Chapter 3. Towards green growth
Hungary has managed to decouple several environmental pressures from its sustained economic growth, although challenges remain. This chapter reviews Hungary’s efforts to promote green growth and sustainable development. It analyses progress in using economic and tax policies to pursue environmental objectives and in reforming environmentally harmful subsidies. The chapter also examines the country’s eco-innovation performance, and discusses public and private investment in low-carbon energy, transport, and water infrastructure and services. Finally, the chapter briefly reviews the country’s progress in mainstreaming environmental considerations into international trade and development co-operation.
The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.
3.1. Introduction: Hungary’s economy, society and the environment
3.1.1. Decoupling environmental pressure from economic growth
Hungary’s small open economy was severely hit by the global economic crisis in 2008/09, but has grown faster than the OECD as a whole since 2012 (Figure 1.1; Chapter 1. ). Key drivers of growth over this period include macroeconomic stimulus (tax cuts, increased expenditure and lower interest rates) and investment funded by the European Union (EU). These helped raise real incomes and spurred private consumption and exports (OECD, 2016a). As new EU-funded infrastructure projects are launched, economic growth is expected to continue (OECD, 2017a). However, sustaining growth in the long term will require boosting labour productivity via enhanced investment in the business sector, innovation, and education and training (OECD, 2016a).
Hungary has continued to make progress in decoupling its economic growth from environmental pressures in the last decade. It has also improved its performance towards most of the 17 Sustainable Development Goals (SDGs).1 On most goals, Hungary is still lagging behind the European Union as a whole. However, it is doing better than the other Visegrád Four countries (Czech Republic, Poland, Slovak Republic) on others, such as “Sustainable cities and communities”, “Responsible production and consumption” and “Climate action” (Annex 3.A).
According to a 2016 OECD study, growth in Hungary’s gross domestic product (GDP) would increase by about 0.5 percentage points on average per year over 2000-13 if adjusted for the cost of total pollution abatement (Cárdenas Rodríguez, Haščič and Souchier, 2016; Figure 3.1).2 This is the third highest value in the OECD. It suggests that Hungary has managed to grow, while protecting its environmental quality. The country has invested in abating pollution either directly or through a restructuring of the economy towards less polluting activities and more energy and resource-efficient production processes.
However, Hungary needs to remain vigilant and to strengthen implementation of environmental policy. Recent and projected economic trends are exerting pressures on the environment, including growing energy consumption and emissions of greenhouse gases (GHGs) and air pollutants from road transport. While municipal waste generation has decreased, waste recycling and recovery remain low (Chapter 4. ). Water contamination and pressures on ecosystems remain of concern (Chapters 1 and 5).
3.1.2. Improving social inclusion and access to basic services
At the same time, Hungary needs to make sure that the benefits of economic growth are well distributed, and that sufficient investment extends access to environment-related services (Section 3.5). While Hungary’s per capita income has considerably increased in the last decade, it is still one-third below the OECD average. Income inequality and poverty have been increasing (Chapter 1. ; Basic Statistics); rural areas in eastern and southern Hungary face widespread poverty. Regional disparities persist with regards to access to drinking water supply and wastewater treatment services, as well as gas and electricity networks. About 10% of housing stock is substandard accommodation with no or limited modern amenities. Further, 80% of buildings fail to meet energy efficiency standards (Chapter 1. ).
The Roma population represents about 7.5% of the total. It tends to live in disadvantaged rural areas with poor housing conditions and lack of access to drinking water and basic amenities (EC, 2017a). Roma people have a higher probability of poverty, poor health and worse labour-market outcomes than the non-Roma population (OECD, 2016a).
Several programmes have targeted these issues, but results have been limited (Ministry of Public Administration and Justice, 2011). These programmes have largely failed to reach the most disadvantaged groups, partly because they lacked a coherent policy. Co-operation among the institutions responsible for the various sectoral programmes (education, housing, social services, environment) needs to be improved. The lack of reliable data, particularly about the Roma population, makes it challenging to monitor and evaluate measures targeting disadvantaged groups. The National Strategy on Social Cohesion for 2011-20 aims to reduce and prevent poverty and social exclusion of all vulnerable groups, including the Roma population. However, it is not clear to what extent Hungary is on track to meet the strategy’s objectives.
3.2. The sustainable development and green growth framework
Hungary has strengthened the institutional arrangements for pursuing the goals of sustainable development. In 2008, it established a multi-stakeholder National Council of Sustainable Development (Chapter 2. ). A year later, it signed the OECD Declaration on Green Growth together with all other OECD member countries and several partner countries. Since then, a cross-party consensus on green growth and its economic benefits for the country has emerged (Biró Nagy and Boros, 2012). As part of the European Union, Hungary committed to achieve 17 SDGs by 2030, which are set out in the 2030 Agenda for Sustainable Development. It will undergo the voluntary national review of SDGs in 2018.3
In 2013, Parliament approved the second National Framework Strategy on Sustainable Development (NFSSD) for 2012-24 based on the Council’s report on Hungary’s “sustainability status”. Preparation included a strategic environmental assessment and a wide-ranging consultation process (ESDN, 2016).
The strategy diagnoses the state and tendencies of the four key resources for Hungary’s sustainability – human, social, natural and economic – as well as the pressures they face. It indicates policy objectives, the necessary strategic responses to achieve them and the indicators to measure progress. The strategy also outlines the responsibilities of the national and local governments, businesses, households and local communities. The government reports to Parliament on implementation of the strategy every two years. In 2017, the government’s second biennial review recommended harmonisation of the NFSSD with the SDGs. In addition, the State Audit Office will start its own review of SDG implementation in 2018.
In line with the OECD Green Growth Strategy (OECD, 2011), the NFSSD highlights that green economy reforms require regulatory, taxation and funding instruments. These would help improve efficiency in resource use, reduce environmental pollution and price use of material appropriately. It recommends shifting the tax burden from labour to natural resource use, assessing the “environmental sustainability performance” of funding, reviewing energy-related funding and taxation, improving the energy certification of buildings, developing green public procurement and possibly streamlining environmental regulations.
The Central Statistical Office has developed more than 100 sustainable development indicators, larger than in most other Central and Eastern European countries (Lepuschitz and Berger, 2014). Hungary would benefit from a more targeted framework for monitoring progress towards green growth objectives. This framework should be based on sound indicators that link economic activity with environmental performance. It should include indicators on the effectiveness of policy in addressing environmental challenges and in generating eco-innovation and green business opportunities. Hungary could build on the OECD green growth indicators framework. It could also draw on the experience of 28 other countries (including emerging and developing economies) that have customised it to their national circumstances (e.g. Chile, Denmark, Germany, Korea, the Netherlands) (OECD, 2017b, 2014).
The NFSSD has had limited ability to guide policy action and provide a long-term vision for the transition of Hungary to a low-carbon, resource-efficient and greener economy.4 Hungary has a wide array of general and sectoral strategies that set the desired directions of the economy, society and environment. In 2012, the government approved a decree requiring harmonisation of strategic planning documents and monitoring of their implementation. However, decisions are still often not in line with the principles articulated within these strategic documents (EIO, 2016).
3.3. Greening the system of taxes, charges and prices
In line with recommendations of the 2008 OECD Environmental Performance Review, Hungary has extended the use of economic instruments to put a price on environmental externalities and encourage efficient use of natural resources. Like many OECD member countries, Hungary applies energy and vehicle taxes. It has also long applied a wide range of levies on pollution and resource use, including on air emissions, water abstraction and water/soil pollution, and has introduced or extended some new environmentally related taxes, namely the landfill tax and environmental product fees (Chapter 4. ). However, as the following sections discuss, tax rates are generally low and provide weak incentives to change production and consumption behaviours. In addition, Hungary participates in the EU Emissions Trading System (ETS) (Section 3.3.3).
3.3.1. Environmentally related taxes: An overview
Hungary has a complex and frequently amended taxation system, which implies high compliance costs. Tax-to-GDP ratio stood at 39% in 2015. This was in line with the EU average, but above the OECD average of 34% and the ratio in the other Central and Eastern European members of the OECD. The government is committed to reduce the ratio to below 36% of GDP by 2019. As in the other Visegrád Four countries, Hungary collects over three-quarters of tax revenues through consumption taxes and social security contribution, which is high in international comparison. Still, the government has continued shifting the tax burden from labour to consumption, including by increasing environmentally related taxes (OECD, 2016a).
Revenue from environmentally related taxes is relatively high in international comparison.5 In 2016, it accounted for 7.4% of total tax revenue and 2.9% of GDP, well above the OECD averages of 5.2% and 1.6%, respectively (data 2014) (Figure 3.2). As in all other OECD member countries, Hungary collects most environmentally related tax revenue through taxes on consumption of energy products (77%) and vehicle ownership and use (13%). Compared to many other countries, Hungary relies more on energy taxes and pollution and resource taxes than on vehicle taxes (OECD, 2017b). Taxes on pollution and resource use include the landfill levy (Chapter 4. ), an air emission charge and water-related levies (Section 3.3.5).
