Green Paper on market-based instruments for environment and related policy purposes {SEC(2007) 388}
Date: 2007-03-28
Institutions: European Commission
Subjects: EU environmental policy, economic instrument for the environment, environmental tax, pollution control measures, waste management

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 28.3.2007 
COM(2007) 140 final 

GREEN PAPER 

on market-based instruments for environment and related policy purposes 

{SEC(2007) 388} 

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GREEN PAPER 

on market-based instruments for environment and related policy purposes 

(Text with EEA relevance) 

1. 

INTRODUCTION 

The EU is a leading force in the world in taking action on environmental sustainability and, in 
particular, on climate change. This has been confirmed recently through the adoption of the 
energy  and  climate  policy  package1  as  endorsed  by  the  Spring  European  Council2  in  which 
the  EU  repeated  its  commitment  to  addressing  climate  change  internally  and  on  an 
international  scale,  to  promoting  environmental  sustainability,  to  reducing  dependence  on 
external  resources  and  to  ensuring  the  competitiveness  of  European  economies.  In  addition, 
halting loss of biodiversity, preserving natural resources that are under pressure and protecting 
public health also require urgent action. 

Without  public  intervention  and  the  strong  commitment  of  all  actors,  these  ambitious 
objectives  cannot  be  reached.  The  EU  has  increasingly  favoured  economic  or  market-based 
instruments (“MBI”) – such as indirect taxation, targeted subsidies or tradable emission rights 
–  for  such  policy  purposes  because  they  provide  a  flexible  and  cost-effective  means  for 
reaching given policy objectives3. The more intensive use of MBI has also been advocated in 
the  EU´s  6th  Environment  Action  Programme  (6th  EAP)  and  the  renewed  EU  Sustainable 
Development Strategy4 as well as the renewed Lisbon Strategy for Growth and Jobs5. 

This  paper  launches  a  discussion  on  advancing  the  use  of  market-based  instruments  in  the 
Community.  In  line  with  the  announcement  in  the  Action  Plan  on  Energy  Efficiency6,  the 
green paper explores possible ways forward with the Energy Taxation Directive7 with the aim 
of launching its announced review. In this sense the paper fits into the framework set by the 
new integrated energy and climate change agenda8 where market-based instruments and fiscal 
policies in general will play a decisive role in delivering the EU's policy objectives. The paper 

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In  particular  Communication  from  the  Commission  An  energy  policy  for  Europe  -  COM(2007) 1, 
10.1.2007 - and Communication from the Commission Limiting Global Climate Change to 2° Celsius: 
the way ahead for 2020 and beyond - COM(2007) 2, 10.1.2007. 
European Council 8/9 March 2007, Presidency conclusions. 
In  addition  to  the  market  based  instruments  discussed  in  this  paper,  other  important  market-based 
instruments  are  implemented  in  the  framework  of  the  Common  Agricultural  Policy  (i.e.  the  agri-
environmental  measures  of  the  Rural  Development  Policy)  and  under  Cohesion  Policy  actions  in  the 
environment and energy sectors. Where the use of MBI may involve state aid, they have to comply with 
the Community rules and have to be notified to the Commission under Article 88 EC Treaty. A review 
of  the  Community  guidelines  on  state  aid  for  environmental  protection  is  currently  under  way. 
Therefore, this green paper will not address issues of state aid assessment. 
OJ L 242, 10.9.2002, and Council document 10917/06 of 26.6.2006. 
Council  Recommendation  2005/601/EC  of  12  July  2005  on  the  broad  guidelines  for  the  economic 
policies of the Member States and the Community (2005 to 2008). 
COM(2006) 545. 
Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for taxation 
of energy products and electricity (OJ L 283, 31.10.2003 p. 51); Directive last amended by Directives 
2004/74/EC and 2004/75/EC (OJ L 157, 30.4.2004, p. 87 and p. 100). 
As underlined recently by the European Council of 8/9 March 2007. 

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also explores options for a more intensive use of market-based instruments in different areas 
of environmental policy at both Community and national levels. 

2. 

USING MARKET-BASED INSTRUMENTS FOR COMMUNITY POLICY PURPOSES 

2.1. 

The case for using market-based instruments as policy tools 

The  economic  rationale  for  using  market-based  instruments  lies  in  their  ability  to  correct 
market-failures in a cost-effective way. Market failure refers to a situation in which markets 
are either entirely lacking (e.g. environmental assets having the nature of public goods) or do 
not sufficiently account for the "true" or social cost of economic activity. Public intervention 
is then justified to correct these failures and, unlike regulatory or administrative approaches, 
MBIs have the advantage of using market signals to address the market failures. 

Whether by influencing prices (through taxation or incentives), or setting absolute quantities 
(emission  trading),  or  quantities  per  unit  of  output,  MBI  implicitly  acknowledge  that  firms 
differ from each other and therefore provide flexibility that can substantially reduce the costs 
of environmental improvements9. MBI are not a panacea for all problems. They need a clear 
regulatory framework in which to operate and will often be used in a policy mix with other 
instruments.  But  if  the  right  instrument  is  chosen  and  appropriately  designed,  MBI10  carry 
certain advantages over regulatory instruments: 

•  They  improve  price  signals,  by  giving  a  value  to  the  external  costs  and  benefits  of 
economic  activities,  so  that  economic  actors  take  them  into  account  and  change  their 
behaviour to reduce negative – and increase positive - environmental and other impacts11. 

•  They  allow  industry  greater  flexibility  in  meeting  objectives  and  thus  lower  overall 

compliance costs12. 

•  They  give  firms  an  incentive,  in  the  longer  term,  to  pursue  technological  innovation  to 

further reduce adverse impacts on the environment (“dynamic efficiency”). 

•  They  support  employment  when  used  in  the  context  of  environmental  tax  or  fiscal 

reform13. 

