Environmental tax reform in Europe: implications for income distribution


Courtesy of European Environment Agency (EEA)

Key messages

- Although ETRs tend to improve incomes across society, they can have mild regressive impacts in that richer households gain more than poorer ones.

- Care is needed to design ETRs in ways that ensure that certain groups are able to benefit equally.

- ETR's overall benefits for the economy, environment and society are potentially significant.

- ETR should therefore be regarded as a key element in the policymaking toolkit for shifting to a green Economy.

In a series of reports on environmental tax reform (ETR), published in 2005, the EEA defined ETR as 'reform of the national tax system where there is a shift of the burden of taxes, for example on labour, to environmentally damaging activities, such as resource use or pollution'.

At the most basic level, therefore, ETR comprises two elements. First, it deters environmentally damaging activities by making them more costly. This can obviously be desirable for numerous reasons, including reducing harm to environments that we value for recreation or their cultural importance; alleviating the pollution that can impact human health and standards of living; and preserving the natural resources and systems that sustain our societies and economies — both today and for future generations.

But the second aspect of ETR is no less important. It involves recycling the revenues gained from increased environmental taxes and using them to create positive economic and social outcomes, such as increasing employment and boosting incentives to work. The recycling of revenues is especially important for the acceptability and equity of the tax reforms. This is because shifting the burden of tax increases some costs and reduces others, and since no two individuals in society will have exactly the same earning and spending patterns, the impacts will vary.

For example, essentials such as energy and food may account for a larger proportion of the consumption spending of poorer households, so measures that increase energy and food prices could well affect those households disproportionately. Contrastingly, reducing taxes on income will benefit those with jobs more than unemployed or retired people.

In fact, ETR can produce (at least) four different types of impacts, each of which may be distributed unequally across society. These comprise the direct consequences of increasing taxes (e.g. higher prices for certain goods); the consequences of recycling (e.g. direct transfers or alleviation of taxes); the broader economic impacts of ETR (e.g. job creation or inflation); and the environmental effects of ETR (e.g. a cleaner environment).

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