Efficient and Equitable Policy Design: Taxing Energy Use or Promoting Energy Savings?

Transcription

1 Effiient and Equitable Poliy Desin: Taxin Enery Use or Promotin Enery Savins? Christoph Böhriner 1, Mirjam Kosh 2, Florian Landis 2, Sebastian Raush 2,3, Otober 10, 2017 Abstrat Should enery use be lowered usin broad-based taxes or throuh promotin and mandatin enery savins throuh ommand-and-ontrol measures and tareted subsidies? This paper examines the effiieny and equity effets of alternative reulatory approahes to environmental poliy. Instrument appraisal is based on both a oneptual and an empirial quantitative assessment, the latter interatin a miro-household simulation analysis into a numerial eneral equilibrium model. At the eonomy-wide level, we find that taxin enery is about five times more ost-effetive than promotin enery savins. The distribution of household-level welfare impats is sinifiantly dispersed under the tax approah to reulation whereas promotin enery savins leads to more similar impats amon households. Dependin on revenue reylin assumptions under a tax approah, about one third of households ain with enery taxes; nearly all households are neatively affeted when environmental reulation is based on ommand-and-ontrol and tareted subsidies measures. Keywords: Environmental poliy, Instrument hoie, Market-based instruments, Command-and-ontrol, Effiieny, Equity, General equilibrium, Heteroeneous households, Mirosimulation JEL: H23, Q43, Q52, C68 1. Introdution Fossil-based enery use enerates environmental externalities. Should enery use be lowered usin taxes or throuh promotin and mandatin enery savins? The hoie and desin of reulatory instruments is a ruial environmental poliy deision. The toolkit of instruments omprises two fundamental ateories. Market-based instruments (MBIs) suh as, for example, emissions taxes, tradable emissions allowanes, and subsidies for pollution abatement harness and hannel the power of the market towards ahievin environmental oals throuh an eonomi inentives approah to reulation. Command-and-ontrol (CaC) Correspondin author: Department of Manaement, Tehnoloy, and Eonomis, ETH Zurih, Zürihberstrasse 18, Buildin ZUE E7, 8032 Zurih, Switzerland. We thank André Müller for helpful omments and Rener van Nieuwkoop for his support with the household data. We ratefully aknowlede finanial support by the Swiss National Siene Foundation (SNF) under rant number and by the Commission for Tehnoloy and Innovation (CTI) throuh the Competene Center for Researh in Enery, Soiety and Transition (SCCER-CREST). 1 Department of Eonomis, Carl von Ossietzky University of Oldenbur, Germany. 2 Department of Manaement, Tehnoloy, and Eonomis, Center for Eonomi Researh at ETH (CER-ETH), and Centre for Enery Poliy and Eonomis (CEPE) at the Swiss Federal Institute of Tehnoloy, Zurih, Switzerland. 3 Joint Proram on the Siene and Poliy of Global Chane, Massahusetts Institute of Tehnoloy, Cambride, USA.

