A Pragmatic Approach to Fuel Taxation

By Robert Vierhout | January 11, 2012

One would think that a relatively easy way for governments to promote biofuels would be to tax biofuels less than fossil fuels—avoid lengthy debates on mandates and simply change the taxation structure in such a way that biofuels will have by far the competitive edge over fossil fuel. Unfortunately, it isn’t that straightforward to create such a level playing field in the EU.

Problem 1: Not only is an adjustment needed between taxing fossil fuels and biofuels, but also to balance the fuel market between diesel and gasoline. Under existing EU law, member states need to respect minimum levels of fuel taxation. These EU minimum levels are different between diesel (33 eurocents per liter) and gasoline (36 eurocents per liter). Not a huge difference, but member states can play with the tax level to promote one over the other and also to willingly distort the internal market. For example, diesel/gasoline taxes in eurocents per litre in Luxemburg is 32/46, in Germany, 47/66, whereas in the UK, 66/66. The highest tax for gasoline is in the Netherlands (80 eurocents) which has a diesel tax of only 42. Clearly, there are several other taxes that influence the consumer’s choice, but the fuel tax is decisive.

Problem 2: Changing the taxation structure at EU level seems often more difficult than changing the EU treaty. Several states see fiscal change as intervening in what is considered, deep down, a national prerogative. The UK is a case in point. Equalizing the tax level in the entire EU would help in obtaining a balanced fuel market and undoing competition distortion—something the UK could only support. But the fact that Europe is determining the level of taxation nationally (even if these are indirect taxes) is unpalatable for the Brits.

Problem 3: Some EU member states gain a lot of money by keeping taxes on fossil fuel artificially low with the purpose either to support the trucking sector through low diesel prices or to boost sales of diesel to nonresidents. Take Luxemburg (500,000 inhabitants) luring lorries to their country with low fuel taxes. The result is that the neighboring country, Germany (75 million inhabitants), is losing revenues big time by having a diesel tax 15 eurocents per liter higher. The weird thing is that Germany doesn’t like the taxation proposal because the diesel car manufacturers, a major political force in Germany, fear loss of market share if taxes become more equal. Giving in to the car lobby means hundreds of millions of euros per year less tax income for the German state. The estimate is that for Luxemburg the extra income per capita is around 1,400 Euro per year.

The present energy taxation law results in perverse effects causing shortages of diesel, surpluses of gasoline, discrimination of biofuels when taxed as fossil fuels and loss of government income when taxes are unequal in neighboring countries. So, change is needed, but any substantial progress does not seem to be happening. 

Since April, member states are trying to agree on a more balanced tax law. After a delay of more than a year before the bill was put to the member states, the Polish president of the EU spent most of the past six months derailing the proposal, because it runs counter to Poland’s coal policy.

All hopes are now set for the first half of this year when the Danes hold the presidency. Even though a brand new government and not very experienced, the Danes want a pragmatic approach: Focus the law on what really will deliver a change in European transport fuel consumption by aligning taxation of diesel and gasoline and forget about all the other goodies, such as introducing a CO2-based tax, taxation on energy density or a higher tax on coal.

Such a pragmatic approach would resolve the perversities we are having with the present law. Even though it would not be the best possible outcome for biofuels in general, it would be still beneficial for ethanol in the long run. Fiscal equalization between fossil fuel will benefit gasoline and, hence, ethanol.