Taxation of Intermediate Goods

Transcription

1 Txtion of Intermedite Goods

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3 Örebro Studies in Economics 19 LARS BOHLIN Txtion of Intermedite Goods A CGE Anlysis

4 Lrs Bohlin, 2010 Title: Txtion of Intermedite Goods - A CGE Anlysis Publisher: Örebro University trycksker@oru.se Print: Intellect Infolog, Kållered 10/2010 ISSN ISBN

5 Abstrct Lrs Bohlin (2010): Txtion of intermedite goods - A CGE nlysis. Örebro Studies in Economics 19, 27 pp. This disserttion is concerned with tx rtes for the use of commodities in generl, nd energy in prticulr. Computble Generl Equilibrium (CGE) models re used to nlyze the normtive question of whether the tx rte for intermedite use by firms should be the sme s the tx rte for finl consumption by households. To nswer this question, distinction needs to be mde between fiscl txes for the purpose of rising revenue for the government, nd Pigovin txes for the purpose of chnging behviour. Concerning fiscl txes, firms should not py txes on their use of inputs if the tx rtes in finl consumption re t their optiml level. If the tx rte for households is bove the optiml level, intermedite use in firms should be txed in order to increse the price of other commodities nd reduce the distortion of reltive prices. Essy 1 scertins wht fctors determine the optiml reltion between the tx rte for finl consumption by households nd intermedite use by firms. Essy 2 nlyses Swedish energy txes from the perspective of reducing globl emission of CO 2. It is found tht the welfre mximizing tx rtes re equl for households nd firms not prticipting in emission trding, while firms tht prticipte in emission trding should hve zero tx rte. Essys 3 nd 4 del with methodologicl issues. Essy 3 derives new method for estimtion of symmetric input-output tbles from supply nd use tbles. This method solves the problem of negtive coefficients, mkes it possible to use both the industry nd commodity technology ssumptions simultneously nd enbles the commodity technology ssumption to be used even when the number of commodities is lrger thn the number of industries. Essy 4 describes the model used in the first two essys. The price structure developed here mkes it possible to tke into ccount price differences between different purchsers other thn differences in tx rtes. This essy lso mkes comprison between the Swedish implementtion of this model nd other Swedish CGE-models used to nlyse climte policy nd energy txtion. Keywords: Optiml txtion, energy txtion, environmentl txes, emission trding, climte policy, Crbon lekge, CGE-nlysis, input-output tbles. Lrs Bohlin, Swedish Business School t Örebro University Örebro University, SE Örebro, Sweden, lrs.bohlin@oru.se

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7 Acknowledgements Writing this thesis hs been long nd struggling process tht would not hve been possible without the help of lot of people. First, I would like to thnk my supervisor Lrs Hultkrntz for his detiled nd helpful comments on ll my writings, nd my former professor Lrs Lundberg who ws my supervisor t the beginning of the process. My collegues t Örebro University gve generously of their support nd vluble comments on my work. I would like to mention Lrs Widell for good coopertion, Ptrik Krpty for your nswers to ll my how to do questions, Jörgen Levin for vluble insights into CGE modelling nd Håkn Persson for lwys checking the mths. Specil thnks to Kristin Ekbld nd Jens Olofsson for discussions bout the problems encountered living the life of PhD student. Anders Edfeldt nd Lrs-Görn Nilsson lwys hd time whenever I needed someone to tlk to. Shermn Robinson nd Hns Löfgren gve me the foundtions of CGE modelling t the CGE-course in Norwy. They lso developed the stndrd model tht I used in the development of SAINT. Jouko Kinnunen kindly prticipted in vluble discussions on how to mke djustments of the stndrd model, nd Bengt Kriström nd Svnte Mndell mde vluble comments on the mnuscript. I would lso like to thnk everyone in my fmily nd ll my friends who supported me with positive energy whenever I needed it. And finlly to ll the women tht hve shred my life during different prts of the process of writing this thesis, I love you one nd ll.

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9 Tble of content 1 INTRODUCTION ENERGY TAXES AND CLIMATE POLICY Energy tx rtes in Europe The development of energy tx rtes in Sweden Climte policy Crbon Lekge Europen emission trding system METHODOLOGY Unit prices nd trde mrgins Flexible nest structure Secondry products THE ESSAYS POLICY IMPLICATIONS AND FUTURE RESEARCH List of Essys Essy 1: Txing Intermedite Goods to Compenste for Distorting Txes on Household Consumption Essy 2: Climte Policy within n Interntionl Emission Trding System A Swedish cse Essy 3: Estimtion of Commodity-by-Commodity Input Output Mtrices Essy 4: SAINT Stndrdized CGE-model for Anlysis of Indirect Txtion

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11 1 Introduction This thesis discusses different spects of commodity txtion. Two purposes for txes on commodities re distinguished. The purpose of fiscl txes is to collect money for government expenditure. The purpose of Pigovin txes is to correct for externlities in consumption or production. In some cses tx fulfils both these purposes t the sme time; in which cse the so-clled double dividend hypothesis is fulfilled. However, in most cses Pigovin tx reduces other tx income since other tx bses re reduced, nd does not fulfil the fiscl purpose. The most importnt issue in this thesis is normtive nlysis of the distribution of commodity tx rtes between finl consumption nd intermedite use. In the simplest cse of closed economy, with optiml tx rtes (ccording to the Hicks-Kldor criterion) for ll commodities in finl consumption, the optiml distribution is known. If the purpose of the tx is to internlize n externl effect, the tx rte should be of equl size for intermedite use nd finl consumption. If the purpose is fiscl, only finl consumption should be txed. Finding the optiml distribution between these ctegories becomes more complex when tx rtes in finl consumption devite from the optiml levels. Yet nother spect tht complictes the nlysis is interntionl trde since only domestic production nd consumption cn be txed. In two of the essys in the thesis these issues re investigted using computble generl equilibrium (CGE) models. Swedish txes on energy re used s exmples of commodity txes. The totl cost to the Swedish economy of different designs of energy txes is nlysed, s is the impct on return to cpitl nd wges in different industries. In essy 1 the optiml distribution of fiscl commodity txes is investigted while essy 2 dels with the CO 2 tx tht is n exmple of Pigovin tx. As reduction of CO 2 emission is costly to the economy, it is importnt to find cost efficient climte policy. The other two essys focus on methodologicl issues. In essy 3 new method to clculte symmetric input-output mtrices is derived. Such mtrices re used in the construction of CGE models. Finlly, essy 4 describes the generl CGE model we hve developed nd its implementtion of the Swedish economy. Chpter 2 of this introduction describes the existing energy txes nd the emission-trding scheme in Europe. Chpter 3 briefly discusses the methodology used in the thesis nd chpter 4 contins short description of the four essys. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 9

