Are environmental taxes in Europe too low?

The European Environment Agency (EEA) has published a new analysis on the share of environmental taxes in total tax and social security revenue in EU countries. According to analysts, the observed downward trend does not support the planned transition towards a green economy.

Tax trends in the EU

The EEA analysis covers the period from 2010 to 2022, spanning from the financial crisis in the EU to the COVID-19 pandemic and its far-reaching consequences. In 2010, the share of environmental taxes in total tax and social security revenue was 6.04 percent, amounting to nearly 260 billion euros.

Until 2016, this figure remained close to 6 percent, although absolute revenues from environmental taxes steadily increased, reaching a record-high sum of almost 300 billion euros in 2018. However, their share in total taxation began to decline gradually, reaching 4.84 percent in 2022.

EEA analysts attribute this sharp decline to COVID-19-related restrictions, particularly in the transport sector. Additionally, the outbreak of war in Ukraine and the resulting risks to energy sector stability led many EU countries to reduce taxes on gasoline and diesel. These were temporary relief measures, expected to be phased out eventually, but they resulted in total environmental tax revenues in the EU reaching just 317 billion euros in 2022 (equivalent to 260 billion euros in 2010 prices).

Structure of environmental taxes

To better understand the impact of global events on environmental tax revenues, the EEA analysis also examines their structure. The largest share of revenue comes from energy taxes, accounting for over 75 percent. However, it is worth noting that in 2022, income from this source was the lowest in 12 years.

The second-largest category is transport taxes, which made up 19 percent of environmental tax revenues in 2022. Pollution and resource use taxes account for only 4 percent of revenues. The share of the latter has been higher in the past three years than a decade ago, indicating that the “polluter pays” principle is effective.

Environmental taxes in individual EU countries

The decline in the share of environmental taxes in overall tax revenues from 6 percent to 4.84 percent across the EU is, of course, an average reflecting varying changes among member states. The most ambitious tax collectors in this regard are Bulgaria and Greece, where the proportion of environmental taxes in 2022 exceeded 15 and 13 percent, respectively. These are also the only countries where the share of environmental taxes in total revenue has increased over the past decade.

Poland ranks fourth in the EEA ranking, with a relatively stable share of 8 percent, experiencing only a slight decline compared to 2010. On the other end of the spectrum, Sweden and Luxembourg have seen their share of environmental taxes in total tax and social security revenue drop by half, from around 6 percent to 3 percent over the analyzed period. Significant declines were also recorded in Latvia, the Netherlands, Denmark, and Malta, but in these countries, the indicator still remains between 5 and 7 percent, above the European average.

The future of the EU ETS system

The ambitious EU Fit for 55 package aims to reduce greenhouse gas emissions by 55 percent by 2030. Its implementation, in addition to improving energy efficiency in buildings and creating a market for hydrogen and decarbonized gas, includes revising the Energy Taxation Directive. The EU Emissions Trading System (EU ETS) plays a key role in this process, setting emission caps and allowances.

Since the introduction of the EU ETS in 2005, European emissions have decreased by 41 percent. According to the EEA, the new provisions of the Fit for 55 package are expected to allow for an increase in environmental taxes. Sectors already covered by the system will be required to meet even more ambitious emission reduction targets. Additionally, EU ETS2, set to take effect in 2027, will extend to road transport, building heating, and fuel consumption in specific industrial sectors.

Furthermore, the EU ETS system includes:

• expanding emission caps to cover maritime transport,
• accelerating the reduction of emission allowances,
• implementing carbon offsets for international air transport,
• revising the Market Stability Reserve, established in 2015 to regulate the number of emission allowances on the market.

EEA experts believe that the EU ETS system could contribute to an increase in the share of environmental taxes in total tax revenue by 2030. However, they also emphasize that this is difficult to predict. At present, it is unclear whether the projected revenue gains from stricter carbon limits will compensate for the downward fiscal trend observed in recent years.

Environmental taxes in the long-term perspective

Both the European Green Deal and the EU’s 8th Environmental Action Program recognize the crucial role of environmental taxes in transforming the economy into a more sustainable model. These taxes are a fiscal tool that allows member states to effectively encourage consumers and producers to reduce pollution and use resources, such as water and energy, more efficiently.

According to EEA analysts, environmental tax revenues are likely to decline. Tightening EU ETS regulations may initially lead to a sharp increase in revenues, but at some point, these restrictions will become so effective that the tax base will shrink significantly. A substantial reduction in greenhouse gas emissions will mean that revenues from energy and transport taxes will decline, as it will be more cost-effective for businesses and individuals to change their practices rather than pay taxes.

This issue is already being considered by the European Commission. Individual member states can counteract this decline in two ways. The first is raising tax rates, a measure already taken by Sweden, which increased the tax on nitrogen oxide emissions. Similarly, the Netherlands has raised taxes on waste production, while the Czech Republic has increased taxes on air pollution.

The second approach involves expanding the tax base by introducing new instruments that implement the polluter pays principle. A 2021 report by the Institute for European Environmental Policy (IEEP) indicates that the portfolio of green taxes could be significantly expanded. European polluters still pay too little, particularly regarding water and air pollution.

One of the biggest paradoxes highlighted in the report is that households bear a significantly larger financial burden for the pollution they generate than the agricultural sector. According to the authors, environmental taxes should be reformed, expanding their scope while simultaneously lowering income taxes for citizens and businesses.