The environment-related tax burden in the economy has been declining in recent years. With the economic recovery and recent tax hikes, environmentally related tax revenue (in real terms) has increased by about 13% since 2010. Overall, the revenue from environmentally related taxes has grown at a lower rate than GDP and total tax revenue since the early 2000s (Figure 3.2). Two main factors may explain this trend. First, registrations of new passenger cars have declined sharply, while registration and ownership vehicle tax rates decrease with car age (Section 3.3.4). The latter provides an incentive to keep a car in use for longer than with age-neutral taxes and to purchase used cars. With a growing stock of cars that are over ten-years-old, revenue from vehicle taxes has declined. Second, use of road fuel declined sharply between 2009 and 2013, especially petrol, which is taxed at a higher rate than diesel. Increasing excise duties since 2011 have helped stabilise revenue from energy-related taxes despite lower road fuel consumption (Figure 3.3).
Hungary could further boost environmentally related taxes and charges, and regularly adjust their rates, including for inflation. It could also improve design of these taxes and charges to maintain their ability to provide incentives for more efficient resource use and to raise revenue. This could also help the government achieve its goal of bringing the debt-to-GDP ratio down to 50%. While Hungary has made progress in reducing the public debt, it remains high compared to most other Central and Eastern European countries (OECD, 2016a). Public spending is high (half of GDP) with a large share going to general public services. According to OECD (2017a), fiscal policy should re-prioritise public spending towards infrastructure investment that supports productivity growth. Investment in infrastructure, education and health (among others) requires high spending, but the government aims to reduce taxes on labour and businesses. As a result, additional and less distortive revenue sources such as environmentally related taxes may be needed.
In this context, a 2016 study suggests considerable potential for shifting taxes from labour (namely social contribution) to environmentally related taxes. Under a best case scenario, these could generate additional revenue equivalent to 0.56% and 0.8% of GDP in 2018 and 2030, respectively. At the same time, they could generate environmental benefits equivalent to 0.08% of GDP by 2030. The largest potential sources of revenue would come from raising the annual motor vehicle tax and introducing a pesticide tax (EC, 2016).6 Other options include: adjusting fuel tax rates; introducing a carbon tax on sectors outside the EU ETS; raising the rates of levies on air pollution, water abstraction, water pollution and landfilling of waste; introducing a weight or volume-based tax on extracted raw construction materials to complement the current royalty;7 include external costs such as air and noise pollution in road tolls for passenger and heavy goods vehicles; and introducing congestion charges in major cities.
3.3.2. Taxes on energy use
Hungary applies an energy tax on all fuels used at stationary facilities (such as coal, electricity and natural gas) and an excise duty on road fuels (petrol, diesel, liquefied petroleum gas). The government raised all tax rates on energy used for stationary purposes in 2015, bringing them in line with minimum rates required by EU regulations. Excise rates on road fuels have been repeatedly raised since 2011. The duty on liquefied petroleum gas has doubled, and a tax on compressed natural gas has been introduced. The government has raised the excise duty on diesel by about 13% to reduce the gap with the excise rate on petrol. This increase reflects the higher environmental costs (CO2 and air pollutant emissions) associated with diesel use. As of January 2017, the standard rate for diesel was still 8% below that for petrol, however.8
In 2016, the government partly linked the excise duty on petrol and diesel to the world market price of crude oil: the tax rates temporarily increase when the price of oil is below USD 50/barrel. According to the government, this measure aims to balance out the potential decline in consumption tax revenue due to extremely low oil prices (IEA, 2017). Despite the tax hikes, the petrol tax rate remains low by international standards, when tax rates are converted per unit of energy (Figure 3.4).
Overall, when expressed in terms of energy content of fuels, Hungary applies higher tax rates on transport fuels than on those for heating and process purposes. This is common to all OECD member countries (OECD, 2015a). Hungary taxes 57% of CO2 emissions from energy use, the fourth lowest share in OECD Europe (OECD, 2016b). Tax rates on energy products do not fully reflect the estimated environmental costs of carbon emissions for several reasons: tax rates on transport fuels are relatively low; rates on other fuels are set at or only slightly above the EU minimum rates; rates are not systematically adjusted for inflation; and fuel use in some sectors is fully tax exempt. All this puts Hungary among the ten OECD countries with the lowest effective tax rate on energy on an economy-wide basis (OECD, 2015a). This does not consider the carbon price emerging from the EU ETS, discussed in Section 3.3.3.
Hungary should consider reducing tax exemptions and further raising energy and excise tax rates to adequately reflect the environmental damage from energy use. Low world oil prices experienced since end-2014 provide an opportunity to permanently increase the energy taxation. This would be a step beyond adjusting petrol and diesel rates based on oil prices, as is currently the case. Higher fuel tax rates would provide an incentive for drivers to reduce fuel consumption. To the extent that this happens through reductions in distance travelled, other social costs (e.g. local air pollution, congestion, accidents and noise in transport) may also decrease (Harding, 2014a).9 In raising fuel tax rates, Hungary needs to assess and address the potential for fuel tourism. This is especially true for neighbouring non-EU countries (e.g. Ukraine), which do not have to meet minimum energy tax rates (EC, 2016). Any adverse impact on vulnerable population groups could be addressed with targeted benefit schemes (Box 3.3).
3.3.3. Carbon pricing
In addition to putting a price on carbon via energy taxes (Section 3.3.2), Hungary participates in the EU ETS. Thirty-four percent of CO2 emissions from fuel combustion (those from power generation, energy-intensive industry and aviation) are subject to the carbon price that emerges in the EU ETS. This compares to 36% in the Slovak Republic, 44% in the Czech Republic and 53% in Poland (OECD, 2016b).
In the first two trading periods (2005-12), emission caps were determined at the national level. At that time, Hungary was granted more emissions allowances than the actual emissions from sectors covered by the EU ETS (Figure 3.5). Companies located in Hungary have been among the major allowance sellers in the system. The supply of allowances dropped in the third period (2013-20), with the introduction of an EU ETS-wide emission cap, the extension of auctioning and the back-loading of allowances.
As in all countries, Hungary’s manufacturing sectors continue to receive a share of allowances for free to address carbon leakage concerns (EEA, 2016a).10 However, evidence from carbon pricing systems around the world indicates that the impact of such systems on competitiveness is generally limited. It does not substantially differ between the firms that benefit from preferential treatment (such as free allocations) and those that do not (Arlinghaus, 2015). In addition, free allocations can create windfall profits for carbon-intensive industries and can skew investment decisions towards carbon-intensive technologies (OECD, 2017c).
Due to this over-supply of allowances, free allocations and low carbon prices in the market, the effects of the EU ETS on low-carbon investment in Hungary’s energy and manufacturing sectors have been limited. Since 2011, energy use and related CO2 emissions in the manufacturing sectors have been growing faster than prior to the 2008/09 recession. Emissions from power generation have declined steadily since the mid-2000s, with a shift to nuclear power and, to a lesser extent, renewables. Other factors than the EU ETS have likely played a major role (Chapter 1. ).
Hungary has been among the largest sellers of international carbon credits. The government has collected revenue from these sales, as well as those for auctioning EU ETS allowances, in green investment funds. It has used them to finance investment in renewables, energy efficiency, and related research and development (R&D) (Section 3.5.4). Earmarking revenue to funds for environmental purposes may be necessary to secure reliable, sufficient resources. However, this can reduce the flexibility of fiscal decisions and, therefore, the efficiency of revenue allocation.
OECD (2016b) estimates that, when accounting for both energy taxes and the emission allowance price, 70% of CO2 emissions from energy use face a carbon price signal in Hungary. However, this share is still below that of CO2 energy-related emissions priced in many other OECD member countries (Figure 3.6). Throughout the OECD, the effective carbon price on road fuels is higher than on energy products for other uses. More than 95% of emissions from fuels used in road transport face a carbon price (via the energy tax) above EUR 30 tCO2 (which represents a low-end estimate of the climate cost of CO2 emissions; OECD, 2016b). However, the average effective carbon rate faced by road transport was EUR 143.4 tCO2 in 2012, which is among the lowest in the OECD (Figure 3.6). This is because fuel taxes have remained relatively low (Section 3.3.2). In all sectors other than transport, CO2 emissions are either priced below EUR 30 tCO2 or not at all. Indeed, 77% of CO2 emissions from energy use in the residential/commercial sector and 22% in industry are unpriced (OECD, 2016b). As IEA (2017) recommended, Hungary could consider an explicit carbon tax on the sectors not covered by the EU ETS, which include primarily road transport and smaller industrial and commercial facilities.
3.3.4. Transport-related taxes and charges
Hungary applies taxes on the acquisition, registration and ownership of vehicles. The acquisition of a new or used vehicle is subject to a property acquisition fee, which increases with the vehicle power. A tax must also be paid upon first registration of a passenger car in Hungary. The rates are based on the engine type (higher for diesel), cylinder capacity and environmental feature of the car in accordance with EU emission standards. The owner of the vehicle pays an annual motor vehicle tax. The tax varies with the vehicle power for passenger cars; it varies with weight for heavy goods vehicles. All these vehicle taxes decrease with the age of the vehicles.
