There May Be a Role For An Energy Tax But Only As Part Of A Wider Package Of Environmental Measures
By Gerry Boyle
There has been considerable debate recently on the necessity to take some heat out of the economy. Well if the Republic is to adhere to its commitments under the Kyoto Protocol we won't have to worry about how to do it. The scale of adjustment that is potentially required is truly staggering.
The Kyoto Protocol was agreed by delegates representing 160 countries at the third United Nations Climate Change Conference held in 1997. Commitments to reduce emissions were made by the EU, US and Japan. By 2010 consensus forecasts suggest that emissions of carbon dioxide could exceed the Kyoto limit by between seven and 10 million tonnes.
The challenge confronting policy-makers is to devise options for eliminating this excess without unduly damaging our otherwise propitious growth prospects. A public debate on the feasible options for addressing our Kyoto obligations is long overdue. There is the real danger that if we don't take decisive and effective action well ahead of the 2010 target date, drastic measures will be required closer to the deadline thereby guaranteeing a hard landing for the economy.
Any action to be contemplated must be undertaken at the least cost to the national economy.
While the transport sector is forecast to generate by far the greatest increase in emissions up to 2010, the agricultural sector produces by far the greatest share of emissions - an estimated 35 per cent. The residential sector, which is the second most important contributor, has a substantially smaller share, of 19 per cent. One of the options that has been put forward from time to time has been energy taxes. Most economists strongly support taxes as a means of giving practical expression to the "polluter-pays principle".
Energy taxes by altering relative energy prices can, it is argued, reduce energy use and emissions. However, the arguments usually put forward in favour of taxes are often at such a high level of generality as to be almost meaningless. It is not possible to determine whether taxes will be effective in reducing greenhouse-gas emissions without addressing the issue of tax design. Nowhere is this observation better illustrated than in the case of proposals to introduce such taxes in the industrial sector. As examples, consider the EU Carbon/Energy Tax (CET) proposal, which was put forward originally in 1991, and the recently proposed Climate Change Levy (CCL) in the UK. While the impact on the average sector's energy prices is fairly similar in both cases, the impact on energy consumption and emissions could potentially be very different. In the case of the CET, carbon-intensive fuels like peat are taxed much more heavily than, for instance, natural gas. The CCL, however, does not penalise the carbon content of fuels. A difference of perhaps greater significance between the two taxes is that while the CET is levied on all industries, including the energy-producing sectors (eg electricity), the latter sectors are exempt under the CCL. For energy-intensive firms it is most unlikely that a tax could be designed to affect their energy usage to any significant extent. Energy consumption is effectively bundled with the technology employed by these firms. Thus, unless a tax can be designed to effect a long-term adjustment in relative energy prices, firms are unlikely to alter their long-term investment decisions on the basis of such taxes. Even under fairly generous assumptions about responsiveness to taxes it is unlikely that Irish industrial emissions would be reduced by much more than 2 per cent of total national emissions in the case of the CET. Most of this reduction would result from fuel switching in the production of electricity.
Given that this sector would be exempt from a CCL-type tax its impact would be insignificant.
While uncertainty attaches to the emissions' impact of taxes, there is no doubt that the unilateral adoption by the Republic of substantial energy taxes would have significant adverse competitiveness effects. In the case of the CET, for instance, about 40 sectors could suffer losses equivalent to half a per cent or more of their turnover. These sectors employed about 75,000 people in 1997. While tax yield could be recycled back to industry in the form of wage subsidies, for instance, this is a somewhat remote possibility in the current near full-employment position. In any event recycling of the tax yield, in this form would not benefit the handful of strategically important energy-intensive sectors. Ultimately the benefits of an energy tax must be assessed in terms of their direct environmental effects and not on any secondary effects, no matter how beneficial.
Views on the merits of energy taxes tend to become polarised into those that believe they are "always and everywhere" effective and those that believe that taxes are "always and everywhere" useless. There is, however, a middle ground which recognises that there may be a role for an energy tax in addressing the greenhouse gas problem but only as part of a wider package of environmental measures and only if it is carefully designed. In the industrial sector, and especially in the energy-intensive industries, a tax which focuses on attempting to change behaviour by altering relative fuel price signals, is unlikely to be effective. But taxes could be used as a kind of "super-levy" for which firms would become liable if they failed to meet emissions targets determined by voluntary agreements or tradable emissions schemes. Industry cannot opt out of its Kyoto obligations, no more than other sectors, but the sector has a legitimate concern to ensure that the chosen policy option has least cost in competitiveness terms. As one commentator has remarked, the fact that Kyoto imposes a predetermined quantity target does not imply that industry should also face a predetermined cost target.
Gerry Boyle is Associate Professor of Economics at NUI Maynooth. He is the principal author of a recently produced study by Farrell, Grant Sparks Consulting Ltd., which was commissioned by IBEC, entitled The Competitiveness and Environmental Impact of Energy Taxation on Irish Industry.