2 instruments suh as, for example, tehnoloy mandates and performane standards impose requirements on prodution proesses or outputs of firms. In evaluatin alternative reulatory strateies, eonomists have tended to fous on effiieny, or its lose relative, ost-effetiveness (Goulder & Parry, 2008; Metalf, 2009). The publi aeptane of a poliy, however, often ritially depends on its distribution of osts and benefits in soiety. While reent work has assessed the distributional impats of MBIs (e.., Bovenber et al., 2005; Bento et al., 2009; Raush et al., 2010; Sterner, 2012; Fullerton & Monti, 2013), surprisinly little is known about the household-level inidene of CaC reulation and potential trade-offs with effiieny at the areate eonomy level. In partiular, this is surprisin as CaC approahes are ubiquitous in realworld environmental poliies in many ountries and, in fat, often seem to be the preferred hoie over market-based approahes to environmental reulation. This paper ontributes by providin insihts into the effiieny and distributional impats of alternative poliy desins aimed at lowerin enery use and arbon dioxide (CO 2 ) emissions. We fous on omparin two fundamentally different paradims of environmental reulation: a Steerin approah that exploits eonomi inentives arisin from taxes on enery use and a Promotion approah that builds on promotin and mandatin measures for savin enery throuh the use of CaC measures as well as setor-speifi subsidy prorams. While our analysis is motivated by and fouses on limate and enery poliy in Switzerland (Federal Counil, 2015a,b), it offers eneral insihts into the fundamental theme of poliy instrument hoie and desin for effiient and equitable environmental reulation. Our analysis of how various MBIs and CaC measures to redue enery use affet eonomi effiieny and the inidene amon heteroeneous households is two-proned. First, we provide a oneptual desription of the different poliy instruments and their hannels throuh whih they affet eonomi outomes. Seond, omprehensive instrument appraisal, however, does not only require a qualitative understandin of the effets of alternative reulatory measures but also alls for a quantitative assessment to aue the importane of the different hannels affetin instrument performane in the ontext of the real eonomy. We thus develop a novel quantitative framework whih interates a detailed miro-household simulation analysis into a numerial multi-ommodity eneral equilibrium framework. Our quantitative framework aptures the poliy-indued eonomi responses whih determine the effiieny and equity of environmental reulation at the areate eonomy and household level. Speifially, our model features an eonomy-wide representation of setoral prodution and onsumption ativities inludin detail on the supply and use of enery while apturin ross-market effets as well as areate eonomy resoure (inome) onstraints. Importantly, the models inorporates all households from a representative sample of the Swiss household population as individual eonomi aents, thus enablin us to analyze in rih detail the heteroeneous responses to and welfare impats of alternative environmental reulatory desins at the household level in a eneral equilibrium framework. We find that more riorous market-based reulation pays off at the eonomy-wide level: the Steerin pakae uts down eonomi adjustment ost by a fator of more than five relative to the Promotion pakae. The ost of the Promotion poliy are hidden to the extent that the osts for providin the budet for the subsidy prorams are not diretly observed by households. Consumer pries for enery are not muh affeted under Promotion while they inrease with Steerin poliy. Furthermore, welfare osts under Steerin are refleted in redutions in real inome from labor and apital whih is larely unhaned under Promotion. We find a lare dispersion of household-level welfare impats for both poliies refletin the heteroeneity of onsumers in terms of preferenes (expenditure patterns) and endowments (inome soures). Similarly, fousin on mean impats for speifi soio-eonomi roups (e.., inome deiles) obsures substantial within-roup variation of impats that swamps the variation in mean impats aross roups. The distribution of household impats, however, is more dispersed under Steerin. Our analysis therefore indi- 2