Vehicle taxes do not fully consider environmental performance of vehicles. They discourage renewal of the vehicle fleet and encourage acquisition of second-hand cars, which are often more polluting. Partly due to these incentives, the car fleet in Hungary is outdated and more carbon intensive than on average in the European Union. The average age of passenger cars was 14.5 years in 2015. This was in line with the average in some other Central and Eastern European countries, but well above the EU average of 10.7 years. While their fuel economy has improved, newly registered cars in Hungary still emit 129.6 g/km of CO2. This level is above the average recorded in other Central and Eastern European countries and well above the EU average of CO2 119 g/km (EEA, 2016b). CO2, NOx and PM2.5 emissions from road transport have been increasing in recent years. The number of cars per capita is among the lowest in the OECD (Chapter 1. ), but is expected to increase with rising income levels. Vehicle taxes could be, therefore, used to foster the renewal of the fleet towards more fuel efficient and less emitting vehicles.
Some steps have been taken in this direction. Since 2016, electric vehicles (EVs) have been exempted from the registration tax, vehicle and company car tax, and motor vehicle duty. Heavy duty vehicles with lower emissions also benefit from tax discounts on the vehicle tax. Since 2011, the amount of the company car tax (paid by the company providing the car to the employee) considers the emission category of the car (Section 3.4.2). However, more could be done by linking the rates of all vehicle taxes to the EU emission standards and vehicles’ CO2 emissions, and by delinking the rates from the vehicles’ age.
Different toll systems apply to heavy goods vehicles and passenger cars. Only the tolls for heavy goods vehicles are based on distance travelled and take account of the vehicles’ emission category (Box 3.1). Hungary is the only EU country among those implementing the time-based electronic road toll system (so-called e-Vignette) not to differentiate the vignettes by vehicles’ Euro emission class (Ricardo-AEA, 2014).
Two electronic road-user charging systems are in place depending on the type of vehicle:
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The time-based electronic road toll system (so-called e-Vignette) applies to all passenger vehicles and small commercial vehicles (with gross weight up to 3.5 tonnes). There are daily, weekly, monthly and annual tolls.
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The network-wide distance-based electronic road toll system applies to heavy goods vehicles circulating on all motorways and most main roads, excluding the main road sections within urban areas. Tolls depend on road type (motorway or main road), vehicle axles and emission classes based on the EURO emission standards (vehicles equipped with Euro III or cleaner engines; vehicles equipped with Euro II engines; and vehicles equipped with Euro I or higher emission engines).
Hungary should consider adjusting road tolls for passenger and heavy goods vehicles to include external costs such as air and noise pollution, as indicated in its National Energy Strategy 2030. In addition, introducing congestion charges in major cities would help place a cost on travel during peak periods and encourage more use of public transport. In areas poorly serviced by public transport, or where concerns over equity arise, social transfers could be used to partly compensate for the charge costs.
3.3.5. Taxes and charges on pollution and resource use
Hungary figures among the five EU member states that have introduced or increased levies (taxes and charges) on pollution and resources (EC, 2017b). It applies a wide range of levies on pollution and resource use, including on air emissions, water discharges to soil and surface water, water abstraction and landfilling of waste. It also applies levies to a wide range of products considered harmful to the environment (Box 3.2). These levies account for 9% of environmentally related tax revenue, well above most other OECD member countries.
The air load charge applies to the emissions of NOx (HUF 120/kg) and SOx (HUF 30/kg) from installations subject to a permit. The charge is halved if the operator installs abatement equipment. The charge does not apply to households, district heating providers and transport.
The soil load charge amounts to HUF 1 200/m³ of domestic sewage and other wastewater discharged to the soil (i.e. on disposal of wastewater by means other than the local public sewerage system). The charge is proportional to the wastewater discharged into the soil, as well as to the sensitiveness of the areas. It aims at encouraging households to use available public infrastructures. It may have contributed to the increase of the population connected to public sewerage (OECD, 2008).
The water load charge has applied to facilities that discharge polluting wastewater into surface water since 2004. The rate depends on the type of polluting substance, its concentration in the wastewater, the characteristics of the recipient water body and the water quality category of the area concerned. Rates range from HUF 90/kg for chemical oxygen demand to HUF 220 000/kg of mercury. Intermediate rates are charged for inorganic nitrogen, phosphorus, cadmium, chrome, nickel, lead and copper. The charge does not apply if wastewater recycling is in place. Further, the charge is halved if the discharger puts in place pollution reduction measures.
The water abstraction charge is paid on groundwater and surface water withdrawals for all purposes. The amount of the charge is proportional to the amount of abstracted water. It also depends on the source (i.e. groundwater or surface), type (karstic, porous or thermal), quality and use for which water is abstracted. In January 2017, the water abstraction charge was extended to water used for irrigation, fish farming and rice production. Rates are generally higher for water used for industry and agriculture.
The landfill tax on non-hazardous waste was introduced in 2013 at a rate of HUF 3 000 (or EUR 10) per tonne of waste. It is to be progressively raised to EUR 40/t by 2016. By 2014, the rate had increased to EUR 20/t. Non-hazardous municipal solid waste, construction and demolition waste, hazardous waste and sewage sludge are all charged at the same rate. Waste from recovery operations benefits from a 50% discount (Chapter 4. ).
The environmental product charges are paid by the economic entity that places products on the market, with rates based on mass (in kilograms) of the product. Products subject to charges include batteries, packaging products, electric appliances and electronic equipment, tyres, commercial printing paper, some plastic and chemical products, and paper stationery. Several deductions and exemptions apply (Chapter 4. ).
Some of these levies, such as the water-related ones, have quite a sophisticated design. However, their impact has been generally limited in Hungary. Rates are relatively low and not systematically adjusted, and the exemptions and rebates may hinder their effectiveness. The discount granted to operators that install pollution abatement equipment is not in line with the polluter pays principle. Overall, these levies have been used mainly as a revenue source, rather than as incentives to reduce pollution and use resources more efficiently.
3.4. Removing potentially perverse incentives
As do other countries, Hungary provides several subsidies that could harm the environment. These subsidies, in the form of direct support or preferential tax treatment, exist primarily in the energy, transport, agriculture and fishing sectors. As part of the European Union, Hungary’s support to agriculture and fisheries follows the EU frameworks; it is largely decoupled from production or input use. To receive support, farmers also need to comply with environmental regulations and best agricultural practices. However, farmers benefit from fuel subsidies. In the energy and transport sectors, most subsidies are provided implicitly through tax reductions, as well as regulated electricity and gas prices.
In general, such subsidies contravene the polluter-pays and user-pays principles. They distort competition, lock in inefficient technology, lead to inefficient allocation of resources and weigh on public finances. As recommended to other OECD member countries, Hungary should establish a process for the systematic review of environmentally harmful subsidies. In addition, it should consider introducing a mechanism to screen new subsidy proposals (and subsidy removals) against their potential environmental impact. This would improve the transparency of the tax and public expenditure system. It could be the basis for subsequent reforms of subsidies and special tax treatment that are not justified on economic, social and environmental grounds.
3.4.1. Fossil fuels subsidies and subsidies for energy use
Hungary’s level of support for fossil fuel consumption is in line with the OECD average. This can be seen in Figure 3.7, which expresses total consumer support for fossil fuels as a share of the revenue from energy-related taxes. Total revenue foregone has declined to around HUF 80 billion annually since 2012 or about 10% of the revenue collected through taxes on energy products (OECD, 2016c).
Several measures support the consumption of fossil fuels. A reduced value-added tax (VAT) rate applies on sales of district heat, which is nearly entirely produced using fossil fuels. Up to 70% of the excise tax for diesel used off-road for agriculture is refunded. Commercial hauliers receive a lower tax rate on diesel. The government also pays an explicit subsidy to public heat suppliers. They, in turn, pass the subsidy to final consumers via heat bills, with a view to reducing final prices paid by households and improving energy affordability (Box 3.3). The subsidy is paid on a per household basis, with no regard for composition of households.
In addition, to address increasing energy affordability risks (Box 3.3), the government mandated several price cuts for electricity, gas and heat in favour of households in 2013. These cuts are partly compensated by higher prices for industrial users. As a result, pre-tax prices of electricity, natural gas and heat for residential end-users are set at levels below costs and are lower than prices in neighbouring EU countries.
Energy affordability, defined as a household’s ability to pay for necessary levels of energy use, has been a rising concern in Hungary. The number of individuals with debts owed to electricity, gas and district heating service providers has doubled since the early 2000s (Ministry of Public Administration and Justice, 2011). Between 48% and 60% of population in Hungary have arrears in accounts (Pye and Dobbins, 2015). Nearly 30% of households spend more than 10% of their income on heating fuels and electricity. Further, nearly 25% of households fall under the poverty line (defined as 60% of the median income) due to their energy bills, among the highest shares in the OECD. Overall, more than 20% of Hungarian households spend more than 10% of their income on energy and fall under the poverty line after expenditure on energy (Figure 3.8).
