Social emissions trading for buildings and transport is necessary and possible

Martin Menner and Götz Reichert
Martin Menner and Goetz Reichert of the Center for European Politics

It is the most controversial proposal of the European Commission’s “Fit for 55” climate package: the introduction of a separate EU emissions trading system for carbon emissions from buildings and road vehicles (ETS 2). No wonder: To be able to also achieve the stricter EU climate targets in these sectors, ETS 2 would make fossil fuels and heating fuels more expensive. In the future, consumers would see directly at the gas pump and in their heating bills that climate protection has its price. This is always unpopular, and especially in times of rapidly rising inflation, it would hit people with lower and middle incomes particularly hard.

No one wants social upheaval, and politicians vividly remember the French yellow vest protests, which were sparked by a CO2 price surcharge on gasoline and diesel. From the very beginning, opposition to an ETS 2 has been strong – not only from Eastern European EU member states, but even within the Commission, which has proposed a social climate fund to mitigate the social impact.

Still, the ETS 2 could now completely fail in both the European Parliament and the Council. This would be a fatal mistake for climate policy, because an ETS 2 can reduce CO2 emissions more effectively and more cost-effectively than other climate protection instruments and can be designed in a socially responsible way at the same time.

ETS 2 is indispensable to achieve EU climate targets

While carbon emissions from energy-intensive sectors and power generation have already been capped by ETS 1 since 2005 and reduced as desired, carbon emissions from buildings have barely fallen over the same period and emissions from road transport have, in fact, increased, despite various climate protection measures such as CO2 fleet limits for cars, vans and trucks. There are several reasons for this:

The decisive factor is that emissions trading caps the total quantity of emissions allowances and thus the maximum permissible CO2 emissions and steadily reduces them to ensure that the predefined climate target can be reliably achieved. In ETS 2, companies must hand over a corresponding number of emission rights for the amount of fuels they put on the market (upstream emissions trading). The constant scarcity of available emission rights causes their price to increase, which in turn means that the use of fossil fuels, for example, becomes accordingly more expensive compared to lower-CO2 alternatives.

In this way, the CO2 price signal set incentives for CO2-saving behavior. Thus, in the face of rising fuel prices, people could drive less and more slowly, switch to a fuel-efficient vehicle or use public transport.

ETS 2 as a long-term price signal

By contrast, in the road transport sector, for example, CO2 limits for road vehicles that have been in place for years were unable to achieve either an effective or a cost-efficient carbon reduction. This is not only because, unlike emissions trading, they apply only to new vehicles and not to old ones. In fact, more fuel-efficient vehicles imposed by CO2 limits do lead to relative fuel savings. However, the resulting savings in fuel costs tend to encourage people to drive heavier and more powerful vehicles and to drive more kilometers. The bottom line is that absolute fuel consumption and associated CO2 emissions actually increase. The decreasing cap of the ETS 2 would counteract such rebound effects.

In addition, ETS 2 would send out a strong signal that the prices of fossil fuels will rise in the long term, even if the global price for oil and gas drops again. Consumers and companies could prepare for this, which would provide planning and investment security for the transition to alternative vehicle drives and low-CO2 heating systems, for example. Furthermore, decarbonization of these sectors will make Europe less dependent on imports of fossil fuels, including from Russia.

Overall, without ETS 2, the carbon reduction instruments of the Fit for 55 climate package, would lack the central element for carbon reduction for buildings and road transport. Given the climate policy shortcomings of the past and its tightened climate targets, the EU simply cannot afford to continue without the introduction of emissions trading for these sectors.

Social ETS 2 is necessary and possible

European climate policy can only be successful in the long term if it is accepted as socially balanced both by citizens and among member states. The good news is that an ETS 2 can certainly be designed in a socially responsible way.

The decisive factor for broad acceptance of ETS 2 among the population is not the level of the CO2 price it generates for fossil fuels and heating, but the effective burden on citizens. By appropriately using the proceeds from the auctioning of ETS 2 allowances and designing the proposed climate social fund, excessive burdens on low and middle incomes could be avoided via per capita transfer payments.

If ETS 2 proceeds are largely paid out as identical per capita payments to all citizens who have to pay taxes on them above a certain income level, large parts of the population can be sufficiently compensated for the rising CO2 prices of ETS 2. Thus, the “regressive” CO2 pricing leads to an overall relief that decreases with income. This is a socially just outcome, because citizens with higher incomes heat more residential space on average, drive larger cars, and subsequently produce more CO2 emissions. Furthermore, climate protection measures would be financed in a more socially just way through “progressive” taxes instead of a “regressive” CO2 price.

If member states were obligated to pay out a good portion of the ETS 2 auctioning proceeds to their citizens on a per capita basis and to provide specific support for severe cases, the complex process of drawing up comprehensive climate social plans, as proposed by the Commission, would also be eliminated. By eliminating the bureaucratic climate social plans, the Climate Social Fund would thus become a pure transfer instrument.

Overall, a social design of the ETS 2 is possible. Even if, in the short term, the current sharp rise in inflation and skyrocketing energy prices increase opposition to the introduction of a CO2 price on fossil fuels and heating, an ETS 2 is the right way to decarbonize the building and road transport sectors in the long term. Therefore, the European Parliament and the Member States should be aware of their responsibility for climate protection and social equity and not continue to block the effective, cost-efficient and socially feasible climate protection instrument of the ETS 2 out of unfounded fear of social upheaval. This climate policy opportunity cannot be squandered now.

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