3 ates substantial trade-offs between the effiieny and equity dimensions of poliy desins. About one third of households ain under Steerin whereas nearly all households are worse off under Promotion. Mean welfare impats aross the soio-eonomi roups we onsider in our analysis (inome deiles, house owners vs. renters, retired vs. workin households, households livin in urban, rural, and alomeration areas) are idential under Promotion. Households that ain under Steerin are those with relatively small expenditure shares on enery oods, hih shares of inome derived from (inflation-indexed) overnment transfers, and low overall inome, who thus disproportionately benefit from per-apita rebates. The inidene aross inome deiles under Steerin poliy depends importantly on how the tax revenues are reyled throuh suh rebates. It is proressive with per-apita rebates, as is done under urrent poliy, but would be reressive with rebates that are proportional to inome. In terms of mean impats under the Steerin poliy, retired households experiene small welfare ains, house owners are more neatively affeted than renters, and rural households are relatively worse off ompared to households livin in urban and alomeration areas. The remainder of this paper is oranized as follows. Setion 2 provides a oneptual disussion of the effiieny and inidene effets of alternative reulatory instruments. Setion 3 presents our quantitative framework, inludin data soures and omputational stratey. Setion 4 desribes our senarios for ounterfatual poliy analysis. Setion 5 presents and disusses our simulation results. Setion 6 onludes. 2. Instrument hoie and desin in environmental poliy: basi oneptual onsiderations In the desin of environmental reulation to redue CO2 emissions, poliy makers fae a hoie aross alternative instruments. The broader toolkit of instruments inludes emissions taxes, tradable emissions allowanes ( ap-and-trade ), subsidies for emissions redutions, performane standards, tehnoloy mandates, or R&D subsidies to foster low-emission tehnoloies. The appraisal of instruments typially proeeds alon various dimensions suh as ost-effetiveness, inidene of reulation, environmental effetiveness, leal framework, and administration. First, the fundamental hallene to instrument hoie is that these dimensions are intertwined and subjet to potentially omplex trade-offs. For example, while one instrument miht be superior to another on ost-effetiveness rounds, it may be inferior on distributional rounds. What makes instrument hoie even more diffiult is that within one dimension the rankin an hane pendin on how broad this dimension is taken. 4 While one instrument is performin better on narrow ost-effetiveness rounds, it may lose out in ost-effetiveness when defined more broadly. Seond, the appraisal of instruments aainst various evaluation riteria miht hane with variations on its speifi poliy implementation. 5 Third, omprehensive instrument appraisal does not only require a qualitative understandin of ausal eonomi hains but alls for a quantitative assessment based on real data how important the different drivers of instrument performane are in the end when bein onfronted with the real eonomy. To a lare extent, the fat that atual limate poliy in Switzerland and beyond is haraterized by a myriad of instruments reflets the ambiuity and in part normative nature of instrument hoie aross different evaluation riteria. Aainst this bakround we provide some basi review on the performane of alternative poliy instruments with respet to our two key riteria for the evaluation of Swiss poliy desin: (i) the ost-effetiveness in meetin the CO 2 emission redution taret and (ii) the inidene of poliy reulation. 4 For example, the riterion of ost-effetiveness miht be narrowly defined in terms of foreone produer surplus aross industries to meet some CO 2 emission redution taret on the domesti supply side but it ould be also more broadly defined as the loss in overall real inome for the eonomy to affet some lobal CO 2 emission redution throuh domesti ation. 5 Examples inlude differentiated emission tax shemes (with partial or full exemptions), onditional randfatherin of emission allowanes suh as output-based rebatin, or the deree of tradability of performane standards. 3

4 2.1. Cost-effetiveness Standard textbook eonomis alls for omprehensive where-flexibility to assure ost-effetiveness in CO 2 emission redution (Metalf, 2009): To meet some emission redution at minimum ost, emission abatement should take plae aross all emission soures where it is heapest. This is equivalent to equatin marinal abatement osts (MAC) aross all abatement options of aents for emissions redution whih is equivalent to harin a uniform emission prie aross all prodution and onsumption ativities. The ommon prie on all eonomi aents (firms/industries as well as households) fully exploits where-flexibility with respet to the different hannels of abatement (Goulder & Parry, 2008): (i) input substitution (fuel swithin, effiieny improvements), (ii) sale adjustment in prodution output and onsumption demand, and (iii) the use of potential end-of-the-pipe tehnoloies suh as arbon apture and sequestration. With a traditional fous on ost-effetiveness, the eonomi literature has distinuished the set of instruments for emission ontrol into two broader ateories whih differ in the inentives they provide for exploitin where-flexibility in emission abatement: inentive-based or market-based instruments (MBIs) and ommand-and-ontrol (CaC) instruments Market-based instruments (MBIs) MBIs reflet the notion that they inentive least-ost abatement throuh a ommon (market) prie for emissions. Most prominent in this ateory are emissions taxes and tradable emissions allowanes, whih absent unertainty, have been shown to be equivalent reardin ost-effetiveness. Emission taxes or apand-trade have been also appraised for ost-effetiveness within a broader (eneral equilibrium) ost perspetive where initial tax distortions are taken into aount. 