ANEXO IV

ANEXO IV

Technical Report for the DGEP Model Results Prepared for the Commission for Green Fiscal Reform

Alfredo Marvão Pereira Dept. of Economics, College of William and Mary, Williamsburg, VA 23187 Email: [email protected]

Rui Marvão Pereira Dept. of Economics, College of William and Mary, Williamsburg, VA 23187 Email: [email protected]

June 30, 2014

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1.

Introduction The last 20 years in Portugal have been marked by substantial changes in the

energy sector and in carbon dioxide emissions from fossil fuel combustion activities, the bulk of greenhouse gas emissions from energy activities and about 70% of total greenhouse gas emissions in the country. In 1990 – a benchmark years for emissions data defined in the context of the United Nations Framework Convention on Climate Change and the Kyoto Protocol – carbon dioxide emissions from fossil fuel combustion activities amounted to 40.9 Mt CO2. Emissions grew 57% between 1990 and 2005 at which time emissions reached their maximum level over the 20 year period of 64.1 Mt CO2. The introduction of natural gas in the late 1990s, the effective promotion of renewable energies as well as the European Union Emissions Trading System have allowed for a 25% reduction in emissions between 2005 and 2012 – in part driven by weak economic conditions and the financial crises of recent years – to current levels of 45.3 Mt CO2. Following these positive outcomes – both in terms of the increased reliance on domestic renewable energies and reductions in greenhouse gas emissions – Portugal, together with the member states of the European Union, has set forth an ambitious program to reduce emissions by 40%, relative to 1990 levels, in 2030 (EU 2013). Achieving these goals will require a comprehensive package of policy instruments which will demand that the country mobilize its efforts in all the relevant areas, a multi-pronged approach. First, it needs to be recognized that because Portugal is totally dependent on imported fossil fuels, the evolution of international prices for the different fuels – oil, natural gas, coal – will have an impact on energy demand in the economy and thereby on emissions. Second, there is plenty of evidence suggesting that there is substantial potential for the adoption of cost-effective energy efficiency improvements. Third, and finally, there is the ongoing debate on the possibility of introducing a new carbon tax. The impact of climate policy on economic performance has been a central part of the policy debate [see, for example, Nordhaus (1993a, 1993b), Babiker et al. (2003), Dissou (2005), Stern (2007), Rivers, (2010), and Morris et al. (2012)]. In addition, we have witnessed a growing concern over mounting public debt in recent years and the need

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to promote fiscal sustainability. In this context, CO2 taxes and auctioned emissions permits have emerged as potentially important fiscal policy instruments for increasing public revenues [see, for example, Metcalf and Weisbach (2008), Galston and MacGuineas (2010), Metcalf (2010) and Nordhaus (2010)]. The interactions between climate policy, economic growth and the public sector account are fundamental since they correlate to some of the most important policy constraints faced by energy-importing economies in their pursuit of sound climate policies: the need to enact policies that promote long-term growth and fragile public budgets. As EU structural transfers have shifted towards new members, countries such as Ireland, Greece, and Portugal, have been forced to rely on domestic public policies to promote real convergence. This poses a challenge since growing public spending, procyclical policies, and more recently, falling tax revenues have contributed to rapidly increasing levels of public debt and a sharp need for budgetary consolidation. The dynamic general equilibrium model of the Portuguese economy incorporates endogenous growth and a detailed modeling of public sector activities. Our model incorporates fully dynamic optimization behavior, endogenous growth, and a detailed modeling of the public sector activities, both tax revenues and public expenditures. Previous versions of this model have been used to evaluate the impact of tax policy [see Pereira and Rodrigues (2002, 2004)], social security reform [see Pereira and Rodrigues (2007)]., and energy and climate policy [see Pereira and Pereira (2013, 2014a, 2014b, 2014c)]. This model brings together two important strands of the taxation literature [see the above applications of this model for a detailed list of the references]. On one hand, it follows in the footsteps of computable general equilibrium modeling. It shares with this literature the ability to consider the tax system in great detail. This is important given the evidence that the costs and effectiveness of climate policies are influenced by existing tax distortions [see Goulder (1995) and Goulder et al (1999)]. On the other hand, it incorporates many of the insights of the endogenous growth literature. In particular, it

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recognizes that public policies have the potential to affect the fundamentals of long term growth and not just for generating temporary level effects [see Xepapadeas (2005)]. While the economic impact of financing reductions in public debt with CO2 tax revenue has been explored in a general equilibrium framework [see, for example, Barker et al. (1993), Koeppl et al. (1996), Farmer and Steininger (1999), Heijdra et al. (2006) and Conefrey et al. (2008)], the distinguishing feature of our methodological approach is our focus on endogenous growth and the associated treatment of public sector behavior [see Conrad (1999) and Bergman (2005) for literature surveys]. Productivity enhancing investments in public and human capital, which have been largely overlooked in applied climate policy [van Zon and Yetkiner (2003) and Carraro et al. (2009)], are, in addition to private investment, the drivers of endogenous growth. Furthermore, the interaction between fiscal policies, public capital, economic growth, and environmental performance has received little attention and then only in a theoretical framework [Bovenberg and de Mooij (1997), Greiner (2005), Fullerton and Kim (2008), Glomm et al. (2008) and Gupta and Barman (2009)]. This report is organized as follows. Section 2 presents the dynamic general equilibrium model and its implementation to the Portuguese case. Section 3 focuses on different fossil fuel price scenarios and their impact. Section 4 addresses the effects of energy efficiency gains. Sections 5 and 6 in turn, focus on the environmental, economic, and budgetary effects of a carbon tax in different policy environments. Section 7, finally, provides a summary and policy implications.

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2.

The Dynamic General Equilibrium Model of the Portuguese Economy In this section we present the dynamic general equilibrium model of the

Portuguese economy in very general terms. Complete model documentation with detailed descriptions of the model equations, parameters, data, calibration, and numerical implementation, can be found in Pereira and Pereira (2012). We consider a decentralized economy in a dynamic general-equilibrium framework. All agents are price-takers and have perfect foresight. With money absent, the model is framed in real terms. There are four sectors in the economy – the production sector, the household sector, the public sector and the foreign sector. The first three have an endogenous behavior but all four sectors are interconnected through competitive market equilibrium conditions, as well as the evolution of the stock variables and the relevant shadow prices. All markets are assumed to clear. The trajectory for the economy is described by the optimal evolution of eight stock and five shadow price variables - private capital, wind energy capital, public capital, human capital, and public debt together with their shadow prices, and foreign debt, private financial wealth, and human wealth. In the long term, endogenous growth is determined by the optimal accumulation of private capital, public capital and human capital. The last two are publicly provided.

2.1.

The Production Sector Aggregate output is produced with a Constant Elasticity of Substitution (CES)

technology, linking value added and primary energy demand. Value added is produced according to a Cobb-Douglas technology exhibiting constant returns to scale in the reproducible inputs – effective labor inputs, private capital, and public capital. Only the demand for labor and the private capital stock are directly controlled by the firm, meaning that if public investment is absent then decreasing returns set in. Public infrastructure and the economy-wide stock of knowledge are publicly financed and are positive externalities. Primary energy demand is produced according to a CES technology

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using crude oil inputs and non-transportation energy sources. The production of nontransportation energy is defined according to a Cobb-Douglas technology using coal, natural gas and wind energy inputs. Private capital accumulation is characterized by a dynamic equation of motion where physical capital depreciates. Gross investment is dynamic in nature with its optimal trajectory induced by the presence of adjustment costs. These costs are modeled as internal to the firm - a loss in capital accumulation due to learning and installation costs - and are meant to reflect rigidities in the accumulation of capital towards its optimal level. Adjustment costs are assumed to be non-negative, monotonically increasing, and strictly convex. In particular, we assume adjustment costs to be quadratic in investment per unit of installed capital. The firms’ net cash flow represents the after-tax position when revenues from sales are netted of wage payments and investment spending. After-tax net revenues reflect the presence of a private investment and wind energy investment tax credits, taxes on corporate profits, and Social Security contributions paid by the firms on gross salaries. Buildings make up a fraction of total private investment expenditure. Only this fraction is subject to value-added and other excise taxes, the remainder is exempt. The corporate income tax base is calculated as revenues from the sale of output net of total labor costs and net of fiscal depreciation allowances over past and present capital investments. A straight-line fiscal depreciation method over the periods allowed for depreciation allowances is used and investment is assumed to grow at the same rate at which output grows. Under these assumptions, depreciation allowances simplify proportional to the difference of two infinite geometric sums. Optimal production behavior consists in choosing the levels of investment and labor that maximize the present value of the firms’ net cash flows subject to the equation of motion for private capital accumulation. The demands for labor and investment are obtained from the current-value Hamiltonian function, where the shadow price of private capital evolves according to the respective co-state equation. Finally, with regard to the

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financial link of the firm with the rest of the economy, we assume that at the end of each operating period the net cash flow is transferred to the consumers.

2.2.

The Energy Sector We consider the introduction of CO2 taxes levied on primary energy consumption

by firms. This is consistent with the nature of the existing policy environment in which CO2 permits may now be auctioned to firms. Furthermore, evidence suggests that administrative costs are substantially lower the further upstream the tax is administered. By considering taxation at the firm level, the additional costs induced by CO2 taxes are transmitted through to consumers and consumer goods in a fashion consistent with the energy content of the good. Not levying the CO2 tax on consumers therefore avoids double taxation of the carbon content of a good. The energy sector is an integral component of the firms' optimization decisions. We consider primary energy consumption by firms for crude oil, coal, natural gas and wind energy. Primary energy demand refers to the direct use of an energy vector at the source in contrast to energy resources that undergo a conversion or transformation process. With the taxation of primary energy consumption by firms, costs are transmitted through to consumers and consumer goods in a fashion consistent with the energy content of the good. Primary energy consumption provides the most direct approach for accounting for CO2 emissions from fossil fuel combustion activities. Carbon is released from fossil fuel upon combustion. Together, the quantity of fuel consumed, its carbon factor, oxidation rate, and the ratio of the molecular weight of CO2 to carbon are used to compute the amount of CO2 emitted from fossil fuel combustion activities in a manner consistent with the Intergovernmental Panel for Climate Change (2006) reference approach. These considerations suggest a linear relationship between CO2 emissions and fossil fuel combustion activities.

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Fossil fuels are hydrocarbons defined by the relative amounts of carbon and hydrogen in each molecule. In the combustion reaction, the compound reacts with an oxidizing element such as oxygen. Thus, the amount of carbon relative to hydrogen in the fuel will determine the fuels carbon emissions factor, the amount of carbon emitted per unit of energy. The molecular weight of carbon dioxide CO2 is 44/12 times greater than the weight of the carbon alone (the molecular weight of carbon is 12 and that of oxygen is 16 which give CO2 a weight of 44 moles and carbon of 12 moles). The fuel’s CO2 emission factor can be computed from the product of its carbon emission factor, in tons of oil equivalent, the fraction of carbon oxidized and the ratio of the molecular weight of carbon dioxide to carbon. The relevant computations are given in Table 1. Crude oil yields 3.04 tCO2 for each ton of oil equivalent consumed, coal yields 3.78 tCO2 for each ton of oil equivalent consumed and natural gas yields 2.34 tCO2 for each ton of oil equivalent consumed. Aggregate primary energy demand is produced with a CES technology in which crude oil, and non-transportation fuels are substitutable at a rate less than unity reflective of the dominance of petroleum products in transportation energy demand and the dominance of coal, natural gas and, to a lesser extent, wind energy, in electric power and industry. Non-transportation fuels are produced with a Cobb-Douglas technology recognizing the relatively greater potential substitution effects in electric power and industry. The accumulation of wind energy infrastructure is characterized by a dynamic equation of motion where the physical capital, wind turbines, depreciates and investment is subject to adjustment costs as private capital. Wind energy investment decisions are internal to the firm while coal, natural gas and oil are imported from the foreign sector.

Table 1 Carbon Dioxide Emission Factor by Fuel FUEL TYPES Crude Oil Gasoline Gas / Diesel Oil Other Bituminous Coal

Unit

Conversion factor (TJ/Unit)

Carbon emission factor (tC/TJ)

Carbon content (Gg C)

Fraction of carbon oxidized

Actual CO2 emissions (Gg CO2)

toe toe toe toe

0.041868 0.041868 0.041868 0.041868

20.00 19.40 19.90 25.10

0.84 0.81 0.83 1.05

0.99 0.99 0.99 0.98

3.04 2.95 3.02 3.78 8

Natural Gas (Dry)

toe

0.041868

15.30

0.64

1.00

2.34

Optimal primary energy demand is derived from the maximization of the present value of the firms' net cash flows as discussed above. In turn, the demand for coal and natural gas are defined through the nested dual problem of minimizing energy costs given the production function and optimal demand for these energy vectors in electric power and industry. Finally, the variational condition for optimal wind energy investment and the equation of motion for the shadow price of wind energy are defined by differentiating the Hamiltonian with respect to wind energy investment and its stock.

2.3.

The Households An overlapping-generations specification was adopted in which the planning

horizon is finite but in a non-deterministic fashion. A large number of identical agents are faced each period with a probability of survival. The assumption that the probability of survival is constant over time and across age-cohorts yields a perpetual youth specification. Without loss of generality, the population, which is assumed to be constant, is normalized to one. Therefore, per capita and aggregate values are equal. The household chooses consumption and leisure streams that maximize intertemporal utility subject to the consolidated budget constraint. The objective function is lifetime expected utility subjectively discounted. Preferences are additively separable in consumption and leisure, and take on the CES form. A lower probability of survival reduces the effective discount factor making the household relatively more impatient. The budget constraint reflects a value-added tax on consumption and states that the households’ expenditure stream discounted at the after-tax market real interest rate cannot exceed total wealth. The loan rate at which households borrow and lend among themselves is greater than the after-tax interest rate reflecting the probability of survival. Total wealth is age-specific and is composed of human wealth, net financial worth, and the present value of the firm. Human wealth represents the present discounted

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value of the household’s future labor income stream net of personal income taxes and workers’ social security contributions. The household’s wage income is determined by its endogenous decision of how much labor to supply out of a total time endowment and by the stock of knowledge or human capital that is augmented by public investment in education. Labor earnings are discounted at a higher rate reflecting the probability of survival. A household’s income is augmented by net interest payments received on public debt, profits distributed by corporations, international transfers, and public transfers. On the spending side, debts to foreigners are serviced, taxes are paid and consumption expenditures are made. Income net of spending adds to net financial wealth. Under the assumption of no bequests, households are born without any financial wealth. In general, total wealth is age-specific due to age-specific labor supplies and consumption streams. Assuming a constant real interest rate, the marginal propensity to consume out of total wealth is age-independent and aggregation over age cohorts is greatly simplified and moreover allows us to write the aggregate demand for leisure as a function of aggregate consumption.