Energy affordability is a common issue in Central and Eastern European countries. The economic and political changes of the early 1990s led to liberalisation of energy markets, rising energy prices and reduced household incomes. Energy affordability risks seem to be more acute in Hungary (Figure 3.8), where they particularly affect some vulnerable population groups such as the Roma people and elderly people in urban areas (Tirado Herrero and Ürge-Vorsatz, 2010). Inadequate levels of electricity and heating use may compromise health and normal activity patterns (Flues and Van Dender, 2017). The use of solid fuels, including waste, for heating and cooking is widespread, with severe air pollution and health consequences (Chapter 1. ).
The low efficiency of residential housing built before 1990 is also a driver of energy affordability risks. More than three-quarters of the dwellings connected to district heating are prefabricated buildings in suburban areas, which host low-income families or individuals, often elderly. These buildings have low thermal efficiency, are often inefficiently overheated and do not usually allow for individual heat metering. Instead, the heat supplied to the building is billed to individual apartments in proportion to their size, which leads to unnecessarily high heating bills (Tirado Herrero and Ürge-Vorsatz, 2012).
This type of price regulation represents a barrier to entry in the highly-concentrated energy market, as well as for companies using renewables to provide power and heat (IEA, 2017). Below-cost end-use prices have resulted in financial losses for energy providers and lower returns on investment in the energy sector (EC, 2017a). The energy price regulation and the subsidies for heat consumption undermine the government’s efforts to improve energy efficiency. They contravene the recommendations of the National Energy Strategy to help households use energy more efficiently rather than offering them lower energy prices. They also conflict with the recommendation of the 2008 OECD Environmental Performance Review to “ensure that incentives for energy efficiency provided by relatively high energy prices are not undermined by unjustified exemptions and subsidies”. In addition, the energy price regulation and the subsidies for heat consumption are not an effective way of fighting the rising energy affordability concerns (Box 3.3). Support to household energy bills locks households into fuel poverty, as artificially low prices do not provide any incentives to save energy or improve energy efficiency. This type of support does not target the people most in need: price cuts benefit all users, including well-off households. Subsidies to heat consumption mostly benefit people living in urban areas, where the natural gas and district heating networks are developed (Tirado Herrero and Ürge-Vorsatz, 2012).
The government should introduce market-based energy prices and give responsibility for regulating prices to the sector regulator, using clear, competition-friendly pricing principles. As the 2016 OECD Economic Survey indicated, public service obligations should be met through explicit and transparent compensation to providers. In addition, energy providers should be given appropriate incentives to promote energy efficiency in end-users. Low-income households should be compensated through social benefits that are not linked to energy consumption, such as income-tested cash transfers. These can be associated with existing protection for registered vulnerable customers.11 Such customers, for example, can pay energy bills in instalments, receive extended payment deadlines or benefit from pre-payment metering devices (Pye and Dobbins, 2015). The government could use money saved from removal of the heat subsidy, or additional revenue from increased fuel taxes, for this purpose. In this way, it could reduce energy affordability risks more effectively (Flues and Van Dender, 2017).
3.4.2. Tax treatment of company cars and commuting expenses
More than 40% of all registered cars are company cars in Hungary, among the highest shares in the OECD; these cars tend to be bigger and more CO2-intensive (Harding, 2014b). This is partly because the benefits from personal use of company cars are not taxed. Consequently, the tax treatment of employees’ compensation in the form of a company car is more favourable than that of cash wage income (Harding, 2014b). According to an OECD study of 25 OECD member countries, most countries provide favourable tax treatments of company car benefits. However, Hungary is one of the few countries (together with Portugal and Mexico) that do not tax these benefits at all. A company car tax based on emission levels of the vehicle does apply at the company level instead. This provides an incentive to businesses to choose less emitting vehicles for their company car fleets.
This tax treatment results in an estimated annual subsidy of more than EUR 2 100 per year, one of the highest among the OECD member countries surveyed. Therefore, it is attractive for employees to be paid part of their salary in the form of company cars. In addition, the fuel costs paid by employers do not increase the employee’s taxable income. As a result, there is no incentive for employees to limit the use of company cars. In 2012, this favourable tax treatment led to revenue forgone in the range of EUR 164 to EUR 255 million, depending on the assumption (Harding, 2014b). This corresponds to about 40% to 60% of the tax revenue from vehicle-related taxes, in the same year.
Employees cannot deduct expenses related to commuting between home and work from their taxable income. Public transport expenses paid by employers are considered as taxable income for employees only if commuting occurs within the administrative area of the workplace. Otherwise, they are exempt. This system is neutral with respect to driving in cities and does not encourage long driving distances that can trigger additional peak-hour traffic. On the other hand, it encourages the use of long-distance public transport. However, free or subsidised parking spaces provided on the employer’s premises are not considered to be taxable income for employees. Given the increasing financial cost of parking, this can be a benefit of substantial value. Specifically, it decreases the cost of driving to work relative to other forms of transport. In so doing, it distorts decisions about the form of commuting (Harding, 2014b).
In addition to weighing on the public budget, the favourable tax treatment of company cars and parking lots tends to encourage private car use and long-distance commuting. It can result in increasing fuel consumption, emissions of GHGs and local air pollutants, noise, congestion and risk of accidents (Roy, 2014). This policy runs against Hungary’s objectives of climate mitigation and air quality improvement in major cities. Hungary should, therefore, reconsider the taxation system of company cars, commuting expenses and parking spaces.
3.5. Investing in the environment to promote green growth
3.5.1. Overview of public expenditure for environmental protection
Public environmental expenditure (current expenditure and investment) has considerably increased since 2000, at both the central and local levels. In 2015, it amounted to 1.2% of GDP and 2.5% of total government expenditure, twice as much as in the mid-2000s (Figure 3.9). The increased expenditure in 2013-15 reflects accelerated spending of the EU funds allocated for 2007-13, which had to be spent by 2015.
As in many other OECD member countries, local governments have major responsibilities in providing environment-related infrastructure and services. On average, local governments spent 1.6 times as much as the central government for environment-related issues in 2000-15 (Figure 3.9). Expenditure has increased in all environmental domains. In Hungary, as in many other countries, it mostly targets wastewater and waste management, also thanks to the use of EU funds (see below).
However, local authorities generally lack financial resources and are heavily indebted. They largely rely on EU funds for their capital expenditure. Despite the technical assistance provided by the central government, smaller local authorities continue to lack human resources and adequate skills to plan and manage large, complex infrastructure projects.
Despite more investment and tangible progress in expanding environment-related infrastructure such as wastewater treatment, investment needs remain high. The quality of infrastructure is perceived to be low relative to local expectations. Firms surveyed continue to report inadequate infrastructure as the most important barrier to doing business (World Economic Forum, 2015). More innovative approaches could be adopted to finance infrastructure and involve the private sector. For example, public-private partnerships, which are little developed in Hungary, could lead to higher investment efficiency (OECD, 2015b). Also, user fees for energy and water supply, wastewater discharges and waste management have been either frozen or cut in recent years. These fees need to be revised to better cover the costs of these services. This would also help Hungary reduce its reliance on EU funds for financing environment-related investment.
European Structural and Investment Funds
Hungary has benefited from considerable financial support from the European Union in the framework of the EU cohesion, rural development and fishery policies. These funds have represented a large share of public investment, especially in environment-related infrastructure.12
Over 2007-13, Hungary received support of EUR 21 billion from the Cohesion Fund and the European Regional Development Fund. This represented on average 3% of annual GDP, equivalent to 57% of government capital expenditure in the period. Investment in transport received the largest share of the allocated funds (31%), followed by environmental infrastructure (20%). While most of the transport-related investment focused on the road network, it also helped extend and improve the urban transport network in Budapest and Szeged. Environment-related investment focused on the water sector and, to a lesser extent, waste management, with the aim of ensuring compliance with the related EU directives. Nearly 480 000 people were connected to new or upgraded wastewater treatment facilities because of these investments (Applica et al., 2016).
Hungary will receive EUR 21.5 billion under the EU Cohesion Policy for 2014-20, as well as EUR 3.45 billion for rural development and EUR 39.1 million for the fisheries sector. This is equivalent to 3% of annual average GDP over 2014-17 and nearly 40% of expected national public investment (EC, 2017a). The largest Operational Programme (OP) is Economic Development and Innovation OP with an allocation of EUR 7.73 billion of the EU Cohesion Policy fund (EC, 2017b).13
In 2014-20, EUR 3.22 billion, or nearly 14% of the total allocation under the Cohesion Policy, is to be allocated to environmental investment. It will be spent through the dedicated Environment and Energy Efficiency Operational Programme (EEEOP). The planned investment focuses on flood protection and climate adaptation; infrastructure in the water, wastewater and waste sectors; improved nature protection; and increased energy efficiency (Figure 3.10).14 In addition, the Rural Development Programme (RDP) allocates 15% of its total to agri-environmental-climate measures, and finances water saving investments (EC, 2017b).15 Disbursement of EU Funds over 2014-20 is conditional on fulfilling certain ex ante requirements. These include co-ordinating environmental investments with water basin management plans or developing the transport plan (EC, 2017a).
