The Welfare Effects and the Distributive Impact of Carbon taxation on Italian Households *.

Transcription

1 The Welfare Effects and the Dstrbutve Impact of Carbon taxaton on Italan Households *. Slva Tezz Department of Economcs Unversty of Sena Pazza San Francesco Sena (I) e-mal: tezzslva@uns.t Ths verson: January 2004 Abstract In ths work the welfare effects and the dstrbutve mpact on Italan households of the Italan Carbon tax are calculated. The Carbon tax has been ntroduced n Italy at the begnnng of 1999 askng for smooth ncreases, over a number of years, n the prces of most fossl fuels. Its welfare effects have been calculated usng True Cost of Lvng ndex numbers and the Compensatng Varaton. The parameters have been obtaned through estmaton of a complete Almost Ideal demand system, usng households data from 1985 to The welfare loss turns out to be qute substantal and affects Italan households n a non-neglgble way, but the dstrbuton of welfare losses across dfferent levels of total monthly expendtures does not allow sustanng the regressvty of Carbon taxaton, as the effect becomes bgger as we move up the ncome dstrbuton. Ths evdence mght encourage the use of Carbon taxes, at least n the transport sector, as cost-effectve nstruments of envronmental polcy, especally after the ratfcaton of the Kyoto Protocol on Clmate Change. Keywords: Carbon taxes, demand analyss, compensatng varaton, dstrbutve effects J.E.L. classfcaton: D12, H31, Q48. *Fundng from the Progetto Govan Rcercator of the Unversty of Sena s gratefully acknowledged. I am n debt wth Prof. P. L. Rzz for hs contnuous supervson, help and advce n the realsaton of ths work. I also wsh to thank Fabrzo Ball for havng extracted the sample used n ths work and Lorenzo Lusgnol of Centro Europa Rcerche for provdng useful documentaton on the Italan Carbon tax. I bear sole responsblty for any errors. 1

2 1. Introducton Over the last decade and, partcularly, after the Framework Conventon on Clmate Change of 1992, many OECD countres have consdered the ntroducton of Green Tax Reforms amed at reducng, through hgher prces, ether the use of scarce resources or emssons of pollutve substances. In ths context carbon/energy/fuel taxes have frequently been advocated, especally as a way to comply wth the Kyoto Protocol oblgatons. To date some countres have mplemented taxes based on the carbon content of energy products, or energy related taxes 1 : Sweden and Norway n 1991, The Netherlands n 1988, Denmark n 1992, Fnland n 1990, Italy and Germany n 1999 (OECD, 2001, pp ). The Unted Kngdom adopted n 1996 a landfll tax and has ntroduced n 2001 the clmate change levy, a tax on ndustry and busness use of energy. In France and Swtzerland proposals were advanced n 1999, but rejected n 2000 (OECD, 2001, p. 52). The Unted States, Australa and New Zealand, after havng explored the possblty, have abandoned the dea (Baranzn et al., 2000, p. 396). Fnally, the European Unon (EU) after a long dscusson, durng the nnetes, on the opportunty of ntroducng a European Carbon tax 2, does not appear to attach a prorty role to t n the Kyoto Protocol strateges. There thus seems to be a wdenng gap between the poltcal dscourse and the polcy practce, f one takes nto account that the share of envronmental taxes n total tax revenues n EU-15 was 5,8% n 1980; 6,8% n 1994 and 6,7% n 1 There are dfferent knds of emsson taxes consderng the carbon content of energy products (Baranzn et al. (2000), pp ). They vary accordng to the tax base (what s actually taxed): 1) a Carbon tax s a charge to be pad on each fossl fuel, proportonal to the quantty of carbon emtted when t s burned. 2) A CO 2 tax s specfed per ton of CO 2 emtted. It can be easly translated nto a Carbon tax, by knowng that a ton of carbon corresponds to 3,67 tons of CO 2. A true emsson tax would mpose a charge per unt of CO 2, f ths s the greenhouse gas one wants to reduce. 3) An energy tax depends on the quantty of energy consumed, and t s specfed n some common unt (for nstance Brtsh Termal Unts, BTU). It also covers nuclear and renewable energy and t can be less cost-effectve than a carbon or CO 2 tax because the lnk between the objectve (emssons abatement) and the tax base s less drect. Scheraga and Leary (1992, quoted n Baranzn et al., (2000) footnote 6, p. 397) have shown that an energy tax could be 20 to 40% more costly than a Carbon tax, for equvalent reductons n emssons. 2 In 1992, the European Commsson proposed a Drectve (COM(92) 226 fnal) for the ntroducton of a tax on all energy products, excludng renewables, but no agreement was reached n the Ecofn Councl. In 1995 the Commsson amended ts ntal proposal (COM(95) 172 fnal) to overcome the obstacles rased durng the prevous dscusson, but stll the Councl was not able to reach an agreement on the modfed CO 2 /energy tax proposal. In 1997, the Commsson adopted a proposal for a Councl Drectve restructurng the Communty framework for the taxaton of energy products (COM(97) 30). The proposed drectve does not ntroduce a carbon and energy tax, but establshes a mnmum level of taxaton on all energy products. Member states may take nto account all ndrect taxes (except VAT) borne by a product n order to fulfl the requred tax level. Thus, dependng on ther natonal envronmental polcy objectves, Member States are free to apply taxes on CO 2 emssons or other emssons, taxes on energy, or excse dutes. 2