12 2 Energy txes nd climte policy In n nlysis of fiscl txes on commodities, Dimond nd Mirrlees (1971) showed tht the efficient tx rtes for intermedite consumption re zero if tx rtes for finl consumption re t their optiml levels. The clssicl lesson is tht one should void disturbing the efficiency in production nd minimize the disturbnce of efficiency in consumption. To this im the Rmsey rule should be pplied, i.e. the tx bse should be defined s brodly s possible nd be corrected for price elsticities so tht goods with low price elsticity hve the highest tx rte. However, n exception to this rule rises when tx rtes for finl consumption devite from their optiml levels. In tht cse welfre could be improved by compensting txes on intermedite use (Newberry 1985). Pigou (1920) showed tht tx rtes with the purpose of internlising externl effects should be equl to the mrginl socil cost of the externlity, nd thus equl for ll users. However, Hoel (2001) showed tht there re rguments for lower txes on emissions from industries competing in the world mrket if the externlity is globl pollutnt, due to the so-clled crbon lekge effect. Tullock (1967) rised the hypothesis tht there is second dividend from environmentl txtion since the revenue rised could be used to decrese other txes nd thus reduce distortions from these txes. The presence of distortionry txes would, in tht cse, cll for environmentl txes higher thn the mrginl socil cost of the externlity. During the 1990s the literture investigted severl spects of this issue. For exmple, the presence of distortionry txes will not only hve n impct on the optiml level of the environmentl tx, but lso on the socil mrginl cost of the externlity, since these txes reduce income levels in the economy, mking the comprison between tx levels nd socil mrginl costs difficult. Moreover, environmentl txes tend to reduce tx income from other tx bses nd thus give limited revenue rising effect. Still, this is not n rgument in fvour of emission trding since tht reduces tx income s much s environmentl txes without giving ny governmentl revenue t ll. For review of the double dividend literture see Jeger (2003). In this thesis we will not mke ny efforts to estimte the socil mrginl cost of CO 2 emission but, compre different mens of chieving specific emission gol or specific level of consumption. The issue of double dividend is thus not relevnt for the conclusions drwn in this thesis. 10 LARS BOHLIN

13 2.1 Energy tx rtes in Europe How do politicins in the rel world distribute the tx burden on energy between finl consumption nd intermedite use? In Tble 1.1 the strtegies chosen between 1990 nd 2007 by some EU member sttes re shown, using the tx rtes for electricity nd light fuel oil s exmples. E denotes n equl tx rte for industry nd household, L denotes lower industry txes, nd H higher industry txes. Some countries chnged strtegy during the period. In tht cse, the strtegy t the beginning of the period is before the slsh, nd the strtegy t the end of the period is fter the slsh. Tble 1.1 Strtegies for energy txtion in EU light fuel oil electricity Austri L/E E/L Belgium E E/L Denmrk L L Finlnd E E/L Frnce E L Germny E L/E Greece E E Irelnd E E Itly E L/H Polnd E E Spin E E/L Sweden L E/L Switzerlnd E E E=Equl tx rte for industry nd households, L=Lower txes for industry, H=Higher txes for industry Tble 1.1 shows tht most countries hve the sme tx rtes for light fuel oil used by households nd industry, while they hve different tx rtes for electricity. An explntion could be tht they consider tx on fuel oil s Pigovin tx nd therefore follow the stndrd recommendtion of n equl tx rte, while tx on electricity is considered s fiscl tx. An interesting observtion is tht the UK nd Itly hve recently dopted strtegy with higher tx on industry. Under some circumstnces this strtegy my be optiml if the tx on electricity is considered to be fiscl tx ccording to the findings tht will be presented in essy 1. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 11

14 There is difference in member sttes strtegies regrding the tx rte for electricity. Politicins from different countries my hve different opinions bout the strtegy tht is best. Member sttes my lso hve different economic structures so tht the optiml strtegy would vry from one country to nother. Moreover, interest groups my hve different impct on the politicl process in different countries. 2.2 The development of energy tx rtes in Sweden Sweden introduced generl exemptions on energy txes for mnufcturing in Previously, exemptions were only grnted on cse by cse bsis. There re, however, lot of other exemptions for different industries in the Energy Tx Act (SFS 1994:1776) so the tx rte vries lot cross firms. There re, for exmple, exemptions for oil used in ril vehicles, eroplnes, shipping nd greenhouses nd for purposes other thn heting or engines. There re lso specific rules for very energy-intense firms. The tx rte is reduced by 76 percent for the prt of the tx pyment tht exceeds 0.8 percent of totl sles. The totl cost of energy txes never exceeds 1.2 percent of totl sles. For electricity, there re lso exemptions for users in the north of Sweden. Figure 1.1 shows the development of the rel tx rte for electricity nd fuel oil in 2008 prices for households in the south of Sweden nd those mnufcturing firms where only the generl tx exemptions for mnufcturing pply. With the introduction of the tx exemptions, the electricity tx rte for industry ws reduced to zero. In 2004 low tx ws introduced ccording to the minimum tx rte rules of the Europen Union. The electricity tx rte for households nd services subsequently incresed over the whole period, incresing the differences in tx rtes even further. The tx rte for fuel oil shows similr pttern, lthough the tx rte for mnufcturing is somewht higher reltive to the tx rte for services nd households. The rel tx rte for fuel oil for mnufcturing hs been firly constnt since 1993; the nominl tx rte hs incresed t the sme rte s infltion. 12 LARS BOHLIN