EU-funded investment programmes have been proceeding at a relatively fast pace. As of mid-2017, Hungary had committed more than 60% of the total available resources for 2014-20 to selected projects compared to the EU average of 36%. It had spent 7% of total available resources on completed projects compared to 5% in the European Union as a whole. Implementation of EEEOP has been somewhat slower. It has allocated 82% of funds to projects, but spent 2% of available resources on completed projects (EC, 2017c). As indicated by OECD (2016a), Hungary should increase financing for public infrastructure investment to complement the EU funds and promote agglomeration effects in high growth areas. It should use these funds more effectively to invest in environment-related infrastructure, improve environmental performance and comply with EU environmental acquis, especially in the water, waste, renewable energy and energy efficiency sectors (EC, 2017a, 2017b).
3.5.2. Business investment
Hungary’s business environment is not conducive to investment. Businesses face a higher administrative burden than on average in the European Union (OECD, 2015c). Frequent and unpredictable changes to regulations worsen investor perceptions. Despite legal requirements, proposed new legislation and regulations are not systematically subject to ex ante impact assessments. Little time is allowed for stakeholder consultation (EC, 2017a).
Environmental expenditure from businesses (large and small) has declined since the mid-2000s, especially in terms of investment (Figure 3.11). Between 2013 and 2014, however, businesses did increase investment in pollution prevention and reduction by 34%, reaching EUR 564 million. While integrated environmental investment increased, more than 80% of businesses focused on direct end-of-pipe environmental investments. Such investments do not modify manufacturing processes (EIO, 2016). Nearly half of business investment focuses on wastewater treatment (Figure 3.11).
According to a 2015 Eurobarometer survey, around 59% of Hungary’s small and medium-sized enterprises (SMEs) have invested up to 5% of their annual turnover in resource efficiency actions. This is above the EU-28 average of 50%.16 In line with EU averages, 59% of Hungary’s SMEs took measures to save energy and 44% acted to save water. These actions helped reduce production costs in half of Hungary’s SMEs (EC, 2017b).
The public sector remains the main driver of environment-related investment in contrast to trends in more advanced EU countries. This indicates that the current mix of market incentives (EU ETS carbon price, fuel taxes, pollution and resource use taxes) and tax credits for energy efficiency (Section 3.5.4) and environmental projects, have not stimulated investment effectively. Like public investment, business investment largely relies on EU funding. Businesses have an incentive to postpone investment to wait for funding opportunities. There is, therefore, a risk that EU funds are used also for investment that would be conducted without public support, rather than being used on additional, more productive and growth-inducing investment (EC, 2017a).
3.5.3. Water investment
Investment in water supply and wastewater networks has increased in the last decade, driven by EU funds. As a result, Hungary has increased access to piped water and sewerage networks. However, additional significant national public and private investments are needed to extend access to good quality water, as well as to ensure adequate maintenance of infrastructure put in place by EU funds (ECA, 2017). While the drinking water supply network is complete, about a quarter of the population is served by drinking water that does not meet EU requirements for quality. The wastewater network, which covers 77% of the population, bypasses many small settlements, leaving wide regional disparities (Chapter 1. ). Infrastructure is ageing, and its average condition is slowly declining (World Bank, 2015).
Tariffs for water and wastewater services are low in Hungary in international comparison (Figure 3.12). They cover 89% of operating costs, although with wide variability across utilities. On average, the cost recovery ratio is less than in other countries in the Danube region (96%) and in the European Union as a whole (110%). Water tariffs are, therefore, not sufficient to fund asset renewal. Investment needs are mainly financed by government transfers and EU funds. Government subsidies are available to support the tariffs of municipalities where service costs are above a certain threshold. Such a mechanism does not encourage utilities to improve their efficiency (World Bank, 2015).
Since water and sewerage tariffs were frozen in 2012 and were decreased by law in 2013, revenues collected by utilities have been decreasing. As a result, utilities have even lower financial reserves than before, and maintenance has become problematic for many operators. In addition, the future maintenance costs of recent development projects have not yet been included in the price of services (World Bank, 2015). Investment needed to improve water quality in Hungary up to 2020 is estimated at EUR 415 to EUR 460 million. This is more than double the EU fund allocation to water supply networks for 2014-20 (ECA, 2017). Hungary should consider revising water supply and sanitation tariffs to ensure better recovery of costs and reduce reliance on EU funds to finance water infrastructure in the long term.
3.5.4. Investing in renewable energy and energy efficiency
Investment in renewable energy sources and energy efficiency improvements are at the core of Hungary’s strategy to reduce GHG emissions (Chapter 1. ). Several financing schemes are in place. These are either state-financed, using revenue from sales of carbon emission allowances and from the state budget, or financed with EU funds.
Half of the revenue from EU ETS allowance auctions is divided equally between the Economy Greening Scheme (EGS) under the Ministry of National Economy and the Green Economy Financing Scheme (GEFS) under the Ministry of National Development (IEA, 2017). GEFS can support a broad set of measures to reduce GHG emissions or adapt to climate change. It focuses on renewable energy generation and energy efficiency projects, especially in the residential sector. Revenue from selling emission units under the Kyoto Protocol has fed the Green Investment Scheme, which focuses on energy efficiency measures in the building sector. About one-quarter of the total EU cohesion and structural funds allocation for 2014-20 is planned for renewable energy and energy efficiency measures through EEEOP and other programmes (IEA, 2017). However, the budgets of these different programmes have frequently changed, which has hampered stability for investment decisions (IEA, 2017). Regular monitoring of activities of environment- and energy-related financing schemes and programmes is needed to keep them in line with policy priorities, as well as transparent and cost-effective.
Renewable energy sources
Investment in renewables has increased in the last decade, resulting in significant growth of their use. Hungary is likely to exceed its target of 14.65% renewable energy in gross final consumption for 2020 set by the 2011 National Renewable Energy Action Plan (NREAP), as well as the respective EU target of 13%. In 2015, renewables already accounted for 14.5% of gross final energy consumption. The NREAP estimates that the planned measures to achieve this target will cost about EUR 2 450 million over 2010-20.
More use of biomass for heat and power production has been the main driver of growth in renewables, although this growth has levelled off in recent years (Chapter 1. ). As the potential for biomass use is reaching its limit, Hungary should focus on other energy sources and remove barriers to their development. Solar power has been a fast- growing sector, but a high environmental product fee on solar panels hampered future growth. Its rate was halved in 2018. Given Hungary’s geographical context and the available wind potential, the development of wind energy is subject to challenging technical requirements. For example, wind farms must be installed far from settlements and capacity shall not exceed 2 MW. Geothermal heat and power is still underdeveloped, although the country has the third largest installed capacity of geothermal district heating in the European Union (EGEC, 2017).
In addition to various forms of financial assistance for capital investment, Hungary has promoted renewable energy through feed-in tariffs. The system in place until 2016 had not always promoted scale effects in the provision of renewable energy (OECD, 2016a). A new renewable energy support scheme (METÁR) took effect in 2017 (Box 3.4). It will be financed by a surcharge to be paid by final non-household customers. IEA (2017) considers that the new system represents significant progress following several years of reform delays. In addition, Hungary is preparing network development plans to enable the connection of increasing renewable generation (IEA, 2017). The planned extension of the cross-border lines with the Slovak Republic and Slovenia will facilitate renewable generated electricity flows within the Central Eastern European region (IEA, 2017).
There is a potential misalignment of the energy price regulation and the corporate income tax code with Hungary’s promotion of investment in renewable electricity generation. As discussed in Section 3.4.1, energy prices for households have been repeatedly cut to levels below costs. This practice lowers returns on investment in the energy sector. As such, it is a barrier to entry in the energy market, including for companies using renewables to provide power and heat (IEA, 2017). In addition, while variable costs of new investment are immediately expensed from the corporate income tax base, capital costs need to be depreciated over time. This feature of the tax code inadvertently discourages investment in carbon-neutral electricity generation technologies, which feature relatively high capital and low variable costs compared to their carbon-intensive counterparts (OECD, 2017c).
A biofuel blending obligation is Hungary’s main measure to promote biofuels in transport. Fuel suppliers are required to blend at least 4.9% of biofuels in petrol and diesel until 2019. This requirement will be raised to 6.4% in 2019-20. The old age of the car fleet makes it technically difficult to further increase the share of biofuels (IEA, 2017). Although the share of renewable fuels in transport reached 7.4% in 2016, the country is unlikely to meet its EU target of 10% by 2020 (Chapter 1. ).
According to METÁR, small renewable energy plants (with capacity below 0.5 MW) will continue enjoying the mandatory offtake regime and feed-in tariffs of the old system. For generating capacities between 0.5 MW and 1 MW, a premium will be paid above the reference price. Larger capacities (over 1 MW) and wind installations will require competitive bidding. For biomass and biogas generating capacities, a so-called brown premium will be introduced to keep biomass-firing competitive in relation to fossil fuels.
The system was launched under a transitional regime, pending approval of the state aid scheme by the European Commission. As of the end of 2017, more than 200 METÁR applications were received. They were all solar power plants, mainly below 0.5 MW, with a total capacity of over 100 MW. No tender for larger plants has been launched.