6 Subsidies for emission abatement an onstitute another ost-effetive market-based instrument for emission abatement. The prinipal mehanism is that eonomi aents fae at the marin the same inentive to redue emissions as with a tax or allowane prie (iven that they foreo the subsidy for every additional unit of emissions). However, the equivalene result only holds if the subsidy does not redue the averae ost. Otherwise, there is an inrease in market entry and prodution whih implies leads to the same deviation from ost-effetive pattern as is the ase for output-based rebates. To the extent that speifi oods are a perfet omplement to emissions, taxin suh oods would be equivalent to taxin emissions diretly. Whenever the omplementarity is not perfet, however, there will be a loss in ost-effetiveness as inentives to abate emissions are distorted away from the ost-effetive pattern. For example, a asoline tax would not diretly taret CO 2 emissions and thus ontribute too little abatement via input substitution (from hih-arbon fuels to low-arbon fuels) and too muh via output redution Command-and-ontrol (CaC) instruments CaC or diret reulatory instruments inlude tehnoloy mandates and performane standards ommandin, for example, some fixed input-output ratios whih restrit omprehensive where-flexibility thereby ausin a deviation from the ost-effetive pattern of abatement via various hannels. Thus, CaC reulation is usually inferior in ost-effetiveness terms as ompared to MBIs. Tehnoloy mandates and performane standards impose restritions on the flexibility of how abatement an be ahieved via input substitution and output adjustment. Mandates are most restritive in presribin 6 The fundamental arument here is that these instruments raise overnment revenue that ould be employed to lower preexistin tax distortions, thereby reduin the exess ost of raisin publi revenues for publi ood provision. Suh a benefiial revenue-reylin effet thus provides a weak double dividend (Goulder, 1995) the eonomi ost of restritin the use of CO 2 in prodution and onsumption an be lowered by revenue reylin. 4

5 diretly how a prodution proess has to take plae. In order to equate MAC, a mandate poliy hines on perfet information requires perfet information aross different prodution tehnoloies. Otherwise, there will be exess ost from reulation due to ineffiient input substitution or end-of-pipe treatment. Performane standards- suh as enery effiieny standards for buildins or household applianes or fuel standards for ars allow for more flexibility but enerally still do not produe a ost-effetive pattern of emission abatement. An eonomy-wide CO 2 emission standard whih ould be implemented as a tradable performane standard aross all sements of the eonomy would indeed equalize MAC as eonomi aents dispose of flexibility how to meet the standard. As with tehnoloy mandates, abatement via output redution is, however, suboptimal also for the ase of performane standards. The reasonin behind is that both instruments are effetively blendin onstraints whih translate into impliit input taxes and impliit output subsidies Holland et al. (2009): The rents on emission reulation on the input side et reyled internally throuh subsidies to output. As a onsequene the output prie will be lower with mandates or standards ompared to emission taxes. This in turn means that there is too little abatement via the output hannel whih must be offset by additional (more ostly) efforts via input substitution or end-of-the pipe abatement efforts. The eonomi interpretation of the impliit output subsidy is that CaC reulation (while apturin the variable ost of tehnoloial adjustment) misses out on the ost of the remainin pollution assoiated with eah unit of output Inidene In poliy pratie, the hoie of environmental instruments may be less driven by ost-effetiveness onsiderations but rather by distributional onerns. Environmental reulation reates ost and rents whih translate into the inidene for households via hanes in ommodity pries (the expenditure side), fator remuneration and potential transfers (the inome side). On the expenditure