ICAEW.com works better with JavaScript enabled.

An international comparison of green tax policy

Author: Stuart Lisle and Martin Callaghan

Published: 01 Jul 2022

An international comparison of green tax policy article image

BDO’s Stuart Lisle, Tax Partner, and Martin Callaghan, Director, Tax Assurance & Risk Management, reveal the results of a comparative review for ICAEW.

Under the 2015 Paris Agreement, 197 countries agreed to try to keep global temperature rises ‘well below’ 2% (and preferably below 1.5°C) to avoid the worst impact of climate change. To achieve this, it is believed that net zero must be reached by 2050. Net zero refers to a state in which the greenhouse gases going into the atmosphere are balanced by their removal out of the atmosphere.

ICAEW has worked on this comparison of green policies with Global Tax and Advisory firm BDO. BDO’s Global Tax practice undertook research among its tax professionals regarding the ‘green taxes’ policies in their jurisdictions. With responses from more than 35 jurisdictions, it assessed how the UK’s environmental tax policies compare internationally, in order to determine whether other countries had implemented policies that the UK government could consider as it builds its green tax agenda.

Each country was asked for details regarding:

  • firm commitments on net zero;
  • specific areas in which green tax changes have been introduced;
  • green-focused incentives, such as increased tax relief for research and development (R&D) and green investment; and
  • whether a desire for behavioural change was a factor underlying any of the tax policy changes.

It quickly became clear that only a few jurisdictions have a coherent strategy for using the tax system to achieve net zero. Many policies appear to have been hampered in their effectiveness by a lack of realistic alternatives for businesses and consumers. Furthermore, many conflate the need for a tax system to raise revenue with the need to influence behaviour.

Progress in the major economies

The UK was the first G7 member to enshrine the move to net zero in law. This was followed in France by the enactment of Law No 2019-1147 on energy and climate, which provides for achieving carbon neutrality by 2050, and Germany by the Climate Protection Act, amended in 2021 to bring forward the target date for greenhouse gas neutrality to 2045. 

Whether reflected in legislation or not, G7 countries have a consistent desire to meet the net-zero target. Several have set interim targets for reducing carbon emissions by 2030. 

The responses from BDO member firms reveal that the approach to achieving carbon neutrality is less consistent. Some jurisdictions lean towards the stick (France), while others take a more incentives-based approach (Germany). Some (Japan, for example) rely on less regulated nudges towards behavioural change.

According to the current French administration, environmental taxation is one of the main economic tools at its disposal to promote the transition to a decarbonised economy, through changing behaviours of households and businesses. The French approach consists of integrating the costs of environmental damage (called ‘negative externalities’) into the price of goods and services.

Increasing the cost of polluting goods and services is seen as a key element to strengthen the competitiveness of recyclable products to steer producers and consumers towards more environmentally friendly activities and sectors. Thus, the incentive for ‘better’ environmental behaviours is that the more polluting choices are more expensive (the polluter pays). This ranges from the Taxe générale sur les activités polluantes (TGAP), aimed at industries responsible for the release of polluting emissions, to reduced tax-deductible amortisation for more polluting cars. 

Germany has also introduced several measures that seek to ensure that the polluter pays. These include an aviation tax, which imposes a tax burden on air travel as an environmentally harmful means of transport, and environmental charges for the disposal of waste. Alongside this are greenhouse gas quotas and elevated pricing related to CO2 emissions that make fossil fuels more expensive.

Evidencing a more holistic approach to tackling the problem of climate change using tax, Germany has also introduced several ‘carrots’ aimed at rewarding good behaviours. For example, tax incentives are available for the construction/renovation of real estate, for measures that contribute to the efficient use or saving of energy (eg, solar power, heat pumps, etc). Additionally, Germany is promoting a switch to e-mobility with subsidies and tax breaks, especially for company or occupational vehicles.

To move passengers away from air travel, a reduced rate of VAT applies to long-distance rail tickets. Significant efforts are also being made to increase R&D in green technology. The direction of travel is interesting, with a reduced VAT rate on products of plant origin or organic meat being discussed to discourage the consumption of highly damaging mass-produced and ultra-processed foods. 

The Japanese government’s measures may not be remarkable compared with those of France or Germany, but its Ministry of the Environment has revised the plan for combating global warming. It reset the target for 2030 as a 46% reduction from 2013 (up from a 26% reduction target set in 2016). This led to several laws for environmental measures being updated.

Under current Japanese tax laws, the global warming countermeasure tax applies to all fossil fuels according to environmental impact (CO2 emissions). It has introduced the ‘carbon neutral investment promotion’ incentive to eligible enterprises. This provides a tax credit or special depreciation deduction for capital investment that produces products with significant decarbonisation effects (eg, lithium-ion batteries) or achieves decarbonisation in their manufacturing processes.

The US offers several green energy tax credits and incentives at the federal level. At state level, there is significant variation, with California at the vanguard of change. Tax credits and incentives also focus on the US automotive industry, with both Michigan and Tennessee creating new tax incentives for the development and production of electric vehicles.

In Canada, there is an imminent ban on single-use plastics that is somewhat broader than the UK’s plastic bag tax and new plastic packaging tax. There is also a federal fuel charge that varies depending on the carbon content of the fuel. In provinces where the fuel charge is administered by the federal government, all revenues collected in a province are returned to households and businesses in the province through a refundable income tax credit.

