Many viable routes for EU to reach a workable fuel tax

It now seems that the revision of the Energy Tax Directive (ETD) is dead. Given how negotiations have been dragging on for three and a half years while only eating away at everything the Commission proposal sought to achieve, it is probably good to call it a day and start afresh.

For transport the ETD is a crucial piece of legislation, potentially even the most effective climate legislation for transport in Europe so far. Why? Mainly because it has put a floor, of 33 cents a litre, under diesel taxes for trucks. Would that floor not be there, many member states would be tempted to lower their diesel taxes to seduce foreign trucks to fill up, and with that fill up the state’s coffers too. It’s a clear example of harmful tax competition that the ETD has managed to prevent to an extent. Still, countries like Luxembourg, Austria and Slovenia have been benefiting enormously from their small size and strategic location by keeping their diesel tax for trucks low and get rich in the process. And this in turn makes it difficult for their neighbours to raise their fuel taxes. Meanwhile, the gap between diesel and petrol taxes is as wide as ever, maintaining Europe’s dangerous addiction to diesel. This is a problem from an environmental, energy and industrial standpoint; we will publish a paper on this imbalance later this year.

The ETD is 11 years old now, and inflation has done its work: the 33 cents of 2003 are equivalent to 42 cents now; so in real terms, EU minimum fuel taxes have dropped by around a quarter. Is this a problem? Yes it is; it is far better to tax oil for transport than to tax other things such as labour. In fact, it is a perfect time for fuel tax increases: oil prices are dropping, deflation not inflation is a worry for the EU, and there is an enormous need to lower labour taxes to tackle unemployment. 

So what went wrong? Obviously one problem is that each of the 28 member states has a veto on tax issues. The UK, outside the euro, can block moves by the eurozone towards greater tax coordination, and so can tiny Malta, Luxembourg or Cyprus. This is a fundamental issue for the economic governance of the euro that, sooner or later, will need to be resolved.

But this is not the full explanation. The Commission strategy on fuel taxation also leaves a lot to be desired. 

As said, there are two problems with fuel taxes in Europe. The first is harmful diesel tax competition – particularly important for trucks. The second is the persistent gap between petrol and diesel taxes, which is a problem for cars. The Commission in 2002 and 2007 proposed to tackle the truck problem by increasing minimum diesel taxes for trucks. Then in 2011 it made a U-turn by proposing that member states should tax diesel as heavily as petrol, to address the car problem. If member states would have done this by raising diesel taxes to petrol levels, the result would have been more fuel tourism with trucks, not less. And in addition the Commission proposed to separate taxes into an energy and a CO2 component. This is quite an academic exercise with little meaning in practice, but it carried a huge political burden because of the vitriolic aversion of some member states, led by Poland, to the very word CO2.

What to do now? It’s still early days but clearly there are two pointers. First, if Europe sticks to its harmonisation approach, it should clearly separate what it wants to see for truck diesel (closer alignment between member states) and car diesel (closer alignment with petrol), and facilitate differentiation between the two. An additional idea is to differentiate between rules for eurozone and non-eurozone countries, since exchange rates can fluctuate strongly, and to have some provisions to account for differences in GDP per head. 

Then the numbers-and-timetables approach could be replaced by a principles-based approach. One could be that minimum rates are inflation adjusted, or that they go up if oil prices fall. Another could be that every national decision should narrow, not widen, the gap between petrol and diesel tax for cars. Another could be that truck diesel taxes cannot be lowered if the neighbours levy higher ones.

Europe can also go another way – not to harmonise truck diesel taxes but enable differences to happen. Funnily enough the US and Canada have done exactly this with their states and provinces. They have set up the International Fuel Tax Agreement (IFTA) which makes truckers pay their fuel tax depending on where they drive, not where they fill up. It works, there is no tax leakage and no fuel tourism, and hence full fiscal independence. It is an old system with fairly primitive administration that the EU could surely improve upon. Europe could start by allowing countries that operate road tolls for trucks to add CO2 to the tolls. 

The solution will probably have to be a combination of these points. It won’t be easy but it won’t be in vain either: people are increasingly aware that lower diesel tax for cars is a bad idea. Italy and the Netherlands, for example, have taken action to close the gap, and the recent new Belgian government accord contained a similar measure. The EU should keep its foot on the accelerator. Now that is a nice test of political courage for our new Commission president from Luxembourg.

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