Carbon Taxes as a Means to Tackle Climate Change: Exploring the Contours of a Climate Inclusive Taxation Policy in the EU

1.1 Background

Climate change is the most unshakeable challenge of the times that we are living in. Historically, climate change has decided and sealed the fate of civilizations. The impact of climate change is often all pervasive. The pace of climate change warrants an urgent intervention on multiple levels. Financing policies, schemes and technology to check climate change are some of the many avenues that require resources.

1.2 Purpose & Delimitation

The purpose of this article is to examine how carbon taxes can be used as a means to mitigate the impact of climate change. This article is based on the following thoughts. Firstly, the premise that there is a need to arrive at a climate sensitive tax policy, which is a tax policy which also factors in climate change. Secondly, such a policy should strive to be inclusive as far as possible. Thirdly, this policy model should be able to explore the design for a standardised carbon tax that could be seamlessly employed across jurisdictions in order to be globally relevant. However, the exact design and formulation of a standard carbon tax is beyond the scope of this article. This will only be explored in a brief theoretical manner.

1.3 Method and materials

The research for this paper has been undertaken following a doctrinal method. Accordingly, different statutory provisions and case laws relevant to the scope of the topic have been examined. To the extent necessary, a comparative analysis with other jurisdictions was also briefly undertaken.

I will briefly provide a short summary of the notable materials that have been used for this paper. The United Nations (UN) Department of Economic and Social Affairs in its ‘UN Handbook on Carbon Taxation’ released in 2021 has shed some light in this regard.1 The UN Subcommittee on Environmental Taxation defines environmental taxes as ‘any compulsory, unrequited payment to general government levied on tax-bases deemed to be of particular environmental relevance’.2

The Organisation for Economic Cooperation and Development (OECD) considers environmental taxes as such taxes ‘whose tax base is a physical unit (or a proxy of it) that has a proven specific negative impact on the environment’.3 The IMF has described carbon taxes as environmental taxes that are usually levied on fossil fuels.4 They encourage a shift in consumer as well as producer behaviour towards options that are more environment-friendly.5 Carbon taxes are considered to be relatively easier to impose and monitor.6

The Report of the Inter-governmental Panel on Climate Change (IPCC) released in 2022 has reiterated the impending fate of human civilization, if climate change is not tackled with a sense of extreme urgency.7 For commitments under the Paris Climate Agreement to lead to fruition, emissions must peak by 2025 and then reduce by 2030 by a staggering 43 %.8 The UN Climate Change Conference held in Glasgow in 2021 stitched together the Glasgow Climate Pact after prolonged deliberations.9 This document lays down the key actions and deliverables to be taken in furtherance to the Paris Climate Agreement.10

2.1 Introduction

Carbon taxes are relevant to tax policy because an integrated approach can ensure that desired outcomes can be achieved in a timely manner. As such, carbon taxes must be incorporated into the overall policy framework of a country in addition to the tax policy framework. This will ensure that their niche is calibrated in tandem with other variables, such as economy, commercial production, supply chain etc. It is necessary to understand in what way carbon taxes can help in safeguarding the environment. In order to understand this, it is necessary to define and explore the design of such a tax. This will be the theme of this section.

2.2 Defining a Carbon Tax

The UN Subcommittee on Environmental Taxation explains carbon tax as taxes which would help in the reducing carbon emissions. The UN Handbook of Carbon Taxes defines carbon taxes as a form of green taxes.11 It further categorises carbon taxes as a sub-set of environmental taxes.12 This is a major step towards understanding and applying carbon taxes, as until this definition was provided by the UN, there was no uniform definition of carbon taxes. The OECD regards environmental taxes as such taxes ‘whose tax base is a physical unit (or a proxy of it) that has a proven specific negative impact on the environment’.13 It is interesting to see that a hierarchy is created between environmental taxes, green taxes and carbon taxes. It is imperative that this interrelationship is appreciated. All carbon taxes are a form of environmental taxes. However, all environmental taxes may not necessarily be carbon taxes. This establishes that these terms should no longer be used interchangeably, as has been the practice often. The delineation is important as it lays a definite scope of the carbon tax.

This difference in definition as provided in the UN Handbook on Carbon Taxes is illustrated as below:14

Figure 1. Flowchart representing the various kinds of taxes pertaining to the environment.15

A fixed definition of a carbon tax is important for many reasons. A definition accords clarity, transparency and certainty to a tax and its goal. The principle of legal certainty is upheld when a clear definition of a tax is provided by the statute,16 as tax-payers know what they are being made to pay for. Further, a well-defined law fits into the broader expectation out of a tax policy. It becomes a tangible, and no longer remains a whimsical effort which confounds people.

A clear definition ensures that administering the law becomes easier. It is less litigated, or even when litigated, it is for credible reasons, and not for the courts to step in to define it in the first place.17 A uniform and consistent definition of the tax, and an overarching legal framework to execute the carbon tax shall only go towards wider acceptability of such a tax. This in turn will ensure greater compliance.18 Over a period of time, this will ensure achieving the desired outcome by addressing the challenges faced during the course of continuing endeavours to check climate change.19

2.3 Formulating a Carbon Tax

Despite the acknowledged relevance of carbon taxes today, there is still no standardised formula of such a tax that could be readily applied by interested jurisdictions. Taxation is a plank that can be a reliable and fast way to raise resources to deal with climate change. The actual task is to figure out a way to compute such a tax, and then to integrate it with taxation policies in a way that it comprehensively delivers on its mandate.

