New era. New plan. EUROPE A FISCAL STRATEGY FOR AN INCLUSIVE, CIRCULAR ECONOMY The Ex’tax Project in cooperation with Cambridge Econometrics, Trucost, Deloitte, EY, KPMG Meijburg and PwC “The difference between what we do and what we are capable of doing would suffice to solve most of the world's problem.” - Mahatma Gandhi 3 Preface In the past, the way we organized our world used to be quite simple, with clear-cut roles for different types of organizations. Governments were to take care of our collective interests, including education, safety and health. Companies were expected to sell products and services to the public, focusing on financial gains and shareholders’ interests, running the economy and creating jobs. International institutions were addressing supra-national issues. Today, the world has become much more complicated and the distribution of responsibilities has become more blurred. Through their global supply chains, for example, companies have a growing impact on people’s lives and on natural capital. There are companies today with revenues more than the GDP of countries. Companies have much more -global- impact than 50 or 100 years ago. And with this increasing impact comes a bigger responsibility, not just for financial but also for social and environmental issues. Since often governments haven’t the solutions (and innovative power) in hand to address on itself the global issues we are facing. This shift in responsibilities means that companies, governments and international institutions have to work together and broaden their scope of interests. Together we should develop solutions that incorporate the three dimensions of value creation simultaneously: for people (societal), planet (environmental) and profit (economic). I strongly believe that people today, and generations to come, would benefit from this. In this respect, we should transition from a linear to a circular economy, by re-designing how resources are being utilized. Shifting from (over-)consumption to (re-)use of materials and the use of bio-based materials. And from fossil dependency to low-carbon solutions. The Stone Age didn’t end because of a shortage of stones. We left the Stone Age behind because we had better alternatives available. The same is true for the Fossil Age; the alternatives are here, let’s move fast into the (Bio-) Renewable Age. Fiscal incentives play a key role in this transition. We should realize that the main area of income for governments is related to taxing labour and much less to the use of scarce resources. We can ask whether we put the correct incentives and focus. Do we want to burden labour and employability and not so much the consumption of scarce materials? When we would have a pricing system for externalities, like carbon emissions, we can reduce other taxes, like those on labour. Why would any country be against the fact that people want to find a job? We should tax the things that we don’t want to be used abundantly. 4 The report New era. New Plan. Europe shows us the possibilities and opportunities a fundamental shift in taxes has to offer. It is a valuable study for policy- and decision makers in businesses and governments who are looking for solutions to address the challenges of our time: climate change, pollution, inequality, unemployment and resource scarcity. We need to develop economic-, cost- and tax-models, which stimulate value creation on the three mentioned dimensions simultaneously. By giving thoughts to the above, we need to redesign our economic system. Since we cannot be successful, nor call ourselves successful, in a society that fails. We need to create sustainable value on all of these dimensions to ensure brighter lives for people today and generations to come. Feike Sijbesma CEO Royal DSM, Co-chair Carbon Pricing Leadership Coalition (CPLC) convened by the World Bank 5 Table of Content Abstract ....................................................................................................................... 10 Executive Summary ...................................................................................................... 11 Introduction ................................................................................................................. 23 1. Europe faces global challenges ............................................................................... 25 1.1. Mass unemployment 25 1.2. Water supply risks 28 1.3. Fossil fuels and materials supply risks 29 1.4. Climate change 31 1.5. External costs and benefits 32 1.6. The need for an integrated approach 35 1.7. International strategies to address the challenges 36 1.7.1. Europe 2020 Strategy 36 1.7.2. The Roadmap to a Resource Efficient Europe 37 1.7.3. The Water Blueprint 38 1.7.4. The 2030 Energy Strategy 39 1.7.5. The Paris Climate Agreement 39 1.7.6. The 2030 Agenda for Sustainable Development (SDGs) 40 1.7.7. The EU Emission Trading System 40 2. Fiscal systems in Europe in relation to these challenges ......................................... 