15 Figure 1.1 The development of rel energy tx rtes in Sweden Electricity Fuel Oil (mk2) Households in the south of Sweden Mnufcturing firm Source: Tx rtes from Swedish tx gency deflted by CPI from Sttistics Sweden, price level 2008 The nlyses in essys 1 nd 2 strt from the tx rtes of 2001 nd simulte different chnges to these tx rtes. The question is whether politicins could hve mde better choice of tx strtegy thn they ctully did. 2.3 Climte policy Since the industril revolution the content of greenhouse gses hs incresed in the tmosphere. CO 2 hs mde up the lrgest prt of this increse. The greenhouse gses let the sunshine rech the erth but reduce the outflow of het. In essy 2 we will study the economic impcts on the Swedish economy nd the impct on the globl emissions of CO 2 off different climte policies. The fct tht the impct from the CO 2 emissions is the sme regrdless of where the gs is emitted mkes it simple to describe cost efficient policy to reduce the emissions. Since there is no need to tke geogrphicl spects into ccount, emission should be reduced where the cost of reducing them is the lowest. However, this mkes it lso extremely difficult to impose the optiml policy, since it requires coopertion between ll lrge ntions in the world. Moreover, climte policy tht mnges to reduce the use of fossil fuels will crete huge economic rents nd redistribute existing rents from extrction of fossil fuels. Thus lot of rent seeking behviour will complicte negotitions TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 13

16 on climte policy. In the Plnet Project (LouLou 2009) severl different models re used to estimte shdow prices of CO 2. These re found to be in the rnge between 100 nd 1000 USD per tonne t globl emission levels of bout 25 billion tonnes in If globl mrket for CO 2 llownces were to be estblished, the totl vlue of the yerly distributed llownces would, ccording to these studies, fll in the rnge between 2.5 trillion USD nd 25 trillion USD. In the scenrios of the Plnet Project, globl GDP is ssumed to be bout trillion USD in 2050, mening tht bout % of globl income would be distributed to the owners of emission llownces or tx collectors. These numbers indicte tht the choice of climte policy will hve huge impct on future income distribution in the world. A globl crbon tx finncing globl bsic income would give ech humn being yerly trnsfer in the rnge of 250 to USD t popultion size of 10 billion people in Such policy would thus eliminte poverty ccording to the UN definition, while it would reduce income levels in oil producing nd oil consuming countries. A trding system bsed upon grndfthering would give lrge redistribution of income from oil-producing to oil-consuming countries, while less developed countries would find it very difficult to chieve ny significnt economic growth t ll nd poverty would be conserved. Needless to sy, compromise between these two extremes of rent distribution tht will be supported by ll ntions in the world is difficult to chieve. 2.4 Crbon Lekge Policies for reducing crbon emission in one country my increse emissions in other countries. In the literture, this effect hs been clled crbon lekge nd hs been divided into two kinds, direct nd indirect crbon lekge. 2 The direct lekge is due to the fct tht decrese in domestic demnd for fossil fuel cn reduce the world mrket price nd thereby increse the use in other countries. The indirect lekge rises if domestic production of goods tht re intense in the use of fossil fuels is rellocted to other countries, or if domestic use of fossil fuel is substituted by imported electricity 1 Three CGE models, DEMETER, WITCH nd GEMINI E3, nd three prtil models, TIAMEC, ETSAP-TIAM nd PEM re used. 2 Direct nd indirect crbon lekge is the vocbulry of Hoel (2001). Burniux nd Mrtins (2000) distinguish between crbon lekges relted to non-energy mrket nd relted to energy mrkets to describe the sme fetures. 14 LARS BOHLIN

17 tht gives rise to high crbon emission in exporting countries. Hoel (2001) hs shown tht, in smll open economy, crbon-intensive trdble sectors should fce lower crbon tx thn other sectors of the economy if import nd export triffs cnnot be used on ll trded goods. The crbon lekge effect hs been motivtion for the Swedish tx exemptions for mnufcturing. The direct crbon lekge effect will be ignored in this study, but it is relly n importnt limittion to tx-bsed climte policy. To mitigte globl wrming, significnt prt of the fossil fuels needs to be left unextrcted in the ground. Therefore tx policies must decrese the world mrket price pth of fossil fuels to level where most reserves will be unprofitble to extrct in ll future time periods. Txes lower thn this will only trnsfer rents from producers of fossil fuels to the governments in importing countries. To postpone globl wrming it is not the level but the time profile of the tx rte tht mtters, t lest under perfect property rights for the reserves. In tht cse resource owner will postpone extrction only if the increse of the tx rte over time is lower thn his discount rte (Zimmer 2001). 2.5 Europen emission trding system One response to the problem of crbon lekge is the Europen Emission Trding System for CO 2 emissions, (ETS). There will of course still be crbon lekge out of the EU, but the problem my be reduced compred to climte policy t the level of the member sttes. ETS ws introduced in Jnury 2005 bsed on Directive 2003/87/EC. The Directive stipultes three phses: (i) Phse 1: , Lerning by Doing phse; (ii) Phse 2: , Kyoto Period; nd (iii) Phse 3: Post During Phse 1, 46 percent of Europen CO 2 emissions were covered. In the EU ETS, the Commission certifies ntionl lloction pln ccording to which ech member stte lloctes llownces to ech instlltion. During Phse 1, t lest 95 percent of the permits were llocted without chrge ccording to historic emissions. In Phse 2, the regultion sttes tht tht ech member stte should llocte t lest 10 percent of the permits through uctioning. With the introduction of ETS, the mrginl cost of emission differs even more between different ctors in the Swedish economy. The tx exemptions were defined from the industry clssifiction of the firm so tht ll firms in the sme industry hd the sme tx rte. The obligtion to deliver emission permits under the ETS depends upon properties of the instlltion. Within TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 15