2.2.  Market-based instruments in the EU context 

Besides their merits in helping achieving specific policy goals, the EU has used market-based 
instruments to avoid distortions within the internal market caused by differing approaches in 

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See  Commission  Communication  "Bringing  our  needs  and  responsibilities  together  –  Integrating 
environmental issues with economic policy" - COM(2000) 576, 20.9.2000. 
COM(2000) 576, 20.9.2000. OECD studies show growing evidence of the efficiency of market-based 
instruments. See Environmentally Related Taxes in OECD Countries – issues and strategies, 2001. 
This idea is often expressed by objectives such as "getting the prices right", "internalisation of external 
costs", "expanding the supply of non-marketed environmental services". 
Cf.  EEA,  Effectiveness  of  urban  wastewater  treatment  policies  in  selected  countries:  an  EEA  pilot 
study,  2005.  The  study  compares  approaches  between  several  MS  and  demonstrates  how  the  use  of 
market-based instruments will help meet environmental objectives at lower costs. 
Cf.  Commission  Communication  “European  values  in  the  globalised  world"  -  COM(2005)  525, 
20.10.2005. 

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individual Member States, to ensure that a similar burden falls on the same sector across the 
EU and to overcome potential adverse competitiveness effects within the EU. Common action 
also makes the EU stronger when confronting external competition from its trading partners. 

At  the  EU  level,  the  most  commonly  used  market-based  instruments  are  taxes,  charges  and 
tradable permit systems. In economic terms these instruments work in similar ways. However, 
they also differ in notable aspects. 

Firstly,  quantitative  systems,  such  as  tradable  permit  schemes,  provide  more  certainty  as 
regards  reaching  specific  policy  objectives,  e.g.  emission  limits,  (subject  to  effective 
monitoring and compliance) compared to purely price-based instruments, such as taxes. Price-
based instruments, in turn, provide security regarding the cost or the price of policy objective 
and tend to be easier to administer14. 

Secondly, they differ when it comes to the aspect of revenue generation. Taxes (and in a more 
limited  way  charges)  have  increasingly  been  used  to  influence  behaviour,  but  they  also 
generate  revenue.  Tradable  permit  systems  can  generate  revenue  if  the  allowances  are 
auctioned  by  public  authorities.  Tradable  permit  systems  using  auctioned  allowances  have 
therefore similar features to a tax (the regulatory and compliance aspects differ). Charges, on 
the  contrary,  are  usually  a  payment  in  return  for  a  clearly  identified  service  or  cost,  and 
therefore lack the flexibility for the public budget to use such revenue.  

The above features have, to an important extent, influenced the ways and areas that the EU 
currently uses market-based instruments at Community level, thus leading to the introduction 
of  instruments  such  as  the  EU  Emission  Trading  Scheme  (“the  EU  ETS”)15,  the  Energy 
Taxation Directive, and, in the field of transport, the Eurovignette directive16. These aspects 
have to be taken into account should the EU consider using market-based instruments further 
at EU level, in such a way as to make the best use of each of them in the most appropriate 
field and avoid overlaps. In principle, Community decision-making rules should not have an 
influential role to play in this context. Nevertheless the unanimity requirement in the tax area 
means that the possibility of using taxation as an instrument differs from other instruments in 
some respects17.  

What  are  the  areas  and  options  for  the  further  use  of  market-based  instruments  at  EU  or 
national level?  

Could  market-based  instruments  be  used  in  a  way  that  promotes  competitiveness,  and  does 
not impose an undue burden on consumers, in particular citizens with a low-income, but at 
the same time ensures revenue for public budgets?  

Should  the  EU  more  actively  pursue  taxation  to  further  Community  policy  purposes  (in 
addition to fiscal objectives)? Is this the right response to current global challenges and the 
fiscal needs of national budgets? 

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See COM(200) 576. 
The  Commission  is  currently  preparing  a  comprehensive  review  of  the  experience  with  the  EU-ETS. 
This point will therefore not be addressed in this Green Paper.  
Directive 1999/62/EC (OJ L 187, 20.7.1999) as modified by Directive 2006/38/EC (OJ L 157, 9.6.2006, 
p. 8). 
Despite  some  flexible  institutional  solutions  provided  for  in  the  EC  Treaty  such  as  enhanced 
cooperation. 

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2.3. 

Growth, jobs and a clean environment – the case for environmental tax Reforms 

The EU is strongly committed towards ensuring environmentally sustainable development as 
well as promoting the Growth and Jobs agenda. An environmental tax reform (ETR) shifting 
the tax burden from welfare-negative taxes, (e.g. on labour), to welfare-positive taxes, (e.g. on 
environmentally  damaging  activities,  such  as  resource  use  or  pollution)  can  be  a  win-win 
option to address both environmental and employment issues18. At the same time, a long term 
tax shift will require relatively stable revenues from the environment related tax base19. 

ETR can also help to alleviate the possible adverse competitiveness effects of environmental 
taxes on specific sectors. If the action is closely co-ordinated at the Community level, these 
impacts can be further reduced compared to unilateral actions by Member States. Reductions 
in  labour  taxation  or  social-security  contributions  which  tend  to  benefit  lower-income 
households,  can  counterbalance  any  possible  regressive  effect  from  environmental  taxes. 
Finally,  with  an  ageing  population,  which  increases  pressure  on  public  expenditure,  and 
globalisation that makes taxation of capital and labour less viable, the shift of tax burden from 
direct 
in  particular,  environmentally  damaging 
consumption, may provide considerable benefits from a fiscal perspective. 

towards  consumption  and, 

taxation 

As  well  as  discouraging  environmentally  damaging  behaviour  through  taxation,  Member 
States may also use fiscal incentives such as subsidies to encourage green behaviour, facilitate 
innovation,  research  and  development,  provided  that  public  resources  are  first  generated  in 
some  other  way  (e.g.  by  taxing  environmentally  damaging  behaviour)  or  that  spending  is 
reduced (e.g. by removing environmentally harmful subsidies). This approach is particularly 
relevant  in  the  context  of  the  ambitious  objectives  of  the  climate  and  energy  agenda  of  the 
EU, notably to achieve the reduction of greenhouse gas emissions by at least 20% by 2020, 
the  binding  target  of  20%  renewables  of  energy  production  by  2020,  and  the  target  of  10% 
biofuels. 

