Competitiveness effects of environmental tax reform ( COMETR ) Paper read to the seminar: “ Environmental Tax Reform ” Institute of European Affairs M. S. Andersen (NERI) J. Fitz Gerald (ESRI) S. Scott (ESRI) 20 June 2007

Outline of talk COMETR an ex post study ETR background Competitiveness issues Pricing power Technology Macro

COMETR C ompetitiveness Effects of Environmental Tax Reform A Specific Targeted Research Project (STREP) of the ‘Scientific Support to Policies’ initiative under the EU’s Sixth Framework Programme for Research (FP6) Partners: 1. Cambridge Econometrics 2. ESRI Dublin 3. Institute for Economic and Environmental Policy, Prague 4. Policy Studies Institute, London 5. Vienna Institute for International Economics 6. NERI, Aarhus University (coordinator) Modules: Conceptual: revenue-neutral carbon tax and competitiveness issues Sectors vulnerable to competition - Pricing power Micro sectoral effects - technology potential Macroeconomic effects Case studies - threat of relocation ’carbon leakage’ Mitigation and compensation mechanisms.

Competitiveness definition Competitiveness is lost if cost of production rises relatively faster than for competitors  Share of global production and export intensity decrease, and import penetration rises  A sustained loss in standard of living.

ETR background EC 1990 proposed carbon/energy tax + rev recycling Least cost strategy. Encourages technology. Targets the true objective. 6 EU states implemented ETR of this sort 1990 Sweden 1992 Denmark 1996 Netherlands 1997 Finland 1998 Germany 1999 UK Detail: Energy-environment taxes introduced as part of policy to lower income taxes for employees (SW, FN). Employers’ social security contributions replaced by climate change levy/CO 2 taxes (UK, DK). Mixed approach, recycling split between employers and employees (DE, NL).

Competitiveness issues Labour intensive sectors have little to fear. Potentially vulnerable? Energy intensive Trade intensive Low abatement potential, and Low pricing power ?  Lose market share? Close down? Relocate?

Potentially vulnerable sectors to be analysed for pricing power Pulp, paper and board Wood and products Basic chemicals Pharamaceuticals Non-metallic mineral products Basic metals Food and beverages

Pricing power explored Using sector’s past behaviour on cost increases: a. Output price externally determined? ( price-taker, vulnerable ) OR b. Mark-up on domestic costs? ( price-setter, market power, less vulnerable ) This question was tested using an econometric model for ETR countries.

Results on pricing power: Sectors ranked from most vulnerable

Vulnerability on energy intensity and pricing power

Vulnerability on technical scope and pricing power (UK only)

Conclusions: vulnerability Important differences in PRICING POWER Sectors can be assessed and ranked: Basic metals has least pricing power (most vulnerable), Non-metallic mineral products has most pricing power (least vulnerable).  Can prioritise sectors in policies to alleviate vulnerability Where the foreign price is dominant it is the EU price (not US or world price)  EU-wide ETR application effective.

Micro study of selected sectors in ETR countries

How to reduce vulnerability? Negotiated agreements – e.g. UK CCA 80% rebate on CCL Exemptions – but problems of EU State Aid rules ! Reduced rates - to sectors or processes - above certain thresholds Recycling – in addition to reducing labour taxes, earmark some revenue to energy efficiency subsidies e.g. UK Carbon Trust.  ETR was very modest !

Technology: UK Climate Change Agreements Specific energy consumption better than targets Chemicals

Technology: UK Climate Change Agreements Specific energy consumption better than targets Cement lime and plaster

Technology: UK Climate Change Agreements Specific energy consumption trends index Meat processing – mixed results

Technology: UK Climate Change Agreements Specific energy consumption better than targets Ferrous metal

Macro impact of ETR - emissions of GHG Cambridge Econometrics E3ME

Macro impact of ETR - GDP Cambridge Econometrics E3ME

Conclusions: Competitiveness effects of environmental tax reform Some sectors are potentially vulnerable Fewer are truly threatened – e.g. Basic metals Use e.g. agreements Technology was encouraged EU-wide ETR would be best Modest ETR in 6 countries had good results COMETR website: www2.dmu.dk/cometr/ Follow Link to conference page Report with Policy BriefLink to conference pageReport with Policy Brief

Appendix: Price-setting model The following model is considered: p i =  0 +  1 mc i + p f i where for sector i p i = the domestic output price mc i = the domestic marginal cost p f i = the foreign or world price (US or German prices) Specifically: P d * = f(P j, R j, W k ), where: P d * = the long-run wholesale price for the sector’s domestic output P j = the wholesale price index in the ‘competing’ country or bloc j R j = the exchange rate with country or bloc j. PPP imposed W k = the price index for domestic input factor k. Wage rates are used. Error Correction Model representation:

Appendix: nominal tax rates for industry Effective rates were lower. Idea of scale: initial Swedish rate is 10 to 12 $US per barrel of oil

Appendix: Technology scope: UK estimated abatement costs, example (ETSU)

Appendix: Technology scope UK estimated abatement costs, example (ETSU)

Appendix: Micro analysis of energy intensity H o : Carbon tax reduces energy intensity (consistent with Porter H o ) Tested: savings in energy costs due to Δ energy intensity > Δ Costs due to new tax. Results: 19 out of 32 tested positive (consistent). Inconsistencies can be explained by low tax rate or low energy intensity, except: Cement (FN):high tax, high intensity but no improvement.

Appendix: micro study of change in competitiveness Details of nine losses of competitiveness:

Appendix: Ireland’s possible ETR 1994 Losers / gainers: Net effect of carbon tax with reduction in social insurance contributions – £ m, first round effects, O’Donoghue 1997 ESRI WP no. 82

Appendix cont’d: Sector codes

Appendix: Ireland Energy elasticities (EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004) Long-Run Income Elasticity Long-Run Price Elasticity Long-Run “Max Price Elasticity” Household Services Industry

Appendix cont’d: Ireland Electricity elasticities (EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004) Long-Run Income Elasticity Long-Run Price Elasticity Household Services Industry

Appendix: Ireland’s proposed ETR Effects on prices in 2003 of Tax of €20 a tonne of CO 2 (EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004) %CoalOilGasElec.Peat House holds Electri city

Appendix: Ireland - proposed ETR (EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004)