Making the best of the new EU Social Climate Fund
Executive summary
The slow pace of decarbonisation of buildings and transportation threatens the European Union’s goal of reducing emissions by 55 percent by 2030 and achieving net zero by 2050. To address this, a new emissions trading system, ETS2, is being introduced to put a carbon price on fuels used in buildings and road transport. However, the resulting cost increases risk a disproportionate impact on vulnerable households and small and medium sized enterprises.
The European Union has created the Social Climate Fund (SCF) to address these distributional challenges. This instrument redistributes a portion of auction revenues generated by the ETS2 among EU countries, in order to protect the most vulnerable. A much larger share of ETS2 revenues will flow directly to national governments, offering significant opportunities for social measures and investments in the green transition. The use of those revenues will dictate how successful EU countries are in managing the transition and protecting households, particularly in higher-income member states, which will receive relatively smaller shares of SCF funding.
ETS2 is an essential part of the EU climate policy toolkit. Governments should employ good practices, as identified by the European Commission, to tackle emissions from buildings and transport and to gradually phase out income support, in line with the achievement of investment targets and milestones. Higher-income EU countries should develop additional targeted financing levers to protect the vulnerable and to introduce extra enablers to encourage private investment.
Proper sequencing, outreach and communication will be essential to ensure the uptake of measures and public support for policy instruments. Cross-country learning should be leveraged, including through the creation of a European policy registry that will help countries compare their approaches and potentially amend their SCF spending plans on the basis of learning from policies that been successful elsewhere.
Financial support from Climate Imperative is gratefully acknowledged
1 Introduction
Decarbonisation of buildings and transport needs to be accelerated sharply across the continent if the European Union is to have a realistic chance of achieving its 2030 and 2050 climate targets. Transport accounts for about one quarter of the EU’s emissions, of which 72 percent stems from road transport, with levels rising between 2013 and 2022 . Under current policy, annual emissions will only revert to 1990 levels in 2032 . Meanwhile, emissions from electricity use, cooling and heating in buildings make up 27 percent of the EU’s total emissions. Though the buildings sector has decarbonised to some extent, the 29 percent reduction in building stock emissions achieved by 2022 relative to 2005 falls significantly short of the necessary level of decarbonisation to be on trajectory to achieve the 2030 climate target (Keliauskaitė et al, 2024).
The start in 2027 of a new emissions trading system covering buildings and transport, the so-called ETS2, will therefore be pivotal to reaching decarbonisation targets. The ETS2 will ensure greater predictability of the EU’s emissions by establishing a clear pathway for the annual reduction of emission allowances. It will also facilitate better fiscal planning, drawing on revenue projections based on the planned reduction of allowances in circulation.
The ETS2 should also complement the Clean Industrial Deal – the EU plan to make decarbonisation an industrial opportunity – by supporting a decarbonised electric-vehicle ecosystem and accelerating charging infrastructure, boosting demand and innovation in Europe’s pressured automotive industry (Menner et al, 2025). Similarly, expanding the heat-pump sector could enhance competitiveness and job retention, while the role ETS2 could play in driving low-carbon heating adoption will be crucial to closing the supply-demand gap .
However, though the trading and reporting of ETS2 emission allowances will be the responsibility of suppliers (ie fossil-fuel companies), the carbon price is expected to be largely passed on to consumers, translating into higher heating bills or fuel costs (Strambo et al, 2022). This raises concerns about the impact on low-income households and small and medium sized enterprises (SMEs), which are likely to be burdened disproportionately. In public discourse the potential upside of ETS2 is overshadowed by concern over political backlash and its potential to aggravate energy and transport poverty .
To address these distributional concerns, some ETS2 auctioning revenues will be redistributed, including through the establishment of a Social Climate Fund (SCF), which will pool €65 billion from total ETS2 revenues . This fund is intended to address within-country inequality by supporting the most vulnerable households and SMEs, and to address between-country inequality by helping the most-affected countries more.
