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Energy prices should ‘tell the economic and ecological truth’. Consequently, energy or CO2 taxes, or an emissions trading system, should be introduced to internalise the external costs of environmental damage and threats to health into the final energy prices. By means of sending out the “right” price signal to market actors, both instruments - taxation and emission trading - improve financial gains from more energy efficient behaviour and/or encourage energy efficiency investments. Revenue generated can be used to further increase the attractiveness of energy efficient solutions by means of providing information and/or easily accessible funding opportunities, grants, or tax credits.
The target of any energy tax is to adjust energy prices in accordance with the real, i.e. social cost of energy use and thus alter end-users’ overall energy consumption patterns, trigger investment into energy-efficient solutions and promote pertinent technological innovation. By contrast, carbon taxes deliberately discriminate between different energy sources with regard to their carbon/CO2-content in pursuit of climate change mitigation targets. However, while their introduction additionally sets financial incentives for energy consumers to opt for renewable or low-carbon energy sources, carbon taxes are less conducive with regard to the aim of fostering energy efficiency at consumption level than energy taxes with a comprehensive tax base.
Instead of setting a price on CO2-intensive activities via taxation, the means for reducing CO2 emissions in an emissions trading system (ETS) is defining quantitative emission limits and issuing tradable allowances/certificates to polluters. The trading will convert the emission limits into a price for an allowance or certificate. Generators of electricity or heat will factor the allowance or certificate prices into the energy price, so the final effect is an increase in energy prices, as with taxation. However, while an ETS with good compliance ensures that emissions will be limited, the price signal it sends is likely to fluctuate and therefore be less predictable for investors.
The introduction of measures that raise the price of energy will be particularly effective when combined with the provision of relevant information as well as financial incentives (e.g. tax credits or grants) and easily accessible funding opportunities (e.g. via the establishment of an energy efficiency fund) for energy efficiency improving measures. A part or all of the revenue generated by the tax or the sale of emissions allowances can be used to fund these policies and measures. Another part of the revenue can be used to reduce the tax burden or social security contributions on labour as part of a wider ‘ecological tax reform’. In addition to information and incentive programmes, the setting of binding Minimum Efficiency Performance Standards (MEPS) for appliances can further promote the demand for energy efficient technologies and thus add to the saving potential.
Taxes on energy of some kind can be found in most countries worldwide. Germany and several other countries have also implemented an ‘ecological tax reform’. Explicit carbon taxes by contrast have been implemented only in a few European countries (Finland (1990), Sweden (1990), Norway (1991), Denmark (1992), the Netherlands (1996), (Slovenia (1997)), Italy (1999), the UK (2000), Switzerland (2008) and Ireland (2010) (cf. Andersen 2011)) as well as in Costa Rica (1997) (cf. Meyer 2010, p. 6), India (2010) and Australia (2012). Moreover, several local or regional initiatives have been launched in the United States (cf. Sumner et al. 2009) and Canada.
While energy / CO2 taxes are cost-effective instruments to correct distorted energy prices and foster energy efficient behaviour and technological innovation, their effectiveness and therefore saving potential is largely dependent on actual tax design (i.e. tax base, tax rate, liable entities and revenue recycling) as well as country specific factors such as the broader tax system and the overall economic and market structure.
Energy / CO2 taxation and/or the implementation of an emissions trading system work towards correcting distorted market prices for energy use by internalising associated external costs (i.e. incorporating the cost of the damage caused by energy production and consumption/CO2 emissions into the price of fossil fuels and other energy using activities) in accordance with the ‘polluter-pays-principle’. By means of sending out the “right” price signal to market actors, both instruments improve financial gains from more energy efficient behaviour and/or encourage energy efficiency investments. Moreover, their use enhances governments’ fiscal leeway - either through generation of tax revenues or by auctioning of emission allowances - to further advance energy efficiency through complementary measures (e.g. programmes offering individual advice and/or financial incentives or preferential loans, or MEPS). Carbon or energy taxation and emission trading schemes are thus market based policy instruments, the individual or combined use of which contributes to the creation of an enabling governance framework for energy efficiency improvements.
The graph shows how energy / CO2 taxation and emissions trading systems increase the energy cost savings and thus the economic benefits for energy efficiency improvements. Thereby, the benefit to cost ratio will be improved.
Environmentally motivated energy taxation and an emissions trading system intend to correct the market price of energy consumption / pollution so that it reflects the full social cost of production. According to basic behavioural and economic theory, both instruments thus create incentives to reduce energy use, stimulate demand for more energy-efficient products, and promote a shift to cleaner fuels and renewable energy. The ultimate environmental target of a carbon tax or emissions trading system is to reduce CO2 emissions in order to mitigate adverse climate change impacts.
