A carbon price on buildings and transport could come at a heavy cost

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The European Commission's plan to create a new emissions trading scheme for buildings and transport risks shouldering the poorest with the new carbon price [OLIVIER HOSLET / EPA-EFE]

Plans to extend the EU’s carbon market to transport and heating fuels will have the greatest impact on the poorest households, writes Piotr Arak.

Piotr Arak is the head of the Polish Economic Institute, a public think tank in Warsaw.

The European Commission is currently designing the biggest reform of the emissions trading system (ETS) to date in order to align it with stricter climate targets for 2030. The EU executive wants to introduce a phase-in period for shipping companies in the trading system between 2023 and 2025, requiring full compliance with pollution caps as of 2026.

If we want to achieve climate neutrality in 2050 and a 55% reduction goal in 2030 there is a need to extend EU ETS. Around 27% of CO2 emissions in the EU comes from transportation and 36% from buildings. 71% of transport emissions come from road transportation and 70% of emissions from buildings comes from the residential sector.

According to the leaks we see in the media, a carbon tax equivalent to the baseline ETS price will be applied in transport, shipping and housing.

This makes technologies with high emission factors, namely those using fossil fuels, more expensive, therefore creating more incentives for consumers to switch to low-carbon technologies, further reducing emissions in these sectors.

Higher energy bills

A report by the Polish Economic Institute, the European Roundtable on Climate Change and Sustainable Transition and Cambridge Econometrics, shows that introducing an ETS system in transport and housing would result in significant benefits in terms of reaching the emissions targets.

There is, however, a big ‘but’. To achieve the required 40% reduction by 2030, the ETS certificates prices would have to reach €170 per tonne of CO2 (currently it’s at €55). This would lead to an enormous cost for EU households – more than €1 trillion by 2040 – and decrease the competitiveness of European businesses.

This mechanism would hurt the poorest EU households the most. They use the cheapest sources of energy and the upfront costs of switching to low-carbon technologies or implementing energy efficiency are usually too high for them.

In our paper, we estimate that emission costs would impose an average yearly cost increase in energy spending of 44% (€373) in transport and 50% (€429) in residential buildings for households in the first (poorest) income quintile.

The poorest member states are more vulnerable to the impact of the extension of carbon pricing. Some of the Eastern European countries, which have a colder climate and use more heating, will face higher emission costs.

As can be expected, countries with lower energy consumption are less resistant to energy price changes. It is therefore important for the former to provide strong incentives that redistribute resources, like a good solidarity mechanism.

Social assistance needed

To keep CO2 prices and costs for consumers at politically and socially acceptable levels, a carbon pricing mechanism should be coupled with other complementary policies to tackle emissions in the road transport and building sectors. Higher prices would disproportionately affect poorer households.

For residential buildings, this could be transfer payments, direct energy bill assistance or targeted energy efficiency programmes for the poorest households.

It should be required that 100% of the revenues generated by solidarity allowances should be spent on energy and climate purposes.

We need to increase the Modernisation Fund and Innovation Fund to mitigate the impact of the ETS extension in those member states where the transition is more challenging.

Risk of political upheaval

Without that the Commission proposal might create a ‘Mouvement des gilets jaunes’ in every EU member state. The Commission needs to be realistic – increasing the EU ETS price to €170 means that many EU households, even in the Western countries, will not be able to heat their homes. Additional prices for road transport mean additional costs for goods sold in the EU.

If European leaders do not think realistically about mechanisms that are going to help us mitigate the tax burden on the poor, we may face a swing of the political pendulum in many EU countries towards populism and extremism.

This is a very real risk that is omitted and I do not know why. Climate policy needs to be realistic in order to succeed.

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