2.4.

The Public Sector The equation of motion for public debt reflects the fact that the excess of

government expenditures over tax revenues has to be financed by increases in public debt. Total tax revenues include personal income taxes, corporate income taxes, value added taxes, and social security taxes levied on firms and workers. All of these taxes are levied on endogenously defined tax bases. Residual taxes are modeled as lump sum and are assumed to grow at an exogenous rate. The public sector pays interest on public debt and transfers funds to households in the form of pensions, unemployment subsidies, and social transfers, which grow at an exogenous rate. In addition, it engages in public consumption activities and public investment activities in both public capital and human capital.

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Public investments are determined optimally, respond to economic incentives, and constitute an engine of endogenous growth. The accumulations of human capital and public capital are subject to depreciation and to adjustment costs that are a fraction of the respective investment levels. The adjustment cost functions are strictly convex and quadratic. Public sector decisions consist in choosing the trajectories for public consumption, public investment in human capital and public investment in public capital that maximize social welfare, defined as the net present value of the future stream of utility derived from public consumption, parametric on household private consumptionleisure decisions. The optimal choice is subject to three constraints, the equations of motion of the stock of public debt, the stock of public capital, and the stock of human capital. The optimal trajectories depend on the shadow prices of public debt, public capital, and human capital stocks, respectively. Optimal conditions are defined for public debt, for public consumption, for public investment, and for investment in human capital.

2.5.

The Foreign Sector The equation of motion for foreign financing provides a stylized description of the

balance of payments. Domestic production and imports are absorbed by domestic expenditure and exports. Net imports incorporate payments by firms for fossil fuels and are financed through foreign transfers and foreign borrowing. Foreign transfers grow at an exogenous rate. The domestic economy is assumed to be a small, open economy. This means that it can obtain the desired level of foreign financing at a rate which is determined in the international financial markets. This is the prevailing rate for all domestic agents.

2.6.

The Intertemporal Market Equilibrium The intertemporal path for the economy is described by the behavioral equations,

by the equations of motion of the stock and shadow price variables, and by the market

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equilibrium conditions. The labor-market clearing condition incorporates an exogenous structural unemployment rate. The product market equalizes demand and supply for output. Given the open nature of the economy, part of domestic demand is satisfied through the recourse to foreign production. Finally, the financial market equilibrium reflects the fact that private capital formation and public indebtedness are financed by household savings and foreign financing. We define the steady-state growth path as an intertemporal equilibrium trajectory in which all the flow and stock variables grow at the same rate, 𝑔, while market prices and shadow prices are constant. There are three types of restrictions imposed by the existence of a steady-state. First, it determines the value of critical production parameters, like adjustment costs and depreciation rates given the initial capital stocks. These stocks, in turn, are determined by assuming that the observed levels of investment of the respective type are such that the ratios of capital to GDP do not change in the steady state. Second, the need for constant public debt and foreign debt to GDP ratios implies that the steady-state public account deficit and the current account deficit are a fraction 𝑔 of the respective stocks of debt. Finally, the exogenous variables, such as public transfers or international transfers, have to grow at the steady-state growth rate.

2.7.

Dataset, Parameter Specification, and Calibration The model is implemented numerically using detailed data and parameters sets.

Data are from the Statistical Annex of the European Community (European Commission, 2012), the Portuguese Ministry of Finance (2012) and the Portuguese Directorate General for Geology and Energy (2012). The decomposition of the aggregate variables follows the average for the period 2000-2013 for macroeconomic data as well as for the energy variables. This period was chosen to reflect the most recent available information and to cover several business cycles, thereby reflecting the long-term nature of the model. Public debt and foreign debt, as well as the stocks of capital, reflect the most recent available data.

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Parameter values are specified in different ways. Whenever possible, parameter values are taken from the available data sources or the literature. This is the case, for example, of the population growth rate, the probability of survival, the share of private consumption in private spending, and the different effective tax rates. All the other parameters are obtained by calibration; i.e., in a way that the trends of the economy for the period 2000-2013 are extrapolated as the steady-state trajectory. These calibration parameters assume two different roles. In some cases, they are chosen freely in that they are not implied by the state-state restrictions. Although free, these parameters have to be carefully chosen since their values affect the value of the remaining calibration parameters. Accordingly, they were chosen either using central values or using available data as guidance. For instance, the elasticity of substitution parameters are consistent with those values often applied in climate policy analysis [see, for example, Manne and Richels (1992), Paltsev et al. (2005) and Koetse et al. (2008)]. The remaining calibration parameters are obtained using the steady-state restrictions.

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3.

On the Environmental, Economic and Budgetary Impact of Fossil Fuel Prices Fuel prices are important in climate policy due to their impact on CO2 emissions.

Fuel prices directly affect emissions through their impact on energy costs, energy demand, and as drivers in the adoption of new energy technologies. High fossil fuel prices reduce energy demand and can stimulate energy efficiency and the adoption of renewable energy technologies, leading to a reduction in emissions [see Martinsen et al (2007)]. Relative price levels, however, may favor a greater use of coal in electric power and synthetic fuels in transportation, increasing emissions [see van Ruijven and van Vuuren (2009)]. Fuel prices also indirectly affect emissions through their impact on economic growth and its dynamic feedbacks with energy demand [see van Ruijven and van Vuuren (2009)]. A great deal of empirical research highlights the dynamic relationship between energy prices, consumption and growth [see Hamilton (2009), He et al. (2010), Korhonen and Ledyaeva (2010), and Balcilar et al. (2010)]. The evolution of fossil fuel prices in international markets suggests an overall reduction in energy demand as fuel prices increase. By 2030, the demand for fossil fuels is 6.2% lower than steady state levels and 11.2% lower in 2050. Changes in relative prices further alter the makeup of the energy sector. The overall increase in the price of fossil fuels relative to renewable energies stimulates investment in wind energy. We observe a 16.6% increase in investment in wind energy and an increase in the stock of wind energy infrastructures by 9.9% in 2030. Similarly, while increasing energy prices reduce demand, the demand for natural gas and coal fall by substantially more than the reduction in crude oil with reductions, relative to steady state levels, of 11.0% for natural gas, 8.3% for coal and 4.5% for crude oil. The reduction in fossil fuel combustion allows for a 6.1% reduction in emissions in 2030 relative to steady state levels.. The macroeconomic impact of fossil fuel prices is fundamentally defined by the total change in energy system costs as opposed to the fuel mix in the energy system. Higher fuel prices and larger expenditures on energy inputs have a negative impact on the firms' net cash flow. Accordingly, businesses reduce private investment by 1.5% in 2030.

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The reduction in private investment drives down the stock of private capital which in turn has a negative impact on economic growth. Over the long term, energy price increases have a negative impact on employment as well, reducing employment by 0.4% relative to steady state levels in 2050. The smaller reductions in private capital and employment than in energy consumption suggests that with growing fuel prices firms substitute capital and especially labor for energy inputs. Given the impact of fuel prices on the private inputs (which as we will see is mirrored by reductions in public and human capital investment), it is no surprise that higher fuel prices, driven primarily by higher oil prices, have a negative impact on GDP. In 2030, GDP is 0.5% below steady state levels. The feedback between domestic demand, production and income defines the impact of fuel prices on private consumption. The net effect of this process is a reduction in private consumption of 1.0%. Consumption smoothing behavior by households implies that these reductions are relatively constant throughout the model horizon. The reduction in economic activity levels due to the increasing expenditure on fossil fuels affects the size of the tax bases and public sector tax receipts. Contracting tax bases drive a 0.6% reduction in tax revenue by 2030. These changes are driven primarily by reductions in VAT tax revenues. On the expenditure side, the public sector optimally adjusts its spending patterns in response to fuel price variations. Total public expenditure falls by 2.2% while public consumption itself falls by 3.1%. Reductions in public investment activities further reinforce the negative effect of declining private inputs on production activities and have a negative impact on economic performance. Overall, despite tax revenue losses, the reduction in expenditure levels reduces public debt levels in 2030 by 5.2% relative to steady state levels. The optimal government response to the increasing opportunity cost of public fund is instrumental in driving positive budgetary effects. Absent these, the contracting tax bases yield an increase in public debt levels. From a political economy perspective, the most important dimension of these results are that independent of the introduction of a tax on carbon emissions, the evolution of fossil fuel prices induces a 6.1% reduction in emissions in 2030 in the

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reference case relative to steady state levels. This reduction in emissions, stemming from increases in the cost of imported fossil fuels corresponds to an exit of financial resources from the economy and – in increasing costs for firms – leads to a reduction in GDP. In contrast to a tax on carbon – which may also produce negative output effects – energy market innovations and price increases in particular do not allow for higher public sector receipts to potential mitigate or eliminate the negative economic effects associated with the reduction in CO2 emissions. Table 2 - Detailed Effects of the Reference Fossil Fuel Price Scenario (Percent change with respect to the reference case) 2020

2030

2040

2050

-2.17

-3.74

-5.32

-6.96

-3.43

-6.16

-8.70

-11.19

Crude Oil

-2.20

-4.45

-6.60

-8.75

Coal

-4.60

-8.32

-11.58

-15.34

Energy Energy Fossil Fuels

-7.30

-10.99

-14.35

-16.94

Investiment in wind energy

Natural

13.46

16.60

18.69

21.52

Wind energy Onfrastructures

4.98

9.94

13.80

16.98

-3.34

-6.07

-8.61

-11.15

Carbon Dioxide Emissions from Fossil Fuel Combustion Economy Growth Rate (Percent Change over Previous Period)

0.95

0.94

0.94

0.94

GDP

-0.02

-0.45

-0.94

-1.45

Private Consumption

-0.94

-0.95

-0.97

-0.98

Private Investment

-0.81

-1.47

-2.10

-2.73

Private Capital

-0.20

-0.67

-1.22

-1.81 -0.38

Employment

0.34

0.12

-0.12

Wages

-0.46

-0.71

-0.99

-1.28

Imported Energy

4.23

6.92

9.45

11.96

Foreign Debt

-7.83

-18.16

-27.13

-34.13

Public Debt

-2.28

-5.22

-7.70

-9.58

Public Expenditures

-2.09

-2.15

-2.20

-2.25

Public Consumption

-3.21

-3.12

-3.02

-2.91

Public Investment

-0.67

-1.29

-1.90

-2.53

Investment in Human Capital

-0.49

-0.60

-0.70

-0.80

Public Capital

-0.19

-0.68

-1.24

-1.84

Human Capital

-0.03

-0.08

-0.14

-0.20

-0.33

-0.64

-0.96

-1.30

Personal Income Tax (IRS)

-0.22

-1.04

-1.86

-2.62

Corporate Income Tax (IRC)

0.16

-0.30

-0.84

-1.42

Value Added Tax (IVA)

-1.02

-1.13

-1.23

-1.34

Social Security Contributions (TSU)

-0.15

-0.68

-1.25

-1.86

Public Sector

Tax Revenues

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The higher and lower price scenarios produce markedly different environmental, economic and budgetary outcomes. Naturally, higher prices across all fuels yield substantially larger reductions in emissions together with more substantial employment and output losses. On the positive side these increases in fossil fuel prices, by contracting the tax base, increase also the opportunity cost of public funds and produce larger reductions in public debt. Table 3 General Effects of Alternative Fossil Fuel Price Scenarios

(Percent change with respect to steady state levels)

2020

2030

2040

2050

Extr. Sup

-13.23

-16.67

-19.28

-21.80

Sup

-9.37

-12.75

-15.36

-17.92

Ref

-3.34

-6.07

-8.61

-11.15

Inf

5.29

3.63

1.17

-1.38

Extr. Inf

10.35

8.81

6.33

3.72

Extr. Sup

0.42

-0.11

-0.53

-0.92

Sup

0.40

-0.04

-0.40

-0.75

Ref

0.34

0.12

-0.12

-0.38

Inf

0.27

0.29

0.18

0.02

Extr. Inf

0.26

0.35

0.27

0.14

Extr. Sup

-0.89

-2.00

-2.86

-3.65

Sup

-0.59

-1.49

-2.23

-2.93

Ref

-0.02

-0.45

-0.94

-1.45

Carbon Dioxide Emissions

Employment

GDP

Inf

0.60

0.70

0.50

0.19

Extr. Inf

0.85

1.10

0.99

0.75

Extr. Sup

-5.02

-9.84

-13.47

-16.10

Sup

-4.22

-8.45

-11.72

-14.10

Ref

-2.28

-5.22

-7.70

-9.58

Inf

-0.08

-1.57

-3.17

-4.49

Extr. Inf

0.52

-0.50

-1.81

-2.95

Public Debt

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4.

On the Environmental, Economic and Budgetary Impact of Energy Efficiency Gains An analysis of the Portuguese energy system using the TIMES_PT model

suggests that autonomous energy efficiency improvements equivalent to an average annual savings in primary energy consumption of 2.5% per year between 2015 and 2030 are cost-effective in the absence of climate policy and at 2010 energy prices. Relative to the existing profile for the energy system in Portugal, this constitutes a potential for reducing emissions by 20% in 2030. The emissions reductions driven by energy efficiency improvements are substantial and can have a significant effect on the national CO2 emissions balance. These improvements, for example, represent 10% of total emissions reported in Portugal in 2012. The economic and budgetary impact of this increase in energy efficiency is evaluated by taking the energy efficiency improvements suggested as exogenous improvements in the productivity of energy resources in our economic model. Energy efficiency improvements of this nature increase the marginal productivity of energy inputs to production. This lowers production costs and stimulates economic activity. The subsequent expansions in the tax base lower the opportunity cost of public funds and public expenditures increase substantially as a result, negatively affecting public sector accounts. The economic and budgetary effects of exogenous energy efficiency improvements of 2% per year are presented in Table 4. By 2030, under the reference fuel price scenario, emissions are 17.4% lower than baseline levels. The improvements in efficiency are not biased in favor of specific energy inputs. As such, their effect across fuels is fairly consistent. The reduction in primary energy consumption and in carbon dioxide emissions from fossil fuel combustion are due to both increasing fossil fuel prices as well as the improvements in energy efficiency. Of this reduction, 11.3% are directly linked to increases in energy efficiency while the remainder of the emissions reduction is due to the evolution of fossil fuel prices in international markets as discussed above.