Interesting ideas from smaller economies

Turning the spotlight on some of the measures being introduced by smaller economies reveals some innovative, interesting ideas for the UK to consider. 

The government of Guyana believes that the country is already at net zero. To retain this position, fiscal policy includes the waiver of taxes on energy from renewable sources and the use of electric vehicles. Guyana also introduced a corporate tax waiver for certain investments in renewable energy. Renewable energy equipment can be written off over two years for tax purposes. Additionally, import duties on renewable energy equipment, electric cars and charging stations are waived. These programmes differ from many of the G7 policies by promoting positive behaviours, rather than punishing poor behaviours.

Although the UK’s capital allowances system effectively offers 100% tax relief through, for example, the annual investment allowance, it remains a relatively blunt instrument with little to support the net-zero agenda. HM Treasury’s invitation to comment on reforming the UK capital allowance regime does not mention targeted reliefs.

Estonia has introduced a series of green tax measures, including natural resource and pollution charges, packaging excise duty, and road usage fees for heavy goods vehicles. Iceland closely follows the ‘polluter pays’ model, taxing fossil fuels based on CO2 emissions. This model is also followed in both China and Spain, with policies that disincentivise ‘bad’ behaviours through higher environmental taxes rather than incentivising less-polluting behaviours.  

An inconsistent approach

Although there is a broad global consensus on the net-zero target, the responses indicate that there is a less-than-consistent approach in terms of tax policy. There are certainly common areas of focus, such as the use of ‘pollution’ taxes, the move towards the use of electric vehicles and efforts to reduce plastic packaging by taxing single-use plastics. But the overall impression is an unstructured, piecemeal approach in most economies. 

There is no easy answer. There are wider implications to both the ‘polluter pays’ and ‘incentives’ models. What is needed, we suggest, is a combination of both.

The Organisation for Economic Cooperation and Development (OECD) has made stunning progress in aligning minimum tax standards around the world. We can only hope that the OECD’s next major tax project will seek to align minimum standards in green tax policies.

Polluter pays

The polluter pays model undoubtedly has a beneficial impact on behaviours. In the UK, for example, there was a dramatic reduction in the issue of single-use plastic bags following the introduction of the plastic bag charge. However, changing behaviour is possible only when the polluter, in this case the consumer, is provided with a viable and acceptable alternative.

Relying exclusively on a punitive approach raises some concerns. Increased behavioural taxes can accelerate a move to outsource bad behaviours to other jurisdictions (or carbon leakage). There is a need to look at the entire supply chain, rather than adopting an ‘out of sight, out of mind’ attitude. 

Increased costs that inevitably fall on the end user, disproportionately affecting those with lower incomes, are likely to be unpopular and vulnerable to political pressure as the political cycle moves towards an election, and could be seen as damaging to UK businesses that compete globally.

There are some ways to mitigate this last point. For example, from 2026, the EU proposes adopting a ‘carbon border adjustment mechanism’ to ensure that products imported into the EU are taxed if they do not meet EU CO2 standards. The UK may also adopt this approach. But unless similar policies are adopted globally, this new levy may be considered protectionist.

The more successful taxes are in changing behaviours, the less revenue they will generate. For example, vehicle excise duty and fuel duty raises £33bn for the Exchequer, an estimated 3.4% of all receipts in 2022/23. Electric vehicle owners pay no fuel duty or vehicle excise duty. What is going to fill the revenue gap – particularly considering the unpopularity of road pricing measures? Fifteen years ago, a petition against the introduction of road pricing attracted more than one million signatures. 

Incentivising behaviour

The use of incentives is an approach adopted in several jurisdictions, largely related to the use and provision of electric vehicles and capital investment in energy-efficient assets.

In South Korea, the use of specific enhanced incentives for R&D is expanding. It recently extended the technology criteria to 48 types of carbon reduction technologies such as carbon capture, usage and storage, hydrogen, and renewables. In addition to extending the R&D tax credit, it has also increased cash grants for foreign investors who back this technology in Korea.

Given the short timeframe for meeting the net-zero target, the fact that specific green R&D tax credits do not appear within many of the other jurisdictions’ tax toolkits is surprising. It is an area in which the UK government could follow South Korea’s lead.

It would be a mistake to focus solely on relief/incentives for obviously green sectors, such as offshore wind generation. What is needed is for all businesses to develop greener ways of operating.

What can we learn?

Taxation policy is a key driver in the move towards net zero. The UK government should be both innovative and ambitious if it is to meet its objective to be carbon neutral within the next 30 years. To achieve targets, the approach should encompass the behaviours of all taxpayers – individuals and businesses alike – and apply consistently throughout all stages of the economic cycle. For individuals, these behaviours include the use of transport, household waste (including food waste) and the energy efficiency of homes. Businesses should be encouraged to enable a more sustainable approach.

Overall, incentives should be prioritised over punitive taxes. This will encourage both good behaviours and the development of new technologies to be incorporated into a green ‘business as usual’ for the UK. But climate change is a global problem, so we hope that the UK government will engage with the OECD to tackle this global issue, as well as setting high standards here.

About the author

Stuart Lisle, Tax Partner, and Martin Callaghan, Director, Tax Assurance & Risk Management, BDO in UK