OECD Economic Surveys: Hungary 2024

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OECD Economic Surveys: Hungary

6 March 2024

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5. Towards more sustainable growth

Donal Smith

Tony Huang

Abstract

Hungary’s green transition has made progress but will need to accelerate to reach emission reduction targets. For a large part, emission reductions achieved so far are related to structural shifts induced by the transition to a market economy in the early 1990s. Regulations and standards are currently the main tools used to support the green transition, but they will likely be insufficient to reach the 2030 and 2050 emission targets. Price signals are key for an efficient decarbonisation, but the EU’s Emission Trading Scheme only covers a third of emissions. Energy price caps have curbed incentives for energy saving and energy efficiency improvements, which contributes to high residential emissions. An aged vehicle stock, low fuel duties and urban sprawl are pushing up transportation emissions. The green transition will require a significant increase in electricity supply from low-carbon sources and massive investments in the electricity grid.

Addressing climate change requires policy action

Hungary stands to gain significantly from contributing to global efforts to rein in climate change, as changing climate patterns are already having significant economic costs due to altering temperatures and rainfall. The annual average temperature rose by 1.15°C between 1907 and 2017, outpacing the global average of +0.9°C, which led to proportionately higher economic losses (Figure 5.1). This will only intensify in the future, implying a need for additional spending on adaptation measures. Extreme heat episodes will increase further, with the number of days classified as extremely hot expected to more than double in 2071-2100 as compared to 1960-1990 (Vahava, 2010[1]). This will create stress for the forestry stock, an important source of carbon sequestration (MIT, 2020[2]).

Rainfall patterns are also affected by climate change. Projections suggest significant changes in the availability and quality of water within a year, even if average annual precipitation is not expected to change significantly (Barreto et al., 2017[3]). Changing rain distribution throughout the year and the increased occurrence of extreme precipitation, along with unsustainable water resource management, have already led to reductions in surface and groundwater reservoirs (Németh, Kravalik and Séra, 2022[4]). In the future, the wettest seasons will be winter and spring and the driest summer, the reverse of the current situation (Vahava, 2010[1]). Moreover, droughts and extreme rainfall events are both expected to become more intense and more frequent (Buzási, Pálvölgyi and Esses, 2021[5]). Droughts are already a challenge affecting over one third of the country and causing average damages for EUR 110 million every year. In 2022, droughts resulted in losses of 0.6% of GDP in agriculture (Németh, Kravalik and Séra, 2022[4]; Ministry of Agriculture, 2022[6]). Moreover, close to one quarter of land is exposed to floods (OECD, 2020[7]). Preventive investments in flood infrastructure have already led to adaptation costs of 1.9% of GDP between 2014-2020 (OECD, 2020[7]).

Figure 5.1. Economic costs of climate change

1980-2020, % of 2020 GDP

A multi-faceted strategy is needed to reduce carbon emissions, with electrification and decarbonisation as key pillars. Many activities that currently rely on high-carbon fuels will have to be electrified, a process that will also cut local air pollution. This hinges on a decarbonisation of electricity generation itself, based on the development of renewable and other low-carbon energy sources. Decarbonisation will also call for a reduction in energy demand through improved efficiency, particularly in housing.

Ensuring that energy supply meets demand as the fuel mix fundamentally alters will require substantial investment. Three key elements in any transition path are: higher carbon emission prices to stimulate the use of non-carbon-based energy sources and innovations in production, transport and heating systems; a well-designed set of standards and regulations; and subsidies and complementary polices to enhance the acceptance of mitigation measures (D’arcangelo et al., 2022[8]). Standards and regulations can be particularly effective in restricting and phasing out high-emitting activities or technologies and accelerating the deployment of low-emitting technologies. They can complement emission pricing and incentive-based policies.

Current policies mostly rely on increasing the share of renewable energy sources and ambitious investments in a new nuclear power plant. Moreover, there are policies to encourage home energy efficiency improvements as well as tax advantages that favour electric vehicle use. However, the system of taxes and subsidies has yet to fully align with these objectives and strengthen incentives to meet green transition targets. Subsidies for sectors with high energy use create distortions and impede price signals from redirecting resources towards less emission-intensive activities. This situation also distorts the market on the supply side. Replacing this system with effective and uniform price signals for emissions would assist in reaching environmental goals.

Against this background, this chapter’s main messages are:

Future policies will need to address an extensive regulation of gas and electricity prices, which results in retail prices being among the lowest in Europe and contributes to high energy use and emissions in the household sector.
Accelerating the development of new low-carbon energy sources will be key. Current plans focus on solar energy and biomass but the potential of wind and geothermal energy is underexploited. This development of intermittent energy sources will also require massive investments in the electricity grid.
An investment in a new nuclear power plant, worth 7% of GDP and with a production capacity corresponding to roughly 50% of the current domestic electricity supply, is subject to risks related to completion delays, cost-overruns and geopolitics.
Substantial investment in water infrastructure will be needed to facilitate adaptation to changing water availability.

Climate mitigation objectives and progress towards net zero

Hungary’s environmental objectives are stipulated in a series of strategies, action plans and legislative measures with the aim of achieving a cut in greenhouse gas (GHG) emissions in line with European Union (EU) targets. Emissions have declined by 32% between 1990 and 2021, from 95 to 64 million tonnes of carbon dioxide equivalent. Based on the latest estimates for 2022, Hungary's GHG emissions decreased by 37% compared to 1990, with per capita GHG emissions (around 6 tonnes) being under the EU average (approximately 7 tonnes). However, much of this reduction occurred in the early 1990s with the structural change of moving from a centrally planned to a market economy. Since then, the pace of emission abatement has fallen by 36% and 85% over the past 20 and 10 years, respectively. The current reliance on regulation and subsidies, but not on price signals, may have been sufficient to reach the previous objective of reducing gross emissions by 40% between 1990 and 2030 (Figure 5.2). However, the National Energy and Climate Plan (NCEP) now aims to reduce gross emissions by 50% by 2030, in line with the EU’s new more ambitious 2030 emission reduction targets and net zero emissions by 2050 (Directorate-General for Energy, 2023[9]). Achieving these goals will require a substantial change in the policy mix, and a stronger role for price signals.

Figure 5.2. CO2 emission targets have become more ambitious

Index, 1990 = 100

Reaching climate change objectives will be challenging and will involve sizeable infrastructure investments. Construction costs of the new Paks II nuclear plant are estimated at 7% of GDP (International Energy Agency, 2022[10]). Upgrading the electrical grid to facilitate the expansion of renewables may to cost between 1.6% and 5% of GDP. Illustrative estimates of improving the thermal insulation of 10% of the housing stock with new windows and modernised boilers total to 3% of GDP (Csoknyai et al., 2022[11]). Furthermore, climate change is expected to alter rainfall patterns adding further impetus to accelerate overdue investments in water infrastructure, estimated to be at least 6% of GDP. Taken together, the cost of these major green transition projects amounts to up to a fifth of 2022 GDP. While substantial, these investments are needed to avoid potentially large costs arising from inaction on climate change. This highlights the scale of resources needed and the importance of pursuing the most economically efficient policies.

Energy generation and transport are the main sources of emissions

At the national level more than half of GHG emissions come from energy use excluding transport, followed by emissions from transport (20% of total emissions), industrial processes and agriculture (12% of total emissions each) (Figure 5.3, Panel A). The largest driver of energy demand is the household sector. Therefore, it will be crucial to achieve energy savings in this sector, as well as to increase the share of energy produced from low-carbon sources. There are also sectors where emissions have risen over the last decade, including transport, industry and agriculture (Figure 5.3, Panel B).

Figure 5.3. Energy use accounts for half of Hungary’s GHG emissions

Policies can mitigate the use of high carbon fuels in energy, transport and industry

Emission reductions can be achieved by a policy mix containing three broad sets of instruments: regulations, price-based measures and complementary and framework policies. Carbon prices are typically the most cost-efficient solution, as a single carbon price incentivises economic agents to adopt the emission solutions with the lowest abatement cost first, until marginal abatement costs, which represent the cost of reducing an additional tonne of CO₂emissions reach carbon prices. Carbon prices can be introduced directly via a carbon tax or indirectly with an Emissions Trading Scheme (ETS). An ETS – as opposed to a tax – is a quantity-based policy that limits or caps the allowed amount of GHG emissions and lets market forces determine the carbon price through emitters trading emissions allowances (D’arcangelo et al., 2022[8]).

The second approach to carbon reduction, regulation and standards, or non-price-based measures, can be also useful to overcome market failures and deal with circumstances where the responsiveness to price signals is weak. Effective regulation and standards can complement carbon prices as they reduce the level of pricing needed to reach emission targets. Indeed, carbon prices that are too high may not be politically feasible to implement. Likewise, carbon pricing may be less effective in influencing long-run household investment decisions, either due to liquidity constraints, risk aversion or because of a present bias. For example, some might not retrofit their homes even when it makes economic sense because savings will be realised far in the future. Well-designed regulations and standards can also help overcome coordination failure and realise network effects, for example, by setting technical standards for electric vehicle charging stations or green hydrogen (D’arcangelo et al., 2022[8]). They can also help to solve problems such as split incentives between homeowners and tenants, which can cause an underinvestment in energy efficiency measures.

Complementary and framework policies are the third component of a comprehensive policy mix. These include all those policies that do not directly target a reduction in emissions but provide the enabling economic and social conditions to do so, by lowering the economic and social costs of decarbonisation. These fall into two broad categories: 1) policies to improve the cost effectiveness of decarbonisation strategies, including measures to accelerate the development and deployment of new abatement technologies, support business dynamism, upgrade infrastructure networks and crowd-in private capital; and 2) policies to allay the distributional effects of climate policies and help people in the transition, such as reforms to the tax and benefit system and active labour market programmes.

