confirmed by different country studies applying a modelling framework to analyse the effects of a
carbon or energy tax on households, even without revenue redistribution Smith 1992; Cornwell and
Creedy, 1996; OECD, 1997; Symons et al., 1997; Barker and Ko¨hler, 1998a. Interesting results are
obtained when energy products are distinguished between domestic energy e.g. energy used for
heating, cooking, lighting, etc. and transport fu- els. In those studies, it appears that the overall
weak regressive effect of carbon taxes is due to taxes on domestic energy because the taxation of
transport fuels possesses a weakly progressive out- come for most European Union countries Barker
and Ko¨hler, 1998a.
Unfortunately, there are few studies on the distributional effects of a carbon tax in developing
countries or countries with economies in transi- tion. Of the few, a study by Shah and Larsen
1992; quoted in OECD, 1995 showed that the impact of a carbon tax in Pakistan could even be
mildly progressive.
Recycling of carbon taxes’ fiscal revenues may offset some of the regressive impacts. There are
two basic options in that context: 1. A ‘lump-sum redistribution’ of fiscal revenues
to population. Such a scheme would correct for distributional impacts because the lowest
incomes will receive a higher amount, com- pared to their income, than highest-income
households. However, this scheme would probably have negative effects on macroeco-
nomic
variables, such
as prices
and employment.
2. Reduction in ‘labour taxes’ a decrease in ‘in- come taxation’, or ‘changes in social security
system’, such as an increase in housing benefits and social benefits based on means-tested
benefits. Those options can have a better out- come in terms of mitigating distributional ef-
fects than lump-sum redistribution. However, such measures should be accompanied by a
complementary
redistribution policy
that targets those social groups that do not benefit
directly from such tax cuts, such as pensioners and the unemployed.
Another possible compensation measure to de- crease the distributional impacts is through the
design of the tax. For instance, energy — in partic- ular metered domestic energy — could be taxed
only above a certain floor so that each household has a tax-free energy allowance. The idea is that
some amount of energy is necessary to satisfy basic needs. Above that floor, energy would be
progressively taxed to maintain the incentive ef- fect to reduce energy consumption. Such a scheme
is already implemented in the Dutch regulatory tax on energy, which provides complete exemp-
tions from the tax to certain small consumers. Such a scheme could also be applied in the trans-
port sector, where distributional issues may ap- pear between urban households and households
living in rural areas without a good public trans- port system. However, administrative costs should
be considered.
5. Environmental impacts
A main reason for implementing carbon taxes is their potential to achieve environmental goals, in
particular the reduction of carbon dioxide emis- sions, while simultaneously increasing economic
efficiency OECD, 1997. In addition, since a re- duction in CO
2
emissions is closely associated with a decrease in fossil fuel consumption, local
air quality may be improved. Compared to the benefits of climate change mitigation and preven-
tion, which are global and longterm, the benefits resulting from the reduction of these local envi-
ronmental problems would mainly accrue in the short term and at the localregional level.
31
A review of the literature by Pearce et al. 1996
found that the estimates of additional environ- mental benefits range widely, from 2 per ton of
carbon abated, to over 500tC see also, Burtraw and Toman, 1997, for a survey of US studies;
Baranzini, 1997b, for a survey of European stud- ies. In some cases, secondary environmental
benefits may thus offset some of the costs of
31
Accounting for these additional environmental benefits could give rise to so-called ‘no-regrets’ policies, i.e. policies
that are worth from an efficiency point of view implementing in their own right, irrespective of the climate change reduction
benefits they may have.
carbon taxes. For instance, Alfsen et al. 1992; quoted in Pearce et al., 1996 calculated that
‘secondary’ environmental benefits may offset about one-third of the initial abatement costs in
Norway. Amano 1994; quoted in Pearce et al., 1996
found similar
results for
developing countries.
However, the actual impact of a carbon tax on emissions cannot be known in advance. Indeed, if
the tax rate is set at a relatively low level com- pared to marginal abatement costs, or if energy
demand is relatively insensitive to price changes i.e. it is inelastic, then emissions will not de-
crease sufficiently to attain a given abatement objective. Even in that case, the environmental
effectiveness of a carbon tax should not be judged based only on its short-term effects. The price
signal given by a tax could, for instance, be included in future investment decisions, at the
time when the old capital is replaced by new technologies Goulder and Schneider, 1999.
