This chapter provides an overview of energy tax and subsidy patterns in the 71 countries covered in the report and estimates the net effect of energy taxes and subsidies on public finances. The chapter then compares the Net Effective Energy Rate (Net EER) across all forms of energy use, including fossil fuel use, but also energy sources that do not emit CO2 when used, such as hydro, wind and solar. The Net EER is the sum of fuel excise and electricity taxes, carbon taxes, and permit prices related to emissions trading systems that apply to CO2 emissions from energy use, net of fossil fuel and electricity subsidies that reduce pre-tax energy prices. The chapter applies the Net EER to analyse whether fossil fuels are effectively taxed more than other energy sources and to compare effective tax rates on diesel and gasoline.
Pricing Greenhouse Gas Emissions
3. Taxes and subsidies on energy use
Abstract
Energy taxes and subsidies are ubiquitous and extend beyond fossil fuels
Almost all countries covered in this report collect energy taxes (i.e. excise taxes on fuels or on electricity consumption). These taxes raise government revenues and increase energy prices, thereby reducing energy use and the negative side-effects associated with it. However, energy taxes are often poorly aligned with the environmental costs of energy use.
The most common form of energy taxes are fuel excise taxes, but electricity use is sometimes also taxed. Fuel excise taxes, even where they are not explicitly linked to a carbon price, are similar to carbon taxes in that the tax liability increases proportionally to fossil fuel use. However, they typically only apply narrowly to certain fuels (e.g. gasoline used for road transport or specific heating fuels). In addition, tax rates do not align with fuels’ carbon content systematically, so they do not provide a consistent carbon price across the economy (see also Chapter 2).
Electricity excise taxes do not apply to the energy sources used to generate it, but rather to tax certain forms of electricity consumption, which is why they are sometimes called output taxes. Electricity taxes are often specified per kWh of electricity use (Chapter 1), and typically do not distinguish between the sources used to generate electricity. As a result, in many countries they tend to make electricity more expensive even when it is produced from clean energy sources and are therefore not included in the effective carbon rates indicator discussed in Chapter 2 (OECD, 2019[1]).
In addition to taxing energy use, several countries also grant subsidies on certain forms of energy use. Subsidies for energy use put a burden on public finances and change incentives for energy use, often in environmentally harmful ways. Fossil fuel subsidies, as defined in Chapter 1, effectively reduce domestic pre-tax fossil fuel prices below supply costs, encouraging fossil fuel use. This is, for example, the case for several liquid fuels in Colombia and Ecuador, heating fuels used by households in Greece and Hungary, and LPG in Morocco. Countries also provide electricity subsidies that reduce pre-tax electricity prices (e.g. in Argentina, Burkina Faso, Dominican Republic).
Governments could use more targeted tools than subsidies or energy tax reductions to achieve the important policy objectives of energy access and energy affordability (OECD, 2021[2]). Fossil fuel and electricity subsidies and energy tax cuts on energy use tend to benefit richer energy users more than poorer ones, especially in absolute terms, and “are generally detrimental to the economic, social, and environmental dimensions of sustainable development” (Rentschler and Bazilian, 2016[3]). Reducing fossil fuel support could free up public funds for higher value uses, including targeted support to low-income groups to ensure that such reform not only provides short-term relief but becomes a fully integrated component in a country’s long-term sustainable development strategy (Rentschler and Bazilian, 2017[4]).
The subsidy reform experience of Egypt is an example of where this has happened effectively in recent years. However, as discussed in Chapter 2, many governments both in and beyond the OECD have reacted to recent energy price hikes by introducing new forms of fossil fuel support (Van Dender et al., 2022[5]). Even where this support has been described as temporary, it may be challenging to roll back as prices stabilise.
Not all forms of subsidies or energy tax cuts are equally harmful from an environmental and public health perspective. For instance, LPG subsidies that are in place in number of developing and emerging economies (e.g. Argentina, Côte d’Ivoire, Dominican Republic, Ecuador, India, Indonesia, Kenya, Malaysia, Morocco, Panama), can help to avoid the use of more polluting fuels, such as traditional firewood – an informal market fuel.1
In some cases, subsidies on electricity use may be associated with higher fossil fuel use in the short term, but could also play an important role in accelerating electrification. Electrification is a promising decarbonisation option for transport, industry and heating as long the power sector itself transitions to net zero GHG emissions. Despite these considerations, electricity subsidies impose a burden on public budgets, and can discourage private investment in the sector, which could slow down the transition to a clean power sector capable of serving countries’ low-carbon energy needs.
