Why keeping pace with sustainability tax policy is imperative

As countries rapidly introduce and expand climate policies, businesses must stay informed or risk falling behind.

In brief

• Governments are looking towards sustainability tax proposals to protect the environment, raise revenue and grow their economies.
• Sustainability incentives, carbon pricing regimes and other environmental taxes can all have big impacts on businesses.
• Keeping pace with new developments is a complex challenge, EY’s Green Tax Tracker offers a snapshot of sustainability programs around the globe.

Never before has the global community been so united in addressing climate change. At US President Joe Biden’s Leaders’ Summit on Climate, many of the 40 jurisdictions present committed to ambitious new climate targets with a goal to limit global warming to 1.5-degrees Celsius. While the goal is shared, the methods to achieve it vary greatly across the globe, given the societal and economic realities of each jurisdiction. Keeping track of all the environmental taxes, related exemptions and sustainability incentives in each jurisdiction is a challenge. However, staying current on evolving policy issues is vital for businesses that wish to take action on climate change, secure valuable incentives to enable these actions and avoid costly surprises.

Why are governments acting now?

Leaders are beginning to understand the costs of climate inaction – and that cost compounds over time. Extra heat in the atmosphere is leading to more frequent and more extreme weather events with significant human and monetary costs.

From an economic perspective, a proactive response to climate challenges in some jurisdictions could place other jurisdictions at an economic and competitive disadvantage. Jurisdictions are looking to grow their economies in the wake of the COVID-19 pandemic by offering incentives that reward green behavior and encourage capital investment. Grants, rebates, tax credits or deductions and a myriad of special funding programs are all used frequently to encourage sustainable behavior. These savings and investments are intended to spur local economies, benefiting citizens and governments financially while also helping the environment. 

Finally, with their coffers hit hard by the COVID-19 pandemic, many jurisdictions are scrambling to raise funds for normal expenditure and pandemic-related costs. While protecting the planet is paramount, environmental taxes offer a targeted, and perhaps better received, source of revenue for governments.  For example, a US carbon tax of $25/ton, adjusted annually by 2% after accounting for inflation, is estimated to raise $1.1 trillion over the 10-year budget window.1 The EU tax on non-recycled plastic packaging is estimated to raise approximately €6 billion per year2. By taxing carbon, pollution, waste and other climate-related activity, governments can raise the revenue while also discouraging behavior harmful to the earth. Such targeted taxes can reflect the environmental costs of certain activities and taxpayer behavior often changes as a result. 

 What’s been done so far?

The sustainability tax landscape is very complex, especially for multinational businesses. According to EY’s Green Tax Tracker, there are around 3,600 sustainability incentives available, more than 80 carbon pricing systems in effect and in excess of 4,300 other environmental taxes with more than 1,000 exemptions for qualifying activities or taxpayers. The details and application of each of these programs vary greatly by jurisdiction but, as outlined below, have several common themes.

Incentives to reduce, switch or innovate

Sustainability incentives can generally be divided into three categories, those that encourage innovation, those that encourage a reduction in natural resource consumption and those that encourage a switch to renewable or alternative energy sources. Many programs are a mix of the three. Incentives to reduce consumption or usage are the most prevalent, with nearly 3,000 programs. Examples include incentives to construct or retrofit energy-efficient buildings, procure energy-efficient process equipment or apply emission reduction technologies. Taxpayers that switch to alternative fuels, renewable energy generation (such as solar, wind, geothermal, etc.) and qualify for on-site generation can avail themselves of more than 2,000 programs. More than 150 programs designed to encourage innovation, such as research and development (R&D) credits, research funding grants or funding rebates for green job training are also available.

Carbon pricing

Currently there are almost 50 national and more than 30 local carbon pricing regimes, many based around the EU Emissions Trading Scheme. These initiatives covered 22% of global greenhouse gas emissions (GHG) and raised US$45 billion in revenues in 2019.3 There are two types of carbon pricing regimes. One is an emissions trading system (ETS), often referred to as a cap-and-trade system, which sets a total cap on greenhouse gas emissions and allows companies to use or sell their allotments, thus creating a market price for emissions. The second is a carbon tax, which sets a direct price per ton on GHG emissions that all emitters generally must pay but has no limit on total emissions.

Other environmental taxes

Fuel taxes are the most common environmental tax and they frequently apply to gasoline, coal, natural gas and other fuels. There are also taxes on electricity generation, water usage, industrial and manufacturing processes, waste production, single use plastics and other activities. For many of these taxes, there are exemptions for certain qualifying products, uses or taxpayers.

What’s next?

Many jurisdictions are committed to doing more to protect the environment and accordingly, all of the measures discussed are likely to increase, both in number and scope. Two of the largest global economies, Japan4 and Mainland China5 have each pledged to be carbon neutral by 2050 and 2060, respectively. The European Green Deal seeks to mobilize at least €1 trillion of investment in the next ten years.6 US President Joe Biden outlined a climate plan during his campaign to spend more than $2 trillion over four years.7 At the same time, carbon pricing schemes are under discussion in Brazil, South Korea, and Japan.

What can businesses do to prepare?

To prepare for the coming wave of sustainability tax developments, businesses should:

• Understand their full operational footprint, from locations and supply chains and finally to customers
• Evaluate how current measures apply to the business:
  o What are the biggest tax exposures?
  o How can operations change to reduce emissions and also save money?
• Stay up to date on developments everywhere they operate and model the effects of potential changes
• Use available incentives, exemptions, and funding – these will help the business innovate and stay resilient
• Talk to policymakers and help them understand how policies impact the business