Europe Is Finally Admitting Electricity Is Overtaxed

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The leaked European Commission recommendation on electricity taxation landed quietly, but it said something that European energy policy has avoided stating plainly for decades. Electricity is still taxed and loaded with levies as if it were a polluting end product rather than the clean energy carrier Europe increasingly depends on for economic competitiveness, energy security, and decarbonisation. The document does not invent a new idea. It acknowledges an old distortion that has become more damaging as electrification has shifted from aspiration to necessity.

The recommendation encourages Member States to reduce VAT and excise duties on electricity using existing legal flexibilities, to remove non energy levies from electricity bills and fund them through general budgets, and to ensure electricity is taxed less than fossil fuels. It links electricity affordability directly to investment certainty and long term industrial competitiveness. This is a meaningful change in tone. Electricity is no longer framed primarily as a consumer good that needs to be taxed and managed, but as critical infrastructure that underpins Europe’s economic future.

Understanding why this matters requires understanding the spark gap. The spark gap is the ratio between retail electricity prices and retail gas prices, usually expressed per kWh. Across much of Europe in 2024 and 2025, households and businesses faced electricity prices of $0.25 to $0.35 per kWh, while gas prices often sat between $0.07 and $0.10 per kWhₜₕ. That produces a spark gap of roughly 2.5 to 3.5. For most direct electrification cases, that gap overwhelms efficiency gains and blocks investment decisions.

In this article, kWh and MWh refer to electricity, while kWhₜₕ and MWhₜₕ refer to delivered heat, to distinguish between electrical energy inputs and thermal energy outputs. Exergy—the ability to do work—matters, electricity has it, gas doesn’t. While both are forms of energy, a MWh of electricity can deliver a MWhₜₕ, but a MWhₜₕ of gas can’t deliver a MWh of work, but has to be converted to electricity first, losing 50% to 60% of the implied energy. Europe choosing units of electricity to measure things that aren’t electricity, such as hydrogen, is a major conceptual flaw that they have perpetuated upon their economy.

The spark gap is not a natural outcome of markets. It is largely a policy artefact. Electricity carries network charges, policy levies, and VAT that can account for 50% or more of the retail price. Gas bills, especially for buildings, have historically carried lower taxes and fewer levies. Carbon pricing under the EU Emissions Trading System has been embedded in electricity generation for years, while most retail gas use in buildings has faced no carbon price at all. The result is a persistent price signal that discourages electrification even where it would reduce emissions, imports, and long term costs.

Reducing VAT and removing levies from electricity bills helps, but it does not solve the problem on its own. If VAT applies to the full electricity bill, cutting VAT from 21% to 10% reduces the VAT-inclusive price by about 9% (because the total price multiplier falls from 1.21 to 1.10). Removing policy levies can reduce bills further, but in many countries those levies are already declining or temporary. When electricity is three times the price of gas, a 10% cut is helpful but rarely decisive.

This is why the spark gap has proven so persistent. Electricity prices are burdened by structural costs that have little to do with marginal energy production. Gas prices for end users, particularly in buildings, have avoided equivalent charges. As long as that imbalance remains, electrification struggles outside of cases with strong efficiency multipliers.

Carbon pricing is often presented as the solution, but its impact on the spark gap has been limited so far. Natural gas combustion emits roughly 0.20 tons of CO2 per MWhₜₕ of gas input. At a carbon price of $75 per ton, that adds about $15 per MWh or 1.5 cents per kWhₜₕ to gas. At $100 per ton, the add on rises to about 2 cents per kWhₜₕ. These are meaningful numbers, but they move gas prices from $0.08 to $0.10 per kWhₜₕ, not to parity with electricity.

Electricity has already absorbed carbon costs upstream for years because gas and coal generation set marginal prices in many markets. Carbon pricing penalises gas, but it does not reward electricity enough to close a multi fold price gap. This asymmetry has been one of the quiet failures of European energy pricing. Carbon pricing exists, but it has not been aligned with retail taxation in a way that accelerates electrification.

