4. Iceland

The use of economic instruments in Icelandic environmental and climate policy has steadily increased in the last decade. Most economic instruments introduced in the last decade have been aimed at reducing greenhouse gas emissions in line with the government's climate policy. Over 90% of CO₂ emissions in Iceland (excluding land use, land-use change and forestry (LULUCF)) are currently covered by economic instruments (Ministry for the Environment and Natural Resources, 2020a).

In 2017, the Icelandic government announced its goal of achieving carbon neutrality by 2040 (Government Offices of Iceland, 2017). In 2021, that objective was enshrined in law with amendments to the Climate Act No 70/2012. In that same year, the government announced its intention to complete the clean energy transition in Iceland no later than 2040, thus making Iceland the first country to become fossil-fuel independent (Government Offices of Iceland, 2021). In its most recent Nationally Determined Contribution (NDC) under the Paris Agreement, Iceland pledged to reduce emissions by at least 55% by 2030 compared to 1990, acting jointly with the EU and its Member States and Norway (Ministry for the Environment and Natural Resources, 2021a). As a part of this cooperation, Iceland participates in the EU Emissions Trading System (EU ETS) and the collective delivery of targets according to the rules laid down in the Effort Sharing and LULUCF legislative frameworks.

Various new economic incentives were introduced in the period 2018 to 2021, to encourage climate-friendly behaviour and investments and to accelerate the clean energy transition, including new tax subsidies for purchases of low and zero emission vehicles. In addition, the carbon tax on fuels was substantially increased and was on average approximately 80% higher in this period than in 2014–2017. A new tax on fluorinated greenhouse gases was introduced in 2020. On the other hand, a landfill tax, which had been planned for several years, was postponed. 

Table 16 illustrates state revenue generated by the highest revenue generating environmental taxes and fees in 2021. In addition to this, Iceland received revenues from auctioning of allowances in the EU ETS, which are not included in table 16. While Iceland has, under the EEA Agreement, been entitled to a share in EU ETS auction allowances since 2013, the auctioning of the Icelandic share was delayed until 2019 (Icelandic Climate Council, 2022). In the period 2019–2021, Iceland received 70.6 million euros in cumulated auction revenues (European Commission, 2021).

Unless otherwise stated, the information provided in this chapter is based on acts and legislative proposals from Althingi (The Icelandic Parliament) and regulations adopted in accordance with Icelandic law. A list of relevant acts is provided in References.

Nearly all electricity production in Iceland is based on renewable sources, with around 70% deriving from hydropower and 30% from geothermal power operations. In addition, geothermal energy provides heating for over 90% of Icelandic households (Environment Agency of Iceland, 2022). Government efforts to reduce energy-related greenhouse gas emissions thus principally address sources such as the transport and fisheries sectors and are less focused on stationary energy production and industrial installations (Ministry for the Environment and Natural Resources, 2020b). It should be noted that while energy intensive industries account for 40% of Iceland's total greenhouse gas emissions (excluding LULUCF), their emission results from production processes and not energy use (Environment Agency of Iceland, 2022). These industries, which include aluminium and non-ferrous metals production, are covered by the European Union Emissions Trading System (EU ETS).

As described in this report, several taxes and subsidies are in place to accelerate the shift to clean energy in road transport, fisheries, and other relevant sectors in Iceland. Additionally, public grants are available to infrastructure development and various energy transition and clean innovation projects, including grants allocated annually from the Energy Fund (Orkusjóður) and the Climate Fund (Loftslagssjóður).

A general tax on carbon has been in place in Iceland since 2010 and is one of the government's key measures to reduce greenhouse gas emissions, especially in the road transport and fisheries sectors (Ministry for the Environment and Natural Resources, 2020b). It is levied on imports and sales of gas, diesel, petrol, fuel oil, petroleum gas and other gaseous hydrocarbons. The tax does not cover aviation and jet fuel.

The average rates for all fuel types have increased by approximately 80% in the period 2018–2021 compared to the period 2014–2017. The rate of the carbon tax was increased by 50% in 2018, and again by 10% in both 2019 and 2020. See table 17.

Two types of excise duty are imposed on petrol: a general excise duty and a special excise duty (also called petrol charge). Excise duty is also levied on gas oil, diesel oil and kerosene. The rates of the excise duty on petrol and oils increased slightly in the period 2018–2021. See table 18. Since 2011, fuels of non-fossil origin have been exempted from the excise duty, including non-fossil additives that have been blended with petrol and oil.

