1 Introduction to economic policy instruments for a circular economy

This chapter provides an overview of different economic policy instruments and their connection to the circular economy in the Nordics. Current development in the EU is also briefly highlighted. Additionally, potential future developments in this area are explored.

The Ellen McArthur Foundation (2023) has defined “the circular economy as a system where materials never become waste and nature is regenerated. In a circular economy, products and materials are kept in circulation through processes like maintenance, reuse, refurbishment, remanufacture, recycling and composting”. Circular economy presents a transformative alternative to the linear "take-make-dispose" model by regenerating and restoring resources. Using the definition of Ellen McArthur Foundation (2023), circular economy can be described by three key principles:

As circular economy disrupts our traditional views on production value chains, transitioning to a circular economy requires measures that foster systemic change. One important means for national and local governments in supporting the circular transition is the use of economic instruments, including taxes, fees and incentives in relation to circular economy principles.

Economic instruments can be categorised in relation to their ability to support a circular economy as shown in Table 1 (Simons et al. 2018; Green Budget Europe, 2018).

Note: Economic instruments often more or less influence all three loop effects by value-chain effects from influenced price signals in the market. Their ability to support a circular economy should be seen as possibilities in a value-chain context that is complex.

Source: Adapted from Simons et al. (2018); Green Budget Europe (2018)

Taxes play an important role in shaping the dynamics of the circular economy by influencing for example resource use, product design, and waste management practices.

Natural resource taxes are linked to the extraction or to the use of natural resources, i.e. activities that deplete natural resources, such as minerals or water reserves. They incentivise the efficient use of raw materials and promote sustainable sourcing practices, encouraging the substitution of virgin material resources with secondary materials. A raw material tax and an import tax are two examples of natural resource taxes, depending on where in the value-chain the tax is intended to influence the economic structure.

Waste taxes refer to taxes related to waste management, including collection, treatment, or disposal. By imposing a tax on waste generation, businesses are steered towards minimizing waste and adopting more efficient production processes. Waste taxes encourage companies to invest in waste reduction strategies, such as recycling and reusing materials, promoting circularity and resource conservation. 

Monitoring Values Added Taxes (VAT) means either increasing or decreasing the VAT for different products or services in order to steer consumer behaviour. For example, a decrease of VAT for resell can promote reuse of products, and an increased VAT for certain products can increase the attractiveness of alternative solutions.

Subsidies refer to positive incentives used to strengthen certain behaviour. A subsidy is a negative tax, as governments use tax money from consumers or companies, to provide subsidies to certain target groups. Subsidies are often provided by governments to encourage the production of specific goods and services such as clean energy, healthcare etc. 

Research Development Incentives (RDI) are used to support innovation and technological development that will facilitate new solutions in the future, by providing grants or loans to research and innovation activities. 

Extended Producer Responsibility (EPR) schemes place the responsibility on producers to manage the entire lifecycle of their products, including collection, recycling, and appropriate disposal. Most EPR schemes relate to widely used groups of products, such as electronic goods and packaging.

The EU Green Deal has an overall goal of making Europe the first climate-neutral continent by 2050. It covers several main elements such as clean energy, climate action, biodiversity, buildings, and renovations (European Commission, 2019). The Green Deal aims to align national taxation systems with the EU's climate objectives by removing subsidies for fossil fuels, shifting the tax burden to the polluter (polluters pay principle), and considering social distributional aspects. Recent tax reform trend across the EU and EEA countries, including the Nordic countries, have mainly been related to energy and transport taxes (European Commission, 2022b).

Current environmental taxes are according to Eurostat classified into energy, transport, pollution, and resources categories. In 2021, environmental taxes contributed to 5,5% of the total tax revenue within the EU-27. Energy tax revenue is the largest category of environmental taxes across all EU Member States, accounting for 78% of EU-27 environmental tax revenue, followed by transport taxes. Figure 1 illustrates environmental tax revenue by category as percentage of total revenues from taxes and social contributions (excluding imputed social contributions), as well as by GDP of each EU/EEA country. Among the Nordic countries, Denmark has the highest share of environmental taxes with (6%), followed by Finland (5,8%), Iceland (4,9%) Sweden (4,5%) and Norway (4,0%) (Eurostat, 2023a).