43 2.1. High labour taxes and social contributions 43 2.2. Low environmental taxes 46 2.3. Environmentally Harmful Subsidies 50 2.4. Value Added Tax in the EU 53 2.5. Updating our tax systems 56 3. Shifting taxation from labour to natural resource use ............................................ 57 3.1. Introduction to Ex’tax 57 3.2. Support for a tax shift 58 3.3. Internalisation of external costs: carbon pricing on the rise 60 3.4. Lowering the tax burden on labour to help solve unemployment 64 3.5. The ‘double dividend’ discussion 65 3.5.1. Impact of a tax shift - in theory 65 3.5.2. Impact of a tax shift - in practice 68 4. The role of business is changing ............................................................................. 71 4.1. Businesses are measuring & disclosing impact 71 4.2. Business leaders are calling for carbon pricing 73 4.3. Businesses are applying ‘shadow pricing’ 74 4.4. Inclusive, circular business model innovation 76 5. The Ex’tax Project approach ................................................................................... 79 5.1. How The Ex’tax Project addresses the challenge of updating the tax system 79 5.2. Goal of this study 81 5.3. Limiting the scope 81 5.4. Methodology 84 6. The E3ME model .................................................................................................... 85 6.1. Introducing the E3ME Model 85 6.2. How the model works 86 6.3. E3ME compared to CGE models 87 6.4. Limitations of modelling a transition 88 6 6.5. The baseline projections 89 7. Building a tax shift scenario ................................................................................... 91 7.1. Step 1: Data collection 91 7.2. Step 2: Exploring options for shifting the tax base 95 7.3. Step 3: Choosing a focus group of tax bases 97 7.4. Step 4: Exploring a focus group of policy measures 98 7.5. Step 5: Explaining the fiscal policy scenario in more detail 100 7.5.1. VAT increase 101 7.5.2. Fossil fuels 104 7.5.3. Water 111 7.5.4. Air pollution 112 7.5.5. Electricity 116 7.5.6. VAT reduction 119 7.5.7. Payroll tax credit for new employment 121 7.5.8. Payroll tax credit for circular innovation 123 7.5.9. Income tax and social contributions 125 8. Modelling results ................................................................................................. 127 8.1. EU-27 results: decoupling growth & resource use 127 8.1.1. Economic impact 129 8.1.2. Impact on labour cost and employment 131 8.1.3. Impact on natural resource use 132 8.2. Member States results 134 8.2.1. Key results per Member State 134 8.2.2. Economic impact per Member State 136 8.2.3. Employment impact 137 8.3. Sector results 139 8.4. Distributional results 143 9. Integrated Value Added Statement (IVA) ............................................................. 145 9.1. Introduction 145 9.2. Scope 147 9.3. The Integrated Value Added Statement 150 9.4. Key methods, assumptions and data sources 152 9.5. Measuring impact on natural capital 154 9.5.1. Valuing impacts of energy and water use 155 9.5.2. Limitations 158 9.6. Measuring impact on social capital 159 9.6.1. The relationship between work, health & wellbeing 159 9.6.2. Valuing the impacts of employment 160 9.6.3. Limitations 162 9.7. Areas to expand and improve the assessment 163 10. Summary of the EU-27 results ............................................................................ 164 11. Case studies ....................................................................................................... 170 11.1. Germany 171 11.2. Poland 177 11.3. Spain 183 11.4. The Netherlands 189 12. Recommendations for next steps ....................................................................... 194 Closing statement ....................................................................................................... 196 7 Figures Figure 1: Tax structure by economic function (EU-28, 2012, % of total taxation) ........................... 43 Figure 2: Tax burden on labour (EU-28, 2012, % of total taxation) ................................................. 44 Figure 3: Implicit tax rate on labour (EU, 1995–2012) ..................................................................... 45 Figure 4: Environmental taxes (EU-28, 2012, % of total taxation) ................................................... 48 Figure 5: Structure of environmental tax revenues (EU-28, 2012) .................................................. 48 Figure 6: VAT (EU-28, 2012, % of total taxation) ............................................................................