Therefore, as illustrated by, for example, the oil price-shock in the 1970s, the long-term effect of a
tax on emissions could be greater than its short- term impact, since the production sector and con-
sumer behaviour have the time to adapt to new conditions Godard, 1993. For OECD countries,
long-term price elasticity for energy range from −
0.3 to − 1.2; in the transport sector, long-term price elasticity for the consumption of petrol has
been estimated at approximately − 0.65 to − 1.0, and − 0.1 to − 0.4 for the number of kilometres
driven EC, 1997, for a survey.
32
The environ- mental effectiveness of a carbon tax will also
depend on at least two other factors: 1. ‘The use of carbon taxes fiscal revenues’. With
respect to environmental effectiveness, two main options may be considered. First, carbon
taxes fiscal revenues could be used to subsidise renewable energy. In the second option, fiscal
revenues may be used for investments in en- ergy saving and research and development. In
Europe, only three EC member states provide investment incentives in income and corporate
taxation for the production of renewable en- ergy, while several have been implemented for
energy-savings EC, 1997. With respect to the respective environmental effectiveness, we may
expect subsidies on renewable energy to per- form better than subsidies in energy-savings.
Indeed, the latter may be profitable anyway, while subsidies on renewable energy may
change the balance for renewable energies.
2. The ‘point of imposition’ of the carbon tax. If the tax is placed ‘upstream’ in the energy
chain, then in principle there is a wide range of available market options to react to the price
signal. In addition, monitoring costs could be relatively low, since emitting sources are few.
However, there is a danger that the tax base will include non-emitting activities OECD,
1996. For instance, fossil fuels also have non- fuel uses, and thus do not emit CO
2
in the atmosphere. Moreover, specific domestic cir-
cumstances like fixed-term contracts, peculiar- ities of the existing tax system or regulatory
reporting systems could finally determine the point of imposition of the tax.
However, other factors may reduce the environ- mental effectiveness of a carbon tax over time,
such as: 1. In the presence of inflation, the tax rate may
lose some of its real value over time, if it is not automatically indexed. However, even a con-
stant tax rate may sometimes be consistent with increased emissions abatement in the fu-
ture because cheaper new technologies for emissions or fuel abatement are implemented
or it corrects pre-existing market failures Schneider and Goulder, 1997. In any case, all
the Nordic countries that have implemented carbon taxes have included a mechanism to
index the tax rate to inflation so that the price signal is kept constant in real terms Baron,
1996. Also, the UK has introduced the ‘road fuel escalator’, which increases the excise tax
on motor fuel by 6 in real terms per annum.
2. The entry of new polluters in the market will cause carbon emissions to rise, and thus the
tax rate should evolve accordingly, to continue providing sufficient incentives to achieve a
given reduction objective. However, since the
32
A price elasticity for the consumption of petrol of − 1.0 means that an increase of the price of petrol by 1 will
decrease its consumption by 1.
tax rate is administratively fixed, it will not automatically change e.g. because frequent
modification of the tax rate is politically difficult, and the environmental effectiveness
of the carbon tax may decrease over time.
Empirical studies evaluating the environmental effectiveness of already implemented carbon taxes
are rather limited OECD, 1997. This lack of appropriate studies can be ascribed to the fact
that there are several methodological difficulties and complexities in doing such evaluation studies
on that topic, cf. Barde, 1997. The few evalua- tion studies show that carbon tax may be an
effective instrument in reducing CO
2
emissions:
An evaluation study of the Swedish CO
2
tax carried out by the Swedish Environmental Pro-
tection Agency SEPA concludes that the CO
2
tax ‘‘…has helped to reduce emissions of car- bon dioxide in line with Swedish environmental
policy’’ SEPA, 1997, p. 52.
Researchers at Statistics Norway found that ‘‘the total effect of the CO
2
tax on CO
2
emis- sions studied in this analysis was 3-4 for the
period 1991 – 1993’’ Larsen and Nesbakken, 1997, p. 287. The study is based on a counter-
factual ex post approach, estimating the energy consumption without a CO
2
tax and compar- ing this result with the actual energy consump-
tion and emissions. To assess this result correctly it has to be seen that only about 40
of total taxable Norwegian CO
2
emissions are covered in this evaluation study.
A short communication of the Ministry of Housing, Spatial Planning and Environment
1997 evaluated that The Netherlands’ Regula- tory tax on energy could reduce by 1.5 the
total domestic CO
2
emissions. It should be noted that this impact depends on the price
effects of the tax, but also on the special provi- sions for environmentally friendly supply-side
options. In addition to that study, the task of the Dutch Green Tax Commission was to eval-
uate the potential for implementing taxes to improve environmental quality and sustainable
economic development. This commission puts forward the following rule of thumb concern-
ing the CO
2
reduction potential of a tax by considering the situation in the Netherlands.
