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Are European energy taxes in line with environmental objectives?

Although not collected by the EU but by each of the countries, taxes on energy at the European level exist, and they are implemented in the form of indirect taxes, also called excise duties. The EU sets harmonised minimum rates of excise duty for all energy products used for heating, transport and electricity (Dir. 2003/96/EC). But these duties date from 2003, no longer reflect the new energy panorama, and are full of anomalies not in line with EU’s Fit for 55 climate objectives. A 2019 revision proposal adopted by the Commission is currently being discussed by EU countries in a dedicated ad-hoc working group of the Council. This proposal responds to the need for a modernized and harmonized EU-wide tax framework for energy. In the meantime, national governments decide their own energy taxes on the basis of this old-fashioned directive and their trajectories on environmental objectives. Let’s take a closer look at the current situation.
 
A European obligation fragmented with anomalies
 
Energy taxes differ significantly among the countries of the heterogeneous European single market. The floor rates of the excise duty set by the EU Energy Taxation Directive (ETD) are largely exceeded in average: €7.1/MWh on average for business-use of electricity (vs €0.5/MWh mandatory), though countries such as Sweden (€0.52/MWh) and Belgium (€0.50/MWh) are closer to the floor than Germany (€15.37/MWh) and the Netherlands (€108.80/MWh ). Similarly for excise duties on gas, most EU countries put higher excise rates than the mandatory minimum rate of 0.36 €/l.

For information, the Energy Tax Directive minimum rates :

Historical and current dependences on certain energy sources shape today’s national fiscal policies. A minimum excise rate intends to provide a general framework for all countries and let national governments (dis)encourage the use of some energy sources by adjusting taxes accordingly to their situation. However, the current energy policy framework skewed towards fossil fuels hinders today’s transition and the reach of climate objectives. The current ETD framework includes:
  • Accounting methodologies in need of refreshing. New and less carbon-intensive fuels emerged after the 2003 adoption of the ETD are taxed at the same volume rate as the competing fossil fuel, discouraging the use of the former. For example, 1 litre of standard diesel has 39 MJ of energy, while the same volume of biodiesel has only 33MJ. This means that, for a tax of 0.33€/l, the equivalent tax for standard diesel is 8.5€/GJ while for biodiesel is 10€/GJ.
  • Possibilities of tax reductions and exemptions on fossil fuels: including gas oil used in agriculture, gas oil and coal used by households to heat (understandable for vulnerable households) or fossil fuels used by energy intensive industries
  • A mandatory tax exemption for maritime and aviation fuels.
The ETD does not provide sufficient incentives for investments in clean technologies. The revision of the ETD will aim to address these issues, for example, by establishing more tax categories for new biofuels, rethinking tax reductions, and eliminating the mandatory tax exemption for maritime and aviation fuels.
 
Carbon pricing mechanisms and their interplay with excise duties

More climate-focused than the existing energy excise, the EU Emissions Trading System (ETS) sets a cap on emissions for industries and allocates allowances that can be traded, creating a market-driven approach to switching to greener energies and reducing carbon output.

 The interaction between the EU ETS and energy taxation is complex: while the ETS covers large emitters like power plants and heavy industry, energy taxes often apply more broadly to smaller businesses and households. But there are risks of overlapping and double taxation. 

For example, in France, an industrial plant consuming natural gas is covered by the EU ETS, which requires it to buy allowances for its CO₂ emissions. At around €80/tonne of CO2, with an emission factor typically of around 0.4 kg CO2/kWh, the cost of purchasing CO2 would be around €32/MWh for the plant. In addition, it is subject to excise duty on natural gas (TICGN) at €8.37/MWh, which already includes a carbon tax (CCE). As a result, the industrial plant must bear a cost of €40/MWh for its energy consumption (numerous exemptions exist, but they are sometimes partial or subject to strict conditions). These overlapping measures can lead to higher marginal abatement costs than necessary for optimal emission reductions. The revised Energy Tax Directive will be more aligned with other recent programs, such as the EU ETS, reducing the risk of overlapping measures.


 Geographical disparities in energy prices inside the single market
 
National carbon taxes have been implemented in several EU countries to complement the ETS and further reduce emissions. Finland’s carbon tax initially targeted fossil fuel consumption and now covers coal, natural gas, and fuel oil, with different rates depending on energy content and carbon intensity. France applies its carbon tax to transport and heating fuels like gasoline, diesel, natural gas, and coal, but industries under the ETS are exempt. These taxes vary widely in scope and rate, leading to potential disparities in energy costs in the same sectors across the EU.
 
It is high time for a modernized, harmonized EU-wide energy tax framework.
 
Energy taxes account for a significant part of total tax revenue in the EU (4.4% in 2021). However, countries will have to face a trade-off between revenue generation and the achievement of climate objectives: taxation of carbon-based fuel use should, over time, lower their consumption, reducing carbon emissions, but also leading to a tax revenue shortfall. The EU will need to play its cards right to strike to achieve its target without causing social unrest or strong political dissents on such a sensitive topic.
 
The new energy tax directive is expected to:
 
  • Establish a revised structure of tax rates based on the energy content and environmental performance of fuels and electricity and broadens the taxable base.
  • Remove anomalies i.e. the mandatory tax exemption for maritime and aviation fuels.
  • Be better aligned with and complement existing environmental programs, such as the ETS.
  • Reduce geographical disparities by aligning countries with higher minimum fossil fuel taxes – pushing those with lower rates to raise them closer to the higher rates of other countries.

Thibault Uhl

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