Several developing countries intend to reduce electricity subsidies (e.g. the Dominican Republic has planned decrease of electricity subsidies starting from November 2021, with the phase-out to be completed by in 2026) (Superintendencia de Electricidad, 2021[6]). Others, such as Malaysia, have improved the targeting of electricity subsidies to the poorest households (Ministry of Finance Malaysia, 2018[7]).
Where it is not possible to phase out electricity subsidies (e.g. because more targeted support faces administrative obstacles), subsidies for electricity could be made conditional on environmental criteria (e.g. on implementing recommendations from an energy audit, or on investing a portion of the subsidy on emissions reduction projects).
What is the net effect of energy taxes and subsidies on public finances?
The mix of taxes and subsidies on energy use varies across countries, and so does their net effect on public finances. Figure 3.1 shows that in 61 out of the 71 countries covered in this report, tax revenues exceed the cost of the subsidies within the scope of this report in 2021. This means that the overall contribution of these energy tax and subsidy policies to public finances and domestic resource mobilisation is positive. Tax revenues were estimated based on the Net EER dataset, which maps fuel and electricity excise taxes, carbon taxes and permit prices from emissions trading systems, as well as fossil fuel and electricity subsidies to the corresponding domestic energy use (Chapter 1).
After netting out fossil fuel and electricity subsidies, taxes on energy, as well as revenues resulting from the sale of emission allowances, make a relatively larger contribution to public finances in OECD countries than in other parts of the world. Taking the simple average across all 71 countries covered in this report, net energy tax revenues are in the magnitude of 1.2% of GDP. The contribution exceeds 3% of GDP in Estonia, Greece and South Africa. The OECD average is 1.7%, in G20 countries it is 1.1%, and in low and middle-income countries that are eligible for official development assistance it is 0.6%.
The cost of subsidies on energy use sometimes exceeds the revenues from energy taxes. In this case, the net effect of energy tax and subsidy policies represents a burden on public finances. This is most common in oil producing countries, such as Ecuador, Egypt, and Nigeria. However, reforms have often already reduced these subsidies substantially in recent years, as discussed in more detail in Chapter 2.
The magnitude and composition of energy tax revenues is likely to change in the coming years as the transition to a low-carbon economy accelerates. During the transition, some of the existing tax bases are expected to be eroded over time. In this respect, the road sector is of particular relevance, considering that it is an important source of fuel excise tax revenues (OECD/ITF, 2019[8]). With the rise of electric vehicles and mode shifts to other mobility options this fuel excise tax base is eroding gradually. This suggests the need to anticipate this shift and proactively design policies that take this transition into account (Van Dender, 2019[9]).
Figure 3.1. Net energy tax revenues estimates, 2021
Note: Net energy tax revenues are a bottom-up estimate of the net revenues resulting from taxes and subsidies on energy, and the revenues from auctioning emissions permits for energy-related CO2 (estimated based on OECD (2021[10])). Bottom-up revenue estimates may not correspond to the actual revenues and expenditures, inter alia due to differences between the base year and the rate date. Subsidy estimates are for 2020 and are based on data on relevant budgetary transfers from the Inventory of Fossil Fuel Support where available and original research for the other countries (OECD, Forthcoming[11]). Country groupings are simple (unweighted) averages. G20 refers to the 18 individual G20 countries covered in this report. ODA recipient refers to all ODA recipient countries covered in this report.