3 1997 (EEA, 2000, pp ) whereas taxes on labour accounted for 51,4% of all EU taxaton n 1995 (Baranzn et al., 2000, p. 396). The recent EU approval of the Kyoto Protocol oblgatons and ts ratfcaton by most of the EU member countres 3, gves reasons to thnk that carbon or energy taxaton mght stll have a role n the future European envronmental polcy or, at least, n the polcy of ts member countres 4, although probably crcumscrbed to the transport sector. Despte the problems n fndng common postons n the EU, the European Commsson (2000) has contnued to advocate envronmental taxes as mportant tools of envronmental polcy 5. In order to make these taxes more poltcally acceptable t has been suggested to use the proceeds from a green fscal reform to sgnfcantly reduce exstng taxes and therefore the welfare cost of Carbon taxaton (Pearce, 1991). The ratonale s that taxes on envronmentally damagng actvtes, largely consdered as cost-effectve nstruments of envronmental polcy, could be used n a revenue neutral context: when other taxes are present, there s the possblty of swappng an envronmental tax for an exstng tax so that the government budgetary poston remans unchanged. A double dvdend could then be produced,.e. mprovements n the envronmental varable whch s the target of the envronmental tax and overall mprovements of the allocaton of goods n the economy (Bosello, Carraro, Galeott, 2001, p. 10). The purpose of ths paper s, frst of all, to assess the welfare effects of Carbon taxaton on Italan households,.e. to measure the gan or loss of welfare caused by the ntroducton of the new tax on households wth dfferent expendture levels 6. These effects wll be calculated through the Compensatng Varaton whch s an exact measure of a welfare change. Secondly, to assess the dstrbutve mpact of the Italan fscal reform,.e. the dstrbuton of the welfare change across dfferent types of households and dfferent expendtures levels. Fnally, the envronmental 3 The European Unon has approved the Kyoto Protocol on May and most of ts member countres have ratfed t on the same day. See 4 Especally f the Kyoto CO 2 reducton targets cannot be met by voluntary acton and programmes n the ndustral sector. 5 See ENDS Envronment daly for the recent development n the EU energy tax plans ( 6 Welfare, n ths context, s measured as the cost or expendture necessary to reach a gven standard of lvng. 3

4 effectveness of the fscal reform wll be assessed, as a frst approxmaton, through estmaton of the demand elastctes for fuels 7. Fve households profles wll be taken nto account and changes n the prces for fuels wll be consdered. The study smulates the ex ante effects on households of a real, not hypothetcal envronmental tax reform, ntroduced n Italy at the begnnng of As far as we know, there are no other such studes for Italy, whch s the frst southern European country havng ntroduced a green fscal reform. Moreover, households data are used whch allow for behavoural responses and for comparsons to be made across dfferent households profles and across dfferent levels of expendtures. The structure of the paper s as follows. In secton 2 some theoretcal consderatons are ntroduced tryng to explan the economc ratonale, the double dvdend ssue and the dstrbutonal mplcatons of Green Taxes. In secton 3 the desgn and purpose of the Carbon tax ntroduced n Italy n 1999 s llustrated. Secton 4 explans how True Cost of Lvng Indces can be used to calculate welfare changes followng a fscal reform and how they can be obtaned from a demand system. Secton 5 comments on the calculatons results. Fnally, n secton 6 we make some fnal consderatons. The paper also ncludes a techncal appendx where the specfcaton of the demand model, the data and the estmaton method used are presented. 2. The Poltcal Economy of Green Taxaton Economsts have long advocated publc polcy nterventon for envronmental protecton. To many of them taxes and charges are the most effectve nstruments to acheve a gven envronmental target. The ratonale for the use of taxes n envronmental polcy s provded by the growng bulk of envronmental externaltes: mpacts on the envronment whch are sde effects of consumpton and producton processes and whch do not enter the calculatons of those responsble for these processes. When these effects are negatve, externaltes are costs that can be partally or wholly nternalsed by levyng a tax on the actvty gvng rse to the effect (Ekns, 1999, p. 41). The 7 The prce elastcty of demand s the percentage change n the demand for a fuel followng a one percent change n ts 4

5 transport and energy sector, n partcular, have been offerng ncreasng evdence, over the last decades, of such negatve externaltes n terms of ther mpacts on the clmate, health and, more generally, on the ecosystem, caused by the greenhouse gases released by fuels. Emssons taxes, among others, are clamed to be market based nstruments of envronmental polcy, because when the authorty has set the approprate tax rate, emssons ntensve goods wll have hgher market prces (Baranzn et al. 2000, p. 396). The market wll thus spontaneously work to reduce emssons. These market based nstruments possess the mportant property of beng cost-effectve: the total cost of reducng emssons to acheve a specfc envronmental objectve s mnmsed, because each polluter s free to choose the most effcent way to comply wth ths polcy measure. Carbon taxes, or other emssons taxes, are usually ntroduced as part of a package of polcy measures amed at reducng emssons and are usually part of a more general fscal reform, because they replace other taxes and try to reduce the dstortonary mpacts of tradtonal taxes on labour, for nstance. Moreover they are usually gradually phased n to avod nflatonary effects, and exemptons are granted to energy ntensve ndustres or to dsadvantaged sectors of the economy. When desgnng envronmental taxaton polcy makers have tradtonally focused on the lkely effcency effects of the envronmental tax that s on a comparson between costs and benefts. The gross costs are gven by the abatement expendtures and prce dstortons between goods generated by the tax. The benefts are gven by the possblty of ganng two potental dvdends (benefts) that ncrease the appeal of taxes n comparson wth other polcy measures: mprovements n envronmental qualty and a reducton n other exstng dstortonary taxes that may have a postve mpact on economc growth, employment or technologcal development. The frst of these dvdends s not controversal, but t s very dffcult to calculate, whereas the relevance and magntude of the second s stll open to debate and has gven rse to a large lterature referred to prce. 5