Source: Eurostat, 2023
Note: TSC is abbreviation for taxes and social contributions

When planning the use of economic instruments for a circular economy, it is important to note that the current environmental taxes will not enable the needed systemic transformation, but a combination of different instruments will be needed to drive the development in a desired direction. According to an Ecopreneur study (2019), the root cause for the lack of demand for circular products and services at current prices is the greatest obstacle for implementing circular business models. Additional incentives are needed that make circular products and services cheaper than traditional linear items. The study calls for stronger incentives to remove this barrier and suggests a combination of the following economic related policy instruments to promote circularity in the textile sector: innovation policies such as investment support and other subsidies, economic incentives such as VAT and other tax shifts and Extended Producer Responsibility (EPR) in addition to other trade policies, regulation, and voluntary actions.

Furthermore, circular taxation, aimed at changing economic agents’ behaviour towards circularity, will require a rethinking of the whole system of building blocks currently used as economic instruments. The transformation will need to include at least a) a shift from labour taxes to resource/material taxes. This would balance out revenue from labour taxation and encourage reduced material extraction. Today it is common to tax labour more than materials, which provides incentives for continuous material extraction and the outsourcing of production to other countries. If materials are more taxed than labour, it encourages businesses to reduce its material extraction, thus provides incentives for more labour hours. b) strengthening the waste management taxes, c) a shift from taxation of services towards taxation of material intensive products d) introducing a tax on virgin raw materials e) reviewing the application of VAT within each national taxation systems (World Bank, 2022).

Finland has several economic instruments in use that aim to protect the environment, including taxes and subsidies. The total revenue generated by the environmental taxes and fees in 2021 was 6,4 billion EUR, where the largest revenue originated from energy related taxes, especially from households, transportation and storage, and service industries (Figure 2) (Statistics Finland, 2023a). Just under half of all greenhouse gas emissions in Finland is covered by the EU-ETS (Ministry of Economic Affairs and Employment of Finland, 2023).

Source: Statistics Finland, 2023a

Currently, the resource taxes in Finland include, for example, excise duty on beverage packaging, waste tax, oil waste duty and oil damage duty. Excise duty on beverage packaging refers to taxation on beverage packaging that is not included in the current deposit system. The waste tax comprises taxation of landfilled waste. In addition to taxes, there are also subsidies and other instruments, for example blending requirement for motor fuels, a feed-in tariff for renewable energy, as well as energy aid and investment aid for key energy projects that promote the production of renewable energy, energy savings or efficiency, utilization of waste heat or making energy systems low-carbon (Ministry of Economic Affairs and Employment of Finland, n.d.). 

In 2021, Finland launched a new national strategic program, which aims at transforming the country's economy into a circular one by 2035 (Ministry of the Environment of Finland, 2021). The program includes measures related to economic instruments. One of these measures involves developing economic incentives that will reduce natural resource consumption and carbon dioxide emissions and promote circular economy service models.

The current economic instruments in use in Finland do not directly target raw materials, instead there is an interest towards developing energy-related taxes and waste taxes to promote circularity of materials. Finland has started the development towards an environmental tax reform by building a Sustainable Taxation Roadmap where the first wave focuses on energy and transportation related taxes. Notably, the second wave will most likely focus on changing the waste tax, by adding construction related plaster waste and green liquor precipitate into its scope. (Finnish Government, 2020). A proposal to add a tax for the mining sector has also been approved and will commence in 1.1.2024. Taxes are levied on minerals extracted in Finland, with the objective of securing societal compensation for the utilization of non-renewable resources. The responsibility for paying this tax falls upon the entity that has mined the mineral, and is subject to a mining permit, as mandated by the Mining Act. (Finnish Tax Administration, 2023)

However, in relation to the national circular economy strategy the Ministry of the Environment of Finland has conducted a study of the effects of increased waste taxes on the development of the circular economy in Finland (Savikko et al. 2022). The study concluded that the waste tax in Finland has already largely achieved its goals to reduce the amount of waste landfilled that could be utilized otherwise, and its current impact is turning fiscal. In the future, when new or more efficient waste treatment options are developed for broader number of waste fractions, the current tax base can be altered and expanded.

