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Fuel taxes are almost as old as the internal combustion engine. For instance, the UK established a fuel tax in its Finance Act of 1908, with the main objective of improving the road network7. However, throughout the last 100 years the purpose of (increasing) fuel taxes has been country and time-specific. For instance, the US established a fuel tax in 1933 as a way to increase government revenue during the Great Depression. Sometimes it has been used to fund wars, but often it simply funds governments’ annual budgets. In the early 2000s in Germany, the Schröder government used the increased revenues from energy taxes to reduce labour taxes. So, historically, many different reasons have been used to justify fuel taxation, not just road building and maintenance. Others include revenue raising, wealth redistribution or payment of external costs (including air pollution and road accidents)8.
In this section we explore why we need higher fuel taxes and whether this is effective, economically smart and fair.
2.1. Because it’s smart economic policy Both the current and previous European Commissions (EC) have been calling for a restructuring of the tax
burden. The 2015 Annual Growth Survey9, the first one of the new EC, states that:
Employment and growth can be stimulated by shifting the tax burden away from labour towards other types of taxes which are less detrimental to growth, such as recurrent property, environment and consumption taxes.10 Research by the EC also supports this argument. One taxation paper concludes that “relying on green taxation to raise revenues, rather than labour taxation, would be expected to be more efficient for the economy as a whole”11.
Despite this evidence, labour tax is still the largest source of tax revenue in the EU and has been increasing since 2009, while environmental taxation has remained stable12. This should change to promote growth and jobs.
Library of Congress, 2014. National Funding of Road Infrastructure: England and Wales.
RAC Foundation, 2012. Fuel for Thought. The what, why and how of motoring taxation.
The Annual Growth survey outlines the main features of the EC’s new jobs and growth agenda. It sets out what more can be done at EU level to help Member States return to higher growth levels. It kicks off the European Semester of economic and budgetary policy coordination.
European Commission, 2014. Annual Growth Survey 2015.
European Commission, 2013. The marginal cost of public funds in the EU: the case of labour versus green taxes.
Eurostat, 2014. Taxation trends in the European Union. Data for the EU Member States, Iceland and Norway.
a study by The fossil fuel supply-chain is one of the least labour-intensive value chains, and has most of its valuecreation outside Europe 13. So shifting spending towards other, more labour intensive, areas of the economy leads to net job creation. Fuel taxation reduces fuel consumption, so people can spend more in other more valuable sectors for the economy as a whole. And given that Europe imports virtually all of its oil, higher petrol taxes would also have a positive impact on the trade balance.
To have an idea of the impact on the revenues of member states of an increase of 1 cent on fuel taxes, the following table summarises the income for member states before emissions-reduction effects are considered (first-order effect). It would yield almost €3.2 billion for EU member states.
Cambridge Econometrics et al., 2013. Fuelling Europe's Future.
a study by
2.2. For innovation Taxation is a powerful tool to steer consumers towards a more resource-efficient use of energy. The European Commission recognises in its Energy Union Communication that “putting the EU at the forefront of clean transport (…) is central to the aim of turning the Energy Union into a motor for growth, jobs and competitiveness”14. Having high fuel taxes creates demand for vehicles with low consumption levels, which pushes manufacturers to keep innovating and creates demand for their more efficient products, which increases their global competitiveness. It is also a stimulus for electric cars, which is one of the objectives of the Energy Union. Electric vehicles, trains and waterway transportation are more efficient than internal combustion engines.
2.3. For energy independence Transport is a critical sector when it comes to energy security. 94% of transport relies on oil products, of which 90% are imported15. This dependency has worsened in recent decades16. In 2014, 29% of all imported crude oil came from Russia, worth up to €78 billion17. All oil imports add up to an annual cost of €271 billion18. In 2012, 76% of energy content of all petroleum products was used by the transport sector19.
That adds up to a cost of €564 million every day in imports for the transport sector only. Road transport uses more than 70% of all oil-derived fuels used in the transport sector20. That means that more than half of all petroleum products are used for road transport in the EU. Proper fuel taxation is key to ensuring that the EU advances towards energy independence.
