Background

The 1999 Ecological Tax Reform (ETR) was the first measure of systematic ecological taxation in Germany. Previous environmental policy was predominantly command and control policies and other non-revenue generating methods of production or price control. The idea and name “ecological tax reform” was coined by Swiss economist Binswanger in the 1980s. In line with the double dividend hypothesis, taxes would target environmentally damaging activities. The raised revenue would be used to replace other taxes to promote employment.

The ETR concept quickly entered the political sphere, gaining momentum in 1994 with the first publication of research on the macroeconomic effects of ETR by the German Institute for Economic Research (DIW). The report indicated an ETR would have both positive environmental and labor market effects while having no significant negative effects on inflation or GDP growth. However, the report also showed that energy-intensive industries would be more negatively impacted. The publication led to a heated debate with proponents and opponents publishing research of their own. Despite industrial lobbying, ETR was eventually introduced in 1999.

Objectives

The objective of the 1999 ETR was twofold: first, to reduce greenhouse gasses to alleviate climate change. The second, to increase employment and reduce labor costs by reducing statutory pension contributions.

Design

Energy taxes

The original German ETR called for 5 stages of energy tax increases targeting various fossil fuels taking place over five years. This was comprised of two laws: the 1999 Law on the Introduction of the ETR implemented the first stage, and the 2000 Law on the Continuation of the ETR supplied the next 4 stages. However, the plan was modified in 2002 with the new government deciding against further tax increases after 2003. The 5 stages of the ETR as implemented are summarized in Fig. 1 below.

Use of tax generated revenue

The generated revenue was primarily used to reduce labor costs arising from Germany’s public pension scheme or prevent costs from increasing. Roughly 90% of revenue went into the pension scheme in 2003. A small portion of the revenue was used to promote the use of renewable energies.

Exemptions

Several tax exemptions were included in the original 1999 Act with some revisions made in 2003. Exemptions were in place to protect energy-intensive industries that would be negatively impacted by the ETR. Manufacturing and agricultural sectors benefited from a reduced tax rate of 20% from 1999-2002 and 60% from 2003 on if a base amount of spending on electricity, gas, and heating oil were exceeded. Firms could receive further refunds if the tax burden was 1.2 greater than the tax relief they experienced from reduced pension fund contributions.

Exemptions were also in place to promote the development of environmentally friendly technologies. For example, public transit systems paid a reduced mineral oil tax, electricity from renewable sources used by the producer was electricity-tax exempt, and combined heat and power plants were exempted from the mineral oil and ecological taxes if their minimum utilization rate was 70%.

Impact

A 2005 ex-post study commissioned by the German Federal Environmental Agency analyzed the impact of the 1999 ETR on the environment, employment, and technological innovation.

Utilizing a counterfactual approach, the study compared real-world data (political scenario) to a counterfactual where the ETR was not implemented (reference scenario). Data from this analysis indicates the ETR was successful in fulfilling its primary objectives: in comparison to the reference scenario, the ETR reduced carbon emissions by 2.4% (20 million tons) in 2003 and emissions continued to decrease after the last tax rate increase. In 2003, when ETR induced job creation/employment peaked, GDP estimates indicate a 0.5% increase in GDP in the political scenario over the reference scenario from 1999-2003. Political GDP returned to reference GDP after 2003 with the abandonment of ecological tax rate increases.

The study theorized that these positive effects were due to two stages of development during the ETR: initially, firms invested in energy-reducing measures to reduce taxes. Later gains are attributed to a reduction in salary-related costs due to the now tax-revenue supported public pension freeing up capital that firms could then invest elsewhere.

The study also analyzed the ETR’s effects on innovation. Due to the large number of factors impacting innovation, researchers were unable to completely isolate the influence of ETR from other variables. Thus, ETR induced effects are described qualitatively instead of quantitatively. Data is drawn from several case studies. Overall, the ETR promoted environmentally friendly innovation. Demand for the adoption of environmentally friendly products by consumers, companies, and other institutions increased. Prices of energy-efficient products, such as LED lamps, decreased relative to energy-intensive ones due to the reduced ecological tax rates. This encouraged mass production and innovation of more environmentally friendly products. Finally, the increased focus on energy-efficient products led to a wider range of products and existing products were further developed, solving old issues.

Overall, the 1999 Ecological Tax Reforms were successful in mitigating climate change by reducing carbon emissions, creating new jobs by decreasing costs associated with the pension plan, and promoting environmentally friendly technological innovation.

References

Beuermann, C., & Santarius, T. (2006). Ecological tax reform in Germany: handling two hot potatoes at the same time. Energy Policy, 34(8), 917–929. doi: 10.1016/j.enpol.2004.08.045

Knigge, M., & Görlach, B. (2005). Effects of Germany’s ecological tax reforms on the environment, employment, and technological innovations. Retrieved from https://www.ecologic.eu/sites/files/download/projekte/1850-1899/1879/1879_summary.pdf