Tax as a driver for sustainability and circularity has also been studied in terms of connecting the tax to life-cycle emissions in Finland. Remes et al. (2023) studied life-cycle emissions-based consumption taxes in Finland, revealing a need for more accurate and consistent information on life-cycle emissions if one was to establish a reliable tax base. According to the study, a life-cycle emissions-based consumption tax could be suitable for products that produce high emissions and are not subject to other relevant emission reduction instruments, and to product categories where emissions do not differ too much between producers, thus enabling fair and purposeful taxation.  For example, if the same product from different producers were manufactured using renewable energy vs. fossil energy, these products might be taxed similarly although their emissions would differ. It might be better if all taxable products under the same category produce emissions of similar magnitude for fair and purposeful taxation.

Sweden has a wide range of economic instruments in use to protect the environment and promote climate friendly behaviour. Generally, economic incentives can be beneficial to encourage more businesses to establish circular business models as well as promote behavioural change.

In 2021, Sweden’s revenue generated by environmental taxes accounted for 10,0 billion Euros (103,6 million SEK). Thirty nine percent of Sweden’s national climate emissions is covered by the EU-ETS (Naturvårdsverket, 2023b). Energy taxes accounted for the largest share of the total environmental taxes, 7,5 billion Euros (77 million SEK) in 2021.

Transport taxes are the second largest category and account for 2,2 billion Euros (23 million SEK). Pollution taxes accounted for 0,3 billion Euros (0,3 million SEK). Resource taxes are the smallest category and account for 0,12 billion Euros (13 million SEK). It is also the only category directly linked to the circular economy.

Source: Statistics Sweden, 2023a

Households pay 50% of the total environmental taxes, where energy taxes are the largest category, accounting for 3,5 billion Euros (36 million SEK), transport taxes being the second largest category with 1,4 billion Euros (14 million SEK).

In 2020, Sweden adopted a new national strategy for a circular economy transition. Four focus areas were selected by the government:

Complementary to the national strategy, action plans for plastics, waste management and waste prevention were also launched. The action plans were chosen for specific areas that are deemed to have the greatest potential in contributing to the circular economy transition and the UN Sustainable Development Goals. The prioritised material flows in Sweden’s national strategy for a circular economy are plastics, textiles, food, the construction and property sector, renewable and bio-based raw materials, and innovation for critical metals and minerals (Swedish Government, 2021).

With its new strategy, Sweden implemented a circular policy element which relates to requirements to sort construction and demolition waste. A business or individual who produces construction or demolition waste is required to sort certain types of waste and store them separately from each other, and from other types of waste. The purpose of this action is to reach a higher level in the waste hierarchy and increase the incentives for accelerating circular flows within the construction sector (Naturvårdsverket, 2020). 

Sweden has, during the period 2017–2022, implemented economic incentives to boost the circular economy, such as lowering tax rates for repairing textiles and for clothes rental. In 2017, the VAT for smaller repairs of bikes, shoes, clothes, and textiles decreased from 25% to 12%. In 2022, the VAT for repairs of shoes, clothing, bikes, and household linen was further reduced from 12% to 6% (Riksdagen, 2022). By the end of 2022, Sweden had a new government installed, and the VAT was again increased from 6% to 12% (by 1 April 2023), with the aim to increase the uniformity of the tax system (Riksdagen, 2023).

During the summer of 2022, the Swedish Government decided to appoint a national committee to investigate which material flows, product groups or services, that are the most appropriate to target by economic instruments aiming at promoting a circular economy. In addition, proposing specific instruments to support the transition. Economic instruments that may stimulate construction with recycled materials instead of raw materials is also examined. The committee aims to present its results by the end of April 2024 (Swedish Government, 2022a).