Worldwide implementation status
Taxes on energy of some kind can be found in almost every country worldwide. Germany and some other countries have also implemented an ‘ecological tax reform’ by using the revenues to reduce taxes or social security contributions on labour. Explicit carbon taxes on the other hand have been implemented only in some European countries (Finland (1990), Sweden (1990), Norway (1991), Denmark (1992), the Netherlands (1996), Slovenia (1997), Italy (1999), the UK (2000), Switzerland (2008) and Ireland (2010) (cf. Andersen 2011)) as well as in Costa Rica (1997) (cf. Meyer 2010, p. 6), India (2010) and Australia (2012). Moreover, several local or regional initiatives have been launched in the United States (cf. Sumner et al. 2009) and Canada.
In most cases carbon/energy taxes have been introduced on a national level. However, there are also examples of regional or local tax schemes, particularly in countries with federal systems (e.g. Spain, USA).
Emissions trading systems can also be found on various levels: trans-national (Europe (EU-ETS, 2005)), national (USA (SO2 Reductions and Allowance Trading under the Acid Rain Program (1995)), regional (USA (Regional Greenhouse Gas Initiative (RGGI), an initiative by the Northeast and Mid-Atlantic States of the U.S. (2009)) and even local (Tokyo (2010)).
Next to these compliance markets, there is a growing market for voluntary offsets, enabling companies and individuals to buy carbon offsets on a voluntary basis.
Energy and carbon taxes / emissions trading systems can be implemented at a national, trans-national or regional level.
To be most effective with regard to environmental/energy efficiency targets, an energy/ CO2 tax or an emissions trading system should ideally cover all relevant sectors of the economy (i.e. residential, industry, commercial and public sector).
All kinds of energy efficiency actions and technologies will benefit from the increased financial gains due to an Energy/ CO2 tax or an Emissions trading system.Appliance examples are:
Depending on actual tax design, the target group is either end-users (i.e. with regard to carbon taxes: downstream sources of emissions) or energy providers (i.e. with regard to carbon taxes: upstream sources of emissions) or both. Regarding mandatory emissions trading systems, the usual target group is power generators and the energy-intensive industry. Voluntary emissions trading systems, however, may include all sectors of the economy as well as individuals.
Carbon taxation and emissions trading systems directly benefit low-carbon and particularly renewable energy sources by creating a comparative cost advantage vis-à-vis energy from carbon intensive sources, thus improving their competitiveness on energy markets.
By increasing the price of energy (from carbon intensive sources), energy/CO2 taxation and emissions trading systems stimulate the demand for energy efficient solutions and thus indirectly benefit engineering consultants, manufacturers and retailers who offer such solutions and technologies
Using energy / CO2 taxation or an emissions trading system to send the right price signals is a necessary means to promote energy efficiency but will not be sufficient to overcome all market barriers for energy efficiency by far. These are often not related to the energy prices, such as lack of information or the investor-user dilemma.
Therefore, the introduction of energy / CO2 taxation or an emissions trading system can only be really effective when combined with the provision of sectors-specific policy packages to increase energy efficiency. These will include amongst others easily accessible information (e.g. via campaigns, individual advice or efficiency labels), financing schemes for energy efficiency investments and additional positive financial incentives in the form of tax credits or direct grants (cf. Kosonen & Nicodème 2009). Such combined programmes can be organised and funded for example through an energy efficiency fund fed from the revenue of the tax or ETS. In addition, the setting of binding Minimum Efficiency Performance Standards (MEPS) for buildings and/or appliances can further secure the demand for energy efficient technologies and thus add to the saving potential.
Particularly in countries that have installed or are subject to an emission trading system, policy makers need to bear in mind the alignment of the design of carbon taxes in order to avoid double taxation (cf. Schlegelmilch & Bunse 2008).
In order to compensate for unwanted distributional effects and negative impacts on the labour market, energy / CO2 taxation could be designed in accordance with the concept of an environmental tax reform (ETR). ETR proposes revenue neutral shifting of tax burden from income or labour to environmentally harmful behaviour such as the unsustainable use of (carbon intensive) energy.
The effective implementation and enforcement of an energy / CO2 tax or an emissions trading system requires a competent, sufficiently funded and well-staffed authority with the capacity to co-ordinate and process the respective system. Also, energy / CO2 taxes and emissions trading systems are only meaningful when there are no subsidies on energy prices or production.