Effective energy rates vary across products, but are generally higher on fossil fuels
Taxing more polluting forms of energy use at higher effective rates, net of subsidies, can shift energy demand towards cleaner energy sources. Chapter 2 already showed that net effective carbon rates are generally poorly aligned with the climate costs of fossil fuel use. However, incentives for reducing fossil fuel use are also affected by the relative tax treatment of fossil fuels vis-à-vis other energy sources that do not emit GHG emissions when used (and are hence beyond the scope of effective carbon rates). A higher relative tax burden on fossil fuels, for instance, strengthens the economic case for switching to electric vehicles in passenger transport. It can also help to improve the business case for decarbonising industrial processes (e.g. in the steel sector). Changing relative prices in favour of cleaner sources can also contribute to directing private and public resources towards the development of new clean technologies. Switching to cleaner sources, such as electricity from hydro power, as well as wind and solar, also comes with important co-benefits, including reduced morbidity and mortality from local air pollution (OECD, 2019[1]).
Effective energy rates are highest for fossil fuels used in road transport. Figure 3.2 shows that the average Net EER varies widely between energy products. The biggest difference in average Net EERs is between fossil fuels primarily used in road transport (gasoline and diesel) and other fossil and non-fossil fuel energy sources. Where coal is priced, it is mainly the result of explicit carbon pricing in the industry and electricity sector. On average, natural gas is priced at similar levels to coal. However, fuel excise taxes are relatively more common for natural gas, which mostly apply to natural gas used for space heating in the buildings sector. For both coal and natural gas, electricity excise taxes practically cancel out electricity subsidies when calculating the average for the 71 countries (Figure 3.2). Fossil fuel subsidies are relatively high for LPG (relevant in Ecuador, Egypt, Morocco, and India), but on average the Net EER for the group of countries considered in this report remains positive, mostly due to fuel excise taxes.
Figure 3.2. Average effective energy rates, by product category, 71 countries, 2021
Note: Subsidy estimates are for 2020. Energy use data is for 2018 (IEA, 2020[12]).
The net effect of energy taxes and subsidies is non-negligible for many non-fossil alternatives, mainly because of electricity taxes. Electricity taxes dominate the Net EER for renewables (with the exception of biofuels) and nuclear. Electricity subsidies also apply to electricity produced from renewable sources, pushing down the Net EER. However, the Net EER remains positive, on average, with the exception of geothermal (which is a major source of electricity produced in the Philippines, where there are electricity subsidies). Note that direct support measures for renewable power production, such as feed-in tariffs, are beyond the scope of the instruments covered in this report (Chapter 1).
Most countries tax fossil fuels at a higher Net EER than other energy sources. Figure 3.3 shows, however, that the difference between the average Net EER on fossil fuels and on other energy sources (excl. biofuels) – the fossil-fuel surcharge – varies substantially across countries. Switzerland has the highest average Net EER on fossil fuels, and also the highest “fossil-fuel surcharge”. There are some countries with a negative fossil combustion surcharge. In countries that tax other energy sources at a higher Net EER on average, this is either because of relatively high taxes on the consumption of electricity (e.g. Brazil) or because of relatively high subsidies on fossil fuels (e.g. Ethiopia), or a combination of the two (e.g. Ecuador). Averages and the fossil fuel surcharge are affected by the composition of energy use and need to be interpreted with caution (see also, Chapter 2). Net EER data disaggregated by energy product categories is available on OECD.STAT.
Figure 3.3. On average, in 2021 fossil fuels are effectively taxed more than other energy sources
Note: Sorted by average Net EER on fossil fuels, starting with the highest at the top of the figure. The labels mark the values of the fossil-fuel surcharge rounded to the nearest eurocent. Subsidy estimates are for 2020.
Most countries tax diesel less than gasoline, even though this is not supported by environmental considerations
From an environmental perspective, diesel merits being taxed at higher effective rates per litre than gasoline. Climate considerations suggest taxing diesel at the same effective rate as gasoline per tonne of CO2, which translates into a higher effective rate per litre because CO2 emissions per litre of diesel are higher. In addition, non-climate damage per litre of diesel use tends to be higher than for gasoline use, even though regulations and emission control technologies could reduce the difference. This damage includes environmental externalities such as air pollution, as well as congestion (Harding, 2014[13]).
