Guiding climate action through taxation – lowering emissions and boosting employment and the economy

Resolving the climate crisis requires wide-ranging and rapid action from all the countries of the world. No economic sector or area of policy can be excluded from these climate measures. Taxation is an effective tool for directing society and the economy and it should be more frequently used in climate policy as well.

“The World Bank, OECD and European Commission have recommended that states implement comprehensive environmental tax reforms in order to reduce emissions. In addition, studies show that environmental tax reforms are an effective way to implement emission taxes. At Sitra, we want to map out the different components that could be used to build such a tax reform in Finland,” explains Mari Pantsar, Director of Carbon-neutral circular economy at Sitra.

An environmental tax reform is one which shifts the focus of taxation from taxing labour and business activities to taxing emissions and natural resources in a budget-neutral manner, meaning that the state budget is neither increased nor decreased in the process. Based on the report published today, implementing such a tax reform in Finland would make it possible to both reduce emissions and simultaneously support employment and the economy.

“Finland can succeed only by making climate change the starting point for all political decisions – this is why solving the climate crisis must be at the centre of economic policy,” Pantsar adds.

The tax reform can and should be fair

The report implemented a broad survey of the tools available for harnessing taxation in the pursuit of emission reductions and circular economy solutions. From this range of options, three packages of measures were created and used to model the impacts on emissions, GDP, employment, companies’ international competitiveness and income disparity. The first two packages focus on tax increases aimed at specific operators, while the third primarily examines tax instruments as a way of promoting the circular economy.

“The central question is how taxation can influence emissions and the kinds of impact it has on the domestic economy and employment, including whether the options selected have a disproportionate impact on the daily life of households or particular economic sectors,” says Leading Specialist Saara Tamminen from Sitra, who was in charge of producing the report. “Typically, people are concerned about the impact of increased emission taxes on low-income earners and on the international competitiveness of export sectors. For this reason, these perspectives have a central role in our work.

“Based on the preliminary impact assessments, a broad-based environmental tax reform would be an effective and fair way for Finland to speed up emission reductions. In particular, lowering labour taxation while simultaneously increasing emission taxes would compensate people for the additional expenses of the increased emission taxes and also boost employment. Climate measures do not need to focus particularly on low-income earners and increases in income disparity can be avoided through careful planning. The impact of increased emission taxes on business competitiveness can also be significantly contained through simultaneously lowering other taxes.”

But taxation alone cannot solve the climate crisis. Support is needed from other regulations that together aim to rapidly reduce emissions. For the impact of the tax reform to be truly visible in emission levels and employment opportunities, its net worth would need to stretch to billions of euros.

Taxation as a climate policy tool

Economic policy measures are one of the options for solving the climate crisis. The tax reform models presented in the report provide Finland’s incoming government with ideas and examples of tools that can be used to implement a fair transition towards an emission-free Finland.

There are many factors that influence the overall effects of different taxation packages on the economic system as a whole as well as on social justice matters and emission levels. This is why the report recommends that comprehensive impact assessments be carried out.

“The climate crisis will not wait. The incoming government should plan a reform, commission impact assessments and get the implementation under way. The packages of measures presented in the report are not complete recommendations, nor are they meant to be implemented as they are – they simply offer decision-makers a perspective on the different options and their impacts. There is not one correct solution for carrying out an environmental tax reform – it is a question of making policy choices,” Tamminen concludes.