While it is possible to define quantified targets for a tax in terms of yearly energy savings or generated revenue (mostly in order to aide the setting of a tax rate level in an ex-ante impact assessment) their actual achievement largely depends on market actors’ choices regarding the balance between tax payments, behavioural changes and energy efficiency investments.
An emissions trading system on the other hand sets a clear target for the amount of emissions to be reduced, however, the price for emissions certificates is not predictable and will be generated by the market. Additionally, the number of participants and number of units involved in an emissions trading system has to be set prior to the start of an emissions trading period.
Co-operation of countries
Governments with the intention of introducing carbon/energy taxation / emissions trading systems could benefit from drawing on experience from other countries that have already implemented such policies. This policy benchmarking practice can be particularly beneficial between countries with similar economic and institutional structures. Moreover, multilateral agreements on aligning national tax policies / emissions trading systems may facilitate the introduction and help to avoid decreases in the international competitiveness of domestic industries as well as tax evasion/carbon leakage.
For evaluation purposes of energy/CO2 taxation a broad database of factors that influence energy consumption is necessary, and this should be built parallel to the tax introduction. Best evaluation practice has shown that for the assessment of energy consumption on a household level, the monitoring of data, not only on the total energy consumption, but also on the use of appliances, general behavioural patterns, type of household by size and income asf. are most useful, while on an industrial level data on the overall consumption of different sectors is sufficient (cf. INFRAS 2007, p. 19).
In emissions trading systems, the monitoring is of great importance. Each installation covered has to be monitored, as the emissions from installations are the basis for the individual right to emit, as well as for the allocation of certificates. Additionally, the sum of all installations’ emissions shows the development of the status quo for reaching the reduction target. As monitoring every single installation is quite extensive, an overall monitoring concept has to be cost-efficient and periodical adaptations and enhancements might be necessary.
For both energy/CO2 taxation and emissions trading systems, the actual energy prices including the measures and the level of taxation respectively carbon price should be monitored as a basis for evaluating their impact on energy prices.
In order to evaluate the different impacts of an energy/CO2 tax or an emissions trading system, the use of Computable General Equilibrium (CGE) models and other econometric approaches (such as e.g. time series analyses before and after introduction of the schemes to evaluate energy price elasticities of energy demand and calculate the energy savings using these) but also Input-Output-Analyses have proven to provide sound and meaningful results. Overall, the availability of relevant data rather than the choice of method is crucial in this respect. With regard to timing, impacts on the energy demand side should be evaluated within 1-3 years after the introduction of the instrument while structural impacts require a longer period of 5 years to emerge (cf. INFRAS 2007).
Impacts that should be considered are, on the one hand, the additional costs to energy consumers from the increase in energy prices but also from energy efficiency investments induced. On the other hand, financial savings from energy savings, reduced social security cost or reduced other taxes, or direct compensation payments or financial incentives received for energy efficiency investments that the state pays out of the revenue from taxation or the auctioning of emission rights need to be included.
Energy (cost) savings from such incentive programmes for energy efficiency can be evaluated directly using bottom-up methods.
For the overall economy, savings on energy supply and from reduced unemployment can be evaluated, but so can the wider changes in GDP. Reduced greenhouse gas emissions are another important benefit that should be evaluated.
In addition, is it useful to quantify the impact on the state’s budget. This includes not only the tax or auctioning revenue and its use, but also secondary effects from reduced unemployment or increased VAT on energy efficiency investment.
An energy tax scheme can promote sustainability for instance by exempting energy production or consumption from renewable energy sources from the tax, thus supporting the transition towards a sustainable energy supply system. Moreover, if primary energy is used as the tax base, the policy provides incentives for more efficient energy conversion thus improving resource efficiency.
Emissions trading systems per se support cleaner production and a more efficient use of energy or the use of renewable energy by increasing the price for a carbon-intensive use of energy. Emissions trading systems can also support health aspects (e.g. SO2 trading which is, however, a different system).
Carbon taxation as well as emission trading systems provide society as a whole with public health benefits due to air quality improvement. Furthermore, if tax revenue or funds from auctioning emission allowances are used to lower the cost burden on labour (e.g. by decreasing social security contributions or the income tax rate), the policy can have positive effects on the labour market.
The following barriers are possible during the implementation of the policy:
Delays in legislation may occur due to political processes and lobbying as well as political resistance/opposition from target groups.
There may be a lack of administrative capacity in order to ensure compliance/enforce the policy.
Emissions trading systems may see high volatility of carbon prices.
The following measures can be undertaken to overcome the barriers:
Thorough and timely policy planning including the consultation of stakeholders and scientific experts is key in order to avoid delays in legislation.
