Commission set to reject VAT cuts for green goods

An internal consultation within the European Commission on draft plans to cut VAT on some green goods and services has ruled out reductions for energy-efficient household appliances.

Value added tax (VAT) cuts for solar panels, wind turbines and energy audits are being considered by the European Commission. But it looks set to reject calls from the UK and French governments to reduce VAT on energy-efficient appliances and light bulbs.

Draft legislative proposals, drawn up by the Commission’s tax department, are in consultation between the European Commission’s directorates in advance of a full public consultation, expected in April.

It follows an agreement made at a European Council meeting in March 2008 that the Commission should "examine areas where economic instruments can have a role to play to increase the use of energy-efficient goods and energy-saving materials."

This followed public calls by Prime Minister Gordon Brown and French President Nicolas Sarkozy for the EU president to consider the move as part of the planned VAT legislative proposals (ENDS Report 398, pp 26-27 ).

Under the 2006 VAT Directive, member states are allowed to apply VAT rates below the bloc-wide minimum of 15% for products agreed at EU level. It is then up to each state to decide whether and at what level to apply the reduced rate, down to a minimum 5%.

In November, the European Commission gave the strongest signal yet that it was pursuing VAT reductions to promote rapid take-up of "green" products. In its economic recovery plan it said it would propose "reduced VAT rates for green products and services aimed at improving in particular building energy efficiency." It confirmed it would also urgently draw up measures for other products which offer very high potential for energy savings.1 The Commission’s tax department believes more market penetration of solar panels and wind turbines could be achieved with reduced tax rates. It also thinks a VAT cut could boost uptake of services such as energy audits. Strangely, cuts for other products such as pesticides and fertilisers are also being considered.

However, the department has ruled out VAT reductions for energy-efficient products because of market distortion concerns. This is despite a cost-benefit analysis produced by consultancy Bio Intelligence Service, which says the high purchase price of the most efficient models compared to others remains the main barrier for the uptake of "green" alternatives.2 It concludes that the impact of fiscal incentives to encourage market transformation varies from product to product, but it offers the biggest scope where the upfront price is a significant issue.

In line with this thinking the Commission’s energy and transport directorate is understood to be lobbying for more products, such as boilers, to be added to the list. The agricultural directorate is reportedly pressing for products such as biofuels to be added.

But it is unclear if the tax department will be swayed. It has been largely informed by a report by Danish consultancy Copenhagen Economics that expresses scepticism about reduced VAT rates on energy efficient products.3 It argues "it is not clear if energy savings will unambiguously follow from such purchase rewards."

It makes several arguments to support its scepticism. It points to rebound effects - where the energy consumption associated with a product increases despite improved energy efficiency because a product is cheaper to run. It also argues that market distortions could emerge for big ticket items, with consumers going cross borders to obtain cheaper prices.

At the time of going to press, environmental groups were in the process of preparing their reaction to the report. But the European Environment Bureau (EEB), an umbrella group of EU environment NGOs, is set to challenge the report’s logic.

For example, in its executive summary the report’s authors argue that nearly all electricity consumption and district heating by households are already covered by the EU’s energy trading scheme: "Any new measures encouraging lower electricity use by households will lead to a lower price of ETS emission allowances but will leave the level of CO2 emissions unchanged."

But while this may be the case in the short term, the report fails to consider potential longer-term benefits. Reduced household energy consumption could potentially allow for tighter caps to be set in future phases of the EU emissions trading scheme.

"The whole idea of the EU’s target to reduce energy consumption by 20% is to reduce emissions through energy efficiency," said Dr Pendo Maro, EU energy policy officer at EEB. "Yes, concerns about market distortion may be justified but there are ways around it. We shouldn’t dismiss it."

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