A special tax is imposed on the sale of hot water to end users, amounting to 2% of the retail price. No tax is however imposed on sales to up to ISK 2,000,000 (EUR 13, 550) per year. Hot water is also subject to VAT but is charged a reduced rate of 11% (the general VAT rate is 24%).

A system of subsidies is in place to lower heating costs of inhabitants in so-called cold spots in Iceland, i.e. areas where geothermal district heating is unavailable. The system includes grants to purchase environmentally friendly energy and to take measures that improve energy efficiency of space heating. Inhabitants in cold spots are also entitled to a refund of VAT when switching from fossil-fuel or electric heating to heat pumps.

To accelerate a shift to climate-friendly cooling agents, a new tax was introduced in 2020 on fluorinated greenhouse gases, i.e. hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulphur hexafluoride (SF₆), and other greenhouse gases containing fluor or blends obtaining any of these substances. The tax is imposed on importers of fluorinated greenhouse gases. The rates are different for each type of these gases (over 50 types are listed), based on their different global warming potential. The maximum amount per kilogram is ISK 10,000 (EUR 67.75). To allow companies to adapt to the new tax, only 50% was collected in the first year, 2020.

To encourage climate-friendly investments, new tax incentives were introduced in 2021, allowing for increased and faster depreciation for new investments that fulfil certain environment and climate related requirements. The incentives are in place for the period 2021 to 2025. Also, since 2021, companies have been eligible for tax deductions for financing certain environmentally and climate-friendly activities, such as carbon offsetting projects.

No environmental charges are collected for cold water in Iceland. However, municipalities charge fees from end-users for services related to water and wastewater. The fee is intended to fund the relevant services and the price is therefore not allowed to exceed the actual cost incurred by the municipalities, although the usage by each household or company can to some extent be estimated based on property size and other factors.

Economic instruments have been employed for over three decades to incentivise proper waste management in Iceland. A deposit-refund system for containers has been in place since 1989 and was among the first such systems in the world. A fee system was introduced for hazardous waste in 1996 and was extended to various products a few years later. In recent years, the government's waste management policy has emphasised measures to reduce waste generation and to reduce greenhouse gas emissions, in line with climate and circular economy objectives (Ministry for the Environment and Natural Resources, 2021b). Around 5% of Iceland's total GHG emissions (excluding LULUCF) is currently attributed to the waste sector, mainly methane emission from landfills (Environment Agency of Iceland, 2022).

To cover the cost of disposal, including the building and operation of treatment facilities, municipalities and operators of disposal sites collect fees from users. The fee is service-based and cannot exceed the actual cost incurred by the municipality related to waste treatment. To decrease the landfilling of organic waste and to reduce waste-related greenhouse gas emissions, the government has for the last few years been preparing to implement a tax on landfills. The most recent climate action plan since 2020 outlined this plan further, revealing the government's intention to impose a tax of ISK 15 (10 eurocents) on each kg of general waste and ISK 0.5 (0.3 eurocents) on each kg of inert waste, such as mineral, cement, tiles, ceramic and glass (Ministry for the Environment and Natural Resources, 2020b). The government abandoned this plan in 2020, but in a new comprehensive waste management policy published in 2021, the government re-introduced a plan to tax landfilling of waste from 2023 (Ministry for the Environment and Natural Resources, 2021b).

Importers and producers of certain types of products are charged a recycling fee which is intended to cover the cost of waste treatment in relation to these products, including their collection, transportation, recycling, recovery and disposal. Examples of products that are subject to the fee include cars, single-use beverage packages, oil products, organic solvents, batteries, paint, car tires and electrical and electronic equipment. As a general rule, the fee is levied on each kilogram and is intended to reflect the actual cost of waste treatment related to the product. The fees for several of the covered products were increased in the period 2018–2021.

The refund price for bottles and cans was ISK 18 (12 eurocent) in 2021 and had been increased by ISK 2 (1.4 eurocents) since the publication of the last report in 2019 (Endurvinnslan, 2022). The recycling rate for drink containers in Iceland has historically been approximately 85%. In 2021, the recycling rate per product was around 91% for aluminium containers, 90% for plastic containers and 82% for glass containers (Endurvinnslan, 2022). Car owners are eligible for a payment of ISK 20,000 (EUR 136) for returning a vehicle for recycling or disposal.