Energy efficiency
There is scope to improve energy efficiency. The energy intensity of the economy has considerably decreased since 2000 and is below the OECD average, but it is still above the average of OECD European countries (Chapter 1. ). In its fourth National Energy Efficiency Action Plan, adopted in 2015, Hungary set an energy-saving target of 73 petajoules by 2020. Over half of these savings are expected to be achieved in the residential sector. The IEA (2017) believes this target could be more ambitious.
In addition to energy efficiency support via GEFS, EEEOP and other programmes, the main policies for industrial energy efficiency are tax credits and energy auditing requirements. Companies can benefit from corporate tax credits for investment to comply with energy efficiency targets. There is a risk that such tax discounts are given for investment that would occur without support; tax credits would be more cost-effective if they were granted for going beyond the targets. Hungary should encourage SMEs to perform energy audits.
Nearly four in five Hungarian homes and public buildings fail to meet modern energy and thermal requirements. The energy efficiency of buildings built between 1946 and 1980 is particularly poor (MND, 2015). Heat generation accounts for more than 80% of household energy consumption. Coal and wood used for household heating and cooking are a considerable source of emissions of GHGs and air pollutants. Heating with waste is prohibited, but often occurs in energy-poor households.
Hungary has acted to address the relatively poor energy performance of the building stock through public funding, local tax incentives, awareness-raising and energy certification of buildings. The Warmth of Home programme 2014-17 aimed to reduce household energy costs and address energy poverty. Among other things, the programme helped replace outdated and inefficient household boilers, a measure that also contributes to fewer air emissions. GEFS and the Green Investment Scheme provided large funding for modernisation of the building stock. According to IEA (2017), these investments have been effective in reducing the energy intensity of residential sectors, especially space heating needs.
Despite progress, there is still large potential for improving the energy performance of buildings. Authorities should consider strengthening the energy efficiency standards for new buildings. The government could also demonstrate leadership by committing to improve energy efficiency in public buildings.
Additional measures may be needed to encourage investment, and incentives for energy efficiency in buildings should be better aligned. On the one hand, the government provides financial support and incentives to improve energy efficiency, including for replacement of old boilers with cleaner and more efficient ones. On the other, it has cut retail energy prices at below-cost levels and subsidises heat consumption (Section 3.4.1). As IEA (2017) recommended, the government should reconsider such pricing policy. Specifically, it should ensure that retail prices for residential customers reflect the full cost of energy supply and delivery, including environmental costs, and provide the correct signal to consumers (IEA, 2017). At the same time, it should introduce well-targeted mechanisms to provide low-income households and vulnerable population groups with the means to switch from burning coal or waste towards cleaner fuels.
As several energy efficiency measures are only starting to be systematically monitored via a National Energy Efficiency Advisors Network in government offices, it is difficult to evaluate their cost-effectiveness. A comprehensive package of policy measures is needed to complement the EU ETS carbon pricing. This should address non-pricing barriers that block investment in low-carbon energy sources and adoption of energy-efficient technology in industry, transport and buildings.
3.5.5. Investing in low-carbon transport modes
Energy consumption and GHG emissions from the transport sector have grown quickly. These are projected to continue to rise as the vehicle fleet expands with rising income levels (Chapter 1. ). Transport-related GHG emissions have been stimulated in part by significant investment in road infrastructure and insufficient support for less carbon-intensive modes of transport. The composition of the vehicle fleet, which is among the oldest and carbon-intensive in Europe (Section 3.3.4), also increases emissions.
Hungary developed a Transport Energy Efficiency Improvement Action Plan. This plan foresees developing bicycle lanes, improving energy efficiency in rail transport (railway electrification and network modernisation) and improving facilities to combine different ways of commuting. It also foresees introducing road taxes, a bus-replacement programme and eco-driving training. These initiatives, if fully implemented, could help reduce emissions (IEA, 2017).
Hungary should ensure investment priorities for transport infrastructure and related financing are consistent with long-term climate and environmental objectives. While additional investments in road infrastructure will be needed to meet increasing demand, further measures to reduce emissions and improve energy efficiency in transport should be a priority.
Funding of national and local infrastructure should aim to recover the full costs of the investment, maintenance, use, and associated environmental and social impacts. This would help ensure competitive neutrality between transport modes. Hungary has put in place a distance-based electronic road toll system for heavy goods vehicles and a time-based electronic toll system for passenger and small commercial vehicles (so-called e-Vignette) (Box 3.1). As in many other EU countries, road tolls do not recover full infrastructure costs, especially when environmental and social costs are included. This is mainly due to a lack of reliable data and guidelines to calculate infrastructure costs, as well as the complexity of recovering costs in a revenue-neutral way. Only the tolls for heavy goods vehicles take account of the vehicles’ emission category (Section 3.3.4).
Electric vehicles
The National Energy Strategy sets a target of 9% of energy consumption in transport to be electric or hydrogen-based by 2030. Uptake of EVs in Hungary has been growing fast, thanks to several incentives. However, it remains limited. There were around 3 200 EVs and hybrid vehicles at the end of 2017 (less than 1% of the car fleet), compared to the government’s target of 30 000 environmentally friendly vehicles by 2020. The main barriers to greater adoption have been the high capital costs of the vehicles and a lack of widespread public charging infrastructure. As of mid-2017, Hungary had about 170 charging stations compared to the government target of 3 000 by 2020.
In line with these targets, the government launched the E-mobility Programme (the Jedlik Ányos Plan) in 2015. The programme provides incentives for EVs and announces plans to increase the number of charging stations. Several incentives for EVs have already been introduced, including “green licence plates” allowing free parking for EVs and exemptions from the registration tax and the motor vehicle duty. In addition, the government subsidises up to 21% of the purchasing price of new EVs. All these measures encourage users to switch to EVs, complementing the existing fuel efficiency and emissions standards. However, they tend to benefit mostly well-off people who could probably afford to buy an EV without public support. Other measures would likely encourage the switch to newer and cleaner cars, including EVs, in a more cost-effective and equitable way. These include adjusting the current vehicle tax and toll systems to take account of emission standards (Box 3.1) and removing the tax depreciation for old vehicles.
The E-mobility Programme also suggests using taxi and bus lanes for EVs, introducing road toll discounts, requiring public bodies to purchase EVs for a proportion of their vehicle fleets, and investing public funds in charging stations. In addition, it foresees amending the Electricity Act to enable charging equipment operators to sell their electricity, as well as simplifying the administrative procedures for the installation of charging points. Further measures could be considered, including supporting e-car sharing systems and the use of EVs for public transport.
Overall, Hungary should review and clarify the investment needs and financing sources for fully implementing the E-mobility Programme, as well as its impact on the electricity generation and distribution systems. It should assess the cost-effectiveness and feasibility of the programme against other options to reduce GHG emissions from transport.
3.6. Promoting eco-innovation and markets for environmental goods and services
3.6.1. Overview of Hungary’s innovation system and performance
Hungarian authorities have increasingly emphasised innovation in recent years. They have made considerable efforts to improve the country’s innovation system, which lags behind many OECD member countries. Hungary has a low rate of both private and public R&D investment (OECD, 2016d). At 1.38% of GDP in 2015, Hungary’s gross domestic expenditure on R&D was still significantly below the OECD average. It also remains below the national goal of 1.8% of GDP by 2020 (as set by the 2030 National Reform Programme). More resources should be devoted to higher education to improve the skill base, as relatively few adults have tertiary education (OECD, 2016a).
While government R&D spending declined in real terms between 2008 and 2015, R&D spending in the business sector has increased since the mid-2000s. Business innovation capacity is mostly concentrated in foreign-owned companies and some large domestic companies. SMEs tend not to be competitive. Most have not integrated production chains of foreign companies into their operations effectively, and show a low interest in innovation. Indeed, SMEs account for less than 60% of the R&D undertaken by businesses (OECD, 2016d).17 Most enterprises introduced new products or processes by purchasing machinery, equipment and software rather than through R&D (HCSO, 2016). The patenting performance is low by OECD standards, which is also due to lack of co-operation between industry and public research. The commercialisation of public research results could be improved (OECD, 2016d).
In 2014, Hungary established the National Research, Development and Innovation Fund (NKFI), merging and streamlining two pre-existing funds to improve efficiency. Public support for business R&D was above the OECD average in 2014, with a roughly equal mix of tax incentives and direct government funding (OECD, 2017d). R&D financing, especially in SMEs, depends heavily on EU funds and other external sources (EC, 2017a).
The new Economic Development and Innovation Operative Programme, which defines development priorities for 2014-20, recognises the need for greater public investment in research infrastructure. The National Research and Development and Innovation Strategy 2013-20, along with the National Smart Specialisation Strategy, indicate the priority sectors of health care, environment, clean energy, education and transport/logistics.
In 2015, the government established the National Research, Development and Technology Innovation Office. This move aimed to overcome institutional fragmentation, which had long been considered a barrier to better innovation performance (OECD, 2016d). However, co-ordination is still not strong enough to ensure funds are used efficiently and in a complementary way to avoid duplication. The use of funds is not systematically monitored or evaluated (EC, 2017a).