18 n industry nd even within firm there will be instlltions with nd without obligtion to deliver CO 2 llownces nd thus with different mrginl cost of CO 2 emissions. In 2005 bout 27 percent of the Swedish emissions of CO 2 were covered by ETS 3. The divergence of the mrginl cost of CO 2 between ETS nd non-ets instlltions will depend upon the price of the llownces. The development of the price nd future prices is shown in figure 1.2. Figure 1.2 The Price of Allownces, phse 1 nd 2 Source: Nordpool. The determintion of the price will depend upon whether unused permits from one period could be sved nd used in lter periods or not. When bnking is llowed, the price will be determined by expecttions bout prices in the future. When bnking is not llowed, prices will be determined solely by supply nd demnd within the current trding period. In phse 1, bnking ws not llowed. Prices of llownces fell in spring 2006 fter the relese of the first emission report, since the oversupply of llownces could not be sved for the second phse (Figure 1.2). Futures on the price in the second phse were still high. In the second phse bnking is llowed nd the divergence between future price nd spot price will only reflect the expected future interest rte. In the beginning of phse two the mrket expected more restrictive lloction of llownces nd the price 3 Tble 3.8 in essy LARS BOHLIN

19 ws lmost s high s in the beginning of phse 1. However, s in phse 1, the price fell bck. The reson for this my be expecttions of less restrictive lloction of permits, expecttions of decrese in the cost of emission reductions or expecttions tht the current globl economic crisis will result in long lsting depression with low demnd for energy. Emission trding is often ssumed to hve lmost the sme impct on efficiency s pigovin tx t the sme level s the price of the permits. This is true in sttic frmework but not in dynmic gme between regultor nd regulted industry. If the behviour of firms hs n impct on how mny permits they will receive in the future, the effect of permit trding will differ from the effect of pigovin tx. Sterner nd Muller (2006) explin the impct of different distribution methods of permits on the incentives for different kinds of decisions in firms. In ETS firms re not llowed to keep their llownces upon exit. Moreover, new entrnts cn, under some circumstnces, get permits even though they did not hve ny emissions in the reference yer. These fetures of the ETS mke it equivlent to Pigovin tx, combined with tx on shutting down polluting plnts nd subsidy for investments in polluting industries. This clerly imposes inefficiencies. Suppose one firm owns two different col power plnts of equl size. If it decides to shut down one of them, it will lose hlf of its permits. If it decides to reduce the cpcity use by hlf in both plnts, it will keep ll its permits. ETS gives incentives for lower cpcity use nd higher fixed costs. Besides, new investment in col power plnts will give the investor permits with high economic vlue tht he will not receive if he insted invests in sun or wind power. The cost of CO 2 emissions implied by ETS, with regrd to investments in btement nd djustment of production levels t existing plnts, will differ from the cost it implies for greenfield investment nd shutting downs. ETS will thus not give cost efficient reductions of CO 2. These fetures re not possible to implement in the CGE model used in this thesis, so ETS will for simplicity be treted s if it ws pure grndfthered system. It is importnt to remember, though, tht the ETS of the rel world for these resons is probbly more costly thn is estimted in this thesis. The introduction of emission trding in the EU hs creted new kind of crbon lekge mong the member sttes. When domestic emissions re reduced in plnt tht is prt of ETS, the firm tht owns the plnt will sell permits to nother firm within the Europen Union. Tht firm will increse its emission by the sme mount. ETS thus cretes new chnnel for crbon lekge where the lekge effect within the Union is 100 percent from policy mesure in one single member stte. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 17

20 This shows tht interntionl emission trding mkes it difficult to undertke independent climte policy in single stte. Tht is prt of the purpose though, since interntionl emission trding is motivted by the fct tht it is difficult to impose efficient climte policy in single ntion. With n efficient interntionl climte policy, ntions do not need to mke ny climte policy on their own. Nonetheless, s long s the interntionl policies re fr from enough to reduce emission to tolerble levels, single ntion tht wnts to do more to mitigte climte chnge must tke into ccount the interction between domestic climte policies nd interntionl emission trding. The second essy in this thesis gives importnt insights into this interction. 18 LARS BOHLIN