Accelerating the clean energy transition in road transport is one of the key climate objectives of the Icelandic government (Ministry for the Environment and Natural Resources, 2020b). Emissions from road transport account for around one third of non-ETS emissions (excluding LULUCF) in Iceland (Environment Agency of Iceland, 2022). This emission increased by 24% between 2005 and 2019, but decreased by 13% between 2019 and 2020, mainly due to drop in tourism related to COVID-19 (Ministry of the Environment, Energy and Climate, 2021a). However, registrations of low and zero emission vehicles have grown substantially in recent years. For example, the number of registered private electric vehicles (EVs) in Iceland grew by 443% between 2018 and 2021 (from 784 to 4,261 vehicles). During the same period, new registrations of private plug-in hybrid vehicles (PHEVs) grew by 71% (from 2,868 to 4,897 vehicles) (Icelandic Transport Authority, 2022).  In 2021, the market share of EVs and PHEVs was 27% and 31%, respectively (Icelandic Transport Authority, 2022). Overall, the share of renewable energy in the transport sector was over 10% in 2021 (Ministry of the Environment, Energy and Climate, 2021a). The government has announced its intention to ban registrations of private fossil fuel cars after 2030 (Ministry for the Environment and Natural Resources, 2020b).

Imported vehicles are subject to excise duty which is based on registered CO₂ emission of each vehicle, calculated as grams per driven kilometre. Until the end of 2018, the rate for private cars ranged from 0 to 65% of the vehicle's customs value; from 0% for vehicles emitting less than 80 grams CO₂/km up to 65% for vehicles emitting 250 grams CO₂/km or more. In 2018, the formula for calculating the excise duty was amended with the introduction of new standards to calculate the CO₂ emissions, the New European Driving Cycle (NEDC) and the Worldwide Harmonized Light Vehicles Test Procedure (WLTP). Between 2019 and 2021, the excise duty was 0.37% of the vehicle's customs value on each g/km of registered emissions exceeding 74 g/km if only using the NEDC standard. The values differed depending on which standard was used to calculate the emissions. The duty was thus 0.34% on each g/km of registered emissions exceeding 81 g/km if using the NEDC and WLTP standards combined, and 0.31% on each g/km of registered emissions exceeding 90 g/km if using only the WLTP standard. Irrespective of standard used, the excise duty could not exceed 65% of the vehicle's customs value.

Vehicles that use methane or methanol as a primary energy source have since 2010 and 2018, respectively, been eligible for a discount from the excise duty up to the amount of ISK 1,250,000 (EUR 8,469). In addition, the excise duty can be partly refunded for up to 1,000 vehicles that have been modified to use methane instead of petrol or diesel.

Certain types of vehicles fall under a special exemption category and are excepted from the excise duty, or subject or reduced rates. Examples of these vehicles are electric motorcycles, as well as vans and other road vehicles used for the transport of goods, which only use methane, methanol, electricity, or hydrogen as energy source.

Taxis and specially equipped vehicles used in the tourism industry were subject to reduced rates until 2018. Since 2019, the calculation of excise duty for these vehicles has been based on a similar formula as the general excise duty, except with less strict values and it cannot exceed a limit of 30% of the vehicle's customs value. The difference between the general excise duty and the special excise duty for these types of vehicles can however never be greater than ISK 1,250,000 (EUR 8,469). 

Rental cars were also subject to reduced rates in the period 2016–2018. In the period 2021 to 2022, special temporary subsidies were offered to car rentals in response to difficulties due to the COVID-19 pandemic. In this period, each purchased vehicle was eligible for a discount up to a maximum of ISK 400,000 (EUR 2,710) under certain conditions. One of the conditions consisted of a guarantee from the rental company of a certain share of low or zero emission vehicles of its total annual vehicle purchases. The minimum share is 15% for the year 2021 and 25% for the year 2022.

A semi-annual vehicle tax, called vehicle fee, is levied on owners of motor vehicles. As a general rule, the fee is based on the vehicle's CO₂ emissions, thus resulting in lower amounts charged for clean energy vehicles. The calculation of CO₂ emissions has since 2019 been based on the NEDC and WLTP standards, mentioned above. In 2021, the base rate for each six-month period for vehicles weighing 3,500 kg or less was ISK 6,380 (EUR 43) for cars emitting up to 133 g of registered CO₂ emission (using both NEDC and WLTP), and ISK 139 (94 eurocents) for each additional g of registered CO₂ emission. As the fee is collected twice per year, the annual cost is twice this amount. The formula to calculate the rate for additional g of CO₂ varies depending on the standard used to calculate the CO₂ emissions. Overall, the vehicle fee increased slightly during the period 2018 to 2021.

