A widely heard criticism of carbon pricing is that it will simply hurt the poor. But just like other similar schemes with environmental aims, such as water charging, the opposite is true. It all depends on having the right policies in place.
One very effective policy for reducing air pollution and mitigating risks from climate change, such as storms, floods and sea level rise, is to raise taxes on domestic energy use. In fact, by taking just one-third of the revenues raised through such taxes to fund cash transfers, policy makers would make it easier for households to pay their energy bills, not harder.
The message that higher energy prices are indeed quite compatible with social policy objectives is the main finding from a new OECD working paper, “The impact of energy taxes on the affordability of domestic energy”.
Energy affordability is the ability of households to pay for the necessary levels of electricity and heating. While the concept of being able to pay of one’s bills has intuitive appeal, measuring affordability is challenging in practice.
The paper uses household level data covering 20, mainly European, OECD countries to analyse energy affordability at current energy prices and after a hypothetical, environmentally-related energy tax reform. It compares three indicators, which are based on expenditure shares, relative incomes, and a combination of both for the third (and strictest) indicator. The strict indicator says that households face energy affordability risk if they spend more than 10% of their disposable income on electricity and heating, and their income is less than 60% of the median income.
Energy affordability concerns are manifest at current prices. According to our strict indicator, less than 3% of Swiss households face energy affordability risk, while more than 20% in Hungary do; the median share is around 8%. Low energy affordability also results in utilities cutting off supply to households. More than 100 000 households see their electricity supply cut each year in France, Germany and Spain. In the United Kingdom more than 1.5 million households cut off their electricity supply because they cannot afford to top up pre-pay meters.
In many countries domestic energy prices are rising, partly as a result of charges that finance the expansion of renewable energies. In practice, incentives for renewables often burden poor households, particularly because the poor tend to spend a higher share of their income on electricity and heating than the rich.
Unfortunately, some politicians have used this relationship to argue against stronger emission cuts. It is a blinkered view. Using taxes to make polluters pay for their emissions actually raises revenues that can be used to support households. This has been done to good social effect in Switzerland, for example.
The simulated energy tax reform aligns prices with environmental objectives, and increases energy prices by 11.4% on average for electricity, 15.8% for natural gas, and 5.5% for heating oil. Redistributing a third of the additional revenues resulting from this reform to poor households, by means of an income-tested cash transfer, is sufficient to improve energy affordability according to the three indicators. Under the strict indicator combining expenditure shares and relative incomes , energy affordability risk would decline by more than 10% on average across all countries considered. Uniform transfers are less effective at combatting affordability problems, although affordability would still improve according to the strict indicator.
Mitigating the adverse impacts of higher energy taxes, which are needed to cut harmful carbon emissions and air pollution, on energy affordability, requires no more than one-third of the revenues raised by the higher taxes. The remaining revenue can be used to make the tax mix for other social objectives, or for more inclusive growth.
References and further reading
Flues, F. and A. Thomas (2015), “The distributional effects of energy taxes”, OECD Taxation Working Papers, No. 23, OECD Publishing, Paris, http://dx.doi.org/10.1787/5js1qwkqqrbv-en.
Flues, Florens, and Kurt van Dender (2017), “The impact of energy taxes on the affordability of domestic energy”, OECD Taxation Working Papers, No. 30, OECD Publishing, Paris, http://dx.doi.org/10.1787/08705547-en.
Kurt, Van Dender (11 October 2016), “Resistance is futile. Higher carbon process needed to guide the transition to carbon neutral growth”, OECD Insights blog, http://oecdinsights.org/2016/10/11/higher-carbon-prices-for-carbon-neutral-growth.
OECD (2016), Effective Carbon Rates: Pricing CO2 through Taxes and Emissions Trading Systems, OECD Publishing, http://dx.doi.org/10.1787/9789264260115-en.
OECD (2015), Taxing Energy Use 2015: OECD and Selected Partner Economies, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264232334-en.
OECD work on taxaxation and the environment: www.oecd.org/tax/tax-policy/tax-and-environment.htm