This is where ETS2 matters. From 2027 carbon pricing will apply to fuels used in buildings and road transport. Under a full ETS2 regime, all gas end uses would face carbon costs. Politically, ETS2 will almost certainly ramp gradually and include price stabilisation mechanisms, but even a moderated version changes the structure of energy prices.

On the electricity side, the picture is also changing. As renewable penetration increases, electricity becomes less exposed to gas prices and carbon costs. Wind and solar have low operating costs and no fuel costs. Long term power purchase agreements fix prices for years. Natural gas increasingly rarely sets the marginal price of peak electricity, so wholesale electricity prices will decline. As grids add more renewables and storage, the average cost of electricity becomes increasingly decoupled from fossil fuel volatility, even if marginal pricing remains. And as more electrons flow across the same grids, the adders to retail electricity prices for transmission and distribution will fall as well.

Combining these trends produces a different spark gap trajectory by 2030. Consider a simplified scenario for Germany and Spain. Assume electricity VAT and non energy levies are removed and funded from general budgets. Assume electricity retail prices fall to around $0.17 per kWh in Germany and $0.13 per kWh in Spain, reflecting lower taxes and higher renewables penetration. Assume gas retail prices before carbon costs are $0.09 per kWhₜₕ in Germany and $0.08 per kWhₜₕ in Spain. Add a full ETS2 carbon price of $100 per ton, increasing gas prices by about 2 cents per kWhₜₕ.

Under those assumptions, gas prices rise to roughly $0.11 per kWhₜₕ in Germany and $0.10 per kWhₜₕ in Spain. The resulting spark gaps are about 1.55 in Germany and 1.30 in Spain. This is a major improvement compared to today, but it is not parity. Direct electrification using resistance heating or straightforward equipment swaps remains difficult in many cases.

Heat pumps are an exception because physics intervenes. A heat pump with a coefficient of performance of 3 turns one kWh of electricity into three kWhₜₕ of heat. At $0.17 per kWh, the effective cost of delivered heat is about $0.057 per kWhₜₕ. Compared to gas at $0.11 per kWhₜₕ, electricity is already cheaper for heat delivery. This is why heat pumps scale even when the spark gap looks unfavourable on paper. Efficiency multipliers overpower distorted price signals.

Some industrial and commercial heat pump applications also benefit from this effect, particularly for low temperature heat below 100°C. Food processing, chemicals, paper, and district heating often operate in ranges where coefficients of performance of 2 to 4 are achievable. In these cases, VAT reductions and ETS2 can be enough to move projects from marginal to investable, even when direct electricity to gas price parity is not reached.

Outside of these efficiency driven cases, progress is slower. Direct resistance heating delivers one kWhₜₕ of heat per kWh of electricity and therefore remains sensitive to the remaining spark gap. High temperature industrial processes and many retrofit heavy building upgrades face similar challenges. For these applications, electricity prices need to fall further relative to gas, gas prices need to rise more decisively, or complementary policy measures need to bridge the gap.

This is where the leaked recommendation falls short. It recognises the problem but treats solutions as optional. It encourages lower electricity taxes but does not require higher fossil fuel taxes. It highlights energy intensive industry but gives less attention to households, even though household electrification unlocks system wide flexibility and demand response. It sets no timelines and leaves implementation entirely to Member States.

The political economy behind this caution is familiar. Governments rely on electricity levies for revenue. Gas taxes are politically sensitive. Households notice electricity bills more than carbon prices embedded in fuel supply chains. Changing the structure of energy taxation requires shifting costs onto general budgets, which exposes trade offs more directly.

Still, the direction is clear. Europe has started to close the spark gap. Carbon pricing is expanding. Electricity is becoming cleaner and more stable in cost. Some Member States have already moved levies off electricity bills and lowered VAT. The leaked recommendation signals that the Commission understands these are not temporary crisis measures but structural corrections.

What remains is a question of pace and ambition. A spark gap of 1.3 to 1.6 by 2030 is progress, but it leaves a large share of electrification potential unrealised. If Europe wants electrification to deliver on competitiveness, security, and decarbonisation, it will need to move beyond encouragement and treat electricity pricing reform as core economic policy rather than a discretionary adjustment.