<\/span><\/h2>\nTo analyse the implications of taxing different sides of the economy, the paper contrasts supply-side measures (taxes on agricultural production based on emissions) with demand-side measures (consumption taxes on food products based on their GHG footprint). It considers a GHG tax of \u20ac100\/tCO2e on producers (i.e. the \u2018GHG tax\u2019) alongside the corresponding consumption tax on consumers (i.e. the \u2018EU cons. tax\u2019). These reforms are equivalent in the sense of implying the same amount of taxation per GHG emissions although on different sides of the economy. To highlight the role played by international trade, we consider both the case where the carbon tax is adopted worldwide (i.e. the \u2018Global GHG tax\u2019) as well as the case where it is adopted in the EU alone (i.e. the \u2018EU GHG tax\u2019). Comparing these scenarios yields the differences between supply- and demand-side taxes.<\/p>\n
Furthermore, we put forward a real-world VAT reform that reflects the GHG intensity of food products by adjusting existing tax rates. By reallocating VAT rates to reflect the environmental impact of food products, the reform aims to reduce emissions while using the existing tax infrastructure. Given that the existing rates of VAT are generally insufficient to produce the needed increase in taxation, this measure can only partially internalise GHG prices in the consumption tax. However, it minimises the administrative complexity, facilitating real-world implementation.<\/p>\n
The VAT reform proposal is examined across four diverse EU countries: Spain, France, Poland, and Romania and the changes in rates are presented in Figure 1. Overall, in our proposed VAT reform, sheep and goat meat, as well as beef move into the highest VAT rate category (i.e. the standard rate of VAT) in all countries, given their high emission intensities. Meanwhile, vegetables, cereals, fruit, and potatoes see no increases in the VAT rate.<\/p>\n
Figure 1 <\/strong>Current rates of VAT by country and product and their proposed reform<\/p>\n<\/span>Notes<\/em>: Arrows indicate the direction of change of the VAT rate of the associated product category. Where no arrow is present, the VAT rate remain unchanged in the reform scenario.<\/span><\/h6>\n<\/span>Taxing the supply side versus the demand side: Implications for competitiveness and carbon leakage<\/span><\/h2>\nOur work systematically contrasts the impact on production, consumption, and GHG emissions of supply-side and demand-side measures, as well as of our proposed real-world VAT reform, to learn their expected implications in terms of the competitiveness of the EU agriculture sector as well as their efficacy in curbing emissions.<\/p>\n
The analysis indicates that EU production falls the most (by an average of nearly 10%) in the EU GHG tax scenario that leaves EU producers in a situation of competitive disadvantage vis-\u00e0-vis foreign ones. That is because, under this scenario, the GHG tax would apply to EU producers only, whereas foreign producers will remain unaffected. By contrast, the production impact is much smaller (close to 2%) under the global GHG tax, the EU consumption tax, and the VAT reform. That is because, under all these scenarios, EU producers\u2019 competitiveness abroad is preserved and even boosted. Indeed, thanks to an emission-efficient production and access to mitigation technologies, compared to the rest of the world, the EU agriculture sector could be able to partially offset demand losses due to increased taxation by boosting exports. Consequently, under all these scenarios, EU consumption generally falls more than EU production with less green foreign production bearing the brunt.<\/p>\n
As for the impact on emissions, in Figure 1 we can then appreciate the implication these various measures have on emission reduction and carbon leakage. There we can see that, unless supply taxes are broadly adopted internationally, they create a significant risk of carbon leakage. That is because domestic producers lose market share to less regulated foreign producers, undermining climate efforts as emissions shift outside the EU. The study estimates that a \u20ac100\/tCO2e tax on EU producers would result in a 42% leakage rate, effectively offsetting much of the emissions reduction achieved domestically. Conversely, an increase in consumption taxation in the EU generates a larger reduction of GHG emissions abroad than at home and hence implies positive spillovers to the rest of the world. Two mechanisms are at play. First, reduced domestic demand leads EU producers to shift their products to the export market, where products do not face the consumption tax. As EU food products tend to have lower emission intensities than those produced abroad, this reduces non-EU emissions. Second, as the consumption tax also applies to products produced outside the EU but consumed within the EU, the tax lowers the EU demand for foreign, high-emission food products such as meat and dairy.<\/p>\n