side, environmental reulation will be reressive to the extent it inreases pries for ommodities where low-inome households tend to spend larer shares of their budets (Poterba, 1989; Hasset et al., 2011). Suh ommodities typially inlude eletriity, home heatin fuels, asoline, and other enery-intensive oods. The rankin of environmental instruments under equity onerns would be inversely orrelated to their poteny of raisin the pries for enery-/emission-intensive ommodities. MBIs are thus likely to yield larer adverse effets on the expenditure side as ompared to CaC reulation. Obviously, the inidene on the expenditure side will hine also on the relative ease of how onsumers an substitute away from more ostly ommodities. On the inome side, environmental reulation hanes the produtivity and thus the remuneration to labor, apital, and speifi resoures (e.., enery resoures). More speifially, emission reulation will drive down the rents to speifi resoures in emission-intensive industries with inelasti supply harateristis a ost inrease on the input side will not pass throuh via hiher output pries but will be shifted bak to the remuneration of the fixed fator (Raush et al., 2011). Another key driver of the inidene is how rents from reulation are reyled. With MBIs reulatory rents an be reyled by the overnment expliitly via diret transfers or tax reforms that attenuate reressive effets (for example, tax redutions in favor or low-inome roups suh as payroll tax rebates or hiher inome tax thresholds). With CaC reulation rents are impliit and et reyled via output subsidies to the reulated setors the diret impliations are lower output pries and a smaller derease in the rent to setor-speifi resoures. However, the eneral equilibrium inidene aross households also hines on the indiret effets for all other fator and ommodity pries. The aim of this paper to provide insihts into potential trade-offs between ost-effetiveness and distributional impats of future Swiss environmental poliy desin. Our interated framework of assessment aommodates a omprehensive representation of poliy-indued eonomi responses and interations that 5

6 Table 1: Overview of model resolution: setors, eletriity eneration tehnoloies, and household roups. Setors (i I) Non-enery Enery supply & onversion Final demand Eletriity eneration tehnoloies (p P) Ariulture (ar), Paper (pap), Chemials (he), Plastis (pla), Other non-metalli mineral produts (nme), Basi metals (bme), Fabriated metal produts (fmp), Medial and preision instruments (med), Manufaturin (man), Mahinery and equipment (mh), Offie mahinery, omputers (om), Radio, TV and ommuniation equipment (elt), Trade and repair exept motor vehiles (wht), Real estate (est), Servies (ser), Constrution (ns), Final demand publi/purhased transport (tr), Intermediate transportation servies (try), Motor vehiles, trailers (veh), Trade and repair of motor vehiles; retail sale of automotive fuel (trd), Air transportion (atp) Motor fuels (benz), Heatin oil (hoil), Other mineral oil produts (omop), Nulear fuel (nu), Crude oil (ru), Coal (oa), Natural as (as), Eletriity eneration (ele), Eletriity distribution & transmission (edt), Eletriity from waste inineration (ewi), Heat from waste inineration (hwi) Private onsumption by representative household, overnment onsumption, investment demand Hydro power, Nulear power, Power from fossil fuels, Power from renewable enery soures Notes: Indiates setors that are subjet to the Swiss Emissions Tradin System (ETS) whih overs enery-intensive industries. drive ost-effetiveness and inidene of poliy reulation. Similarly, the interated model permits a broad notion of ost-effetiveness while offerin enormous details in how speifi households are affeted. We now turn to the desription of the model. 3. Desription of the data and model This setion provides an overview of our quantitative framework whih interates an eonomy-wide multi-setor eneral equilibrium model with a mirosimulation analysis of households. We first desribe the various data soures used for alibration of the model. A brief desription of the model struture and our omputation method for solvin the eonomi equilibrium model with a very lare number of households follows Data The numerial model employed in this study is based on national aounts and household survey data. National aounts provide information on value flows between different setors of the eonomy, households, and the overnment. Household survey data indiates how areate household expenditure for different ommodities and inome from different prodution fators are distributed amon sinle households. We harmonized the two data soures to onstrut a balaned set of aounts for the model s base year National eonomi aounts and enery data For the areate Swiss eonomy, value flows are iven by the soial aountin matrix (SAM), and are omplemented by physial enery flow data in the National Aountin Matrix inludin Environmental Aounts (NAMEA) (Nathani et al., 2013). The SAM provides information on eonomi transations 6

