On 4 March 2020 the European Commission has opened the first round of feedback regarding two new legislative proposals aimed at tackling carbon emissions and taxation of certain fuels. The proposals are planned to materialize into European Directives by mid 2021.

Currently the initiatives are in the earliest stages of European law-making procedure and inception impact assessment reports have been issued for both proposals. These initiatives are part of the EU’s new ‘European Green Deal’. Introduced on 11 December 2019, the Green Deal aims at transforming EU into a carbon-neutral economic bloc while retaining its market competitiveness and technological innovations. The Green Deal’s roadmap dictates that EU must become completely carbon neutral by 2050. As part of that measure, EU will gradually introduce new European Climate Laws in order to ‘turn political commitments into legal obligations’.

Carbon Border Adjustment Mechanism

The legislative proposal suggests the establishment of the carbon border adjustment mechanism aimed at preventing the phenomenon known as ‘carbon leakage’. Carbon leakage occurs when different jurisdictions have different carbon pricing and taxation policies in place resulting in different treatment of energy-intensive products. As a result, companies have fiscal incentives to shift their bases of production into jurisdictions with lesser or non-existent carbon pricing laws and then importing them back into EU. This mitigates EU’s effort at reducing carbon footprint and directly challenges the Green Deal.

The proposed carbon border adjustment mechanism would tackle this issue directly by putting price on the carbon burden of goods being imported to EU. The initial impact assessment notes that these tax rules will have to comply with WTO rules and TFEU Articles 192 [environmental measures] and 207 [common commercial policies] will be the legal basis of the new legislation.

The proposal is at a very early stage, hence there is no decision as to how exactly the carbon border adjustment mechanism will manifest itself – it could be in a form of direct carbon tax, carbon customs import duties or application of EU ETS on imports.

Detailed economic and social impacts assessments have not yet been made. The inception impact report does suggest that the tax measure could be of a regressive nature as the price of consumer products will most likely increase, suggesting that certain countermeasures will have to be implemented separately to offset the increase in costs of living, especially for vulnerable quartile of the population. The report also notes that the initiative will have a positive effect on job creation in EU as there will be less incentives for businesses to substitute European production efforts with third country ones that have less stringent carbon pricing laws.

Amendments to Energy Tax Directive

The second legislative proposal suggests amending the existing Energy Tax Directive 2003/96/EC to better reflect the market and technological developments in the fuel sector. According to the evaluation report of the Energy Taxation Directive published on September 11th 2019, Member States were left with considerable discretion in devising their taxation systems vis-à-vis fuels and electricity and the Directive in its current state can no longer be considered to be effective in meeting the EU environmental policy needs. This is further exacerbated by the existence of multiple exemptions, when Member States can choose not to apply the minimum rates of taxes on certain kinds of fuels, which the inception impact assessment acknowledges to be a form of de facto subsidies on fossil fuels. This goes against the Green Deal’s objectives of becoming a carbon neutral economic bloc.

The initiative proposes amending the minimum excise rates applicable to fuels to better reflect their carbon footprint/energy content. Furthermore, there will be further analysis into how should motor fuels and heating fuels be differentiated in terms of excise rates, exemptions and reductions.

According to the inception impact assessment report, the legislative amendments can incentivize investments into new fuel and electricity technologies as well as encourage the use of alternative sources of energy.

Similarly, to the carbon border adjustment mechanism, amendments to the Energy Tax Directive would lead to some regressive effects on the final consumer. The report acknowledges that price changes of motor and heating fuels is a powerful incentive for changes in consumer behaviors, but there will be challenges if the regressive effect of the taxes is not offset with countermeasures. Those may be, among other things, in a form of labor tax reductions or lump sum payments.

The two proposals can be seen within the broader context of Green Deal’s timeline as the 4th of March marks the first day of introduction of legislative work to reflect the political commitments to carbon-neutral Europe in law. The European Commission plans to review all EU and national legal measures for their consistency with the Green Deal’s objective by September of 2023. The revision exercises will be conducted thereafter on a 5-year period basis.

First round of feedback for both initiatives is open until April 1st 2020. The European Commission takes into account relevant feedback when developing and fine tuning the initiatives. Further information on the Carbon Border Adjustment Mechanism can be found here and on proposals for amendments to Energy Tax Directive here.