The main challenge in this for policymakers is to direct the funds effectively to vulnerable groups. Evidence from the energy crisis showed that many countries worldwide struggled to effectively target households with necessary support because of limited administrative capacity at national level (Castle et al, 2023). This problem has not been sufficiently addressed, creating a risk that scarce financial resources will be used to support or even overcompensate consumers that do not strictly need support. Furthermore, Social Climate Plans, the national documents that detail the use of the SCF, must be submitted by the end of June 2025, suggesting that guidance from the Commission on the drafting of these plans is urgently needed.
2 Managing the distributional effects of climate policy
2.1 Distributional effects of climate policy
While carbon pricing is typically the most efficient decarbonisation policy (Duma et al, 2022), it may have regressive effects, meaning it puts a higher relative burden on lower-income households. This applies to pricing levied directly on households and to indirect taxation through which industry passes costs on to consumers (Wier et al, 2005). Regressivity can stem from multiple channels and is one of the main concerns when designing policies.
Low-income households tend to focus on immediate consumption, experience higher borrowing constraints and spend larger shares of their incomes on essential goods such as heating or food. This leads to higher shares of their incomes spent on products that may be subject to carbon pricing. Households that are unable to invest in green technologies, such as electric vehicles or more efficient heating systems, also see fewer benefits from subsidies provided for such purchases. Emission standards can lead to higher costs for consumers, impacting lower-income households more intensely (Zachmann et al, 2018). Inequality directly affects the welfare and economic growth of countries and hence climate policies should not aggravate inequality (Mejino-López and Zachmann, 2024).
Impacts on income are also unequal. Jobs in carbon-intensive industries are primarily done by lower-income groups (Strambo et al, 2022) and shifts caused by the green transition, such as the move towards electric vehicle production, are already affecting employees . Pisani-Ferry and Mahfouz (2023) stressed that the transition will create and destroy jobs unevenly across sectors. Achieving a net benefit will require successful and effective government measures to reallocate resources and labour.
Differences in the characteristics and circumstances of the most affected individuals and companies are significant between and within EU countries. The drafting of national Social Climate Plans and spending of ETS2 revenues should factor in these differences.
2.2 Buildings
Retrofitting the worst-performing buildings offers immense potential for energy and emissions savings. Deep renovations of just 10 percent of the worst-performing buildings could reduce buildings-related emissions by 20 percent and ETS2 emissions by 8 percent (Keliauskaitė et al, 2024). Renovations of these buildings, often inhabited by low-income households that spend up to 30 percent of their income on heating, could alleviate energy poverty, which affects 50 million Europeans and incurs annual public health costs of €167 billion (Ahrendt et al, 2016).
However, transitioning from coal, oil or gas heating to zero-carbon electric alternatives or connecting to district heating requires substantial financial resources which energy-poor households typically do not have. Moreover, tenants in rented property lack the authority to upgrade their heating systems, leaving them unable to reduce their emissions structurally. As a result, they remain locked into carbon-intensive options, facing rising carbon prices without viable alternatives. Without targeted support to ease the transition, decarbonisation efforts risk being stalled, while vulnerable households face increased financial strain.
Figure 1: Household expenditure on heating energy (electricity, gas, liquid/solid heating fuels, heat energy), by income quintile
Source: Bruegel based on Eurostat. Note: high-income countries have a net equivalent income of 120-175% of the EU average, low-income countries have a equivalent income of 40-70% of the EU average. Data is missing for Italy.
Data on household expenditure on heating energy reveals that in the lowest-income households in low-income countries, more than 10 percent of expenditure goes on heating (Figure 1). A carbon tax levied on top of (some of) these fuels would impose a large burden on these households. Figure 1, based on Eurostat data, also suggests significant inequality between countries. The households with the highest incomes in low-income countries spend higher shares of their incomes on heating energy than the households with the lowest incomes in rich countries. This is influenced by divergence in incomes across countries and in the quality of buildings, resulting from the materials used in construction or age of the building stock (Gevorgian et al, 2021). Finally, household needs and absolute spending vary widely, so a household may face energy poverty even if it spends relatively more on energy.
