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Carbon Tax
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How to tackle climate change in an efficient way

Carbon TaxBy Lorenzo Sala

According to many international rankings, Sweden is among the top countries for quality of life. Certainly, one of the key factors making Sweden such an attractive place to live in is environmental quality. Sweden is a leader among European countries in environmental policies, and this is shown by the fact that since 2011, only 1% of waste has ended up in landfills, while the remaining 99% has been recycled or used for district heating. This success relies on both a shared culture of respect for the environment that has strong roots in Scandinavian countries, as well as a fiscal policy often forgotten in the international debate: the carbon tax.

In 1991, Sweden was among the first countries to implement a carbon tax on fossil fuels. It was integrated with the existing energy tax that has been lowered and which is now at the minimum level set by the EU. The shift from a general tax on all energy products to a tax burden depending on the CO2 content of fuels has set a strong incentive to reduce emissions. The possible adverse impact on the economy has been minimized by starting with a low tax level and increasing it gradually. Nowadays, Sweden has the highest carbon tax in the world (€137/tons of CO2), and from 1990 to 2015 it decreased its CO2 emissions by 25% while having a GDP growth of 69%. The carbon tax is collected through a small number of fuel distributors and large energy consumers. Moreover, it is administered in the same way as the energy tax on fuels. Therefore, it implies low administrative costs (0.1% of revenue) and a very low rate of evasion (less than 1%) with respect to other taxes. So far there has been a higher tax rate for households and services and a lower tax rate for many industries in order to prevent the risk of carbon leakage, that is to say, the delocalization of energy-intensive firms in more polluter-friendly countries. However, in 2018 these tax rebates will be phased out. The carbon tax has also been integrated with the EU Emission Trading System, which puts a cap on the emissions of power generators and many other industry sectors requiring the purchase of allowances to pollute. The allowance price has been too volatile and too low to give a strong price signal, and indeed the ETS system is currently being reformed. However, the cap on emissions and the Renewable Directive have developed remarkably renewable energies in Europe (even if much still needs to be done).

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Thanks to its policies and to the high degree of innovation of its firms, Sweden is nowadays leading the transition towards renewable energies, with more than half of its final energy consumption coming from renewable sources. But the results have also been outstanding in sectors not covered by the EU ETS, such as transports and residential heating. This shows that the carbon tax has been useful to give a stronger price signal to incentivize a low-carbon economy and to apply the “polluter pays” principle also to other sectors of the economy so far ignored by policies in other EU countries. Carbon tax revenues have been used to offer alternative low-carbon solutions with investments in housing insulation and public transportation. In the past years, the rise in environmental taxes has also been used to cut income taxes, with a focus on low incomes. Such an approach has been followed by the British Columbia Carbon Tax that became effective in 2008 as a revenue-neutral tax, which means that all the money raised has been returned to citizens via tax cuts (BC has income tax rates for corporations and individuals that are among the lowest of OECD countries).

What should be learnt from the Swedish practice? First of all, that GDP growth and CO2 emissions can be decoupled. Secondly, that carbon tax and carbon pricing in general are the most cost-effective ways to reduce carbon emissions, because by applying a uniform price to emissions, polluters will reduce emissions until their marginal abating cost equals the carbon price. This means more saving for firms and citizens more efficient in abating emissions, and thus a stronger incentive to invest in low emission technologies than with command and control policies like pollution standards.

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Thus, so far in Italy, why do none of the major parties appear to strongly support the carbon tax? That’s a good question, since not only would it be beneficial for the environment, but it could also help cut other distortionary taxes as well, like the high labour cost Italian firms face.

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