7 amon firms, households, and overnment aents. The physial enery flow data allow for inferrin CO 2 emissions assoiated with enery demand. In its oriinal form, the SAM distinuishes 66 industries and ommodity roups and 20 ateories for final demand. Table 1 provides an overview of our ommodity areation. We identify eleven setors of enery supply and onversion separatin various fuels (motor fuels, heatin oil, natural as, oal, rude oil) and seondary enery arriers (omprisin various forms of eletriity and heat). The hoie of areation for the 21 non-enery setors is uided by the onsiderations to separately identify setors whih are lare in terms of eonomi size (i.e., ontribution to ross value-added), exhibit a hih enery-intensity, enable representin the setors overed by the Swiss emissions tradin system (ETS), or setors that are tareted with speifi poliy measures (for example, private transportation, household enery demand, industrial setors). Three final demand setors represent private and overnment onsumption, and investment demand. The soial aountin data further provides payments of payroll taxes, inome taxes, value-added taxes, import tariffs by ommodity, setor-speifi output taxes, subsidies, and enery-related taxes inludin mineral oil taxes Miro-household data and data reoniliation On the household side, a representative sample of the Swiss population of households is portrayed by the Swiss Household Budet Survey Haushaltsbudeterhebun (HABE). The HABE survey is onduted on an annual basis by the Swiss Federal Statistial Offie (BFS). It ollets information for rouhly households on expenditure patterns and inome soures. Household data is weihted aordin to the inlusion probability. 7 The weihts are adjusted for samplin bias and alibrated to the observed distribution of the Swiss population (Cornali Shweinruber et al., 2007). To inrease sample size, our underlyin data set areates three waves of survey data from the onseutive years (BFS, 2012a, 2012b, and 2013) usin annual weihts published by BFS (2014). Thus, we arrive at a set of observations of household aounts that are used to desribe household expenditure and inome in the model. Besides the information on inome expenditure, the HABE data inlude other information suh as household omposition, ae of household members, urbanization deree, and ownership status of housin. The weihted sum of inome and expenditures of households reported in HABE has to be reoniled with the national aounts in the SAM. A math between national areates and household based data in the base year alibration of the model is required for onsistent evaluation of ounterfatual senarios. 8 In a first step, we impute missin data based on information about households expenditures and soio-eonomi harateristis (inome, rentin or ownin a house, et.). 9 In a seond step, the national onsumption in terms of COICOP Classifiation of Individual Consumption Aordin to Purpose ateories was then imposed on the household data by salin the weihted household onsumption from the survey by the respetive fator for eah onsumption ateory. Similarly, household data on wae inome was saled to 7 The inlusion probability of a member of the population is its probability of beomin part of the sample durin the drawin of a sinle sample. 8 The areated household onsumption in the HABE and SAM aounts an differ sinifiantly for several reasons: (i) missin households: in ontrary to the national aounts, the HABE data does not onsider non-profit institutions servin households (NPISH) and olletive households, (ii) differenes in definition of ost (for example, health are and eduation expenditure), (iii) missin response on ertain questions, and (iv) misreported items (for example, expenditures on alohol). 9 For more information on imputation tehniques, see, for example, Bethlehem et al. (2011) and Rubin (1987). Imputation was used to orret inomplete observations in the HABE data with respet to thermal fuel onsumption of households, for whih an unrealistially hih share of households does not report any spendin. 7

