Climate Change Series As the world enters a punishing economic downturn, the urgent task of engineering an energy revolution seems more difficult. The growth of “green” industries could play a big role in economic recovery. But mounting budget deficits will squeeze governments’ ability to find the cash for more subsidies and make them wary of inflicting further damage on hard-hit industry and consumers by ratcheting up the price of carbon.
So far, the growth of green energy sources has owed relatively little to governments’ faltering efforts to put a price on carbon. The most dramatic strides in green technology have been achieved using less cost-effective but more politically palatable tools: principally investment tax credits, subsidies and price supports, such as feed-in tariffs for renewable energy.
The US is challenging Germany to be the world leader in wind energy generation – thanks to the former’s generous renewable energy production tax credits, which cover 50-60 per cent of total project costs. After months of uncertainty, the tax credit was renewed in October as part of the economic rescue package that bailed out the banking sector.
In Europe, feed-in tariffs, under which energy companies have to buy renewable power at an above-market price, have been the main driver of the strong growth in renewables in countries such as Germany and Spain.
Few doubt that large-scale subsidies have an important role in spurring the continued development of renewable energy sources. Fred Copeman of Ernst & Young’s tax credit investment advisory group says progress in the US has been critically dependent on the production tax credit. “Without this array of incentives, the cost of generating energy from renewable sources versus fossil fuels has simply been too high to justify their development,” he says.
But subsidies can only offer a partial, temporary solution. A recent report by the Intergovernmental Panel on Climate Change said that subsidies, while critical in aiding the penetration of new technologies, tended to take on a life of their own, making them difficult to eliminate or reduce. The Organisation for Economic Co-operation and Development has also warned against using subsidies to promote technology “winners”, citing the failure of biofuel programmes, which proved costly and pushed up food prices.
Ultimately, increased use of economic instruments that put a price on carbon – either by taxes or the sale of carbon permits – will be needed.
Finding the political will to impose a higher price on carbon is unlikely to be easy. In spite of the rhetoric of the past 20 years, progress has been held back by concerns about competitiveness and the impact on poorer households. Currently, industrialised countries raise just over 2 per cent of gross domestic product from environmental taxes – mostly long-established taxes on vehicles and vehicle fuels.
The exemptions in existing energy taxes – introduced to protect energy-intensive industries and poorer households – have limited their effectiveness. A 2006 analysis by the European Environment Agency found that green taxes would need to be raised 15 per cent to yield the equivalent of a 2 per cent increase in labour taxes.
But governments have begun the process of putting a higher price on carbon. Europe has introduced an emissions trading scheme in which permits will be auctioned. Australia is working on a trading system expected to start in 2010. Seven states in the US are working on a trading system, while Barack Obama, US president-elect, is expected to consider a trading scheme as part of his plan to achieve sweeping cuts in carbon emissions by 2020.
Governments have also introduced myriad tax measures designed to spur businesses and individuals into going green. The UK recently increased the climate change levy, the energy tax on business. It also introduced controversial changes to car taxation to persuade individuals to shift to more efficient vehicles. And businesses are offered enhanced capital allowances that give them 100 per cent first year tax relief on energy-saving investments.
Some European countries, led by the Scandinavian states, introduced ecological tax reform in the 1990s, in which new taxes on energy were offset by reductions in labour taxes. In the US, income tax credits, sales tax exemptions, property tax abatements and recycling credits from states, counties and cities are all used to offset the cost of renewable energy investments or other emissions reductions. In China, energy conservation projects can win businesses a three-year tax holiday; and equipment used in wind generation and hydropower receive an exemption from customs duty and value added tax. In Japan, businesses receive tax credits for investing in renewable power.
But speaking in September, Angel Gurría, secretary-general of the OECD, said that the emphasis would increasingly be on raising money from carbon emitters – either through heavier green taxes or by trading schemes.
“Cap-and-trade schemes, or emission taxes, are cost-effective because they induce firms to look for abatement options where they are cheapest, and boost incentives to scale up climate-friendly R&D. Leaders must build on recent developments and act now to make greater use of economic instruments,” he said.
Vanessa Houlder is tax correspondent
