The carbon tax as an important lever for climate-friendly solutions

The carbon tax as an important lever for climate-friendly solutions
19 Okt 2021

Since January 2021, the new carbon tax is intended to encourage consumers and companies to save energy and to drive forward the energy transition. It makes products which are harmful to the environment more expensive – with the aim of promoting the development of low-emission alternatives. But the carbon levy is not uncontroversial.

Germany is currently failing to meet its own and internationally specified climate policy targets. By 2030, annual greenhouse gas emissions must be reduced by at least 55% (compared to 1990). They must be reduced by at least 80% to 95% by 2050. But the energy transition is stalling at the moment: the proportion of electricity generated by renewable energy is still far too low and is actually shrinking. This is shown by current figures from the German Association of Energy and Water Industries (BDEW). According to the BDEW, in the first three quarters of 2021, renewable energy covered around 43% of total electricity consumption. Back in 2020, this proportion was significantly higher, at 48%.

But why are climate protection measures not being implemented sufficiently at the moment? One important reason is that, until now, greenhouse gases haven’t had an appropriate price. This is where the carbon levy or carbon tax comes in. Since January 2021, the government has been using it to encourage consumers and companies to switch to environmentally friendly solutions. But because the prices for oil, gas and coal are currently being driven by inflation (as of mid-October) and threatening to slow down the post-Covid recovery, the carbon levy is regarded with considerable scepticism.

In France, for example, at the end of 2018 a carbon tax resulted in the yellow vests protests. The name comes from the yellow high-visibility vests worn by those demonstrating. The protests (some of which became violent) were against the additional fuel tax of 7 cents on a litre of diesel and 3 cents on a litre of petrol planned for 2019 – after a general price increase of 18% in 2018.

This article attempts to explain the fundamental thinking behind the carbon tax, and describes the advantages and disadvantages.

Market economy approach

A carbon tax is a levy on emissions of the greenhouse gas carbon dioxide. This makes use of a market economy approach. The aim is to make products which are damaging to the environment more expensive than less harmful alternatives, and therefore to make these products less attractive. The underlying idea: when the demand for products which are damaging to the environment falls due to their price, they will be used more sparingly – and consumers and companies will look for more environmentally friendly alternatives.

That means it will be easier for consumers to be more environmentally friendly, because products which protect the climate will be cheaper compared to the more harmful alternative. For companies, this results in a strong incentive to develop new, low-emission products. So a price on carbon would reduce carbon dioxide emissions and could become a key tool for climate policy.

There are two options for setting the carbon dioxide price: trading certificates and the carbon tax. With the first option, affected companies purchase certificates which give them the right to pollute with greenhouse gas emissions. The price is variable, because the certificates are purchased via national or European emissions trading. In contrast, the second option – the carbon tax – sets the price directly.

The current carbon tax: 25 EUR per tonne of carbon dioxide

In Germany, there has been a carbon tax on petrol, diesel, heating oil and gas since January 2021. Previously, only businesses such as airlines or industrial companies had to pay for emitting carbon dioxide, because they produce large quantities of greenhouse gases. But with the uniform carbon dioxide price, all those who offer or use products or services – and, in doing so, emit carbon dioxide – must pay. Specifically, the charge is 25 EUR per tonne at the moment. This should increase to 55 EUR per tonne by 2025.

So motorists, renters and house owners will have to pay more for petrol, heating oil or gas. At a price of 25 EUR per tonne of carbon dioxide, the cost of petrol increases by around 7 cents per litre. The price increase for diesel and heating oil is around 7.9 cents per litre. For natural gas it goes up by around 0.6 cents (gross) per kilowatt-hour – and the rise is set to continue.

To cushion the blow, the plan is to reduce or entirely eliminate the Renewable Energy Sources surcharge – currently 6.5 cents per kilowatt hour of electricity – over the coming years. Tax relief for commuters will probably also be increased to offset higher petrol prices. Other measures such as a per capita bonus are conceivable to ensure the impact on wider society is not unfair. The income from the carbon tax would be used to help low-income households, so that they get more back than they pay out.

For and against: is it fair?

But the carbon tax is not uncontroversial. Here are the most important pros and cons:

Benefits

  • The carbon tax works using the polluter pays principle. Those who pollute more must pay more. So the carbon tax promotes environmentally friendly behaviour.
  • This responsible behaviour is awarded indirectly, because no additional taxes must be paid. So, for example, people who often travel to work by bike instead of going by car every day have an advantage.

Disadvantages

  • Even without a new carbon levy, the tax burden in Germany is already very high. What’s more, this tax burden integrates existing environment-related taxes which have not solved the climate problem.
  • The carbon tax risks overburdening low-income households.
  • A tax does not directly prevent excessive carbon dioxide emissions. It is questionable whether people will really change their behaviour or just pay the extra. Commuters in rural communities for example, rely on their cars to get to work.

As a matter of principle, the objective of the carbon tax in Germany should be to reduce emissions efficiently and not to acquire additional tax revenue. For the general population to accept this tax, the government needs to return this additional income, for example via a flat payment for every inhabitant or through a reduced electricity tax.


Stefan Winklhofer