The European Union (EU) has been at the forefront of promoting sustainable and green businesses in the region and beyond. The EU has adopted various policies and measures to support the transition to a low-carbon and circular economy, such as the European Green Deal, the Circular Economy Action Plan, and the Sustainable Finance Strategy. One of the key instruments that the EU uses to incentivize sustainable and green businesses is taxation.
Taxation can play a vital role in steering economic activities towards more environmentally friendly practices and products. By using tax incentives and disincentives, the EU can encourage businesses to invest in green innovation, reduce their carbon footprint, and adopt circular business models. Taxation can also help to internalize the environmental and social costs of economic activities, such as pollution, resource depletion, and climate change.
One of the most prominent tax strategies that the EU has adopted to combat climate change is carbon pricing. Carbon pricing is a policy tool that puts a price on greenhouse gas (GHG) emissions, either through a tax or a cap-and-trade system. The aim of carbon pricing is to make polluters pay for the environmental and social costs of their emissions, and to create an incentive for them to reduce their emissions or switch to cleaner sources of energy.
The EU has implemented two main forms of carbon pricing: the EU Emissions Trading System (ETS) and the Energy Taxation Directive (ETD). The EU ETS is a cap-and-trade system that covers around 40% of the EU’s GHG emissions from sectors such as power generation, industry, and aviation. The EU ETS sets a cap on the total amount of emissions that these sectors can emit, and allocates emission allowances to each participant. Participants can trade these allowances among themselves or buy them from auctions. The price of an allowance reflects the scarcity of emission rights and the demand for them in the market. The EU ETS aims to reduce the emissions from these sectors by 43% by 2030 compared to 2005 levels.
The ETD is a directive that sets minimum tax rates for energy products based on their energy content and environmental impact. The ETD covers around 60% of the EU’s GHG emissions from sectors such as transport, heating, and agriculture. The ETD aims to harmonize the taxation of energy products across the EU and to promote energy efficiency and renewable energy sources. However, the ETD has not been revised since 2003 and does not reflect the current market conditions and policy objectives. For instance, the ETD does not take into account the carbon content of energy products, which means that some fossil fuels are taxed less than some renewable fuels.
To address these shortcomings, the EU has proposed several reforms to its carbon pricing framework. For example, in July 2021, the EU presented a package of legislative proposals called “Fit for 55”, which aims to align the EU’s climate policies with its target of reducing its net GHG emissions by 55% by 2030 compared to 1990 levels. Among these proposals are:
- A revision of the EU ETS to increase its ambition and scope. The proposal includes lowering the cap on emissions by 4.2% annually from 2024 onwards, expanding the coverage of the system to include maritime transport and road transport (for vehicles above 3.5 tonnes), and creating a separate ETS for buildings and road transport (for vehicles below 3.5 tonnes).
- A revision of the ETD to align it with the EU’s climate goals and carbon pricing policies. The proposal includes introducing a carbon component in the taxation of energy products based on their GHG emissions, increasing the minimum tax rates for fossil fuels and reducing them for renewable fuels, and phasing out tax exemptions and reductions for fossil fuels.
- A proposal for a Carbon Border Adjustment Mechanism (CBAM), which is a levy on imports of certain goods from countries that do not have comparable carbon pricing policies. The CBAM aims to prevent carbon leakage, which is the risk that businesses relocate their production or investments to countries with lower environmental standards, undermining the EU’s climate efforts. The CBAM would cover sectors such as cement, iron and steel, aluminum, fertilizers, and electricity.
These reforms are expected to have significant implications for businesses operating in or trading with the EU. On one hand, they could increase their costs of production or consumption due to higher taxes or levies on their energy use or imports. On the other hand, they could create new opportunities for businesses that invest in green innovation or offer low-carbon products or services.
Another tax strategy that the EU has pursued to support sustainable and green businesses is promoting the circular economy. The circular economy is an economic model that aims to minimize waste and maximize resource efficiency by designing products that last longer, can be repaired, reused, remanufactured or recycled, and by using renewable or recycled materials as inputs. The circular economy can help reduce GHG emissions, preserve natural resources, create jobs, and enhance competitiveness.
The EU has adopted several policies and measures to foster the circular economy in the region, such as:
- The Circular Economy Action Plan (CEAP), which is a comprehensive strategy that sets out various initiatives to make all phases of the product lifecycle more circular, from design and production to consumption and waste management.
