Replacing energy taxes with a higher VAT would result in more effective environmental policies

The Swedish energy and environmental tax system does not contribute to society’s resources being used optimally. Moreover, it is difficult to grasp. This is concluded by professors Runar Brännlund and Bengt Kriström in a new SNS report. They propose abolishing the energy tax and increasing the VAT, in addition to abolishing unjustified environmental taxes and subsidies.

Fossil fuels currently constitute an important tax base, but this tax base is rapidly shrinking as a result of current developments. Furthermore, the energy tax system is extremely complex, consisting of instruments with unclear objectives and a plethora of special rules and exceptions. That is why, according to the researchers, change is needed.

The point of departure for the two researchers is that broad tax bases are preferable to narrow tax bases and that environmental taxes should be used when environmentally justified. That is why they propose abolishing the energy tax and increasing the VAT. They have calculated that if energy taxes were to be abolished, the resulting drop in tax revenues could be covered by scaling up the different VAT rates by around 8 percent. This means a 2 percentage point increase in the highest VAT rate and a 1 percentage point increase in the food VAT rate, which is currently at 12 percent.

“We here see an opportunity to achieve the climate goals at a lower cost while at the same time improving the Swedish economy. Our proposal also contributes to a more sustainable tax system”, says Runar Brännlund, professor of economics at the Centre for Environmental and Resource Economics, Umeå School of Business, Economics and Statistics, Umeå University.

Reduced energy taxes would subsequently reduce the price on fossil fuels, which would in the short term lead to increased carbon dioxide emissions and reduced air quality. However, according to the researchers, this may be offset by environmental policy instruments such as a carbon dioxide tax and road tolls.

“Based on our proposal, a number of ineffective environmental policy instruments can be abolished without any negative consequences on the environment. Here, we include instruments such as the aviation tax, bonus-malus, the tax on plastic bags and overlapping regulations and subsidies such as the Climate Leap Program”, says Bengt Kriström, professor of resource economics, Swedish University of Agricultural Sciences (SLU), and senior advisor, the Centre for Environmental and Resource Economics, SLU and Umeå University.

This proposal is revenue neutral for the public sector. Using a model developed by the National Institute of Economic Research, the researchers calculate the effects of the proposal on the climate and the Swedish economy. They find that the Swedish GDP increases by SEK 1 billion per year compared to a reference scenario involving current taxes. This includes applying fairly substantially increased carbon dioxide taxes in order to achieve the 2030 climate target. This result is a conservative estimate since increased efficiency resulting from simplified taxation is not taken into account.

“Mainly low-income households in sparsely populated areas benefit from our proposal, as these households spend a relatively greater portion of their money on electricity and fuels”, says Runar Brännlund.

A comparison between sectors shows that agriculture is a winner, as is the electricity sector. In practice, however, many sectors are only affected to a very limited extent since there are so many exemptions from energy taxes.

Although going from energy taxes to VAT seems to have a positive impact on the environment, the researchers are aware there are short-term obstacles with regards to implementing the proposal. Not only is there an EU directive on minimum tax rates, there is probably also political opposition with regards to increasing the VAT. Furthermore, it would also represent yet another example of the “bumpiness” in Swedish energy policy.

“In the longer term, however, the chances of our vision becoming a reality look good. However, in light of climate change adaptation, the time has come for the Riksdag to seriously address this issue already at this stage”, says Bengt Kriström.

The report is published within the framework of the SNS research project Taxes in a Globalised World.

Download a summary of the report Swedish Energy and Environmental Taxation – A Reform Proposal