1. On Policy Reform of CO 2 reduction in Taiwan Chi-Yuan Liang Institute of Economics, Academia Sinica

2. Introduction On 30th September, 2004, the Russia Cabinet has approved the Kyoto Protocol and had sent it to the Congress for approval. Since the Congress is controlled by the ruling party, the Protocol is expected to be approved soon. Although Kyoto Protocol has been signed by more than one hundred countries, until today, the Kyoto Protocol is still pending for not meeting one of the threshold requirements of the countries signed exceeding the 55 percent global CO 2 emission in 1990. Since Russia accounts for 17 percent of global CO 2 emission, once Russia signs the Protocol, the Kyoto Protocol will be valid soon.

3. 6 years ago, in response to the Kyoto Protocol announced on 11/11/97, the government of Taiwan hosted a nationwide Energy Conference in May 1998. Two of important recommendations emerged at this conference: (1) the targeted reduction in CO 2 should be 24% to 48% lower than the BAU (business as usual) projection by 2020; (2) the energy efficiency should increase 1.2% per year by 2020. However, by 2003 CO 2 emission for the whole economy had increased from 189.56 million ton in 1996 to 267.87 million ton, which is a 41.3% increase or 5.06% per annum during 1996- 2003. It is noted that although the average GDP growth rate declined from 5.55% during 1996-1999 to 2.58% during 1999- 2003, CO 2 growth rate increased from 4.79% per annum to 5.27% per annum during 1999-2003. As a result, the income elasticity of CO 2 emission jumped from 0.71 during 1996-1999 to 2.61 during 1999-2003.

4. CO 2 and GDP Growth in Taiwan,96-02

5. Research Purpose The purpose of this paper is (1) to analyze the causes of the acceleration in CO 2 growth; (2) to propose CO 2 reduction policies; (3) to assess the CO 2 reduction policies on CO 2 emission and its impact on the economy. (4) Finally, policy recommendations will be drawn from the findings.

6. The Causes of CO 2 Acceleration Growth (1) the decline in energy efficiency The energy efficiency, in terms of energy productivity was stable at the level of 106 (NTD/LOE) during 96-99. However, it decreased from 106.03 (NTD/LOE) in 1999 to 96.65 in 2003, an 8.85% decline or a 2.3% per annum decrease during 99-03. In contrast, the energy efficiency, in terms of energy intensity was also stable at the level of 9.4 (LOE/Thousand NT$). However it increased from 9.43 (LOE/Thousand NT$) in 1999 to 10.35 (LOE/Thousand NT$) in 2003, a 9.76% increase. The greater the energy intensity, the smaller the energy efficiency. (2) the energy structure changes

7. Changes of Energy Efficiency in Taiwan 96-03

8. Energy Structure Changes in Taiwan, 96-04

9. The CO 2 Reduction Policies (1) Energy Supply Restructuring According to MARKAL engineering model the CO 2 conversion factors of various types of energy are as follows: coal (3.53 tons CO 2 /KLOE), oil products (2.89 tons CO 2 /KLOE), natural gas (2.09 tons CO 2 /KLOE) and hydropower, nuclear power and most of renewable energy have no CO 2 emission. During 96-03, we found that the share of energy with high CO 2 emission in total energy supply increased remarkably, while that of energy with low CO 2 emission decreased. For instance, the share of coal in total energy supply increased from 27.0% in 1996 to 32.6% in 2003. On the contrary, the share of hydropower and nuclear power decreased from 2.7% and 11.3% respectively in 1996 to 1.4% and 8.0%, respectively in 2003.

10. This is surely an important factor to explain the acceleration of CO 2 growth during 1996-2003. Since 2000, the energy policy of Taiwan basically changed. At present, No-Nuke homeland and the development of renewable energy are two pillars of the energy policy. Considering the drastic increase in crude oil price this year (i.e., crude oil price increases from US$32.25/barrel to US$51.1/barrel on October 6) and the latest development of Kyoto Protocol, government should adopt a more balance energy policy that is an energy policy consisted of the following four pillars: (1) No-Nuke homeland, (2) Development of renewable energy, (3) Greenhouse gas control and (4) stability of energy supply.

11. Energy Efficiency Improvement The decrease in energy efficiency during 1996-2003 could be attributed to (1) the industrial structure changes; (2) the economic recession; and (3) low energy price With respect to the low energy price, Taiwan is one of the countries, which has the lowest price in gasoline, diesel and electricity. For instance, Taiwan’s gasoline and diesel prices were NT$21.5 and NT$16.5 per liter in June 2004. They were 42.5% and 31.4% respectively lower than the corresponding averages for Japan, Korea, Hong Kong and Singapore. This is due to the fact that Taiwan’s tax rate on oil products is the lowest among the five countries mentioned above. Taiwan’s electricity price (for lighting) is 2.3996 (NT$/kwh), 5.938 (NT$/kwh) of Japan and 5.2669 (NT$/kwh) of Germany. In fact, Taiwan’s electricity price for lighting decreased from 2.59/kwh in 1996 to 2.40/kwh in 2003; while electricity price for non-lighting declined from 1.87/kwh to 1.74/kwh.

