Economic policy strongly influences the quantity and types of energy used and hence the quantity and types of pollutants released by the energy system, including greenhouse gases (GHGs). Here are some common government interventions in energy markets:
- An emissions trading system is a market mechanism that allows those entities (such as countries and companies) that emit greenhouse gases into the atmosphere to buy and sell these emissions (as permits or allowances) amongst themselves.1 This system is also known as “cap-and-trade.”
- A carbon tax is a price set by a government that emitters must pay for each ton of carbon dioxide and other greenhouse gas emissions they emit.
- An excise tax is a tax levied by governments on specific goods or services at the time they are purchased. Excise taxes can be ad valorem (paid by percentage of the price) or specific (cost charged by unit).2
The Organisation for Economic Cooperation and Development (OECD) studied the tax and subsidy policies of 71 countries, which together account for approximately 80% of global GHG emissions and energy use.3 The overall impact of energy and carbon taxes in a country was measured by the tax revenue as a percent of the Gross Domestic Product (GDP). The macroeconomic impact was generally the largest in Europe. In Estonia and Greece, the energy and carbon tax burden was close to four percent of GDP. The United States (0.4% of GDP) had one of the lowest rates.
Almost all countries studied collect energy excise taxes on fuels or electricity consumption. But fuel taxes, principally on transportation fuels such as gasoline and diesel fuel and some heating fuels, are far more common than taxes on electricity. Interestingly, most countries tax diesel fuel at a lower rate than gasoline. Note these are federal taxes only. In the United States, many states levy a tax on electricity. Explicit carbon taxes are relatively rare and are highly concentrated in Europe.
The European Union’s Emissions Trading System (ETS) is the world’s most ambitious cap and trade system to reduce GHG emissions. The ETS covers emissions from about 10,000 installations in the energy sector and manufacturing industry, as well as aircraft operators flying within the EU. This activity accounts for about 40% of the EU’s GHG emissions.4 As the chart indicates, the ETS is a significant addition to the overall energy tax in many EU countries.
Overall energy tax policy is not aligned with GHG reduction goals. For example, fuel excise tax rates do not align with fuels’ carbon content systematically. In addition, electricity excise taxes apply to electricity consumption, not to the sources of electricity generation. In many countries, this policy tends to make electricity more expensive even when it is produced from clean energy sources.3
1 Eurostat, “Emissions trading system (ETS),” Link
2 Kagan, Julia, “Excise Tax: What It Is and How It Works, With Examples,” Investopedia, October 20, 2023, https://www.investopedia.com/terms/e/excisetax.asp
3 OECD (2022), “Pricing Greenhouse Gas Emissions: Turning Climate Targets into Climate Action,” OECD Series on Carbon Pricing and Energy Taxation, OECD Publishing, Paris, https://doi.org/10.1787/e9778969-en
4 European Commission, “What is the EU ETS?” Accessed November 1, 2023, Link