Revision of the Energy Taxation Directive - guide

13 April 2011
by eub2 -- last modified 13 April 2011

The European Commission has presented a proposal to overhaul the outdated rules on the taxation of energy products in the European Union. The new rules aim to restructure the way energy products are taxed to remove current imbalances and take into account both their CO2 emissions and energy content. Existing energy taxes would be split into two components that, taken together, would determine the overall rate at which a product is taxed. The Commission wants to promote energy efficiency and consumption of more environmentally friendly products and to avoid distortions of competition in the Single Market. The proposal will help Member States to redesign their overall tax structures in a way that contributes to growth and employment by shifting taxation from labour to consumption. The revised Directive would enter into force as of 2013. Long transitional periods for the full alignment of taxation of the energy content, until 2023, will leave time for industry to adapt to the new taxation structure.

What is the Energy Taxation Directive?

Energy taxes already exist in all EU Member States, and are harmonised to a certain degree at EU level. The current Energy Taxation Directive, adopted in 2003, was designed primarily to avoid competitive distortions in the energy sector within the Internal Market. It sets out common rules on what should be taxed, when and what exemptions are allowed. Minimum rates, based mainly on the volume of energy consumed, are laid down for products used in heating, electricity and motor fuels. Above these minimum rates, Member States are free to set their own national rates as they see fit.

Why does the Commission want to revise these rules?

The current Energy Taxation Directive is outdated in that it does not address the EU's higher ambitions in energy and climate change policies. It also needs to be revised to address problems that have emerged in the Internal Market. Finally, its current scope is incoherent with that of the EU Emission Trading System (ETS) which is biggest international scheme for the trading of greenhouse gas emission allowances.

Firstly, the current minimum rates for energy products are mainly based on volume (EUR/1000l) and are set according to historical rates in the Member States. This creates unfair competition between fuel sources and unjustifiable tax benefits for certain types of fuel compared to others. For example, under the current minima, coal is the least taxed and ethanol is the most taxed. Renewables face particular discrimination under the current Energy Taxation Directive, because they are taxed at the same rate as the energy source they are intended to replace (e.g. biodiesel is taxed the same as diesel etc). As this rate is based on volume, rather than energy content, products with lower energy content such as renewables carry a heavier tax burden compared to the fuels they are competing with. This issue would be addressed in the Commission's revised Directive, because energy tax would be linked to energy content.

Secondly, from a climate change point of view, the current Energy Taxation Directive does not address in any way the need to reduce CO2 emissions. In fact, as just outlined above, certain fossil fuels are taxed more favourably than cleaner competitors. An EU framework would allow Member States to apply a CO2 tax to meet their effort sharing targets, without fear of jeopardising their competitiveness within the EU.

Finally, a revised Energy Taxation Directive with a CO2 element would prevent a patchwork of national policies from creating obstacles and distortions in the Internal Market. Member States are already beginning to introduce their own national CO2 taxes, but different interpretations can lead to double taxation and high compliance costs for businesses operating cross-border. An EU approach to CO2 taxation would create a level playing field for industry across the EU, and make cross-border activity easier. CO2 taxation would not be applied to renewables, providing them with a further advantage compared to the conventional fuels they are competing with.

What are the main objectives of the proposed new Energy Taxation Directive?

The revised Directive aims to restructure the way in which energy is taxed to support the objective of moving to a low-carbon and energy-efficient economy, and to avoid problems for the Internal Market.

    Climate Change: By introducing a CO2 element into energy taxation, the proposal aims to bring energy taxation in line with the EU's climate change commitments. A price will be put on CO2 emitted by sectors outside the EU ETS: the higher the emissions of a particular fuel are, the higher the CO2 tax will be. This will reward greener energy sources and extend the efforts to meet the EU's targets on CO2 reduction, energy efficiency and renewable energy.

    Energy Efficiency: Energy is scarce, and taxation should reflect this. Linking the level of tax to the energy content of fuels would create a great incentive across all sectors to be more energy efficient.

