Climate Policy and Green Tax Reform in Denmark Some conclusions from the 2009 report to the Danish Council of Environmental Economics Presentation to the BCCD-BIU on March 9, 2009 by Professor Peter Birch Sørensen Chair of the Environmental Economic Council

Agenda Danish energy and climate policy goals Prospects for energy use and greenhouse gas emissions in Denmark Alternative strategies for reduction of greenhouse gas emissions and the role of green taxes

Background GHG regulation at EU and national levels EU level: European CO 2 Trading Scheme (ETS) –Tradable CO 2 quotas for firms in ETS sector, encompassing energy producers and large energy intensive firms National GHG targets in non-ETS sectors –Emission in ETS sector determined at EU level, so –National GHG policy should focus on non-ETS sector Not possible to shift CO 2 -reduction from ETS sector to non-ETS sector

Danish policy goals 1.Reduction of gross energy consumption by 4 percent by 2020 (compared to 2005) 2.Sustainable energy sources (wind, biomass etc.) should provide for 30 percent of total final energy consumption by percent reduction of greenhouse gas emissions from non-ETS sector by 2020 (compared to 2005)

A forecast for Danish energy consumption and GHG emissions Tools of analysis: A macroeconomic model coupled with A model of energy demand from businesses and households coupled with A detailed model of energy supply from the energy-producing sectors

The forecasted business-as-usual scenario 1.Reduction of gross energy consumption by 6½ percent by 2020 –Policy goal achieved primarily through improved efficiency in energy production 2.Sustainable energy provides more than 40 percent of total final energy consumption in 2020 –Policy goal achieved mainly through market adjustment to changing relative prices of the various sources of energy 3.Reduction of GHG emissions from non-ETS sector by 4 percent by 2020 –Substantial rise in GHG emissions from transport sector –Need for further reduction of GHG emissions of 6 million tons of CO 2 - equivalents (in part through purchase of GHG emission rights abroad) Achievement of policy goal requires new policy initiatives

GHG emission in non-ETS sector Our forecast compared with GHG target for 2020

Achieving the climate policy goal through green taxes

Issues for Danish climate policy How high are the costs of reducing GHG emissions from the non-ETS sector? –Who must reduce emissions? –How are the various industries and household groups affected? What are the consequences of higher green taxes? –Income distribution –Production structure in industries and services

GHG emission in non-ETS sector

The case for a tax on GHG emissions Cost-effectiveness: a GHG tax ensures a uniform cost of GHG emissions across all firms and households. The market will then find the cheapest ways of reducing emissions Dynamic efficiency: a GHG tax provides a permanent incentive to develop cleaner technologies

A multisector model for the analysis of green taxes (MUSE) A model of the small open Danish economy including 130 production sectors using capital, labour, energy and intermediates 11 household types (10 income deciles in the labour force, one outside the labour force) consuming 71 different types of goods and services A tax system including taxes on income and commodities plus ‘green’ taxes Environmental effects in the form of emissions of various air pollutants, including GHGs

Reductions of non-ETS GHG emissions induced by a uniform GHG tax Households Businesses All non-ETS Reduction in GHG emissions

Reductions of household GHG emissions induced by a uniform GHG tax Transport Heating All non-ETS Reduction in GHG emissions

Reductions of non-ETS GHG emissions induced by a uniform GHG tax Agriculture Other business sectors All non-ETS Reduction in GHG emissions

Marginal GHG reduction costs Uniform tax on all non-ETS emitters Exempting agricultural sector from GHG tax Reduction of GHG emission

‘Required’ GHG tax in non-ETC sector 11 % reduction of GHG emission compared to 2005 corresponds to 4 mill. tons reduction 2/3 of additional reduction needed to reach 2020 GHG target 400 DKK per tonnes CO 2 when tax imposed on all emitters (including agriculture) –Approximately 1 DKK per litre gasoline DKK per tonnes CO 2 when the agricultural sector not included –Approximately 3 DKK per litre gasoline CO 2 –tax higher than the expected price of CO2 quotas (225 DKK per tonnes in 2020)

Implications for Danish climate policy Achieving the GHG goal solely through domestic emissions reductions will be very expensive The marginal GHG reduction costs are higher in the household than in the business sector Exempting agriculture from emissions reductions will be extremely expensive

The problem with agriculture Danish agricultural production is very GHG intensive and highly exposed to international competition The potential for international GHG ”leakage” is therefore particularly big in the agricultural sector, especially if other EU countries do not impose effective GHG targets on their farming sectors

Potential solutions A tax on the GHG content of food products consumed in Denmark is hard to administer and helps very little to achieve the goal of domestic emissions reductions A better way forward: a modest GHG tax on farm animals combined with subsidies to GHG- reducing measures (e.g. manure used to produce biogas etc.) could equate the cost of GHG emissions between the agricultural and the non-agricultural sectors

Some further recommendations Marginal GHG reduction costs are much lower in the ETS than in the non-ETS sector. Therefore: shift energy demand and supply from the non- ETS to the ETS sector (promote electric cars, district heating, heating pumps etc.) Buy as many GHG emission rights abroad as possible and work to liberalise EU rules on the international trading of emission rights

International GHG regulation

EU-regulation of CO 2 -emission Different regulation for ETS and non-ETS sectors –Emission from ETS sector determined at European level –Separate national GHG reduction targets in non-ETS sectors of EU member states The reduction targets for the non-ETS sector in the different countries were determined by distributional considerations –High income EU countries have to reduce by more (Denmark in particular!) –The marginal CO 2 -reduction costs in non-ETS sectors are very across EU member states CO 2 -reduction in EU could be obtained at lower overall cost

Recommendations for changes in EU-regulation First best: Allow EU Member States to buy CO 2 -quotas in the European ETS market as a way to meet national targets in non-ETS sector –would ensure uniform marginal GHG reduction costs between ETS and non-ETS sectors and between countries –would thereby minimise the overall costs of GHG reduction in the EU Second best alternative: Allow EU Member States to trade GHG emission rights for their non- ETS sector as a way of meeting national goals for that sector –would ensure uniform marginal GHG reduction costs across the non- ETS sectors in the EU –would not ensure uniform reduction cost between ETS and non-ETS sector

Final comments on current Danish policies and policy goals

The recent tax reform agreement included, among other things: higher electricity taxes on firms and households (no environmental effect) higher taxes on energy used for heating in firms and households (very little environmental effect) A new energy tax on fuels used by businesses for manufacturing purposes (very little environmental effect)

Welfare cost of reducing GHG emissions from the non-ETS sector Use of energy taxes Use of carbon tax Reduction of GHG emissions

The tax reform agreement from an environmental economic viewpoint The ’green’ tax increases are extremely poorly targeted from an environmental point of view If the main purpose of a ’green’ tax is to raise revenue, it should be levied only on households to avoid impairing the efficiency and international competitiveness of the business sector

Official policy goals 1. Reduce total energy consumption 2. Reduce GHG emissions (and emission of other pollutants) 3. Improve the security of energy supply 4. Increase the share of sustainable energy in overall energy supply But: Do goals no. 1 and 4 make sense if we have already achieved goals no. 2 and 3?

Recommendations from the Environmental Economic Council Pursue the climate policy goals and environmental policy goals through targeted emissions taxes rather than through general energy taxes Pursue the goal of energy security through targeted taxes on oil and natural gas rather than through general energy taxes With the policies recommended above, there is no need for separate targets for energy savings and for the share of sustainable energy sources