Notwithstanding the terrible pandemic we are currently living through, the climate change question has continued to create headlines and is likely to take centre stage in our lives for the foreseeable future, writes Michael Hayes, KPMG Global Head of Renewables.

The similarities between the COVID-19 crisis and climate change have been well documented elsewhere. The reality is that as national Governments and the European Union plan for a post-COVID economic recovery, the Green Agenda is assuming real significance particularly as part of the various stimulus plans being put in place. The EU Green Deal is testament to this and reflects a determination that new investment arising as a result of various stimulus packages will be focused on building back a greener economy. 

Rise of net zero

Coupled with this, we are seeing the rise of net zero commitments from both countries (most recently China) and major corporations (BP, Shell, Microsoft) and this trend is only going to accelerate as well as science-based targets. Here in Ireland, the Government has now published its Climate Action Bill which is designed to put in place the relevant measures to decarbonise the Irish economy over a short period of time and commits Ireland to net zero carbon emissions by 2050.

This global and local transformation to net zero economies is going to have vast implications for budgetary policy and we are already starting to see signs in terms of the type of budgetary policies the EU is starting to develop. These policies will manifest itself in two forms:

  • Budgetary policy will now have to take account of the new capital requirements which will be needed to fund these decarbonisation activities, and secondly;
  • Governments are now starting to focus on the question of using tax policy to drive different behaviours on the climate agenda which is the key focus of this article.

This article asks what all of these developments mean for Irish budgetary policy both for Budget 2021 and for subsequent years. 

Role of tax policy

There is no doubt in my mind that tax policy is going to play a fundamental role as Governments consider actions to reduce carbon emissions and to focus on achieving their net zero objectives. Some evidence of this from the European Union is already clear:

  • The proposed Carbon Border Adjustment Mechanism seeks to ensure that an adjustment mechanism (as in a tax charge) is put in place to prevent carbon leakage. This occurs when production is transferred from a jurisdiction with high ambition for emission reductions such as the EU to other jurisdictions with lower ambition which can result in more carbon intensive imports coming into the European Union. In effect, taxation policy will be used to eliminate the difference and to ensure that EU companies are not penalised.
  • Secondly, the EU is looking at implementing a new Energy Taxation Directive which would have the effect of imposing new excise taxes on many energy products particularly those produced from fossil fuels. Many of these products are currently exempt.

This is really just the beginning of a whole new approach to climate where tax measures (both incentivising and punitive) will be used to really drive different behaviours on carbon emissions and this should be considered separately from the whole question of funding climate and decarbonisation initiatives. Heretofore, tax policy was typically designed with other objectives in mind principally economic and social. However, carbon and climate objectives will now start to feature significantly in Irish budgets with some early steps in Budget 2021 but with more pronounced actions in subsequent budgets.

These measures will be necessary for a number of reasons not least because of the increased focus from the European Union on the climate actions being taken by individual member states and Ireland remains very much under the spotlight in this regard. Also, the Irish Government have made very strong commitments in this area in the recent Programme for Government and in the Climate Action Bill. Additionally, Irish citizens are now much more strident in demanding climate action. To be fair, this new Government recognises the reality and appears willing to respond positively.

What could this mean for future budgetary policy in Ireland?

  1. The whole area of tax incentivisation is going to come back into consideration again and there will be strong impetus to introduce tax incentives to facilitate greater level of green investment in the Irish economy. This could happen in a number of areas particularly to encourage greater use of renewable energy (particularly localised and community solutions), to encourage consumers to adopt energy efficiency solutions, to give certain types of tax relief to investors who are investing in green finance products and most importantly to rethink the whole system for tax relief for innovation spending as the current R&D tax incentive is not really fit for purpose for the climate industry.

    I can already hear the concerns that we have seen the downside of tax incentivisation policies in the recent past and it is true to say that in recent years, the Irish Government has moved away from the whole area of tax incentivisation given that it sometimes favours certain parts of the economy over others. However, we need to think about solving the biggest risks to our planet, and none come bigger than climate change. Therefore, it will be critical that any new tax incentive measures are properly implemented and properly policed, but I believe that it would be wrong to turn away from using this highly effective technique.
  2. For some, we are also going to see more punitive tax measures. This could take many forms, including higher carbon taxes, but also the level of carbon emissions may become a deciding factor in deciding on the level of future tax measures in areas such as VRT and taxes on petrol and diesel.

Increasingly, we are likely to see levels of carbon emissions as a key difference between something that gets more favourable tax treatment than something that does not. This could apply to many different areas of future Government investment including roads, agriculture and energy. 

Tax as a driving force

While many different solutions for climate change will be considered over the next five to ten years, it is very clear that tax policy will take on a very important role. The evidence from history is clear – tax policy has always been one of the most effective tools available to Government to change economic patterns and social behaviours and we have seen the positive effects of informed tax policies on infrastructure and other sectors in the Irish economy. Hopefully, it will now play a key part in helping to drive real change on the climate agenda. 

Further reading