In  the  first  place  the  Commission  considers  that  it  is  for  Member  States  to  find  the  right 
balance  between  incentives  and  disincentives  in  their  tax  systems,  while  respecting  overall 
fiscal constraints and fiscal neutrality. The Commission would like, however, Community tax 
policy to facilitate this balance (cf. Chapter 3).  

There  may  be  scope  to  improve  the  structured  exchange  of  information  between  Member 
States on their best practices in the area of MBI in general and environmental tax reform in 
particular.  While  specialised  structures  exist  in  some  areas  there  is  no  horizontal  forum 
available. In this respect, one option could be the establishment of an MBI Forum. 

Should the EU more actively promote environmental tax reforms at national level?  

How could the Commission best facilitate such reforms? Can it for example offer some kind 
of co-ordination process or procedure? 

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The Commission raised this issue already in 1993 in its White Paper on Growth, Competitiveness and 
Employment - COM(93) 700, Chapter 10 - and again more recently in its recent communication on the 
European  social  model  or  in  a  paper  on  the  links  between  employment  policies  and  environment 
policies. Cf. COM(2005) 525 and SEC(2005) 1530. Ex-post evidence from the Nordic countries as well 
as the results of model-based studies indicate the existence of both types of benefits. 
The relationship between revenue generation and theincentive effect of taxation is further addressed in 
the staff working document. 

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Would the establishment of the abovementioned MBI Forum be useful to stimulate exchanges 
of  experience/best  practice  on  Environmental  Tax  Reform  between  Member  States?  How 
could  it  be  organised  in  an  optimal  way?  How  should  it  be  composed  to  avoid  potential 
overlap with existing structures?  

How  does  the  need  to  reduce  the tax  burden  on  labour  in  many  Member  States  fit  with  the 
objective  to  promote  innovation  and  to  support  research  and  development  in  order  to  shift 
towards a "greener" economy? How can this be achieved while at the same time respecting 
the  budgetary  neutrality?  Would  a  more  significant  tax  shift  towards  environmentally 
damaging activities be the right answer? 

2.4. 

Reform of environmentally harmful subsidies 

Many  subsidies  are  not  only  economically  and  socially  inefficient  but  can  also  adversely 
affect  the  environment  and  human  health20.  They  can  also  counterbalance  the  impact  of 
market-based  instruments  applied  for  environmental  or  health  purposes  and  can  generally 
hinder competitiveness21. While their reform or removal could contribute public funds to an 
environmental fiscal reform, it is also justified in its own right22. The Commission intends to 
work  with  Member  States  on  reforming  environmentally-harmful  subsidies,  both  at 
Community  and  national  levels.  Dialogue  with  stakeholders  will  be  important  to  ensure  all 
issues are considered. The European Council has asked the Commission to prepare a roadmap 
for reform, sector by sector, by 200823.  

What is, in the light of national experiences, the best way to advance the process of reforming 
environmentally-harmful subsidies?  

3. 

OPTIONS FOR FURTHER APPLICATION OF MBIS IN INFLUENCING ENERGY USE 

Energy  is  currently  at  the  top  of  the  EU  priorities  since  it  represents  a  major  challenge,  as 
regards  environmental  sustainability,  as  well  as  security  of  supply  and  competitiveness.  In 
order  to  make  European  energy  use  more  sustainable,  secure  and  competitive,  the 
Commission  has  been  calling  both  for  more  efficient  energy  consumption  and  the 
mobilisation  of  resources  for  the  take-up  of  cleaner  energy,  investment  in  new  technologies 
and  innovation.  These  objectives  were  recently  endorsed  by  the  EU  Heads  of  State  and 
Government in the form of the integrated climate change and energy agenda. Fiscal policies, 
taxation in particular, and the further refinement of the EU ETS will have an important role to 
play in achieving these objectives. 

Although primarily serving the internal market, Community tax policy and more specifically 
the  Energy  Taxation  Directive  come  into  play  in  this  context.  This  Directive  sets  common 
rules  for  taxing  energy  consumption  and  integrates  environmental  and  energy  objectives. 

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Cf.  for  example  OECD,  Environmentally-harmful  subsidies  –  challenges  for  reform,  2005,  and  the 
literature quoted in the document. 
The  OECD  (1998)  defines  environmentally  harmful  subsidies  as:  ‘all  kinds  of  financial  supports  and 
regulations  that  are  put  in  place  to  enhance  the  competitiveness  of  certain  products,  processes  or 
regions,  and  that,  together  with  the  prevailing  taxation  regime,  (unintentionally)  discriminate  against 
sound environmental practices’. 
This was also emphasised in the renewed EU Sustainable Development Strategy. 
Review of the EU Sustainable Development Strategy, Council Document 10917/06 of 26.6.2006. 

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Traditionally  energy  taxation  contributes  to  the  objectives  of  energy  efficiency,  security  of 
supply and competitiveness. 

3.1. 

Streamlining and developing the Energy Taxation Directive 

Energy  taxation  offers  the  potential  for  the  EU  to  combine  the  incentive  role  of  taxation  in 
favour  of  more  energy-efficient  and  environment-friendly  energy  consumption,  with  the 
ability to generate revenue24. 

However, the current rather flexible and general approach of the Energy Taxation Directive 
may  not  in  all  cases  enable  the  objectives  of  energy  efficiency  and  environment-friendly 
energy  consumption  to  be  effectively  integrated  into  the  harmonisation  established  at  EU 
level. Therefore there may be a case for a clearer linking of energy taxation to the relevant EU 
policy objectives. 