Hungary is pursuing emission reductions to a large degree through non-market-based measures, such as regulations and standards (Figure 5.4). The OECD Environmental Policy Stringency Index illustrates the rise of climate mitigation efforts in Hungary in the last two decades. While non-market-based policy instruments contributed the most to this increase, in recent years the technology support sub-index shows a significant rise as well. The EU-ETS contributed to the increase in the stringency of market-based policies since 2006. Nonetheless, the scope for higher and more unified carbon pricing remains significant. Given the rebalancing of the policy mix needed, complementary and framework policies can improve the public acceptability of these changes.

Figure 5.4. Non-market based environmental policies dominate

The OECD Environmental Policy Stringency Index, from 0 (not stringent) to 6 (highest degree of stringency)

The EU’s Emission Trading Scheme is currently the most salient price-based measure applied in Hungary. The cap declines over time, ensuring that the desired emission mitigation target in the EU ETS sectors is achieved cumulatively. However, this currently only applies to energy generation, industry, and aviation (OECD, 2023[12]). Just 32% of Hungarian emissions are covered by the scheme, compared with 40% on average in the European Union. For sectors not covered by the ETS, individual member states are responsible for applying a positive carbon price. These sectors are covered by an EU regulation called “Effort sharing regulation”, providing country-specific targets but no specific pricing mechanism to reach these targets. Under this regulation, Hungary has committed to a 18.7% emission reduction by 2030 (European Council, 2023[13]). Non-ETS sectors generate almost 68% of total emissions in Hungary and include some of the largest energy users, transport, housing, agriculture and waste management (IEA, 2022[14]).

There are many reasons why the coverage of the EU-ETS is limited to selected sectors, including practical implementation and political economy aspects. Ideally, economic efficiency would call for additional measures that align carbon prices in non-ETS sectors with those inside the ETS to equalise marginal abatement costs. In Hungary, however, carbon prices for some sectors outside the EU ETS are currently at or close to zero. As a consequence, average prices across the whole economy are low, below EUR 60 which is a mid-range estimate of carbon costs consistent with a slow decarbonisation scenario, and most likely insufficient to achieve emission targets (Figure 5.5) (OECD, 2021[15]). In the future, many of these sectors will face positive carbon pricing under the soon to be implemented EU ETS 2 (Box 5.1).

Figure 5.5. Net Effective Carbon Rates

All sectors, EUR per tonne of CO2, 2021

A further issue is that net effective carbon prices related to energy use are lowered by subsidies and exemptions. These include a reduced VAT rate for district heating (almost entirely produced with fossil fuels), an up to 82% refund on excise tax for diesel used in agriculture, a lower tax rate on diesel for commercial hauliers, and a subsidy to public heating suppliers. Large differences in net effective carbon prices across sectors and activities lead to a substantial variation in abatement incentives, increasing the overall cost of emission reductions.

Housing has one of the lowest net effective carbon prices internationally (Figure 5.6). Looking ahead, a higher effective carbon tax on households would encourage improvements in energy efficiency and heating systems towards a wider use of low carbon options (OECD, 2021[15]). Given the long timeline for housing renovations, such policies would take significant time to show effects, which is a strong argument for acting early. This would also ease the transition to the new ETS 2 emission system at the EU level, where emissions from buildings will be covered (European Commission, 2020[16]). In addition to carbon taxation, other non-carbon-based green taxes can be used to combat other polluting activities. These taxes reflect the polluting characteristics of the different products or activities, e.g., on water use, water pollution, waste, certain chemicals and waste landfill (OECD, 2018[17]).

Figure 5.6. Net effective carbon rates for the buildings sector are among the lowest in the OECD

Box 5.1. Fit for 55: reform of the EU emissions trading system

The ETS is the cornerstone of the EU’s climate mitigation policy as it determines a market-based carbon price. The 'Fit for 55 package' is a set of proposals, including a reform of the EU ETS, to revise the EU’s climate-related legislation in order to achieve the 55% emissions reduction target by 2030 (against a previous target of 40%), and net zero emissions by 2050 (European Council, 2023[3]).

As well as an enhanced emissions target, the package aims to raise the coverage of the ETS to other sectors, and increase the share of renewables in electricity supply to 40%. There will be a gradual phase-out of free emission allowances from the EU ETS until 2027. The phase-out will be accompanied by a phase-in of a border carbon adjustment mechanism (CBAM) to address the risk of carbon leakage. A new and separate ETS 2 will cover sectors such as buildings, road transport, and additional sectors (mainly small business) which are exempt from the ETS. This will expand carbon pricing to all major sectors aside from agriculture and land-use.

Source: (International Carbon Action Partnership, 2023[18]; European Council, 2023[19])

Residential energy prices in Hungary are among the lowest in Europe

Residential gas and electricity prices in Hungary are among the lowest in Europe, pushing up energy demand (Figure 5.7). Since 2010, the government has set maximum retail prices for electricity and natural gas for almost all consumers under the so-called Universal Service Scheme (USC) (Szőke, Hortay and Farkas, 2021[20]). This has implications for the government budget through large contingent liabilities. Furthermore, in 2013–2014 prices for natural gas and electricity were reduced by 25% for households and by 27% for district heating (Weiner and Szép, 2022[21]). These prices have remained unchanged since. The USC has helped to achieve an impressive reduction in poverty. The share of those unable to keep their homes sufficiently warm and those in arrears on their utility bills have both have fallen by over 10 percentage points since the scheme commenced (Streimikiene, 2022[22]). However, low prices have also led households’ use of energy for heating to be among the highest in Europe (Figure 5.8). This high energy use reflects poor insulation as well as a significant share of buildings being unnecessarily overheated, by around 1-3°C (Csoknyai et al., 2022[11]).

Figure 5.7. Price caps for electricity and gas generate Europe’s lowest energy prices

Figure 5.8. Households energy consumption is comparatively high

Energy consumption of households for heating, climate corrected, in kilograms of oil equivalent (koe) per square metre (m²)

Energy price caps have created a large fiscal burden. In 2019, 99.6% of electricity provided to household consumers and small businesses was delivered through a regulated price universal service contract (International Energy Agency, 2022[10]). Energy suppliers must pay for the difference between the wholesale costs and the regulated prices. To cover the resulting losses and maintain service provision, the government pays full compensation to suppliers. The fiscal cost of maintaining low energy prices for households and small businesses has amounted to an average of 2% of GDP per year over 2022-2023.

Moreover, evidence points to regressive distribution effects of the energy price caps, given that richer households reap most of the financial benefits. This is in part due to the comparatively high reliance of poorer households on coal and wood for heating which are not covered by the cap (Weiner and Szép, 2022[21]). In addition, the fiscal cost of price regulation dwarfs spending on social assistance programmes specifically targeting fuel poverty. The Social Fuel Programme aims to assist small settlements with household heating. The budget for the programme in 2020 was HUF 3 billion as opposed to a medium-term average of over HUF 230 billion per year for the general price control (Weiner and Szép, 2022[21]). A better approach would be to clearly target and means test social assistance programs. Reaching social objectives through uniform price controls has a high fiscal burden and is inefficient.

Price regulation is also slowing down the energy transition by weakening incentives for households to reduce energy consumption and invest in energy-efficiency upgrades of their housing. The Hungarian housing stock is one of the oldest in Europe and despite a range of renovation programmes, continues to have a poor level of energy efficiency (Box 5.2). This reflects the large share of housing built prior to 1990 during the communist period, when public construction programmes often delivered poorly insulated low-quality housing (Figure 5.9). Compared to neighbouring countries with a similar legacy, however, little progress has been made in upgrading thermal efficiency (Figure 5.10, Panel A) (Tamás et al., 2014[23]; Weiner and Szép, 2022[21]). Currently, approximately 65% of the housing stock is considered obsolete from an energy efficiency perspective (Ritter, 2022[24]).

Figure 5.9. There is a large stock of old and poorly insulated houses

Figure 5.10. Housing insulation lags neighbouring countries and electrification is minimal

Outdated heating systems contribute to local air pollution

Low-emission intensive heating systems like electric heating are hardly used. In fact their penetration rate is among the lowest in Europe (Figure 5.10, Panel B) (Csoknyai et al., 2022[11]). By contrast, Hungarian households stand out for their high emissions both in terms of CO₂ and fine particles, and most of this is related to the heating of dwellings (Figure 5.1). Natural gas is the dominant heating method and appliances are generally old, with most exceeding 20 years. Older gas heating systems are usually less efficient. A modern gas boiler can achieve efficiency of 86%, up to 50% more than older models (Frédéric, 2015[25]). Besides gas heating, many households continue to use coal and wood for heating and cooking purposes and an estimated one third of household waste is illegally burned for heating purposes (OECD, 2021[26]).

Figure 5.11. Residential buildings contribute disproportionately to emissions and pollution

Rebalancing incentives towards more efficient home heating systems could be achieved through a rise in energy prices in line with their carbon content and pollution impact. Switching from gas boilers to electric heat pumps for space heating would reduce CO₂ emissions by at least 20%, even when running on emissions‐intensive electricity, and up to 80% with cleaner electricity (IEA, 2022[27]). However, heat pump technology may not be technically feasible in all buildings or too costly for some households. A major limiting factor in the adoption of heat pumps is poor home insulation, making it economically unviable relative to other sources (Manners, Yang and White, 2022[28]; Kelly, Fu and Clinch, 2016[29]). For households that cannot improve their insulation, and remain on gas, the replacement of inefficient and high-emission heating systems would be a first step and could be accelerated with subsidies. Furthermore, a ban on the most inefficient and polluting systems along with fines for local air pollution would cut emissions and improve air quality.

Higher energy prices would align private sector incentives with emission mitigation goals

The government has introduced a wide range of programmes aimed at encouraging households to make energy efficiency improvements, however these are undermined by low energy prices (Box 5.2). The budget of these programmes is dwarfed by the size of the price subsidies. Under the IEA’s net-zero emissions by 2050 scenario, deep energy retrofits can cut household heating needs by as much as half (IEA, 2020[30]). While this may be an ambitious target, one illustrative example is that a renovation of 10% of the Hungarian housing stock could save as much energy as 20% of the overall current domestic electricity supply. Insulation is also an essential first step before decarbonising through electrification can begin. The current target is to reach 90% of nearly zero-energy buildings by 2050 (Ministry of Innovation and Technology, 2020[31]). However, the number of nearly zero-energy building has almost stagnated recently, with a minor increase from 0.3% of the stock in 2020 to 0.4% in 2021 which is far from the pace needed to reach the 2050 target.