    Internal Market: Creating an EU framework for CO2 taxation would avoid a patchwork of environmentally friendly tax policies amongst Member States, giving businesses more legal certainty and reducing compliance costs. The proposal would also make a distinction between sectors covered by the EU ETS and those outside it, which would help to avoid double taxation.

    Promote growth and jobs: Member States could decide to operate a growth-friendly tax-shift, increasing taxation of energy products to reduce the tax burden on labour in line with the 2020 Strategy.

What changes will the new proposal bring forward?

Taxes on energy would be split into 2 components: one based on CO2 content and the other based on energy content.

CO2: A single minimum rate for CO2 emissions (20 €/t CO2) would be introduced for all sectors not covered by the EU ETS. This would provide a carbon price for these sectors of the economy, namely households, transport, smaller businesses and agriculture that are outside the EU ETS. Renewable energy sources would not be subject to this CO2 element.

ENERGY: Minimum tax rates for energy would be based on the energy content of a fuel (€/GJ) rather than the volume. This means that a fuel will be taxed on the basis of the amount of energy that it generates, and greater energy efficiency will automatically be rewarded. The energy component of the tax will help to remove current distortions for competing energy sources (e.g. petrol and diesel) and will make taxation fairer for consumers because energy content is more important than volume when it comes to energy consumption. One GJ would be taxed in the same way, regardless of the product producing it.

Both CO2 and energy content elements would be combined to produce the overall rate at which a product is taxed. Member States will be free to set their own rates above the EU minima, and design their own structure for these taxes: for instance, they could decide to only increase the energy-content tax element above the minima and not the CO2 element or the other way round). However, the same rates and structure must then be applied to all fuels used for the same purpose (motor fuels or other fuels).

Long transitional periods for the full alignment of taxation of the energy content, until 2023, will leave time for industry to adapt to the new taxation structure.

What is the scope of the proposal?

The energy element of the tax would apply to all fuel used for transport and heating. Non-fuel related uses of energy products will remain outside the scope of energy taxation as is currently the case (e.g. in metallurgical processes).

The CO2 element of the tax will complement the emission trading system by applying to sectors that remain outside (transport, households, agriculture and small industries). In this way, all emissions from industrial installations will be subject to one CO2 price signal.

Why now?

A number of reasons explain why it is now the opportune moment for the Commission to table this proposal. Firstly, as Member States design and implement their strategies to meet the EU 2013-20 energy and climate change goals, this proposal would provide a clear answer on the role that taxes could play. Secondly, the revised Energy Taxation Directive is designed to complement the third phase of the EU ETS (2013-2020) which will set forth an EU global CAP and provides for the move from allowances to auctioning. It is therefore urgent to make a proposal now to allow time for it to be agreed by Parliament and Council.

From an Internal Market perspective, it is also important to establish a common framework for CO2 taxation now. Member States are beginning to introduce their own CO2 taxes and their approaches may differ. A patchwork of national policies could create difficulties for businesses operating cross-border, and distortions in competition within the EU. It is therefore better to introduce an EU approach now, rather than later, when complex re-adjustments of national laws may be needed.

Lastly, the revision of the Energy Taxation Directive is also an element in the Europe 2020 Strategy and responds to a request made by the European Council of March 2008. It also echoes the UN Climate Change Conference that was held in Cancun, Mexico, in November and December 2010. In that way, it would contribute to sustainable growth, and the promotion of a more resource-efficient, greener and more competitive economy. Given that many Member States are now defining their policy strategies to exit from the economic and financial crisis the revised Energy Taxation Directive also provides opportunities to match environmental and economic targets. It would allow them, if they so choose, to shift some of the tax burden away from labour or capital and towards taxation that promotes environmentally-friendly, energy-efficient behaviour. Many different stakeholders, the European Parliament as well as a number of Member States, NGOs and parts of the business community are urging the Commission to come forward with this proposal as soon as possible.