One  option  might  be  to  divide  the  Community  minimum  levels  of  taxation  into  energy  and 
environmental  elements  (or  counterparts),  which  would  be  mirrored  at  national  level  in  the 
form of an energy tax and an environmental (emissions) tax. This would build on the existing 
approach  in  energy  taxation  but  would  make  it  more  coherent,  while  refining  its 
environmental aspects. 

In order to represent an effective and uniform incentive towards efficient energy consumption, 
without  creating  distortions  between  energy  products,  all  fuels  should  be  taxed  in  the  first 
place  in  a  uniform  way  according  to  their  energy  content,  developing  further  the  approach 
already existing in the heating fuel area and for electricity. In addition, taking into account the 
fact that the emissions generated during combustion differ from one fuel to another, taxation 
could  in  the  second  place  reflect  the  environmental  aspects  of  energy  (by  differentiating 
between greenhouse gas and non-greenhouse gas emissions). Such an approach would allow 
for  a  more  automatic  and  straightforward 
in  favour  of  more 
environmentally-friendly  energy  sources,  notably  renewables,  as  compared  to  what  is  the 
current  situation.  Amongst  other  functions  energy  taxation  would  explicitly  recognise  the 
environmental and security of supply benefits of renewables. 

tax  differentiation 

There  are  several  aspects  to  be  taken  into  account  which  are  further  explored  in  the 
accompanying Commission staff working document. Most importantly: 

–  Fuels used for heating and fuels used as propellants are traditionally treated in a different 
way  for  tax  purposes,  reflecting  in  particular  the  indispensable  nature  of  fuel  used  for 
heating. There may be a justification for further differentiating taxation according to use.  

–  The CO2 emissions derived from most electricity production are currently addressed by EU 
ETS, whereas electricity production is, in principle, exempt from energy tax in accordance 
with the Energy Tax Directive. An additional environmental counterpart in form of taxes, 
reflecting  the  same  environmental  aspects  as  those  addressed  by  the  EU  ETS  might  not 
seem to appear appropriate in this particular instance. 

The Commission intends to further explore these ideas for the possible revision of the Energy 
Taxation Directive. 

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Three  quarters  of  revenues  from  environmentally-related  taxes  comes  from  taxes  on  energy  (see  the 
Staff working document). 

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Should  the  Energy  Taxation  Directive  be  reviewed  to  make  a  clearer  link  to  the  policy 
objectives  the  Directive  integrates,  in  particular  in  the  field  of  environment  and  energy? 
Would  this  make  energy  taxation  a  more  effective  instrument  by  better  combining  the 
incentive effects of taxation with the ability to generate revenue? 

Is  splitting  the  minimum  levels  of  taxation  between  energy  and  environmental  counterparts 
the best way for doing so? What would be the pros and cons and the main practical aspects of 
such  an  approach?  Would  the  environmental  incentive  created  by  energy  taxation  be  a 
sufficient and adequate response to reflect the objectives of the energy policy in the field of 
biofuels, including the creation of a market-based incentive for second generation biofuels? 

Is  there  a  need  for  additional  taxation  addressing  the  remaining  environmental  aspects  of 
electricity  production  (if  any)?  Is  the  proposed  approach  sufficient  to  favour  uptake  of 
electricity  of  renewable  origin?  What  is  the  impact  of  such  a  Community  framework  for 
electricity  of  nuclear  origin  (bearing  in  mind  the  differing  approaches  at  national  level 
towards the use of nuclear energy)?  

3.2. 

Interaction  of  energy  taxation  with  other  market-based  instruments,  in 
particular the EU-ETS 

Of  the  different  Community  market-based  instruments  existing  in  the  field  of  energy, 
transport and environment, energy taxation is, perhaps, the most cross-cutting with impacts in 
all three areas and directly interacting with all other instruments. 

The  review  of  the  Energy  Taxation  Directive  would  allow  these  aspects  to  be  taken  into 
account  by  clarifying  the  aspects  covered  by  harmonised  energy  taxation.  In  practice,  the 
explicit  identification  of  an  environmental  element  in  the  minimum  levels  of  taxation 
(differentiating  between  greenhouse  gas  and  non-greenhouse  gas  emissions)  would  enable 
energy taxation to complement other market-based instruments better at EU level. 

The  EU  ETS  currently  applies  to  emissions  from  certain  combustion  and  industrial 
installations, while energy taxation applies instead to fuel uses of energy25, while leaving the 
most  energy  intensive  sectors  (currently  covered  by  EU  ETS)  outside  its  scope  in  an 
important number of cases. The Commission considers that this rule could be explored further 
to  see  whether  sectors  covered  by  EU  ETS  could  be  excluded  from  the  scope  of  the 
environmental  element  of  the  Energy  Taxation Directive  to  the  extent  that  their  greenhouse 
gas  impact  is  adequately  addressed  by  EU  ETS  (in  other  words  so  that  the  relevant 
environmental elements of the minimum levels of taxation would not be applicable to them, 
while the energy based element would remain as well as other environmental elements). On 
the contrary, for situations when certain operators do not participate in emission trading due to 
small  size  or  other  considerations,  the  environmental  counterpart  of  the  minimum  levels  of 
taxation  would  ensure  a  more  widespread  application  of  the  polluter  pays  principle.  These 
rules could effectively apply both to the industrial sector and to aviation.  

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In particular energy taxation does not normally apply to energy products (and electricity) used as raw 
materials  in  industrial  processes,  nor  to  energy  products  used  in  the  production  of  energy  products 
(most commonly in the case of refineries) or as inputs for electricity generation. This result is brought 
about through various techniques. For details, cf. Articles 2(4), 14(1)(a) and 21(3) and (6) of the Energy 
Tax Directive. 