The volume of emissions produced by buildings varies greatly across EU countries. It is determined mainly by the energy mix used for heating and the climatic conditions driving heating demand throughout the year (Eden et al, 2023).
Figure 2: Heating mix of EU countries and emissions per households from ETS2-covered heating commodities
Source: Bruegel based on Eurostat. Note: for Sweden, heat pumps are categorised under electricity.
Countries in which households rely on burning fossil fuels, such as Ireland, generally produce higher per-household emissions than countries that rely on district or electric heating, such as Sweden. Oil and coal, which emit much larger quantities of CO2 per unit of heat generated than natural gas, are drivers behind especially high per-household emissions in Poland and Czechia, despite the total share of fossil fuels in their respective energy mixes being lower than in other countries.
After the introduction of the ETS2, fuel prices will rise as producers pass their cost increases on to consumers. Keliauskaite et al (2024) estimated price fluctuations between €60 and €200 per tonne of CO2, depending on the success of decarbonisation efforts. At an ETS2 price of €60 per tonne of CO2, standard use of a gas boiler would incur additional heating costs of €162 per year, whereas users of a coal-boiler would see their costs increase by €350 per year . A German low-income household, where gas is likely used, can thus expect to spend an additional 1.2 percent of its total expenditure on heating because of the ETS2. In Poland, where coal burning is more common, the additional burden for a low-income household relying on coal would be about 3.1 percent. Naturally, with rising carbon prices, the price effect increases proportionately. A price of €200 per tonne of CO2 would have price effects exceeding those of the 2022 energy crisis (Keliauskaite et al, 2024).
2.3 Private and public transport
Lower-income households are also affected by the rising costs of petrol and diesel. About 70 percent of national transport emissions across the EU arise from traffic in areas outside the major cities , suggesting that the rural population will be more strongly affected by the ETS2 fuel price increase, and also that the most significant emission reductions can be achieved through low-carbon investment in these areas.
Typically, transport-poor households are located rurally, especially in lower-income countries (Strambo et al, 2022) . Remotely located households rely more on personal transport because they are further from essential services and lack public transport infrastructure. This already exposes them to a greater financial burden from transport, further aggravated by the ETS2.
The passing-on of costs to consumers could lead to prices rising by up to €0.38 per litre of petrol (Agora Energiewende and Agora Verkehrswende, 2023). However, this represents the worst-case scenario, if prices were to reach €200 per tonne of CO2. In more moderate scenarios, the additional cost would be on average between 0.2 percent to 0.6 percent of consumption expenditure across different income groups of EU households. In contrast to buildings, the largest relative expenditure increases are expected for the higher quintiles of low- and middle-income countries, because of the higher levels of internal combustion engine car usage by those households (Held et al, 2022).
However, using the average across income quantiles means obscuring the divide between rural and urban populations. Figures 3 and 4 detail the differences in this regard and show the absolute and relative costs for Denmark, Germany, Poland and Romania. Based on the differences in driving patterns and incomes across different spatial allocations, the share of income spent on the fuel price increase differs significantly. Rural households in Germany for example are assumed to drive the furthest, leading to the highest CO2 cost. Relative to their incomes, however, rural households in Poland and Romania still spent twice as much as German rural households.
Figure 3: Potential rural and urban increases in fuel costs from ETS2 per year
Figure 4: Potential rural and urban increase in fuel costs from ETS2 as percentage of income
Source: Bruegel. Note: costs estimated using €60 per tonne of CO2 emitted and urban and rural incomes from Eurostat. Urban emissions estimated using average urban car travel kilometres per country according to Eurostat (https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Pass…), assuming an average petrol car emitting 170g CO2 per km. Calculation based on the assumption that urban emissions represent 30 percent and rural emissions represent 70 percent of total transport emissions.