3.6.2. Focus on eco-innovation
Hungary has made progress in targeting eco-innovation in its strategic innovation framework. In 2011, the country adopted its first National Environmental Technology Strategy 2011-20, which sets objectives, policy measures and indicators to monitor progress. In 2014, Hungary enacted legislation to ensure that projects receiving NKFI funds contribute to solving social, environmental or economic challenges (OECD, 2016d). A specific energy technology strategy is under development. A new Research, Development and Innovation Action Plan for the energy sector is expected in 2018.
Eco-innovation performance does not match the increased policy focus. As for other research fields, the government is the main source of funding for environmental research. Hungary spends 4.6% of its government R&D budget on environment- and energy-related research. This is among the bottom half of OECD member countries (Figure 3.13). Environment-related R&D accounted for 2.6% of government R&D outlays in 2014-15, down from 3.5% in 2008. Energy efficiency and renewables have accounted for over 98% of the government energy R&D budget since 2008. This is the highest share in the OECD, although overall funding for energy R&D remains limited to around 2% of public R&D spending (Figure 3.13).
With reduced public R&D funding, patent applications related to environmental management technologies have declined. Applications related to some climate change mitigation technologies increased in the first half of the 2000s, but have been slowing down since the economic crisis of 2008/09 (Figure 3.14). These trends contrast with those observed in many other countries, where patenting in environment- and climate-related technologies has grown faster than in all technology domains. This has been partly driven by global climate mitigation commitments (Figure 3.14; OECD, 2017b). Environment- and climate-related technologies made up about 7% of all patent applications in 2012-14. This is among the lowest shares in the OECD and below the shares in the other Visegrád Four countries. Hungary has not yet developed a specialisation and a competitive advantage in environmental technology (OECD, 2017b, 2016e).18 There is no Hungarian verified technology in the EU Environmental Technology Verification system (EIO, 2016).
Overall, the policy mix for innovation and eco-innovation is biased towards supply side measures such as R&D funding. This is common to most (if not all) OECD member countries. More efforts are needed on demand-side measures such as green public procurement and aligning market incentives with environmental objectives. For example, regulated electricity and gas prices for households (Section 3.4.1) do not reflect costs. This results in financial losses for service providers and fewer incentives for greener investments (EC, 2017a). Environmental product fees were extended to photovoltaic panels, which runs counter to the renewable energy goals (EIO, 2016). In addition, most environmentally related taxes are poorly designed or their rates are too low to stimulate eco-design and innovation (Section 3.3). Hungary needs to swiftly adopt and implement its national action plan for green public procurement. This would help stimulate demand for greener products and services, and encourage innovation.
Making progress on innovation and eco-innovation remains challenging. While Hungary streamlined innovation responsibilities, environmental responsibilities remain fragmented across several ministries (Chapter 2. ). This hampers co-ordination and entails relatively high administration and transaction costs. Legislation, including on innovation, has been often changed suddenly, but investors need stability to make decisions. The highest educated people are increasingly leaving the country. The economic efficiency of the environment-related innovation policy and its contribution to improved environmental performance, resource productivity and energy efficiency are not systematically evaluated.
3.6.3. Promoting the green industry
The environmental goods and service sector has grown in Hungary, but seems to be less developed than in most EU countries. Revenue from selling products and services related to waste and wastewater management has increased in real terms since the mid-2000s. In 2014, businesses providing environmental products and services employed about 17 000 people, a slight decline since the mid-2000s (Figure 3.15). About 0.6% of total employment is in the wastewater treatment, waste management and remediation activities, among the highest shares in the OECD. However, these activities generate lower value added than in many other OECD member countries (OECD, 2017b).
Hungary’s SMEs have a lower propensity to produce greener products than the average of EU firms. According to a 2015 Eurobarometer survey, 18% of SMEs in Hungary offer green products and services (the EU average is 26%). Meanwhile, 14% have taken steps to design products that are easier to maintain, repair or reuse (the EU average is 22%). Similarly, 22% of SMEs in Hungary have one or more full-time employee working in a “green job”19 at least some of the time, compared to the EU average of 35% (EC, 2017b).
There are opportunities to make the green industry more competitive, enlarge environmental markets and catch up to other EU countries. For instance, full implementation of the existing EU waste legislation could create more than 13 300 jobs in Hungary and increase the annual turnover of the waste sector by EUR 1.4 billion (EC, 2017b). According to Hungary’s National Renewable Energy Action Plan 2010-20, the implementation of the plan could create more than 50 000 new jobs.
The government acknowledges these opportunities, and plans to develop a strategy to promote green industry in 2018. The strategy would be part of the 2016 re-industrialisation plan (so-called Irinyi Plan). This plan aims to increase the share of manufacturing in GDP from 23.5% to 30% over 2015-20 and to differentiate the manufacturing output that depends on the motor vehicle supply chain.
3.7. Contributing to the global sustainable development agenda
Hungary has a long tradition of international co-operation in the environment field, especially at the regional level to address transboundary issues related to the Danube River Basin. Hungary has an excellent record in signing and ratifying environmental international agreements involving the European Union (EC, 2017b). For instance, it was the first EU member state to ratify the Paris Agreement on climate change.
3.7.1. Mainstreaming environmental considerations into international trade
Hungary’s participation in global value chains is one of the highest in the OECD. This is due to large inflows of foreign direct investment and high integration of foreign-owned companies in the national economy, particularly in the electrical, vehicle and chemicals industries (OECD, 2016a). An export-oriented economy, Hungary’s performance on facilitating trade has improved in the first half of the 2010s. However, it needs to progress further to take advantage of the trade flow increase and the potential for facilitating trade to reduce costs (OECD, 2016e).20
As in all other OECD member countries, the consequences of Hungary’s domestic and trade policies can go – intentionally or unintentionally – beyond the country’s borders. For example, Hungary became a net importer of CO2 emissions in 1998. Consumption-based CO2 emissions from fuel use quickly increased at the turn of the century. In 2000, they were 45% higher than the conventional measure of production-based CO2 emissions (Figure 3.16; Wiebe and Yamano, 2016). Many factors underlie this trend, including reduced reliance on fossil fuels for electricity generation; modernisation of the industrial structure; and an increasing share of imports from CO2-intensive trade partners. Nonetheless, with the delocalisation of industrial production to Hungary, the difference between demand-based and production-based emissions has declined since 2000. Overall, Hungary’s net imports of CO2 emissions are relatively modest compared to most other OECD countries.21
Hungary participates in the free trade agreements involving the European Union. All bilateral trade agreements concluded by the European Union with non-EU member countries include environmental provisions. The European Union regularly monitors the implementation of these provisions in co-operation with its partner countries.
Hungarian authorities have developed strategies to limit the potentially negative international environmental effects of exports. For example, the Hungarian import-export bank (Eximbank) has developed screening and monitoring procedures. These assess the environmental, social and human rights impact of supported projects, in line with the OECD Recommendation on officially supported export credits.22 A project is eligible for export credits if the risks involved are acceptable or if appropriate mitigation measures are put in place. So far, no project has been refused export credit support because of the screening. Hungary’s screening practice does not go beyond the scope defined by the OECD Recommendation.
3.7.2. Mainstreaming environmental considerations into development co-operation
In December 2016, Hungary joined the OECD Development Assistance Committee (DAC). It pledged to fulfil obligations of this membership, including the need to develop systems for evaluating its development co-operation activities.
Hungary has developed its legislative and institutional frameworks to provide more effective development co-operation. Since 2004, when it joined the European Union, Hungary has almost doubled the volume of its official development assistance (ODA). This volume reached nearly USD 160 million in 2016 or 0.13% of the country’s gross national income (GNI). This is in line with the ODA effort of the other Visegrád group countries. However, it is considerably below the average effort of OECD DAC member countries (0.3% in 2015). It also falls below the target of 0.33% of GNI by 2030 common to all member states that have joined the European Union since 2002 (OECD, 2017e). With its good economic and fiscal performance, Hungary has an opportunity to increase ODA volume in line with international goals, notably the 2030 EU target. It should consider increasing its aid programme, particularly its bilateral ODA activities, consistently with this purpose.
Hungary provides most of its ODA via multilateral channels, particularly through the European Union (OECD, 2017e). Its bilateral assistance is concentrated in European and Asian countries. Hungary’s projects focus on building democratic institutions and a market economy, as well as on promoting social, economic and infrastructure development.
The International Development Cooperation Strategy and Strategic Concept for International Humanitarian Aid of Hungary 2014-20 identifies environmental protection and climate change as priorities. Cross-cutting principles, notably gender equality and environmental sustainability, are still to be incorporated into Hungary’s development co-operation strategy and activities in a systematic way (OECD, 2017e). The Ministry of Foreign Affairs and Trade should use the opportunity of the ongoing mid-term review of the strategy to integrate the SDGs and the other cross-country principles into it.