6 as the double dvdend hypothess (Bosello, Carraro and Galeott, 2001; Goulder 1995; Pezzey and Park, 1998). The possblty of ganng a double dvdend s lnked to the redstrbuton of the fscal revenues generated by the tax to the populaton or to the economy (revenue recyclng). One partcular way of recyclng mples revenue neutralty: the tax revenues are used to decrease other taxes so that the government budgetary poston remans unchanged and the overall tax burden remans the same. The Italan green fscal reform was ntroduced n a revenue neutral context. A bt more specfcally, swaps of envronmental taxes for dstortonary taxes could produce a frst dvdend by dscouragng envronmentally damagng actvtes and a second dvdend by reducng the dstortonary cost of the tax system (Goulder, 1995, p. 158). The lterature on the double dvdend hypothess that has been developed snce the begnnng of the nnetes can be dvded nto two groups of contrbutons (see Bosello, Carraro and Galeott 2001 for detals): the frst one focuses on the welfare effects of envronmental taxaton,.e. on the mpact, over some knd of welfare measure, of dstortons of the tax system before and after the fscal reform. The emphass s thus on ndvdual welfare rather than on the specfc ways n whch fscal revenues are recycled and ther consequences for the economy. The second group of contrbutons focuses, nstead, on the mpact that recycled fscal revenues can have on macroeconomc varables, for nstance employment. Ths work falls nto the frst group of contrbutons. The relevant lterature draws a dstncton between a weak double dvdend and a strong double dvdend (Goulder, 1995). There s a weak double dvdend when the gross cost of the envronmental tax reform combned wth lump-sum transfers of the revenues s greater than the gross cost of the envronmental tax reform accompaned by cuts n dstortonary taxaton. To make the envronmental fscal reform convenent on effcency grounds n presence of a weak double dvdend one should know the dmenson of the Envronmental Beneft produced. One gans a strong double dvdend, nstead, when the second dvdend s even larger than the gross costs, so that the envronmental fscal reform mples a net effcency gan. In ths case the exact knowledge 6

7 of the Envronmental Beneft produced s unnecessary n order to justfy the envronmental tax. However the lterature shows that the strong double dvdend can occur only under strct and rather unlkely assumptons about the functonng of the economy, therefore the double dvdend noton should be the relevant one to polcy makers. Even when carbon taxes are appealng on pure effcency grounds, ther consequences n terms of compettveness and dstrbutve mpacts may be fundamental factors determnng ther poltcal acceptablty and, therefore, ther actual mplementaton. A carbon tax s reflected n the frms cost structure and t s thus one factor affectng compettveness. Gven that not all frms may react n smlar ways a carbon tax may produce compettve losses or dsadvantages dependng on the specfc crcumstances. The dstrbutonal mplcatons of carbon taxes are also a major ssue n determnng ther poltcal acceptablty. Although the dstrbutve mpact can be measured n a number of ways, the majorty of the exstng studes focus on measures across dfferent ncome groups. Intutvely one expects carbon taxes to be regressve,.e. to burden the poor proportonately more, because low ncome households spend a larger fracton of ther avalable ncome on energy than hgh ncome households do. The exstng emprcal studes suggest that carbon taxes may be mldly regressve, but ths often depends on the modellng framework used. Moreover ths regressve effect s much attenuated, or even reversed, n a revenue-neutral context. Symons, Speck and Proops (1998), for nstance, found that whle energy or CO 2 taxaton s regressve n Germany, France and slghtly n Span, t s progressve n the UK (except for the hghest ncome group) and neutral n Italy. Moreover, nterestng results are obtaned when energy products are dstngushed between domestc energy and transport fuels (Baranzn et al. 2000, p. 405). Barker and Kohler (1998) found that whle taxaton of transport fuels s weakly progressve, taxaton of domestc energy has a weakly regressve mpact. The followng table tres to summarse the results of some emprcal studes on the dstrbutve mpact of carbon-energy taxes. 7

8 Country studes on the Dstrbutve Impact, on Households, of Green Taxaton Country Study Type of Energy Taxaton Dmenson of the Dstrbutve Impact Dstrbutve Effect Sweden (Brännlund & Nordström, 1999) CO2 tax leved on all fossl Income groups; Number of fuels chldren per household; Regressve n case of no tax replacement; not so n a revenue neutral context U.K. (Smth, ) Road Fuels Tax Income groups; regons Not regressve when all households are consdered; Regressve f only car-ownng households are consdered Span (Labandera & Labeaga, 1999) Carbon tax on all fossl fuels Expendture Groups; Dfferent demographc profles Not regressve Australa (Cornwell & Creedy, 1996) Carbon tax on fossl fuels used n producton and consumpton Income Groups Regressve when no technologcal substtuton s allowed; less so when technologcal substtuton s allowed U.K. (Symons, Proops & Gay, 1994) Carbon tax on fuels Expendture Groups Regressve n case of no tax replacement; less so n a revenue neutral context 5 European Countres. Symons, Speck and Proops (2000) EU-11 Barker and Kohler (1998) Energy/Carbon taxes Excse dutes on energy products Income Groups Expendture groups Regressve n Germany, France and Span; progressve n the UK; neutral n Italy Weakly regressve n most countres when domestc energy s ncluded. Weakly progressve when only road fuels are taxed on ther own. Fnally, the effectveness of a carbon tax should also be evaluated n terms of ts envronmental mpact,.e. n terms of the reducton of carbon doxde emssons t can acheve. Ths may depend to a large extent on the senstveness of energy demand to prce changes. Thus f energy demand s relatvely nsenstve to prce changes,.e. t s nelastc, emssons wll not decrease suffcently to obtan a gven abatement objectve. The responsveness of the quantty demanded of an energy product to the market prce can be calculated through the prce elastcty of demand obtaned by dvdng the percentage change n the quantty demanded by the correspondng percentage change n ts prce. The am of ths paper s to provde a country specfc analyss of the consequences of the use of green taxes n order to add emprcal evdence to some of the theoretcal ssues rased n ths 8 Results from the Smth paper are derved from the IFS Commentary n. 65: Blow, L. and I. Crawford (1997) The Dstrbutonal Effects of Taxes on Prvate Montorng. 8

