On 7 February 2022 the European Environment Agency (EEA) issued a briefing entitled The role of environmental taxation in supporting sustainability transitions. This examines trends in taxes on pollution, greenhouse gases and resource use and considers their potential for increasing revenue and supporting sustainability.

It is widely understood that tax systems must be updated to cope with present day challenges arising from environmental, social and economic issues. Taxation systems must be capable of dealing with issues around digitalisation, demographic changes, inequality and environmental crises.

The necessity for a shift in emphasis from labour taxes to environmental tax has long been recognised, but despite this there has been little progress on phasing out environmentally harmful subsidies, and the revenues from environmental taxes have not increased sufficiently.

The EEA briefing notes that revenues arising from environmental taxes could support the transition to a climate-neutral economy by 2050; and achieve a net 55% reduction of greenhouse gas emissions by 2030, in line with the European Green Deal. There are currently strong reasons in favour of shifting to environmental taxes owing to population ageing which will ultimately lead to lower labour tax revenues and higher welfare system costs.

The EEA briefing points out that implementation of environmental taxes has been very slow. In the EU, the revenue from environmental taxes accounts for 5.9% of total taxes, which is less than in 2002 when the share was 6.6%. The revenue from environmental taxes varies by country, but the European countries that took the lead in introducing environmental taxes have also seen a decline in revenue from these taxes as a percentage of total taxes.

This trend arises from the problem that effective environmental taxes influence the behaviour of the taxpayers and as a result the tax base for these taxes is eroded over time. The main focus of environmental taxes needs to be to support the environment and climate objectives, rather than to raise more revenue.

The European Green Deal gives an important role to taxation in supporting the transition to a sustainable economy, including carbon pricing measures and changes to facilitate the transition to a greener economy. Higher government revenues will result from changes to EU energy taxation and carbon pricing, including the EU Emission Trading System. As Europe transitions away from non-renewable energy, the tax base will be eroded, so the correct balance must be found between attaining the environmental objectives and maintaining revenue. This means that new sources of tax revenue must be found.

Although EU countries have been slow to shift their tax systems away from labour taxes towards environmental taxation, a more comprehensive and sustainable tax reform could take place in the next decade as a greater role is given to taxes on other revenue sources such as financial transactions, digital services, property transactions and wealth.