In 2021, Norway’s revenue from environmental taxes, including taxation of CO₂ emissions, accounted for 7,3 billion Euros (74,6 million NOK). Like the other Nordic countries in this study, energy taxes were the largest category with 5,1 billion Euros (51,8 million NOK). Transport taxes were the second largest category with 1,9 billion Euros (19,5 million NOK), while pollution taxes accounted for 0,3 billion Euros (3,3 million NOK). Much like the situation in Sweden and Finland, resource taxes were the smallest category in Norway, and accounted for 0,01 billion Euros (140 million NOK). In 2022, approximately 85 percent of domestic greenhouse gas emissions were either covered by the EU-ETS, subject to a domestic tax, or both (International Energy Agency, 2022).

Source: Statistics Norway, 2023

Households paid 42% of the total environmental taxes, and energy taxes was the largest category, accounting for 1,7 billion Euros (17,5 million NOK). Transport taxes was the second largest category for households, it accounted for 1,1 billion Euros (10,9 million NOK).

In June 2021, the Norwegian Government (2021) launched a strategy for developing a green, circular economy. EU policies (e.g. Circular Economy Action Plan, European Commission, 2023c) are the main drivers for development of circular economy policies in Norway. Norway closely monitors EU regulations in the area of waste and circular economy. The national strategy focuses on actions within four sectors that have been identified as having the greatest potential for circularity and green competitiveness: agriculture, forestry, fisheries, process industry, construction and buildings, and trade. The Norwegian Government has acknowledged that counties and municipalities play a key role in terms of pushing initiative and action to promote a circular economy across stakeholders within businesses and civil society as well as different public sector levels. The strategy aims to make use of local and regional resources, combined with national industries to further develop a circular economy in Norway.

The business sector has during the latest years been working on preparing road maps to boost green competitiveness across various sectors such as e.g. waste management, process industry, retail and wholesale trade and the packaging industry. The national strategy will also strengthen consumer rights in terms of making it easier for consumers to adopt circular consumption patterns. Additionally, expanding the availability of sustainable and durable products, as well as improving consumer information. More support for Ecolabelling will also be provided. One of the new key areas are related to promoting circular solutions within bio-based sectors. This implies an increased focus on promoting industries that produces goods and services from renewable biological resources, with an overall aim to replace non-renewable options to support climate and environmental targets. 

Within the public sector, green innovation and sustainable consumption will be promoted through the public procurement system. Norway will focus on making more use of digital tools to boost the shift to a circular economy. With national ICT

ICT is an abbreviation for Information and Communication Technology

solutions such as product passports and digital marketplaces it will be possible to collect and analyse large amounts of data, and make these available for researchers, businesses, and authorities.

During the summer of 2021, the Norwegian government decided to appoint a committee that was given the task of scrutinizing the entire tax system in terms of assessing how economic instruments can be used to boost a circular transition (Norwegian Government, 2021). At the end of December 2022, the expert committee presented its results, concluding that the field of circular economy is relatively new within economics. To date, little research is available on how economic instruments such as environmental taxes may affect the development of a circular economy. The committee emphasised that more studies are needed in this field. The need to modify taxes should be assessed in relation to other policy instruments, such as legislation, and in relation to efficiency and administrative costs. The expert committee presented some examples of measures that do not specifically target the source of the external costs. These include e.g. taxes on plastic packages and new textiles, and reduced taxes on sales of goods and services that promote the circular transition. The committee found that the best option for Norway is to consider second-best solutions, such as taxes or subsidies that is targeted specific group of goods or services on a national scale. The committee further concluded that the greatest challenges are related to the high Norwegian consumption of imported goods and services, where the Norwegian Government has limited possibilities to impact the national legislations and their environmental burden. Targeting the source of the external cost is therefore not feasible. Furthermore, the committee suggests that a broader study should be launched, that examines in more detail the possibilities of using economic instruments to boost a circular transition. This study should also consider how any policy instrument affect distribution, revenues, and administrative costs (Norges Offentlige Utredninger, 2022).