2.4. For social purposes Some argue that fuel taxes might have a greater impact on the poor. However there are two reasons why this need not be the case and why, in fact, the poor can actually benefit.
First, richer households make greater use of private motoring than poorer households21. For instance, in the UK the poorest 10% households spend a lower percentage of their budget (3%) compared to the average household (4.9%). Some of the richest households (8th and 9th decile) spend 5.9% of their budget on fuel. Looking at the graph below, it can be concluded that an increase in fuel taxes impacts more the richest households, and, in fact, fuel taxes are considered a progressive tax. It is explained both by car ownership and by the fact that richer households have more fuel-consuming cars.
European Commission, 2015. Energy Union Package. A Framework Strategy for a Resilient Energy Union with a ForwardLooking Climate Change Policy.
European Commission, 2015. Energy Union Package. A Framework Strategy for a Resilient Energy Union with a ForwardLooking Climate Change Policy.
European Commission, 2014. EU Energy markets in 2014.
European Commission, 2015. Monthly and cumulative crude oil imports into the EU.
€-$ average exchanged rated used (1.3285): European Central Bank, 2014. ECB reference exchange rate, US dollar/Euro.
http://www.eea.europa.eu/data-and-maps/indicators/final-energy-consumption-by-sector-8/assessment-2 http://www.eea.europa.eu/data-and-maps/daviz/transport-energy-consumption-eea#tab-chart_2 RAC Foundation, 2012. Fuel for Thought – The what, why and how of motoring taxation.
Second, social impacts strongly depend on the use of the revenues. The extra revenue from higher fuel taxes can be used for redistributing wealth through social programmes for the households with the lowest income. An alternative would be to switch from other types of taxation, such as reducing labour taxes for those on the lowest incomes or to reduce VAT on basic goods.
2.5. For the climate Preventing dangerous climate change is a strategic priority for the European Union. The EU has legislated to achieve a 20% reduction of GHG emissions by 2020 below 1990 levels. In January 2014, the European Commission issued a communication proposing a next step for 2030: the EU should reduce its greenhouse gas emissions by 40% compared with 1990 levels23. EU leaders agreed with this in October 201424. The EU’s 2050 ambition is to reduce greenhouse gas emissions by 80-95% compared to 1990 levels.
Different sectors will contribute differently towards achieving decarbonisation of the EU’s economy. The importance of the transport sector, where emissions grew by 20% between 1990 and 201025, is growing.
The figure below illustrates the evolution of transport emissions without additional measures to curb them. The figure clearly suggests that without significant transport emission cuts the EU’s 2030 and certainly 2050 goals are not achievable.
RAC Foundation, 2012. Fuel for Thought – The what, why and how of motoring taxation.
http://ec.europa.eu/clima/policies/2030/index_en.htm, consulted on April 2015.
European Council, 2014. Conclusions on 2030 Climate and Energy Policy Framework EEA GHG viewer.
The White Paper on Transport27 established that a reduction of at least 60% of GHGs by 2050 with respect to 1990 is required to achieve the overall target. It also established an interim target of 20% GHG reductions compared to 2008 by 2030. More recently, the EU agreed on reducing emissions from sectors not included in the EU Emissions Trading System (EU ETS), which are those under the scope of the Effort Sharing Decision (ESD), by 30% by 2030 below 2005 levels. Most of the transport sector is under the scope of the ESD. Only aviation is included in the EU ETS, although currently only those arising from intra-EU flights. International maritime emissions are currently not included in either the ETS or the ESD.
Road transport is the main contributor to CO2 emissions (more than 90%28) in the non-ETS sector. Taxes play a vital and proven role in decreasing our transport-related emissions.
