Discussing Measures to Address the Risk of Carbon Leakage in EU Climate Change Policy: Coordinating Taxation, Emission Trading and State Aid

Abstract

Since January 2005, European energy-intensive sectors are double regulated. Their energy consumption is covered both by the Energy Taxation Directive and the European Union Emission Trading Scheme Directive. To address the risk of carbon leakage and competitiveness loss following from EU climate change policy different State aid regimes are available to deal with direct and indirect emission costs. This paper assesses the coherence of this regulatory overlap and performs a critical analysis of its effects. Following this analysis it is concluded that some changes to EU climate change regimes are required to improve their environmental impact and cost-efficiency. The first-best option seems to be an obligatory EU-wide exemption from national energy taxation (both regarding energy and emissions tax components) for all sectors covered by the EU ETS together with an EU-wide energy tax, which would replace the previous national ones. The ETS dilemma could then be addressed by charging a higher tax rate on the power sector.