This article is written by Torbjörn Schiebe, Case Officer at the Swedish Competition Authority. For more like this, see our environmental policy newsfeed.
Carbon pricing, meaning carbon taxes and emission trading schemes, is widely recognised as the most cost-effective way to reduce carbon emissions.
A growing number of countries and jurisdictions are therefore implementing carbon pricing tools as well as strengthening existing once. Yet carbon pricing is, in the words of John Roome, Senior Director at the World Bank’s Climate Change Group, “nowhere near where it should be [as it] still covers only a small part of global emissions at prices too low to significantly reduce emissions”.
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Looking at carbon prices in particular, the World Bank shows that less than five percent of the emissions covered by a carbon pricing initiative are priced at a level consistent with achieving the goals of the Paris Agreement, ie. US$40-80 per tonne CO2 by 2020, and US$50-90 per tonne CO2 by 2030.
Sweden is however one of the few countries with a carbon tax above these limits. The Swedish carbon tax is today by far the highest in the world, with a price of SEK 1180 (€110/US$123) per tonne fossil CO2 emitted.
In this article I will briefly show how Sweden has managed to balance a high carbon tax with other policy considerations such as competitiveness and employment, as well as outlining some of the challenges ahead.
How does the carbon tax work?
The Swedish energy taxation system is made up of a carbon tax and an energy tax.
While the energy tax has been levied on major motor fuels since the 1930s, and heating fuels since the 1950s, the carbon tax was first introduced in 1991 as part of a major tax reform. This tax reform dramatically lowered marginal income taxes on capital and labour in exchange for, among others, a base broadening of the value added tax.
The Swedish experience shows that it is possible to reduce emissions while maintaining economic growth
In a nutshell, the introduction of the carbon tax was the result of two separate political processes: On the one hand, a demand for a drastic reduction in marginal income tax rates which had reached very high levels, and on the other hand, an increased interest in environmental issues, both politically and throughout the society.
The carbon tax is levied on motor fuels and heating fuels in proportion to their average fossil carbon content, as CO2 emissions released in burning any fossil fuel are proportional to the carbon content of the fuel. No measuring of actual emissions is therefore necessary, which greatly simplifies the system. To further simplify the system, the carbon tax rates are in the tax law expressed in common trade units (by weight or volume) for the different fuels. As only fossil carbon emissions result in net increases of carbon in the atmosphere, sustainable biofuels are not subject to the carbon tax.
The carbon tax was first introduced at a rate corresponding to SEK 250 (€23) and has gradually increased over the years.
Time to adapt
The tax changes has been implemented stepwise to give households and firms time to adapt.
In addition, the carbon tax increases have, typically, been combined with general tax reliefs in other areas to avoid an increase in the overall level of taxation and to make sure that the tax doesn’t disproportionately affect low-income households.
From the start, the Swedish industry furthermore enjoyed substantial relief from the carbon tax in order to secure competitiveness and mitigate the risk of carbon leakage. The Swedish carbon tax can thus, in simplified terms, be described as having started out as a two-level system, where a lower tax level for the industry was considered a prerequisite for a higher tax level for other sectors.
More specifically, industries covered by the EU Emissions Trading Scheme (EU ETS), who generally are energy intensive, have — in order to apply only one general economic instrument as an incentive to reduce greenhouse gas (GHG) emissions — been fully exempt from paying carbon tax in Sweden. For industries outside the EU ETS, which were initially also subject to lower levels of carbon taxation, the tax reliefs has been gradually phased out between 2011 and 2018.
In 2018 the Swedish carbon tax alone secured €2.43 billion ($2.65 billion) to the state treasury, which covers roughly half of the budget for the Swedish defence forces
Overall, the Swedish experience shows that it is possible to reduce emissions while maintaining economic growth. During the period between 1990 and 2017 GDP increased by 78%, while domestic GHG emissions decreased by 26% in the same timespan. In 2019 Sweden moreover ranked 8th on the Global Competitive Index.
However, while the carbon tax has been instrumental to achieve these emissions reductions, it is evident that a steadily increasing carbon tax is only feasible if households and firms are provided with real alternatives to fossil fuels.
Indeed, the 26% emissions reductions is primarily attributed to, on the one hand, the extensive expansion of fossil free electricity production (primarily nuclear power, hydropower and bioenergy), and, on the other hand, the extensive expansion of the district heating network, (primarily fuelled by household waste and various wood residues), which has almost entirely phased out fossil heating fuels in Sweden.
Challenges on the horizon
That being said, and although Sweden is indeed a frontrunner and a positive example for other countries to look at, many challenges remain. The primary one in this regard is the transport sector, which accounts for one third of Sweden’s overall emissions.
Worryingly, there are signs that it could be increasingly difficult to find broad political support for further carbon tax increases – which previously has not been the case. Political parties to the right of the spectrum increasingly oppose raising the carbon tax amid growing public opposition, particularly in the countryside and in rural areas, against what is considered excessive motor fuel prices.
From a climate perspective this is certainly bad news. With the current instruments in place, emissions in the transport sector are only expected to decrease by 35% by 2030, in comparison to 2010, which is a far cry from the 70% mandated by the Swedish climate goals. In fact, according to preliminary statistics, emissions from the transport sector even increased by 0.5 % in 2018 as a result of increased lorry traffic.
The difficulties encountered in relation to the transport sector, however highlights, again, the importance of providing real alternatives if decarbonisation should be politically feasible. In this regard, sustainable biofuels has an important role to play as it enables substitution in existing vehicles.
However, in the long run, electrification is the key.
Zero emissions, zero carbon tax revenues
The importance of electrifying the transport sector also brings me to one, interlinked, last point that often flies under the radar — namely, the issue of decreasing state revenues as a result of decreasing emissions. In 2018 the Swedish carbon tax alone secured €2.43 billion ($2.65 billion) to the state treasury, which covers roughly half of the budget for the Swedish defence forces.
Needless to say, this will be a problem long before emissions reach zero and thus a crucial issue to solve going forward. Generally, the most common solution to this problem is spelled some type of road pricing, such as a kilometre tax. As a matter of fact, the possibility of introducing a kilometre tax in Sweden to compensate for future expected tax losses is currently the subject of a publicly funded research project led by the Swedish Environmental Research Institute, IVL.
Whether a kilometre tax will be a reality remains to be seen. However, in the meantime, the Swedish carbon tax continues not only to generate substantial revenue, but most importantly, contribute to decreased GHG emissions. — Torbjörn Schiebe
(Picture credit: Unsplash)