Urban transport in Europe is also dominated by car usage. In most European cities, more than 60 percent of distance covered is travelled by car (as passenger or driver). Increasing fuel prices could encourage the move from cars to public transport, especially for households that have suitable infrastructure available to them, and for whom the switch to electric vehicles remains too costly. An increasing influx of cheap Chinese electric vehicles might alleviate this concern to some extent, but mainly for those already looking to purchase a new vehicle. The problem will remain significant for households that cannot afford the upfront cost and rely on the cars they already own. Figure 5 shows household expenditure on bus transport in different countries, comparing first and second income quintiles to the average of the third, fourth and fifth, showing that any move from car to bus use is likely to have unequal regressive effects across countries, likely due to different mobility habits and options.
Figure 5: Expenditure on bus transport as a share of total household expenditure in Germany, France and Spain
Source: Eurostat. Note: comparison of the first and second quintiles with the average of the last three. This data refers to ‘public transport by road’ exclusively, thus not covering trains, trams or other means of public transportation. For Germany for example, this corresponds to an average of €109 annually.
3 The policy solutions available: ETS2 national revenues and the SCF
3.1 Structuring of ETS2 allowances and revenues
The estimated 5700 million ETS2 allowances that will be allocated through auctions between 2027 and 2032 will generate substantial public revenue, the total depending on the carbon price. The price ceiling that the European Commission aims to protect is €45 per tonne of CO2 in 2020 prices, corresponding approximately to €60 when the ETS2 takes effect in 2027. However, actual prices may deviate significantly .
Figure 6: Flow of ETS2 revenues, 2027-2032
Source: Bruegel based on European Commission and Braungardt et al (2022). Note: the funding ranges correspond to an average CO2 per tonne price from €60 to €100 for 5700 million allowances. * In its first year, 2026, the SCF will be part financed by ETS1 revenues.
Of the total allowances, one portion will be distributed among EU countries based on their historical emissions between 2016 and 2018. This share, in conjunction with the allowance price, determines the countries’ auction revenues. The second part of the allowances will be allocated to the Social Climate Fund , totalling €65 billion . Countries top-up the SCF funding by nationally co-financing the measures to be implemented under Social Climate Plans (SCPs), the nationally designed spending proposals. Countries are obliged to jointly fund their SCPs and to top up their own shares for achieving the measures under their SCPs.
3.2 The importance of national revenues
The funds flowing into national budgets come from the auctioning of allowances allocated to each EU country. This represents the largest share of total revenue, with estimates ranging between €255 billion to €483 billion in total, suggesting significant potential for national measures to tackle both emissions and distributional concerns. Figure 7 shows the expected revenues per country as percentage of GDP.
Figure 7: Annual expected ETS2 resources per EU country, % of GDP
Source: Bruegel based on EU Regulation 2023/955 and the European Environmental Agency. Note: a carbon price of €60/tCO2 is assumed.
For high-income countries, which will receive smaller shares of SCF financing, the focus will be on the efficient use of national resources. The spending of this money is less strictly regulated than the SCF. According to the regulation, measures should target vulnerable households or contribute tangibly to the reductions of emissions. However, the increased discretion for governments means that they might prioritise different political objectives, such as public support for climate policies , electoral impact, jobs or support for specific constituencies, instead of addressing social issues or supporting clean investments.
3.3 The SCF: purpose and allocation
The national SCPs detailing how each country plans to spend its share of the fund must be sent to the European Commission in June 2025. For each measure, milestones and targets must be defined, with SCF payments to the countries only made after they are reached. The measures themselves must aim to alleviate the additional financial pressure ETS2 puts on vulnerable households and SMEs. Only a maximum of 37.5 percent of the total costs of the SCPs may be allocated to temporary direct income support. Finally, up to 2.5 percent may be used for improving and building capacity of implementing bodies; this can include consultations, studies or communication activities (Regulation (EU) 2023/955).