Box 5.2. Housing renovation policies

Social and family policies with an energy efficiency component

Family Housing Support Programme: The programme provides preferential loans and grants for families with children, supporting homeownership and modernisation of dwellings. The budgetary cost between 2019-2022 was approximately 1.1% of GDP. From 2024, the Family Housing Support Programme Plus will replace the Family Housing Support Programme. Within the framework of the Programme, married couples can take out a fixed 3 percent loan of a maximum amount of HUF 50 million when they have a child.

Home Renovation Support: This targeted renovation programme, run between January 2021 and March 2023, supported the renovation of 370,000 family homes. Eligible measures included both energy efficiency and renewable energy investments. The programme cost approximately 1.6% of GDP.

Warm Homes Programme: Launched in 2014, the aim of the programme is to provide non-refundable grants to improve the energy efficiency of houses and assist the development of renewable energy. It has funded the modernisation of 210,000 family dwellings. The total budget amounted to HUF 40.3 billion of which HUF 35.6 billion, or 10 subprogrammes, were financed from the Green Economy Financing Mechanism (from the sale of CO₂ allowances).

Prenatal Baby Loan: Although not primarily aimed at the housing sector, under this scheme families expecting or raising children are eligible for a free-purpose HUF 10 million loan with zero interest. In the case of a family of three or more children, the loan is converted to a grant. Families can combine the funds with other targeted programmes for house purchase and renovations. Between 2019-2022, the cost was approximately 0.6% of GDP.

Green Bond Framework Programme: Proceeds from the Green Bond issuance are focused on increasing energy efficiency in the housing sector, as part of the Climate and Nature Protection Action Plan. Between 2017-2020, proceeds were used, in part, to replace household appliances to decrease electricity consumption.

The government has taken steps to address energy price regulation by easing price controls in 2022, in reaction to the energy price surge. The reduced utility price remains in place for the average residential consumer, as defined by consumption of 1729 cubic meters of gas per year. Any excess is exposed to a significantly higher price, 7-9 times the regulated price (Csoknyai et al., 2022[11]). Furthermore, non-residential customers, such as municipalities, are now excluded from the scheme. Electricity was subject to a similar abrupt change in scheme. These changes led to a surge in demand for insulation, wood burning fuel heating systems, heat pumps, solar panels and firewood. Demand for wood stoves and solar panels increased tenfold while that for heat pumps increased sixfold (Csoknyai et al., 2022[11]). Hungary could build on these positive developments over the medium-term with a progressive easing of the price control system through further lowering the allowance, more income related targeting and setting expectations towards a sizable reduction in its scope over time. This would further incentivise insulation and energy efficiency investments.

Some of the resources currently spent on price subsidies could be allocated to upgrade the housing stock of financially constrained households. This can improve public acceptance of a reduction in energy price supports as part of a policy package. The payoff from investments in energy efficiency improvements may take a long time to materialise fully, which can be a challenge for financially constrained low-income households and limit their capacity to provide co-financing. Many specific housing renovation programmes are currently operated on a co-financing basis, which may also explain why they often do not reach low-income households (Gróf, Janky and Bethlendi, 2022[32]). Easing or eliminating co-financing requirements of renovation programmes for low-income households may enhance take-up.

Public support programmes could become more effective by prioritising investments in retrofitting the least energy-efficient housing units and focusing on the households most in need. Adjusting subsidies to the actual energy efficiency gains may improve the value for money of these programmes, in combination with an income ceiling for household eligibility and an overall cap on the support amount. For multi-family buildings, the effectiveness of insulation programmes can be limited by a split incentive problem where owners of apartments and individual tenants have different incentives to improve energy efficiency (Csoknyai et al., 2016[33]). Rethinking the current voting majority requirements by reducing the quorum for building improvements could help to mitigate this problem (OECD, 2023[34]).

Looking ahead, the further development of renewable energy sources will lead to more intermittent electricity supply throughout the day. The challenges resulting from intermittence may be mitigated by shifting consumption patterns in line with hours of peak supply. This would require a dynamic pricing strategy with retail electricity prices that fluctuate within the day. The planned roll-out of smart meters will be key to inform users about their electricity consumption and their most energy-intensive appliances, and to improve the alignment of electricity demand with supply.

Energy certification can improve incentives to insulate buildings

Energy certificates provide a simple and standard measure of building efficiency for buyers and renters. This can change the market value of a building, adding a 20% premium to the price of an average family home with good insulation, as the operating cost is influenced by its energy performance (Ertl et al., 2021[35]). Tenants and property owners do not necessarily know how poorly insulated their homes are, as energy certificates are only mandatory when renting or selling a property. Certificate coverage was less than a third of residential buildings in 2022. A new regulation, operational from November 2023, is a step in the right direction. It will see energy performance certificates apply to all newly constructed, sold and rented buildings with sanctions for non-compliance. There will also be a requirement for energy certification when public subsidies are granted for housing renovations. Looking forward these initiatives should be expanded more generally to cover all dwellings. This would close an information gap on the energy cost of properties allowing price signals to work more effectively and providing additional incentives for renovation. Wider certification would also provide a better and real-time overview of the state of dwellings for the government. This would allow monitoring progress on housing renovations and assessing the efficiency of the different support programmes.

Electricity demand from industry will increase strongly

The Hungarian economy has a modern and globally competitive manufacturing sector and is taking a leading role in the electric car industry in Europe, which will be vital for the green transition. However, the energy for industrial production is mostly based on fossil fuels, accounting for half of total coal consumption in 2020 (IEA, 2022[14]). Many industries have limited scope for electrification without adding considerably to operating costs. For aluminium smelters, an energy-intensive activity, the respective cost increase would be on the order of a quarter to a third. Reducing GHG emissions from heavy industry will therefore likely involve a mix of both cleaner production methods and a reallocation of resources towards cleaner sectors.

Emission-intensive heavy industry sectors have received substantial government support in the past. Subsidies and tax expenditures should be carefully evaluated and better targeted. This type of direct support for high-emission industries tends to lock in operations with high emissions, thus placing a higher reduction burden on other parts of the economy. An efficient distribution of emission reductions across sectors would instead call for all economic agents facing the same incentives under a polluter pays principle with uniform emission pricing. Increasing carbon prices over time in a predictable way, as has occurred in the Netherlands, could ease the transition. This would allow more time for industries to adjust and for the development and adoption of promising but seldom used technologies like carbon capture (OECD, 2015[36]; Winkelman, Muller and Bontenbal, 2021[37]; Budinis, Fajardy and Greenfield, 2023[38]). Remaining firm support should be well targeted and incentivise emission reductions, for example by supporting the development of green technologies.

Hydrogen produced through electrolysis using electricity produced from renewables (green hydrogen) can play an important role in reducing greenhouse gas emissions from industries. It has the potential to replace fossil fuels in high-temperature industrial processes of hard-to-abate sectors such as steel production, in road freight traffic, and to store energy produced from intermittent sources. In most net-zero emission scenarios, green hydrogen plays a pivotal role, although the production of green hydrogen is still about three times more expensive than hydrogen made from natural gas (OECD, 2023[39]).

Reducing emissions from the transport sector

Emissions from the transport sector have increased since 1990 (Figure 5.12, Panel A and B). This is largely related to an increase in car ownership along with rising income levels, which has expanded access to flexible transportation and enhanced commuting options which in turn have increases labour market flexibility. As the car ownership rate is still low (Figure 5.12, Panel C), this trend is expected to continue. Nevertheless, Hungary has one of the highest shares of old cars in Europe, with an average age of 14 years (Figure 5.12, Panel D) (ACEA, 2022[40]). This reflects extensive purchases of imported used cars which are typically more polluting, with higher fuel consumption and fine particle emissions per kilometre than modern cars (Apte et al., 2017[41]). This issue is compounded by the fact that the average distance travelled by car in Hungary (17,000 km) is significantly higher than the Western European average (11,430 km) (ACEA, 2022[40]). Limiting emissions from the transportation sector will necessitate policies to encourage the renewal of the car stock, deter the use of cars when there is a public transportation alternative, improve the quality of public transportation, and limit urban sprawl.

Figure 5.12. Cars are the main source of emissions in the transport sector

Tax incentives to reduce emissions in passenger transport are weak

Hungary has one of the lowest rates of excise duty on petrol and diesel in Europe. (Figure 5.13, Panel A). This contributes to high usage and one of the highest rates of emissions from transportation in Europe (Figure 5.13, Panel B). Raising fuel taxes would be a crucial step to reduce transport emissions. Beyond a general increase, there is also a case for raising the taxation of diesel fuel above that of gasoline to reflect diesel’s higher carbon content and particulate matter emissions (ICCT, 2019[42]; Nieuwenhuis, 2017[43]). A high emission price on motor fuel has been important in the policy mix in other countries’ successful emission reductions (D’Arcangelo et al., 2022). To improve acceptability, the revenue raised from increased fuel duties could be recycled to enhance existing subsidies for electrical vehicle use. Subsidies can encourage the scrapping of old and dirty cars when replaced by EVs, such as the “Prime à la Conversion” in France.

Figure 5.13. Transport emissions are high even though car ownership is low

Both regulation and taxation have a role to play to encourage the renewal of the car stock towards low-emission vehicles. Raising minimum standards for emissions as part of the mandatory inspections of cars would be a first step to speed up the renewal of the fleet and cut local pollution (Furu et al., 2022[44]). Moreover, linking ad valorem vehicle taxes to the environmental performance of cars would increase incentives for households to purchase electric or low-emission vehicles. A sizable share of cars enter the Hungarian market as company cars provided to households as benefits in kind. This implicit subsidy encourages car ownership and use. Removing the favourable tax treatment of company cars would eliminate a distortion in remuneration choices that favours in-kind pay. This benefit should be reviewed so that in-kind benefits are taxed at the same level as wage income, which would eliminate the current incentive towards private car use.