- The Single-Use Plastics Directive (SUPD), which is a legislation that aims to reduce the consumption and environmental impact of certain plastic products that are commonly used once and discarded.
- The Waste Framework Directive (WFD), which is a legislation that sets binding targets for the reduction of waste generation and landfilling, and for the increase of recycling and reuse.
- The Eco-design Directive (EDD), which is a legislation that establishes minimum environmental performance standards for energy-related products, such as appliances, lighting, electronics, and vehicles.
Taxation can play an important role in complementing these policies and measures by creating incentives for businesses and consumers to adopt more circular practices and behaviors.
For example, taxation can:
- Encourage producers to design products that are more durable, repairable, reusable, or recyclable by reducing taxes on such products or increasing taxes on products that are not.
- Encourage consumers to buy products that are more circular by offering tax credits, rebates, or deductions for such purchases or increasing taxes on products that are not.
- Encourage waste prevention, reuse, and recycling by reducing taxes on waste management services that follow these principles or increasing taxes on services that do not.
- Encourage the use of renewable or recycled materials as inputs by reducing taxes on such materials or increasing taxes on materials that are not.
Some examples of existing or proposed tax instruments that aim to support the circular economy in the EU are:
- A reduced value-added tax (VAT) rate for repair services, such as bicycle, shoe, or clothing repairs, which is applied in some member states, such as Sweden, Belgium, and France.
- A reduced VAT rate for second-hand goods, which is applied in some member states, such as Denmark, Finland, and Ireland.
- A plastic packaging tax, which is a levy on plastic packaging materials based on their weight or volume, which is applied or planned in some member states, such as Italy, Spain, and Hungary.
- A landfill tax, which is a levy on waste disposal in landfills based on their weight or volume, which is applied in most member states with varying rates.
These tax instruments can help create a level playing field for sustainable and green businesses that offer circular products or services, and stimulate innovation and competitiveness in this field.
Tax strategies for sustainable and green businesses in the European Union:
Carbon Pricing Mechanisms:
The EU has implemented carbon pricing mechanisms, such as the Emissions Trading System (ETS), which places a price on carbon emissions. Under the ETS, companies are allocated a certain number of carbon allowances, and those exceeding their allowances must purchase additional allowances or reduce their emissions. This mechanism provides an economic incentive for businesses to reduce their carbon footprint and invest in cleaner technologies.
Green Investment Tax Credits:
Some EU member states offer tax credits or deductions for investments in environmentally friendly technologies and infrastructure. These incentives aim to encourage businesses to adopt renewable energy sources, energy-efficient equipment, and other green technologies. Examples include tax credits for installing solar panels, wind turbines, or energy-efficient building systems.
Accelerated Depreciation and Investment Allowances:
To encourage investment in sustainable infrastructure and equipment, the EU provides accelerated depreciation or investment allowances for assets with a low carbon footprint. This means that businesses can deduct a larger portion of the asset’s cost in the earlier years, reducing their taxable income and providing a financial incentive for green investments.
Research and Development (R&D) Tax Incentives:
The EU offers tax incentives for businesses engaged in R&D activities related to sustainable technologies and solutions. These incentives may include enhanced deductions or tax credits for qualifying R&D expenses in areas such as renewable energy, energy storage, waste management, and sustainable agriculture. These incentives promote innovation and encourage the development of sustainable solutions.
Green Bonds and Financing:
The EU supports the issuance of green bonds, which are financial instruments used to raise capital for environmentally friendly projects. Green bonds offer tax advantages, such as tax-exempt interest or reduced withholding tax rates, making them an attractive financing option for sustainable businesses. These bonds help channel investments into green projects and support the transition to a low-carbon economy.
Reduced VAT Rates for Green Products and Services:
Some EU member states apply reduced Value Added Tax (VAT) rates for certain green products and services. This includes goods such as energy-efficient appliances, electric vehicles, and renewable energy equipment, as well as services like energy audits and eco-friendly construction. Reduced VAT rates make these products and services more affordable and encourage their adoption.
Energy Efficiency Tax Deductions:
EU countries may offer tax deductions for businesses that improve their energy efficiency. These deductions can be based on the costs of energy-saving measures, such as insulation, efficient lighting systems, or HVAC upgrades. By incentivizing energy efficiency improvements, these deductions contribute to reducing energy consumption and greenhouse gas emissions.
Tax Incentives for Sustainable Transport:
The EU promotes sustainable transport by providing tax incentives for electric and hybrid vehicles. These incentives may include tax credits, exemptions from vehicle taxes, reduced road tax rates, or access to special parking and charging facilities. By encouraging the adoption of cleaner vehicles, the EU aims to reduce air pollution and dependence on fossil fuels.
