In July 2021, the Israeli government set ambitious targets for reducing greenhouse gas emissions in Israel. The goal is to reduce emissions by at least 85% by 2050 compared to the emissions level in 2015. The government also set an interim target of reducing emissions by 27% by 2030. In order to achieve these targets, there is a need to set effective courses of action, just like those practiced in the vast majority of OECD member states.
The Ministry of Environmental Protection conducted comprehensive studies for the purpose of formulating a plan. The studies found, inter alia, that the costs of the negative externalities caused by the use of fossil fuels in Israel are currently underpriced. The studies called to rectify this market failure as soon as possible. One of the ways to do this is through carbon pricing (i.e., taxation on fuel imports or fuel marketing) based on the environmental principle “the polluter pays” (without lowering the incentives to concurrently reduce greenhouse gas emissions) and while establishing mechanisms to minimize the adverse impact on weak populations.
Carbon Pricing Mechanisms
Carbon pricing mechanisms are currently in place in many countries that signed the Paris Agreement (particularly in OECD member states). In recent years, carbon pricing has been gaining momentum and many countries are expanding the sectors in which they are implementing carbon pricing.
Today, countries use two main carbon pricing mechanisms, the carbon taxation mechanism and the carbon emissions trading mechanism. The emissions trading system is essentially a tool for reducing emissions by allocating quotas based on the “cap and trade” system. This system sets a cap on allowed emissions units and the various players in the arena have the opportunity to trade the emissions permits issued to them. For example, an enterprise that has difficulty reducing its emissions and exceeds its emissions quota may buy unused emissions quotas (depending on each enterprise’s predefined allocation) from enterprises that succeeded in reducing emissions and remain under their cap.
We note that the trend in recent years has been to set minimum prices for emissions permits. This trend ensures that emissions trading prices are high and stable, which incentivizes enterprises to reduce emissions. On the other hand, this step also constitutes a kind of indirect method of levying a carbon tax.
The carbon tax is largely levied on fuel imports or marketing (depending on carbon content or the volume of emissions during combustion). Generally speaking, taxation is simpler and creates certainty about the cost of carbon. However, it does not create certainty about the extent to which emissions have been reduced. On the other hand, an emissions trading mechanism requires the establishment of extensive complex infrastructure for monitoring the emissions trading, and collections are more expensive using this mechanism. However, this mechanism does provide certainty about the maximum volume of emissions.
The Ministry of Environmental Protection’s current position is that implementing the carbon taxation mechanism is preferable and more suitable for Israel.
Carbon Taxation in Israel
An analysis of studies found that levying a carbon tax in Israel should lead to savings of about ILS 20 billion as a result of the reduced air pollution by 2050 (compared to business as usual). This is partly due to the reduced costs of the negative externalities of air pollutants and greenhouse gases.
It is possible to calculate the carbon tax according to the carbon content in the fuel and according to carbon emissions quantity. We note that most countries customarily tax carbon according to the carbon content in fuel. This is a more accurate method when it comes to pricing emissions. Additionally, this method of taxation is less costly. In Israel, carbon taxation according to the carbon content in fuel can be integrated into Israel’s existing mechanisms (excise tax or purchase tax on imported fuels) and save on the costs of setting up a new and separate taxation system.
The pricing of fuels (for the purpose of contending with the underpricing of the costs of negative externalities mentioned above) could tax about 80% of combustible fuels that are causing Israel’s greenhouse gas emissions.
Therefore, the Ministry of Environmental Protection decided to take action by way of amending the fuel excise tax order, the customs tariff and exemptions order, and the purchase tax on goods (which will result in gradual internalization of the costs of the negative externalities of carbon emissions). The 25th Knesset will deliberate these amendments, since the Ministry of Environmental Protection has already drafted them.
Undesirable Consequences of Carbon Pricing Mechanisms
Alongside the many advantages inherent in carbon taxation, these mechanisms could lead to undesirable consequences, especially in the short term. Firstly, there may be a negative impact on competition in the energy-intensive industries primarily exposed to international trade. Raising fuel prices will directly increase the cost of manufacturing relative to the prices in countries where carbon pricing is low (or nonexistent). Consequently, some countries adopt exemption mechanisms up to particular emissions caps and also provide financial incentives to encourage industries to transition to clean energy sources.
Thus, on a positive note, in the long run, carbon taxation could serve as an incentive to develop green technologies. It could also prompt energy-intensive industries to allocate some of their economic resources to developing such technologies.
Secondly, carbon taxation could have a negative impact on households (particularly low-income households). Raising the prices of energy, electricity, and fuel could have a material impact on household expenditures and pose a considerable financial burden. Many countries are contending with this issue by funding energy efficiency in households or by transferring grants directly to households facing hardships.
Formulating an Ancillary Carbon Pricing Policy
Carbon taxation offers many advantages. According to the Israeli Ministry of Environmental Protection’s policy document, tax collection implemented through existing taxation mechanisms should lead to a fundamental change in the consumption of fuels and electricity.
The Ministry of Environmental Protection has recommended several measures in this regard. They include providing support and subsidies for projects based on green construction, expanding the deployment of charging stations for electric vehicles, incentivizing fleets of heavy vehicles to transition to electric power, distributing vouchers to households in the lower deciles, etc.
It appears this is a necessary course of action to align with all other developed countries leading the battle against the climate crisis. That said, it must be done while taking into account the expected future impact on all sectors in Israel. This course of action will significantly improve Israel’s ability to achieve the targets it has committed to reach. However, Israel must prepare in advance and ensure that this will not adversely affect vulnerable populations.
The proposed regulatory amendments deriving from the Israeli government’s policy toward carbon pricing and other environmental issues will also compel business owners and companies to prepare in advance for the proposed regulatory amendments and the additional costs they will impose.
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Barnea Jaffa Lande is at your service if you have any questions about the carbon taxation policy or about any other environmental law issues.
Izabel Pashayev is an associate specializing in environmental law in Barnea Jaffa Lande’s Corporate Department.
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