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Monday, 15th April 2024
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Incentivising us to be greener - what can tax do? Back  
The Programme for Government commits the Government to phase in fiscal measures to lower carbon emissions, including a carbon levy over its lifetime. Hence the new Commission on Taxation has been asked to prioritise work in the area of carbon tax. Brian Daly explains why the carbon emissions tax agenda is much wider than the concept of a carbon levy and gives some food for thought on possible pitfalls and opportunities in this area.
The issue
Under the Kyoto Protocol, many developed countries committed to reduce their greenhouse gas emissions. Ireland’s commitment was to limit emissions to no more than 13% above 1990 levels in the period 2008-2012. However it is estimated that Ireland’s actual emissions will be c.22.6% above 1990 levels by 2010. Carbon dioxide released from the burning of fossil fuels (coal, oil and gas) is the focus of most emissions reductions efforts.

In order to meet our targets and avoid steep fines, Ireland will have to purchase ‘carbon credits’. This is facilitated by the “emissions trading” regime under which industrialised nations can buy and sell emissions credits, or acquire credits via investment in projects in developing countries. This will entail significant economic cost (estimated at least €540m over the next 5 years but possibly much more depending on the final tonnage cost of credits).
Brian Daly


We need to make more progress in actually reducing emissions. However, a carbon tax is not necessarily the panacea which it is sometimes presented as in this regard. It is possible that it could have inflationary effects without generating corresponding environmental benefits. Its potential introduction therefore needs careful consideration.
In looking at carbon emissions tax policy, thought needs to be given to the following three elements:
• Demand side – reducing carbon intensive energy consumption
• Supply side – incentivising greener energy production
• Carbon Trading Market
Green demand - “carrot and stick” approach
Carbon tax - an effective “stick” to curb demand?
A carbon tax is a tax on the carbon dioxide emissions from burning fossil fuels, thus discouraging the use of products with high emissions. The recent overhaul of the motor taxation and VRT systems reflects the concept of carbon taxation. Many climate change economists believe that carbon tax is the lowest cost way to reduce emissions. However, it has its shortcomings.
It cannot promise a fixed emissions reduction within a fixed time-frame and, for example, historical evidence suggests that increases in fuel costs and associated taxes have to reach very high levels before behaviour changes. Arguably carbon taxes are regressive – disproportionately affecting poorer households.

The terms of reference of the Commission on Taxation (‘the Commission’) indicate an intention that such tax would be introduced on a “revenue neutral” basis, presumably meaning the tax would be redistributed to taxpayers in other ways, e.g. via reductions in other taxes. In reality, this will be difficult - if the tax succeeds in its objective of reducing emissions, amounts collected will decrease over time. Will other taxes then be increased again to compensate? Or will the carbon tax rate increase to allow previously reduced taxes to remain the same? If this happens, will it have negative economic effects?

These are difficult questions and the Commission will need to review other countries’ experiences e.g. Sweden and Denmark who have enacted carbon tax regimes with reliefs for companies who commit to environmentally friendly alternatives.
A difficulty is that there are so many factors at play in this area that there is no certainty as to what impact tax policy may have. For example, will the new car tax regime ensure a significant switch to lower-emissions, lower-taxed vehicles or will retailers increase prices of these cars to reflect increased demand and might disproportionately high diesel prices counteract the tax benefits of lower emissions models for customers, resulting in a return to petrol models?

We don’t know the answers and constant monitoring of actual results will be critical. However one certainty is that any further carbon taxes will only alter behaviour if consumers have alternatives. Given our relatively poor public transport infrastructure, it is not clear that further taxes could reduce car usage substantially. Presumably analysis can be undertaken on car usage patterns for the last few months with soaring fuel costs to establish the elasticity of the market as, in theory, prices
should be encouraging reduced fuel usage already.

In the current inflationary environment and with additional excise duty on electricity looming for businesses following this year’s Finance Act, there is a risk that further carbon taxes could move industry to pastures less “green” and cause undue hardship on individuals without sizeable carbon emissions improvements.

“Carrots”:
More incentives are needed to positively encourage use of low emissions alternative products.
This year’s Finance Act introduced an accelerated 100% write off for the cost of certain energy efficient equipment acquired by companies. While this idea is to be commended as an initiative, it is too limited in terms of who can avail of it and the type of equipment which qualifies, which must be specifically named on an approved list.

UK experience has already proven similar legislation introduced there to be impractical. Most large projects involve payment of a lump sum for bigger spend items and getting the detail to check that individual components are on a “list” will be painfully time consuming, at best, and impossible at worst.

The tax benefit is only one of timing. Given our low 12.5% corporation tax rate, an additional upfront tax credit, alongside existing wear and tear allowances, with more practical conditions attached, may prove more influential to purchase decisions. This initiative needs further review.

Consideration could also be given to provision of credits and/or VAT and stamp duty incentives to encourage individuals to purchase/build energy efficient homes and invest in making existing homes more efficient, through insulation, solar/geothermal heating systems etc.

Green supply - tax incentives
Without alternative sources of energy supply, penalties intended to curb the demand for carbon intensive energy will, to a large extent, become a burden on the consumer and will fail to achieve the required reductions in emissions. Tax incentives can have an important role in encouraging “green supply”.

