Carbon Tax - Paying the price for power

Past attempts to introduce a carbon tax in Ireland were contentious and ultimately failed. With the Green Party now in government, Ireland should look to other countries for best practice in carbon policy. By Sheila Killen

Ireland's carbon emissions are more than 25 per cent ahead of 1990 levels, the benchmark year for the Kyoto agreement. The country is on track for a significant bill under Kyoto for carbon tax credits. A €270 million carbon fund has already been established to meet this obligation, and many feel it will be inadequate. Since this fund is financed from mainstream tax revenue, it is becoming clear that this is already a form of carbon tax, not targeted at polluters, but at taxpayers as a whole.

Scandinavia has led the world in environmental taxes since the early 1990s. In 1997 the Finnish tax was switched to electricity consumption rather than production, so as not to disadvantage exports of Finnish electricity.  Finland also imposed the tax at a higher rate on households, so as not to impair industrial competitiveness. Norway's carbon tax gives breaks to coal used for energy production, and to particular industries such as cement and fishmeal. Sweden transformed its energy costs to a carbon tax in the early 1990s, levied mainly on fossil fuels. The country's electricity production was already entirely based on renewable sources, so there was no environmental benefit to taxing it. The Swedish tax, together with taxes on sulphur and nitrous oxide, is credited with a 10 per cent saving in emissions. In these countries, the revenues from the carbon tax are recycled to reduce income and indirect taxes on labour.

The UK introduced the Climate Change Levy in 2000 as part of a range of measures, including regulations on the fuel efficiency of cars, and the use of renewable sources of commercial electricity. The tax is credited with a 5 per cent reduction in emissions. Unlike Finland, the UK levy targets industry rather than electricity producers or households. Again, the tax is revenue neutral, with revenues recycled by reducing the employers' share of labour taxes. In all of these countries, the double dividend of reduced emissions and reduced mainstream taxes seems to have been achieved.

Elsewhere, the imposition of carbon taxes has been more problematic. In the US, debate about a national carbon tax remains heated and divisive. New Zealand had a detailed proposal abandoned after a change in government. Canada has just introduced a tax on oil companies. It is not yet clear whether the cost will be passed on to consumers, though this seems likely. Switzerland has slated a fuel tax for introduction in 2008, and plans to recycle the income to health insurance and labour taxes.

So what can Ireland learn from theory and international experience? Firstly, resistance to the introduction of a carbon tax is to be expected, and planned for. Secondly, the tax will be most effective in reducing emissions when introduced as part of a package of measures including fuel efficiency, public transport, or electricity from renewable sources etc. Third, environmental taxes have proven most acceptable where revenues are recycled to reduce other taxes. The idea of reducing employers' PRSI is particularly useful, as it benefits industry and reduces a disincentive on creating employment. Fourthly, the tax needs to be pitched at a rate high enough to have a deterrent effect on emissions, and low enough to avoid penalising consumption of unavoidable goods, such as electricity. Fifth, before the tax can succeed, low-carbon alternatives must be in place for consumers, including better public transport, and the option of greener electricity and/or biofuels. The ultimate aim of the tax is to reduce emissions – to modify behaviour. Taxing “bad” sources of energy will only change behaviour if there are “good” sources out there to meet the demand.

Finally, and most contentiously, a political choice needs to be made on the balance between targeting households, as in Finland, or industry, as in other countries. A tax on fuel used by households will fall disproportionately on the poor. A tax on industry may damage competitiveness if revenues are not recycled efficiently. However, if no carbon tax is devised, both households and industry must foot the bill for Ireland's Kyoto obligations, and emissions will continue to rise. The design of Ireland's next carbon tax may be the most important piece of tax policy in the forthcoming budgets. Let us hope for political leadership.

Sheila Killian lectures at the Kemmy Business School, University of Limerick, Ireland.