9 paragraph. The focus s on a specfc country, Italy, and on one of the subjects nvolved n the green fscal reform, households. More specfcally, three of the ssues rased above wll be covered. Frst, we wll look at the welfare costs or benefts, n terms of real expendture, to dfferent households, of the Italan Carbon tax. Second, we wll calculate the dstrbutonal mpact of the tax on households wth dfferent ncome levels. Thrd, the prce elastcty of demand for domestc fuels and for transport fuels s calculated as a frst approxmaton of the envronmental mpact of the tax. 2. Carbon taxaton n Italy Wth the approval of the Fnancal Law for 1999, a carbon tax on the consumpton of energy products and related compensaton measures has been ntroduced n Italy (L n. 448, art. 8). The new green tax s based on two man components (OECD, 2000, pp ): a reducton n CO 2 emssons through a re-modulaton of excse dutes 9 on mneral ols to be acheved wth a smooth transton from 1999 to 2005; the ntroducton of a consumpton tax on coal and natural btumen used n the combuston plants as defned by the EU Drectve 88/609/1998. The followng products are nvolved: leaded and unleaded petrol; Desel ol (used for both heatng and for transports); natural gas (used for both heatng and transports); heavy fuel ols; Lquefed Petroleum Gas (LPG). Ths s n lne wth the natonal actons defned n 1998 (CIPE 10 resoluton of ) to reduce CO 2 emssons n order to comply wth the oblgatons of the Kyoto Protocol. To modfy the structure of excse dutes, the target vector of the above energy products tax rates has been dentfed 11. Ths s amed at satsfyng both the necessty to tax each fossl fuel accordng to ts specfc CO 2 emssons and the requrements of the EU Drectve (COM/97/30) on the harmonsaton process of excse rates on energy products, accordng to whch mnmum excse rates are fxed at the European level based on the product and the sector of utlsaton. Indcatng 9 As Barker and Kohler (1998) have ponted out (p. 386) there s a man dfference between a carbon/energy tax and excse dutes. The Carbon tax s ncluded n the basc prces of the energy ndustres. Excse dutes on the other hand are to be pad further down the chan of productvty. In ths case the basc prces of the energy ndustres are largely unaffected except n as much as ther labour costs and own use of electrcty and fuels are taxed. 10 Comtato Intermnsterale per la Programmazone Economca. 9

10 wth α the excse duty on product, the new energy excse rates n Italy are structured as follows: α = k β + A, where k s the rato between the Italan excse duty on product pror to the m ntroducton of the new tax and the mnmum excse rate level proposed by the European Drectve 12 COM/97/30; β m s the mnmum excse level proposed by the above mentoned European Drectve and A s the envronmental component of the tax, proportonal to the kgs of CO 2 emtted by the fossl fuel under consderaton. Ths term s equal to 10 Lre per kg of CO 2 released n the combuston of 1 kg of fuel up to 2,75 kg of CO 2. For emssons level n the range 2,75 to 4 kg of CO 2 per kg of fuel a lnear ncrease of 400 Lre for each addtonal kg of emssons s assumed 13. Ths procedure has allowed settng out the excse rates for mneral ols to be appled on January 1 st Accordng to the Law, durng the years from 1999 to 2004 the rates are supposed to be rased smoothly wthn a range not lower than 10% and not hgher than 30% per year of the dfference between excse rates pror to the green reform and target level excse rates. In addton to that, a consumpton tax of Lre per ton has been ntroduced for coal and natural btumen used n the combuston plants as defned by the EU Drectve 88/609. The followng table shows prce ncreases n the consumpton of the taxed products to be acheved by the end of Prce changes due to the Carbon tax Unt of measurement Excse level n 1998 Prce levels n 1998 Exce levels n 2005 Prce levels n 2005 % prce varaton Transport fuels Unleaded petrol lre/ltre 1022, , Desel ol (transports) lre/ltre 747, , To be acheved on January 1 st The k coeffcent s calculated for each sector by referrng to the most used product n that sector: petrol for transports, methane for the cvl and ndustral sector, for nstance. 13 Such structure s also appled to energy products used n the ndustral sector, but the rates are reduced when appled to the producton of electrc power snce n Italy electrcty s already taxed as output. In ths area the tax rate s calculated by applyng the component proportonal to the envronmental mpact only wth a very lmted ncreased coeffcent. 10

11 LPG (transports) lre/kg 597, Natural gas (transports) lre/m Domestc fuels Desel ol (domestc) lre/ltre 747, , LPG (domestc) lre/kg 325, Natural gas (domestc) lre/m Heavy fuel ol (domestc) lre/kg , Industral use and energy producton Natural gas (ndustral use) lre/m Natural gas (electrcty producton) lre/m , Coal (electrcty producton) lre/kg , Heavy fuel ol (energy producton ) lre/kg 28, , The proposed taxaton scheme hts transport fuels the most, although Italy s already one of the OECD countres where transport fuels are most heavly taxed. Households costs are ncreased not only by the hgher prce of heatng fuels, but, also, by the ndrect effect on households of the hgher costs of electrcty producton. The law provdes a lower tax rate on natural gas for households lvng n dsadvantaged areas of the country. The heavest tax burden s on Coal used for electrcty producton, whch should cause a reducton n the use of ths fuel n thermoelectrc energy producton, although ths knd of energy generaton exhbts the lowest unt cost of producton. More generally, the proposed scheme seems to provde ncentves to promote substtuton of natural gas for fossl fuels n the domestc and energy sector and a substtuton of unleaded petrol for other fuels n the transport sector. As sad before, the green tax reform has been ntroduced n a revenue-neutral context. The explct goal of the reform s to explot a double-dvdend: to promote envronmental mprovement and, at the same tme, to reduce the tax wedge on labour costs. In the sx years of the reform revenues of 6.987,66 Mllon/Euro are projected 14, coupled wth a 12 mllon tons reducton of C0 2, representng about 12% of the target reducton (to be acheved by 2010) n CO 2 emssons for Italy 14 Ths s the projected revenue publshed n the report ssued by the techncal commttee n charge of llustratng the new fscal measure to the Councl of Mnsters. See, also, Rapporto CER/Centro Europa Rcerche n. 1/1999, pp Roma, Veutro Edtore. The expected revenue for 1999 was 1.125,87 Mllon/Euro and 1.172,36 Mllon/Euro for the followng fve years, assumng consumpton levels and composton unchanged wth respect to 1999 levels. 11