21 3 Methodology Anlysing problem with different methods is often complementry since there re different drwbcks with different methods. The dvntge of econometrics is tht historicl observed dt is used, but drwbck is tht it is often difficult to get ccurte nd relevnt dt with enough observtions nd vribility. The dvntge of CGE model is tht it is esy to hold ll other things constnt nd chieve the effects from one specific event. The drwbck is tht the results re very sensitive to ssumptions bout structurl nd behviourl reltionship in the economy. The Swedish energy txes hve been nlysed in severl CGE models, for exmple the EMEC model used by the Swedish Ntionl Institute of Economic Reserch (Östblom & Berg 2006), the Kriström model used in SGOR nd the Hill model (Hill 2001). SAINT, the CGE-model developed nd used in this thesis nd the dt used in the pplied model for Sweden re described in detil in Essy 4. A methodologicl development in this thesis is the new method to redistribute secondry products in order to clculte symmetric input-output tbles described in the fourth essy. Other dvntges with SAINT re the flexible nest structure tht mkes it esy to chnge structurl ssumptions in the model nd the user-specific trde mrgins tht llow for price differences between different ctors other thn explined by differences in tx rtes. 3.1 Unit prices nd trde mrgins In ntionl ccounts, pyments in the economy re divided into three components. Trde mrgins go to the retil sector, txes go to the governmentl sector nd pyments t bsic prices go to the producers. If these components re summed up the costs re chieved in purchser prices, i.e. the mount of money pid by the finl user. SAINT follows this price structure nd it is thus esy to use dt from ntionl ccounts without much modifictions. The mrginl cost of energy will not only depend upon tx differences for different ctors nd the price of emission llownces, but lso on other price differences. Lrge purchsers will normlly get lower unit prices thn smller purchsers. The wy trde mrgins re treted in SAINT mkes it possible to model these differences in unit prices. This feture is not very common in CGE models but hs been used by Hill (SGOR 2008:108, ppendix 1). The mrginl cost of energy will lso depend upon the type of contrct. If the trde mrgin to lrge extent is fixed cost, which is not relted to the quntity purchsed, the impct from trde mrgins on mrginl cost will be low. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 19

22 In CGE model this is n importnt feture to tke into ccount since specific unit tx rte will give different percentge increses of the mrginl cost for different ctors nd different types of contrcts. Moreover, from the purchsers point of view, the effect of trde mrgin will be more or less the sme s the effect of tx. Even if model, which ignores differences in trde mrgins, gives the conclusion tht households should be more hevily txed, this my not be the cse in relity if households lredy py higher trde mrgins thn firms. To understnd the importnce of trde mrgins, consider the use of electricity in the pulp nd pper industry nd the household sector presented in Tble 2.1 below. From the third row in Tble 2.1 it cn be seen tht verge prices differ quite lot between households nd the pulp nd pper industry. In most CGE models prices re ssumed to be equl for ll users nd re normlised to 1, i.e. the quntity unit would be equl to the quntity tht is purchsed for one million SEK. From the fourth row of Tble 2.1 it cn be seen tht such procedure would mke very lrge difference in the quntity units for different ctors in terms of GWh. Tble 2.1 Electricity prices nd use 2001 Sector Pulp nd pper households Use of electricity in GWh Amount of money spent (million SEK) Txes (million SEK) Money spent less txes (million SEK) Averge price less txes (SEK per kwh) Electricity purchsed by 1 million SEK (GWh) Source: Own clcultion bses upon dt from Sttistics Sweden The technique of normlising prices to 1 hs three problems. First, we cnnot be sure tht supply would equl demnd in physicl terms but only in money terms. Second, it would be difficult to clculte the totl use of electricity in physicl terms. Third, it would be difficult to define n equl unit tx rte per GWh, since tht tx rte must differ between different users. In SAINT trde mrgins re user-specific. This wy of modelling trde mrgins gives possibility of tking into ccount differences in unit prices other thn tx differences. 20 LARS BOHLIN

23 3.2 Flexible nest structure In most CGE models it is esy to run sensitivity nlyses over elsticities while the nest structure of different functions in the model re more or less given. The development of the SAINT softwre ddresses this problem by the flexible nest structure tht cn esily be chnged using few commnds. By defining different sets of commodities, the user is ble to chnge the nest structure in production functions nd household demnd functions. In this thesis the fctors determining the optiml structure of tx rtes re nlysed. One importnt fctor is the structure of production functions. A model with flexible nest structure is needed to fulfil tht purpose. 3.3 Secondry products In ll CGE-nlyses in this thesis, secondry products re removed, so tht ll commodities re produced in only one industry. Some industries will produce more thn one commodity since the number of commodities is lrger thn the number of industries. From the Ntionl Accounts dt the costs in different industries re known, but costs must be redistributed to specific outputs. In technicl terms the supply nd use mtrices from ntionl ccounts must be trnsformed into symmetric input-output tble. To do so, ssumptions bout cost distribution re needed. In the literture two ssumptions re mde. The Industry technology ssumption is tht cost shres within specific industry re the sme for ll outputs. The cost shres re thus independent of wht commodity is produced. The Commodity technology ssumption is tht the cost shre is the sme for specific commodity regrdless of wht industry produces it. The commodity technology ssumption hs theoreticlly preferred properties (Kop Jnsen, ten R 1990), but hs been difficult to use due to problems with negtive technologicl coefficients nd the requirement of the sme mount of industries nd commodities. The new method of redistributing secondry products, derived in the third essy of this thesis, solves both of these problems. This method is implemented in SAINT, enbling originl supply nd use tbles to be used s dt for the model. The user my choose whether to llow secondry products in the model or redistribute them together with their costs to the min industry. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 21

