Fuel taxation

In April 2011, the European Commission proposed to update the EU's energy tax law which, among other things, sets the minimum levels of road fuel taxation in Europe. Read our briefing here. Since April 2011, the Commission proposal has been discussed by EU finance ministers, but because any changes to EU rules tax issues have to be agreed unanimously by all 28 national governments, negotiations are a long drawn-out process.

Illustration of a blue steam roller driving accross euro notes

What’s the problem?

The EU Energy Tax Directive sets a minimum tax level for different kinds of fuels, including diesel, petrol and heating fuel. Most important from an environmental point of view is the diesel tax minimum rate, since lorries in international traffic systematically make detours to fill their tanks in the countries where the fuel tax is lowest.

Fuel used in international aviation and shipping is currently not taxed l. This is a massive indirect subsidy to these industries. And in addition, aviation is also privileged with a VAT exemption, subsidies for building and running airports and for opening new air routes. It’s also a hangover from protecting the nascent aviation sector in Europe in the 1940s and 1950s, which has been perpetuated in the Energy Tax Directive. It created a hurdle which requires a government wishing to apply a tax to conclude bilateral agreements with all 28 other EU countries to apply a tax to fuel used for fights between European airports.

If this fuel tax loophole were closed, just in aviation, to be on a par with fuel taxes in road transport, it would raise an additional €20-32bn per year for public finances. However, this would only end the exemption for flights within Europe – ending the exemption for flights to and from Europe would require a renegotiation of air service agreements (ASAs), which currently prohibit such taxation.

On the ground, some countries act as "fuel tax havens", deliberately setting their diesel taxes lower than their neighbours in order to attract hauliers to fill their lorries there, thereby increasing their tax revenues. The most obvious example is Luxembourg where diesel sales per inhabitant are 5-8 times higher than in the neighbouring countries and the extra diesel tax revenues are sufficient to cover 4-5 percent of the national budget. This "diesel tourism" causes extra traffic, but most seriously, it makes it difficult for other countries to use fuel taxes as a tool to reduce greenhouse gas emissions from transport in a cost-efficient way.

This explains why fuel taxation – in conflict with the general perception – has steadily decreased over the last 10 years in real terms (inflation-adjusted). Relative to both energy content and greenhouse gas emissions and despite the proven damage that diesel fumes cause to our health, diesel tax is much lower than petrol tax across Europe. The generous tax treatment of diesel is a major explanation for the dramatic increase in the diesel share among new cars and to a large extent explains why traffic is responsible for a growing share of CO2 and air pollutant emissions.

What should be done?

The continuing failure by the EU and member states to tax fuel used in international aviation and shipping must come to an end.

The minimum level of fuel tax should be increased, particularly for diesel, to tackle the problem of diesel tourism. This will give national governments more fiscal independence to set tax rates without fearing loss of revenues to tax-haven countries, and so make fuel taxes a more effective element of climate policy.

In the longer term, it would make much more sense to tax fuel ‘where you burn, not where you buy’, to reflect real emissions in different countries and to put an end to harmful fuel tax competition. This already happens in the US and Canada (the International Fuel Tax Agreement, or IFTA), where lorries pay fuel taxes according to the fuel used, not the fuel filled, in each state/province. This gives states total independence in setting fuel tax rates in line with their (climate, energy, environment) policy goals.