12 set out n the Kyoto Protocol. The revenue for the frst year (1999) of the reform s mplementaton has been 1.125,88 Mllon/Euro. The largest share (60,5%) of ths revenue, 681,21 Mllon/Euro, was used for cuttng socal securty contrbutons, thus reducng the tax wedge on labour costs by 0,82% ,1% of t, 352,74 Mllon/Euro, was targeted on compensaton measures ncludng a tax credt for lorry haulers, a reducton n the Desel-ol duty and a reducton n taxaton of heatng fuels for the poorest and coldest areas of the country. Fnally, 8,4% of the revenue, 154,94 Mllon/Euro, was devoted to nterventons mprovng envronmental effcency of energy use. The dfference between the expected Carbon tax revenue and the above expendtures (about 67,14 Mllon/Euro) was covered through the ncrease n the excse on unleaded petrol already decded n 1996 and confrmed n the Fnancal Law for The Carbon tax was formally adopted on 15 January In 1999 the ncrease n the excse rates has been equal to 20% of the total ncrease to be appled as of January 1 st Eleven months after enterng nto force, n November 1999, the tax progresson was suspended due to fears that on top of the surge n world ol prces, the ecotax would mpose unacceptable nflatonary pressures (ENDS, 2000a). At the same tme, a government decree let the retal prces of petrol and desel fell by an average of 30 Lre per Ltre thus compensatng for the Carbon tax. The tax was re-appled n June 2000 at levels slowly hgher than those n force n Durng 2001 and 2002 the tax levels were mantaned at the 2000 levels. The Government n 2001 has extended the tax rebates already allowed for petrol and desel fuels to natural gas and desel used for domestc heatng (ENDS, 2000b). At the same tme, pressures have been growng to abolsh t, especally from government representatves (TaxNews Update 2002) and the ndustral assocatons (ENDS, 2002). A commttee of Italan MPs has also recommended ts abolton n a revew of natonal energy polcy ssued n Aprl Meanwhle Italy has ratfed, together wth the other members of the EU, the Kyoto Euros nstead of Lre wll be used henceforth. The exchange rate Lre/Euro s 1.936,27 Lre for 1 Euro. 15 Ths has been acheved through removal of some socal securty contrbuton, through halvng the socal contrbutons due by young entrepreneurs n the handcraft and commercal sector and through transfer on the account of the state budget (fscalzzazone) for three years of the socal contrbutons due by frms for the labour force recruted n the Southern regons by the end of

13 Protocol on the 31 st of May 2002 even though ts greenhouse gases emssons have rsen by 5,6% from 1990 to 2001 and carbon doxde emssons from the transport sector alone have ncreased by 22,8% snce 1990 levels (ENDS, 2002). 4. True-Cost-of-Lvng Indces and the Compensatng Varaton Our am s to assess the welfare effects of prce ncreases determned by the ntroducton of the Carbon tax on dfferent households and also to assess ts dstrbutve effects,.e. how households at dfferent levels of ncome and wth dfferent demographc profles are affected. In order to do that we calculate, frst, True-Cost-of-Lvng (TCOL) ndex numbers and then the Compensatng Varaton. A TCOL ndex number compares the cost of achevng a gven level of welfare before a prce ncrease wth the cost of achevng the same level of economc welfare after the prce ncrease and measures how much extra ncome s needed to get back to the orgnal welfare level (Deaton and Muellbauer, 1980a, p. 170). If u 0 s the base level of welfare, the correspondng true ndex of the cost of lvng s gven by: c c 0 1 ( u, p ) 0 0 ( u, p ) P ( p, p, u ) = = TCOL (1) where c(u 0,p 1 ) s the mnmum cost of reachng utlty u 0 at the prce vector p 1, whereas c(u 0,p 0 ) s the mnmum cost of reachng u 0 at prces p 0. TCOLs represent a more precse measure of the welfare change caused by a change n prces than the Laspeyres ndex number, because they allow for substtuton possbltes n the bundle of goods consumed holdng utlty constant, whereas the Laspeyres ndex number measures the change n the cost of lvng assumng that the same bundle of goods wll be bought before and after the prce change. The money metrc measure of a welfare change correspondng to TCOLs s the Compensatng Varaton (CV) defned as the mnmum amount by whch a consumer would have to be compensated after a prce change n order to be as well off as before (Deaton and Muellbauer, 1980a, p. 186). In ths case, nstead of havng ratos as wth the TCOL ndex number, we have sums of money expressed as the dfference n costs of 13

14 reachng the same utlty level at two dfferent prce vectors. As t s well known, the CV s the area between the compensated or Hcksan demand curve and the prce before and after the change. Hcksan demands are the dervatves of the cost functon, therefore ntegraton gves the dfference n costs of reachng the same ndfference curve at two dfferent prce vectors (Deaton and Muellbauer, 1980a, p. 186). Snce the compensated or Hcksan demand curve shows the relatonshp between the prce and quantty demanded at constant levels of utlty, CV s a precse measure of the change n welfare followng a prce change. If we defne CV as: CV = c(u 0, p 1 ) c(u 0, p 0 ), ths can be easly obtaned from a TCOL as: ( u p )[ TCOL 1] = c( u, p ) c( u, p ) CV c, = (2) To calculate the TCOL n (1) we need to know the parameters of the cost functon c(u, p), whch can be obtaned through estmaton of a complete system of demand equatons. Ths has been specfed as an Almost Ideal Demand System (AIDS) (Deaton and Muellbauer, 1980b). Detals on the specfcaton and estmaton of the demand system and on the data used can be found n the appendx. The values of the AID system s parameters to be used later for calculaton of the TCOLs are shown n table II together wth ther standard errors, the coeffcent of multple determnaton and the Durbn Watson statstc. 5. TCOLs calculaton The estmated parameters of the demand system have been used to produce TCOLs (see equaton 7). These have been calculated from January 1985 (1) tll December 2000 (12). For each of the fve households profles consdered (see the appendx for detals), TCOLs have been calculated for fve dfferent welfare levels lny 16. These have been chosen as follows. Indcatng wth ln y the mean of the monthly 1995 total expendture of each famly type (h=n1,,n5) and wth lny n, (n=1,...,5), the chosen level of welfare, for each of the fve households profles of our sample we have chosen the followng values of the expendture dstrbuton: 14