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Excluding  the  environmental  impacts  addressed  by  EU  ETS  from  the  scope  of  the  Energy 
Taxation Directive might be a viable solution that could also resolve the problem of potential 
overlap between the two instruments while ensuring that the remaining objectives of energy 
taxation  are  observed.  Such  a  solution  could  also  avoid  difficulties  stemming  from  the 
differing features of EU ETS (uniform price across the EU that however varies over time) and 
energy  taxation  (different  prices  reflecting  the  freedom  of  Member  States  to  set  tax  rates 
above the minima as they see fit, that tend, however, to be rather stable over time). However, 
any move towards such a solution merits further in-depth analysis, especially if the EU ETS is 
significantly broadened in scope. 

Whichever  the  solution,  it  needs  to  be  seen  in  a  global  perspective.  There  is  an  increasing 
global  recognition  that  environmental  protection  needs  to  be  integrated  into  economic 
decisions in order to ensure long term sustainable development. This will lead to an extended 
application  of  MBI  by  national  authorities  and  their  use  should  be  promoted  at  the  global 
level. The EU should actively engage in dialogue with other countries, to promote the use of 
market-based instruments that allow policy objectives to be met in a cost-effective way. 

But  as  long  as  this  is  not  the  case  and  the  EU  and  third  countries  apply  different  levels  of 
carbon taxation or other methods of reducing greenhouse gas emissions (such as the ETS), it 
is  important  to  provide  the  necessary  incentives  to  encourage  the  EU's  trading  partners  to 
undertake effective measures to abate greenhouse gas emissions. The feasibility of all policy 
measures  for  this  purpose  should  be  analysed.  This  has  already  led  to  the  beginning  of  a 
debate on the application of carbon equalisation mechanisms, such as border tax adjustments. 
At  the  same  time,  it  is  recognized  that  this  approach  is  subject  to  legal  and  technical 
constraints, which need to be further examined. 

Would the suggested changes to the Energy Taxation Directive and the proposed approach to 
its scope be the best solution for ensuring coherence between the Directive and EU ETS? Are 
there other options to achieve this objective?  

What  are  the  potential  options  that  should  be  explored  in  order  to  provide  the  necessary 
incentives  to  encourage  the  EU's  trading  partners  to  undertake  effective  measures  to  abate 
greenhouse gas emissions? 

4. 

OPTIONS FOR FURTHER USE OF MBI IN ENVIRONMENT POLICY  

4.1. 

Tackling the environmental impact of transport  

Transport is a major contributor to air pollution and CO2 emissions and the trend in emissions 
is  increasing.  For  instance  road  transport  was  responsible  in  2004  for  22  %  of  total  CO2 
emissions,  aviation  and  shipping  account  for  about  3-4%  of  total  GHG  emissions,  and 
aviation emissions in particular have grown rapidly (by 86% from 1990 to 2004). There has 
been  some  use  of  MBI  at  EU  level  to  address  the  negative  environmental  impacts  of  the 
different modes of transport, substantial as they are. This contrasts with the national and local 
levels where several different types and designs of MBI have been used and are in the process 
of being developed.  

Several initiatives were adopted recently by the Commission or by other institutions in order 
to tackle transport emissions. The introduction of a CO2-dependent element in the tax base of 
both annual circulation and registration taxes in the Commission's proposal for passenger car 

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related taxes26 would encourage car buyers to take energy efficiency and CO2 emissions into 
account. Once adopted, and together with the legislative framework to reduce CO2 emissions 
from cars27, and energy taxation, this will help the EU reach its climate change objectives by 
reducing CO2 emissions from cars. In the context of the forthcoming review of the EU ETS, 
the European Council invited the Commission to consider a possible extension of the scope of 
the ETS to a number of other sectors that include surface transport. 

The Commission has proposed to include aviation emissions under the EU emissions trading 
scheme  (ETS)  and  announced  its  intention  to  present  a  proposal  to  address  nitrogen  oxides 
emissions by the end of 200828.  

As concerns shipping, the evaluation of proposals to promote low-emission shipping has been 
mentioned as one of the targets of future maritime policy29. Any MBI in this area would have 
to  be  carefully  designed  so  as  not  to  conflict  with  the  provisions  on  charging  in  the  United 
Nations  Convention  on  the  Law  of  the  Sea  (UNCLOS)30.  In  addition,  there  are  further  key 
issues, including legal and political requirements, geographic differentiation, monitoring and 
compliance mechanisms that need to be investigated in order to develop specific proposals to 
promote low-emission shipping.  

What  would  be  the  best  MBI  to  tackle  emissions  from  shipping,  taking  into  account  the 
specific nature of maritime transport? How could it be best designed? 

Apart  from  CO2  emissions,  road  use  has  other  effects  on  the  environment,  such  as  air 
pollution by SO2, NOx or particulate matter, and also noise pollution and congestion. Beyond 
partially  harmonised  annual  circulation  taxes  for  heavy  goods  vehicles  the  "Eurovignette 
directive"  provides  a  charging  framework  on  trans-European  road  networks.  Germany  and 
Austria  have  introduced  distance-based  differentiated  infrastructure  charges  for  heavy-duty 
vehicles.  Although  average  charges  can  only  cover  infrastructure  costs  and  thus  exclude 
external costs, Member States have to differentiate charges by Euro emission class from 2010 
onwards, and may apply further differentiation to combat environmental damage and address 
congestion.  If  such  charging  systems  were  integrating  differentiation  of  environmental 
damage  in  the  overall  costs,  this  would  lead  to  more  efficient  infrastructure  use31.  The 
Commission  shall  present,  after  examining  all  options  including  environment,  noise, 
congestion  and  health-related  costs,  a  generally  applicable,  transparent  and  comprehensible 
model for the assessment of all external costs to serve as the basis for future calculations of 
infrastructure  charges.  This  model  shall  be  accompanied  by  an  impact  analysis  of  the 

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28 
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31 

COM(2005) 261, 5.7.2005 
Cf.  Commission  Communication  Results  of  the  review  of  the  Community  Strategy  to  reduce  CO2 
emissions  from  passenger  cars  and  light  commercial  vehicles  -  COM(2007)  19,  7.2.2007.  The 
Commission is also undertaking a study on ways to improve the performance of heavy-duty vehicles in 
terms of greenhouse gas emissions. 
COM(2006) 818, 20.12.2006. 
Cf. Green Paper Towards a future Maritime Policy for the Union: a European vision for the oceans and 
seas - COM(2006) 275. A consultation process is underway until 30 June 2007. 
For details see a 2004 study on this issue: 
http://www.europa.eu.int/comm/environment/air/pdf/04_nera_report.pdf 
Outside  the  EU,  this  approach  has  been  followed  in  Switzerland,  where  charging  systems  for  heavy 
duty vehicles also include the external environmental costs. From an economic point of view, charges 
should  be  modulated  according  to  those  external  costs  and  the  place  and  time  of  driving,  in  order  to 
improve the efficiency of infrastructure use. 

