New ESRI research assesses the most effective means of curbing aviation-related CO2 emissions while minimising economic effects

Key Findings:

• This research shows that the most effective method of taxation, which leads to the greatest emission reductions at the lowest cost to the economy or the aviation sector, are those which target CO2 directly.
• Under the EU Emissions Trading System (EU ETS) airlines are required to purchase emissions allowances to cover their emissions, however, they receive a large amount of these allowances at no cost.
• This study shows that the removal of these free EU ETS allowances and taxing kerosene fuel, as proposed in the European Commissions “Fit for 55” package of measures, would lead to the greatest emission reductions at the lowest cost to the Irish aviation industry and the economy, compared with other measures such as the implementation of passenger taxation or charging VAT on flights.
• The study also shows that the impacts of recent EU aviation taxation proposals under the ‘Fit for 55’ package will heavily depend on the future development of the EU ETS allowance price.

Since 2005, the number of air passengers has increased 60 per cent in the EU, resulting in a substantial increase in aviation emissions. Developments at the international level, including the recently concluded COP26 negotiations, have highlighted the need for action in all sectors, including aviation. Recent proposals in the EU Commissions ‘Fit for 55’ package, have proposed measures to reduce emissions in all sectors. Among those measures which will impact the aviation industry, are a proposed introduction of a tax on aviation fuel and a proposed change to the existing carbon pricing mechanism of the EU ETS for aviation, as a means to reduce CO2 emissions.

The ESRI’s Aviation Carbon Tax Project in collaboration with the Department of Transport explores the impacts of changing the taxation structure of the airline industry. The research examines different policy scenarios, including an EU Policy scenario modelling the phasing out of free ETS allowances and the removal of the kerosene tax exemption as currently proposed by the Commission in its 'Fit for 55' package. Other illustrative scenarios such as the introduction of passenger taxation or the removal of a VAT exemption were also modelled.

The results of the ESRI’s ‘Ireland, Environment, Energy and Economy (I3E)’ model show that all forms of taxation lead to an increase in the price of aviation and result in a decrease in demand and decreased economic activity. However, the scale of the impact is relatively low ranging from a reduction of 0.04 per centto 0.09 per cent in GDP and 0.5 per cent to 3.1 per cent in aviation value added (VA) in real terms in 2030, across different scenarios. Resulting emission reduction is also relatively low, ranging from 0.8 per cent to 1.9 per cent by 2030. This is in line with the findings of previous research which suggests that very large price increases are required to change individuals’ decisions to travel, particularly on island nations such as Ireland where road- and rail-based alternatives are not available.

The results suggest that the ETS allowance price will play an important role in determining the cost and efficiency of taxation measures. If the EU policy package is modelled with a higher ETS price (€100 per tonne of CO2 as opposed to €32 by 2030), the cost to GDP and VA of the aviation sector are -0.6 per cent and -13.7 per cent, respectively, while the resulting emission reduction is -14.8 per cent in 2030. This illustrates how EU policies and the future path of the ETS will have important repercussions for the aviation industry and the Irish economy.

This research shows that, of the measures which were modelled, the most effective method of taxation, which leads to the greatest emission reductions at the lowest cost to the economy or the aviation sector (measured by GDP and VA, respectively) is the removal of free EU ETS allowances and the taxation of kerosene. This is in line with the findings of previous research, which suggests that taxing CO2 directly, through taxes which target the carbon content of fuel are more efficient than measures that target it indirectly, through taxing flights or passengers.

The analysis finds that spillover effects in most other economic sectors would be limited except for sectors that more directly interact with aviation, such as the petroleum sector, warehousing, machine repair and installation. In assessing the impacts on the travel and tourism sector, this analysis estimates the decreased spending by tourists resulting from a decrease in arrivals. The results show that tourism is the most impacted sector after aviation, with impacts of 0.9 per cent reduction in the tourism VA in the EU Policy Scenario.

It should be noted that the methods applied in this analysis (the I3E model) only allows for an examination of the aviation sector as a whole and passengers as a group. Impacts are likely to vary across different market segments of the aviation industry and different passenger classes. Impacts may be different for different routes, assessing this connectivity impact was outside the scope of this analysis.

Commenting on the report, co-author Kelly de Bruin of the ESRI stated:

“There is increasing commitment to decrease EU’s aviation emissions and we can expect increasing taxation on aviation. However, even if the recently proposed EU policies come into force, impacts on the emission reduction will be small without an increase in the ETS price. Taking further policy actions, on the other hand, such as a passenger tax, would be harder in the short run due to the harsh impacts of the COVID-19 crisis on the industry and less cost-effective. In the case of Ireland, as a small island state, the lack of substitutes for aviation requires in-depth considerations of further policy actions.”