Environmental tax reform: increasing individual incomes and boosting innovation

European governments could simultaneously reduce income tax, increase innovation and cut pollution by introducing well-targeted environmental taxes and recycling the revenues back into the economy. This was one of the findings from a pair of reports on environmental tax reform (ETR) published today by the European Environment Agency (EEA).

EEA

© OFE

Environmental tax reform is defined as 'reform of the national tax system where there is a shift of the burden of taxes, for example from labour to environmentally damaging activities, such as unsustainable resource use or pollution'.

There are at least four possible types of effects of ETR. The first effect is to make various goods or activities more expensive, while the second effect comes from the direct or indirect distribution of this extra revenue. Thirdly, job creation and eco-innovation may be another result of this process. And lastly, effective ETR will also result in environmental benefits, for example by reducing pollution.

Environmental taxation also has an important role to play in spurring innovation, according to a broad range of studies. By increasing tax on pollution and other environmentally-damaging activities, governments can use the extra funds to provide incentives for innovation, such as developing renewable energy. For advanced economies like the EU, such schemes also create new technologies which can be exported globally, the reports say.

The reports also look at ETR in practice across Europe. Analysis of policies in Germany and the Netherlands showed that ETR and other environmental policy instruments have broadly positive effects in increasing innovation. The wider economic effects of ETR have also been analysed in Germany, where environmental taxation cut pension contributions and created an estimated 250 000 jobs.

One of the challenges of ETR is ensuring the costs and benefits are appropriately distributed across society, and do not negatively impact the poorest people. Instruments also need to balance the right mix of environmental and economic incentives. Ultimately, ETR mechanisms can only be implemented if they are acceptable to the public and policy-makers.

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