15 lny h 1 = ln (0,25 y); lny h 2 = ln (0,75 y); lny h 3 = ln y; lny h 4 = ln (1,25 y); lny h 5 = ln (2,75 y) ndcatng very low to very hgh welfare levels. These reflect the real expendture dstrbuton n the sample used. Ths specfcaton of dfferent welfare levels for each type of households wll be used to assess the dstrbutve effects of ths fscal reform. In order to smulate the ncrease n prces due to the ntroducton of the Carbon tax we have buld up two dfferent prce ndces for the two aggregates under consderaton: transport fuels (BENZI) and domestc fuels (GAS). Only the prces of leaded and unleaded petrol, heatng ols and natural gas have been modfed, n the transport fuels aggregate, to keep track of the tax, although the Law specfes ncreases n the prces of addtonal products whch have not been taken nto account here due to lack of data. In the baselne smulaton, the prces for the taxed products, suppled by Unone Petrolfera (the Italan Ol Frms Unon), have been modfed to phase out the Carbon tax and obtan the baselne prce tme seres. The consumpton prce s gven by: ( + α )( + γ ) p = 1 where p t s the ndustral prce of product n month t; α t s the excse duty t p t t on product at tme t and γ s the value added tax (VAT) rate calculated as a fxed percentage of the sum of the other two components of the prce structure 17. We have thus obtaned the baselne monthly tme seres of prces to be used n the smulatons, whch have been normalsed wth respect to the mean 1995 prce. A second tme seres has been obtaned as follows. We have smulated the ntroducton of the Carbon tax for four years, choosng as the startng month January 1997 (although we use the tax system vald from January 1999, as provded by the Law) and have carred out the smulaton tll December 2000, because for ths perod data on prces were avalable. The monthly prces have been ncreased lnearly, by 20% per year of the total rse to be acheved at the end of the fourth year, as ndcated by the Law. We have thus obtaned two tme seres of monthly prces for each taxed product, normalsed wth respect to the mean 1995 prce. These are 16 At the normalsaton pont, the welfare level u s equal to the logarthm of total expendture y. 17 Ol prce rses n the year 2000 have boosted the assocated VAT revenues and the Italan government has used ths addtonal revenue to cut the excse on ol products between 30 to 50 Lre per Ltre (OECD, 2000, p. 24). 15

16 the same up untl December 1996 and start dvergng from January Snce we have squeezed the prce ncreases to four rather than sx years (as provded by the Law), the smulaton s lkely to produce welfare changes that mght be hgher than what would result from a lnear prce ncrease over sx years. 5.1 The Compensatng Varaton (Welfare Effects) After havng obtaned TCOLs for the two dfferent scenaros: a and b (a = no Carbon tax scenaro; b = Carbon tax scenaro), we have calculated monthly CV for each type of household and each welfare level, from 1997 (1) tll 2000 (12) as defned n (2). CV s a money metrc measure of welfare and can be defned as the level of ncome necessary to compensate the consumer for a prce change n order to be as well off as he was before the change n prce. The dfference n the CV calculated for the two scenaros a and b thus ndcates the amount of ncome that, after the ntroducton of Carbon taxaton (scenaro b), would allow households to enjoy the same level of welfare they would have had wthout the fscal reform (scenaro a). Ths s gven by: CV h, t h, t n CV b n, =, a n, b t h t ( ) h, t TCOL TCOL h,, y n, a n where CV n,b h,t s the CV of household h, at tme t, at the welfare level n, calculated accordng to scenaro b; CV n,a h,t s the CV of the household h, at tme t, at the welfare level n, calculated h,t accordng to scenaro a and y n s the welfare level n of household h at month t. So we get 25 dfferent welfare changes per month: one for each household type, h, and welfare level, n. In order to have an aggregate measure of the welfare change, the number of households n each household and expendture class has been multpled by a coeffcent (also publshed by ISTAT) that allows to convert the sample used nto the exstng populaton,.e. nto the real number of households of that type and of households n that class of expendture lvng n Italy n Table V shows the annual aggregate welfare losses (expressed n Mllon/Euro 95) calculated for 18 In other words, gven the baselne tme seres of prces, the prce rses due to the Carbon tax have been mplemented startng from January 1997 and untl December We could not smulate the prce ncreases from January 1999 and onwards for sx years, because monthly prces were avalable only up untl December

