Tuesday, November 15, 2011

Europe:Taxing times for diesel

After almost two years of difficult internal and external discussions, the European Commission (EC) finally released its ‘Proposal for Council Directive amending Directive 2003/96/EC restructuring the Community framework for the taxation of energy products and electricity’. This proposal is now with the European Parliament, the Council and the European Economic and Social Committee, commencing the project’s legislative procedure.

Under the existing energy taxation directive the minimum tax rates for energy products are based on volumes. This creates, according to the EC, unfair competition among fuel sources and unjustifiable tax benefits for certain types of fuel compared with others. Indeed, the effect of this tax system is that products with lower energy content, such as gasoline, carry a greater taxation burden per energy unit than products with a higher calorific value, such as diesel. However, although the current taxation system does not explicitly take into account a fuel’s CO2 output, the favourable treatment of diesel fuel was often linked to the better fuel efficiency of diesel engines, which results in lower tailpipe CO2 emission per kilometre.

Translated into numbers, diesel fuel enjoys a relative tax advantage of around 24% compared to gasoline – measured on energy bases – while it generates about 32% more CO2 emissions. This has led to a situation in which the open market diesel price is higher than that for gasoline due to greater diesel demand, but retail prices for final consumers are reversed at the pump because of lower taxation rates. This creates even more demand for diesel, despite EU shortages. The EC wants to put an end to this distortive treatment, with diesel currently taxed at a lower rate than gasoline in all but one EU member state (the UK).

Two other issues the EC’s new proposal seeks to resolve relate to the taxation of renewable fuels and policy consistency in the tax system in relation to the objectives of the EU Emissions Trading Scheme (ETS). Currently, the minimum tax on renewable fuels is equal to the tax rate of the conventional fuels they replace.
For example, ethanol is taxed as gasoline, even though emissions from these fuels are different. Moreover, the current tax directive does not take into account ETS rules, or the potential interaction with this system. Thus there are overlaps in a number of areas. As a result, it eliminates some potential effects of the ETS by distorting price signals.

Two elements of the energy tax

With the new tax proposal, the EC introduces a distinction between fuels specifically linked to carbon intensity (CO2-related taxation) and energy taxation with the purpose of generating budget revenue (a general energy consumption taxation). The first component, the CO2-related taxation, will be based on the reference CO2 emission factors set out in Commission Decision 2007/589/EC. The second component, the general energy consumption tax, will be calculated based on the net caloric value specified in Annex II to Directive 2006/32/EC. 

In the case of biomass and products based on biomass, the reference values shall be those set out in Annex III of the EU’s Renewable Energy Directive (RED). For biofuels, these reference values may be applicable only if biofuels meet the sustainability criteria specified in the RED, otherwise the energy content should be the value used for the equivalent heating fuel or motor fuel. The proposed minimum levels for motor fuels are summarized in the table below.
Proposed Taxation from 1 January 2013- Europe

Despite a number of exceptions to these general guidelines, the proposal assumes a gradual increase to the minimum tax level for on-road motor fuels – apart from gasoline – so by 2018 the minimum tax rate for all fuels is equal. For key motor fuels, gasoline and diesel, the implication is that minimum tax rates on diesel are set to increase by around 25% from €0.33/litre t €0.41/litre, while the minimum duty on gasoline stays roughly the same, at €0.36/litre. Moreover, restrictions on fuel tax neutrality after 2020 could see minimum diesel taxes eventually rise 15% above gasoline.

It is important, however, to recall that only these figures represent minimum tax rates and EU member states are free to set rates much higher. Currently, gasoline is taxed at €0.72/litre in the Netherlands, twice the minimum required rate, while, in the UK, diesel is taxed at €0.66/litre, or double the minimum rate.

Under the new tax directive, diesel taxes would have to rise in more than half the EU’s 27 member states. However, they are already higher in Europe’s largest car markets – Germany, the UK and France – where no changes would be necessary.

On the other hand, this proposal could also be viewed as a signal to EU member states to reverse unwarranted tax advantages to diesel and to steer towards a more balanced future demand pattern which is sustainable for the refining industry. An early assessment of the potential implications of this proposal on gasoline and diesel demand in Europe suggests that the progressive shift in diesel taxes will not be sufficient to reverse diesel demand growth within this decade. However, it could slow down the rate of new diesel car registrations in the coming years, with a subsequent gradual shift to a higher share for gasoline engines.

It is too early at this point, however, to determine the full extent of this proposal. Depending on the response of EU member states to this new directive, the effect is likely to be limited in the medium-term, but should become more visible after 2020.

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