Mobilising financiers
We have a relief for equity investment by corporates in renewable energy companies, whereby the amount invested can be written off for tax purposes against total income subject to various onerous conditions and limited caps. Given our low corporate tax rate of 12.5% and the fact that the investee would expect to share in the benefit, this does not represent a significant incentive and has attracted only very limited interest.

Consideration should be given to replacing this system with tax credits - giving Euro for Euro relief, along with an increase in the amounts of expenditure which can qualify and a relaxation of
the conditions.

There are also lessons to be learnt from other countries. As one of our partners, Mike Hayes, outlined in a Tax Monitor article last September, the US has been advanced in its thinking on incentivising green energy supply.

For example, mechanisms have been introduced whereby Production Tax Credits (“PTCs”) and accelerated depreciation deductions (“MACRs”) for certain environmentally friendly energy generation can be monetised. Thus, institutions who invest can obtain tax benefits from these incentives at the early stages of industry development, where the energy producers themselves are likely to be still incurring losses. The financier normally exits the structure once a certain return has been achieved, leaving ongoing returns to the developer. Canada and the Netherlands have also introduced incentives worth reviewing in this area.
Another area to explore is a possible refinement of the leasing ring fence provisions to enable financiers who lease, for example, wind farm assets to developers, to offset the allowances against non leasing income, making these structures more tax attractive.

Attracting R&D to Ireland
There is still a long way to go to develop reduced carbon or carbon-free energy generation alternatives into commercially viable large scale products. Cutting edge scientific research is ongoing into possibilities like genetically modifying bacteria to improve the output of certain bio fuels, permanently capturing carbon rather than releasing it into the atmosphere etc.
Ireland has very successfully utilised tax policy to attract inward investment when global expansion of certain industries was at its peak over the years, e.g. manufacturing, pharmaceuticals, internet, financial services etc.

It is almost certain that environmental research will be a huge growth area in the short to medium term. Is there an opportunity for us to attract some of this R&D activity to Ireland?

Ireland has general provisions for R&D credits equal to 20% of qualifying incremental R&D expenditure over a base year. However, a form of “super R&D credit” granted on an absolute rather than incremental basis, given in cash form to companies in loss making start up situations, could be a good starting point for attracting renewable energy projects.

Of course, tax policy alone will not achieve this. Maybe now is the time to overtly incentivise science and mathematics again in the third-level points system?

Carbon trading market
Carbon trading markets are often viewed as commercial alternatives to carbon taxation. The relevant EU market is the EU Emissions Trading Scheme (“EU ETS”).

As part of Ireland’s efforts to meet emissions target, following agreement at EU level, government agencies grant allowances to industrial firms to emit certain levels of greenhouse gases, essentially a form of cap. If companies exceed their allowance they must buy more “carbon credits” on the ETS. If they come in under the allowance, they can sell the excess, thus making money or at least recouping some of the cost of making environmental improvements.

The cap ensures that targets to reduce emissions by a specific amount can be met. In a sense, carbon becomes a trade able commodity, of interest to the markets. Companies see tangible benefits to going green if they can sell excess credits.
Pricing is volatile however – e.g. if adverse weather conditions cause energy companies to burn more fuels than predicted, more credits will have to be bought and increased prices will be passed on. Ongoing administration and supervision are needed to ensure caps are not breached and that stated emissions savings are made and some environmental purists disagree with the concept of effectively allowing some companies to buy their way out of environmental change.

Emissions trading is growing in popularity however and looks like it may be here to stay. It is welcome therefore that this year’s Finance Act provided some support to this market by extending the definition of “financial asset” for the purpose of our securitisation regime to include “greenhouse gas emissions allowances” which will allow the Irish securitisation of emissions allowances on a tax neutral basis. A new stamp duty exemption for the transfer of such allowances further enhances Ireland’s attractiveness in this area. We need to watch out for further innovative opportunities for Ireland to benefit from the trading opportunities arising from environmental reform.

We will also need to consider the framework for taxing flows in relation to emissions trading, where little guidance is available except in relation to VAT matters. Perhaps consideration could be given to introduction of a direct tax policy which grants a tax deduction for the purchase of credits but exempts income from their sale thus encouraging companies to reduce emissions to realise tax-free income from the sale of excess allowances?

Small piece of global jigsaw?
Climate change is a global problem needing global solutions. The issues are complex but we, like other countries, must face this challenge, drawing on best practice around the EU and beyond.

Tax policies will need to be capable of being flexed, as appropriate, in view of behavioural impacts and latest environmental science to ensure the outcomes of incentives are still desirable. For example, the pitfalls of over zealous policy encouragement are seen in the current demand squeeze for food crops and massive scale deforestation in Brazil and the Far East, exacerbated by the bio fuel frenzy.

Ireland has a track record of innovation on environmental change, such as the plastic bag levy, the smoking ban, the switchover to smokeless fuels. When given alternatives, the population has been shown to be very open to change.

Whatever the Commission decides on carbon tax will need to be supplemented by measures to improve the supply of green energy, to encourage R&D activity in this area and to incentivise environmentally-friendly consumption practices amongst industry, agriculture and consumers alike.

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