An electronic toll system is in place for motorways and main roads where vehicles are subject to a time-based toll with vignettes valid for a week, a month or a year (13 months). However, time-based toll systems are weakly linked to distance travelled and emissions. Introducing distance-based tolls for smaller vehicles, as is done for heavy goods vehicles exceeding 3.5 tonnes, and linking them to the environmental performance of vehicles would better account for the full environmental cost of road transportation (OECD, 2021[45]). Digital technologies can substantially reduce the cost of implementing distance-based tolls.

Developing the adequate charging infrastructure is key for electric vehicles

Despite a range of incentives, the uptake of electric vehicles remains low, accounting for less than 0.5% of all passenger vehicles in the stock and around 2% of newly registered vehicles (Figure 5.13, Panel C). Electric vehicles are supported by a zero tax rate and direct subsidies of up to HUF 1 million – similar to measures in many other European countries (European Automobile Manufactures Association, 2020[46]). Subsidies could be increased with revenues from higher fuel taxes. Furthermore, subsidies on more luxurious EVs can be capped so as to make incentives more progressive (D’arcangelo et al., 2022[8]).

Hungary has more charging stations than other east European countries, but much less than Western European countries. The density of charging stations in some Western European countries is 50 times higher than in Hungary (Electromaps, 2023[47]). Moreover, the stations tend to be clustered around larger cities and major traffic corridors, leaving smaller towns and remote areas relatively underserved. Looking ahead, increasing the use of electric vehicles could be supported by a better developed network of charging stations.

Urban sprawl is contributing to increased emissions from transportation

On the back of strong economic growth, the area around Budapest has seen a rapid expansion in suburbanisation, leading to increased emissions from transportation. Despite a population decline nationally, over the past 20 years the region surrounding Budapest has grown by over 20%, with an accompanying 17% increase in greenhouse gas emissions. Budapest itself accounts for over a quarter of all emissions (European Union, 2021[48]). This development has brought increased congestion with the estimated carbon footprint per journey increasing by 32%. Budapest is now in the top 8% of the most congested cities in Europe (Kovács et al., 2019[49]; TomTom, 2023[50]). The spatially dispersed development pattern is reflected in recent house price changes (Figure 5.14).

Figure 5.14. Average house price per square meter by postcode, Budapest

Land use policy has contributed to urban sprawl. In reaction to a regulation change in 2005, aimed at tightening planning rules, municipalities moved to rezone vast swathes of land from agricultural to residential. This has left Budapest with 250  km² vacant land available for future development, approximately the same amount of land that was consumed between 1990 and 2012 (Kovács et al., 2019[49]).

Policy should focus on discouraging further urban sprawl by strengthening the system of congestion charges and giving lower charges to higher-occupancy vehicles. This could be combined with time-based fees for parking places and a distance-based road toll system. This would help to raise the cost of car commuting relative to public transportation. A tightening of land use regulation would also help to prevent further urban sprawl. Dense developments facilitate low-carbon lifestyles and create a critical mass for public transportation. Carbon pricing, excise duty, parking fees and congestion charges would increase the cost of commuting and rebalance incentives towards the city centre. This should be combined with land use management that facilitates access to local services (ITF, 2023[51]). An extension of metro lines would allow more of the growing population to access this system (OECD, 2021[26]). Brownfield sites could be further developed to facilitate densification close to existing public transportation infrastructure. As in many eastern European countries, due to a legacy of state-run industry, Budapest has a large number of brownfield sites, estimated at 68 km², or 13% of the metropolitan territory (Perić, 2016[52]). Furthermore, dense urban development patterns can provide the economies of scale required for economically viable district heating projects and utility services (OECD, 2020[7]; ITF, 2021[53]).

Further measures to reduce inner-city transport emissions include strengthening public transportation with a focus on improving efficiency and availability. Hungary has a high share of public transport users (Figure 5.15, Panel A). Rail travel has low GHG emissions, given that three quarters of journeys are electric (Figure 5.15, Panel B). Developing “Park and Ride” facilities would allow the growing population in the regions outside of Budapest to utilise the existing public transportation network. To encourage use, more emphasis could be placed on raising rail punctuality of currently 90%, including by upgrading the ageing rolling stock (MÁV-START Zrt., 2023[54]). Despite this growth, there is a lack of resources to improve transportation, e.g. the Budapest Mobility Plan and the Sustainable Urban Mobility Plan (SUMP) are underfunded. This can perpetuate car dependence and high-carbon commuting patterns. The Green Bus Programme can lead to lower emissions from local public buses and cut air pollution in urban areas. Most of the approximately 2,900 buses in towns and cities with more than 25,000 inhabitants are outdated. The subsidy covers 80% of the purchase of vehicles and 60% of the development of the necessary charging infrastructure. As of 2023, 139 electric busses have been acquired at a cost of HUF 20 billion. Along with improving bus and rail services, integrated ticketing systems and better interconnections between various modes of public transportation would encourage greater use. In addition, soft transport modes, such as cycling and walking, could be encouraged by developing the associated infrastructures (ITF, 2021[53]). Infrastructure improvements can also help to reduce the relatively high number of fatalities in cycling, the 3^rd highest in Europe over the period 2016-2018 (European Commission, 2020[55]).

Figure 5.15. Public transport use is high and railway emissions are low

Hungary has one of the lowest rates of teleworking in the European Union both overall and within occupation categories (Milasi, González-Vázquez and Fernández-Macías, 2020[56]). Adaptation of digital technologies in smaller firms lags behind other countries and mobile internet prices are high (see Chapter 3 this survey). Through addressing deficiencies in the digital infrastructure, teleworking can be further expanded as a means to reduce car use and commuting pressures (see Chapter 2 of this survey and also OECD, 2020_[53]).

Agriculture and waste management contribute to emissions and pollution

More intensive production in agriculture has increased emissions and water pollution

Emissions from agriculture (excluding LULUCF) account for 12% of greenhouse gas emissions (Figure 5.3). An intensification of agricultural production and destruction of wetlands has increased emissions. The main source of GHG emissions in agricultural production in Hungary is nitrous oxide, the share of emissions from this source is among the highest in Europe. Nitrous oxide emissions arise from intensive fertiliser use in crop production (Godlinski et al., 2010[57]). Some types of fertilisers contribute to emissions due to their nitrogen content as well as their release of carbon. Such emissions have tripled since 2005 (MIT, 2020[58]). Furthermore, recent studies indicate that ammonia emissions from agriculture contribute about half of the concentration of urban fine particle pollution (OECD, 2018[17]). Adequate taxation of the use of fertilisers can lead farmers to internalise these negative external effects and discourage their use (Henderson et al., 2021[59]). Proposals to encourage more use of organic fertilisers and discourage the excessive use of fertilisers by keeping less fertile land in its natural state, should be developed and implemented. However, many agricultural incentives are currently defined by the EU’s Common Agricultural Policy (CAP), thus limiting the scope of policy action of national governments.

One area where the government can take action is on the destruction of wetlands, which is releasing 5.2 MtCO₂/year due to drainage, more than absolute emissions from drainage in France, despite a six times smaller territory (FAO, 2023[60]). Pricing carbon emissions from land-use change and forestry may offer one way to reduce them. For example, such emissions are included in the New Zealand Emission Trading Scheme (NZ-ETS) (OECD, 2023[61]). Landowners are thereby liable for reductions in carbon stored and credited for carbon uptake. A similar scheme could alleviate pressure on wetlands by adding a cost to destruction and an incentive for preservation.

In addition to capturing CO₂, Hungary’s wetlands are among the most important habitats in Europe for birds, particularly migratory species. Despite representing only 3% of the EU territory, Hungary harbours 17% of the priority species in the EU Habitats Directive (OECD, 2018[17]). Nonetheless wetlands can be exposed to pressure from the intensification of irrigation, the expansion of land used for biomass as well as from altered rainfall patterns as a result of climate change. One way to counterbalance the agricultural use of these areas would be to promote ecotourism, as this would create an economic incentive to protect Hungary’s habitats. Vast grasslands, caves, rivers and wetlands with an abundance of biodiversity give Hungary an opportunity to developing ecotourism where the natural setting is the primary attraction (Hungarian Tourist Agency, 2017[62]). The government’s Tourism 2.0 strategy identifies biodiversity conservation as one of the pillars of sustainability in tourism. Strong natural capital and active tourism can also promote active lifestyles (Active and Ecotourism Development Center, 2022[63]). Ecotourism can be supported by promoting the integration of tourism into the wider economy, including with primary industries such as agriculture and forestry at the destination level.

Agriculture also contributes to water demand and pollution, further straining water management systems. This will likely be exacerbated by climate change. The most significant pressure on water resources in Hungary is agriculture, with 41% of water sources affected by physical alteration (OECD, 2019[64]). In addition to increasing emissions, the intensive use of nitrogen fertilisers in Hungary is an important source of groundwater contamination (European Environment Agency, 2022[65]). The intensity of water use in agriculture is set to increase; the government has set a goal to expand the irrigated area by 100,000 hectares by 2024. The current irrigation system only covers 2% of the production area and is outdated (OECD, 2018[17]).

Agricultural policies should be reviewed as in many cases they are contrary to environmental water management objectives. The incentive under the CAP is to remove water from flooded areas as quickly as possible as only productive land can receive payments (OECD, 2021[66]). Recent CAP reforms do however allow payments for unproductive/flooded land and this should be fully exploited to preserve ground water stocks and natural water storage on land. Hungary can work with European partners on a reform of this aspect of the CAP and use the new scope to make improvements. A more consistent application of fines for water pollution would assist in improving water quality. A more uniform cost for water abstraction across all sectors, while reflecting regional environmental conditions and service provision costs, would align environmental and economic incentives among users.

