Fuel Exemptions, Revenue Recycling, Equity and Efficiency: Evaluating Post-Kyoto Policies for Switzerland

Fuel Exemptions, Revenue Recycling, Equity and Efficiency: Evaluating Post-Kyoto Policies for Switzerland Jan Imhofa JEL-Classification: D31, D58, H23, Q48, Q52, Q58 Keywords: Carbon Tax, Computable General Equilibrium, Double Dividend, Tax Exemptions, Climate Cent, Distributional Consequences 1. Introduction The Swiss parliament is in the process of revising its CO2 law as its reduction targets are running out in accordance with the first commitment period of the Kyoto Protocol. It is very likely that the parliament will extend measures already in place. Those measures consist of a CO2 tax on stationary fuels of 36 CHF per ton of CO2 and the Climate Cent1 for transportation fuels. In addition, the parliament is likely to impose a domestic reduction target of 20% below 1990 levels by 2020, in line with current EU proposals. Taking into consideration the official CO2 balance (Federal Office for the Environment, 2011) it seems likely that the current policy measures are not strict enough to fulfill this ambitious future emission reduction target. Additionally, the Climate Cent scheme – equivalent to an exemption of transportation fuels from the CO2 tax – is controversial, since first, transportation fuels have seen continually increasing use under the policy, and second, a cost-effective carbon policy guaranteeing the equalization of marginal abatement costs is absent.2 a 1 2 Centre for Energy Policy and Economics, ETH Zurich, Zürichbergstrasse 18, CH-8034 Zurich, Switzerland. Email: . The author wishes to thank Thomas Rutherford, two anonymous reviewers and participants of the 67th Congress of the IIPF, the 2011 international conference of the IAEE and the YSEM 2011 in Bern for helpful comments and suggestions. All remaining errors are the author’s responsibility. The Climate Cent foundation is financed by a charge of 1.5 Swiss Cents levied on every liter of gasoline and diesel sold at the pump. This corresponds to roughly 6 CHF per ton of CO2. See Boehringer (2002) for a textbook discussion of the importance of equalizing marginal abatement costs. © Swiss Society of Economics and Statistics 2012, Vol. 148 (2) 197–227 198 Jan Imhof Efficiency and equity issues associated with green taxes are discussed broadly in the literature. One branch of literature focuses specifically on the economic efficiency of green tax reforms. Papers discuss either the double dividend, achievable by reducing distorting pre-existing taxes through revenue recycling (e.g. Bovenberg and De Mooij, 1994; Goulder, 1995; and Wissema and Dellink, 2007), or the efficiency losses or gains due to tax exemptions (e.g. Böhringer and Rutherford, 1997; Paltsev et al., 2005; or Abrell, 2010). While Böhringer and Rutherford (1997) show that sectoral tax exemptions may hurt economic efficiency considerably since marginal abatement cost are not equalized, Abrell (2010) finds that tax exemptions for transportation fuels increase welfare. However, Paltsev et al. (2005) point out that pre-existing fuel taxes are important, as tax exemptions for transportation fuels may “correct pre-existing distortions and reduce the cost” in Europe, while a uniform taxation in the US can reach a given reduction target at least cost. The explanation for their finding is that a pre-existing petroleum tax may act as a pre-existing CO2 tax on transportation fuels. Equalizing marginal abatement costs over fuels imposes different CO2 tax rates such that pre-existing fuel taxes are equaled out. However, this only holds if it is assumed that the pre-existing fuel tax is useless and does not internalize any external effect. Otherwise, if the pre-existing fuel tax is a perfect Pigouvian tax this argument does not hold and the optimal CO2 taxes should be set at an equal rate regardless of other fuel taxes. The second branch of literature is concerned with the distributional effects of green tax reforms and with tax incidence. While generally carbon taxes have been shown to be regressive (Poterba, 1991; Jorgenson, Slesnik, and Wilcoxen, 1992; OECD, 1995; Scott and Eakins, 2004; or Wier et al., 2005),3 Metcalf (1999, 2007) points out that, depending on the mode of revenue recycling, effects on the income side can lead to almost any desired distributional outcome. Graigner and Kolstad (2009) show that revenue recycling can offset disproportional effects on households. This dominating effect of revenue recycling is not surprising, since fuel expenditures are usually only a minor budgetary item. However, the question why undesired distributional outcomes should be approached directly via the green tax reform remains. Atkinson and Stiglitz (1976) show that income taxation should be employed to redistribute income. 3 In developed countries poorer households tend to spend a bigger share of their disposable income on energy. There is strong evidence that this does not hold for developing countries (Boyce, Brenner, and Riddle, 2005; Van Heerden et al., 2006; Yusuf and Resosudarmo, 2007; Corong, 2008). Swiss Journal of Economics and Statistics, 2012, Vol. 148 (2) Evaluating Post-Kyoto Policies for Switzerland 199 Jacobs (2011) explicitly shows that in the optimal environmental tax reform distributional issues should be addressed with non-linear income taxes. In Switzerland, however, where direct federal tax rates are rather low, the distributional outcome has to be addressed directly in a green tax reform, since cantonal direct tax rates are not accessible. Finally there is a branch of studies conducted for Switzerland. Müller and van Nieuwkoop (2009) and Sceia, Thalmann, and Vielle (2010) examine the economic effects of the revised CO2 law. However, they base their scenarios on the original proposals from the Federal Council which have changed significantly since the debate in the federal parliament. In light of the revision of the CO2 law this paper aims to examine different potential Post-Kyoto policies for Switzerland. First, the paper poses the question of how high carbon tax rates need to be in order to reduce domestic CO2 emissions by 20%. Second, the paper estimates the economy-wide cost of a reduction of CO2 emissions by 20% below 1990 levels and compares different revenue-neutral policy proposals regarding revenue recycling and exemptions for transportation fuels. Third, the paper examines the distributional outcomes of the different tax regimes. This will be accomplished using the static CEPE model.4 CEPE is a static computable general equilibrium model of the Swiss economy, suitable for climate and energy policy evaluation. The model portrays Switzerland as a small open economy incorporating 14 household groups, 42 producing sectors and 51 goods of which 9 are energy goods. This paper provides estimates of the economic impact of the CO2 law revision based on recent developments of the debate in parliament. The paper also reexamines the role of exemptions for equity, something which has not been addressed in other CGE studi (...truncated)