B1.1.5 Continued…


Within the EU

According to Europa, two main types of market-based instrument are used at Community level:

  1. Instruments influencing prices, thus altering them: this applies principally to taxes (which increase the price of a product or service) and financial or fiscal incentives (which reduce the price).
  2. Instruments influencing quantities, by which a maximum quantity is set (in absolute terms or per unit of output): this is the case with tradable permit schemes such as the greenhouse gas emissions trading scheme, under which a maximum quantity of a particular pollutant that may be emitted is set, the quantity being divided up between economic operators and traded by them on a market specifically set up for that purpose, according to their ability to comply with the emissions limits (those who emit fewer pollutants than they are allowed can sell their unused quotas while those who emit more can buy quotas to make up the shortfall).


Instruments influencing quantities offer greater certainty and visibility in terms of achieving specific objectives (emission limits, for example), while instruments influencing prices offer certainty as regards the cost of achieving the objective (taxes, for example) but are as a rule easier to implement. In addition, taxes are a source of revenue while tradable permit schemes only generate revenue where the quotas traded are first granted by public tender. Charges do not generate any revenue for public budgets because they only represent payment for services rendered.

Compared to regulatory instruments, market-based instruments offer the following advantages:

  • external costs are internalised (i.e. they are taken into account in the end price);
  • they allow businesses greater flexibility in meeting their objectives and thus lower compliance costs;
  • they give firms an incentive to invest in innovation to reduce their impact on the environment;
  • they support employment when used in the context of green fiscal reform.


However, the European Commission stresses the importance of precisely identifying the areas in which the use of market-based instruments could be envisaged in a way that also promotes competitiveness without imposing an undue burden on consumers.

An environmental tax reform could benefit the three components of sustainable development (the environment, economic growth and employment). For example, shifting the tax burden from capital and labour (direct taxes) to environmentally damaging consumption could reduce welfare-negative taxes in favour of welfare-positive taxes. Fiscal incentives, such as subsidies to encourage innovation, could also benefit both business and the environment (provided that the public funds from which the subsidies are paid are generated in a way other than by direct taxation, or that spending is reduced).

In the first place it is for the Member States to find the right balance between incentives and disincentives in their tax systems, while respecting overall fiscal constraints and fiscal neutrality. Introducing a framework for closer coordination, including environmental tax reform, and setting up a general market-based-instrument forum could promote the use of these instruments.

The European Commission also stresses the need to reform or abolish environmentally harmful subsidies sector by sector.


Market instruments and energy policy

The European Commission is examining whether the Energy Taxation Directive (laying down minimum levels of taxation on energy products and electricity used as heating or propellant fuels) should not be reviewed in order to establish a clearer link between energy taxation and the environmental and other related objectives of the Directive.

One option might be to divide the tax into energy and environmental elements. Energy sources would then be taxed according to their energy content and their environmental impact (greenhouse gas emissions and other polluting emissions). Such a system would make it easier to promote more environmentally friendly energy sources, in particular renewable energy. However, some differentiation according to use may be necessary to take account of the indispensable nature of fuel used for heating.

A review of the Energy Taxation Directive would also help to ensure greater consistency with other market-based instruments, complementing them and avoiding potential overlaps.

This is particularly the case with the greenhouse gas emissions trading scheme. It applies to certain combustion and industrial installations. A review of the Energy Taxation Directive would allow such installations to be brought within the scope of the Directive where they use energy in the form of heating or propellant fuels, and to apply to them either only the energy element of the tax where they are covered by the emissions trading scheme (i.e. not including the environmental element), or both elements of the tax (energy and environmental) where the installations do not participate in emissions trading.

The Commission also considers that the EU should promote market-based instruments at international level, in particular to its trading partners.

Further information is available here:




The European Scrutiny Committee discussed the “Draft Directive amending Directive 2003/96/EC restructuring the Community framework for the taxation of energy products and electricity”: 

Directive 2003/96/EC, the Energy Taxation Directive, which came into effect in January 2004, provides an EU framework for taxation of energy products and electricity. It sets minimum rates of taxation, as well as the optional tax reliefs allowed by Member States, applicable to energy products when used as motor or heating fuels and to electricity, rather than as raw materials or for the purposes of chemical reduction or in electrolytic and metallurgical processes. In general terms the Directive does not define structural rules for energy taxation (for example, the tax base used, such as energy or carbon content, or the differential between national tax rates on competing energy products). 

