Taxing questions

The EU's new Taxation Commissioner Algirdas Semeta has announced that he is planning to revive previously shelved plans for an EU-wide carbon tax, aiming to set a minimum levy of €10/tonne of CO2 emitted (although the exact level is a bit unclear) from energy sources such as petrol, coal, and natural gas when they are used as motor and heating fuel, or to produce electricity.

Based on the Commission's previous proposal we've calculated that such a tax would cost the UK economy at least £3.2bn a year. This cost will hit poorer consumers and small businesses disproportionately hard.

Is the cost worth it? Well, a carbon tax can, and has worked in some member states - Sweden being the most conspicous example (the country has cut carbon emissions by 9% since introducing a carbon tax in 1991, while the economy has grown by 48% during the same time period). Unlike the EU's flawed Emissions Trading Scheme, a carbon tax would create a firm price on carbon (although still largely arbitrary) and ensure that polluters have to pay rather than being rewarded. This, in turn, would provide a strong incentive to switch to, and invest in, green energy. If replacing other, poorly targeted, CO2 policies a carbon tax could be the right way to go.

But apart from this discussion, the proposed tax raises two further important issues.

Firstly, why an EU-wide harmonised tax? We must remember that the EU already has all manner of climate change policy instruments playing different tunes. It has an extensive cap-and-trade system for large emitters of CO2, such as power generators and heavy industry. It has heavily prescriptive renewable energy targets and biofuel targets (the latter of which even the Commission now admits might be a mistake). It also has various other environmental regulations restricting emissions such as the Large Combustion Plant Directive, which will force the closure of nine of the UK's power plants by 2015.

Those in favour of an EU-wide tax say that it must be harmonised across Europe in order to avoid 'distortions to the Single market'. However other countries, Sweden for instance, have successfully implemented a domestic carbon tax without any detrimental impact on their economies.

But more importantly, if the stated end goal is not EU tax harmonisation in and of itself but emissions reduction, all that really needs to be decided at an EU level is the extent of the emissions reduction targets. As for the means, who cares? The job of meeting these targets should be left up to member states, who are best equipped to devise a policy mix tailored to their individual circumstances - and when it comes to energy, these are often very diverse.

A carbon tax may be a cost-effective option, or it may not. But it should not be the European Commission's job to decide.

This leads us to the second issue. There are understandable concerns that the Commission has an ulterior motive for its carbon tax. While the current proposal would see member states collecting the revenues from any tax, such "eco taxes" have long been seen by many within the Commission as a way of directly financing the EU budget - a view shared by EU President Herman Van Rompuy.

If such a carbon tax were established, it would clearly create an obvious focal point for those calling for an EU funding stream that bypasses member states' treasuries, with the ultimate aim being a direct tax.

All the more reason to follow a pragmatic approach that concentrates on the stated aim of cutting emissions at the lowest cost to businesses and consumers, rather than creating yet more centralised and complex EU rules that limit member states' ability to tailor climate change policies to their own needs.