Enhanced environmental inspections would ensure enforcement of existing laws

Convictions and fines for environmental degradation have declined since the 2016 abolition of the National Environmental Inspectorate (Figure 5.16, Panel A). Former functions of the inspectorate have been divided into county and district government offices, which often have insufficient human and technical resources (OECD, 2018[17]). Inspection frequency is low in comparison with good practices in other EU member states. Strengthening the system of environmental inspections, including through better targeting of environmental inspections and enhanced training for inspectors, would improve compliance. This could be complimented with increased fines for breaches.

Figure 5.16. Environmental convictions been falling, and waste management relies on landfill

Low regulated prices have created economic losses in waste management

Emissions from the waste sector account for 5% of greenhouse gas emissions (Figure 5.3). Low prices prevail in waste management and contribute to high landfill use where fees do not cover the costs of operation, let alone the cost of offsetting the associated environmental damages (Figure 5.16, Panel B). Curtailing landfill use would reduce emissions as each additional metric ton of municipal solid waste diverted to recycling reduces emissions by 1.3 to 2.7 metric tons of CO₂ on average across the OECD (OECD, 2012[67]). Currently, 84% of the waste management sector’s GHG emissions come from landfill sites (MIT, 2020[58]). However, in 2013, public waste management fees were frozen and are now below costs. Operators’ losses were HUF 9 billion in 2020 (MEKH, 2022[68]). To ensure continued operation the government paid a service fee to operators.

A new waste management system replaced the previous one as of July 2023 to encourage the re-use and recycling of waste. A single concessionaire has been selected to collect all waste and operate all recycling facilities in the country under a 35-year contract with the government (Portfolio, 2023[69]). This concessionaire has to prepare a 10-year rolling development plan and update it every year to reach the objective of less than 10% of waste ending up in landfills by 2035, compared to 50% currently. At this stage, waste management is financed by a fee set by the public authority overseeing the concessionaire, and by producers, as part of the extended producer responsibility. Looking ahead, it will be key to ensure that this financing mechanism covers all operating and investment costs incurred by the concessionaire, and allows reaching the 2035 recycling objective.

The increase in the quantity of waste generated over the last years can be largely explained by an increase in construction waste (OECD, 2018[17]). With the scale of housing renovation implied by green transition goals, combined with the age and poor insulation performance of the current stock, there is a risk that this volume will substantially increase in the coming years. Stricter regulations on the sorting and recycling of construction waste should be enforced before the renovation of the housing stock accelerates. The planned updating of the 2004 regulation covering construction waste should cover these issues.

Shifting towards low-carbon energy supply

With over half of CO₂emissions originating from energy use (Figure 5.3), moving towards low-carbon energy sources will be fundamental to achieving emission targets. Electrification will be a key instrument, but this will cause a large increase in electricity demand that will need to be met with a strong supply expansion. The currently high dependence on fossil fuel imports from Russia and electricity imports from neighbouring countries may imply risks, especially as neighbours will face rising electricity demand due to their own green transition (Figure 5.17).

Figure 5.17. Hungary relies significantly on high carbon fuels and energy imports

Illustrative potential changes in the supply and demand of energy reveal the scale of the challenge (Table 5.1). Hungary is planning to become a leading battery producer through a number of large-scale investments in battery production for electric cars (Dunai, Yang and Nilsson, 2022[70]). In 2022, an investment equivalent to 4.3% of GDP was announced, aiming to build a 100 GWh battery plant in Debrecen. This would be Europe’s largest electric car battery factory (Portfolio, 2022[71]). While batteries and EVs will be essential to decarbonise transport both in Hungary and globally, the production of batteries is electricity-intensive (Degen and Schütte, 2022[72]). Increased electricity demand from the Debrecen plant along with an illustrative electrification of 10% of energy use in transport and industry would amount to 60% of the current nuclear capacity (Table 5.1).

One way to limit the rising electricity demand would be improvements in energy efficiency, for example, this could come from better insulation of housing (see above). Despite significant uncertainties, estimates suggest that retrofitting 10% of the housing stock would come at a cost of 3.2% of GDP (Table 5.1). The scale of prospective electricity needs and the costs of dwelling renovations strengthen the case to expand low-carbon electricity production and increase energy prices to incentivise energy savings and efficiency improvements.

Scenario	Effect on electricity demand and supply
	% of current domestic electricity generation
Drivers of additional demand
Electrification of 10% of all industrial energy currently not electrified	17%
Phase out coal-based power plants	9%
Planned investment in battery manufacturing (In Debrecen only)	8%
Electrification of 10% of the car stock	3%
Renovation of 10% of the housing stock (electricity equivalent)	- 20%

Drivers of additional supply
Planned Paks II nuclear power plant (eventually replacing the existing nuclear supply)	48%
Double current solar energy production	7%

Note: Assumptions for the transportation scenario are 17.3 KWh/100 km of electricity consumption for the car stock (Government of Hungary, 2021[73]). Average car travel is taken as 17,000 km a year (Herczeg, 2018[74]). Renovation of 10% of the housing stock including better insulation, new windows and modernised boilers would save 6,700 GWh yearly (Csoknyai et al., 2022[11]). For transportation, if 10% of the car stock were electrified demand for electricity would increase by 1,100 GWh yearly (Herczeg, 2018[74]; Government of Hungary, 2021[73]).

The current strategy to meet both energy security and supply needs is based on a major investment in nuclear energy, which is already the largest source of electricity generation, and an expansion of renewable energy sources. This will allow phasing out coal-based electricity supply, which currently accounts for 9% of electricity generation. Hungary has a target to phase out coal from its electricity mix by 2030 (IEA, 2022[14]).

Nuclear power is set to be a pillar of the green transition

The cornerstone of the future low-carbon energy strategy is a €12.5 billion, 7% of 2022 GDP, investment in a new nuclear energy plant. Nuclear energy is already a critical source of low-carbon electricity generation in Hungary (Figure 5.18). The current nuclear power plant Paks I provided almost half of domestic electricity generation in 2020. The new investment, the Paks II project, will eventually replace the current four reactors in Paks I with two new generation III+ reactors. The original four reactors have already had their lifetimes extended beyond the original 30-year limit to 50 years of operation and are expected to be decommissioned in the 2030’s, except if a further extension is permitted. Paks II, which is expected to be operational in 2030, will not substantially increase electricity supply in Hungary once Paks I ceases operation (IEA, 2022[14]).

Compared to renewable energy sources that produce electricity in an intermittent way, nuclear electricity production is more stable over time while also being low carbon, although there are environmental concerns related to the storage of waste. Nuclear energy provides multiple times the electricity of solar energy, even if the peak capacity of solar under ideal weather conditions is currently more than 50% that of nuclear in Hungary (IEA, 2022[14]). The nuclear project is in line with the International Energy Agency’s Sustainable Development Scenario if countries are to meet their objectives under the Paris Agreement (IEA and NEA, 2020[75]).

Figure 5.18. Nuclear power is vital in domestic electricity generation

Delays and cost-overruns are typical risks in nuclear plant construction

While Paks II represents an ambitious long-term commitment to securing a stable source of low carbon electricity and will maintain skills in a key low-carbon technology, nuclear projects have often been subject to cost increases and delays (Table 5.2). Internationally, delays have become more significant over time and particularly afflict new reactor designs, reflecting the increasing complexity of nuclear technology and more stringent safety and environmental standards. This requires more labour- and material-intensive processes, raising construction, operation and maintenance costs (Portugal-Pereira et al., 2018[76]). Hungary has selected to construct two new design Gen III+ VVER-1200 reactors, first made operational in 2017. No construction cost data are available for comparable projects by the same provider and data quality makes comparison to those completed elsewhere difficult (Wealer et al., 2019[77]). If delays were to materialise, this would risk creating prolonged electricity shortages which could harm decarbonisation progress and could be economically damaging (Box 5.3).

There is a question whether cost overruns could harm decarbonisation objectives by crowding out investment in renewables. It may turn out difficult not to divert resources given the sunk costs that will have been incurred and the share of domestic electricity reliant on completion. The experience of OECD countries with third-generation reactors indicates a possibility of significant cost overruns relative to the planned €12.5 billion. Based on an estimate of cost per unit of electrical capacity from a range of similar projects, which has increased by a factor of 4 over the last 15 years, the cost of Paks II risks being in the region of €16-18 billion (IEA, 2019[78]). For example, the Vogtle plant in Georgia, USA, a third-generation reactor like Paks II, has doubled in budget and construction time. Building modules offsite for eventual on-site assembly was expected to reduce cost during the construction of the Vogtle plant, and the same construction arrangement is planned for Paks II. Offsite construction proved infeasible and quality, design and fabrication problems in components became a key source of cost overruns. By some estimates, construction costs account for 70-80% of the levelised (break-even) cost in third-generation reactors, and returns on investment will likely be low (Khatib and Difiglio, 2016[79]). Downside risks are large and can include project cancellation. In 2017 the construction of two third generation reactors in South Carolina were cancelled, despite assistance from the US federal government, and USD 9 billion of investment written off because of cost overruns (IEA, 2019[78]). A further risk to operation is related to fuel supply. A diversification of suppliers and longer contracts could reduce supply uncertainties.

Type	Country	Unit	Construction start	Initial announced construction time (years)	Ex-post construction time (years)	Power (MWe)	Initial announced budget (USD/kWe)	Actual construction cost (USD/kWe)
AP 1000	China	Sanmen 1, 2	2009	5	9	2 x 1 000	2 044	3 154
AP 1000	United States	Vogtle 3, 4	2013	4	8/9*	2 x 1 117	4 300	8 600
APR 1400	Korea	Shin Kori 3, 4	2008	5	8/10	2 x 1 340	1 828	2 410
EPR	Finland	Olkiluoto 3	2005	5	16*	1 x 1 630	2 020	>5 723
	France	Flamanville 3	2007	5	15*	1 x 1 600	1 886	8 620
	China	Taishan 1, 2	2009	4.5	9	2 x 1 660	1 960	3 222
VVER 1200	Russia	Novovoro-nezh II-1 & 2	2008	4	8/10	2 x 1 114	2 244	**

Source: IEA (2020), Projected Costs of Generating Electricity 2020, IEA, Paris.