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More importantly, energy efficiency improvements have a positive impact on employment and output growth. An exogenous improvement in energy efficiency of 2% per year increases GDP 1.1% relative to baseline levels in 2030. This positive economic outcome stands in sharp contrast to the 0.5% reduction in output driven by the evoulatoin of fossil prices. The net effect here is an overall increase in output, relative to the the fule price baseline of 1.6%. Table 4 Detailed Effects of an Annual Energy Efficiency Gain of 2% Under the Reference Fossil Fuel Price Scenario (Percent change with respect to the reference case) 2020

2030

2040

2050

-8.04 -8.19 -8.16 -8.25 -8.25 -20.82 -7.28 -8.19

-17.30 -17.41 -17.39 -17.46 -17.46 -29.00 -16.75 -17.41

-25.53 -25.54 -25.54 -25.54 -25.54 -37.67 -25.52 -25.54

-33.27 -32.78 -32.85 -32.61 -32.61 -50.60 -35.29 -32.78

Growth Rate (Percent Change over Previous Period)

1.06

1.09

1.10

1.10

GDP

-0.21

1.08

2.62

4.21

Private Consumption

2.73

2.77

2.80

2.84

Private Investment

1.92

4.17

6.24

8.16

Private Capital

0.39

1.71

3.43

5.29

Employment

-1.14

-0.46

0.31

1.09

Wages

1.11

1.93

2.86

3.80

Imported Energy

-8.18

-17.41

-25.54

-32.80

25.12

68.04

115.48

161.25

6.89

16.68

25.34

32.02

Energy Energy Fossil Fuels Crude Oil Coal Natural Investiment in wind energy Wind energy Onfrastructures Carbon Dioxide Emissions from Fossil Fuel Combustion Economy

Foreign Debt Public Sector Public Debt Public Expenditures

6.14

6.32

6.46

6.58

Public Consumption

9.66

9.35

8.99

8.62

Public Investment

1.51

3.63

5.63

7.54


1.32

1.61

1.88

2.12

Public Capital

0.33

1.71

3.50

5.38

Human Capital

0.08

0.21

0.36

0.52

Tax Revenues

0.76

1.72

2.77

3.82


0.33

2.83

5.49

8.01


-0.83

0.51

2.27

4.20


2.90

3.27

3.60

3.90

19


0.04

1.68

3.55

5.47

20

5.

On the Environmental, Economic and Budgetary Impact of Carbon Taxation

5.1

On the Choice of Reference Tax Rate We consider the introduction of a tax of 15 Euro per tCO2. This tax level was

chosen based on a recent report by the EEA (2013) and is also indicative of the efforts required to meet domestic targets [see Pereira and Pereira, 2013]. A tax of this level was also introduced in Ireland for those sectors not covered by the European Union Emissions Trading System. The value of 15 Euros per ton is near the average price for CO2 emissions observed in the EU-ETS between 2006 and 2011. During this period, the price of carbon reached a maximum of 34 Euros. Prices, however, have shown a great degree of volatility. The price of carbon fell substantially over weak demand to 8 Euros per tCO2 in 2012, 4.7 Euros in 2013 and an average of 5.96 Euros in 2014. More importantly, from our perspective, is that a tax of 15 Euros is the used as an average reference value for the sectors covered by the EU-ETS for the period from 2015 to 2030 (EC 2013) with the price of carbon growing to 35 Euros in 2030. The value of 15 Euros per tCO2 can therefore be understood as an increasing tax over time but with long term average values hovering around this level. A broad tax will provide for a cost effective allocation of emissions control efforts. In addition, in order to evaluate the global potential for carbon pricing policies in the Portuguese economy we assume that every sector of the economy is subject to the tax. This assumption is consistent with the introduction of a CO2 tax in sectors not covered by the EU-ETS and auctioning permits for those firms participating in the EU-ETS. In this way, firms and sectors not covered by the EU-ETS will face a price signal reflecting the costs of carbon through the tax while those firms and sectors participating in the EU-ETS will face this price signal in the market. Although the current market price for carbon is substantially below 15 Euros per tCO2, adjustments to the cap and projections undertaken for the EU between 2015 and 2030 suggest an average value of 15 Euros per tCO2, as indicated above.

21

22

5.2

On the Impact of a Carbon Tax of 15€ per tCO2 The effect of a 15 Euros per tCO2 tax on energy demand, emissions, economic

performance and the public sector account are presented in Table 5. The CO2 tax increases the price of fossil fuels relative to renewable energy resources and changes the relative price of the different fossil fuels to reflect their carbon content. This has a profound impact on the energy sector, driving a reduction in fossil fuel consumption of 9.9% in 2030 and increasing the stock of wind energy infrastructure by 11.6%. The impact of CO2 taxation on aggregate fossil fuel demand, however, masks important changes in the fuel mix. In particular, we observe a 29.4% reduction in coal consumption while crude oil fall by 6.8% and natural gas by 2.1%. As such, the CO2 tax stimulates a shift in the energy mix which favors wind energy at the expense of coal. The tax reduces CO2 emissions by limiting the growth rate of emissions in order to satisfy the emissions targets. Thus, CO2 emissions are 11.0% lower in 2030. Over the long term, the tax induces a 10.3% reduction in emissions from baseline levels. More ambitious long term targets naturally suggest the need for larger and increasing tax levels. The CO2 tax works primarily through two mechanisms. First, by affecting relative prices, the CO2 tax drives changes to the firms' input structure that affects the marginal productivity of factor inputs. Second, the CO2 tax increases energy expenditure and reduces the firms' net cash flow, household income and domestic demand. These scale and substitution effects are central in defining the impact of CO2 taxation. CO2 taxation, by increasing energy system costs, has a negative impact on the firms' net cash flow which limits the firms' demand for inputs. Employment falls by 0.5% in 2030, less than the reduction in private investment of 1.8% and the associated drop in capital inputs of 1.3% and substantially less than the drop in fossil fuel demand of 9.9%. This is consistent with an overall reduction in input levels coupled with a shift in the firms' input structure away from energy inputs and an increasing role for capital and especially labor. This facet of the substitution mechanisms driving the impact of CO2 taxation is also seen in changes in public and human capital investment.

23

Given the reductions in factor demand, it is no surprise that CO2 taxation has a negative impact on economic growth and activity levels. The reduction in the firms' net cash flow has a direct impact on household income since it is an integral part of total wealth. This drives down private consumption and initiates an important dynamic feedback between income. consumption and production. As a result, private consumption falls by 0.4%. The net effect of this interaction is a reduction in GDP levels of 1.1% in 2030 and 1.4% in 2050. We further observe a reduction in exports and imports, and in particular of fossil fuels. By 2030, fossil fuel imports are 7.7% lower than baseline levels. The reduction in domestic demand, coupled with the reduced expenditure on imported energy resources stemming from demand adjustments, suggests that foreign debt levels fall by 10.3% relative to baseline levels in 2030. The carbon tax contributes positively towards fiscal consolidation. Results suggest that a tax of 15 Euros per tCO2 contributes towards a 1.9% reduction in public debt – equivalent, using 2014 values as a reference point, to a 2.5 percentage point reduction in the public debt to GDP ratio. This positive effect is due fundamentally to reductions in public expenditures but also due to the increased revenues associated with the introduction of the tax. On the revenue side, a reduction in income, consumption and private inputs results in contracting tax bases. Accordingly, we observe a reduction in personal income tax, corporate income tax, value-added tax revenues and in social security contributions. These reductions are clearly offset by the CO2 tax receipts. As a result, total tax revenue is 0.1% greater in 2030. The reduction in tax revenues is particularly pronounced in 2050 led by a reduction in personal income tax receipts of 1.8%, in corporate income tax revenue of 1.6%, in value added tax receipts of 0.7% and in social security contributions of 1.7%. On the expenditure side, and considering an appropriate policy response to high levels of public indebtedness, public expenditures fall by 1.9% in 2030. This increase reflects a shift in public expenditure from consumption to investment. Public

24

consumption falls by 2.4% in 2030 while public capital investment falls 1.7% and human capital investment falls 0.5%. The drop in public investment is again consistent with shifts in the firms' production structure towards labor.

Table 5 Detailed Effects of a 15€ Tax Per tCO2 With Lump Sum Recycling (percentage change vis-a-vis the reference case) 2020

2030

2040

2050

-7.09

-6.38

-6.02

-5.72

-9.97

-9.93

-9.71

-9.39

Crude Oil

-6.68

-6.77

-6.71

-6.60

Coal

-30.22

-29.39

-28.38

-27.20 -2.78

Energy Energy Fossil Fuels

Natural Gas

-2.12

-2.63

-2.71

Investment in wind energy

16.19

11.57

9.96

9.07

Wind energy infrastructures

7.86

10.78

10.71

10.07


-11.07

-10.97

-10.70

-10.32

Economy Growth Rate (Percent Change over Previous Period)

0.90

0.92

0.93

0.93

GDP

-0.76

-1.12

-1.29

-1.40

Private Consumption

-0.42

-0.40

-0.39

-0.37

Private Investment

-1.90

-1.82

-1.81

-1.85

Private Capital

-0.74

-1.29

-1.54

-1.68

Employment

-0.29

-0.45

-0.53

-0.58

Wages

-0.78

-0.93

-0.97

-0.98

Imported Energy

-7.56

-7.65

-7.56

-7.40

Foreign Debt

-5.05

-10.26

-14.31

-17.63

Public Debt

-1.06

-1.91

-2.38

-2.65

Public Expenditures

-1.75

-1.71

-1.70

-1.70

Public Consumption

-2.44

-2.35

-2.30

-2.27

Public Investment

-1.71

-1.70

-1.75

-1.81


-0.40

-0.46

-0.51

-0.55

Public Capital

-0.83

-1.35

-1.58

-1.70

Human Capital

-0.03

-0.07

-0.11

-0.15

0.36

0.14

0.03

-0.04


-0.81

-1.36

-1.63

-1.78


-0.70

-1.24

-1.49

-1.63


-0.74

-0.71

-0.70

-0.69


-1.10

-1.44

-1.61

-1.71

Public Sector

Tax Revenues

25

5.3 On the Impact of Revenue Neutral Fiscal Reform Demand Driven Revenue Recycling Policies For the two demand driven reforms, the CO2 tax revenue is used to stimulate private and public consumption activities by offsetting VAT revenues and by financing public consumption directly. The resulting CO2 tax revenues can finance a 5.0% reduction in the value added tax rate or a 3.7% increase in public consumption relative to the lump sum case. These demand policies yield a small improvement in economic performance over the lump sum recycling policy, yielding a weak double dividend. In both cases, GDP falls by 0.6% while employment falls by 0.2% in 2050 for the value added tax replacement policy and 0.3% for the public consumption financing policy. This small improvement in GDP and in employment outcomes reflects the small distortions associated with indirect taxation. In turn, both demand policies allow for a third dividend as a result of optimal reductions in public spending. The reductions in public debt, however, are smaller than for the lump sum recycling policy. The value added tax replacement policy leads to smaller public debt gains than the public consumption financing policy because the public sector is free to increase public consumption levels in the value added tax replacement policy while public consumption levels are fixed in the public consumption financing policy at the lump sum levels plus the additional spending made possible by the CO2 tax receipts. The principal distinction between the value added tax replacement policy and the public consumption financing policies lies in their impact on private and public consumption behavior. Naturally, the value added tax replacement policy stimulates increased private consumption; the public consumption financing policy, in contrast, encourages increased public consumption.

26

Table 6 Impact of a Carbon Tax of 15€ Per tCO2 With Demand Driven Revenue Recycling Policies

(Percent change with respect to the reference case)


Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

2030

2050

Lump- sum recycling

-10.97

-10.32

-0.45

-0.58

-1.12

-1.40

-1.91

-2.65

IVA recycling

-10.70

-9.96

-0.14

-0.21

-0.81

-1.00

-1.30

-1.68

Public consumption recycling

-10.81

-10.15

-0.25

-0.33

-0.94

-1.22

-4.41

-9.15

Employment Driven Policies We now turn our attention to the employment driven reforms: the personal income tax replacement, firms' social security contributions replacement and human capital investment financing policies. These allow us to evaluate labor responses to reductions in the tax burden on households and firms as well as responses to financing for labor productivity enhancing public sector investment in education. The CO2 tax revenues finance either a 18.0% reduction in the personal income tax rate, a 7.4% reduction in the employers' social security contribution rate or a 7.1% increase in public investment in education. Overall, the employment driven policies generate larger improvements in economic performance and larger reductions in the costs of climate policy than do the demand driven policies. These policies result in a 0.2% reduction in GDP for the personal income tax replacement policy, 0.3% for the firms' social security contributions replacement policy. The human capital investment financing policy produces a strong double dividend, with an increase in GDP of 1.3% in 2050. The personal income tax and firms' social security contributions replacement policies result in a strong double dividend with respect to employment that is, an improvement in environmental performance together with employment gains, while the human capital investment financing does so only in the long run. Employment increases by 0.4% in the personal income tax replacement policy and by 0.3% in the firms' social security contributions replacement

27

while it falls by 0.5% in the human capital financing policy in 2020 increasing by 0.3% in 2050 relative to baseline levels. The main difference between the personal income tax replacement and the remaining two employment policies is the effect on wages. The firms' social security contribution replacement policy represents a labor demand shock which leads to a short term increase in wages. In contrast, the increase in labor supply for the personal income tax replacement policy represents a labor supply shock which yields a 1.0% drop in wages. Similarly, human capital investment serves as a relative substitute for worker hours and yields lower wages. Both the personal income tax replacement and the firms' social security replacement policies allow for a third dividend while the human capital investment financing policy does not. Public debt falls by 3.5% in the personal income tax replacement policy, by 3.2% in the firms' social security contribution replacement policy, and increase by 11.3% in the human capital investment financing policy in 2050, which makes this a rather undesirable option. Table 7 Impact of a Carbon Tax of 15€ Per tCO2 With Employment Driven Revenue Recycling Policies (Percent change with respect to the reference case) Carbon Dioxide Emissions

Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

2030

2050

IRS recycling

-10.45

-9.93

0.30

0.09

-0.54

-0.97

-2.05

-3.47

TSU recycling

-10.53

-9.94

0.16

-0.01

-0.63

-0.98

-1.98

-3.21

Investiment in human capital

-10.01

-7.89

-0.29

0.27

-0.05

1.27

5.62

11.33

Investment-Driven Policies Finally, we consider the cases that use CO2 tax revenues to finance investment in physical capital, namely a private capital and wind energy infrastructure investment tax credit, and public capital investment financing. The resulting tax revenues could be used to finance either a 181 times larger wind energy investment tax credit, a 5.3 times larger

28

private investment tax credit financing or a 16.1% increase in public investment relative to the lump sum policy. The private investment tax credit policy stimulates a 3.6% increase in private investment, boosting GDP by 0.2% by 2020 and 1.0% by 2050. In turn, the public investment financing policy crowds in private investment by 2.7% and yields a 1.0% expansion in economic activity in 2020 and 3.6% in 2050. Accordingly, both policies yield a strong double dividend. In addition, over the long term both policies lead to an increase in employment. Employment increases by 0.2%, in 2050 in the private investment tax credit financing policy and by 0.8% for the public capital financing policy. These employment gains, however, occur only after minor short term losses in employment. The case of the wind energy investment tax credit policy differs in that it only yields a weak double dividend. The relative merits of the private capital investment tax credit and public investment financing policies depends primarily on the marginal products of each type of capital investment, its depreciation rate and adjustment costs. In both policies, the marginal increase in investment financing is equal to the CO2 tax revenue. As a result, the public investment policy is subject to greater adjustment costs due to the relatively smaller stock. Over the long term, however, the lower depreciation rate and slightly larger marginal product provide for a substantial contribution towards economic growth. As more investment in wind energy is undertaken this will yield substantial adjustment costs, nonlinearities in the substitutability of wind energy for other energy resources, and a diminishing marginal product consistent with the fact that additional capacity is more likely to be installed in less productive locations. None of the three investment driven policies yield a third dividend, reducing public debt. The private investment tax credit financing policy increases public debt by 3.3%. The public capital financing policy increases public debt by 13.8%, which makes it a rather undesirable option. The wind energy investment tax credit financing policy increases public debt by 0.3% relative to baseline levels in 2050.