8 meet the national areate. 10 Savins are also in the household survey and were saled to math areate household savins from the SAM. The remainin differene between inome and expenditure of households was attributed to diret transfers between households and the overnment Household heteroeneity in enery use: a first look at the data Fiure 1 summarizes shares of different enery oods in total household expenditure for different inome deiles of the Swiss population. The data show that for thermal fuels and eletriity, households in the lower inome deiles tend to spend a hiher share of their expenditures on these enery oods than do households in the hiher inome deiles. This makes low inome households more vulnerable towards inreases in pries of heatin fuels and eletriity. No lear trend an be observed for motor fuels. But notably, the variation of expenditure shares for enery oods amon households of any inome deile is lare ompared to the differenes of mean expenditure shares aross deiles. Fiure 2 shows how inome is omposed of the inome soures waes, apital rents, and overnment transfers. Government transfers make up a lare fration of household inome for low inome households, whereas hiher inome households earn an inreasin share of inome from labor Model overview We here briefly outline the main key features of our numerial model. Appendix C ontains a omplete alebrai desription of the model s equilibrium onditions Heteroeneous households All households from the HABE survey are represented as individual eonomi aents in the eneral equilibrium model. This enables us to aount for the heteroeneity of the entire Swiss household population alon the two dimensions expenditure and inome. The utility funtions of households are alibrated suh that they reprodue expenditures at initial pries aordin to the (harmonized) HABE data, and labor supply, endowments of apital, and entitlements to overnment transfers are distributed suh that the inome patterns in the HABE data are ahieved. For ounterfatual senarios, the model fixes labor supply and savins at business-as-usual levels. Household savins are used for purhasin a omposite investment ood. Given oods and fators pries, households maximize their utility by alloatin inome reeived from overnment transfers, waes and rents on apital to onsumption. Utility from onsumption is desribed by a nested onstant-elastiity-ofsubstitution (CES) utility funtion (see the upper panel in Fiure A.1 in the appendix). In the ases of private eletrial applianes (pea) and private personal transport (ppt) households onsume enery servies that are produed by ombinin durable oods (vehiles and eletrial applianes) with the respetive enery oods (motor fuels and eletriity) and by employin hiher quality durable oods the quantity of enery oods per unit of enery servies an be redued Prodution tehnoloies and firm behavior In eah industry, ross output is produed usin primary inputs of labor and apital toether with intermediate inputs that are omposed of domestially produed oods and imported oods. We employ CES funtions to haraterize the substitutability between inputs of prodution (see the lower panel in Fiure A.1 10 Operatin surplus of eonomi setors inludes profits that are diretly reinvested and thus a diret link to apital rents of investors annot be made. Based on historial observations, about half of the operatin surplus enerates atual inome to households, while the remainder is diretly reinvested. 8

9 (a) Thermal fuels (b) Eletriity () Motor fuels Fiure 1: Within- and aross-inome deile distribution of household-level enery expenditure shares. Boxes show the interquartile (IQR) rane and solid lines within the box show the mean. 9

10 Fiure 2: Mean inome shares by inome soure and by annual inome deile in the appendix). Given input pries (ross of taxes and subsidies), firms minimize prodution osts subjet to physial tehnoloy onstraints. Firms operate in perfetly ompetitive markets sellin their produts at a prie equal to marinal osts. Capital and labor are assumed to be mobile aross Swiss industries. We assume that Swiss and forein investors view investments inside or outside Switzerland as perfet substitutes. This implies that rents on apital are determined by the international interest rate on whih Swiss poliy has no effet. Power eneration is modeled usin a ompat bottom-up ativity analysis representation where disrete tehnoloies produe a homoeneous eletriity ood by ombinin tehnoloy-speifi apital with inputs of labor, fuel, and materials. The substitution elastiity between tehnoloy-speifi apital and the omposite inputs is hosen to math exoenous tehnoloy-speifi prie elastiities of supply. The national aounts provide data to alibrate prodution funtions for eletriity eneratin tehnoloies that have been ative in the base-year 2008: hydro power, nulear power, power from renewables, and power from fossil fuels Government ativity A sinle overnment entity represents overnment ativities at all levels federal, antonal, and loal as well as part of the soial seurity system. The overnment ollets taxes to finane transfers and the provision of a publi ood. Besides value-added taxes, inome taxes, orporate profit taxes and soial seurity ontributions, the model features industry-speifi output taxes and subsidies as well as import and export levies. The publi ood is produed with ommodities purhased at market pries. The eonomi impat assessment of different poliy senarios always involves revenue-neutral tax reforms in order to keep the provision of the publi ood onstant. Thus, we an provide a meaninful welfare omparison without the need to trade off private and overnment (publi) onsumption. Revenue neutrality is ahieved 10

