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Market-based instruments for the environment

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Market-based instruments for the environment

The Commission believes that greater use should be made of market-based instruments, including quota trading schemes, taxation measures and subsidies, to achieve environmental and other strategic objectives. With this Green Paper, it is seeking to generate a discussion on this subject and raises crucial questions about the promotion of market-based instruments.


Commission Green Paper of 28 March 2007 on market-based instruments for environment and related policy purposes [COM(2007) 140 final - Not published in the Official Journal].


In this Green Paper the Commission launches a discussion on advancing the use of market-based instruments in the European Union. Reactions to the Green Paper are expected by 31 July 2007.

The consultation process and discussion launched by the Green Paper will help guide the direction for Community policy in terms of a wider use of market-based instruments: in particular within the context of the review of energy taxation and in various areas of environmental policy.

In recent years the EU has made ever greater use of this type of instrument to meet its objectives. The Commission believes that these instruments should be used even more, as called for in the Sixth Environment Action Programme, the renewed Sustainable Development Strategy and the Lisbon Strategy.

Description of market-based instruments

Two main types of market-based instrument are used at Community level:

  • instruments influencing prices, thus altering them: this applies principally to taxes (which increase the price of a product or service) and financial or fiscal incentives (which reduce the price);
  • instruments influencing quantities, by which a maximum quantity is set (in absolute terms or per unit of output): this is the case with tradable permit schemes such as the greenhouse gas emissions trading scheme, under which a maximum quantity of a particular pollutant that may be emitted is set, the quantity being divided up between economic operators and traded by them on a market specifically set up for that purpose, according to their ability to comply with the emissions limits (those who emit fewer pollutants than they are allowed can sell their unused quotas while those who emit more can buy quotas to make up the shortfall).

Instruments influencing quantities offer greater certainty and visibility in terms of achieving specific objectives (emission limits, for example), while instruments influencing prices offer certainty as regards the cost of achieving the objective (taxes, for example) but are as a rule easier to implement. In addition, taxes are a source of revenue while tradable permit schemes only generate revenue where the quotas traded are first granted by public tender. Charges do not generate any revenue for public budgets because they only represent payment for services rendered.

Compared to regulatory instruments, market-based instruments offer the following advantages:

  • external costs are internalised (i.e. they are taken into account in the end price);
  • they allow businesses greater flexibility in meeting their objectives and thus lower compliance costs;
  • they give firms an incentive to invest in innovation to reduce their impact on the environment;
  • they support employment when used in the context of green fiscal reform.

However, the Commission stresses the importance of precisely identifying the areas in which the use of market-based instruments could be envisaged in a way that also promotes competitiveness without imposing an undue burden on consumers.

An environmental tax reform could benefit the three components of sustainable development (the environment, economic growth and employment). For example, shifting the tax burden from capital and labour (direct taxes) to environmentally damaging consumption could reduce welfare-negative taxes in favour of welfare-positive taxes. Fiscal incentives, such as subsidies to encourage innovation, could also benefit both business and the environment (provided that the public funds from which the subsidies are paid are generated in a way other than by direct taxation, or that spending is reduced).

In the first place it is for the Member States to find the right balance between incentives and disincentives in their tax systems, while respecting overall fiscal constraints and fiscal neutrality. Introducing a framework for closer coordination, including environmental tax reform, and setting up a general market-based-instrument forum could promote the use of these instruments.

The Commission also stresses the need to reform or abolish environmentally harmful subsidies sector by sector.

Market instruments and energy policy

The Commission is examining whether the Energy Taxation Directive (laying down minimum levels of taxation on energy products and electricity used as heating or propellant fuels) should not be reviewed in order to establish a clearer link between energy taxation and the environmental and other related objectives of the Directive.

One option might be to divide the tax into energy and environmental elements. Energy sources would then be taxed according to their energy content and their environmental impact (greenhouse gas emissions and other polluting emissions). Such a system would make it easier to promote more environmentally friendly energy sources, in particular renewable energy. However, some differentiation according to use may be necessary to take account of the indispensable nature of fuel used for heating.

A review of the Energy Taxation Directive would also help to ensure greater consistency with other market-based instruments, complementing them and avoiding potential overlaps.

This is particularly the case with the greenhouse gas emissions trading scheme. It applies to certain combustion and industrial installations. A review of the Energy Taxation Directive would allow such installations to be brought within the scope of the Directive where they use energy in the form of heating or propellant fuels, and to apply to them either only the energy element of the tax where they are covered by the emissions trading scheme (i.e. not including the environmental element), or both elements of the tax (energy and environmental) where the installations do not participate in emissions trading.

The Commission also considers that the EU should promote market-based instruments at international level, in particular to its trading partners.

Market instruments and environmental policy

Transport is a major contributor to air pollution and CO2 emissions. The Commission has already proposed linking passenger car tax to CO2 emissions and including the aviation sector in the greenhouse gas emissions trading scheme.

17. The introduction of a market-based instrument to reduce emissions in the shipping sector must take account of the provisions on charging in the United Nations Convention on the Law of the Sea (FR) and the special features of the sector (in particular as regards geographical differentiation and monitoring mechanisms).

A charging framework tailored to land-based infrastructure (road and rail) and incorporating environmental concerns into the " Eurovignette " Directive would also enable greater account to be taken of the costs arising from, among other things, air pollution by SO2, NOx and particulates as well as noise pollution and congestion. The Commission will continue to support an exchange of information on urban transport, in particular to spread best practice identified in successful local experiments such as in London and Stockholm.

The EU is also encouraging the Member States to used market-based instruments to address pollution and protect resources. For example, the Water Framework Directive requires the Member States to introduce water pricing to encourage efficient water use, which could be supported by reinforcing the links between investments in national projects and the introduction of corresponding water pricing.

In addition, taxing landfill would help to promote recycling and recovery, provided that tax levels are relatively harmonised across the Member States (because widely varying levels could lead to 'tax dumping'). The Commission also suggests introducing market-based instruments for packaging differentiated according to the impact of the products and waste to promote more sustainable consumption.

Several types of market-based instrument are already being used to protect biodiversity but could be used more, as is the case with payments for environmental services (such as agri-environmental measures under the agricultural policy) and biodiversity compensation schemes (habitat banking).

As regards air pollution, it is worth investigating the use of emission quota trading to control the classical atmospheric pollutants (SO2 and NOx) having a local impact, in particular under the review of the Directive on national emission ceilings for atmospheric pollutants and the IPPC Directive.

Last updated: 11.06.2007