Fair and green: A new European grand bargain on tax is possible

European tax systems today are neither fair nor green. But a new political grand bargain on tax is now possible that can help boost jobs, fight inequalities and bring Europe’s economy back inside our planetary boundaries. Here’s how.

The tax burden has been shifting for years from corporate profits and personal wealth to labour income, particularly of lower wage earners, helping to stifle job creation and drive growing inequality in Europe. Meanwhile environmental taxes make up barely 6% of EU government revenues, over a third of EU carbon emissions are still not priced at all, and tax breaks across the EU amount to some 35 billion euros per year in fossil fuel subsidies, far higher than total government subsidies for wind and solar energy combined.

But there has never been a better time to flip this around, and build government revenues less on low-income labour, and more on capital and pollution. In the wake of the COVID-19 crisis, a new political grand bargain on tax is possible that can help boost employment, fight inequalities and bring Europe’s economy back inside our planetary boundaries. What could it look like?

Figure 1: Outline of a twin shift for fair and green tax reform

The first step would be lower taxes on labour, including targeted measures to cut income tax for low income households, and cuts to social security contributions (SSCs) for small and medium-sized enterprises (SMEs). In the near-term, this will help SMEs – that typically account for the bulk of employment, especially of more marginalised groups – to get back on their feet and help more people back to work as economic restrictions are lifted. The OECD reports that 25% of its members have introduced SSC waivers or cuts in response to the pandemic, including the US, where the Biden Administration extended the Employee retention tax credit enacted under Trump.

But it makes good sense to keep such measures over the longer term too, provided universal social benefits (like pensions) are funded through other taxes, particularly as automation trends threaten jobs. And if employers pass on the savings in higher wages, it could also enable shorter working weeks. That is a policy which is good for our health and the environment and – by freeing up more time for men to do care work – supports gender equality, too.

Second, governments can pay for these cuts and fund sustained investment in public services – instead of a return to austerity – by increasing taxes on corporate profits and personal wealth. After decades characterised by a race to the bottom on corporate tax rates in Europe and around the world, the Biden Administration’s corporate tax plan is simply a game-changer. If enacted, EU governments could recover more than 100 billion euros in revenues.

Beyond the Biden plan, the European Commission is pushing ahead with its own proposals to tax digital technology giants, an EU Financial Transactions Tax is back on the table, and the drum-beat is growing louder to tax the eye-watering pandemic wealth gains of, mostly male, billionaires. These are all measures that not only generate major new government revenues, but would help reverse economic and gender inequality. To strengthen their environmental benefits, higher capital gains rates could be applied to shareholdings in fossil fuel or other highly destructive industries.

Third, governments can seize the opportunity to end fossil fuel subsidies in Europe under the forthcoming revision of the Energy Taxation Directive (ETD), as part of a broader tax alignment with the EU’s environmental objectives. It is striking that OECD governments have to date focused tax rises to fund their pandemic recoveries on environmental taxes (see Figure 1) and ending tax exemptions for fossil fuels is also a strong theme of the Biden corporate tax plan.

 

Figure 2: Number of tax rate increases and new taxes introduced in response to the COVID-19 pandemic reported by the OECD

There is no question that the EU’s energy taxation framework needs an overhaul. Adopted in 2003, the ETD sets minimum tax rates for energy products and electricity in the EU that bare no relation at all to the carbon content of fuels, while allowing numerous exemptions and flexibilities that undermine the transition to carbon neutrality. Highly polluting diesel is taxed less than petrol, fuel for aviation and industrial fishing trawlers is not taxed at all, and there’s no requirement to incentivise electricity from renewables over fossil fuels, for example.

That said, reform won’t be easy. An earlier attempt from 2011-2015 ran aground after relentless industry lobbying to protect their tax breaks, and in many countries carbon taxes have become taboo for both the political left and right after the Yellow Vests protests. But while carbon pricing in home heating and land transport are regressive, the best chance to address this is likely as part of a broader package of progressive reforms to labour and capital taxes.

As part of this new grand bargain, energy tax revenues should be used to support lower income and marginalised groups. US Secretary of the Treasury Janet Yellen is among the advocates of direct lump sum payments, likely the best way to improve public acceptability. More efficient would be investing in low carbon alternatives, like public transport or subsidised electric heat pumps (with rent controls for low income tenants). And as the experience of countries like Sweden shows, a phased introduction will always help.

Designed in this way, reformed energy taxes can have multiple benefits. They can complement the Emissions Trading Scheme, establishing a comprehensive carbon pricing regime in Europe, covering 100% of emissions. They can help cut deadly local air pollution from cars, to which low-income groups in city centres are often disproportionately exposed. And if revenues help to expand safe, public transport, then women – who typically drive far less than men – and low-income households without a car will be among the main beneficiaries.

It is clear that tax reforms are not a magic wand – stimulating new decent jobs, lowering inequalities and redressing environmental harm require a swathe of supporting policies. And while the economy is so fragile and borrowing rates so low, there’s no immediate need to raise taxes to repay public debts. But trying to build a fairer, greener European economy without a major fiscal overhaul is like trying to swim with one arm behind your back. The window of opportunity is now open for governments and their social partners to design the twin progressive and environmental tax shifts we need.