Figure 2 <\/strong>Greenhouse gas emission reduction (Mt CO2e, compared to baseline) of different policy designs<\/p>\n<\/span>Notes<\/em>: Absolute changes in agricultural GHG emissions for the EU and World for different policy scenarios as computed in CAPRI. GHG emissions from agricultural production cover most of methane and nitrous oxide agriculture emitting sources. The global GHG tax is estimated to reduce 913 Mt CO2e globally.<\/span><\/h6>\nDespite the positive spillover effect on emissions outside of the EU, the EU consumption tax achieves 41% less of the reduction in GHG emissions, compared to the worldwide emissions reduction of an EU-only GHG tax. The reason is that a consumption-based tax does not provide direct incentives to farmers to reduce GHG emissions, as efforts to bring down farm-specific emissions would not be reflected in the tax rate. As such, this measure brings smaller progress towards EU greenhouse gas emission reduction goals, e.g. as specified in the Fit-for-55 package. Furthermore, compared to the fine-grained consumption tax, a coarser VAT reform that uses the existing rate structure of VAT systems limits the GHG impact further by about one-third.<\/p>\n
<\/span>Addressing equity concerns<\/span><\/h2>\nIn the absence of large-scale international coordination, demand-side price measures best reconcile environmental and EU competitiveness instances. Nonetheless, these measures are open to equity concerns. Indeed, food is a necessity good that represents a higher share of consumption in the basket of lower-income households (e.g. Maier and Ricci 2023). As the recent cost of living crisis has highlighted (see Freier and Ricci 2023), shocks to food prices have a regressive impact that disproportionately affects poorer households who also have little financial room to shoulder increases in the cost of their consumption baskets. We therefore explore the distributional consequences of our proposed VAT reform. We furthermore consider how adverse distributive outcomes can be addressed by appropriately designed compensatory measures.<\/p>\n
Figure 3<\/strong> Distributional impact of VAT reform and Feebate (% household disposable income)<\/p>\n<\/span>Notes<\/em>: Deciles of individuals based on equivalised household disposable income. Welfare changes are expressed relative to household disposable income for each decile.<\/span><\/h6>\nIn Figure 3, we present our distributional assessment based on a household welfare metric measured in terms of compensating variation at constant quantities.
\n\u00a0 We focus on vertical equity analysing the impact of our proposed VAT reform on household welfare across income deciles. There, we can appreciate that the impact of our proposed VAT reform (red bars) is regressive in all countries with the poorest households shouldering the greatest burden. French households in the first decile bear the largest loss of up to 1.1% in disposable income, while in all other countries the impact is about half of it. To make sense of these differences, consider the distance between current VAT rates and those implied by the VAT reform, in Figure 1. In the case of France, the rate of VAT implied by the reform over the most polluting food items, such as beef and pork meat, is more than four times the current one, whereas in Spain and in Romania the change is just half of it.<\/p>\n
All in all, our distributional analysis suggests that the impact of our VAT reform on households is generally small. In the reform scenario, households are generally found with a welfare loss corresponding to less than 0.4% of their disposable income. However, despite its relatively small magnitude, the inequality-enhancing direction of the reform remains a concern for a number of reasons. Firstly, because the poorest households are often credit-constrained and consume more than they earn. As such, increases in prices can immediately affect their ability to sustain their material standards. Secondly, because the present reform cannot generate, by itself, all the necessary reductions in emissions needed to achieve the EU climate goals, meaning it needs to be part of a broader package of reforms. In this context, adverse distributional outcomes might compound and become \u2013 as a whole \u2013 very significant. Addressing the regressivity of any intervention is therefore necessary.<\/p>\n
To counteract the regressive impact of the VAT reform, we evaluate a revenue-neutral compensatory mechanism based on a Feebate. \u2018Feebate\u2019 stands for a \u2018Fee rebate\u2019 system where additional VAT revenues generated by the VAT reform are used to reduce the rates on low-emission products. As a result, the overall tax burden from VAT and the VAT revenues remain unchanged with respect to the current situation while the tax gradient is further tilted in favour of lower-emission consumption. As can be appreciated from Figure 3, the Feebate mechanism (blue bars) flattens the impact across income groups, and it is successful in making the reform more equitable.<\/p>\n