Are taxes actually effective in the fight against climate change?

Published on: 7 July 2022

Topical issues in the field of economy, (responsible) investment, pension and income: every week, one of APG's experts provides a clear answer to this week's question.

In this edition: Johan Barnard, Head International Public Affairs, on the question whether tax incentives are effective in the fight against climate change. “If the fuel prices stay at this high level for a prolonged period of time, people will start looking for ways to reduce the costs.”

In the beginning of July, the government announced that car drivers will pay more per kilometer driven starting 2030, instead of a fixed amount for owning a car - as currently is the case for the vehicle tax. It is one of the ways in which taxes can be utilized to encourage behavior leading to less CO2 emissions. And there are more buttons the government can push: the fuel taxes, the purchase tax (BPM), the vehicle tax, the maximum amount for an untaxed mileage allowance for employees and the fiscal addition for lease cars.

The question arises: how successful is that type of measures really?

According to Barnard that depends, among other things, on the price elasticity of demand: the degree to which the demand responds to a price change. “In case of elastic demand it responds to a large extent to a price change, in case of an inelastic demand that effect is relatively low. The latter applies to tobacco, for instance. For car fuels, the demand is also inelastic in the short term. Because oil is very expensive at the moment, the prices of petrol and diesel are also very high. Yet, this doesn't have a major effect on the number of cars on the road. But if the fuel prices stay at this high level for a prolonged period of time, people will start looking for ways to reduce the costs. For example by driving smaller, fuel-efficient cars or by getting rid of a second car. This means an increase of the taxes on fuel may therefore be an effective way in the long term to reduce the CO2 emissions.”

But the button of an increase of the fuel taxes also comes with some complications, Barnard says. For example, the border effects. “People in the border region can fuel their car in Belgium or Germany if its cheaper in those countries. There has been made an attempt once to eliminate that effect by means of a grant scheme for fuel station operators near the border. However, that attempt failed because it required more subsidy than allowed under the European state aid rules.”

Burning fingers
Moreover, most politicians don’t want to get their fingers burnt on an increase of the fuel taxes. “The government has now actually implemented a temporary decrease of the taxes. That is explicable in a political sense, but it does cause friction with the goals of the climate transition.”

The BPM – tax on the purchase of a new car or motorcycle – is also utilized as a means to reduce the emissions. No BPM is levied on electric cars, for example, and the BPM on a vehicle with a low emission level per kilometer is lower than on a vehicle with a higher emission level per kilometer. Yet, a decrease or abolition of the BPM could also be advantageous for the climate, Barnard says. “The advantage of a decrease or abolition of the BPM is that new cars will become cheaper, making it easier for people to switch to a more fuel-efficient car sooner. However, the downside is that the government in that case loses an instrument to encourage the purchase of electric cars, because the difference in BPM with fuel-driven cars no longer exists.”

Not stimulated
Barnard believes that, in addition to road pricing, other measures will be necessary. He outlines alternative possibilities that are targeting emission reduction utilizing a mixture of different existing fiscal instruments with a more focused approach.  “Only the vehicle tax is considered at the moment. That will be abolished and replaced with road pricing. But if it's really all about emission reduction, there are also possibilities to reach your goal through a combination of tax increases, a different fiscal treatment of lease cars and an increase of the maximum tax-free allowance for commuter traffic. The lease care driver is not stimulated right now to drive less kilometers. And this while the maximum allowance for commuting kilometers has not been sufficient for years already to cover the costs of that car use. Road pricing can be made more effective in a climate-related sense by levying less tax on kilometers driven with a clean car than on kilometers driven with a relatively polluting car. In addition, it can be used as an instrument to reduce traffic congestions by making road pricing per kilometer dependent on where and when those kilometers are driven.”

When it comes to emission reduction through taxes, the aviation industry and maritime sector cannot be ignored. Aviation kerosene, for example, is currently tax-free.  Barnard: “Agreements have been made in this respect in international treaties on which airlines rely. If you want to implement tax on kerosene, it entails at least European and possibly even broader international alignment. The large airports compete with one other and no country wants to put its own airports at a disadvantage relative to competitors. Should the EU countries agree to implement tax on kerosene, the airports in these countries will become vulnerable to competition from Heathrow Airport and Zurich Airport. That vulnerability mainly applies to an airport such as Schiphol that, the same as Heathrow and Zurich, has a business model based on a hub function between transatlantic flights and short-distance flights within Europe.”

Also an increase of the flight tax or VAT on tickets can contribute to emission reduction, Barnard says. “The flight tax would have to be increased to such an extent that a level playing field arises between airplane and train for certain distances. That is definitely not the case yet. For that matter, the government could also utilize a price increase for the landing rights at Schiphol. Schiphol is a public company after all.”

Privileged position
The same as the aviation industry, also the maritime sector enjoys a privileged position: the fuel, usually diesel, is untaxed. “The arguments for this are comparable with the reasons why airplane fuel is tax-free. But one element in maritime shipping is catching the eye in a negative sense. Because shore power is taxed, ships continue to run their diesel engines in the ports to provide for their power needs. As a result, the emission of one single cruise ship in the port of Rotterdam or Amsterdam is higher than the emission reduction realized in that same time slot due to the establishment of low-emission zones. This is like fighting a losing battle. In order to avoid those kinds of perverse effects, the fiscal exceptional position in the maritime sector also has to be addressed.

Summarized: taxes can be effective in the fight against climate change if all transport sectors are treated equally and provide targeted incentives through a mixture of fiscal instruments.