and what kind of energy is used when and where
◼ The realisation of concrete energy-saving potential and thus possible measures, as changes of behaviours and processes or of investments.
Such a requirement can be considered a no-re-gret option, because it does not put a real burden on the companies, apart from some adminis-trative costs. It supports companies in estab-lishing a data information system on energy flows and greenhouse gas emissions, increasing
110 transparency. On this basis it is much easier to identify concrete investment options for improv-ing energy efficiency and the use of renewa-ble energies. This combination of instruments, carbon/energy taxation and energy management systems, has been applied in the United Kingdom, for example, where positive experiences were noted (Government Digital Service n.d.).
Often this instrument combination can be differ-entiated into two further options:
◼ Establishing just the data information flow, while still identifying options for investments and changes of behaviour in case future steps are anticipated as possible
◼ Exploiting these potential options by imple-menting measures in a certain time frame.
The former option basically comes without added costs, apart from the administrative efforts, but it brings about benefits in the form of more trans-parency on energy and of cost-saving poten-tials. Its application can therefore be generally recommended. Several countries implemented this option, among them Germany and Denmark (UNIDO 2015). The latter option may involve substantial costs for the companies. Hence, the potential design element of requiring the implementation of these identified investment options should be applied with more care. Here, the investment cycle is likely the most impor-tant criterion to be taken into account: when replacement investments are due anyways, a switch to more efficient machinery results in lower marginal costs. Assuming that the energy management requirements take the invest-ment cycle into account and include minimum requirements for profitability, the second option can be recommended.
3.5. BORDER CARBON ADJUSTMENTS
Border carbon adjustments offer a trade mecha-nism to counterbalance potentially higher costs due to domestic environmental taxation, thus levelling the playing field between countries with higher environmental taxation and those with lower or none. The aim is to allow coun-tries to be frontrunners and not to punish them
by endangering their industries. In practice, this would mean that products from countries with a lower level of environmental taxation would be charged at the border by an environmental tax of a level similar to the domestic one.
A border carbon adjustment could also include relieving exported products from the part of the energy taxation that exceeds the level encoun-tered abroad. Hence, border carbon adjustments offer an effective means of ensuring the competi-tiveness of energy-intensive industries while still incentivizing industry to take ambitious actions towards climate change mitigation.
Practical examples include the tax on ozone-de-pleting chemicals in the US and on primary construction materials in Denmark, called the gravel tax (Internal Revenue Service 2007; Chris-tensen 2011; Wageningen University & Research 2016). However, border carbon adjustments have not been applied more broadly, since most coun-tries shy away from the risk of triggering trade wars. The targeted country or its industries might consider a border carbon adjustment an unfair measure, since it could be considered disguised protectionism if not adequately designed, intro-duced, communicated and implemented.
3.6. INTERNATIONAL COOPERATION AND COORDINATION OF CARBON PRICING
International cooperation and coordination is likely to be an effective way of avoiding competi-tive disadvantages. However, there are only a few practical cases where a minimum of cooperation could be achieved.
One example is the agreement of September 2016 between the Canadian provinces Ontario and Quebec and extending their cooperation on climate change with Mexico. They all agreed to work more closely on carbon tax policy (Clean-tech Canada 2016). Another example is the Euro-pean Union: Since 2004, there has been a common framework for energy and carbon taxation in the EU that requires at least minimum energy tax rates on all energy products in all EU Member States, while any country is free to exceed these rates (EU 2004).
111
Pricing Environmental Resources and Pollutants and The Competitiveness of National Industries
4. RECYCLING OF REVENUES
As stated earlier, environmental fiscal reforms do not only set incentives for structural change by shifting the competitive positions of industries, but they have the additional benefit of raising government revenues. There is a longstanding and ongoing debate about the best way to allo-cate these revenues (OECD 2005; World Bank 2005). However, since revenue raised through environmental fiscal reform is equivalent to all other revenues, the actual issue is how govern-ment revenues in general should be spent. It should be clear that there is no straightforward answer. However, there are some common spend-ing options.
Probably the most sensible way to recycle envi-ronmental revenues is to evaluate them from a political and strategic perspective. One strat-egy worth considering is to identify the high-est national political priority, which may not be related explicitly to the environment, and use the environmental revenues toward this aim. A second approach is to identify winners and losers from the environmental fiscal reform and use the revenues to mobilize powerful stakeholders and seize opportunities to build coalitions. Political and economic leaders who have the perseverance to lead the process through the inevitable chal-lenges are key to the success of environmental fiscal reform. Approaching spending choices from this very practical point of view can be reasonable, given that spending decisions are fundamentally political in character. Thus, assigning environ-mental revenues to policy priorities and strategic uses can be key factors for building reform coali-tions successfully.
4.1. EARMARKING—PROS AND CONS
Earmarking the revenues for particular purposes can be an option to demonstrate transparently how the revenues are used, which facilitates communication. The advantages and disadvan-tages of four particular earmarking options invite analysis: green investments, tax shifting, offset-ting potentially negative effects on competitive-ness and managing effects on poor people and particularly vulnerable groups in society such as women and youth.
The concept of earmarking requires some context.
First, the constitutions of many countries do not allow earmarking (Box 7.3). Also, the prac-tice can complicate budget processes because it
invites interest groups to lobby for certain reve-nue streams to fund their interests. Finally, it may prove problematic when earmarked revenues do not match the need of a particular spending project. This was the case for the UK Climate Change Levy revenues that were earmarked to fund reduced national insurance contributions, but did not raise sufficient revenues to match the reductions (Cottrell et al. 2013). Although attractive from a communication point of view, earmarking revenues can be unattractive from a fiscal point of view. Both politicians and finance ministries generally demand the freedom to allo-cate revenues according to current requirements (World Bank 2005).