The European Environment Agency (EEA) published two reports which shows that European governments could simultaneously reduce income tax, increase innovation and cut pollution by introducing well-targeted environmental taxes and recycling the revenues back into the economy.

According to a pair of reports on environmental tax reform (ETR) published by the European Environment Agency (EEA), European governments could reduce income tax, increase innovation and cut pollution by introducing well-targeted environmental taxes and recycling the revenues back into the economy. The environmental tax reform is defined as a reform of the national tax system where there is a shift of the burden of taxes, for example from labour to environmentally damaging activities, such as unsustainable resource use or pollution. In June 2011, MEPs also asked for better monitoring sustainable development.

The EEA also highlights four possible types of effects of ETR. The first effect is to make various goods or activities more expensive, while the second effect comes from the direct or indirect distribution of this extra revenue. Thirdly, job creation and eco-innovation may be another result of this process. And lastly, effective ETR will also result in environmental benefits, for example by reducing pollution. In addition, the reports show that by increasing tax on pollution and other environmentally-damaging activities, governments can use the extra funds to provide incentives for innovation, such as developing renewable energy. For advanced economies like the EU, such schemes also create new technologies which can be exported globally.

The assessments are based on the analysis of policies in Germany and the Netherlands, which showed that ETR and other environmental policy instruments have broadly positive effects in increasing innovation. The wider economic effects of ETR have also been analysed in Germany, where environmental taxation cut pension contributions and created an estimated 250.000 jobs. Furthermore, the model suggests that increasing the price of emitting one tonne of carbon dioxide to €68 by 2020 could create 152.000 additional jobs in Germany.