The concept of the circular economy, and the “right to repair” are becoming increasingly prevalent in discussions on product design, supply chains, sustainability, and geopolitical challenges. In addition to the potential environmental benefits, in terms of reduced consumption of natural resources and reduction in CO2 emissions, it has been argued that the adoption of a circular economy approach could also have a range of business and social advantages. It is also argued that adoption helps to create higher levels of security, self-sufficiency, and sustainability, allowing businesses to fulfil customer and service obligations while maintaining costs and competitiveness.

However, proposed changes to legislation could result in increased costs for manufacturers and potentially for consumers if it proves more expensive to repair an object rather than replace it. As the economy faces a cost-of-living crisis and potential recession what impacts might this have on business and society at large?

KPMG hosted this roundtable discussion to explore, from a European perspective, whether the design and practice of tax approaches could help to unlock the circular economy and reconcile the tension between economic growth, sustainability and the issue of uncertain global supply chains. If so, which levers are best placed to make realistic change? The conversation was held under the Chatham House Rule and was attended by 9 expert participants (see below for a list of attendees).

Executive summary

  • There were calls to align fiscal incentives with a circular – rather than linear – economy
  • Reducing labor taxes in favor of taxes on natural resource consumption could be a key move to incentivize a more closed-loop economy
  • There are concerns that current global circumstances will require governments to recycle tax revenue to uplift the economy, upskill their citizens and address the most pressing economic concerns – rather than earmarking environmental taxes to promote an acceleration towards a circular economy
  • Hypothecating tax revenue could promote an acceleration towards a circular economy
  • Managing transitionary lead times, effective communication and creating a balance of policies will be crucial to ensure business has time to revise current models, invest in sustainable practices and avoid perverse outcomes
  • Tax reforms should be considered at the global level to reduce distortions and drive towards the same ambition

Fiscal incentives

Aligning fiscal incentives with a circular, rather than linear, economy

In Europe, most fiscal incentives are still in line with a linear economy. This means that many incentives are designed to minimize labor even if the consequence is a more resource-heavy system of manufacturing. Circular manufacturing practices such as refurbishment, remanufacturing and take-back schemes are much more labor-intensive in nature and are therefore disincentivized by many current fiscal policies. The OECD Environment Directorate found that modelling reduced labor taxation had significant potential in accelerating the transition to circularity 1. Shifting the tax burden away from labor and, for example, onto natural resource consumption would incentivize a more closed-loop economy.

Fossil fuel subsidies and significant subsidies for primary mineral extraction may present a real barrier to a transition to a more circular economy. However, one participant highlighted that if these are to be phased out, then a reliable supply of high-quality secondary materials is necessary to support the supply chain and the cost implications of this need to be addressed in conjunction with any potential taxes on primary materials.

It is also important to consider what appetite there will be amongst governments at this time to shift from taxing labor to taxing materials in this time of inflation. Would this transition exacerbate economic instability under current circumstances?

Earmarked taxation

Hypothecating tax revenue to promote an acceleration towards a circular economy

Multiple participants expressed an interest in earmarking environmental taxes to promote an acceleration towards a circular economy. This could help support businesses to transition away from a linear model and encourage innovation.

The issue of whether to hypothecate revenue from certain taxes raised questions around current levels of trust in governments in Europe and around the world. In addition, the question of whether current global economic circumstances trump earmarking and require governments to recycle tax revenue to uplift the economy, upskill their citizens and address the most pressing economic concerns.

Managing the transition is key

Lead times and a balance of policies are crucial in avoiding perverse outcomes

The need for a well-thought-through balance of policies to curtail incentivizing perverse outcomes – such as promoting damaging methods of waste destruction – was expressed many times throughout the discussion.

One participant suggested that if a government has been previously encouraging one type of investment then it will be important to introduce changes in a way that won’t create a massive cost burden on business. For example, ‘energy from waste’ schemes – in some countries incineration of waste was encouraged by governments as an alternative to waste to landfill which also generated energy – this resulted in many waste incinerators being built. Due to air pollution concerns, the future of waster incinerators is uncertain and if they were banned or subject to heavy taxation in a short space of time, businesses may find it difficult or inefficient to adjust their processes. Lead times and effective communication are crucial in ensuring businesses have time to revise current models and invest in more sustainable practices.

There was also discussion that tax may not always be the most appropriate mechanism for delivering the desired outcome. In the case of single-use plastics, bans may be more effective than product excise taxes in delivering a more rapid reduction in usage. Alternatively, can a package of incentives alone do the job? One participant noted that the revised Inflation Reduction Act in the United States appears to be trying to do just that; ‘It’s a big experiment.’

National vs Global

The barriers for tax and the circular economy at the global level

We were reminded by one participant that taxes at their core are still very national tools and for an organization working across multiple jurisdictions, navigating the differences in those tax systems can be tricky. ‘It is hard to be as circular as you might like to be’.

If circularity on a global scale is to be achieved tax reforms will need to be considered at the global level to reduce distortions and drive towards the same ambition.

One participant observed that ‘We are at an inflection point - the war in Ukraine has created concerns such as the cost of living etc. but also the way in which we see energy and our own economies. The circular economy debate fits within this complete rethinking of current systems both nationally and globally’.

The views and opinions expressed herein are those of the authors and do not necessarily represent the views and opinions of KPMG International.