The UN Handbook on Carbon Taxes discusses the concept by defining as well as discussing the two ways to approach it. The first method that the Handbook describes to compute a carbon tax is to measure the carbon content in the fuel being used. This may be alternatively termed as the ‘fuel-based’ approach.20 The second method of ascertaining a carbon tax focusses on measuring the carbon emissions. This method is termed as the ‘direct emissions approach’. It is usually more convenient to tax the carbon content of the fuel than the emissions.21 The entire carbon content is usually accounted for as the fuel is taxed upstream, and prior to consumption.22 A carbon tax definition followed by a formula to levy such a tax can ensure that these can be effectively used by a wide number of jurisdictions.

As a field of study, climate change is an inter-disciplinary area that is the melting-pot of multiple academic streams. Certainly, there will be many ways that lead to the goal of addressing it. Taxation is one such means to check climate change resulting from environmental degradation. For the simple reason that taxation impacts people directly, it warrants examining an approach to mitigate climate change by placing taxation at the core.

It would be interesting to note how tax policy could be interpreted as a means to address this topic. Based on my understanding from the research undertaken for this article, in most countries, taxation and climate change are disjointed ends of policy discourse. If one were to count, there would be a select list of countries that integrate their taxation policy around environmental concerns. The Nordic countries stand out for their efforts at staying ahead of the curve. Finland was one of the first proponents of a carbon tax in the early 1990s.23 The integration of waste management, energy generation and sustainable environment narrative in Sweden demonstrates a highly integrated policy and administrative model.24 It would be worth exploring their success to decipher their methods of implementation and reasons for acceptance by tax-payers. This could probably be instructive for experimentation on a more global level and could lead the way to eventually arrive at a standardised tax policy that could also incorporate a carbon tax. A sound tax policy must be dynamic in accepting the challenges surrounding its acceptance, as much as it should be technically sharp.25 The goal must be to target climate change and work towards its mitigation. The means to achieve that could be carbon taxes.

3.1 Introduction

Europe has a dedicated vision for greening its economy. It has strived to achieve its green goals backed with concrete efforts. Examining its policies demonstrates that Europe relies on a diverse set of policy and legislative interventions. It is relevant to closely observe this, especially in the context of exploring carbon taxes. Accordingly, this chapter shall examine the work done on carbon taxes in the EU region specifically. This will help in putting into perspective the journey of environmental taxes in the EU.

3.2 Green efforts and EU

3.3 The OECD

The OECD has come up with a Report in 2022 for G20 countries that encourages them to join its carbon mitigation forum that will encourage them to adopt low carbon footprint policies in order to generate resources.41 Again in November 2022, the OECD has published its Report titled ‘Turning Climate Targets into Climate Action’ to help countries achieve their respective green targets. For the purpose of this Report, the OECD reviewed carbon pricing, subsidies and energy taxes in about 71 countries. It concluded that while efforts in the domain of carbon prices and taxes are afoot globally, there is much to be done still that can impact climate goals effectively on a global level.42 Broadly similar observations have been also made in the IMF/OECD Report for the G20 Finance Ministers and Central Bank Governors on tax policy and climate change that was published in 2021.43

With these reports, the OECD has highlighted the obvious that currently efforts pertaining to carbon pricing, energy and environmental taxation in general are inadequate. I feel that through these reports, we may act in the direction of pursuing a comprehensive effort to look at environmental taxes in general, and carbon taxes in particular. The examples of countries that have enacted policies in this domain or have retracted their existing policies can provide valuable lessons. Bearing the failures in mind, and pegging the successful jurisdictions as models, a global model of climate sensitive and climate responsible taxation policy should be endeavoured. However, I also feel that organisations such as the OECD must play a larger role to build consensus while providing adequate space for dissent. This will enable a lasting policy outcome in a frontier area such as carbon taxation.

In February 2023, the OECD launched an ‘Inclusive Forum on Carbon Mitigation Approaches (IFCMA)’. The IFCMA aims to address global efforts at reducing carbon emissions. Importantly, it is an effort at collating the work from different countries on this aspect.44 It brings together about 133 countries representing 91 % of global Gross Domestic Product (GDP) and about 83 % of emissions.45 These highlights the need to focus efforts on a multilateral climate policy. I believe the effort to bring on board a diverse range of economies for addressing climate change will be a game-changer potentially. This is because a lasting policy impact and concrete outcomes can be ensured when large number of countries representing diverse economic profiles collaborate.

4.1 Introduction

Climate finance is central to generating resources to deal with climate change. Any discourse on resource generation would inevitably concern taxation and fiscal policy of the concerned countries. This part will discuss how environment concerns can be addressed using taxes. In doing so, it will consider the importance of taxation for climate change.

