Minimum energy taxes for climate and clean air in the EU: Environmental and distributional impacts

EU energy taxes could provide a powerful lever to enhance climate action, yet they are characterized by exemptions and are not aligned with climate and environmental goals. This paper assesses the environmental and distributional impacts of a revised Energy Taxation Directive, broadening the tax base and increasing the minimum energy tax levels across energy sources, sectors, and EU countries. We combine an economy-wide general equilibrium model and a household-level microsimulation model to quantify the effects on emissions of greenhouse gases and air pollutants, tax revenue, poverty, inequality, and welfare. Three scenarios consider additive reforms as they gradually stack up energy, climate, and air pollution-based components in the design of minimum energy tax rates. These reforms raise effective energy taxation in the EU roughly by one quarter, by half, and by two-thirds, respectively. Removing exemptions and harmonizing tax rates based on energy content brings down CO2 and PM2.5 emissions in the EU by 2–3 %, with substantial heterogeneity across EU countries. Reform scenarios that add climate and air pollution-based tax components lead to stronger emission reductions and reveal environmental co-benefits, as CO2-based tax rates lower air pollutant emissions, and tax rates reflecting air pollution damages lower CO2 emissions. We furthermore quantify the social trade-off between emission reductions and inequality, and illustrate numerically that regressive impacts can be overcome through revenue recycling. The inequality-increasing price effect is partially offset by income-side impacts (before revenue recycling) but is strengthened by cross-country heterogeneity in energy use and taxation. Overall, our findings suggest that gearing the EU's energy tax structure towards environmental sustainability can help deliver a just transition when embedded in a broader policy package.