The general fuel tax generating revenues of about 1 billion HFL corresponding to 450 mil
ECU leads to a reduction of CO
2
emissions by about 1 – 1.5 Mton. An additional reduction of
CO
2
emissions by 2 – 5 Mton can be estimated if about 500 mil HFL 225 mil ECU are spent
on positive incentives, such as accelerated de- preciation and energy investment tax credits.
This analysis of the environmental effectiveness of economic instruments can be cautiously
summarised as the following: an incentive ef- fect of a tax credit scheme i.e. positive incen-
tives of 100 mil HFL 45 mil ECU can be set equal to the incentive effect of an increase in
the revenue generated from energy taxes of about 700 mil HFL 315 mil ECU Vermeend
and van der Vaart, 1998.
The Ministry of Finance in Denmark quoted in Baron, 1996 estimated the effect of its car-
bonenergy tax regime, also accounting for the recycling of tax revenues through investment in
grants to improvements in energy efficiency. They estimate it would provide about 4.7
reduction in CO
2
emissions from 1988 levels in the year 2000.
However, even if there are few evaluation stud- ies on the environmental impact of carbonenergy
taxes, we may rely on other related environmental policies. Even if carbon taxes are not imple-
mented, some countries have programmes to sup- port
renewable energy
that combine
price incentives with the use of the generated revenues.
For instance, since 1990, the UK has imple- mented a system of economic instruments to
boost electricity generated from renewable energy sources. Known as the ‘Non-Fossil Fuel Obliga-
tion’ NFFO, this programme is especially di- rected to the market enablement of renewable
electricity generation instead of pure RD pro- grammes. The underlying idea is to support re-
newable energy projects by providing a premium price per kilowatt-hour of electricity to the gener-
ators if their bid was successful in getting a con- tract under the NFFO. The public electricity
suppliers regional electricity companies RECs are required under the NFFO to pay this pre-
mium price to the successful generators, and the difference between this premium price and the
average monthly pool-purchasing price is financed via a fossil fuel levy on electricity. This fossil fuel
levy — which has all features of an economic in- strument described above — has to be paid by the
consumers, increasing the electricity bill by about 2.2. This policy measure is also sometimes de-
scribed as ‘‘…a subsidy to the contractors; and it accepted the principle that paying a premium
price for electricity from near market technologies is an efficient and appropriate means of transfer-
ring
those technologies
to competitiveness’’
Mitchell, 1995, p. 1077. So far, four NFFO Orders have been made with a total capacity of
2094 MW. Electricity generated from renewable energy sources still makes up a very small propor-
tion of total electricity produced the share is around 2 of electricity available in the UK
compared to other European countries. However, the funding of projects under the NFFO has led
to an increase in this figure, considering that in 1990 projects under the NFFO accounted only
34 of total capacity compared to 83 by 1997 DUKES, 1998. A fifth round of NFFO was
announced in September, 1998, representing a total capacity of 1177 MW. The bid prices under
this last NFFO have fallen sharply compared to the four NFFO Orders. The average contract
price is competitive with the current electricity pool price. Projects which have won support un-
der this order are split fairly between onshore wind farms, landfill gas and waste-to-energy
schemes. In 1991 NFFO-2, electricity price was 7.2 pencekWh, 4.35 in 1994 NFFO-3 and 3.46
in 1997 NFFO-4, which was the current price of electricity in the UK. This translates into an extra
of 3.74 pencekWh in 1991, which can be inter- preted as an implicit carbon tax of approximately
200 UStonC, since the electricity displaced was generated by burning coal. This programme com-
prising the fossil fuel levy and the recycling mech- anism has led to a fast increase in installed
capacity of electricity generated from renewable energy sources and can be described as successful.
The projects that were supported under the NFFO can also record a drop in the prices per
kilowatt-hour as a result of this programme.
In the context of combining different economic incentives to reduce emissions, an interesting sim-
ulation study for the US compared four policy options to reduce cumulative emissions of CO
2
by 15 in the 100 years after 1995 Schneider and
Goulder, 1997. The policy options are: a carbon tax alone: a targeted research and development
RD subsidy for renewable energy alone: a carbon tax plus targeted RD subsidy of 10;
and a carbon tax plus broad RD subsidy of 10. The study showed that the RD subsidy
alone never offers the cheapest way in terms of GDP to achieve the required emissions reduction.
The case for accompanying a carbon tax with a subsidy for RD into alternative energy supplies
is less clear. Indeed, this policy option becomes interesting compared to the others when there are
some spillover from research and development activities. If it is not the case, a carbon tax alone
may be cheaper.
6. Conclusions
