Chapter 1: Less pain, more gain: the potential of carbon pricing to reduce Europe’s fiscal deficits
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The over-riding challenge for many European governments today is to reduce major fiscal deficits with the least collateral damage to the economy. Fiscal consolidation remains a key policy driver in many EU countries. In March 2012, 25 European member states signed the Treaty on Stability, Coordination and Governance, containing a ‘fiscal compact’ to limit their structural deficit to 0.5 per cent of their gross domestic product (GDP) (1 per cent for low-debt countries), and to ensure that general government debt does not exceed, or is sufficiently declining towards, 60 per cent of GDP. In the current economic circumstances, there has been a tendency to perceive dealing with climate change as something that should take second place to fiscal consolidation, or as something that simply cannot be ‘afforded’. Carbon taxation, however, can be a significant source of fiscal revenue and can, therefore, contribute to fiscal re-balancing in Europe. Further, it causes less economic harm per unit of revenue than direct (that is, income) or other indirect taxes (such as Value Added Tax (VAT)), while also producing environmental benefits. Indeed, as noted by the Organisation for Economic Co-operation and Development (OECD, 2012): ‘Introducing or increasing taxes on polluting behaviour provides potentially a win-win option . . . Since many countries are committed to reducing greenhouse gases, the time is propitious for addressing fiscal consolidation and environmental protection jointly.’

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