10. Towards a cost-effective and green taxation system in the Nordic countries

10.1 Cost-effective environmental taxes in theory

Taxes directly address market failures that causes markets to ignore environmental impacts. A well-designed environmental tax increases the price of a good or activity to reflect the environmental cost it imposes on others. The cost of the environmental “externality” – is thereby internalised into the market prices (OECD, 2011). This ensures that consumers and firms take these costs into account in their decisions. In theory it is easy to introduce a cost-effective environmental tax scheme for clean technologies: Implement environmental taxes as high as the external cost for every unit of emission. According to economic theory all measures to reduce the emissions that cost less than or equal to the external cost will be implemented by actors as they take the cost of tax payments into account. Furthermore, the polluter pays principle would be fulfilled and the government will receive revenues, making it possible to lower other taxes that instead inhibit the economy, such as income taxes.

10.2 Obstacles for cost-efficiency

Do we have a cost-effective taxation system for clean technologies in the Nordic countries? No, the taxation system is far from cost-effective. In general, the taxation system in the different Nordic countries is non-cost-effective for several reasons:

There are several environmental taxes on carbon dioxide, while other emissions in many cases lack taxation. Those emissions are often regulated in other ways, but if allowed, other emissions are usually free to emit up to emissions limit values of other regulatory instruments such as licenses.
Carbon dioxide taxes have very different levels in different countries worldwide. This makes the system cost-inefficient on an international level. The marginal cost to emit one unit of carbon dioxide varies also greatly between countries.
The same is true when we examine the Nordic levels. Carbon dioxide taxes differs significantly between the Nordic countries, see part 1 of this report. For instance, if a low carbon technology, profitable in one Nordic country, is non-profitable in another Nordic country this will lead in cost-ineffective decisions on reducing carbon dioxide on a Nordic level.
Also, the national taxations systems for carbon dioxide are non-cost effective as different economic sectors have different tax levels for carbon dioxide. All Nordic countries have exceptions for different sectors that pay less, or no tax for climate emissions. For example, exceptions existed for the shipping industry and operators included in the European Emission Trading System, the EU ETS-system resulting in different actors facing different levels of carbon prices. Hence, a typical car owner, facing a higher carbon price will usually be willing to pay more to lower its emissions, than a typical ship owner making the investments in clean technology suboptimal. The proposal adopted by the European Commission to include maritime transport activities in the EU ETS will reduce price differences and suboptimality.

There is a plethora of reasons behind the use of different carbon prices levels, one of the most prominent relates to the fact that national policymakers tend to take international competition into account, thus avoid taxing national companies much higher than their international competitors (OECD, 2022b).

10.3 Economic policies for increased cost effectiveness

Since there are many reasons behind the non-cost-effectiveness of the taxation system today, there are many possible policy changes which can increase the cost-effectiveness. In this section, we will discuss what the Nordic countries can do, in order to contribute towards a more cost-efficient green taxation system on an international level. The policy changes discussed are listed below.

Including more activities and countries in the EU ETS-system
Use the same tax level for each type of emissions
Less exemptions and reduced taxes
More equal tax levels between countries
Taxes on consumer goods, instead of on the producer
Implement environmental taxes on other emissions as well

Including more activities and countries in the EU ETS-system

The most common exemption from paying carbon dioxide tax in the Nordic countries are operators listed within the EU ETS system. The EU ETS system includes all EU countries and Norway, Iceland, and Lichtenstein. Starting around 10 EUR in early 2009 due to oversupply of credits, prices increased to an almost record-high of around 30 EUR in mid-2019 and has since then continued to increase. End of December 2021, the cost for the right to release one ton CO₂in the system was 80 EUR (Ember, 2022). The EU ETS systems covers emissions from industries, power plants and domestic flights within EU.

This implies that many economic sectors that are exempt from paying carbon dioxide taxes - instead must pay for emitting carbon dioxide. Nonetheless, some sectors are obliged to pay both national carbon dioxide taxes and a fee to the EU ETS system, while some sectors still were not included in the EU ETS system as of 2021 and some sectors still do not pay national carbon dioxide taxes. The economic sectors which are excluded from national carbon dioxide taxes, or that qualify for lower taxes vary greatly between the Nordic countries. There are always good reasons for these exemptions, such as juridical, economic, or political reasons. However, from a socio-economic point of view such exemptions are ineffective and will lead to higher overall costs in order to reduce carbon dioxide emissions.