17 each of the 4 years of the smulaton ( ) for each household profle and welfare level. For the poorest group of famles, the annual welfare loss goes from 0,52 Mllon/Euro 95 n 1997 to 5,27 Mllon/Euro 95 n 2000, at the target level of taxaton; whereas for the rchest group the annual loss amounts to about 21 Mllon/Euro 95 n 1997 and to 213,55 Mllon/Euro 95 n The large drop one can observe n the welfare loss for the 5 AD and lny5 n table V s due to the fact that the 5 th household type was the less represented among those consdered n ths work. Data shown n tables V can be used to make a tentatve comparson between the expected cumulated revenue from the Green Reform,.e. about 6.987,66 Mllon/Euro as explaned n paragraph 3, and the cumulated loss of the 5 households types under consderaton up to the year 2000, whereas table IV can be used to assess the dstrbutve mpact. In table V, summng over household types and years, we get 2.320,44 Mllon/Euro 95 amountng to, roughly, 33,3 % of the expected cumulated revenue from the Carbon tax. The aggregate welfare loss seems to be sgnfcant and to amount to a consderable porton of the expected cumulated revenue from the reform. However comparsons of the estmated welfare loss wth the projected cumulatve revenue from the Carbon tax must be taken wth care, because only 5 household s profles are accounted for n our smulatons, although they are the most representatve ones. Moreover, the projected cumulatve revenue of 6.987,66 Mllon/Euro s calculated assumng constant consumpton levels over the sx years of mplementaton, whch probably causes the expected revenue from ncreased taxaton to be rather large. The last fve rows n table V show the annual aggregate welfare loss per welfare level and the last column n the table ndcates the share of the cumulated loss for each household profle and welfare level over the total welfare loss. As we have already ponted out, the large drop we can observe for the lny5 profle s lkely to be due to the number of the famles wth that profle lvng n Italy n The Dstrbutve Impact 17

18 Snce we are also nterested n evaluatng the dstrbutve effects of Carbon taxaton we have calculated, n table IV, the mean monthly welfare loss n the year 2000 (at the target rate of Carbon taxaton) per household type and welfare level as a percentage of the mean monthly 1995 expendture level. Contrary to what has been found n other smlar studes, the tax burden s progressvely dstrbuted across households at dfferent welfare levels. Thus, the presumed regressvty of Carbon taxaton s not sustaned here. Ths mght be due to the fact that the reform has manly ht transport fuels, whereas heatng fuels prces have ncreased relatvely less. As Smth (2000) has ponted out, ths effect mght also be due to households n the lowest expendture levels not ownng a car. Indeed, n the Brtsh study, when only car-ownng households are taken nto consderaton, the dstrbutve effect s reversed. Fgure 1 shows the progressvty of Carbon taxaton n Italy more clearly. Moreover, t can also be observed, from fgure 1 and table IV, that the tax burden seems to affect manly households wth one and two adults and decreases for larger famles. Ths could be explaned by the fact that the tax burden due to car ownershp, for nstance, s more dstrbuted as the number of household members ncreases, because the number of car owned does not ncrease lnearly wth the number of households member. 5.3 Effectveness of the Carbon tax Behavoural responses to the fscal reform can be evaluated ex ante, by lookng at the prce elastctes of demand for transport and domestc fuels. They tell us the percentage reducton n the demand of the taxed goods followng a 1% ncrease n ther prce. Elastctes can be thought of as a prelmnary measure of the envronmental effectveness of the fscal reform, because they ndcate the capacty of the envronmental tax to acheve the goal of reducng emssons of the pollutve substances. From the demand system n (10) we can easly calculate the matrx of Marshallan (non compensated) prce elastctes of demand and the vector of ncome elastctes as: e j c w j j = b + bj * w w w P b y ln δ IJ Marshallan elastctes 18

19 wth δ j =1 for =j and δ j =0 for j. b e = +1 Income elastctes w These are shown n table IIIA and table IIIB together wth the estmated budget shares. Elastctes have been calculated at the sample mean (over 720 observatons) and standard errors are computed usng the Delta Method 19 mplemented through the ANALYZ command of TSP4.4. The drect prce elastctes show that the demand for domestc fuels (GAS) and transport fuels (BENZI) turns out to be sgnfcantly elastc: -1,057 and -1,282, thus sgnallng that the Carbon tax can be effectve n reducng carbon emssons. The demand for transport fuels s even more elastc than that of domestc fuels. Ths result suggests that Carbon taxaton n the transport sector could play a sgnfcant role n the future Italan envronmental polcy, especally after the Kyoto protocol ratfcaton of May 31 st The effect of the tax on the consumpton pattern can be studed observng the cross prce elastctes. The thrd and fourth rows of table IIIA are the relevant ones. The change n demand of food, outdoors meals, publc transports and other goods due to a change n the prce of domestc fuels s low (-0,135; -0,068; 0,323; 0,383; 0,053). The demand for domestc fuels appears to be complementary to transport fuels, although ths elastcty s also low (0,311). The same sort of changes n the consumpton pattern s shown when the prce of transport fuels changes (0,137; 0,367; 0,489; -0,276; -0,160). Thus, whereas the tax mght be effectve n reducng the consumpton of the pollutng goods, t does not sgnfcantly affect the consumpton pattern. As to the ncome elastctes of demand, domestc fuels turn out to be a luxury good (1,523), whereas the demand for transport fuels ncreases less than proportonally wth respect to the ncrease n ncome: 0, Fnal consderatons 19

20 In ths paper we have calculated the welfare loss due to the Carbon/Energy Tax ntroduced n Italy at the begnnng of 1999 by the Centre-Left coalton, whch allows for gradual ncreases n the prces of most fossl fuels over sx years. The reform hts manly transport fuels and heatng fuels, through ncreases n the excse rates of these products to be acheved wth a smooth transton from 1999 to Heatng fuels are taxed relatvely less and, n addton, the generated revenues are partly recycled by compensatng households lvng n clmatcally dsadvantaged regons for the ncreased burden of taxaton. Only gross welfare costs to households are calculated assumng no revenue recyclng. Ths s equvalent to the Fscal Revenues from the reform beng dscarded, but helps dentfyng the crude dstrbutonal mpact of the tax. The welfare effects have been calculated usng the Compensatng Varaton obtaned by True Cost of Lvng ndex numbers. True Cost of Lvng Indces measure how much extra ncome s needed to get back to the orgnal welfare level. The advantage of usng True Cost of Lvng Indces rather than other prce ndces s that behavoural responses to a prce change (.e. substtutons n the bundle of goods chosen by the household as a consequence of a change n the prce of one of the goods) are ncorporated, so that the measure of welfare change s more precse. As West and Wllams pont out n ther welfare calculatons for the Unted States (2002, p. 19): ''Omttng demand responses may lead one to substantally overstate the welfare cost of the gas tax. Omttng demand responses also makes the gas tax appear more regressve. Own prce gas demand elastctes are relatvely smlar across most of the ncome dstrbuton, but gas demand for the top quntle s substantally less elastc. Thus the relatve burden of the top quntle s larger under measures that nclude demand responses makng the tax more progressve.'' When nformaton on the expendture functon of households s avalable (.e. when data are avalable on total expendtures, prces and expendtures on the goods among whch the demand system s dvded) the calculaton of exact measures of welfare change, such the Compensatng 19 The method lnearses non-lnear functons around the estmated parameter values and calculates standard errors of 20