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internalisation  of  external  costs  for  all  modes  of  transport  and  a  strategy  for  a  stepwise 
implementation of the model for all modes of transport32. 

Community  law  also  allows  Member  States  to  vary  infrastructure  charges  on  railways 
according to external environmental impacts. They shall not raise the overall level of income 
accruing  to  the  infrastructure  manager  in  the  absence  of  any  comparable  level  of  charging 
environmental costs on other competing modes of transport33. 

How  can  infrastructure  charging,  including  considerations  related  to  environmental  costs, 
best be applied to transport modes? Should this model apply to all transport modes, or take 
into  account  specificities  of  each  transport  mode?  To  what  extent  should  the  Eurovignette 
directive be used in this respect? 

Local  charging  systems  have  been  applied  in  a  number  of  EU  cities,  such  as  London  and 
Stockholm,  to  improve  traffic  conditions,  inter  alia  to  reduce  urban  congestion34.  Recent 
appraisals  show  that  this  objective  was  reached,  increasing  average  traffic  speeds  while 
significantly decreasing the emissions (PM, NOx and CO2) and energy consumption of road 
traffic within the charged area35. There are even discussions at national level, e.g. in the UK 
and  also  in  Germany,  on  extending  congestion  charging  to  all  roads.  The  Commission  will 
continue  to  support  existing  information  exchange  networks  and  investigate  the  need  for 
supportive action on EU level in the frame of the Green Paper on Urban Transport in 2007.  

4.2. 

The use of MBI to address pollution and protect resources 

The EU also encourages Member States to use taxation and other MBI in the framework of its 
environmental thematic strategies. Member States have made use of these possibilities, but to 
very  different  degrees,  and  have  gained  experiences  in  applying  different  designs.  Beyond 
environmental considerations, there might be a need to harmonise at EU level in those cases 
that  have  cross-border  dimension  and  where  taxation  has  increasingly  been  used  at  national 
level and may have an impact on the functioning of the Internal Market.  

4.2.1.  Water 

Water needs to be managed in a sustainable way. The Water Framework Directive36 (WFD) 
provides an overall framework for action. It requires that Member States introduce by 2010 
water-pricing policies that encourage efficient water use. This will make all users bear costs 
(incl. external environmental and resource costs) under the "polluter pays" principle, which in 
certain  cases  is  not  yet  fully  applied37.  Member  States  also  have  to  report  on  the  steps  they 
take to implement these provisions in their river-basin management plans by 2009.  

Several Member States already apply taxes or charges on groundwater and/or surface water 
abstraction  or  on  water  consumption,  which  have  reduced  consumption,  leakage,  and 
pollution. The Commission considers the use of MBI essential to meet the requirements of the 

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36 

37 

Article 1.9 of Directive 2006/38 of 17 May 2006. 
Directive 2001/14/EC of 26 February 2001 and COM(2001) 307. 
The  revised  Eurovignette  Directive  explicitly  mentions  the  scope  for  MS  to  use  such  schemes 
(Article 9). 
Cf. EEA 2006, p. 57. 
Directive 2000/60/EC of the European Parliament and of the Council of 23 October 2000 establishing a 
framework for Community action in the field of water policy (OJ L 327, 22.12.2000). 
EEA, Market-based instruments for environmental policy in Europe (EEA Technical Report 8/2005). 

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WFD. It will continue the close cooperation with the Member States on these issues as part of 
the  Common  Implementation  Strategy  as  agreed  with  the  group  of  water  directors  of  the 
competent national authorities.  

How can the Commission most effectively ensure implementation of the water pricing policies 
set out in the Water Framework Directive? What options could be explored to reinforce the 
links  between  investments  in  national  water  projects  and  the  introduction  of  corresponding 
water pricing to provide incentives for users and avoid distorting competition? 

4.2.2.  Waste management 

The  main  aim  for  the  waste  prevention  and  management  enshrined  in  the  6th  EAP  is  to 
decouple waste generation from economic growth, and there are signs that this is beginning to 
happen. 

While  landfill  tends  to  be  the  worst  option  from  an  environmental  perspective38,  market 
signals often favour it as they do not take environmental impacts into account. Furthermore, 
while  taxing  disposal,  particularly  landfill,  can  be  an  effective  way  of  correcting  this 
distortion and encouraging waste recycling and recovery39, differences in national tax levels 
could lead to purely tax-induced shipments of waste and distorted competition between waste 
management operators.  

The Commission has therefore encouraged Member States to exchange information on their 
approaches  to  landfill  taxes  and  to  keep  the  Commission  informed40.  Beyond  this,  a  further 
step  to  address  the  second  issue  could  be  to  establish  common  criteria,  including 
environmentally-effective  minimum  rates,  to  design  landfill  taxes  based  on  proven  best 
practice.  