24 4 The Essys The first essy, Txing Intermedite Goods to Compenste for Distorting Txes on Household Consumption, nlyses the fiscl motive for commodity txtion. It is well known tht fiscl txes on intermedite goods should be zero if txes on finl consumption re t their optiml level. In contrst to this clssicl result in Dimond nd Mirrlees (1971), tht fiscl txes should not be levied on intermedite use of goods, Newbury (1985) showed tht, in closed economy with Leontief technology, input txes should be used to indirectly tx commodities tht for some reson re untxed in finl consumption. In this essy the Newbury s result is extended to more generl cses; i. e., to open economies with substitution possibilities in the production functions. In ddition, we show tht the welfre mximizing proportion between the tx rte for intermedite use by firms nd finl demnd by households declines with higher elsticities of substitution in production functions, nd with higher price elsticities in import demnd functions nd export supply functions. We lso show tht the welfre mximizing proportion of tx rtes between households nd firms for one commodity will lso depend upon the corresponding proportion of importnt substitutes for tht commodity. These results re shown both in stylized CGE models nd in n pplied CGE model of the Swedish economy where the tx on electricity is used s n exmple. The second essy, Climte Policy within n Interntionl Emission Trding System A Swedish cse, nlyses the txes tht re ment to internlise externlities. Here Swedish txes on fossil fuels nd electricity re optimized to decrese globl emission of CO 2 in cost efficient wy. The essy nlyses the sitution both before nd fter the introduction of ETS nd shows therefore the impct of ETS on the optiml domestic tx scheme. The economic impct of the introduction of ETS on the Swedish economy is lso nlysed. There re importnt interctions between tx rtes for electricity nd tx rtes for fossil fuels. Electricity nd fossil fuels re importnt substitutes in both finl consumption nd intermedite use. Moreover, fossil fuels re importnt inputs in the production of electricity in the Europen electricity mrket. A chnge in the net export of electricity from Sweden would thus crete crbon lekge. Therefore, optiml tx rtes re derived for electricity nd fossil fuels simultneously, given the purpose of reducing globl emissions of CO 2. While lot of studies in Sweden hve nlyzed txes on fossil fuel 22 LARS BOHLIN

25 to decrese crbon emission, this is the only one tht studies the impct on CO 2 emissions from chnges in the tx rte for electricity. It is shown tht before the introduction of ETS the optiml tx rte for electricity should be rther high, while it should be s low s possible fter the introduction of ETS. The reson for this is tht, fter the introduction of ETS, decrese in production of electricity does not reduce the emission of CO 2 since the power plnts just sell their llownces to some other firms tht increse their emission. Before the introduction of ETS the tx rte for fossil fuels should be the sme for ll ctors. After the introduction of ETS the tx rte should be zero for those industries tht tke prt in the emission trding. In the third essy, Estimtion of Commodity-by-Commodity Input Output Mtrices, simple method to derive Symmetric Commodity by Commodity IO-Mtrices, (SIOTs) is developed. In the derivtion of the SIOTs two ssumptions bout technology could be mde. These re the industry technology ssumption (ITA) nd the commodity technology ssumption (CTA). The benefits of the method presented in this essy re tht it solves the problem of negtive entries when using the commodity technology ssumption, tht it is possible to derive mixed tbles where both ssumptions re used t the sme time, nd tht it is possible to use the commodity technology ssumption even when the number of commodities is lrger thn the number of industries. Sttisticl uthorities generlly derive SIOTs on less thn nnul bsis nd often use only one specific technologicl ssumption. If resercher uses officil dt, he hs to ssume tht SIOTs re pretty stble over time nd he cnnot mke sensitivity nlysis of different technology ssumptions. In this essy we investigte how lrge the chnges in SIOTs re over time in order to see whether it is resonble to ssume if they re stble or not. Moreover, the difference in SIOTs derived using different technology ssumptions is evluted in order to see whether it is importnt to mke sensitivity nlysis of technologicl ssumptions. Ntionl sttisticl uthorities hve the exclusive right to estblish which numbers should mke up the officil sttistics nd which ssumptions re to be used in the estimtion of this dt. The drwbck of this is tht if ll reserchers use the sme dt, derived from using the sme ssumptions, the impct of these ssumptions on scientific results will never be discovered. In fctor content of trde ppliction included in this essy the impct from the technology ssumptions does not seem to be very importnt in spite of the fct tht the men of the technologicl coefficients, clculted from the different ssumptions, differs by up to 50 percent. For most technologicl ssumptions the chnge in technologicl coefficients from one yer to nother TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 23

26 is between 10 nd 20 percent. CTA, however, gives higher vribility over time with yerly chnges of bout percent. The fourth essy, SAINT Stndrdized CGE-model for Anlysis of Indirect Txtion, describes the stndrdized model used to implement the different CGE models in the thesis. One dvntge with SAINT is tht it hs user-specific trde mrgins. This mkes it possible to tke into ccount price differences between different purchsers other thn differences in tx rtes. Another dvntge with SAINT is the flexible nest structure tht mkes it esy to chnge structurl ssumptions bout the economy. This essy lso describes the dt for the Swedish version of the model. A comprison is mde between the impcts from 100 percent increse in the CO 2 tx ccording to our model, nd the impct ccording to two other CGE models tht hve been used to nlyse energy txes in Sweden. 24 LARS BOHLIN

27 5 Policy implictions nd future reserch The min focus in this thesis is on whether it would be beneficil for society to hve different tx rtes for intermedite use by firms nd for finl demnd by households. The thesis identifies some importnt spects to consider when nswering tht question. These re the purpose of the tx, the production technology in firms, the openness to interntionl trde, nd the tx rtes for importnt substitutes for the txed commodity. When it comes to fiscl txes investigted in the first essy, the most importnt question is whether the tx rte of finl consumption is t its optiml level or not. If we impose optiml txes on finl demnd, intermedite use should be untxed. But if the commodity is txed bove its optiml level, tx on intermedite use would compenste for tht by lso incresing prices of other commodities nd thus reducing the distortion of reltive prices. This effect is strongest under Leontief technology in closed economies, where the tx rte for intermedite use should be higher tht the tx rte for finl consumption. Under Leotief technology the tx cnnot disturb decisions in firms, since the use of inputs cnnot be chnged. Regrding Pigovin txes, investigted in the second essy, the tx rte should be equl for ll users if we hve closed economy, while the so-clled crbon lekge effect my cll for lower txes for industries tht compete in the world mrket. Even the crbon lekge rgument is strongest under Leontief technology, since the Pigovin tx in tht cse hs lower impct on domestic emissions. Under Leontief technology it is not possible to reduce emission per unit of output. In the cse of energy txes in Sweden the min conclusion is tht the tx rte on finl demnd nd intermedite use should be equl regrdless of the purpose of the tx under most relistic ssumptions bout technology. If Leontief technology is ssumed, however, the tx on intermedite use should be higher thn the tx on finl demnd if the purpose is fiscl, but lower thn the tx on finl demnd if the purpose is to reduce CO 2 emissions. An importnt fctor for the impct on CO 2 emissions in Sweden is the impct on the demnd for trnsports. More reserch is thus needed in developing models where trnsport demnd is connected with interregionl nd interntionl trde. Since the ssumptions bout technologies re importnt for the results, more econometric studies of industry-specific elsticities of substitution would probbly improve the relibility of CGE models for these kinds of policy issues. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 25

