Environmental-Unfriendly Tax Avoidance

This paper examines how firms use carbon allowances to reduce corporate tax burdens by routing allowance transactions through internal trading hubs in low-tax jurisdictions and by exploiting fluctuations in carbon prices. Using a dataset that captures the universe of carbon-allowance transactions in the European Union Emissions Trading System (EU ETS) from 2014 to 2020, we document that roughly 35% of corporate groups operate internal hubs that collect and redistribute allowances across affiliated entities required to surrender them. Many of these hubs are located in jurisdictions with low statutory tax rates or in recognized tax havens, resulting in significantly lower effective tax rates for hubs relative to other entities within the same multinational group. These internal reallocations of allowances generate substantial tax savings. We further document that such tax-motivated internal trading and profit shifting is associated with lower investment in decarbonization and higher volumes of allowance surrenders. Taken together, it appears as if tax avoidance alleviates the financial pressure to reduce emissions.