12. International Comparison on Gasoline Prices

13. International Comparison on Diesel Prices

14. International Comparison on Fuel Oil Prices

15. International Comparisons on Electricity Price (lighting)

16. International Comparison on Gasoline Price

17. International Comparison on Diesel Price

18. International Comparison on Electricity Price (lighting)

19. It is pertinent for Taiwan to raise its energy price via higher energy related taxes such as road maintenance fee and carbon tax to increase energy efficiency and to reduce the social costs associated with energy consumption, which arise because of air pollution, CO 2 emission, traffic congestion and instability of energy supply. In other words, the energy price should reflect not only its internal cost but also its external cost. Taiwan has levied air pollution fee and petroleum fund on energy. Nevertheless, it is suggested to implement the road maintenance fee and carbon tax as well. However, whether the implementation of energy related taxes is plausible or not depends on a precise evaluation of the effect of the taxes on energy conservation and the economy. By the way, after the drastic increase in fuel price during 2003-2004, the electricity price needs to adjust upward to reflect its fuel cost.

20. The Simulation Model and Procedure The Theoretic Model – Dynamic General Equilibrium Model of Taiwan The dynamic general equilibrium model of Taiwan (DGEMT), which was first applied to the energy tax study by Liang and Jorgenson (2002) included: (1) Producer's Model (2) The Consumer's Model (3) DGBAS Macro-Economic Model (4) MARKAL Engineering Energy Model of ITRI Simulation Procedure Base case projection Simulation Involving Carbon Tax and Energy Price Increases

21. DGEMT DGBAS Macro-Economic Model Taiwan Energy Economic Model MARKAL Engineering Energy Model Producer's ModelConsumer's Model aggregate Sub-Model Energy Sub-Mode Non-energy Intermediate Input Sub-Model Oil Product Sub-Model

23. The Simulation Results The Rationalization of Electricity Price The fuel price of electricity generation increased remarkably in the past one year. During Oct. 2003 to Oct. 2004, the fuel price increased as follows: diesel 21.6%, fuel oil 10.5%, natural gas 26.3% and coal 64.6%. Very preliminary estimate shows that if Taipower maintains a 4.6 % return on equity (ROE), i.e., the ROE in 2003, the electricity price should increase at least 9.0% in 2004. A 9.0% increase in electricity price will increase the GDP deflator by 0.612% and lower the economic growth rate by 0.126%. The most affected sectors among seven one-digit sectors are water, electricity and gas. Among the manufacturing industries the paper products, textile, non-metallic mineral products, chemical and plastics and basic metal product will suffer the greatest impact with a price increase between 1.0% and 1.48 % and an output growth decrease between 0.26% and 1.27%. However, a 9% increase in electricity price will reduce the CO 2 emission by 2.9%.

24. The Impact of the Electricity Price Rising 9% on Price, Output Growth and CO 2 Emission by Main Sectors

25. The Impact of the Electricity Price Rising 9% on Price, Output Growth and CO 2 Emission by Manufacturing

26. The Effect of Imposing Road-Maintenance Fee on Oil Products Since 60’s, Taiwan has already imposed the road-maintenance fee. However, the fee is levied on types of cars according to exhaust volume instead of on oil products consumed. This system is unfair to those who drive less mileages than the average and provides no incentive to energy conservation. We suggest that the fee should levy on oil products. The more gasoline you consumed, the more fee you pay. Giving total tax revenue, the new system will result in the increase of gasoline price by NT$3 per liter. Since the tax burden of gasoline users is identical after imposing the new system, there will be no impact on the general price level. Nevertheless, other things being equal, the increase in gasoline price will reduce the demand for gasoline. The price of gasoline is 23.2 per liter at present. Thus, a NT$3 per liter fee on gasoline will cause the gasoline price increase by 12.9%. According to Liang(1997), the price elasticity of demand for gasoline is –0.3. Consequently, imposing road maintenance fee on gasoline with a tax rate of 12.9% liter will reduce the gasoline demand by 3.87% or 506 thousand kiloliter in 2003. CO 2 emission will also reduced by 1,133.56 kilo-ton, a 0.42% reduction of the total (268,829.5 kilo-ton) of Taiwan in 2003.