However, diesel for road use only faces a higher average Net EER per litre of fuel than gasoline in seven out of the 71 countries covered in this report (Côte d'Ivoire, Egypt, Jamaica, Malaysia, Mexico, Nigeria, Switzerland and the United States).2 In Bangladesh and the United Kingdom the average Net EER on diesel and gasoline in road transport is identical per litre. Bangladesh neither taxes nor subsidises diesel and gasoline in the road sector. There has been little change in the tax preference enjoyed by diesel in many countries - the diesel discount - since 2018 (OECD, 2019[1]; OECD, 2021[2]).
Figure 3.4. The diesel discount
Note: Sorted by average Net EER on diesel, starting with the highest at the top of the figure. The labels mark the values of the diesel surcharge, which is negative for countries with a diesel discount, rounded to the nearest eurocent. Uruguay is marked with an asterisk because in Uruguay diesel used in road transport is subject to VAT (outside the scope of this report), but no fuel excise, whereas gasoline is subject to fuel excise, but not VAT. Subsidy estimates are for 2020.
References
[13] Harding, M. (2014), “The Diesel Differential: Differences in the Tax Treatment of Gasoline and Diesel for Road Use”, OECD Taxation Working Papers, No. 21, OECD Publishing, Paris, https://doi.org/10.1787/5jz14cd7hk6b-en.
[12] IEA (2020), World Energy Statistics and Balances, http://www.iea.org/statistics/topics/energybalances.
[7] Ministry of Finance Malaysia (2018), Budget 2019, https://www.mof.gov.my/portal/arkib/budget/2019/bs19.pdf.
[10] OECD (2021), Effective Carbon Rates 2021: Pricing Carbon Emissions through Taxes and Emissions Trading, OECD Publishing, Paris, https://doi.org/10.1787/0e8e24f5-en.
[2] OECD (2021), Taxing Energy Use for Sustainable Development, http://oe.cd/TEU-SD.
[1] OECD (2019), Taxing Energy Use 2019: Using Taxes for Climate Action, OECD Publishing, Paris, https://doi.org/10.1787/058ca239-en.
[11] OECD (Forthcoming), Net Effective Carbon Rates.
[8] OECD/ITF (2019), Tax Revenue Implications of Decarbonising Road Transport: Scenarios for Slovenia, OECD Publishing, Paris, https://doi.org/10.1787/87b39a2f-en.
[4] Rentschler, J. and M. Bazilian (2017), “Policy Monitor—Principles for Designing Effective Fossil Fuel Subsidy Reforms”, Review of Environmental Economics and Policy, Vol. 11/1, pp. 138-155, https://doi.org/10.1093/reep/rew016.
[3] Rentschler, J. and M. Bazilian (2016), “Reforming fossil fuel subsidies: drivers, barriers and the state of progress”, Climate Policy, Vol. 17/7, pp. 891-914, https://doi.org/10.1080/14693062.2016.1169393.
[6] Superintendencia de Electricidad (2021), Resolución SIE 087-2021-TF, https://sie.gob.do/wp-content/uploads/2021/09/SIE-087-2021-TF-Modif-Res-SIE-075-2021-TF.pdf.
[9] Van Dender, K. (2019), “Taxing vehicles, fuels, and road use: Opportunities for improving transport tax practice”, OECD Taxation Working Papers, No. 44, OECD Publishing, Paris, https://doi.org/10.1787/e7f1d771-en.
[5] Van Dender, K. et al. (2022), Why governments should target support amidst high energy prices, OECD, https://www.oecd.org/ukraine-hub/policy-responses/why-governments-should-target-support-amidst-high-energy-prices-40f44f78/.
[14] Zinecker, A. et al. (2018), Swap: Reforming support for butane gas to invest in solar in Morocco.
Notes
← 1. Nevertheless, replacing these subsidies with direct support for cleaner alternatives, such as solar, could accelerate the energy transition (Zinecker et al., 2018[14]).
← 2. For both Egypt and Jamaica, this is only true on average. In Egypt, some gasoline types do not attract excise and bring the gasoline average below the average for diesel. Otherwise where fuel excise taxes apply, rates tend to be higher for gasoline than for diesel in Egypt. In Jamaica, taxes differ between types of gasoline, one is taxed below diesel, and this dominates the average Net EER. Nigeria subsidises gasoline and does not price diesel. Malaysia subsidises gasoline more than diesel (no energy or carbon taxes apply).