For vehicles weighing more than 3,500 kg, the fee is still based on the vehicle's weight. The base rate in 2021 was ISK 59,785 (EUR 405), plus ISK 2.55 (2 eurocent) for each additional kg of registered weight of the vehicle, up to a limit of ISK 94,095 (EUR 638) in each period. However, vehicles that use methane or methanol as a primary fuel instead of petrol or diesel are only subject to the base rate (no charge for additional kg). Since 2020, this also applies to electric vehicles (EVs) and hydrogen vehicles (HVs).

Private vehicles and camping trailers weighing 10,000 kg or more, and vehicles and camping trailers for special use weighing 5,000 kg or more are subject to a vehicle tax based on distance, called kilometer fee. The rate is based on the weight of the vehicle, or the camping trailer and the number of kilometers driven, measured with equipment which is installed in the vehicle or the camping trailer. The prices of the kilometer fee only changed slightly in the period 2018–2021.

To support the clean energy transition, VAT discounts have been offered for purchases of electric vehicles (EVs), hydrogen vehicles (HVs) and plug-in hybrid vehicles (PHEVs) since the year 2013. In addition, sellers of these vehicle types can deduct a certain amount from their taxable turnover. The discounts were renewed on a yearly basis until 2017, when they were extended until the end of 2020. In 2019, the discounts for EVs and HVs were extended until the end of 2023 and the discount for PHEVs was extended until the end of 2022.

The amount of the discount differs between categories and has varied between years. In 2017 the discount was ISK 1,440,000 (EUR 10,808) for EVs and HVs and ISK 960,000 (EUR 7,206) for PHEVs and had then remained unchanged since 2013. The discounts for EVs and HVs were raised to ISK 1,560,000 (EUR 10,569) starting from July 2020 and spanning to the end of 2023. The discount for PHEVs remained ISK 960,000 for 2020–2021 and was reduced to ISK 480,000 for 2022. In 2017, a limit was set to the total number of EVs, HVs and PHEVs that were eligible for the VAT discount. In 2018 and 2019, the discount was limited to 10,000 vehicles in each category. In 2020 and 2021, the limit was 15,000 vehicles in each category.

In 2019, VAT discounts were introduced for purchases of electric and hydrogen motorcycles, mopeds, electric bicycles, electric scooters, and regular bicycles for the period 2020 to2023. Discounts are also offered for rentals of low and zero emission vehicles, and purchases of up to 120 low and zero emission buses for public transportation, during the same period.

To accelerate the clean energy transition in road transport, owners and builders of residential buildings have since 2020 been eligible for a 100% refund of VAT on labour related to the installation of electric vehicle charging stations. Since 2020, 100% of the VAT related to the purchase of charging stations for use on residential property, has also been refunded. The current refund scheme applies until the end of 2023.

Since 2016, grants have been offered from a public fund, the Energy Fund, for a part of the installation cost of fast charging stations along roads and by tourist lodgings, recreational areas, and similar areas. In recent years, some municipalities, including the municipality of Reykjavík, have offered grants for the installation of charging stations for multi-occupied buildings.

In the period 2020–2023, businesses can depreciate vehicles used in their operation to the minimum value in the year of purchase if the vehicle uses methane, methanol, electricity or hydrogen as its only energy source.

Since the early 1990s, fisheries in Iceland have been subject to a property rights system which creates incentives for fishers to harvest fish stocks in a sustainable manner (OECD, 2017a). The system is based on the allocation of transferable quotas to individual fishers and fishing companies. The quotas represent a given portion of the total allowable catch (TAC) for each fish stock over one year, which is decided on basis of the advice of the Marine and Freshwater Research Institute (Ministry of Food, Agriculture and Fisheries, 2022).

Since 2002, fishing companies have been subject to a fishing fee. The amount of the fee differs between species and is determined for each year based on a formula which takes into account the annual value of the catch value. The fishing fee is intended to finance public research, control, surveillance and supervision of fisheries and seafood product processing and to ensure that the general public receives a share of the profit created by the exploitation of marine resources.

The level of public support to agriculture in Iceland is among the highest in the OECD, at 57% of gross farm receipts. The support is mostly in the form of market price measures, principally tariffs that maintain high domestic prices, complemented by direct and indirect payments to farmers (OECD, 2021).

To support the government's climate strategy, public funding for reforestation, revegetation, afforestation and wetland reclamation has increased in recent years, after having been reduced considerable following the financial crisis in 2008. This financial support takes various forms, such as grant schemes, collaborative projects, and direct financial assistance (Ministry for the Environment and Natural Resources, 2019).