The money pooled in the SCF is distributed among countries in order to ensure the fairest outcome. The allocation formula takes into account total population, population at risk of poverty living in rural areas, the percentage of households in utility bill arrears, gross national income per capita in purchasing power standard, overall greenhouse gas emissions and CO2 emissions from fuel combustion by households. This results in the distribution seen in Figure 8.
Figure 8: Social Climate Plans expected funding 2026-2032, € billions
Source: Bruegel based on the European Commission and Eurostat.
The five greatest beneficiaries of SCF funding in absolute terms are Poland, France, Italy, Spain and Romania. However, this figure does not take into account the number of (vulnerable) households in each country (Figure 9).
Figure 9: SCF resources available per household
Source: Bruegel based on the European Commission and Eurostat.
Relative to households in need, Bulgaria and Poland will have substantial financial resources to aid households falling into the lowest 20 percent or 30 percent of the income distribution, or at least to shield them from aggravated energy and transport poverty. For higher-income countries, SCF funds will not be sufficient to alleviate the burden of even the first income decile of households, making efficient use of national revenues even more important.
4 Targeting: the biggest obstacle to implementation
4.1 The role of the SCF as instrument to shield the most vulnerable
While most of the population is not fundamentally opposed to climate policy , the social justice component must be carefully calibrated to ensure public support, through fairness in burden-sharing and preventing expensive fossil fuel lock-ins (Gagnebin et al, 2019). Revenue recycling can contribute to this, while also fostering patience among those bearing the costs of the policies, allowing time for policy-driven investments to take effect and deliver tangible benefits.
However, evidence suggests that policies gain more support if the affected populations are compensated equally (Woerner et al, 2024). Lower-income groups tend to be in favour of any compensation mechanisms, whereas higher-income groups (often with more political power) may disagree with policies supporting only the most affected and favour social investment strategies (Eick et al, 2024). Political and economic systems already deprioritise the needs of the most vulnerable, mainly benefitting middle-income groups or industrial workers, with greater electoral and political significance, strengthening the need for an instrument such as the SCF.
Furthermore, from a utilitarian perspective, allocating resources to the most vulnerable improves overall welfare, as one euro has a higher marginal impact on a lower-income household than a wealthier one.
4.2 The main obstacle to implementation
Implementing effective targeting in climate policies is complex and costly, requiring significant administrative capacity that many countries lack. Striking a balance between simple measures prone to misallocation and well-targeted policies that impose a heavy bureaucratic burden is essential. Administrative capability is a significant barrier to the success of the SCF, particularly in Central and Eastern European (CEE) countries, where means-tested support accounts for only 1 percent to 4 percent of total social spending, compared to 10 percent to 12 percent in Western Europe and 35 percent in Denmark (Figure 12). This limited use of means-tested support raises concerns about the ability of CEE countries to reach vulnerable groups.
Figure 10: Means-tested support across Europe, % of total social spending
Source: Bruegel.
While using existing channels, such as unemployment benefit schemes, can reduce administrative burdens, they do not cover all citizens. If means-tested targeting is not feasible, countries might favour a more universal approach using secondary criteria such as postal codes. Targeting could also be carried out ex post, for example coupling a uniform transfer with a measure such as income taxation of that payment, eg for households above a certain income threshold (in this case it must be ensured tax backflows are also only available for SCP measures). Application-based schemes can reduce data-collection efforts but risk excluding the most vulnerable, who are often the least likely to apply.
Overall, the 2.5 percent limit on use of SCF resources for building administrative capacity appears too restrictive, especially in light of the experience of the low absorption rate of another EU fund, the Just Transition Fund (Box 1). Expanding this allocation through national revenues could enhance transparency, reduce political favouritism and build infrastructure for future crises.