Given the high risk and potential consequences of delays, the case for more contingency planning is compelling. Extensions of existing plants are usually less costly than new constructions. Even with improvements in the cost of renewable energy sources, nuclear extensions will remain one of the most cost-effective ways of providing low-carbon electricity through to 2040 (IEA, 2019[78]). The proposed additional 20-year extension of the lifetime of Paks I is expected to take up to 5 years and will require the support of the International Atomic Energy Agency. The extension can follow practice in the United States where the Nuclear Regulatory Commission (NRC) is focusing on “subsequent license renewals”, which would authorise plants to operate for up to 80 years (IEA, 2019[78]).

Box 5.3. Potential sectoral impacts of an electricity supply reduction

Nuclear energy accounts for almost half of domestic electricity supply. Any delay in the completion of the nuclear plant could cause a significant economic disruption. This box presents the potential impact, at the sectoral level, from an illustrative 20% reduction in electricity supply.

Simulations are conducted using an input-output model, with OECD Trade in Value Added data. The formulation is supply driven: changes in sectoral output are calculated based on exogenously specified changes in sectoral inputs and is particularly appropriate in this analysis, because it represents a shock to a difficult to substitute primary input. Using the supply-side input-output approach implies that the results represent a short-term impact. Longer-term adjustment mechanisms, such as the substitution to alternative energy sources, are not present in the analysis and output coefficients are fixed. The model assumes perfect demand adjustments to changes in supply.

Simulations show that an electricity supply shock of 20% would decrease overall output by 0.6%. Two indicators are calculated to illustrate the impact on output in other sectors (aside from electricity generation): (1) the reduction in output for each sector, and (2) the sectoral contributions to the reduction in overall output net of that of the electricity sector (Figure 5.19). The disruption would extend beyond manufacturing and would have the potential to impair the provision of public services such as health and education. The results are assuming the case of no policy intervention in the form of rationing or redirecting energy supply to essential activities, to the detriment of others. While this is unlikely with a shock of this scale, the scenario does still highlight the magnitude of the disruption the government would be faced with.

Figure 5.19. Impact of electricity supply disruption on output

Renewable energy should be expanded

Renewables capacity will need to almost double by 2030 to reach the 20% target of renewables in gross electricity consumption (IEA, 2022[14]). This will require an expansion of all renewable sources, including wind, geothermal and solar energy generation. The future use of biomass, a major renewable source, is problematic due to the long period of time needed for carbon neutrality and the emission of fine particles.

Biomass use raises carbon emissions and air pollution

The tripling of the share of renewables in final energy consumption since 2000 has been driven almost entirely by an expansion in biomass use (Figure 5.20). Solid biomass, 85% of which is wood, accounted for around two thirds of total final energy consumption of renewables in 2020 (IEA, 2022[14]; Bio Screen CEE, 2021[80]). Of all biomass used, around three quarters is by households for heating (Bio Screen CEE, 2021[80]). A future expansion of biomass is set to become an important component of the net zero transition, with energy from biomass projected to increase by more than 50% in the decade up to 2030 (MIT, 2019[81]). Current plans aim to encourage more residential burning and, at larger scale, the development of biomass power plants and more use of biomass for district heating.

Figure 5.20. Biomass dominates renewable energy generation

Switching to biomass increases emissions in the short and medium-term. Wood has approximately the same carbon intensity as coal per unit of energy. However, combustion and processing efficiencies are lower and so wood generates 82% more carbon dioxide per unit of energy than coal (Sterman, Siegel and Rooney-Varga, 2018[82]). Burning wood instead of coal creates an immediate increase in carbon dioxide emissions. That carbon debt can be repaid over time if the forests grow back, a process that is estimated to take up to 100 years. This long time-horizon creates a sizable problem for the reliance on biomass to reach 2030 and 2050 emission reduction targets (Sterman, Siegel and Rooney-Varga, 2018[82]). In addition, significant risks to the length of the payback period include fire, drought, insect damage, re-harvest, or conversion to other uses that can limit or prevent forest recovery. Expanding energy generation from biomass is therefore not a promising avenue to reach emission reduction targets.

In addition, wood combustion emits a range of fine particle matter pollutants including PM2.5 and PM10, which pose significant health risks (Box 5.4). Per unit of energy, particle emissions from burning wood are double that of coal, 200 times that of oil and 1250 times that of natural gas (DEFRA, 2017[83]). Hungary’s population is already subject to extensive exposure to fine particles, at levels that far exceed the OECD average (Figure 5.21). In 2021, the European Court of Justice found that between 2005 and 2017, the daily limit value for particulate matter was frequently exceeded in the Budapest and Pécs regions and the Sajó valley (CJEU, 2021[84]).

Figure 5.21. Welfare cost of premature deaths from exposure to fine particles, top ten OECD countries

% of GDP equivalent, 2000-2015

Life-cycle taxation principles can be applied to biomass. Ideally, a carbon neutral source would be one that sequestered as much carbon in its growth cycle as is released later when burned as fuel, with sequestering occurring simultaneously rather than over future decades. Emissions would be underpinned by a comprehensive lifecycle analysis, encompassing changes in the forest carbon stock alongside supply chain emissions. This would however be technically demanding. Furthermore, the taxation of biomass should account for its much more detrimental impact on public health through local air pollution even compared to fossil fuels. An appropriate carbon tax would level the playing field with other renewables and allow the market mechanism to better operate among differing technologies in determining the most economically efficient low-carbon fuel mix.

Moreover, older wood heating systems are emission-intensive. In a residential setting, open fireplaces emit almost double the number of fine particles per unit of energy as compared to boilers and stoves (DEFRA, 2017[83]). The variation in emissions from wood burning technologies is substantial. Advanced or eco-labelled appliances and wood pellet stoves/boilers emit substantially lower particles than older wood burners (DEFRA, 2017[83]). Several Nordic countries have implemented scrapping payments and replacement subsidies to encourage the replacement of boilers with new low-emissions eco-labelled products (Orru et al., 2022[85]). Regulation to ban the most polluting burners and subsidies for upgrading older systems would cut emissions and improve air quality. This could be complemented by full implementation of plans to strengthen fines for air pollution and a wider reporting of the findings of inspections.

Household biomass use is lacking well-defined domestic or European sustainability criteria. Indeed, 50–60% of firewood consumed is of unknown origin and potentially sourced from illegal logging (Weiner and Szép, 2022[21]). Hungary aims to further increase forest areas to reach 27% of forest cover by 2050, up from 22% today (MIT, 2020[58]). The application of sustainability criteria to biomass used in household heating could mitigate the problem of illegal logging. Furthermore, improved data collection on the biomass-to-energy cycle could ensure that biomass does not originate from biodiverse land or protected areas. A more consistent application of fines and legal consequences for illegal logging would also help to protect forestry resources.

Box 5.4. Health impacts of biomass burning

During wood burning, a number of harmful pollutants including carbon monoxide, volatile organic compounds (VOC), oxides of nitrogen, and fine particles (PM10 and PM2.5) are released. Small-scale wood burning in individual dwellings is responsible for emitting a large volume of fine particles (around a third of fine particles in Central and Eastern Europe).

Long-term exposure to fine particulate pollution is the largest environmental risk factor for human health, with an estimated 7 million deaths per year worldwide. Wood smoke specifically is estimated to cause at least 40,000 premature deaths per year in Europe. There have been upward revisions of deaths from air pollution arising from improvements in the ability to monitor air pollution and increased medical understanding.

The small diameter of fine particles causes inflammation and stress and have been shown to lead to a decline in lung function of healthy adults. Illnesses that are associated with fine particles range from lung cancer, bronchitis, and other respiratory infections, through to strokes, dementia, type II diabetes and Parkinson’s disease.

The growing popularity of wood burning stoves for home heating has raised concerns about high concentrations of indoor pollution. Due to time spent indoors, risks to health may be greater than from exposure to outdoor air pollution. Wood burning has a significant impact on air quality inside homes. Peak levels of harmful fine particulates can be as high as 250-400% times the level of non-wood burning homes. These short-term intense exposures can be potentially more harmful than longer periods of above average exposure.

Sources: (Ni, Shi and Qu, 2020[86]; McDuffie et al., 2021[87]; Orru et al., 2022[88]; Chakraborty et al., 2020[89]; Dechezleprêtre, Rivers and Stadler, 2019[90]; Roy and Braathen, 2017[91]).

Solar and wind energy generation face infrastructure and planning constraints

There has been rapid growth in solar generation. Installed solar energy generation capacity has doubled in the last two years, supported by a comprehensive system of public grants (MIT, 2019[81]) (Figure 5.22, Panel A). This expansion is part of a planned five-fold capacity increase between 2020 and 2030, to reach 12% of electricity consumption. In light of the intermittence of solar energy, the expansion in solar needed to replace high carbon fuels is considerable. With a typical 25 year lifespan the expansion of solar panels further motivates improvements in recycling and waste management (Chowdhury et al., 2020[92]).

In contrast to the trends in almost all other European countries, the development of wind as a renewable energy source has stagnated. A 2016 decree declared that wind turbines could not be installed within 12 kilometres of populated areas, leading to a de facto ban on installation (IEA, 2022[14]). Today, solar energy generates almost six times the electricity of wind in Hungary. However, given the geographical setting, estimates of renewable energy generation potential indicate that the solar to wind ratio should be closer to one, with sizable potential for wind generation in the north of the country (Campos, Csontos and Munkácsy, 2023[93]; Radics and Bartholy, 2008[94]).

The main measure for expanding renewables is the renewable energy support scheme (METÁR) of 2017, which combines feed-in tariffs and feed-in premiums for small and mid-size energy plants. Larger plants have to participate in a competitive bidding process in order to receive the feed-in premium. The new system is transitory as eventually competitive bidding will be in place for all new plants. The system has attracted many small solar plant applications. In 2019, only a single tender for larger plants has been issued. To accelerate the process, the government should follow through with its intention to issue tenders annually. Moreover, the current focus on solar installations should be broadened to include wind technology to ensure a market-based expansion of renewable energy sources.