Circular Economy Tax Measures:
The EU is committed to promoting a circular economy, where resources are used more efficiently, waste is minimized, and products are designed for durability and recyclability. Tax measures, such as lower taxes on recycled materials or tax deductions for companies that incorporate recycled content in their products, incentivize businesses to adopt circular economy practices and reduce waste generation.
Disclosure and Reporting Requirements:
The EU requires companies to disclose their environmental and sustainability-related information through frameworks like the Non-Financial Reporting Directive. By mandating transparency in reporting, businesses are encouraged to assess and disclose their environmental impacts, helping investors and stakeholders make informed decisions and promoting sustainable practices.
Green Investment Funds and Tax Incentives:
The EU promotes the establishment of green investment funds that focus on financing environmentally friendly projects. These funds may benefit from tax incentives such as reduced corporate tax rates, exemptions from certain taxes, or preferential treatment for capital gains. By providing tax advantages to green investment funds, the EU encourages investments in sustainable businesses and projects.
Renewable Energy Feed-in Tariffs:
Some EU member states have implemented feed-in tariff schemes to promote renewable energy generation. Under these schemes, energy producers receive a guaranteed payment for the electricity they generate from renewable sources, often above market rates. The feed-in tariffs incentivize investments in renewable energy projects, making them financially viable and attractive to businesses.
Carbon Offsetting and Voluntary Carbon Markets:
The EU recognizes the importance of carbon offsetting as a mechanism to mitigate carbon emissions. Businesses can participate in voluntary carbon markets by purchasing carbon credits to offset their emissions. Some EU countries provide tax incentives for businesses that engage in carbon offsetting activities, such as tax credits or deductions for the purchase of carbon credits.
Environmental Impact Assessments:
When undertaking significant projects with potential environmental impacts, businesses are required to conduct environmental impact assessments (EIAs) in accordance with EU regulations. EIAs assess the potential effects of projects on the environment and propose mitigation measures. Compliance with these assessments is crucial for businesses to ensure they meet their legal obligations and address potential environmental risks.
Green Public Procurement:
The EU promotes green public procurement, which encourages public authorities to prioritize environmentally friendly products and services in their procurement processes. Governments may give preference to suppliers that meet certain environmental criteria, such as energy-efficient products or materials with lower environmental impacts. Green public procurement contributes to market demand for sustainable products and stimulates innovation in green technologies.
Tax Transparency and Anti-Avoidance Measures:
The EU has implemented measures to enhance tax transparency and combat tax avoidance in relation to sustainable and green businesses. These measures aim to ensure that businesses operating in the EU pay their fair share of taxes and do not engage in aggressive tax planning that undermines the objectives of sustainability initiatives. Enhanced reporting requirements and anti-avoidance provisions help prevent tax abuse in the context of sustainability efforts.
EU Ecolabel Scheme:
The EU Ecolabel is a voluntary certification scheme that identifies products and services with reduced environmental impacts. Businesses that meet the criteria for the EU Ecolabel can use it as a marketing tool to promote their environmentally friendly products and services. While the EU Ecolabel does not provide direct tax incentives, it can enhance the marketability of sustainable products, leading to increased demand and potential business growth.
EU Sustainable Finance Initiatives:
The EU is actively promoting sustainable finance initiatives to redirect capital flows towards sustainable and green investments. These initiatives aim to integrate environmental and social considerations into financial decision-making processes. The EU taxonomy regulation, for example, establishes a framework for classifying environmentally sustainable economic activities. These initiatives may indirectly impact taxation by influencing investment decisions and fostering a sustainable investment ecosystem.
Incentives for Energy Efficiency Improvements:
EU member states may offer tax incentives for businesses that undertake energy efficiency improvements in their operations. These incentives can include tax credits, grants, or accelerated depreciation for investments in energy-efficient equipment, building retrofits, or renewable energy systems. By reducing energy consumption and carbon emissions, businesses can benefit from lower energy costs and potential tax savings.
Collaboration and Knowledge Sharing:
The EU encourages collaboration and knowledge sharing among businesses, research institutions, and government bodies to promote sustainable practices. This collaboration can lead to the development of joint projects, sharing of best practices, and collective efforts to address sustainability challenges. By fostering collaboration, the EU aims to accelerate the adoption of sustainable business models and technologies.