29

Table 8 Impact of a Carbon Tax of 15€ Per tCO2 With Investment Driven Revenue Recycling Policies



Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

2030

2050

Investment tax credit for wind energy

-13.78

-13.52

-0.12

-0.09

-0.56

-0.54

-0.03

0.28

Investment tax credit

-9.39

-8.18

0.07

0.21

0.63

0.95

2.49

3.31

Investiment in public capital

-7.64

-5.77

0.30

0.75

2.57

3.59

9.18

13.84

Mixed Policies The marked differences with respect employment effects and public debt effects among the employment driven and the investment driven policies suggest that combining the two policies may alleviate some of the short term employment losses in the capital investment financing policies – as well as the negative long term budgetary effects while encouraging long term growth through investment in physical capital. Indeed using half of the CO2 tax revenue to reduce the personal income tax and half to financing an increase in the private investment tax credit can reduce emissions, stimulate marginal gains in employment and neutralize the negative long term effects of the CO2 on employment without jeopardizing the long term sustainability of public sector accounts. In general, revenue recycling policies focused on financing corporate income tax deductions for private investment and a combination of reductions in the personal income tax rate and social security contributions appear most promosing, leading to positive employment and output effects with very small effects on public debt levels. This strategy also has the advantage of addressing any equity concerns that may emerge from distributional considerations and concerns regarding the competitiveness of domestic firms.

30

Table 9 Impact of a Carbon Tax of 15€ Per tCO2 With Mixed Revenue Recycling Policies


Investment Tax credit

TSU

50%

25%

50%

50%

50% 50%

5.4

10%

IRS


Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

2030

2050

-9.93

-9.04

0.15

0.13

0.04

0.01

0.26

0.02

-9.95

-9.04

0.12

0.10

0.02

0.00

0.27

0.08

50%

-9.91

-9.03

0.19

0.16

0.06

0.01

0.25

-0.04

40%

-9.91

-9.04

0.17

0.15

0.05

0.01

0.25

-0.02

25%

Effects of Partial Use of CO2 Revenue Although recycling the CO2 tax revenue is importante from both and economic

and budgetary perspective, it is importante to recognize that other considerations – such as environmental concerns, distributional considerations, and electric power rate regulation – may lead to a reduction in the amount of the revenue that can be productively recycled. Partial recycling of the CO2 tax revenues reduces the positive effects of each policy relative to the lump sum case. Both the personal income tax replacement and the social security contributions replacement policies require that at least 50% of the revenue be direct at reducing the effective tax rates in order to produce short run gains in employment. The long term gains (or null effects) materialize only when more than 75% of the revenue is recycled. Similarly, the positive employment and output gains for the investment tax credit only materialize when more than half of the revenue is used to finance an increase in the investment tax credit, with positive results reflected in the 75% recycled case but not the 50% case

31

Table 10 Impact of a Carbon Tax of 15€ Per tCO2 With Partial Revenue Recycling Policies: Pure Strategies



2030

2050

0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90

-10.92 -10.89 -10.86 -10.84 -10.81 -10.79 -10.76 -10.73 -10.71 -10.68 -10.65 -10.63 -10.60 -10.58 -10.55 -10.52 -10.50

-10.28 -10.26 -10.24 -10.22 -10.20 -10.18 -10.16 -10.14 -10.12 -10.10 -10.08 -10.06 -10.04 -10.02 -10.00 -9.98 -9.97

0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90

-10.93 -10.90 -10.88 -10.86 -10.84 -10.82 -10.79 -10.77 -10.75 -10.73 -10.71 -10.68 -10.66 -10.64 -10.62 -10.60 -10.57

-10.28 -10.26 -10.24 -10.22 -10.20 -10.18 -10.17 -10.15 -10.13 -10.11 -10.09 -10.07 -10.05 -10.03 -10.01 -9.99 -9.97

0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90

-10.81 -10.73 -10.65 -10.57 -10.49 -10.41 -10.33 -10.25 -10.17 -10.09 -10.01 -9.94 -9.86 -9.78 -9.70 -9.62 -9.55

-10.11 -10.00 -9.89 -9.78 -9.67 -9.57 -9.46 -9.35 -9.24 -9.14 -9.03 -8.92 -8.82 -8.71 -8.60 -8.50 -8.39

Employment 2030

2050 2030 IRS recycling -0.37 -0.51 -1.06 -0.33 -0.48 -1.03 -0.30 -0.45 -1.00 -0.26 -0.41 -0.97 -0.22 -0.38 -0.94 -0.18 -0.34 -0.91 -0.15 -0.31 -0.88 -0.11 -0.28 -0.85 -0.07 -0.24 -0.82 -0.03 -0.21 -0.79 0.00 -0.17 -0.77 0.04 -0.14 -0.74 0.08 -0.11 -0.71 0.12 -0.07 -0.68 0.16 -0.04 -0.65 0.19 -0.01 -0.62 0.23 0.03 -0.59 TSU Recycling -0.39 -0.53 -1.07 -0.36 -0.50 -1.04 -0.33 -0.47 -1.02 -0.30 -0.44 -0.99 -0.27 -0.41 -0.97 -0.24 -0.38 -0.94 -0.21 -0.35 -0.92 -0.18 -0.32 -0.89 -0.15 -0.30 -0.87 -0.11 -0.27 -0.85 -0.08 -0.24 -0.82 -0.05 -0.21 -0.80 -0.02 -0.18 -0.77 0.01 -0.15 -0.75 0.04 -0.12 -0.72 0.07 -0.09 -0.70 0.10 -0.07 -0.68 Investment tax credit recycling -0.40 -0.50 -0.94 -0.37 -0.46 -0.85 -0.34 -0.42 -0.76 -0.32 -0.38 -0.67 -0.29 -0.34 -0.58 -0.26 -0.30 -0.49 -0.24 -0.26 -0.41 -0.21 -0.23 -0.32 -0.19 -0.19 -0.23 -0.16 -0.15 -0.14 -0.14 -0.11 -0.06 -0.11 -0.07 0.03 -0.08 -0.03 0.12 -0.06 0.01 0.20 -0.03 0.05 0.29 -0.01 0.09 0.38 0.02 0.13 0.46

GDP

Public Debt 2050

2030

2050

-1.36 -1.33 -1.31 -1.29 -1.27 -1.24 -1.22 -1.20 -1.18 -1.16 -1.14 -1.11 -1.09 -1.07 -1.05 -1.03 -1.01

-1.92 -1.93 -1.93 -1.94 -1.94 -1.95 -1.95 -1.96 -1.97 -1.97 -1.98 -1.99 -2.00 -2.01 -2.02 -2.02 -2.03

-2.72 -2.76 -2.80 -2.83 -2.87 -2.91 -2.95 -2.99 -3.03 -3.07 -3.12 -3.16 -3.20 -3.25 -3.29 -3.33 -3.38

-1.36 -1.34 -1.32 -1.29 -1.27 -1.25 -1.23 -1.21 -1.19 -1.16 -1.14 -1.12 -1.10 -1.08 -1.06 -1.04 -1.02

-1.92 -1.92 -1.92 -1.93 -1.93 -1.93 -1.94 -1.94 -1.94 -1.95 -1.95 -1.95 -1.96 -1.96 -1.97 -1.97 -1.97

-2.70 -2.73 -2.75 -2.78 -2.81 -2.83 -2.86 -2.89 -2.92 -2.94 -2.97 -3.00 -3.03 -3.06 -3.09 -3.12 -3.15

-1.16 -1.05 -0.93 -0.81 -0.69 -0.57 -0.45 -0.34 -0.22 -0.10 0.02 0.14 0.25 0.37 0.49 0.60 0.72

-1.48 -1.26 -1.04 -0.82 -0.60 -0.38 -0.16 0.06 0.28 0.50 0.72 0.94 1.16 1.38 1.60 1.83 2.05

-2.06 -1.77 -1.47 -1.18 -0.88 -0.59 -0.29 0.01 0.31 0.60 0.90 1.20 1.50 1.80 2.10 2.40 2.71

32

Table 11 Impact of a Carbon Tax of 15€ per tCO2 With Partial Revenue Recycling Policies: Mixed Strategies


Carbon Dioxide Emissions 2030

2050

Employment 2030

GDP

2050

Public Debt 2030

2050

2030

50 (ITC) 25 (TSU) 25 (IRS) 0.25

-10.71

-10.00

-0.30

-0.40

-0.82

-1.05

-1.37

-1.99

0.50

-10.45

-9.68

-0.15

-0.23

-0.53

-0.70

-0.83

-1.33

0.75

-10.19

-9.36

0.00

-0.05

-0.25

-0.34

-0.29

-0.66

50 (ITC) 50 (TSU) 0.25

-10.71

-10.00

-0.31

-0.41

-0.83

-1.05

-1.37

-1.98

0.50

-10.46

-9.68

-0.17

-0.24

-0.55

-0.70

-0.82

-1.30

0.75

-10.20

-9.36

-0.02

-0.07

-0.26

-0.35

-0.28

-0.61

50 (ITC) 50 (IRS) 0.25

-10.70

-10.00

-0.29

-0.40

-0.82

-1.05

-1.38

-2.00

0.50

-10.44

-9.68

-0.13

-0.21

-0.52

-0.69

-0.84

-1.35

0.75

-10.17

-9.36

0.03

-0.03

-0.23

-0.34

-0.30

-0.70

50 () 10 (TSU) 40 (IRS)

5.5

0.25

-10.70

-10.00

-0.29

-0.40

-0.82

-1.05

-1.37

-2.00

0.50

-10.44

-9.68

-0.14

-0.22

-0.53

-0.69

-0.83

-1.34

0.75

-10.18

-9.36

0.02

-0.04

-0.24

-0.34

-0.29

-0.68

Sensitivity Analysis: On the Effects of Different Price Scenarios Each of the price scenarios presents a range of different level and relative price

movements by 2030, including an increase in crude oil prices of 10.8% in the reference fuel price scenario, 38.2% in the high fuel price scenario and a reduction of 16.6% in the low price scenario. The different scenario also suggest a range of differences in the prices of coal and natural gas, with coal prices changing by 25.5%, 21.23% and 16.9% in the high, reference and low price scenarios respectively, the smallest range of values for the fossil fuels considered. In contrast, natural gas prices show more substantial variability with changes of in natural gas prices of 59.5%, 24.9% and -9.7% in the high, reference and low price scenarios respectively. The relative prices for coal and natural gas differ markedly across the two scenarios; coal prices increase by 29.5% relative to natural gas

33

prices in the low price scenario and decrease by 21.3% relative to natural gas prices in the high price scenario. As such, the superior and inferior scenarios should not be construed as simply high and low price scenarios. Overall the low price scenarios suggest a very large shift from coal to natural gas as part of the baseline trajectory for the economy. In contrast, the high price scenario implies a shift towards coal, and away from natural gas and oil. In the high price scenario natural gas consumption is 33.5% below steady state levels and oil consumption is 21.4% below steady state levels in 2050 while coal consumption is 16.4% lower. For the low price scenario coal consumption is similarly lower (16.2%) while both natural gas and oil consumption are above steady state levels. In addition, the high fuel price scenarios reflect a substantial negative impact on GDP while the low price scenarios reflect an increase in GDP over steady state levels. With these considerations in mind, the Sup scenarios generally imply smaller economic and budgetary effects that do the references scenario while the Inf scenarios suggest greater costs associated with the policy. This may further be driven by the fact that the unit tax on CO2 emissions implicitly yields a smaller% increase in the price of the different fuels in the Sup scenarios than in the Inf scenarios. As such, the effects – relative to their respective baselines – are smaller for the Sup scenarios and larger in the Inf scenarios. Generally, however, these values fall within a relatively narrow range. The scenarios yield between a 0.54 and 0.64 reduction in employment, a 1.3 and 1.5% reduction in GDP and a reduction in public debt between 2.5 and 2.9% relative to their respective baseline levels by 2050.