Bilateral and multilateral ODA for global environmental issues such as climate change and biodiversity increased to more than USD 5 million in 2015. This represented nearly 4% of total ODA disbursements. As a rough comparison, the share of committed bilateral aid for the environment was 17% in the Czech Republic, 6% in Poland and 14% in the Slovak Republic. For their part, DAC members committed on average more than 30% towards the environment (OECD, 2017e).23 Hungary supports projects focusing on adaptation to climate change (Figure 3.17), mainly on water management infrastructure and flood management. In addition, the country allocated up to HUF 2 billion (USD 8 million) in 2015 to participate in international climate finance efforts, and pledged half of this to the Green Climate Fund. Hungary should increase the share of ODA devoted to the environment, particularly for bilateral co-operation.
Strategic framework
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Ensure alignment of the National Framework Strategy on Sustainable Development with sectoral strategies; develop a framework for monitoring their implementation and progress towards green growth objectives, based on a targeted set of indicators linking economic activity and social welfare with environmental performance.
Price signals
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Improve the design of environmentally related taxes to reinforce their incentive function: i) take advantage of the low world oil price to permanently raise the tax rates on petrol and diesel to levels that reflect the environmental costs of driving; ii) consider introducing a carbon tax on sectors outside the EU ETS; iii) link vehicle taxes to fuel economy and air emission standards and progressively untie them from the age of vehicles; iv) gradually raise the rates of pollution and resource taxes to align them with the environmental costs of pollution and resource use; v) regularly adjust tax rates for inflation.
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Remove incentives to private car use and long-distance commuting; reform the tax treatment of the personal use of company cars and parking spaces; link road tolls for passenger vehicles to the vehicles’ emission standards; consider introducing congestion charges in major cities.
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Establish a process for systematic review of environmentally harmful subsidies and regularly evaluate proposals for new subsidies and subsidy removals against their potential environmental, social and economic impacts.
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Re-introduce market-based energy prices and gradually phase out the heat subsidy, while compensating vulnerable groups through social benefits that are not linked to energy consumption.
Green investment and innovation
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Increase, better prioritise and enhance the transparency and cost-effectiveness of national public spending on environment-related infrastructure while reducing reliance on EU funds; leverage private funding and revise tariffs for energy and water to ensure better cost recovery.
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Align transport infrastructure investment with long-term environmental objectives; identify investment needs and financing sources for implementing the E-mobility Programme; analyse its impact on electricity generation; compare its cost-effectiveness with other options to reduce GHG emissions from transport.
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Strengthen energy efficiency standards for new buildings; set rules for dividing the costs and benefits of energy efficiency improvements between tenants and landlords; scale up investment in raising energy efficiency of public buildings; develop energy networks to connect additional renewable generation capacity.
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Reduce transaction and administrative costs to facilitate investment decisions in green technology; increase public R&D funding for environment-related innovation and evaluate the efficiency and effectiveness of its allocation; swiftly adopt and implement a national action plan for green public procurement.
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Notes
← 1. The UN adopted the SDGs within the framework of the 2030 Agenda for Sustainable Development in September 2015. They replace and further refine the Millennium Development Goals. The SDGs provide a baseline against which to measure how countries are progressing in achieving sustainable and inclusive growth, eradicating poverty, and protecting ecosystems and human health. These objectives are classified according to 17 goals and 169 targets; some targets are directly linked to environmental protection, while others have only indirect linkages.
← 2. Without adjusting for pollution abatement, GDP growth would be underestimated in countries that divert scarce resources to abating pollution rather than to producing material goods. Conversely, growth would be overestimated in countries that rely on heavily polluting activities to generate GDP growth.
← 3. The 2030 Agenda for Sustainable Development foresees regular national voluntary reviews of progress towards the SDGs. The UN High-Level Political Forum on Sustainable Development conducts the reviews together with the reviewed country and multiple stakeholders.
← 4. In response to a survey for the European Sustainable Development Network, the Secretary General of Hungary’s National Sustainable Development Council stated that Hungary has “lots of good strategies, but when a minister of a government takes a decision, the national sustainable development strategy might have little impact on concrete decisions” (Lepuschitz and Berger, 2014).
← 5. Environmentally related taxes are defined as any compulsory, unrequited payment to general government levied on tax bases deemed to be of environmental relevance. Taxes are unrequited in the sense that benefits provided by government to taxpayers are normally not in proportion to their payments.
← 6. In a best case scenario, revised or new environmentally related taxes could add revenue for EUR 0.65 billion in 2018, rising to EUR 1.21 billion in 2030 (in real 2015 terms). Raising the annual motor vehicle tax would yield EUR 0.46 billion in 2030 (at 2015 prices) or 0.3% of GDP. Introducing a pesticide tax would add revenue for EUR 0.19 billion in 2030 (at 2015 prices) or 0.13% of GDP (EC, 2016).
← 7. Under Hungary’s Mining Act, a 5% royalty is charged on the value derived from non-metallic mineral raw materials obtained from open cast excavations.
← 8. As of January 2017, the standard excise duty on diesel was HUF 110.35/litre. It would be raised to HUF 120.35/litre if the world market price of crude oil is USD 50/barrel or less. The standard excise duty on petrol was HUF 120/litre. It would be raised HUF 125/litre if the world market price of crude oil is USD 50/barrel or less.
← 9. Fuel taxes can help account for local air pollution and other social costs directly or indirectly linked to energy use (e.g. congestion, accident and noise costs in transport). However, other instruments may theoretically be more appropriate. Congestion, noise and accident costs are a function of the amount, location and timing of vehicle traffic. Thus, they are only indirectly linked to fuel use, as greater fuel use generally reflects increased distance driven. The impact on local air pollution also partly depends on the location of vehicle use or emitting facility. In remote or rural regions, for example, higher pollution may have lower health effects than in more populated or urban regions, but a higher impact on natural resources and vegetation (Harding, 2014a). Country-wide, time- and location-specific road pricing would generally be more cost-effective to address congestion, accidents and noise.
← 10. In addition to the free allocations to manufacturing sectors, until 2013, Hungary was eligible for transitional free allocation to the power generation sector. This was conditional upon investing the value of freely allocated allowances in the modernisation of electricity generation.
← 11. According to Hungarian legislation, vulnerable customers are defined as those household customers in social need (indigent) and receiving certain social benefits, as well as customers receiving disability allowances. To be entitled to benefits, vulnerable customers need to renew their application every year.
← 12. In 2014-20, the EU Structural and Investment Funds include: European Regional Development Fund, Cohesion Fund, European Social Fund, European Agricultural Fund for Rural Development, European Maritime and Fisheries Fund and the Youth Employment Initiative.
← 13. There are seven national Operational Programmes and one covering only the more developed central region. They are all funded by the European funds for cohesion, regional development and social development. In addition, there are two specific programmes for rural development and the fishery sector, funded by the EU funds dedicated to these sectors (EC, 2017b).
← 14. EEEOP is expected to help reduce GHG emissions by 1.5 Mt CO2eq. per year. It plans to install 940 MW of renewables and improve energy performance of nearly 52 000 homes. It is expected to give access to improved water supply and wastewater treatment to an additional 340 000 and 800 000 people, respectively. Further, EEEOP plans to install capacity for recycling 60 000 tonnes of solid waste per year and provide flood protection measures to 1.1 million people.
← 15. The RDP finances water-retention measures and irrigation investments with a 5% or 10% minimum potential water savings, provided water metering systems are in place (EC, 2017b).
← 16. The share of SMEs that acted to minimise waste (48%), save materials (49%), recycle by reusing material or waste within the company (18%), and sell their scrap material to another company (20%) are all below the EU28 averages.
← 17. Companies in the pharmaceutical industry, the production of chemicals and chemical products, and the manufacture of road vehicles appear as the most innovative in the manufacturing sector (MNE, 2014).
← 18. The revealed technological advantage index measures the share of an economy’s patents in a specific technology relative to the share of total patents owned. The index is equal to zero when the economy has no patents in a given field; it equals one when the economy’s share in the technology field is equivalent to its share in all fields (no specialisation); and it rises above one when specialisation is observed. The index is based on patents filed at the European Patent Office or the US Patent and Trademark Office that belong to patent families within the Five IP offices, by earliest filing date and inventor’s location.
← 19. The Flash 426 Eurobarometer defines “green job” as one that directly deals with information, technologies or materials that preserve or restore environmental quality. This requires specialised skills, knowledge, training or experience. These could include, for example, verifying compliance with environmental legislation, monitoring resource efficiency within the company, and promoting and selling green products and services.
← 20. Performance on facilitating trade is measured through the OECD Trade Facilitation Indicators such as information availability, streamlining of border procedures, border agency co-operation, involvement of the trade community, and information about fees and charges (OECD, 2016e).
← 21. This means that the share of goods imported and consumed in Hungary – that embed CO2 emissions generated in other countries – is only marginally above the share of goods produced and generating CO2 emissions in Hungary, but exported.
← 22. Recommendation of the Council on Common Approaches for Officially Supported Export Credits and Environmental and Social Due Diligence (The “Common Approaches”), adopted by the OECD Council on 6 April 2016.
← 23. Data are not fully comparable for several reasons, including that Hungary’s data are still partial, they refer to disbursements (and not commitments), and most of Hungary’s ODA is channelled through multilateral organisations, which may not use the funds to support environment-related projects.