To increase cost-efficiency the Nordic countries can work together to achieve the following objectives:

Work together to persuade more countries to connect to the EU ETS systems. One way to achieve this could be to use incentives for new countries to join or link other systems to the EU ETS. For instance, since 1 January 2020, there is an agreement to link the ETS registries of the EU ETS and the Swiss ETS.
Take active part in the ongoing discussions about potentially expanding the EU ETS system to include other sectors such as transport, buildings, agricultural, and waste (European Environment Agency, 2022).

Less exemptions and reduced taxes

Beyond the connection to EU ETS system, all Nordic countries have national carbon tax systems as described in part 1 of this report. Two reasons behind this double regulation are that the EU ETS system does not cover all emissions, thus the emission system alone is not powerful enough for the Nordic countries to reach their climate goals.

All Nordic countries have carbon tax exemptions or tax rate reductions for different sectors. We have studied data on exemptions and tax reductions from the World Bank (2022). One important reason behind the reductions and exemptions is the international competition. If firms in some countries do not have to pay a tax, or a lower tax, they get competitive advantages and opportunities to outperform companies in countries with higher tax levels.

When studying the coverage of different carbon dioxide tax schemes in the Nordic countries (see table 32) we find large differences. If we start with the coverage of the carbon taxes, they often, but not always, exempt operators covered by EU ETS system. The Nordic country with the highest coverage of the carbon tax is Norway (63%), while Finland (36%) and Denmark (35%) has the lowest coverage. A low coverage of the tax is a sign of the tax not being cost-effective. A cost-effective tax scheme results in the same margin cost for climate investment across all sectors. A low coverage of the carbon tax will result in some climate investments being profitable in some sectors, while non-profitable in others. In the last column of Table 32 we make a comment about the coverage.

Country	Coverage	Exemptions	Cost-effectiveness
Sweden	40%	Operators covered by the EU ETS, except for district heating. Partial exemptions for train, shipping, aviation, power production, forestry and agriculture.	The coverage of the tax is low.
Finland	36%	Commercial aviation, fuel used as raw material in industrial processes and peat.	The coverage of the tax is low.
Norway	63%	Operators covered by the EU ETS (but not offshore oil production activities), domestic aviation and waste incineration.	The coverage of the tax is good.
Denmark	35%	Operators covered by the EU ETS, except for district heating and waste incineration plants. Partial exemption for energy-intensive industries, trains, shipping, aviation, and power and heat production.	The coverage of the tax is low.
Iceland	55%	Operators covered by the EU ETS, international aviation and shipping sectors.	The tax level is too high for being cost effective and the coverage of the tax is quite good.

Table 32. Overview of coverage of carbon taxes across the Nordic countries

Source: World Bank, 2022.

To further increase the cost efficiency of the national carbon tax systems Nordic countries can:

harmonize tax levels across fuels and sectors in their national carbon tax schemes which includes.
to reduce the tax reductions for sectors which pays lower carbon taxes.

More equal tax levels between countries and climate duties

The carbon tax levels vary across the different countries and include different exemptions, which leads to suboptimal investments in clean technologies on a global scale as well as lower cost efficiency. The technical cost of the measures taken into account in each country will greatly differ. In order to change this, a more homogenous carbon tax level is needed. To increase the cost-efficiency of the national carbon tax systems the Nordic countries could

strive for a harmonisation of carbon price levels among national CO2 price instruments

A study made by Nordhaus (2015), has examined the possibilities of replacing a global tax on carbon with a climate club, that hosts countries which has agreed to harmonise CO2 price levels.

A big obstacle for cost-efficiency relates to the fact that producers in different countries face different environmental taxation rates, which implies that a clean technology that is introduced in one country may not be profitable in another. Typically, the Nordic countries have higher environmental taxes than the countries we import consumer goods from. Those countries often also have lower labour costs, than in the Nordic region. This leads to a non-cost-efficient consumer pattern, where consumers buy a lot of cheap consumer goods with higher environmental impact. From an environmental point of view, this high consumption of untaxed goods is non-cost effective.

To reach a more cost-effective consumer pattern, the Nordic countries, in cooperation with the EU, could implement climate change duties. That implies that goods from countries with no or very low carbon taxes must pay extra duties when exporting their goods to EU. That would make the competition between production in different countries fairer, more cost effective and make it more profitable to invest in clean technologies all across the world. With the aim to avoid carbon leakage, the European Council agreed in March 2022 to introduce the Carbon Border Adjustment Mechanism, CBAM regulation (see also chapter 1.1) (European Council, 2022b).