34

Table 12 Sensitivity Analysis: Effects of Different Fossil Fuel Price Scenarios


IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS)

5.6

Carbon Dioxide Employment Emissions 2030 2050 2030 2050 Central Fuel Price Assumptions -10.45 -9.93 0.30 0.09 -10.53 -9.94 0.16 -0.01 -9.39 -8.18 0.07 0.21 -9.93 -9.04 0.15 0.13 -9.95 -9.04 0.12 0.10 -9.91 -9.03 0.19 0.16 -9.91 -9.04 0.17 0.15 Extra Sup -9.49 -9.02 0.28 0.08 -9.57 -9.01 0.15 -0.02 -8.46 -7.32 0.08 0.20 -8.98 -8.16 0.15 0.12 -9.00 -8.16 0.11 0.09 -8.96 -8.15 0.18 0.14 -8.97 -8.15 0.17 0.13 Sup -10.21 -9.68 0.29 0.08 -10.29 -9.68 0.15 -0.02 -9.17 -7.97 0.07 0.20 -9.70 -8.81 0.15 0.12 -9.72 -8.82 0.11 0.10 -9.68 -8.81 0.19 0.15 -9.68 -8.81 0.17 0.14 Inf -11.10 -10.57 0.32 0.11 -11.19 -10.59 0.17 0.00 -10.02 -8.76 0.06 0.22 -10.57 -9.65 0.16 0.14 -10.60 -9.66 0.12 0.11 -10.55 -9.65 0.19 0.17 -10.56 -9.65 0.18 0.16 Extra Inf -12.04 -11.45 0.33 0.12 -12.13 -11.47 0.17 0.00 -10.95 -9.61 0.06 0.22 -11.50 -10.52 0.16 0.14 -11.53 -10.53 0.12 0.11 -11.48 -10.51 0.20 0.17 -11.49 -10.52 0.18 0.16

GDP

Public Debt

2030

2050

2030

2050

-0.54 -0.63 0.63 0.04 0.02 0.06 0.05

-0.97 -0.98 0.95 0.01 0.00 0.01 0.01

-2.05 -1.98 2.49 0.26 0.27 0.25 0.25

-3.47 -3.21 3.31 0.02 0.08 -0.04 -0.02

-0.50 -0.58 0.63 0.06 0.03 0.08 0.07

-0.94 -0.93 0.91 0.00 0.00 0.00 0.00

-2.00 -1.96 2.35 0.21 0.21 0.20 0.20

-3.51 -3.28 3.13 -0.10 -0.05 -0.15 -0.13

-0.52 -0.60 0.63 0.05 0.03 0.07 0.06

-0.95 -0.95 0.92 0.00 0.00 0.01 0.00

-2.02 -1.98 2.40 0.22 0.23 0.21 0.22

-3.51 -3.27 3.19 -0.06 -0.01 -0.12 -0.09

-0.57 -0.67 0.63 0.02 0.00 0.05 0.04

-1.01 -1.02 1.00 0.01 0.00 0.02 0.02

-2.13 -2.02 2.62 0.30 0.33 0.28 0.29

-3.51 -3.20 3.50 0.11 0.18 0.04 0.07

-0.59 -0.69 0.64 0.02 -0.01 0.04 0.03

-1.03 -1.05 1.02 0.01 0.00 0.02 0.01

-2.19 -2.06 2.69 0.32 0.34 0.29 0.30

-3.56 -3.24 3.59 0.13 0.21 0.06 0.09

Sensitivity Analysis: On the Effects of Different Technical Substitution

Possibilities It is widely recognized in the literature that the elasticity of substitution between added and energy as well as among energy inputs play a significant role in a general equilibrium analysis of energy-related matters. This is because the appropriate choice for the elasticity of substitution parameters can yield smooth continuous approximations consistent with engineering estimates from bottom up representations of the energy

35

system. The elasticity of substitution between value and energy measures the facility with which firms can substitute capital and labor for energy inputs. The elasticity of substitution between oil and other energy inputs measures the ease with which firms can substitute between oil and non-transportation fuels – coal, natural gas and wind energy. The economic and budgetary effects of CO2 emissions limits and CO2 taxation are more sensitive to the specification of the elasticity of substitution between value added and energy than that among energy inputs. A lower elasticity of substitution implies that a greater degree of emissions reductions must originate in reduced output as opposed to substitution away from fossil fuels in production. This means that a greater tax is required to achieve the emissions objective and the GDP impacts of the policy are greater. Similarly, the larger tax also means greater revenues and a more positive effect on public debt levels. In contrast, from the perspective of a 15.00 Euros per tCO2, the greater substitution elasticity implies larger tax interaction effects and larger policy costs. The magnitude of the results, though not the ranking of the policies nor general considerations regarding the realization of the third dividend, are most sensitive to restrictions on the ease with which firms can substitute away from energy in production. Generally, the order of magnitude of the changes in the economic and budgetary results due to differences in the elasticities of substitution, particularly in the effect of moving to a Cobb-Douglas specification – a widely understood effect – are on par with the changes generated by the endogenous growth mechanisms and endogenous public sector behavior.

36

Table 13 Sensitivity Analysis: Elasticity of Substitution between Value Added and Energy


IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS)

Carbon Dioxide Emissions 2030 2050 𝜎 = 0.125 -6.25 -6.16 -6.34 -6.17 -5.07 -4.15 -5.67 -5.14 -5.69 -5.14 -5.64 -5.13 -5.65 -5.13 𝜎 = 0.400 -10.45 -9.93 -10.53 -9.94 -9.39 -8.18 -9.93 -9.04 -9.95 -9.04 -9.91 -9.03 -9.91 -9.04 𝜎 = 1.000 -18.89 -17.59 -18.96 -17.60 -18.07 -16.29 -18.49 -16.94 -18.51 -16.94 -18.47 -16.93 -18.48 -16.94

Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

0.33 0.18 0.07 0.17 0.13 0.21 0.19

0.11 -0.01 0.23 0.15 0.12 0.17 0.16

-0.41 -0.51 0.84 0.21 0.18 0.23 0.22

-0.91 -0.91 1.21 0.17 0.17 0.18 0.18

-2.31 -2.17 2.73 0.28 0.31 0.25 0.27

-3.97 -3.57 3.72 0.03 0.12 -0.06 -0.03

0.30 0.16 0.07 0.15 0.12 0.19 0.17

0.09 -0.01 0.21 0.13 0.10 0.16 0.15

-0.54 -0.63 0.63 0.04 0.02 0.06 0.05

-0.97 -0.98 0.95 0.01 0.00 0.01 0.01

-2.05 -1.98 2.49 0.26 0.27 0.25 0.25

-3.47 -3.21 3.31 0.02 0.08 -0.04 -0.02

0.25 0.12 0.06 0.12 0.09 0.16 0.14

0.07 -0.01 0.17 0.10 0.08 0.12 0.11

-0.76 -0.84 0.25 -0.26 -0.29 -0.24 -0.25

-1.05 -1.06 0.51 -0.27 -0.27 -0.26 -0.26

-1.59 -1.63 2.04 0.23 0.21 0.24 0.24

-2.57 -2.52 2.58 0.03 0.03 0.02 0.02

Table 14 Sensitivity Analysis: Elasticity of Substitution between Oil and Other Fossil Fuels (Percent change with respect to the reference case)

IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS) IRS TSU ITC 50 (ITC) 25 (TSU) 25 (IRS) 50 (ITC) 50 (TSU) 50 (ITC) 50 (IRS) 50 (ITC) 10 (TSU) 40 (IRS)

Carbon Dioxide Emissions 2030 2050 𝜎 = 0.125 -10.44 -9.94 -10.52 -9.95 -9.38 -8.19 -9.91 -9.05 -9.94 -9.06 -9.89 -9.05 -9.90 -9.05 𝜎 = 0.400 -10.45 -9.93 -10.53 -9.94 -9.39 -8.18 -9.93 -9.04 -9.95 -9.04 -9.91 -9.03 -9.91 -9.04 𝜎 = 1.000 -10.47 -9.89 -10.55 -9.90 -9.42 -8.15 -9.95 -9.01 -9.97 -9.01 -9.93 -9.00 -9.94 -9.00

Employment

GDP

Public Debt

2030

2050

2030

2050

2030

2050

0.31 0.16 0.07 0.15 0.12 0.19 0.17

0.09 -0.01 0.21 0.13 0.10 0.16 0.15

-0.54 -0.63 0.63 0.04 0.02 0.06 0.05

-0.97 -0.98 0.96 0.01 0.00 0.01 0.01

-2.06 -1.99 2.50 0.26 0.28 0.25 0.26

-3.48 -3.21 3.32 0.02 0.08 -0.04 -0.01

0.30 0.16 0.07 0.15 0.12 0.19 0.17

0.09 -0.01 0.21 0.13 0.10 0.16 0.15

-0.54 -0.63 0.63 0.04 0.02 0.06 0.05

-0.97 -0.98 0.95 0.01 0.00 0.01 0.01

-2.05 -1.98 2.49 0.26 0.27 0.25 0.25

-3.47 -3.21 3.31 0.02 0.08 -0.04 -0.02

0.30 0.16 0.07 0.15 0.11 0.19 0.17

0.09 -0.01 0.21 0.13 0.10 0.16 0.15

-0.53 -0.62 0.63 0.04 0.02 0.06 0.06

-0.96 -0.97 0.95 0.01 0.00 0.01 0.01

-2.05 -1.98 2.47 0.25 0.27 0.24 0.24

-3.46 -3.20 3.29 0.01 0.07 -0.05 -0.02

37

5.7

Sensitivity Analysis: Different Behavioral Assumption for the Public Sector The overarching message is that only in a very limited number of cases can

positive budgetary outcomes be sustained through the combination of revenue raised directly by the CO2 tax and net positive second order effects. That is, curtailing spending, particularly public consumption, is an essential component of fiscal reform policies capable of producing the third dividend. Exogenous public consumption decisions affect both the magnitude and the nature of the second dividend, particularly with respect to employment. Exogenous public consumption decisions can produce marginally favorable labor market outcomes and allow for a realization of the strong double dividend that would not materialize in the presence of optimal adjustments to public consumption. This is most notable for the public consumption financing policy and the wind energy investment tax credit financing policy in which a strong employment dividend materializes in the presence of an exogenous public consumption trajectory. Exogenous public sector investment decisions also affect the magnitude of the second dividend. By preventing policy induced reductions in investment spending, we observe positive economic growth effects, suggesting lower policy costs than in the presence of the endogenous growth mechanisms. Generally, exogenous public investment levels serve to dampen the effects of the policies. Consider now the third dividend. An exogenous trajectory for public consumption implies that, in most cases, optimal reductions in public consumption do not materialize. This effectively eliminates the gains in fiscal consolidation in all but the firms' social security contributions option. In contrast, lower levels of public consumption in the public investment financing policy allow for a third dividend where it did not exist before. In general, it is clear that responsible public consumption decisions are critical for the third dividend to materialize.

38

Table 15 Sensitivity Analysis: With Respect to the Model Structure


ITC

TSU

100% 100% 50% 50% 50% 50%

25% 50% 10% 100%

100% 50% 50% 50% 50%

25% 50% 10%

IRS 100% 25% 50% 40% 100% 25% 50% 40% 100%

100% 50% 50% 50% 50%

100% 25% 50% 10%

25% 50% 40% 100%

100% 50% 50% 50% 50%

100% 25% 50% 10%

25% 50% 40%

Carbon Dioxide Employment Emissions 2030 2050 2030 2050 Central Assumption -10.45 -9.93 0.30 0.09 -10.53 -9.94 0.16 -0.01 -9.39 -8.18 0.07 0.21 -9.93 -9.04 0.15 0.13 -9.95 -9.04 0.12 0.10 -9.91 -9.03 0.19 0.16 -9.91 -9.04 0.17 0.15 Exogenous Public Consumption (1) -10.50 -9.99 0.25 0.07 -10.62 -10.07 0.06 -0.11 -9.32 -8.08 0.14 0.27 -10.23 -9.35 0.10 0.07 -10.27 -9.38 0.05 0.02 -10.16 -9.27 0.19 0.16 -10.18 -9.28 0.17 0.14 Exogenous Growth (2) -10.15 -9.27 0.29 0.24 -10.24 -9.35 0.15 0.12 -9.46 -8.40 0.08 0.15 -9.83 -9.04 0.25 0.21 -9.97 -9.00 0.10 0.12 -9.79 -8.82 0.20 0.22 -10.01 -8.97 0.17 0.22 Exogenous Public Sector (1+2) -10.13 -9.24 0.32 0.29 -10.26 -9.38 0.12 0.08 -9.43 -8.37 0.13 0.18 -10.12 -9.14 0.08 0.10 -10.16 -9.18 0.03 0.05 -10.09 -9.10 0.13 0.15 -10.10 -9.12 0.11 0.13

GDP

Public Debt

2030

2050

2030

2050

-0.54 -0.63 0.63 0.04 0.02 0.06 0.05

-0.97 -0.98 0.95 0.01 0.00 0.01 0.01

-2.05 -1.98 2.49 0.26 0.27 0.25 0.25

-3.47 -3.21 3.31 0.02 0.08 -0.04 -0.02

-0.59 -0.73 0.71 -0.02 -0.06 0.06 0.05

-1.04 -1.13 1.06 -0.08 -0.11 0.01 0.00

0.36 -1.06 0.95 0.26 -0.11 0.66 0.51

2.36 -0.90 -0.37 0.12 -0.72 0.97 0.63

-0.21 -0.30 0.55 0.15 -0.01 0.19 -0.05

-0.24 -0.33 0.71 0.01 0.06 0.25 0.09

-0.34 -0.47 1.88 2.08 -0.57 2.47 0.03

-0.43 -0.61 2.20 5.17 -0.58 5.14 0.40

-0.19 -0.33 0.59 0.11 0.07 0.14 0.13

-0.21 -0.36 0.74 0.16 0.12 0.20 0.18

1.06 -0.54 0.78 0.47 0.06 0.88 0.72

2.82 -0.86 -0.33 0.25 -0.71 1.20 0.82

39

6.

On the Environmental Economic and Budgetary Impact of Alternative Tax Levels Our focus on a tax of 15 Euros per tCO2 have allowed for a detailed assessment of

the mechanisms through which the tax can affect environmental outcomes, economic performance and the public sector account and has allowed us to assess the relative effects of different revenue recycling policies. From a broader perspective – associated with the choice among energy technologies or economic and political considerations – it is important to examine the impact of alternative levels of taxation. In this section, we present marginal abatement cost curves associated with the introduction of CO2 tax with revenues recycled in a lump sum fashion.