If  there  is  insufficient  progress  to  divert  waste  away  from  landfill,  should  the  Commission 
consider proposing a harmonised landfill tax with EU-wide minimum rates? 

impact  would 

The  environmental  impact  of  different  packaging  materials  or  of  different  products  in  the 
same category, e.g. batteries, differs. Market-based instruments differentiated according to the 
products´ 
therefore  encourage  more  sustainable  consumption.  Under 
Community  law,  MS  can  adopt  national  measures  to  reach  targets,  such  as  preventing 
packaging  waste  or  encouraging  the  use  of  returnable  packaging  or  for  the  collection  and 
recycling of waste batteries as well as to promote the use of batteries containing less polluting 
substances41, thus implementing the "polluter pays" principle. In all cases these measures need 

38 

39 

40 
41 

Cf. Commission Communication Taking sustainable use of resources forward: A Thematic Strategy on 
the prevention and recycling of waste - COM(2005) 666, 21.12.2005. 
This has been applied in several Member States. Cf. EEA 2006. However, a recent OECD study also 
points out that in a few Member States the tax now significantly exceeds the estimated externality costs. 
Cf. OECD, Sustainable Development in OECD Countries, 2004. 
COM(2005) 666, 21.12.2005. 
Directive 2006/66/EC of the European Parliament and of the Council of 6 September 2006 on batteries 
and accumulators and waste batteries and accumulators and repealing Directive 91/157/EEC (OJ L 266, 
26.9.2006). 

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to  respect  the  Treaty  obligations  (in  particular  rules  on  internal  market  and  non-
discrimination, incl. Article 90 EC42). 

Many  of  them  have  used  MBI  like  taxes,  deposit-refund  systems  or  tradable  permits  for 
packaging  waste  in  general  or  specific  types  (e.g.  drinks  containers  or  plastic  bags)43. 
Denmark has adapted its packaging tax to reflect the differences in environmental impact of 
each  material,  and  Latvia  has  also  introduced  differentiation  according  to  material44.  The 
Commission  is  prepared  to  support  a  structured  exchange  of  information  between  Member 
States on their approaches. 

Does the Community legal framework provide sufficient scope for Member States to use MBI 
to  address  waste  management  issues?  Should  the  Commission  facilitate  the  application  of 
MBI in this area, e.g. through supporting exchanges of information?  

4.3. 

The use of MBI to protect biodiversity 

The  use  of  MBI  to  protect  biodiversity  is  gaining  acceptance  as  a  means  of  integrating 
conservation  into  the  decision-making  of  economic  actors  and  cost-effectively  reaching 
objectives for conservation and sustainable exploitation of resources, such as those in the EU 
Biodiversity  Action  Plan  and  in  the  common  fisheries  policy45.  All  three  standard  types  of 
MBI – taxes/charges/fees, subsidies and tradable permits - are in use, mainly for habitat and 
ecosystem conservation, but also for the protection of specific species. 

MBI can be efficient instruments to encourage landowners to maintain forests or wetlands, or 
to  compensate  for  the  unavoidable  harm  that  development  projects  do  to  biodiversity  by 
creating similar habitats elsewhere to ensure no net loss of biodiversity (biodiversity offsets).  

Charges  and  fees,  such  as  hunting  and  fishing  permits  can  help  limit  the  use  of  the 
biodiversity  resource  to  a  sustainable  level.  There  are  also  cases  where  financial  support  is 
granted in the form of "Payments for Environmental Services" (PES), e.g. agri-environmental 
measures  of  the  Common  Agricultural  Policy,  to  compensate  landowners  for  maintaining 
forests  or  wetlands  that  filter  water,  act  as  reservoirs  or  provide  habitats  for  insects  that 
pollinate  neighbouring  plantations,  because  they  will  be  giving  up  revenue  for  the  common 
good46.  Finland  has  used  auctions  where  recipients  bid  for  the  minimum  subsidies  they 

42 

43 

44 
45 

46 

Directive  94/62/EC  on  packaging  and  packaging  waste  (OJ  L  365,  31.12.1994),  as  amended  by 
Directive  2004/12/EC  (OJ  L  47,  18.2.2004),  in  particular  Article  15.  See  also  the  Commission's 
implementation report on the Directive COM(2006) 767. Naturally, quality requirements for packaging 
have to be respected as well. 
For details, see the OECD/EEA database on economic instruments used for environmental policy and 
natural resources management: http://www1.oecd.org/scripts/env/ecoInst/index.htm. 
Cf. EEA, Using the market for cost-effective environmental policy, 2006. 
COM(2006)  216.  A  further  example  is  fisheries  management  where  management  systems  involving 
market-based instruments, such as individual transferable fishing quotas, are more common. Cf. OECD, 
Using  market  mechanisms  to  manage  fisheries  –  smoothing  the  path,  2006.  Cf.  COM(2002)  181, 
28.5.2002  and  COM(2006)  103,  9.3.2006  as  well  as  the  recent  Communication  on  the  use  of  rights-
based management tools in fisheries to protect biodiversity. See COM(2007) 73, 26.2.2007. 
When  only  small  groups  are  involved,  such  compensation  schemes  can  also  be  established  directly 
between  private  parties.  PES  are  also  advocated  internationally,  inter  alia  as  an  instrument  to  protect 
tropical  forests.  Cf.  World  Bank,  At  loggerheads,  2006.  PES  may  involve  state  aid  and  in  this  case 
would have to be notified under Article 88 EC Treaty. 

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require to carry out biodiversity protection measures, as a way of avoiding setting subsidies 
too high47.  

Another example for the use of MBI is habitat banking, a trading instrument first developed in 
the  US  (in  this  case,  wetland  banking)  in  the  context  of  liability  regimes.  Such  schemes 
transform environmental liabilities into marketable assets, thus changing incentive structures 
and  behaviour  by  assigning  property  rights  and  creating  markets.  Specialised  companies 
create wetlands and then sell wetland credits to developers. This ensures that environmental 
objectives are met with no net loss of total value and at the same time leads to a competition 
among companies to establish new wetlands cost-effectively. Like tradable permit schemes in 
general,  such  schemes  help  to  integrate  conservation  objectives  into  mainstream  business, 
thus  helping  to  overcome  business  resistance.  However,  equivalence  of  habitats  must  be 
maintained  and  there  must  be  measurement  criteria.  In  the  case  of  protected  areas, 
compensatory measures for habitat loss should only be applied as a measure of last resort. 

