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Environmental Economics

Market-Based Instruments

Market-based instruments (MBI), such as environmental taxes, tradable permit systems or targeted subsidies, are a cost-effective way to protect and improve the environment. They provide incentives to firms and consumers to opt for greener production or products. Governments can also opt for an Environmental Fiscal Reform or the reform of Environmentally Harmful Subsidies.

  • Green Paper on Market-Based Instruments

The Commission presented this paper in March 2007 in order to launch a broad public consultation on advancing the use of market-based instruments for environment and related policy purposes in the Community. The Green Paper starts from the broadly shared view that market-based instruments, such as taxes, charges and tradable permit schemes but also targeted subsidies provide a flexible and cost-effective instrument for enforcing the polluter-pays principle. Depending on the issue, they will often be combined with regulatory instruments to ensure the best and most cost-effective policy mix for the protection of the environment. In the Green Paper, the Commission explores a very wide range of areas where the use of market-based instruments could be promoted further, either at Community or Member State level. This includes energy consumption, the environmental impact of transport as well as the sustainable management of water, waste management, protection of biodiversity and reduction of conventional air pollution. See further details.

  • The EU Emissions Trading Scheme  

In January 2005 the European Union Greenhouse Gas Emissions Trading System (EU ETS) started operation as the largest multi-country, multi-sector Greenhouse Gas Emission Trading System world-wide. It covers over 11.500 energy-intensive installations across the EU, around half of Europe’s emissions of CO2. These installations include combustion plants, oil refineries, coke ovens, iron and steel plants, and factories making cement, glass, lime, brick, ceramics, pulp and paper. Emissions trading does not imply new environmental targets, but allows for cheaper compliance with existing targets under the Kyoto Protocol. Letting participating companies buy or sell emission allowances means that the targets can be achieved at least cost. The price of allowances is a function of supply and demand. If the Emissions Trading Scheme had not been adopted, other – more costly – measures would have had to be implemented. The second trading period of the EU ETS began on 1 January 2008 and runs for five years until 31 December 2012. This period coincides with the period during which industrialised countries must meet their Kyoto Protocol emission targets. The EU ETS will be substantially reformed for the third trading period, which will start on 1 January 2013 and run until 2020. See further details.

  • Database on economic instruments in environment policy

The OECD and the European Environment Agency (EEA) have, in co-operation with the European Commission, developed a database on the use of market-based instruments for environmental policy and natural resource management (environmentally-related taxes, fees and charges, environmentally-motivated subsidies, tradable permits systems, deposit-refund systems) in Member countries which includes all Member States of the EU as well as non-EU members of the EEA (in particular the accession countries). It also covers voluntary approaches. The database, available to the public at large on the OECD website through a number of pre-defined queries can be accessed here.

  • Environmental Tax Reform

An Environmental Tax Reform is the combination of an increased application of environmental taxes with the reduction of other, more distorting taxes, e.g. on labour, in order to improve the environment and to further employment, within a context of budget neutrality. The graph below shows changes in the share of environmental and labour taxes in total tax revenue in the EU Member Sates since 1995. A description of the developments can be found in the 2008 Environment Policy Review – Environmental taxation.

mbi

More data on environmental taxes can also be found in Eurostat's annual publication Taxation trends in the European Union (more specifically Annex A, tables C4).

  • Reform of Environmentally Harmful Subsidies (EHS)

Some subsidies for the industrial, transport, agriculture and energy sectors can be environmentally harmful because they promote the use of polluting or energy-intensive products or processes. They can also introduce distortions in the Single Market. A combination of an Environmental Tax Reform with a reduction of Environmentally Harmful Subsidies is commonly referred to as an Environmental Fiscal Reform.

The Organisation for Economic Co-operation and Development (OECD) started work on reforming environmentally harmful subsidies in the 1990s and published several publications on the matter. See further details here .

A 2007 study ordered by the European Commission presented information relating to the definitions of subsidies and environmentally harmful subsidies, their quantification, arguments for the reform of Environmentally Harmful Subsidies and on identifying practical lessons for taking forward the reform of Environmentally Harmful Subsidies. The report attempts to offer practical insights into subsidy reform drawing on existing literature, the knowledge and expertise of the contributors and a number of case studies that were selected and studied.

A 2009 study followed the 2007 study. It's objective was to develop a methodology for identification, assessment and quantification of environmentally harmful subsidies (EHS). The study tested the tools developed previously by the OECD on six case studies of subsidies in energy, transport and water sector. Based on this analysis and on results of a workshop, the study developed the "EHS Reform tool" for screening, integrated assessment and reform of environmentally harmful subsidies. The study includes also a methodological guidance how to assess the value of subsidies, illustrated on concrete cases.

See here more studies on the use of market-based instruments in environmental policy.