21 Varaton, s farly easy and gves more relable nformaton on the welfare changes and on the dstrbuton of the burden of a prce change. The parameters of the True Cost of Lvng Indces have been obtaned through estmaton of a complete system of demand usng mcro-data suppled by the Italan Natonal Statstcal Insttute from 1985 to All the welfare changes are postve, thus representng losses to households rather than gans, as consequences of the reform. One may also observe that the tax burden seems to affect manly households wth one or two adults and decreases for larger famles. Ths could be explaned by the fact that the tax burden due to cars wdespread use, for nstance, s more dstrbuted as the number of households ncreases, because the number of cars owned and used does not ncrease lnearly wth the number of households members. From table V we can see that the aggregate welfare loss (cumulated over the years and takng nto account the number of households of each type lvng n Italy n 1995) s qute substantal and affects Italan households n a non-neglgble way. The expected welfare loss to households could be compared to the expected fscal revenues that could be used, ex post, to compensate households for the ncreased burden of taxaton. However, comparsons wth the expected cumulated fscal revenues are to be taken wth care. On one hand, we only consder fve households profles. On the other hand, the projected cumulated revenue has been calculated, by the polcy maker, wthout takng nto account behavoural responses,.e. assumng constant consumpton over the sx years of mplementaton. In fact consumpton, and thus the fscal revenues, s lkely to be reduced as a consequence of ncreased taxaton. The other relevant result s that varaton of welfare losses across dfferent levels of total expendtures does not allow sustanng the presumed regressvty of Carbon taxaton, as the cost of lvng of households n the lowest ncome groups s not most adversely affected by the tax ncreases. In fact the effect becomes bgger as we move up the ncome dstrbuton:.e. for each household profle, the welfare loss ncreases wth ncome. Ths mght be due to the fact that the the estmated parameters. 21

22 reform has manly ht transport fuels. If households at the lowest expendture levels do not own a car the tax burden mght be progressve, as notced by Smth (2000). Other studes have produced smlar results such as Labandera and Labeaga (1999) for Span and Symons, Speck and Proops (2000), for some European Countres, although the methodologcal framework adopted s dfferent. As to the envronmental effectveness of the tax reform, prce responses seem to play an mportant role n the Italan case: the prce and ncome elastctes for transport fuels, calculated at the sample mean, are very hgh. Ths could be due to the fact that alternatve transportaton optons, other than prvate cars, are avalable. In Italy cars have for a long tme been a status symbol rather than a necessary means of transportaton. Publc means of transportaton are wdespread and rather effcent and dstances are much shorter than, for nstance, n the Unted States where the demand for fuels s more nelastc (West and Wllams, 2002, p. 7, fnd that the prce elastcty of demand for gasolne s n the range -0.5, -0.7 except for the top quntle of the ncome dstrbuton). Thus, the way people react to polcy changes seems to be crucal and behavoural responses should be taken nto account when assessng the effects of ncreased taxaton. We hope that exercses such as ths may help provdng useful nsghts, to the polcy makers, nto the lkely effects of envronmental polcy measures. One of the factors causng great resstance n developed countres to the ntroducton of Carbon taxes s ther presumed regressvty. However, the Italan Carbon tax does not seem to be regressve. Ths evdence mght encourage the use of Carbon taxes as cost-effectve nstruments of envronmental polcy, at least n the transport sector, as a way to comply wth the Kyoto protocol oblgatons. APPENDIX The Demand System: specfcaton, data and estmaton The system of demand has been specfed as an Almost Ideal Demand System (AIDS) (Deaton and Muellbauer, 1980b). We start from a logarthmc cost functon whch mples PIGLOG preferences 22

23 (Deaton and Muellbauer, 1980a, pp ),.e. whch allows perfect aggregaton over consumers: ( u, p) ln a( p)(1 u) u ln b( p) ln c = + (3) Where a(p) and b(p) are functons of prces and ln ndcates the natural logarthm. By adoptng the flexble functonal forms approach (3) can be approxmated through a functon that, thanks to ts large number of parameters, can be consdered as a second order approxmaton of the true cost functon. Thus lettng: ln a( p) = α ln 1 * α + p + c j ln p ln p j (4) 2 j 0 p b ln b( p) = ln a( p) + b0 (5) where =1,...,n and j=1,...,n are the number of goods consdered, substtutng (4) and (5) nto (3) and dfferentatng wth respect to the prces, lnp, we obtan the Hcksan demand functons as shares and substtutng the ndrect utlty functon (obtaned by nverson of the cost functon) nto the Hcksan demand functons we obtan Marshallan demand functons as shares of the form: w y = α + cj ln p j + b ln (6) j P where y s total expendture, the P prce functon s defned as: ln P = α 0 + α ln p + 2 j 1 c j ln p ln p j and the parameters c j are defned as: c j =1/2(c * j + c * j)=c j. These demand functons satsfy ntegrablty,.e. are consstent wth utlty maxmzaton, when the followng restrctons on the parameters are satsfed: α = 1 b = c j = 0 Addng-up 23