To increase cost-efficiency the Nordic countries can work together to achieve the following objectives:

Promote that EU implements climate duties for countries without or with low carbon taxes.

Taxes on consumer goods instead of on the producer

One of the main obstacles to cost-effective environmental taxing schemes is that national companies face international competition. That implies that if businesses in Nordic countries pay higher environmental taxes than businesses in other countries their international competitiveness decreases. During the interviews for part 1 of this report one of the experts from Denmark stated that the agricultural sector has been deeply squeezed in terms of pricing, that there is little room for bigger investments and therefore farmers struggle to survive in the long run and switch to green farming.

One way to circumvent these obstacles is to introduce environmental taxes on sectors with fierce global competition, such as avoiding taxing polluters and instead tax consumers. The construction to tax the consumer of goods instead of the producer, makes it possible to tax all goods regardless of what country they are originally produced in. There are already some examples of environmental consumer goods taxes in the Nordic countries. For instance, the Swedish tax on electronics, which aims to make the polluters pay for the environmental effects of the flame retardant that all electronics contain (by law).

The Swedish Inquiry of Circular Economy (Swedish Ministry of Environment, 2017) discussed the possibility to expand the taxation of consumer goods to include all goods in the market. An environmental tax based on what material different goods contains of, should reflect the external cost of all goods regardless how they were produced. For example, in 2020 consumer-based carbon dioxide emissions for Sweden had an estimated value of 79 billion SEK (Naturvårdsverket, 2020). If all those goods had to pay carbon dioxide tax the consumption of those goods would decrease to a cost-effective level, since part of the external effect would be included in the price. Such a taxation scheme would make consumer goods and services much more expensive, on the other hand ordinary taxes could be lowered. This would make the transition even more cost-effective since taxes on labour decrease the labour supply, thus decreased taxes on labour would therefore be a cost-effective reform.

Obviously, there are many obstacles. For example, it is much easier to collect taxes from employee’s wages before they get paid, compared to succeed to tax all goods and services that are consumed in a country. In order to reach a cost-effective economy which includes environmental external effects both nationally and abroad it would be a good option to avoid suboptimal investments in clean production technologies.

To increase the cost-efficiency, Nordic countries can

introduce environmental taxes on consumer goods in level with the marginal costs of those goods’ external environmental costs.

Environmental taxes on other emissions

The focus of environmental taxes is on emissions that affects the climate and in the long run causes climate change. However, not all emissions that affects the health of humans, or the environment causes climate change. Nevertheless, other emissions, even if there are exceptions, typically lack environmental taxation. For instance, there is no tax on emissions from contaminated water from industries, from chemicals in clothes or emissions of particles from combustion. Other emissions than carbon dioxide is instead mostly controlled through different regulations. For example, industries need permission from the authorities to emit contaminated water. There are EU legislations which regulate what type of chemicals that are allowed in clothes. For combustion there is technical regulations that keep down the emissions of particles. However, the emissions that are allowed are free to emit. Is the lack of environmental taxes a sign of cost-ineffectiveness? Yes, according to economic theory it is. Obviously, the emitter can, after making sure the law is followed emit those emissions without having to pay the external cost, a situation that will lead to a non-optimal level of emissions.

To increase the cost-efficiency the Nordic countries can

introduce environmental taxes on other emissions than climate related emissions, in level with the marginal costs of those goods’ external environmental costs.

10.4 Discussion and conclusions

The green taxation systems are far from optimal. There are suboptimal solutions on many levels. Yet, the environmental taxes that are in place do help producers and consumers to make more cost-effective choices.

However, the Nordic countries can contribute further to a more cost-effective green taxation system by introducing taxes and try to get other countries to introduce taxes that better follow the marginal costs for external environmental effects. For example, on a national level the Nordic countries can:

include more sectors in their national carbon tax schedule.
reduce the number of exemptions and tax reductions for sectors that pay lower carbon taxes.
introduce environmental taxes on consumer goods in level with the marginal costs of those goods’ external environmental costs.
introduce environmental taxes on other emissions than climate related emissions, in level with the marginal costs of those goods’ external environmental costs.

On a European level, Nordic countries can:

promote a development of the European EU ETS System to include more countries and more sectors.
strive for a harmonization of carbon price levels among national CO2 price instruments.