European Environment Agency (EEA)

Environmental tax reform in Europe: opportunities for eco-innovation


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Environmental taxation, innovation and the green economy

'Environmental taxation can spur innovation.' This simple, compelling message was a central finding of a recent OECD study of taxation, innovation and the environment (OECD, 2010).

It is an insight of profound importance. Environmental policy instruments are frequently characterised as obstacles to economic activity but the OECD analysis suggests that environmental taxes can, in fact, be the opposite — serving as catalysts for the creativity that underpins thriving economies.

In the short term, such innovation can boost efficiency and competitiveness. In the long term it arguably holds the key to sustained prosperity by enabling economic growth to continue within environmental limits. Innovation, particularly the kinds of innovation stimulated by environmental policy, is essential in the process of creating 'green economies' that can deliver growing incomes while preserving natural systems and social equity.

Environmental tax reform (ETR) appears to offer an attractive mix for policymakers. It deters environmentally damaging activities by making them more costly, while incentivising the creation and diffusion of new technologies. For advanced economies like the EU, eco-innovation can also create opportunities to export new tools and processes globally.

While increasing the costs of polluting and using resources is likely, by itself, to subdue economic output, governments can use the tax revenues accrued to reduce the fiscal burden elsewhere.

Cutting labour taxes, for example, can help boost work incentives — potentially increasing employment and offsetting negative economic impacts. Moreover, as the recent petre project (1) has demonstrated, governments can potentially enhance net benefits further by reinvesting some of the revenues secured through ETR in eco-innovation.

In view of the potential gains, there is clear value for policymakers and society more broadly in expanding the knowledge base on ETR and innovation. The present report aims to do just that, using two approaches: a literature review and a scenario-based modelling exercise. Together the two analyses confirm the important interplay between environmental taxes, innovation and macroeconomic performance — and the potential role of ETR in shifting to a green economy in Europe. The key findings are set out below.

Key findings of the literature review
The literature review identified four relevant groups of studies: assessments of environmental regulation's impacts on innovation; theoretical analyses of how different policy instruments influence innovation; empirical studies using statistical and econometric techniques to assess the impacts of 'actual' policy interventions; and case studies providing descriptive assessments of actual experiences.

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