28 References Burniux, J.M. & Mrtins J.O. (2000), Crbon Emission Lekges - A Generl Equilibrium View OECD Economics Deprtment Working ppers No 242. Hill, M (2001), Essys on Environmentl Policy Anlysis: Computble Generl Equilibrium Approches Applied to Sweden, Stockholm School of Economics Hoel, M. (2001), Interntionl trde nd the environment: How to hndle crbon lekge. In H. Folmer (Red.) Frontiers of Environmentl Economics, Edwrd Elgr Publishing Limited, s Jeger, W.K. (2003) Environmentl Txtion nd the Double Dividend. In Eric Neumyer (editor) Ecologicl Economics Encyclopedi, Interntionl Society of Ecologicl Economics. Kop Jnsen, P. nd ten R, T. (1990) The choice of model in the construction of input utput coefficients mtrices, Interntionl Economic Review, 31, pp Loulou, R. (2009) A preliminry explortion of multi-model results for PLANETS Climte scenrios, speech t the 2009 Interntionl Energy Workshop in Venice. Pigou, A. C. (1920) The economics of welfre. London Swedish Government Officil Report (1997:11) Sktter, miljö och sysselsättning, Fritzes offentlig publiktioner [Txes, Environment nd Employment] Swedish Government Officil Report (2008:108, ppendix 1) Sveriges ekonomi, Scenrier på lång sikt. Fritzes offentlig publiktioner [Swedish Economy, Long Run Scenrios]. Sterner, T. nd Müller, A. (2008), 'Output nd Abtement Effects of Alloction Redjustment in Permit Trde', Climtic Chnge (vol. 86 pp33-49) 26 LARS BOHLIN

29 Tullock, G. (1967) Excess Benefit. Wter Resource Reserch 3, Zimmer, M (2009) How much greener is relly green? Crbon Txtion Design nd Resource Extrction, Presented t Interntionl Energy Workshop 2009 Östblom, G. & Berg, C. (2006) "The EMEC model: Version 2.0", Working Pper No 96, (Swedish) Ntionl Institute of Economic Reserch. TAXATION OF INTERMEDIATE GOODS A CGE-ANALYSIS 27

30

31 ESSAY I

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33 Txing intermedite goods to compenste for distorting txes on household consumption ESSAY I Lrs Bohlin Swedish Business School Örebro University, Sweden Abstrct: In contrst to the clssic result in Dimond nd Mirrlees (1971) tht fiscl txes should not be levied on intermedite use of goods, Newbury (1985) showed tht, in closed economy with Leontief technology, input txes should be used to indirectly tx commodities tht for some reson re untxed in finl consumption. This pper extends the Newbury result to more generl cses; i.e., to open economies with substitution possibilities in the production functions. Moreover, it shows tht the welfre mximizing proportion between the tx rte for intermedite use by firms nd finl demnd by households declines with higher elsticities of substitution in production functions nd with higher price elsticities in import demnd functions nd export supply functions. It lso shows tht the welfre mximizing proportion of tx rtes between households nd firms for one commodity will depend upon the corresponding proportion of tx rtes for importnt substitutes for tht commodity. These results re shown both in stylized Computble Generl Equilibrium (CGE) models nd in n pplied CGE model of the Swedish economy where the tx on electricity is used s n exmple. Keywords: Optiml txtion, CGE-nlysis JEL Code: H21, D58 ESSAY 1: TAXING INTERMEDIATE GOODS TO COMPENSATE FOR DISTORTING TAXES ON HOUSEHOLD CONSUMPTION 1

34

35 1 Introduction The efficient distribution of txes on commodities between finl nd intermedite use depends upon the purpose of the tx. In the following, txes with the purpose of chnging behviour will be clled pigovin txes, while txes with the purpose of rising government revenue will be clled fiscl txes. The conventionl wisdom is tht pigovin tx should hve the sme rte for ll users, while fiscl tx only should be levied on finl consumption. There re, however, importnt exceptions to this simple rule. In the cse of pigovin txes there re rguments for lower txes in industries competing in the world mrket (Hoel 2001). In the cse of fiscl txes devitions from the optiml tx rtes in finl consumption my cll for compensting txes on intermedite use (Newberry 1985). This pper limits the nlysis to fiscl txes, nd nlyses the efficient distribution of the tx burden between intermedite use by firms nd finl consumption by households when not ll commodities in the economy re txed. Dimond nd Mirrlees (1971) showed tht the efficient tx rtes for intermedite consumption re zero if tx rtes for finl consumption re t their optiml levels. The clssicl lesson is tht one should void disturbing the efficiency in production nd minimize the disturbnce of efficiency in consumption. To this im the Rmsey rule should be pplied, i.e. the tx bse should be defined s brodly s possible nd be corrected for price elsticities so tht goods with low price elsticity hve the highest tx rte. However, n exception to this rule rises when some commodities cnnot be txed directly (Newberry 1985). In tht cse input txes should be used to tx the otherwise untxed commodities through the use of inputs in the production process. The literture on optiml fiscl txtion of intermedite goods is very scrce. Strret (1998) nlyzes the cost of txes on intermedite goods but does not nlyze optiml levels of these txes. The Dimond nd Mirrlees result seems to hve been considered s n end of discussion of optiml fiscl txes on intermedite goods. In the rel world, however, politicins often fil to set household txes t their optiml level, either due to difficulties in estimting the optiml rtes or becuse of other objectives for tx policy. The exception discovered by Newbury therefore needs much more interest from economists nd politicins. It my, for exmple, be the cse tht Newbury s result is not fully recognized in the politicl discussion on energy txes. In mny OECD countries electricity tx rtes re substntilly higher for households thn for industry. 1 This would be supported by Dimond ESSAY I 1 Energy Prices nd Txes, ESSAY 1: TAXING INTERMEDIATE GOODS TO COMPENSATE FOR DISTORTING TAXES ON HOUSEHOLD CONSUMPTION 3