6.1

Marginal Abatement Cost Cusrves Table 16 presents the marginal abatement cost curves for 2030 and 2050 fully

incorporating the dynamic feedbacks between emissions, energy costs, economic activity and the public sector account. Emissions abatement are measured as percent deviations from the baseline defined by the reference fuel price scenario and corresponding to tax levels up to 50.00 Euros per tCO2 in increments of 0.50 Euros. The CO2 tax revenues are transferred to the households in a lump sum fashion. We further consider three complementary abatement cost curves. The second panel depicts the labor market effects of reducing emissions through CO2 taxes. The second and third panels depict the economic impact on employment and GDP while the fourth panel, depicts the impact on public debt. These complementary curves suggest that, although CO2 taxes produce a meaningful reduction in CO2 emissions, they have a negative impact on economic performance, particularly over the long term. In addition, they have positive budgetary effects, contributing to reductions in public debt, the longrun effects being again more pronounced. Higher tax rates will produce larger reductions in emissions consistent with those required to reduce emissions by 20% relative to 1990 levels by 2030. The accompanying

40

economic and budgetary impacts of these policies are also substantially larger. From the marginal abatement cost curves we note that a tax of 50 Euros per tCO2 can reduce emissions by 25.2% relative to baseline levels in 2030, while reducing employment, over the long term (by 2050) by 1.7% and GDP by 4.2%. On the positive side, this is accompanied by a 8.2% in public debt levels. The long term effects of the revenue recycling options mirror these effects with substantially larger reductions in employment, GDP and public debt in those policies in which only a weak form of the double dividend materializes and larger gains in those in which the strong form of the double dividend materializes – with accompanying effects on public debt levels. A tax of 75 Euros per tCO2 can reduce emissions by 31.7% in 2030 at the cost of a 2.5% reduction in employment and a 6.1% reduction in GDP in 2050. Here, public debt levels in 2050 are 11.8% lower than baseline levels.

Table 16 Marginal Abatement Cost Curves Panel 1 – Carbon Dioxide Emissions 0 Percentagem

-5 -10 -15 -20 -25 -30 0

5

10

15

20

25

30

35

40

45

50

40

45

50

Carbon Tax (Euros per tCO2) Lump Sum (2030) Lump Sum (2050)

Panel 2 – Employment

Percentagem

0,0 -0,5 -1,0 -1,5 -2,0 0

5

10

15

20

25

30

35


41

Panel 3 – GDP 0 Percentagem

-1 -2 -3 -4 -5 0

5

10

15

20

25

30

35

40

45

50

40

45

50


Panel 4 – Public Debt 0 Percentagem

-2 -4 -6 -8 -10 0

5

10

15

20

25

30

35


6.2

Effects of other levels of taxation with mixed recycling strategies In the preceding section, we examined the marginal abatement cost curves

associated with CO2 taxes under the assumption that the revenues raised are returned to households in a lump sum fashion. In this section, we consider, in detail, the effects of different levels of CO2 taxation with the mixed revenue recycling policies considered above.

42

Mixed recycling strategies – 50% CFIP; 40% IRS; 10% TSU Table 17 Impact on Energy and Emissions (Percent change with respect to the reference case) 2020

2030

2040

2050

-4.19

-3.95

-3.74

-3.52

-2.59 -3.68 -2.14 -13.02 -0.16 6.35 3.10

-2.14 -3.47 -2.01 -12.35 -0.23 4.72 4.29

-1.91 -3.29 -1.92 -11.71 -0.22 4.13 4.34

-1.74 -3.11 -1.85 -11.03 -0.25 3.79 4.14

-7.58

-7.18

-6.83

-6.48

-4.69 -6.72 -4.14 -22.49 -0.67 12.25 5.88

-3.86 -6.37 -3.90 -21.49 -0.76 9.12 8.24

-3.46 -6.07 -3.74 -20.52 -0.71 7.99 8.36

-3.17 -5.77 -3.60 -19.47 -0.74 7.34 7.99

-10.43

-9.93

-9.49

-9.04

-6.46 -9.32 -6.01 -29.70 -1.40 17.81 8.42

-5.31 -8.87 -5.68 -28.55 -1.48 13.27 11.92

-4.76 -8.48 -5.45 -27.41 -1.38 11.63 12.14

-4.37 -8.10 -5.26 -26.15 -1.39 10.70 11.61

-12.91

-12.33

-11.81

-11.30

-8.00 -11.61 -7.77 -35.41 -2.26 23.07 10.77

-6.54 -11.09 -7.35 -34.20 -2.32 17.22 15.39

-5.87 -10.63 -7.06 -32.96 -2.17 15.09 15.71

-5.41 -10.18 -6.83 -31.59 -2.15 13.89 15.05

-17.07

-16.38

-15.78

-15.17

-10.59 -15.51 -10.97 -43.90 -4.20 32.92 15.01

-8.59 -14.89 -10.42 -42.68 -4.22 24.63 21.80

-7.71 -14.34 -10.04 -41.39 -3.96 21.57 22.36

-7.13 -13.79 -9.74 -39.94 -3.86 19.87 21.48

5 Euros per tCO2 Carbon Dioxide Emissions from Fossil Fuel Combustion Energy Energy

Fossil Fuels Crude Oil Coal Natural

Investiment in wind energy Wind energy Onfrastructures




15 Euros per tCO2 Carbon Dioxide Emissions from Fossil Fuel Combustion Energy Energy Fossil Fuels

Crude Oil Coal Natural

Investiment in wind energy Wind energy Onfrastructures 20 Euros per tCO2 Carbon Dioxide Emissions from Fossil Fuel Combustion Energy Energy






43

Table 18 Economic Impact (Percent change with respect to the reference case) 2020

2030

2040

2050

0.96 -0.01 0.00 0.53 0.23 0.04 -0.07 -2.57 0.51

0.95 0.03 0.00 0.43 0.34 0.06 -0.03 -2.43 0.72

0.94 0.03 0.01 0.37 0.37 0.06 -0.02 -2.32 0.61

0.94 0.02 0.01 0.33 0.36 0.05 -0.01 -2.23 0.36

0.96 -0.03 -0.01 0.99 0.42 0.08 -0.15 -4.84 0.94

0.95 0.04 0.00 0.80 0.65 0.11 -0.08 -4.60 1.30

0.94 0.04 0.00 0.70 0.70 0.11 -0.05 -4.40 1.06

0.94 0.02 0.01 0.62 0.68 0.09 -0.03 -4.24 0.59

0.97 -0.05 -0.03 1.41 0.60 0.12 -0.23 -6.90 1.29

0.95 0.04 -0.02 1.15 0.92 0.15 -0.13 -6.57 1.77

0.94 0.05 -0.01 1.00 1.00 0.15 -0.08 -6.30 1.39

0.93 0.01 0.00 0.89 0.97 0.13 -0.06 -6.08 0.68

0.97 -0.08 -0.05 1.80 0.77 0.15 -0.31 -8.78 1.59

0.95 0.04 -0.04 1.46 1.18 0.19 -0.18 -8.38 2.15

0.94 0.04 -0.03 1.28 1.27 0.19 -0.12 -8.06 1.62

0.93 -0.01 -0.02 1.13 1.24 0.16 -0.09 -7.78 0.67

0.98 -0.14 -0.11 2.48 1.06 0.21 -0.48 -12.15 2.06

0.95 0.01 -0.10 2.02 1.63 0.27 -0.30 -11.64 2.68

0.94 0.01 -0.08 1.76 1.75 0.26 -0.22 -11.23 1.81

0.93 -0.07 -0.07 1.56 1.71 0.23 -0.18 -10.88 0.35

5 Euros per tCO2 Growth Rate (Percent Change over Previous Period) GDP Private Consumption Private Investment Private Capital Employment Wages Imported Energy Foreign Debt 10 Euros per tCO2 Growth Rate (Percent Change over Previous Period) GDP Private Consumption Private Investment Private Capital Employment Wages Imported Energy Foreign Debt 15 Euros per tCO2 Growth Rate (Percent Change over Previous Period) GDP Private Consumption Private Investment Private Capital Employment Wages Imported Energy Foreign Debt 20 Euros per tCO2 Growth Rate (Percent Change over Previous Period) GDP Private Consumption Private Investment Private Capital Employment Wages Imported Energy Foreign Debt 30 Euros per tCO2 Growth Rate (Percent Change over Previous Period) GDP Private Consumption Private Investment Private Capital Employment Wages Imported Energy Foreign Debt

44

Table 19 Budgetary Impact (Percent change with respect to the reference case) 2020

2030

2040

2050

0.09 -0.04 0.02 -0.12 -0.12 -0.09 -0.01 -0.04 -0.87 -3.12 0.07 -0.71 -0.04

0.11 -0.04 0.01 -0.08 -0.14 -0.09 -0.02 -0.01 -0.77 -2.95 0.06 -0.66 0.00

0.07 -0.05 0.02 -0.09 -0.15 -0.09 -0.03 -0.01 -0.74 -2.87 0.05 -0.64 0.01

0.02 -0.05 0.02 -0.11 -0.16 -0.09 -0.05 -0.01 -0.73 -2.81 0.05 -0.64 -0.01

0.15 -0.10 0.01 -0.25 -0.25 -0.17 -0.02 -0.08 -1.68 -6.02 0.12 -1.38 -0.08

0.19 -0.10 0.00 -0.17 -0.27 -0.19 -0.04 -0.03 -1.50 -5.72 0.10 -1.29 -0.01

0.12 -0.11 0.01 -0.19 -0.29 -0.18 -0.07 -0.02 -1.45 -5.56 0.09 -1.26 -0.01

0.03 -0.11 0.02 -0.23 -0.32 -0.20 -0.09 -0.03 -1.44 -5.47 0.08 -1.26 -0.03

0.21 -0.17 -0.02 -0.39 -0.37 -0.26 -0.03 -0.12 -2.45 -8.76 0.16 -2.02 -0.14

0.26 -0.17 -0.03 -0.27 -0.40 -0.29 -0.06 -0.06 -2.20 -8.34 0.13 -1.89 -0.04

0.16 -0.18 -0.02 -0.30 -0.44 -0.28 -0.10 -0.05 -2.13 -8.13 0.12 -1.85 -0.03

0.02 -0.19 0.00 -0.36 -0.47 -0.31 -0.13 -0.06 -2.12 -8.00 0.11 -1.86 -0.06

0.26 -0.25 -0.07 -0.53 -0.49 -0.35 -0.03 -0.17 -3.19 -11.37 0.19 -2.64 -0.19

0.31 -0.25 -0.08 -0.38 -0.53 -0.39 -0.08 -0.09 -2.88 -10.84 0.15 -2.48 -0.07

0.18 -0.26 -0.06 -0.41 -0.58 -0.39 -0.13 -0.08 -2.79 -10.58 0.14 -2.43 -0.06

0.00 -0.27 -0.04 -0.49 -0.63 -0.43 -0.18 -0.10 -2.79 -10.42 0.12 -2.44 -0.11

0.33 -0.43 -0.19 -0.82 -0.72 -0.54 -0.05 -0.27 -4.58 -16.26 0.23 -3.81 -0.32

0.38 -0.43 -0.20 -0.61 -0.79 -0.61 -0.12 -0.16 -4.16 -15.56 0.18 -3.60 -0.16

0.17 -0.45 -0.18 -0.66 -0.86 -0.62 -0.20 -0.15 -4.06 -15.22 0.15 -3.54 -0.15

-0.09 -0.46 -0.15 -0.77 -0.94 -0.68 -0.27 -0.18 -4.06 -15.01 0.13 -3.56 -0.22

5 Euros per tCO2 Public Debt Public Expenditures Public Consumption Public Investment Investment in Human Capital Public Capital Human Capital Tax Revenues Personal Income Tax (IRS) Corporate Income Tax (IRC) Value Added Tax (IVA) Social Security Contributions (Employer) Social Security Contributions (Worker) 10 Euros per tCO2 Public Debt Public Expenditures Public Consumption Public Investment Investment in Human Capital Public Capital Human Capital Tax Revenues Personal Income Tax (IRS) Corporate Income Tax (IRC) Value Added Tax (IVA) Social Security Contributions (Employer) Social Security Contributions (Worker) 15 Euros per tCO2 Public Debt Public Expenditures Public Consumption Public Investment Investment in Human Capital Public Capital Human Capital Tax Revenues Personal Income Tax (IRS) Corporate Income Tax (IRC) Value Added Tax (IVA) Social Security Contributions (Employer) Social Security Contributions (Worker) 20 Euros per tCO2 Public Debt Public Expenditures Public Consumption Public Investment Investment in Human Capital Public Capital Human Capital Tax Revenues Personal Income Tax (IRS) Corporate Income Tax (IRC) Value Added Tax (IVA) Social Security Contributions (Employer) Social Security Contributions (Worker) 30 Euros per tCO2 Public Debt Public Expenditures Public Consumption Public Investment Investment in Human Capital Public Capital Human Capital Tax Revenues Personal Income Tax (IRS) Corporate Income Tax (IRC) Value Added Tax (IVA) Social Security Contributions (Employer) Social Security Contributions (Worker)

45

Mixed recycling strategies - 50% CFIP; 50% TSU Table 20 Impact on Energy and Emissions (Percent change with respect to the reference case) 2020

