Increasing carbon and material productivity through environmental tax reform

Environmental tax reform (ETR), a shift in taxation towards environmental taxes, has been implemented on a small scale in a number of European countries. This paper first gives a short review of the literature about ETR. An Appendix briefly describes the model used for a modelling exercise to explore, through scenarios with low and high international energy prices, the implications of a large‐scale ETR in the European Union, sufficient to reach the EU's emission reduction targets for 2020. The paper then reports the results of the exercise. The ETR results in increased carbon and materials, but reduced labour, productivity, with the emission reductions distributed across all sectors as a reduction in the demand for all fossil fuels. There are also small GDP increases for most, but not all, EU countries for all the scenarios, and for the EU as a whole. Both the environmental and macroeconomic outcomes are better with low than with high energy prices, because the former both increases the scale of the ETR required to reach the targets, and reduces the outflow of foreign exchange to pay for energy imports. ETR emerges from the exercise as an attractive and cost‐effective policy for environmental improvement.