27. Effect of Carbon Tax - A Progressive Approach According to the simulation, we found the impact of carbon tax on the economy to be significant if the tax rate is as high as the Swedish tax rate (US$22.2/CO 2 (Ton). By imposing the highest carbon tax (US$22.2/CO 2 (Ton)) through the use of a one-step approach, CO 2 emissions decrease by 25.77 percent for the economy as a whole in 1999. The energy demand in relation to coal has the largest decrease, which is –36.45 percent, followed by oil products (–23 percent), electricity (– 15.76 percent) and natural gas (–14.23 percent). For the economy as a whole, the GDP deflator will increase by 2.26 percent in 1999. For the effect on output growth for the economy as a whole, GDP will decline by 1.57 percent if the highest energy tax rate (US$22.2/CO 2 (Ton)) is imposed. Alternatively, we might choose a progressive approach to achieve the same goal of CO 2 reduction, while minimizing its impact on the economy. Using a progressive ad valorem tax approach, we assume that the tax rate in 2020 is the same as that when a one-step approach is used in 1999.

28. The Comparison of Carbon Taxes and Energy Prices in 1998

29. The Effect of Carbon Taxes [U.S.$ 22.2/CO2 (Ton)] on Energy Demand and CO2 Emission (One-Step)

30. The Effect of Different Carbon Taxes on Price by Sector in 1999 (One-Step)

31. The Effect of Carbon Taxes on Output Growth in 1999 (One-Step)

32. Time Scheme of 22- Year Progressive Ad Volarem [Carbon Tax Rate - U.S.$ 22.2/ CO2 (Ton)]

33. The Effect of Carbon Taxes on Energy Demand and CO2 Emission by 2020 (Progressive Approach) [U.S.$ 22.2 / CO2 (Ton)]

34. The Effect of Different Carbon Taxes on Price by Sector by 2020 (Progressive Approach)

35. Table 14 The Effect of Carbon Taxes on Output Growth by 2020(Progressive Approach)

36. Marginal Social Abatement Cost of CO2 Reduction in Taiwan, 1999

37. Marginal Social Abatement Cost of CO2 Reduction in Taiwan, 1999- 2020(One-Step Approach)

38. Marginal Social Abatement Cost of CO2 Reduction in Taiwan, 1999-2020 (Progressive Approach) Marginal Social Abatement Cost of CO2 Reduction in Taiwan, 1999-2020 (Progressive Approach)

39. Conclusion and Policy Suggestions (1) Energy supply restructuring Considering the drastic increase in crude oil price this year and the latest development of Kyoto Protocol, government should adopt a more balance energy policy that is an energy policy consisted of the following four pillars: (1) No-Nuke homeland, (2) Development of renewable energy, (3) Greenhouse gas control and (4) energy security. (2) The Rationalization of Electricity Price The fuel price of electricity generation increased remarkably in the past one year. Very preliminary estimate shows that if Taipower maintains a 4.6 percent return on equity (ROE), i.e., the ROE in 2003, the electricity price should increase at least 9.0 percent. A 9.0 percent increase in electricity price will increase the GDP deflator by 0.612 percent and lower the economic growth rate by 0.126 percent. However, a 9 percent increase in electricity price will reduce the CO 2 emission by 2.9 percent.

40. (3) Road-maintenance Fee We suggest that road-maintenance fee should levy on oil products. The more gasoline you consumed, the more road-maintenance fee you pay. Giving total tax revenue, the new system will result in the increase of gasoline price by NT$3 per liter. Since the tax burden of gasoline users is identical after imposing the new system, these will be no impact on the general price level. Nevertheless, other things being equal, the increase in gasoline price will reduce the demand for gasoline. The price of gasoline is 23.2 per liter at present. Thus, a NT$3 per liter road-maintenance fee on gasoline will cause the gasoline price increase by 12.9 percent. Imposing road maintenance fee on gasoline with a tax rate of 12.9 per liter will reduce the gasoline demand by 3.87 percent or 506 thousand kiloliter in 2003. CO 2 emission will also reduced by 1,133.56 thousand ton, a 0.42 percent reduction of the total CO 2 emission (268,829.5 thousand ton) of Taiwan in 2003.

41. (4) Carbon Tax Implementing a ‘progressive’ energy tax will lessen the negative effect on the economy. Consequently, it is recommended that the ‘progressive’ carbon tax approach instead of the ‘one step’ carbon tax approach be adopted. Moreover, if the tax revenue can be used to reduce distortionary taxes elsewhere in the economy, such as income tax, the impact of the carbon tax on the economy will be reduced and economically and politically plausible for the taxpayer to accept. ~Thank you~