2030

2040

2050

-4.20

-3.95

-3.74

-3.53

-2.60 -3.69 -2.15 -13.03 -0.17 6.34 3.09

-2.15 -3.48 -2.02 -12.36 -0.24 4.71 4.28

-1.92 -3.30 -1.93 -11.71 -0.23 4.13 4.34

-1.75 -3.12 -1.86 -11.03 -0.25 3.80 4.14

-7.59

-7.19

-6.84

-6.49

-4.70 -6.74 -4.16 -22.50 -0.69 12.23 5.87

-3.88 -6.39 -3.92 -21.50 -0.77 9.11 8.23

-3.47 -6.08 -3.75 -20.53 -0.72 7.99 8.35

-3.17 -5.77 -3.61 -19.47 -0.74 7.35 7.99

-10.46

-9.95

-9.50

-9.04

-6.48 -9.34 -6.04 -29.72 -1.42 17.77 8.41

-5.33 -8.90 -5.70 -28.57 -1.50 13.25 11.90

-4.78 -8.50 -5.46 -27.42 -1.40 11.63 12.12

-4.38 -8.10 -5.26 -26.16 -1.39 10.71 11.61

-12.94

-12.35

-11.83

-11.30

-8.03 -11.64 -7.80 -35.43 -2.29 23.02 10.75

-6.57 -11.11 -7.38 -34.22 -2.35 17.19 15.36

-5.89 -10.65 -7.08 -32.97 -2.19 15.09 15.69

-5.42 -10.18 -6.83 -31.60 -2.15 13.91 15.05

-17.11

-16.42

-15.80

-15.17

-10.63 -15.55 -11.01 -43.92 -4.24 32.85 14.98

-8.63 -14.92 -10.46 -42.70 -4.26 24.59 21.76

-7.73 -14.36 -10.07 -41.41 -3.98 21.57 22.33

-7.14 -13.80 -9.74 -39.94 -3.87 19.90 21.47















46


2030

2040

2050

0.96 -0.02 -0.02 0.51 0.22 0.03 0.02 -2.58 0.54

0.95 0.02 -0.02 0.42 0.34 0.04 0.06 -2.44 0.80

0.94 0.02 -0.02 0.37 0.36 0.04 0.07 -2.33 0.78

0.94 0.01 -0.01 0.33 0.36 0.04 0.07 -2.23 0.62

0.96 -0.05 -0.05 0.97 0.41 0.05 0.03 -4.86 0.98

0.95 0.02 -0.05 0.79 0.63 0.08 0.10 -4.62 1.47

0.94 0.03 -0.04 0.70 0.69 0.08 0.12 -4.41 1.40

0.94 0.01 -0.04 0.63 0.68 0.07 0.13 -4.24 1.09

0.97 -0.08 -0.09 1.38 0.59 0.08 0.04 -6.92 1.36

0.95 0.02 -0.08 1.13 0.90 0.12 0.12 -6.59 2.02

0.94 0.03 -0.08 1.00 0.98 0.12 0.16 -6.32 1.89

0.94 0.00 -0.07 0.90 0.97 0.10 0.18 -6.08 1.43

0.97 -0.11 -0.13 1.75 0.75 0.10 0.03 -8.81 1.68

0.95 0.00 -0.12 1.44 1.15 0.15 0.14 -8.41 2.48

0.94 0.02 -0.11 1.27 1.25 0.15 0.20 -8.08 2.28

0.93 -0.02 -0.10 1.15 1.23 0.13 0.22 -7.79 1.65

0.98 -0.19 -0.23 2.42 1.03 0.14 0.01 -12.19 2.19

0.95 -0.03 -0.21 1.99 1.59 0.20 0.16 -11.68 3.18

0.94 -0.02 -0.20 1.76 1.73 0.20 0.24 -11.25 2.79

0.93 -0.07 -0.19 1.59 1.70 0.18 0.27 -10.88 1.82


47


2030

2040

2050

0.08 0.00 0.09 -0.13 -0.10 -0.09 -0.01 -0.01 -0.09 -3.13 0.05 -1.30 0.04

0.11 0.00 0.08 -0.09 -0.11 -0.10 -0.02 0.01 0.00 -2.96 0.04 -1.24 0.08

0.08 0.00 0.08 -0.09 -0.12 -0.09 -0.03 0.02 0.02 -2.87 0.04 -1.21 0.09

0.04 0.00 0.09 -0.11 -0.13 -0.10 -0.04 0.01 0.01 -2.82 0.03 -1.19 0.08

0.15 -0.01 0.14 -0.27 -0.21 -0.19 -0.01 -0.03 -0.17 -6.04 0.09 -2.52 0.07

0.20 -0.01 0.14 -0.18 -0.23 -0.20 -0.03 0.01 -0.02 -5.74 0.07 -2.41 0.14

0.15 -0.02 0.14 -0.19 -0.25 -0.19 -0.06 0.02 0.01 -5.58 0.06 -2.35 0.15

0.06 -0.02 0.15 -0.23 -0.27 -0.20 -0.08 0.01 0.00 -5.47 0.06 -2.33 0.13

0.21 -0.04 0.18 -0.42 -0.31 -0.28 -0.02 -0.06 -0.26 -8.78 0.12 -3.68 0.09

0.27 -0.04 0.17 -0.29 -0.34 -0.31 -0.05 0.01 -0.05 -8.37 0.09 -3.52 0.19

0.20 -0.05 0.17 -0.30 -0.37 -0.30 -0.08 0.02 0.00 -8.15 0.08 -3.45 0.20

0.08 -0.05 0.19 -0.35 -0.40 -0.32 -0.11 0.01 -0.02 -8.01 0.07 -3.41 0.17

0.26 -0.08 0.19 -0.57 -0.41 -0.38 -0.03 -0.09 -0.35 -11.39 0.13 -4.79 0.10

0.33 -0.08 0.18 -0.40 -0.45 -0.42 -0.07 -0.01 -0.08 -10.87 0.10 -4.59 0.22

0.23 -0.09 0.19 -0.42 -0.49 -0.41 -0.11 0.01 -0.02 -10.61 0.08 -4.50 0.24

0.08 -0.10 0.21 -0.48 -0.53 -0.43 -0.15 -0.01 -0.04 -10.44 0.07 -4.46 0.20

0.33 -0.19 0.18 -0.88 -0.61 -0.57 -0.04 -0.15 -0.53 -16.29 0.15 -6.88 0.10

0.42 -0.18 0.17 -0.64 -0.66 -0.65 -0.10 -0.05 -0.17 -15.60 0.10 -6.62 0.26

0.26 -0.19 0.18 -0.66 -0.72 -0.65 -0.16 -0.03 -0.09 -15.25 0.08 -6.51 0.28

0.04 -0.21 0.21 -0.75 -0.79 -0.68 -0.23 -0.05 -0.12 -15.03 0.06 -6.46 0.22


48

Mixed recycling strategies – 50% CFIP; 50% IRS Table 23 Impact on Energy and Emissions (Percent change with respect to the reference case) 2020

2030

2040

2050

-4.18

-3.94

-3.73

-3.52

-2.58 -3.67 -2.14 -13.02 -0.15 6.36 3.10

-2.13 -3.47 -2.00 -12.34 -0.22 4.73 4.30

-1.91 -3.29 -1.92 -11.70 -0.21 4.14 4.35

-1.74 -3.11 -1.85 -11.03 -0.25 3.79 4.14

-7.56

-7.16

-6.82

-6.48

-4.67 -6.70 -4.13 -22.47 -0.65 12.28 5.89

-3.85 -6.36 -3.89 -21.48 -0.74 9.14 8.26

-3.45 -6.06 -3.73 -20.51 -0.70 8.00 8.37

-3.17 -5.76 -3.60 -19.47 -0.73 7.34 7.99

-10.41

-9.91

-9.47

-9.03

-6.44 -9.30 -5.99 -29.69 -1.37 17.84 8.44

-5.28 -8.85 -5.66 -28.54 -1.45 13.29 11.94

-4.75 -8.47 -5.43 -27.40 -1.37 11.64 12.15

-4.37 -8.09 -5.26 -26.15 -1.38 10.69 11.62

-12.88

-12.30

-11.80

-11.29

-7.97 -11.58 -7.74 -35.39 -2.22 23.12 10.79

-6.52 -11.06 -7.32 -34.18 -2.29 17.24 15.42

-5.86 -10.61 -7.04 -32.95 -2.15 15.10 15.73

-5.41 -10.17 -6.82 -31.59 -2.14 13.87 15.06

-17.03

-16.35

-15.76

-15.16

-10.55 -15.47 -10.93 -43.87 -4.15 32.99 15.04

-8.55 -14.85 -10.38 -42.65 -4.18 24.66 21.85

-7.69 -14.31 -10.02 -41.38 -3.93 21.57 22.39

-7.13 -13.79 -9.73 -39.94 -3.86 19.84 21.48








Investiment in wind energy Wind energy Onfrastructures 20 Euros per tCO22 Carbon Dioxide Emissions from Fossil Fuel Combustion Energy Energy Fossil Fuels





49


2030

2040

2050

0.96 0.00 0.02 0.54 0.23 0.06 -0.16 -2.56 0.49

0.95 0.03 0.03 0.43 0.35 0.07 -0.12 -2.42 0.63

0.94 0.03 0.03 0.37 0.38 0.07 -0.10 -2.32 0.44

0.94 0.02 0.03 0.33 0.36 0.06 -0.10 -2.22 0.11

0.96 -0.01 0.03 1.01 0.44 0.11 -0.33 -4.83 0.89

0.95 0.05 0.04 0.81 0.66 0.13 -0.25 -4.59 1.13

0.94 0.05 0.05 0.71 0.71 0.13 -0.21 -4.39 0.73

0.93 0.02 0.05 0.62 0.68 0.11 -0.20 -4.23 0.08

0.97 -0.03 0.03 1.44 0.62 0.16 -0.49 -6.87 1.23

0.95 0.06 0.04 1.16 0.94 0.19 -0.38 -6.55 1.52

0.94 0.06 0.05 1.01 1.01 0.18 -0.33 -6.29 0.89

0.93 0.01 0.06 0.88 0.98 0.16 -0.30 -6.07 -0.08

0.97 -0.05 0.03 1.84 0.79 0.20 -0.65 -8.75 1.50

0.95 0.07 0.04 1.48 1.20 0.24 -0.51 -8.36 1.81

0.94 0.06 0.05 1.28 1.29 0.23 -0.44 -8.04 0.95

0.93 0.00 0.06 1.12 1.24 0.20 -0.41 -7.78 -0.34

0.98 -0.10 0.00 2.54 1.09 0.29 -0.97 -12.11 1.92

0.95 0.05 0.02 2.05 1.66 0.34 -0.77 -11.61 2.17

0.93 0.03 0.03 1.76 1.78 0.32 -0.67 -11.20 0.81

0.93 -0.06 0.05 1.54 1.71 0.27 -0.62 -10.87 -1.15


50


2030

2040

2050

0.09 -0.09 -0.05 -0.11 -0.14 -0.08 -0.01 -0.06 -1.65 -3.11 0.09 -0.12 -0.12

0.10 -0.09 -0.06 -0.07 -0.16 -0.08 -0.02 -0.03 -1.53 -2.94 0.07 -0.08 -0.08

0.06 -0.09 -0.05 -0.09 -0.17 -0.08 -0.04 -0.03 -1.49 -2.86 0.07 -0.08 -0.08

0.00 -0.10 -0.05 -0.11 -0.19 -0.09 -0.05 -0.03 -1.48 -2.81 0.06 -0.09 -0.09

0.16 -0.19 -0.13 -0.23 -0.29 -0.16 -0.02 -0.12 -3.18 -6.01 0.15 -0.24 -0.24

0.19 -0.19 -0.13 -0.16 -0.31 -0.17 -0.05 -0.07 -2.98 -5.70 0.13 -0.17 -0.17

0.10 -0.20 -0.13 -0.19 -0.34 -0.17 -0.08 -0.07 -2.91 -5.55 0.12 -0.16 -0.16

-0.01 -0.20 -0.11 -0.24 -0.37 -0.19 -0.10 -0.08 -2.88 -5.46 0.11 -0.19 -0.19

0.21 -0.30 -0.22 -0.36 -0.43 -0.25 -0.03 -0.18 -4.64 -8.74 0.21 -0.36 -0.36

0.25 -0.30 -0.23 -0.25 -0.47 -0.27 -0.07 -0.12 -4.35 -8.32 0.18 -0.26 -0.26

0.12 -0.31 -0.22 -0.29 -0.51 -0.27 -0.11 -0.11 -4.26 -8.11 0.16 -0.26 -0.26

-0.04 -0.32 -0.20 -0.37 -0.55 -0.31 -0.16 -0.13 -4.23 -7.98 0.15 -0.30 -0.30

0.26 -0.42 -0.33 -0.49 -0.56 -0.33 -0.04 -0.25 -6.02 -11.34 0.25 -0.49 -0.49

0.29 -0.42 -0.33 -0.36 -0.62 -0.37 -0.10 -0.17 -5.67 -10.81 0.21 -0.36 -0.36

0.12 -0.43 -0.32 -0.41 -0.67 -0.37 -0.15 -0.16 -5.56 -10.56 0.19 -0.36 -0.36

-0.09 -0.45 -0.29 -0.50 -0.73 -0.42 -0.21 -0.19 -5.53 -10.41 0.17 -0.42 -0.42

0.32 -0.67 -0.57 -0.77 -0.84 -0.51 -0.06 -0.39 -8.63 -16.22 0.30 -0.74 -0.74

0.34 -0.68 -0.58 -0.58 -0.92 -0.58 -0.14 -0.28 -8.17 -15.52 0.25 -0.58 -0.58

0.08 -0.70 -0.55 -0.65 -1.00 -0.60 -0.23 -0.27 -8.03 -15.18 0.22 -0.58 -0.58

-0.22 -0.72 -0.51 -0.79 -1.09 -0.67 -0.31 -0.31 -8.00 -14.99 0.20 -0.66 -0.66


51

Mixed recycling strategies - 50% CFIP; 40% IRS; 10% TSU Table 26 Impacto n Energy and Emissions (Percent change with respect to the reference case) 2020