The strong renewables expansion that Hungary needs will likely require reconsidering rigid planning regulation to allow the installation of wind turbines. Furthermore, investment support could be strengthened. Denmark has had a deliberate policy of allocating revenue from an additional tax on electricity consumption to the development of renewables, an “electricity pays for (renewable) electricity” principle. This investment subsidy, combined with feed-in tariffs, has been important in facilitating the rapid deployment of wind energy technology, and the subsequent reduction in costs would not have been possible otherwise (OECD, 2019[95]).

Figure 5.22. Solar capacity has expanded rapidly, but grid investment is low

Although government initiatives to increase solar generation have been a considerable success, historically low levels of investment in the electrical grid complicate further renewable expansion and create balancing issues for the grid (Figure 5.22, Panel B), (Zsiborács et al., 2021[96]). At the end of 2022, the government announced a suspension of connections for newly installed solar panels, as there was no capacity to take more supply onto the grid (Portfolio, 2022[97]). In May 2022 the transmission system operator MAVIR set the solar capacities that can be admitted to the grid at zero, again due to capacity constraints (MAVIR, 2022[98]).

Intermittent energy sources such as solar and wind, add grid costs that are several orders of magnitude higher than for electricity supplied by gas or coal (OECD and NEA, 2012[99]). These costs arise from extending the transmission system to connect with renewable sources, grid reinforcement, building new sub-stations, installing voltage transformers and securing back-up capacity for when renewables do not generate electricity. Estimates for the US indicate that a high renewables scenario would require a threefold increase in national transmission capacity to 2035 requiring up to ten thousand miles of new high-capacity lines to be built per year (Denholm et al., 2022[100]). Costs can be high and uncertain with planning permission needed for the vast expanse of new power lines (Mitchell-Ward, 2022[101]). The expansion of renewables also complicates the economic viability of nuclear electricity generation because it leads to increased price volatility. At the same time, and contrary to renewables, nuclear energy provides a constant baseload of electricity ensuring a degree of supply security that is not reflected in the price.

Given the dynamic growth of renewables, the condition of the grid, the mix of public and private ownership and the difficulty in expanding transmission, required cost estimates are significant. Government estimates put these at 1% of GDP (Government of Hungary, 2022[102]). However, other estimates place the cost at 5% of GDP (Janoskuti et al., 2022[103]). Current regulation prevents the network operator from raising network fees to cover these costs and frontload investments in infrastructure development. At this stage grid investments are expected to be covered by EU and government financing. Given the necessity of these investments to unlock renewable energy supply, and the significant cost uncertainty, the increase in network fees should be considered if EU and government financing proves insufficient.

Geothermal energy can decarbonise district heating systems

After Iceland and Italy, Hungary has the third largest potential for geothermal energy utilisation in Europe, and this potential can be further harnessed (Szanyi, Kovacs and Scharek, 2009[104]). Government estimates indicate that the amount of energy generated by geothermal for district heating could increase by a factor of seven (IEA, 2022[14]).

An important barrier to geothermal development is geological risk. Even after discovery of hot water, the rock structure can make economic exploitation unfeasible (Mountney et al., 2021[105]). Risk mitigation schemes with financial instruments such as risk insurance and capital grants are established in some European countries (Denmark, France, Germany, Iceland, the Netherlands, Switzerland, and Turkey) (Karytsas et al., 2022[106]). Although comparable schemes are not currently in place in Hungary, these is a partial reimbursement to cover drilling risk in the event of unsuccessful exploration. The government has proposed de-risking plans to facilitate the development of geothermal energy. The Implementation and expansion of these plans will be important to grow this energy source. A positive step in this direction is the March 2023 regulatory change to the Act on Mining. This simplified the licensing system for geothermal exploration and production of energy. This change has led to a substantial increase in geothermal projects with 89 new permits since March 2023.

Capital-intensive energy supply projects are hindered by low regulated prices as evidenced by the minimal foreign investment in this area. The low-price environment especially hampers projects with high initial capital costs such as geothermal and hinders development of the district heating system. Most foreign investors have withdrawn since the introduction of regulated energy prices (IEA, 2022[14]). Geothermal has a high potential for decarbonising district heating systems, however both geothermal and district heating are capital intensive technologies. Allowing energy prices to rise would allow market forces to operate and would create new possibilities for investments.

Mitigating the social and political economy impact of the green transition

Reducing emissions will involve a decline in some industries and labour reallocation

The transition to higher carbon prices and a move towards electrification will precipitate changes in the industrial structure, which will inevitably give rise to adjustment costs. Concerns around competitiveness, although sometimes overstated, are valid. Higher carbon prices can increase energy prices and reduce output, employment and exports in energy intensive industries. Significant GHG emission cuts have not prevented strong economic and employment growth in the last three decades. Nonetheless, more stringent policies to reach ambitious emission reduction targets will have effects on the allocation of labour and capital across sectors and firms. For example, workers will have to move from shrinking emission-intensive industries, where some firms will contract or exit the market, to growing low-carbon sectors, where new job and business opportunities will emerge (D’arcangelo et al., 2022[8]). In addition, more gradual and pre-announced changes in economic framework conditions would allow producers and consumers to adjust more smoothly, which would likely reduce the adjustment costs.

The overall job reallocation triggered by environmental policies will likely be relatively small compared to other major structural transformations, such as technological progress and globalisation, partially because employment in emission-intensive industries, which are most affected by higher carbon prices, is relatively low (OECD, 2021[107]). Based on macroeconomic simulations, employment in sectors that may be subject to job losses by 2040 as a result of policies to reduce emissions in line with the Paris Agreement amounts to less than 3.5% in all Hungarian regions (OECD, 2021[108]). While overall numbers may not be large, at the local level and for specific skill groups, the impact can be sizable. The regions of Central Transdanubia and Northern Hungary will be proportionality more impacted due to their higher concentration of employment in chemicals and the coal industry.

The reallocation of labour across sectors and firms will lead to significant adjustment costs for displaced workers (OECD, 2021[109]). They will face income losses, have to search for a new job, learn new skills, and often have to bear, together with their families, the social costs of moving to other locations to find a new job (Grundke and Arnold, 2022[110]). Job creation in sectors that benefit from the green transition might happen in locations that are different from the locations suffering from the decline of carbon-intensive industries. Moreover, rising carbon prices will significantly affect the relative consumer prices of goods and services depending on their carbon content. As poorer households spend a higher share of their income on carbon-intensive items, distributional effects on the consumption side may be regressive.

Policies to reduce adjustment costs and smooth the transition

Public support for costly emission reductions will hinge on people’s acceptance of the importance of limiting global warming (Dechezleprêtre et al., 2022[111]). This is potentially limited in Hungary where only 52% of people are in favour of stricter government measures that impose a change in people’s behaviour to tackle climate change and just 11% support capping home temperatures at 19° C in winter. These shares are among the lowest in Europe for both policies (European Investment Bank, 2023[112]). Furthermore, there is a generally negative perception of taxes on fossil fuels (Umit and Schaffer, 2020[113]).

Identifying prevalent views among the public and designing framework policies accordingly may boost public support. Overly regressive and uncompensated policies can undermine public support for climate change mitigation and can make reaching green transition targets difficult or impossible. Climate policies’ reallocative costs are likely to be large especially for disadvantaged groups such as low-skilled low-wage workers. Many view these outcomes as unfair and may therefore stoke opposition to the source policies, even if they are not directly harmed themselves (D’arcangelo et al., 2022[8]). Such opposition may be addressed by introducing revenue recycling and complementary support measures (Box 5.5). Hungary can recycle gas and electricity subsidies where some of the revenue savings from a phase out can be reinvested to increase public acceptance. For example, public information campaigns can significantly improve the acceptance of climate change policies if they are based on explaining their effectiveness rather than focusing on highlighting the consequences of climate change (Dechezleprêtre et al., 2022[111]).

Flexible labour market regulation and an effective social safety net focusing on the protection of workers and not of jobs would facilitate the transition of workers to new job opportunities in low carbon-intensity industries, especially when combined with efficient job placement services (Grundke and Arnold, 2022[110]). Improving policies in these areas is key for facilitating the green transition, but also other structural transformations (OECD, 2012[114]). The skills required in brown jobs are only partially transferable to green jobs, especially within the same working categories (Dechezleprêtre et al., 2022[111]). Skill transferability suggests that most of the training needed for green jobs may take the form of a ‘top-up’, allowing already qualified workers to adapt their skills and knowledge to suit green jobs’ practices and technologies. Job-search and training schemes, such as those implemented in Germany (Ruhr region), Canada (Alberta) and the United Kingdom, have helped workers with brown jobs to find green opportunities with equivalent skills.

Public expenditure on active and passive labour market policies in Hungary is among the lowest in the OECD (OECD, 2020[115]). Active labour market policies could provide more support for mobility and upskilling. Compared with other countries, active labour market policies have little focus on training and job search assistance. Public employment services suffer from insufficient funding, a high caseload and limited outreach. In addition, job counselling is often not tailored to the needs of the most disadvantaged groups (OECD, 2021[26]). Expanding the scope and efficiency of support policies can alleviate the disruption of transition to a low-carbon economy. The transition can also be eased through use of EU programmes. The Just Transition Mechanism is designed to support the areas most affected by the transition to climate neutrality and minimise regional disparities. Hungary has utilised the EU’s Environment and Climate Action Programme (LIFE) to enable an equitable green transition of the Mátra region where coal is produced and used for electricity generation. The LIFE Programme allows local conditions to inform the implementation of the Just Transition Fund.

Box 5.5. Revenue recycling to improve public acceptance of climate mitigation policies

Indonesia

Indonesia is one of the world’s largest GHG emitters. Coal, natural gas and oil consumption and production were supported by decades-long and generous fossil fuel subsidies. Subsidies contributed to increased use, worsening local air pollution, and climate change. The social-welfare redistributive rationale of aiding low-income households was only partly met, due to flawed targeting that resulted in middle- and high-income households being the major beneficiaries.