4.2 Carbon Taxes as a means to Induce Climate Friendly Behaviour

Taxation has been long used for shaping social behaviour. There are certain kinds of taxes that are imposed with a view to discourage the use of certain class or kind of goods. Pigouvian taxes are imposed on goods whose decreased consumption will lead to more efficient outcomes.46 One such example of this could be smoking.47 Inducing tax-payers to move to a more climate responsible behaviour by adoption of cleaner/ newer technology, low emission fuel alternatives and more sustainable lifestyle can all be achieved by introducing carbon taxes. This has been seen to be effective in the case of Canada, which has a successful record with climate related tax and fiscal measures.48 Therefore, a carbon tax can be a means to a larger end, that is, combating climate change.

A greater international coordination can surely ensure the overall success of a carbon tax.49 Each nation could undertake an enormous effort to curb climate change through its tax policy. However, pollution and environmental degradation will not stop at the borders. Therefore, greater global coordination may be necessary in this regard. This coordination may be of two kinds. First is an internal coordination among countries and their respective tax systems. Second is a coordination between taxation and the policies dealing with climate change. Without aligning taxation (and even fiscal) policy to a country or region’s environmental goals, mitigating climate change would continue to be a daunting task. In my view, the synergy from a domestic policy and legal framework on the above lines is bound to influence global policy efforts as well.

At a theoretical level, arriving at the above situation would mean looking at the next logical step. Any effort always requires resources. In this case, ascertaining viable avenues of finance is central to a continued engagement with the issue. Financing climate mitigation is the heart of any effort. Moving away from conventional means of human existence which have been accomplished after years of fine-tuning technology and optimising costs would entail massive costs. For example, for a private individual to decide to buy an electric vehicle, rather than a car with a traditional engine, it would be possible only when the costs are within the person’s reach. Affordability of goods and services for mass consumption with a drastically reduced carbon emission rate will be possible only when perfect substitutes are in place. And providing consumers with such options is possible only when there is substantial curiosity to locate cleaner alternatives for most actions of daily occurrence. Dedicated R&D into clean technology alternatives could very well facilitate more wide-spread usage of clean technology, which is more climate friendly.

Similarly, when creating infrastructure which follows the requirements for climate and environment, enormous investment would be necessary. Also, disposing the waste from goods that will go out of use on account of switching to climate sensitive economy would entail costs. These are some of the examples that illustrate the paramount importance of ascertaining viable means to raise resources. This is how climate finance takes the centre stage.50 As per the UN, climate finance is defined as “local, national or transnational financing—drawn from public, private and alternative sources of financing— that seeks to support mitigation and adaptation actions that will address climate change.”51 To reiterate, climate finance is necessary for many significant efforts towards reducing emissions, which includes adaptation to climate change.52 It is imperative that the tax policy factors in climate change as part its narrative in order to align with efforts at mitigating it. This is how taxation policies and carbon taxes can help in raising resources, and inducing a shift towards cleaner and greener alternatives.

4.3 Elements of a Climate-Sensitive Tax Policy

Having seen why tax policy is necessary and how it can impact the discourse on climate change, it is worthwhile to explore the elements of such a tax policy. Any tax policy should have equity, certainty, convenience in terms of payment of taxes and these should be bolstered by an effective tax administration.53 These are seminal fundamentals which are true for any kind of tax policy and was enunciated by Adam Smith in his famous work, Wealth of Nations in 1776.54 A sound tax policy should be transparent and must owe accountability to the tax-payers. In my opinion, tax policy must accommodate contemporary challenges. Accordingly, a climate sensitive tax policy must endeavour to have the above features, and assimilate climate change mitigation with itself in order to be effective.

When talking of carbon taxes, it is also essential that there must be harmony between the fundamental principles of taxation and of environmental law. Established principles of environmental law, such as the ‘principle of polluter pays’, ‘the precautionary principle’, ‘the precautionary principle’,55 common but differentiated responsibility,56 and so on, must be balanced with tax related policies. A carbon tax, in its broad sense, that operates on the foundation of the polluter pays principle.57 The polluter pays principle lays down that anyone causing pollution, must bear the costs of the same.58 This in effect implies a production centric principle, where the producers of goods end up facing the tax. However, when a carbon tax is designed to target the consumers, it may seem unfair to the consumer who would lack the wherewithal to access better alternatives. Providing more climate friendly and accessible alternatives to the consumer will help them move to these goods.

When we ask ourselves the all-important question, ‘What form should a carbon taxation policy take?’, in my opinion, the answer may be rather layered. A bouquet of interventions may make the outcome more efficient and comprehensive. This composite approach may also mean that more than one kind of intervention is employed to achieve the eventual realisation of climate mitigation goals.

Figure 2. Representation of the interdisciplinary relationship between environmental and other policies.

Ultimately, we must bear in mind that this is a complex area with many intertwined disciplines. Accordingly, continued inter-disciplinary research is most crucial to continuously update the tax model so that optimum results can be achieved.59 A positive intervention in each area of study affects the eventual outcome. Areas such as science, technology, geography, economics, taxation, sociology, and so on, are mutually reinforcing. It is all the more important why a comprehensive view is important in order to arrive at a viable solution for a climate sensitive tax policy.60