2030

2040

2050

-4.18

-3.94

-3.73

-3.52

-2.59 -3.68 -2.14 -13.02 -0.16 6.36 3.10

-2.14 -3.47 -2.01 -12.34 -0.22 4.73 4.30

-1.91 -3.29 -1.92 -11.71 -0.22 4.13 4.34

-1.74 -3.11 -1.85 -11.03 -0.25 3.79 4.14

-7.57

-7.17

-6.83

-6.48

-4.68 -6.71 -4.13 -22.48 -0.66 12.27 5.89

-3.86 -6.36 -3.89 -21.48 -0.75 9.13 8.25

-3.46 -6.06 -3.73 -20.51 -0.71 7.99 8.37

-3.17 -5.77 -3.60 -19.47 -0.73 7.34 7.99

-10.42

-9.91

-9.48

-9.04

-6.44 -9.31 -6.00 -29.69 -1.38 17.83 8.43

-5.29 -8.86 -5.66 -28.54 -1.46 13.28 11.94

-4.75 -8.47 -5.44 -27.40 -1.37 11.63 12.15

-4.37 -8.09 -5.26 -26.15 -1.38 10.69 11.62

-12.89

-12.31

-11.80

-11.30

-7.98 -11.59 -7.75 -35.40 -2.24 23.10 10.78

-6.53 -11.07 -7.33 -34.18 -2.31 17.23 15.41

-5.86 -10.62 -7.05 -32.95 -2.16 15.09 15.72

-5.41 -10.17 -6.83 -31.59 -2.14 13.88 15.06

-17.05

-16.36

-15.76

-15.17

-10.56 -15.49 -10.95 -43.88 -4.17 32.97 15.03

-8.57 -14.87 -10.40 -42.66 -4.20 24.65 21.83

-7.70 -14.32 -10.03 -41.38 -3.94 21.57 22.38

-7.13 -13.79 -9.73 -39.94 -3.86 19.85 21.48















52


2030

2040

2050

0.96 -0.01 0.01 0.53 0.23 0.05 -0.13 -2.56 0.50

0.95 0.03 0.02 0.43 0.35 0.06 -0.09 -2.43 0.67

0.94 0.03 0.02 0.37 0.37 0.06 -0.07 -2.32 0.50

0.94 0.02 0.02 0.33 0.36 0.05 -0.06 -2.22 0.21

0.96 -0.02 0.02 1.00 0.43 0.10 -0.26 -4.83 0.91

0.95 0.05 0.02 0.81 0.66 0.12 -0.18 -4.59 1.20

0.94 0.05 0.03 0.71 0.70 0.12 -0.15 -4.40 0.86

0.94 0.02 0.03 0.62 0.68 0.10 -0.13 -4.23 0.28

0.97 -0.04 0.01 1.43 0.61 0.14 -0.38 -6.88 1.25

0.95 0.05 0.02 1.16 0.94 0.17 -0.28 -6.56 1.62

0.94 0.06 0.03 1.00 1.00 0.17 -0.23 -6.30 1.09

0.93 0.01 0.03 0.88 0.97 0.15 -0.20 -6.07 0.23

0.97 -0.06 0.00 1.82 0.78 0.18 -0.51 -8.76 1.54

0.95 0.05 0.01 1.47 1.19 0.22 -0.38 -8.37 1.95

0.94 0.05 0.02 1.28 1.28 0.22 -0.31 -8.05 1.22

0.93 -0.01 0.03 1.12 1.24 0.19 -0.28 -7.78 0.06

0.98 -0.12 -0.04 2.52 1.08 0.26 -0.77 -12.12 1.98

0.95 0.03 -0.03 2.03 1.65 0.31 -0.58 -11.62 2.38

0.94 0.02 -0.01 1.76 1.77 0.30 -0.49 -11.21 1.21

0.93 -0.06 0.00 1.55 1.71 0.25 -0.45 -10.87 -0.55


53


2030

2040

2050

0.09 -0.07 -0.03 -0.11 -0.14 -0.08 -0.01 -0.05 -1.33 -3.11 0.08 -0.36 -0.09

0.11 -0.07 -0.03 -0.08 -0.15 -0.08 -0.02 -0.02 -1.23 -2.95 0.07 -0.31 -0.05

0.07 -0.07 -0.02 -0.09 -0.16 -0.08 -0.04 -0.02 -1.19 -2.86 0.06 -0.30 -0.04

0.01 -0.08 -0.02 -0.11 -0.18 -0.09 -0.05 -0.03 -1.18 -2.81 0.06 -0.31 -0.06

0.16 -0.15 -0.08 -0.24 -0.27 -0.17 -0.02 -0.10 -2.58 -6.01 0.14 -0.70 -0.18

0.19 -0.15 -0.08 -0.16 -0.29 -0.18 -0.05 -0.05 -2.39 -5.71 0.12 -0.62 -0.11

0.11 -0.16 -0.07 -0.19 -0.32 -0.17 -0.07 -0.05 -2.32 -5.56 0.11 -0.60 -0.10

0.01 -0.17 -0.06 -0.23 -0.35 -0.20 -0.10 -0.06 -2.31 -5.46 0.10 -0.62 -0.13

0.21 -0.25 -0.14 -0.37 -0.40 -0.25 -0.03 -0.16 -3.76 -8.75 0.19 -1.03 -0.27

0.25 -0.25 -0.15 -0.26 -0.44 -0.27 -0.07 -0.09 -3.49 -8.33 0.16 -0.92 -0.17

0.14 -0.26 -0.14 -0.30 -0.48 -0.27 -0.11 -0.08 -3.41 -8.12 0.14 -0.90 -0.17

-0.02 -0.27 -0.12 -0.36 -0.52 -0.31 -0.15 -0.10 -3.39 -7.99 0.13 -0.92 -0.21

0.26 -0.35 -0.22 -0.51 -0.53 -0.34 -0.04 -0.22 -4.89 -11.35 0.23 -1.35 -0.37

0.30 -0.35 -0.23 -0.37 -0.58 -0.38 -0.09 -0.14 -4.55 -10.82 0.19 -1.21 -0.25

0.15 -0.37 -0.22 -0.41 -0.64 -0.38 -0.14 -0.13 -4.45 -10.57 0.17 -1.19 -0.24

-0.05 -0.38 -0.19 -0.50 -0.69 -0.43 -0.20 -0.15 -4.43 -10.41 0.15 -1.23 -0.29

0.33 -0.58 -0.42 -0.79 -0.79 -0.52 -0.06 -0.34 -7.01 -16.24 0.27 -1.97 -0.57

0.35 -0.58 -0.43 -0.59 -0.87 -0.59 -0.14 -0.23 -6.57 -15.53 0.22 -1.79 -0.41

0.12 -0.60 -0.40 -0.66 -0.95 -0.61 -0.22 -0.22 -6.44 -15.20 0.19 -1.77 -0.41

-0.17 -0.62 -0.37 -0.78 -1.03 -0.67 -0.30 -0.26 -6.42 -15.00 0.17 -1.82 -0.49


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6.3

Summary The mixed strategies for revenue recycling have the capacity to reduce CO2

emissions from fossil fuel combustion activity and generate positive employment effects while eliminating any negative effects on GDP and maintaining current public sector budgetary balances. For a tax of 15 Euros per tCO2, the most favorable outcomes materialize when half of the CO2 tax revenues are used to finance an increase in the corporate income tax deduction for private investment and half of the revenues are used to finance a reduction in the personal income tax. This policy reduces CO2 emissions by 9.91% relative to baseline levels while increasing employment by 0.16% and GDP by 0.06% in 2030. Neutrality for the public sector is only achieved over the long run with public debt levels unchanged in 2050. Lower levels of taxation will reduce the positive environmental and economic outcomes associated with the green fiscal reform while increasing the tax levels will increase the environmental effectiveness and marginally increase the employment gains from the fiscal reform. The effects on output for different tax levels are minimal. The effects on public debt, however, become more beneficial, promoting fiscal consolidation in the long run, with higher levels of taxation.

55

Table 29 Impact of Carbon Taxatio with Mixed Recycling Strategies (Percent change with respect to the reference case) ITC

TSU

IRS

Carbon Dioxide Emissions 2030

2050

Employment 2030

GDP

Public Debt

2050

2030

2050

2030

2050

5 Euros per tCO2 50%

25%

50%

50%

50% 50%

10%

25%

-3.95

-3.52

0.06

0.05

0.03

0.02

0.11

0.02

-3.95

-3.53

0.04

0.04

0.02

0.01

0.11

0.04

50%

-3.94

-3.52

0.07

0.06

0.03

0.02

0.10

0.00

40%

-3.94

-3.52

0.06

0.05

0.03

0.02

0.11

0.01


25%

50%

50%

50% 50%

10%

25%

-7.18

-6.48

0.11

0.09

0.04

0.02

0.19

0.03

-7.19

-6.49

0.08

0.07

0.02

0.01

0.20

0.06

50%

-7.16

-6.48

0.13

0.11

0.05

0.02

0.19

-0.01

40%

-7.17

-6.48

0.12

0.10

0.05

0.02

0.19

0.01


25%

50%

50%

50% 50%

10%

25%

-9.93

-9.04

0.15

0.13

0.04

0.01

0.26

0.02

-9.95

-9.04

0.12

0.10

0.02

0.00

0.27

0.08

50%

-9.91

-9.03

0.19

0.16

0.06

0.01

0.25

-0.04

40%

-9.91

-9.04

0.17

0.15

0.05

0.01

0.25

-0.02


25%

50%

50%

50% 50%

10%

25%

-12.33

-11.30

0.19

0.16

0.04

-0.01

0.31

0.00

-12.35

-11.30

0.15

0.13

0.00

-0.02

0.33

0.08

50%

-12.30

-11.29

0.24

0.20

0.07

0.00

0.29

-0.09

40%

-12.31

-11.30

0.22

0.19

0.05

-0.01

0.30

-0.05


25%

50%

50%

50% 50%

10%

25%

-16.38

-15.17

0.27

0.23

0.01

-0.07

0.38

-0.09

-16.42

-15.17

0.20

0.18

-0.03

-0.07

0.42

0.04

50%

-16.35

-15.16

0.34

0.27

0.05

-0.06

0.34

-0.22

40%

-16.36

-15.17

0.31

0.25

0.03

-0.06

0.35

-0.17

56

7.

Summary and Policy Recommendations

7.1

Overview of the Results We have identified important environmental, economic and budgetary effects

associated with the evolution of fossil fuel prices in international markets. Increasing fossil fuel prices lead to a substantial reduction in CO2 emissions though these are accompanied by negative economic and budgetary outcomes. We have also identified important technological opportunities which can, through an increase in energy efficiency, lead to a reduction in CO2 emissions while promoting economic growth and fiscal consolidation. Furthermore, by 2030, a tax of 15 Euros per tCO2 can lead to a 10.9% reduction in CO2 emissions relative to baseline level, the projected trajectory for fossil fuel prices can induce a 6.1% reduction in emissions, and energy efficiency improvements can lead to a 11.3% reduction in CO2 emissions relative to baseline levels. The combined effects of these policies is approximately a 28.3% reduction in emissions in 2030 relative to baseline levels. Our results have also highlighted the environmental, economic and budgetary impact of the introduction a tax of 15 Euros per tCO2. The tax alone – absent accompanying revenue recycling policies – reduces CO2 emissions but has a negative effect on economic performance both in terms of output and employment. It is possible, however, to design a revenue neutral fiscal reform package that can produce three dividends. That is, the introduction of a CO2 tax with accompanying reductions in distortionary tax rates or financing for public or tax expenditures can reduce emissions while producing long term economic and budgetary effects that are positive or, at a minimum, neutral. The realization of the second and third dividend depends on the judicious use of the revenues generated to neutralize or reverse the negative economic and budgetary effects associated with the tax in its most direct form. The revenue recycling policies that appear most promising are those that use the revenue raised from the tax on CO2 emissions to finance private investment tax credits and a reduction in social security contributions and the personal income tax rate.

57

Recycling the tax revenues through a mixture of reductions to the personal income tax, social security contributions and financing for corporate income tax deductions for private investment produces importante changes in the cost structure of our economy, increasing the costs of energy while reducing the costs associated with labor and capital inputs. Naturally, allowing for the leakage of a meaningful amount of carbon tax revenues away from these purposes would seriously hinder the ability of the recycling strategies to mitigate and invert the potential negative economic effects of the tax itself.

7.2

Implementation Issues The introduction of a carbon tax itself poses some important institutional

challenges. First, the participation of limited number of firms and sectors in the EU-ETS requires some reflection. Different prices for carbon in different sectors will cause the resulting distribution of emissions control efforts to deviate from cost-effective levels, increasing the costs associated with achieving a particular environmental objective. This differentiation across sectors may also give rise to equity concerns that may jeopardize the political feasibility of the proposal. Given the low cost of carbon associated for those participating in the EU-ETS, it may be necessary to introduce a surcharge on carbon for those sector participating in the EU-ETS in order to normalize the market price of carbon from above. Another option may be to normalize prices from below, that is, to index the carbon tax to the prevailing price of carbon in emissions markets. This alternative, however, may reduce the environmental gains associated with the proposed green fiscal reform. This option may be appealing as a means to set up the institutional capacity and mechanisms for the introduction of a new fiscal policy instrument – a tax on carbon dioxide emissions. Furthermore, with a tightening of the emissions cap, carbon prices are forecasted to grow over the next 30 years in which case the subsequent reductions in emissions will be more pronounced. In either instance, the emissions permits traded in the EU-ETS should be auctioned to mitigate adverse tax interactions. Second, it is understood that often a carbon tax leads to distributional concerns as low income households may potentially suffer disproportionately from the tax. It is

58

important that these concerns not be addressed through exemptions for the tax, thereby neutralizing the price signal and environmental benefits associated with the tax. These distributional concerns can be fully addressed within the context of reform in the personal income tax while maintained the price signal associated with the tax. This recommendation is consistent with that of international instututions such as the OECD and the IMF, among others. Thus, the potential to recycle the CO2 tax revenue through reduction in the personal income tax rate discussed above, beyond its efficiency effects, can also serve this function by differentiating the reduction in the personal income tax rate in a manner that supports low income households. Third, it is also understood that the carbon tax may create some concerns in a country critically dependent on improving its international competitiveness. It is important not to address these conerns through exemptions to the tax so as not to reduce the environmental effectiveness of the proposed fiscal reform. These concerns can be addressed through a reduction in labor costs by reducing social security contributions or in the context of the provision of corporate income tax deductions for investments in private capital. In particular, both the adjustments to the firms’ social security contributions as well as incentives for private investment can be differentiated by sector in order to address concerns about competitiveness in energy intensive industries. Finally, reducing firms’ social security contributions – while desirable from an economic perspective in terms of its effect on output and employment (functioning in much the same way as fiscal devaluation) – must be accompanied by mechanisms to ensure that this reduction does not have a negative effect on the long term sustainability of the social security accounts. Furthermore, caution is required in implementing this fiscal reform policy to avoid problems of political economy that have been observed a year ago in Portugal.

7.3

Caveats

59

Despite its detail and policy relevance, the analysis presented in this paper suffers from two important shortcomings. First, it is an aggregate model and therefore does not accommodate sector specific issues pertaining to the energy and the environment. In particular, it does not allow for a differentiation between the sectors that participate in the European carbon market, responsible for about 37% of the CO2 emissions, and those which do not. Indeed, we have assumed that the price of carbon is equal across all sectors. Those sectors participating in the EU-ETS face this price through permit auctions while those do not participate in the EU-ETS face this price through the tax. Note that the free distribution of the emissions permits provides those firms participating in the EUETS with a valuable commodity which can be sold and thereby increase the firms cash flow. As a corollary, this implies that an important opportunity cost exists when the cost of abatement within the firm exceed the price of permits in the market – a consideration with important economic implications. This dimension of the policy environment has been explored in a limited way due to time constraints. Second, the model does not contemplate the differential effects across different income groups of the introduction of the carbon tax. The welfare effects of the CO2 tax among different household groups is directly driven by the share of consumers' expenditure devoted to energy goods. As gasoline, electricity and other household energy sources are necessary goods – the demand for these goods increases at a less than proportional rate than income – the expenditure shares for energy are greater among lower income households. As a result, the compensating and equivalent variation in income will be greater among lower income households. These differences may be substantial with welfare effects among lower income groups four times greater than those among higher income groups. The regressivity of the tax can be addressed through the appropriate adjustments to the personal income tax in the context of the fiscal reform as suggested above.

7.4

Final Thoughts

60

We conclude with some final reflections associated with the introduction of a tax on CO2 emissions that are not directly associated with the model results nor inspired by them. First, it is imperative that the introduction of the tax is undertaken in a transparent fashion and through the active effort, participation and communication with stakeholders to ensure the success of the fiscal reform. Second, environmentally damaging subsidies should be eliminated. More generally, the introduction of a tax on CO2 emissions is only one part, albeit an important one, of a comprehensive package of policy instruments required to address the multiple dimensions of the environmental, economic and budgetary problems that the country faces.

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