Market-based (or economic) instruments (MBIs) are financial incentives or disincentives used as a tool to address market failures or achieve other policy objectives. They can take various forms, such as indirect taxes or subsidies. In April 2007 the Commission issued a Green Paper to stimulate discussion on developing the use of MBIs in relation to EU environmental and energy objectives, including through a revision of the Energy Taxation Directive.[50]

In April 2011 the Commission presented this draft Directive to revise the Energy Taxation Directive. In an accompanying Communication the Commission set out the context and aim of the draft Directive. It asserted that energy taxes can be used to promote greater energy efficiency and reduced carbon emissions as well as to raise revenues. It suggested the aim of the legislative proposal was to bring the present Energy Taxation Directive more in line with the EU’s energy and climate change objectives and that the proposal would serve to:

  • ensure consistent treatment of taxation of energy sources and provide a level playing field amongst energy consumers using different fuels;
  • provide a more coherent framework for the taxation of renewables, and
  • provide an energy taxation framework that complements the EU Emissions Trading System,[51] whilst avoiding overlap with it.

The Commission argued that it is important to restructure energy taxation so as to encourage energy efficiency and the use of environmentally friendly sources. It suggested the draft Directive would help Member States meet their Europe 2020 commitments on emission reduction in a cost effective way.

The draft Directive contains a large number of complex provisions. In summary they would:

  • introduce a new mandatory requirement for Member States to operate both of two tax bases for the taxation of energy products — one would be to cover the carbon emissions associated with the use of energy products and the other would be to cover the energy content of each product, that is the net calorific value of each energy product;
  • revise the existing minimum rates for energy products so as to set EU minimum rates for each of the tax bases and to introduce automatic indexation of these rates by reference to the EU wide consumer price index;
  • require, in addition to the existing requirements for meeting the EU minimum rates, national tax rates to be structured in a way that ensured competing energy products were taxed in relative proportion to their tax base — this would mean that for the carbon emissions tax base, national tax rates for competing energy products would have to be set at the same rate per carbon emission, even if they were above the minimum rate, and similarly, for the energy content tax base, competing energy products would have to be taxed at the same rate per energy content;
  • introduce new mandatory exemptions from the carbon emissions tax on energy products subject to the EU Emissions Trading System; and
  • remove or limit various optional tax reliefs, for example by withdrawing the existing provisions that allow Member States to tax the commercial use of diesel in the transport sector at a lower level than diesel put to private use.

The Commission proposed that a revised Directive would come into force in 2013, although several provisions would be phased in up to 2023.

Source: http://www.publications.parliament.uk/pa/cm201213/cmselect/cmeuleg/86-xvi/8613.htm


To date this Directive has not come into force, but debate on it has resurfaced. A fresh consultation closed in May 2017. The results of that are awaited.



Market instruments and environmental policy

Transport is a major contributor to air pollution and CO2 emissions. The Commission has already proposed linking passenger car tax to CO2 emissions and including the aviation sector in the greenhouse gas emissions trading scheme.

The introduction of a market-based instrument to reduce emissions in the shipping sector must take account of the provisions on charging in the United Nations Convention on the Law of the Sea (FR) and the special features of the sector (in particular as regards geographical differentiation and monitoring mechanisms).

The EU is also encouraging the Member States to used market-based instruments to address pollution and protect resources. For example, the Water Framework Directive requires the Member States to introduce water pricing to encourage efficient water use, which could be supported by reinforcing the links between investments in national projects and the introduction of corresponding water pricing.

In addition, taxing landfill would help to promote recycling and recovery, provided that tax levels are relatively harmonised across the Member States (because widely varying levels could lead to ‘tax dumping’). The Commission also suggests introducing market-based instruments for packaging differentiated according to the impact of the products and waste to promote more sustainable consumption.

Several types of market-based instrument are already being used to protect biodiversity but could be used more, as is the case with payments for environmental services (such as agri-environmental measures under the agricultural policy) and biodiversity compensation schemes (habitat banking).