How will the proposal promote energy efficiency?

The Commission has committed to promote energy efficiency to improve both EU competitiveness and security of supply while achieving more ambitious greenhouse gas reduction targets. Taxation is a powerful tool to steer consumers towards a more resource-efficient use of energy. Taxing energy products according to their energy content is the most efficient approach to incentivising a more efficient use of energy as it gives the user a clear price signal linked to the real "energy value" of the product he consumes.

As regards the energy component of the tax, the proposal will also strengthen the relevance of the minimum rates by ensuring that reductions below the minima will no longer be possible for businesses. Furthermore, the possibility to grant reduced tax rates, that would however need to be set above the minima will have to be clearly linked to the achievement of energy efficiency objectives, e.g. through industry agreements with verifiable savings objectives.

How will the new proposal take into account pollution?

The proposal will take into account the CO2 emissions of fuel in the tax system by applying a CO2-related tax element to fuels that are not covered by the EU ETS. As CO2 emissions do not know frontiers and are of a cross-border nature, it makes sense to address the issue in the common EU taxation framework. On the other hand, when it comes to local air pollution it is more appropriate that the Commission leaves the choice of instrument to Member States. In fact, other instruments such as road or congestion charges might be used in a more targeted way to address these issues than energy taxation.

Why does the Commission propose minimum rates rather than full harmonisation of energy taxes?

The approach of minimum rates was chosen as a compromise solution in 1993 in order to both limit distortions in the Internal Market and allow Member States some flexibility to fulfil their budgetary needs. While the general approach is still valid, it is important that the minimum rates laid down in EU legislation remain meaningful and are regularly updated regularly to take into account economic, political and international developments.

What is the impact of the revised Energy Taxation Directive on motor fuels?

Its impact will depend on a number of factors, including existing tax levels and the way Member States decide to structure their taxes around the new minima. The main impact for all Member States will be that they will have to end the current distortive tax treatment of petrol and diesel. The latter is currently taxed at a lower rate per litre than petrol in all but one Member State (UK) in spite of its higher energy and CO2 content per volume. This has led to a situation where market price signals cannot fulfil their role any more: while the price for diesel (before tax) is higher than the price for petrol (due to an excess in demand for diesel in the EU), this relationship is reversed at the pump because of the tax system. This in turn leads to ever higher demand for diesel in spite of its shortage in the EU. The proposal will end this distortion by applying neutral taxation to petrol and diesel as well as other motor fuels after a transitional period of a ten years period to allow market actors to adapt their industrial processes. Most Member States will be able to achieve this either through an increase in diesel or a reduction in petrol rates.

What will be the treatment of alternative motor fuels such as LPG (liquefied petroleum gas) and CNG (compressed natural gas)?

The Member States that promote CNG and LPG often apply very low levels of taxation to these products. Nevertheless, the overall level of take up has so far been rather limited.For more consistency, the same tax rates per energy and CO2 content should at the end be applied to all motor fuels, including CNG and LPG. This means that the relative advantages of each fuel in terms of CO2 emissions will be automatically rewarded through the tax system, but beyond that no competitive advantage will be given. However, since current tax rates on these products are often quite low and a certain timeframe might still be needed until they can compete equally with traditional motor fuels, the new Directive foresees long transitional periods for the alignment of tax rates. Member States may therefore continue to award beneficial treatment to CNG and LPG for twelve years.

What will be the impact of the proposal for biofuels?

Currently, biofuels are taxed on the basis of volume, at the same rate as the fuel they are intended to replace, which puts them at a competitive disadvantage. Under the proposal, biofuels would be taxed on the basis of their own – generally lower – energy content. They would also be exempt from the CO2 element to reflect their better performance as regards CO2 emissions. However, this positive treatment is reserved to biofuels complying with relevant sustainability criteria as defined in Article 17 of the Renewable Energy Directive (2009/28/EC) and in Article 7b of the Fuel Quality Directive (2009/30/EC).