Government reforms of the program promoted energy pricing liberalisation and better targeting of subsidies. This has resulted in a reduction in consumption of subsidised fuels, as well as substantial budget savings, which the government reallocated to infrastructure, rural development, welfare, health, education and agricultural subsidies. To cushion the impact on the poor and increase acceptability, the reforms were complemented by mitigation measures (such as temporary cash transfers), and accompanied by public information campaigns highlighting their rationales and benefits.

Switzerland

In 2008 Switzerland implemented carbon pricing on heating fuels in order to meet its annual carbon target. The policy raised distributional and competitiveness concerns, which the federal government has attempted to address via redistributive mechanisms and earmarking of revenues to environmental goals. About two-thirds of the tax revenue were redistributed to households and firms through a lump-sum rebate of social security contributions of around EUR 80 per person and reimbursement of firms proportional to their wage bill. The remaining third of tax revenue is earmarked for retrofitting works and the development of sustainable heating fuels. Furthermore, the level of the carbon tax would depend on the country’s climate performance and its success in meeting annual objectives. Prices would be frozen upon early achievement of abatement goals, adding another incentive for emission abatement and eliminating any perception of climate policy as a taxation measure.

Source: (D’arcangelo et al., 2022[8])

Climate-change adaptation and improved water management can strengthen resilience to water risks

Groundwater depletion and flooding are projected to increase

Progress towards net zero greenhouse gas emissions by 2050 must go hand in hand with a concerted effort to strengthen the resilience of people, economies and ecosystems to the rapidly increasing impacts of climate change (OECD, 2022[116]). Climate adaptation efforts help reduce the occurrence and extent of climate hazards as well as the current and future exposure and vulnerability of communities and assets to their impacts. Understanding climate risks is essential for determining priorities for adaptation and informing policy action. For Hungary, one of the most pressing challenges posed by climate change is the increased strain placed on water resources through altered rainfall patterns, flooding and drought risks. Hence, enhanced water resource management needs to go hand in hand with climate adaptation efforts.

Beyond what is already envisaged in Hungary’s National Climate Change Strategy (NCCS), climate adaptation action should build on comprehensive climate risk assessments and rely on a combination of structural and non-structural measures. For example, the consideration of existing and projected water related risks should be a requirement when making land-use planning decisions, especially when these entail new asset development. The risks and impacts posed by climate change should also be considered when planning and managing infrastructure, e.g. by mainstreaming climate adaptation in strategic plans, funding schemes, project design and appraisal, procurement processes and maintenance operations. Some progress has been made in this area with the 2014-20 Environment and Energy Efficiency Operational Programme (OP) containing nature-based adaptation solutions related to flood and flash flood risk management, municipal level adaptation-oriented green surface development and plans for groundwater level rehabilitation.

The conservation and restoration of natural ecosystems can help reduce the risks and impacts of water scarcity. Groundwater resources have been depleted over time and this trend is projected to intensify with climate change (Bisselink et al., 2020[117]; OECD, 2023[12]). Groundwater is a crucial resource in Hungary as it accounts for 95% of the drinking water supply (OECD, 2020[7]). However, from 2003 to 2020, Hungary recorded the second largest fall in ground water recharge in Europe (Xanke and Liesch, 2022[118]). The linked problems of protecting ground water resources, flood and drought management, can be tackled with water management adaptation measures. Restoration of wetlands and floodplains can reduce the risks associated with increased flood frequency through improved flow regulation (OECD, 2023[12]). An expanded area of wetlands and floodplains would allow for enhanced groundwater recharge (Salem et al., 2023[119]). Enhanced recharge can delay drought propagation and provide an efficient means of water supply during drought episodes (Chung, Kim and Senapathi, 2023[120]).

Despite close to a quarter of the land area at risk of flooding, Hungary has one of the lowest rates of flood insurance coverage in Europe (Figure 5.23, Panel A). An improved dissemination of information on climate-related risks would improve the insurance industry’s assessment of climate risks and its ability to price these accurately. Expanding private insurance coverage can also limit the extent to which the government becomes the insurer of last resort, which can have high fiscal costs (OECD, 2023[121]). In some countries, catastrophe risk insurance programmes have proven successful in keeping insurance premiums for risks otherwise considered “uninsurable” affordable, while also backing up insurance providers through a state guarantee (OECD, 2023[122]). For example, France has developed a solidarity mechanism called CatNat. which is funded through a flat rate contribution by every household and vehicle insurance policy holder in the country (OECD, 2023[12]). As a result, 98% of French households are covered against most types of natural hazard damage with the proceeds reinvested in future risk prevention. The consideration of natural disaster risk should be a requirement when making land-use planning decisions for new developments.

Figure 5.23. Flood insurance coverage and investment in the water infrastructure are low

2011-2021

Water infrastructure investment has been held back by low regulated prices

Adaptation challenges in water management make long-overdue improvements in water infrastructure even more pressing (Figure 5.23, Panel B). Low regulated water charges have created a loss-making environment and contributed to high rates of usage (Figure 5.24). Water supply and sanitation tariffs were frozen by law in January 2012 and further decreased by 10% in 2013. As a consequence, major water operator Alföldvíz has failed to make a profit in all but one year since 2013 (Kis and Ungvári, 2019[123]). Losses are exacerbated by a widespread failure to enforce payment of water bills. Providers have severely limited options to penalise customers who do not pay their bills as water cannot be withheld. To keep water provision operational the government has provided a subsidy to operators. Without subsidies the operating loss of the sector would have been HUF 31 billion in 2020 (MEKH, 2022[68]). Unpaid bills amounted to HUF 12 billion in 2020, almost 40% of the operating loss without subsidies.

A prolonged period of low investment has deteriorated the water infrastructure (Figure 5.23). As a result, technical surveys report that 56% of drinking water supply systems are at risk, pipe replacement is less than 20% of what is necessary to maintain the current system and the percentage of obsolete assets has grown over the years (Kis and Ungvári, 2019[124]). Necessary maintenance and new investment together are estimated to be at least 6% of GDP over 2021-2035 (MEKH, 2021[125]). Replacement and investment needs should primarily be paid by the water utility service fee, including through a more consistent enforcement of unpaid bills via an efficient legal system. A better-funded water provision system will be better equipped to meet the challenges posed by climate change.

Figure 5.24. Water usage is high in international comparison

Phasing out the current policy of holding water charges artificially low would allow prices to rise to cover both running costs and infrastructure requirements. Issues related to poverty and water access can be managed through the general welfare system with targeted cash transfers to households (Leflaive and Hjort, 2020[126]). Higher retail charges would also reduce water use and alleviate associated environmental pressures. The charging system could be simplified with a harmonisation of water tariffs as there are currently around 4,000 different water tariffs in operation across municipalities (Portfolio, 2023[127]). Only some variation in tariffs would remain to reflect local groundwater conditions. Given the energy use in the water sector, policies that would encourage more efficient energy use, such as increased prices, would also be of benefit.

Main findings	Recommendations
Energy/carbon prices
Energy price caps have been costly for the government budget and low energy prices reduce incentives for energy efficiency.	Restructure energy support by moving from price caps to more targeted cash transfers to support vulnerable households while reducing the overall fiscal costs.
Carbon prices outside the EU-ETS are at or close to zero and do not provide a strong market-based incentive for emission reductions.	Enforce emission reductions through a mix of regulations and carbon prices, and progressively align carbon prices in sectors outside of emissions trading to those in the EU-ETS.
Buildings
Building insulation is often poor and many heating systems are outdated, leading to high CO₂ emissions and air pollution from households.	Promote the insulation of dwellings and the replacement of inefficient and polluting heating systems, including through targeted subsidies. Make energy performance certification mandatory for all dwellings.
Transportation
Low excise duties on petrol and diesel encourage car usage.	Raise excise taxes on petrol and diesel.
Hungary has one of the highest shares of cars over ten years old of any country in Europe with an average age of 14 years.	Raise minimum car emission standards.
Despite policy incentives, the uptake of electric vehicles remains low.	Link ad valorem vehicle taxes to cars’ environmental performance.
The area around Budapest has seen a rapid growth in suburbanisation leading to increased congestion and higher transport emissions.	Raise parking fees and congestion charges.
Energy supply
The current low-carbon energy strategy is based on the construction of a large nuclear plant, whose timely completion may be subject to risks.	Develop contingency plans for risks surrounding the PAKS II nuclear plant, including by further extending the lifetime of existing nuclear reactors.
Energy generation from biomass increases emissions and air pollution in the short and medium-term. A large share of biomass use is left without any sustainability safeguards.	Tax biomass use for energy generation in line with its carbon emissions and its impact on local air pollution. Raise fines and enforcement against illegal logging.
Geothermal potential is largely untapped.	Consider public insurance and capital grants to mitigate exploration risks, while easing the licensing process for geothermal energy projects.
Wind capacity expansion has come to a standstill in the last decade.	Remove restrictive rules on windmill installation, particularly the distance to housing rules.
Massive investments in the electricity grid will be needed to accommodate more renewable energy sources.	Allow the grid operator to raise fees to cover operating costs and investment needs if EU and government financing is insufficient.
Waste management
Low regulated waste disposal charges contribute to high landfill use. The new concessionaire in charge of waste management is expected to significantly increase the recycling rate by 2035.	Monitor progress towards recycling objectives and ensure that the coverage of operating and investment costs incurred by the concessionaire is in line with these objectives.
The increase in the volume of waste over the last years has been driven by the construction sector. Large-scale renovations to improve housing energy efficiency will further increase the volume of construction waste.	Enforce stricter regulations on the sorting and recycling of construction waste as soon as possible.
Water management
Low regulated water charges generate losses and encourage high usage. A lack of investment has deteriorated the water infrastructure.	Align water charges with actual costs, including those of required infrastructure investments.
Flooding is projected to increase and flood insurance coverage is low.	Expand insurance coverage against flooding.
Environmental policy
Convictions for environmental degradation have declined since the 2016 abolition of the environmental inspectorate.	Enforce higher frequency of environmental inspections and better training for inspectors.
Due to the reallocation effects that they usually imply, climate policies may face opposition by the general public.	Run public information campaigns explaining the rationale and the effectiveness of climate policies.

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