Should the Member States make a more intensive use of these types of instruments? Should, in 
particular,  "payments  for  environmental  services"  be  used  more  intensively  to  achieve 
environmental objectives? And should the scope for introducing systems of biodiversity offsets 
at Community level, e.g. wetland banking, be further examined? 

4.4. 

The use of MBI to address air pollution 

Air pollution damages human health and the environment. The need to deliver cleaner air has 
been recognised for several decades. While action at national and EU level led to significant 
improvements,  serious  air  pollution  impacts  persist  which  are  addressed  by  the  Community 
thematic strategy on air pollution.  

Several  Member  States  use  market-based  instruments  to  address  air  pollution,  in  particular 
taxes and charges on NOx and SO2. More recently, national systems of emission trading have 
been  introduced  to  reduce  problems  from  conventional  air  pollutants.  While  trading  will  of 
course  be  more  efficient  on  a  larger  market,  environmental  sensitivity  to  these  pollutants 
varies across Europe and so care must be taken that emissions trading does not lead to serious 
local  pollution  ("hot  spots")  or  leads  to  deterioration  of  the  natural  environment  through 
acidification, eutrophication or ozone. 

The  Commission  is  analysing  whether  optional  cross  border  emissions  trading  schemes 
between groups of Member States could increase flexibility and lower compliance costs while 
maintaining a high level of environmental protection: 

–  When  reviewing  the  National  Emissions  Ceilings  Directive48,  the  Commission  will 
consider  how  emissions  trading  could  cost-effectively  reduce  emissions  further49.  The 
Netherlands and Slovakia could give valuable lessons from experience with their own NOx 

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Cf. study The Use of Market Incentives to Preserve Biodiversity 
(http://ec.europa.eu/environment/enveco/studies2.htm#market). Australia has also used this approach.  
Directive 2001/81/EC of 23 October 2001 (OJ L 309, 27.11.2001). 
In  its  proposal  for  a  directive  on  ambient  air  quality  and  cleaner  air  for  Europe  -  COM(2005)  447, 
21.9.2005  -  the  Commission  referred  to  the  use  of  emissions  trading  schemes  by  Member  States  as 
instruments  for  air  pollution  abatement  at  regional  or  national  level.  They  could  use  these  to 
demonstrate  efforts  towards  Community  air  quality  standards  even  if  they  needed  to  request  a  time 
extension. 

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and  SO2  emissions  trading  schemes  to  Member  States  that  want  to  use  this  instrument, 
possibly even linking national systems50. 

–  The Commission is also examining the scope for emissions trading for NOx and SO2 in its 
review of the Integrated Pollution Prevention and Control Directive51. It is already possible 
for  Member  States  to  set  up  schemes  that  allow  trade  in  the  emissions  remaining  after 
implementation  of  Best  Available  Techniques  (BAT).  A  further  issue  is  whether  they 
should  be  allowed,  either  individually  or  jointly,  to  opt  for  emissions  trading  instead  of 
BAT-based permits52.  

Do  you  see  scope  for  using  cross  border  emissions  trading  schemes  between  groups  of 
Member States to combat conventional air pollution through SO2 and NOx? How should such 
a  system  be  designed  to  fit  with  national  taxes  and  charges  that  are  applied  in  several 
Member States? 

5. 

CONCLUSION 

The  Commission  believes  that  alongside  regulation  and  other  instruments,  there  should  be 
increased use of MBI, including trading schemes, taxation measures and subsidies, as a cost-
effective tool to achieve environmental and other policy objectives, both at Community and 
national  levels.  This  would  be  in  keeping  with  the  Sustainable  Development,  Lisbon  and 
Better Regulation Agendas. 

The  new  energy  and  climate  policy  agreed  in  Europe  implies  nothing  less  than  a  new 
industrial revolution over the next 10 to 15 years. It will require a substantial change in the 
way  Europe  deals  with  energy  with  the  final  aim  of  achieving  a  real  low  carbon  economy. 
Several policy areas - at the national as well at the European level - will have to contribute 
and to be adapted in order to lead to this ambitious objective. Market-based instruments will 
be  important  parts  of  the  efforts  to  achieve  real  change  through  changing  incentives  for 
businesses  and  consumers.  On  top  of  this  important  long  term  role,  these  market-based 
instruments  also  carry  important  advantages  for  fiscal,  other  environmental  and  allocative 
purposes addressed in this paper. 

By means of this paper the Commission would like to generate a discussion about more active 
contribution of Community market-based instruments to these objectives, in particular when it 
comes to indirect taxation. Furthermore, a number of further areas for the application of MBIs 
have  been  identified  in  this  paper  where  the  Community  could  play  a  facilitating  role  to 
advance exchanges of best practice. The Commission seeks reactions to the ideas and specific 
questions included in this paper as well as comments on the kind of MBI best to be chosen in 
order to combine a maximum of potential positive effects. 

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The  UK  intends  to  introduce  a  trading  scheme  for  both  NOx  and  SO2,  as  well  as  dust,  from  2008 
onwards. 
Report  of  the  Commission  on  the  implementation  of  Directive  96/61/EC  concerning  integrated 
pollution prevention and control - COM(2005) 540, 3.11.2005. 
In answering this question, it will be important to consider not just the issues of varying environmental 
sensitivity  and  avoidance  of  "hot  spots",  but  also  the  risk  that  the  integrated  approach  of  the  IPPC 
Directive could be distorted by introducing trading for selected pollutants. The existing monitoring and 
enforcement  system  of  the  IPPC  Directive  must  not  be  weakened  either.  This  would  need  to  be 
evaluated  against  the  extent  to  which  emissions  trading  schemes  could  lead  to  more  cost-effective 
emissions reduction than under the present system. 

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Replies to the consultation should be sent to Green-paper-mbi@ec.europa.eu by 31 July 2007. 

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