What will the impact be for heating fuels?

For heating fuels, too, the new Directive will remove current distortive treatment of energy products by obliging Member States to apply the same level of tax per t/CO2 as well as per GJ. This means for example that current very low tax rates on coal, which is the product with the highest CO2 content, will have to increase.

At the same time, with the introduction of a CO2-based element, taxation of heating products will for the first time reflect the climate-related effects of the products. As all businesses subject to the EU ETS will be automatically exempted from this tax element, the proposal will also lead to a level playing field between installations inside and outside the ETS and ensure that all emitters contribute to the Green House Gas reduction effort.

What is the treatment of electricity?

In principle, the revised Energy Taxation Directive will not change the treatment of electricity. As before, energy content related tax will be levied at the point of consumption and the minimum rate won't be modified.

As for the CO2 element, it could only be levied on the input fuels used to generate electricity as electricity does not lead to emissions at the point of consumption. However, electricity generation is subject to the EU ETS and will therefore be exempted from the CO2 element. Nevertheless, the CO2 element will apply to small electricity generation installations falling out of the ETS because of their size.

Will the proposal have an impact on nuclear energy?

The proposal will not affect the treatment of nuclear energy. Electricity from nuclear sources is taxed at the point of consumption like electricity coming from all other sources. Taxes on nuclear fuel such as the one recently introduced in Germany fall outside the scope of the Energy Taxation Directive and are therefore not affected by the present revision.

How will the new proposal affect households?

Households make up 10% of CO2 emissions, so Member States will have to include this sector in their strategies, regardless of the means they wish to use (e.g. CO2 tax or requirement to replace heating systems). Environmental policies sometimes impact household budgets – particularly lower income households. Therefore, it is acknowledged that ambitious environmental policies should have solid safety nets and be accompanied by social measures. The impact of the proposed new energy/CO2 tax would depend largely on how Member States decide to recycle the revenue from this tax. For example, they could use part of the revenue to compensate households (particularly low-income ones) with lump sum payments. Part of the energy tax revenue could also be effectively redistributed to greatly minimise the impact for households. It is very common that the Member States which already introduced a CO2 tax, have accompanied such measures with effective social measures.

In addition, the proposal will continue to allow Member States to opt for a reduced rate for energy products used in domestic heating. However, unlike under the current Directive, where this option of a reduced rate applies only to natural gas, coal and electricity, Member States will be able to apply such an exemption equally to all heating fuels for domestic purposes (including gas oil an coal). The Commission will review the effects of this exemption provision in a report after two years.

Will it take into account specificities of certain sectors?

One of the objectives of the revised Energy Taxation Directive is to ensure that energy taxation applies in a more consistent and effective way throughout the EU. The new tax system would therefore only distinguish between sectors under the ETS where a carbon price already applies and those outside the ETS which will have to pay the CO2 element.

Nevertheless, in order to avoid adverse effects, certain specific rules are being proposed for those sectors with a risk of carbon leakage (i.e. industries that emit green house gas and could be tempted to displace their production out of the EU to remain competitive). They will benefit from a tax credit based on the evolution of their consumption for the CO2-related tax element. To a certain extent, the specificity of agriculture will continue to be reflected in the revised Directive given that full exemptions from the energy tax element will remain possible if certain engagements in favour of environment and energy efficiency are taken.

Finally, certain transitional periods have been proposed in order to avoid brutal changes for users of certain energy products (such as diesel, see above).

What about imported goods?

Putting a price on carbon emissions linked to production within the EU can lead to distortions vis-à-vis producers from third countries where similar mechanisms are not in place. The majority of greenhouse gas emitting industries at risk of "carbon leakage", are covered by the ETS. In this context the EU has taken the decision to counter the risk of carbon leakage by distributing a higher share of free allowances to the sectors at risk, rather than by trying to impose a "carbon border tax" on imported products. Therefore, the revised Energy Taxation Directive does not provide for a "carbon border tax" on imported products. The non-ETS industries that would be subject to the CO2 element are generally smaller and, less susceptible to international competition and possible carbon leakage. Nevertheless, the proposal contains provisions for installations in sectors that may be at risk of carbon leakage (e.g. sectors with a high energy intensity and trade exposure such as a number of mineralogical processes), in the same way as provisions are made for industries at risk under the ETS. These will receive a tax credit for the CO2 element based on historical energy consumption, a solution which shields them from unfair competition while leaving the incentive to reduce their own emissions in place.

