Competitiveness effects of environmental tax reform ( COMETR )

1. 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

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

3. COMETR Competitiveness Effects of Environmental Tax ReformA Specific Targeted Research Project (STREP) of the ‘Scientific Support to Policies’ initiative under the EU’s Sixth Framework Programme for Research (FP6) Partners: • Cambridge Econometrics • ESRI Dublin • Institute for Economic and Environmental Policy, Prague • Policy Studies Institute, London • Vienna Institute for International Economics • 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.

4. 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.

5. 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/CO2 taxes (UK, DK). Mixed approach, recycling split between employers and employees (DE, NL).

6. 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?

7. 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

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

9. Results on pricing power:Sectors ranked from most vulnerable

10. Vulnerability on energy intensity and pricing power

11. Vulnerability on technical scope and pricing power(UK only)

12. 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.

13. Micro study of selected sectors in ETR countries

14. 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 !

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

16. Technology:UK Climate Change Agreements Specific energy consumption better than targetsCement lime and plaster

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

18. Technology: UK Climate Change Agreements Specific energy consumption better than targetsFerrous metal

19. Macro impact of ETR - emissions of GHGCambridge Econometrics E3ME

20. Macro impact of ETR - GDPCambridge Econometrics E3ME

21. 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 pageReport with Policy Brief

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

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

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

25. Appendix: Technology scopeUK estimated abatement costs, example (ETSU)

26. Appendix: Micro analysis of energy intensity Ho : Carbon tax reduces energy intensity (consistent with Porter Ho ) 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 .

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

28. 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

29. Appendix cont’d: Sector codes

30. Appendix: Ireland Energy elasticities(EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004)

31. Appendix cont’d: Ireland Electricity elasticities(EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004)

32. Appendix: Ireland’s proposed ETREffects on prices in 2003 of Tax of €20 a tonne of CO2(EPA-ERTDI paper by Bergin, Fitz Gerald et al. 2004)

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