36 nd Mirrlees result only if n electricity tx is n optiml fiscl tx, i.e. if n electricity tx is less distorting for the choices of households thn, for exmple, the VAT. 2 This pper deepens the Newbury nlysis nd considers more relistic models with interntionl trde nd substitutbility in production functions. The Newberry nlysis ws done in closed-economy model with Leontief technology, nd in retrospect his result is pretty trivil. If the use of inputs is lwys proportionl to output, then tx on n input would hve exctly the sme effect on the decisions of firms s tx on output. If the tx on specific output devites from the optiml level, it is lwys possible to impose n pproprite tx or subsidy on the use of inputs to chieve the optiml prices in finl consumption. With Leontief technology, txes on inputs would not distort the decisions of firms since the mix of inputs cnnot be chnged. This pper therefore investigtes the impct of substitution possibilities in the production function on the optiml tx rtes. Moreover, n increse in the domestic cost of production would increse prices more in closed economy thn in n open economy. Therefore the pper lso investigtes the impct of openness to interntionl trde on the optiml tx rtes. With the exception of Newbury, I hve not found ny studies tht investigte the cse of optiml fiscl txtion of intermedite goods, which therefore is n obvious motive for this study. However, this study cn lso be relted to the literture on optiml pricing of public utilities with blnced budget requirement under economies of scle nd scope, i.e. when mrk up of mrginl cost is needed (Bmoul nd Brdford 1970, Lffont nd Tirole 1993). Such public utility often needs to decide whether to differentite prices between households nd firms. Since socilly optiml txes on intermedite goods re determined from the socil optiml prices of intermedite goods, the results concerning txes on intermedite goods in this pper re relted to this issue. Feldstein (1972) showed tht the public utility should use the sme pricing rule when setting prices on finl consumption nd prices on intermedite use. In both cses the devition from mrginl cost pricing should be function of the price elsticity of de- 2 At lest in the Swedish Government Officil Report the Dimond & Mirrlees rule hs been used without n nlysis of whether the tx rtes on finl consumption re t their optiml level, or not. Se for exmple SGOR 2003:38 pge 139. Moreover Sørensen (2010) writes, If the purpose is simply to rise revenue, economic theory prescribes tht energy txes should be levied only on finl consumers in the household sector. In the sme report he writes tht n equl VAT rte probbly is preferble wy to rise revenue by commodity txtion. He seems to be wre tht energy txes re non-optiml s fiscl txes. 4 LARS BOHLIN

37 mnd. Thus, if the price elsticities differ between households nd firms, there will be cse for price differentition between these ctegories. Feldstein s nlysis ws mde under the ssumption of Leontief technology. Lter, Yng (1991) showed tht his result lso holds with generl technology. However, both Yng s nd Feldstein s nlyses re mde for closed economy, while our study considers the impct of interntionl trde. Here, we show tht the optiml commodity tx, i.e the optiml mrk up on mrginl cost, is dependent on the production technology. This is not contrdiction of the results of Feldstein nd Yng, since the price elsticity of demnd for n intermedite good is dependent on the production technology of the firm tht is using tht good. Yng (1991) further sttes tht it is not desirble to prctice price discrimintion mong privte firms s production efficiency should be preserved. Our pper shows tht firms with different technologies should hve different mrk ups from mrginl cost pricing of their inputs. This is consistent with Yng s pricing rule, tking into ccount the fct tht price elsticities my differ between different firms. Production efficiency requires mrk ups of mrginl cost to be differentited with respect to price elsticities of demnd, nd thus ccording to differences in production technology mong firms using the good. In prctice, this result my not be very importnt for tx policy, since it is difficult to estimte firm-specific price elsticities nd leglly difficult to give different firms different tx rtes. Moreover, rbitrge mkes it difficult to vry tx rtes. In the empiricl ppliction of this pper we will therefore restrict the nlysis to tx schemes with equl tx rtes for ll firms. The purpose of this pper is to nlyze numericlly how the welfre mximizing proportion of the tx rtes for intermedite use by firms nd finl consumption by households depend on different structurl ssumptions in the models. More specificlly, we nlyze the impct of elsticities in the production function nd the impct of trde elsticities. We lso nlyse the impct of tx rtes for importnt substitutes. The next section of this pper derives n expression for optiml tx rtes for intermedite use in closed economy with Leontief technology. This expression provides n lterntive proof of the Newberry result. In section 3 this expression is used to clculte the optiml tx rtes for intermedite use in two numericl exmples. In section 4 one of these exmples is used to simulte optiml tx rtes t vrious levels of the elsticity of substitution of the production function. In section 5 we lso introduce interntionl trde. Section 6 crries out simultions of electricity tx rtes in n pplied model of the Swedish economy under different structurl ssumptions. Section 7 concludes the pper. ESSAY I ESSAY 1: TAXING INTERMEDIATE GOODS TO COMPENSATE FOR DISTORTING TAXES ON HOUSEHOLD CONSUMPTION 5