The gradual implementation of a tax / emissions trading system provides those targeted with the opportunity to minimize adaptation costs and thus may help to overcome political resistance.
A timely set up of a sufficiently staffed and well endowed organisation helps to avoid problems of enforcing the policy.
For emissions trading systems, in order to limit fluctuations in the prices for allowances/certificates and therefore in the price signal to consumers, the cap should regularly be adapted to both the effects of energy efficiency improvements and low-carbon electricity generation and cap-setting should be co-ordinated with the respective sectoral policies, but also to reflect changes in GDP (cf. Hermann & Matthes 2012 for the need to adapt the cap for the EU ETS). Another option could be setting a minimum floor price for allowances/certificates.
Due to the multitude of design options with regard to tax base, liable entities, tax rate and revenue recycling as well as country specific context factors (such as the embeddedness of a carbon/energy tax into the broader tax system and energy demand elasticities), it is clearly not possible to make universally valid statements about the energy saving potential of energy/CO2 taxation. An ex-post evaluation of the impact of the 1996 Dutch energy tax on household energy demand in 2004 showed that the policy led to a small but significant yearly average reduction in electricity (8%) and gas (4.4%) (cf. Berkhout et al. 2004). Moreover, a survey of empirical ex-post evaluations of the effects of CO2-based taxes showed that they do in fact reduce emissions (cf. Agnolucci 2004).
Generally, certainty of energy saving impacts will be much higher if a part of the tax revenue is used to fund sector-specific energy efficiency policies.
On the other hand, an emissions trading system can define the absolute amount of emissions and therefore also the emissions reduction vs. the baseline trend. However, the economic advantage of emissions trading systems is their freedom in the ways to reduce emissions. These can be energy efficiency improvements but also renewable energies or carbon capture and storage, and even options to reduce other greenhouse gases, depending on the scope of the ETS. The impact on energy savings is therefore uncertain.
Again, certainty of energy saving impacts can be increased if emissions rights are auctioned and the revenue is used to fund sector-specific energy efficiency policies.
From an administrative/governmental perspective, the implementation of an energy/CO2 tax is, compared with other instruments (such as an emission trading system) that target energy prices or with regulatory/command-and-control approaches, the lowest-cost policy option to reduce energy consumption. Although administrative and company costs of energy/CO2 taxes may - due to considerations of companies’ competitive abilities in the tax design - be higher than for other tax forms, they are nonetheless generally cost-efficient (Agnolucci 2004, p. 52).
In view of the policy’s basic objective, target groups will naturally face higher costs for energy use. These cost increases may however be fully or partly offset by means of revenue recycling (e.g. grants for energy efficiency investment, reduction of contributions to social security systems to reduce labour costs, tax refunds, asf.). In general, the target group specific net increase in energy costs will differ depending on tax design, i.e. tax base, liable entities, tax rate and revenue recycling approach.
In practice, emissions trading systems can also be run at low administrative costs. For example, the administrative effort of Germany for the European Emissions Trading in the first trading period (2005-2007) amounted to 0.089 per cent. This was a lower percentage than for the administrative costs of the Ecological Tax Reform (0.13 per cent) (Schlegelmilch & Bunse 2008).
When accurately designed in accordance with the principles of environmental tax reform and properly implemented, energy/CO2 taxes are suitable policy instruments to cut CO2 emissions/save energy without curbing economic development. If revenues are retransferred to reduce labour costs, small positive or no significant macroeconomic effects on production and employment in either direction are to be expected. On the other hand, significant reductions in energy consumption/pollution are possible (cf. Bosquet 2000).
Denmark for instance had introduced an energy tax back in 1977, which was amended in 1992 by a carbon tax and all measures were reviewed and strengthened in 1996 (“The Green Tax Package”) and again in 2009. The main part of generated revenue has been recycled by reducing employers' labour market contributions and ATP (supplementary labour market pension) payments. An evaluation study in 2000 found insignificant but positive effects on employment, gross value added and balance of payments (cf. The Danish Energy Agency 2000, p. 29). Moreover, based on data for the period 1995 to 2000 the same study estimated a 5% reduction in CO2 emissions from 1995 to 2005.
The general aim of an emissions trading system is to reduce emissions where it is most cost-effective. In so far as energy efficiency improvements are cost-effective, the system will reduce overall energy costs to the economy. In addition, the price signal will have similar effects as for energy/CO2 taxation.
Try the following external libraries:
|Energy Efficiency Policy Database of the IEA|
|Energy Efficiency Policies and Measures Database of the World Energy Council|
|CLASP’s Global S&L Database|