To sum up, what are the current exemptions under the energy taxation Directive and how will they be like in the future?

Member States will to a large extent retain the flexibility that they enjoy today, in line with the energy and climate policy objectives.

    As regards motor fuels, the proposal aims to apply a consistent treatment of all products in terms of energy and CO2 content after a transitional period. Therefore, existing exemptions for biofuels, CNG (compressed natural gas) and LPG (liquefied petroleum gas) will be phased out over time (until 2023). It means that in 2023 each product will only benefit from exemptions if justified by its CO2 balance.

    As regards heating fuels used by businesses, current rules allow Member States to reduce tax rates down to zero for energy intensive businesses and down to 50% of the EU minima for other businesses, under certain conditions. In order to reduce competitive distortions between Member States and avoid State aid problems, the revised Directive will allow for discretionary tax reductions by Member States only under the condition that the EU minima are respected (for both the energy and the CO2 tax component). On the other hand, businesses participating in the EU ETS will automatically be exempted from the CO2 tax component; furthermore companies from sectors exposed to a risk of carbon leakage will receive a mandatory CO2 tax credit. Both rules will be applied on a mandatory basis by Member States, which will avoid distortions.

    As regards domestic heating, the current flexibility for Member States to exempt some products (gas, coal and coke and electricity) will be extended to all heating fuels (including mineral oils) to allow for consistent treatment for energy products. At the same time the Commission will report on the effect of this exemption in its regular report assessing whether it is in line with its energy and climate policy objectives.

    Concerning agriculture, it will continue to benefit from lower tax rates, although these will now depend on the environmental objectives to ensure that agriculture also contributes to the sharing effort to save energy.

    Member States will retain the option to apply more favourable tax treatment in cases where this is justified from an environmental point of view, such as to electricity of renewable origin or highly efficient cogeneration of heat and power.

    Today's proposal will not change the current exemptions for international aviation and maritime transport because of existing international obligations and the risk of competitive distortions in the case of unilateral actions from Member States. However, these exemptions will also be re-examined in the regular Commission's report on the application of the Directive.

    Nine new MS (Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Slovakia) will benefit from a transitional period until 2020 during which they will not have to implement the CO2 element. This is justified by their generally lower income level.

Will the minimum rates be adapted to external developments such as inflation or the development of the CO2 price?

Yes. It will be one of the key advantages of the proposal. Minimum rates will adapt to external developments such as inflation or increases/decreases of the CO2 price. The revised Energy Taxation Directive will therefore reflect more these external factors. The energy-content related minimum tax rate will keep its real value and will be adapted every three years according to the core inflation rate (inflation rate of products excluding food and energy). As for the CO2-related minimum rate, the Directive foresees a regular revision to ensure that it is in line with the CO2 price under the EU ETS and that competitive distortion between ETS and non-ETS companies are minimised in this respect.

Which countries have already put in place a carbon tax?

Today, Denmark, Ireland, Finland and Sweden have a carbon tax in place. However, these national rates are fixed at very different levels and do not reflect the carbon price under the EU ETS.

When will the revised Energy Taxation Directive come into effect?

The revised Directive would begin to apply from 2013, to work in parallel with the third phase of the EU ETS. There would be an appropriate phase-in period for Member States to restructure their taxes, to allow national administrations, businesses and the energy sector time to adjust. Long transitional periods for the full alignment of taxation of the energy content, until 2023, will leave time for industry to adapt to the new taxation structure.

Source: European Commission