For instance, the United States uses almost three times the amount of petrol and diesel for road transport per person29. Pump prices in the US are half of those in the EU30. The most common indicator used by economists to study the relationship between the changes in prices of a certain good and how they affect demand is called price elasticity of demand. Low elasticity means that even if prices increase, the demand is not really affected. On the contrary, high elasticity implies that if the price goes up, the demand will go down.
How sensitive demand is to fuel price/tax increases has been the subject of extensive research. There are important differences between long and short-term price elasticities of demand. Short-term elasticity tends to be lower, because there are fewer alternatives to change habits than in the long term (choice of car, place to live, etc). However, long-term elasticity tends to be higher, because consumers can take informed decisions to change their behaviour and consumption pattern. Short-run elasticities are European Commission, 2013. Trends to 2050. Reference Scenario 2013.
European Commission, 2011. Roadmap to a single European transport area - Towards a competitive and resource-efficient transport system.
EEA GHG Viewer, 2012 emissions data.
Calculation by T&E. For petrol and diesel consumption in the EU, European Commission, 2014, EU transport in figures was used.
For the US, World Bank data on Road sector diesel and gasoline fuel consumption per capita was used.
World Bank data, Pump price for gasoline (US$ per liter), consulted on 16/04/2015.
a study by between -0.25 and -0.3431, and they tend to be higher in Europe than in the US32. It can be interpreted as European consumers being more responsive to price changes as they have more alternatives. In the short run, fuel consumption tends to be inelastic. However, long-run elasticities, which are more interesting from a policy perspective, tend to be more elastic, between -0.58 and -0.84. That means that a 10% rise in fuel prices (for instance through taxation) reduces fuel consumption between 5.8% and 8.4% in the long run.
Most of these studies deal with passenger cars; less has been done on the freight side, which currently accounts for about a third of fuel use in road transport. A literature overview by CE Delft33 for T&E arrives at a long-term elasticity of -0.2 to -0.6 for road freight.
Putting these results together, we can assume an overall price elasticity of -0.6. So if fuel prices rise by 10%, consumption and emissions go down by 6%.
A recent study34 has also concluded that not all changes to final fuel prices have the same repercussions for demand. Consumers have a stronger response to fuel tax changes. Tax changes are associated with bigger changes in fuel consumption and vehicle choices than equivalent changes in overall final prices. It would imply that fuel taxes may be even more effective in reducing fuel consumption than previously thought.
On top of this, a new study35 found that many known fossil fuel reserves must not be burned for global temperatures to rise no more than 2°C, and avoid the most disastrous effects of climate change. This includes one-third of known and extractable oil reserves, including most Canadian tar sands and all Arctic oil. These unconventional types of oil are more expensive to extract and are generally only profitable when oil prices are high. The aim of vehicle efficiency policies is to reduce oil consumption and demand but ultimately it would also reduce oil prices, which in turn could stimulate demand and emissions. A fuel tax is a smart way to solve this dichotomy. No matter how cheap or expensive oil is on the market, it should be expensive for the consumer in order to reduce road transport emissions. This would decrease demand for oil and depress oil prices. This would help keep unconventional types of oil in the ground.
3. The lost decade of fuel taxes
3.1. Recent attempts to reform EU fuel taxation In October 2003, less than one year before the largest enlargement of the EU, to the east, the Energy Taxation Directive (ETD) became law. It established a minimum tax level for motor fuels: 33 cent for each litre of diesel (during the initial years was a transitional value of 30.2 cent) and 35.9 cent for each litre of petrol. It included much lower taxation for certain categories of vehicles, such as machinery used in construction or vehicles used for agricultural or piscicultural works. Most member states also had exemptions for specific purposes, such as local public passenger transport vehicles, ambulances or national armed forces. In general, all road transport vehicles were covered by the ETD.
However, the Directive had some key shortcomings. For example, no binding review clauses or automatic inflation adjustments were included. This means that minimum taxation levels established back in 2003 have remained stable throughout the period. The European Commission itself recognised, back in 2011, OECD, 2012. Greenhouse Gas Emissions and Price Elasticities of Transport Fuel Demand in Belgium.