11 by endoenously settin areate amounts of lump-sum transfers between the overnment and households. The lump-sum transfers are alloated amon households in proportion to base-year household onsumption International trade and model losure With the exeption of rude oil, whih is treated as a homoeneous ood, domesti and imported varieties of the same ood are differentiated followin the Arminton (1969) assumption (i.e., for eah ommodity, its total market supply is a CES omposite of a domestially produed variety and an imported variety). In analoy to the import side, domestially produed oods are onverted throuh a onstant-elastiity-oftransformation funtion into oods destined for the domesti market and the export market, respetively. In international trade, Switzerland is assumed to be small, implyin that the levels of Swiss exports and imports do not affet world market pries. Switzerland holds its balane-of-payments (measured in forein exhane) onstant aross poliy senarios and the exhane rate adjusts endoenously to reflet hanes in terms of trade Computational stratey Followin Mathiesen (1985) and Rutherford (1995), we formulate the model as a mixed omplementarity problem and represent the eonomi equilibrium throuh two lasses of onditions: zero profit and market learane. Numerially, we solve the model in GAMS usin the PATH solver (Dirkse & Ferris, 1995). The alibration of the numerial model follows the standard proedure in applied eneral equilibrium modelin (see, for example, Harrison et al., 1997; Böhriner et al., 2016). The main hallene for omputin equilibria in a CGE model with a lare number of households is dimensionality: the number of simultaneous variables and equations beomes lare and may reate numerial problems for solution alorithms. To overome dimensionality restritions, we employ a sequential realibration alorithm as proposed by Rutherford & Tarr (2008). The alorithm deomposes the lare-sale market equilibrium problem into two subproblems and employs an iterative proedure to find a onsistent eneral equilibrium solution. The first subproblem solves a representative aent version by replain the heteroeneous households by a sinle representative aent (RA). The seond subproblem solves a partial equilibrium relaxation of the household side by evaluatin household demand funtions takin equilibrium pries from the first subproblem as iven. Chanes in households quantity hoies based on pries from the first subproblem will enerally not oinide with areated demand as predited by the RA model of the first subproblem and thus the solutions of the two subproblems are inonsistent. In a next iteration, the utility funtion of the RA in the first subproblem thus has to be realibrated to the observed areate demands of the seond subproblem. Solution of the first and then the seond subproblem and realibration of the first subproblem is iterated until the to subproblems have onvered Senario desin This setion desribes the senarios whih underlie our numerial simulations for ounterfatual poliy analysis. We provide detail on our baseline assumptions as well as the different market-based and CaC poliy measures Business-as-usual (BaU) senario Our analysis evaluates the eonomi effets of future poliy measures ompared to a business-as-usual (BaU) senario, whih assumes that already existin poliies ontinue to be in plae but that no new poliies 11 See Raush & Rutherford (2010, pp. 3-7) for a more elaborated desription of the deomposition alorithm. 11

12 Table 2: Alternative business-as-usual trends until 2030 Central ase Optimisti Pessimisti BaU assumptions GDP (% relative to 2008) Enery demand (% relative to 2008) Motor fuels Coal Eletriity Distribution & Transmission Natural Gas Heatin oil Other mineral oil produts Enery-related CO 2 emissions (% relative to 1990) Poliy tarets Enery-related CO 2 emissions ( 40% relative to 1990) % relative to BaU in Eletriity onsumption ( 3% relative to 2005) % relative to BaU in are introdued. To represent BaU onditions in 2030, soial aountin and survey data from 2008 are alibrated forward employin estimates for trends of GDP, enery demands, emissions, autonomous enery effiieny improvements (AEEI), tehnoloial hane in the power setor, and hanin fuel pries on the world market. Table 2 summarizes our assumptions about these trends for three different version of the BaU that differ with respet to projeted enery demand and GDP rowth. Our Central ase senarios implies a redution in the demand for most fuels by 2030 relative to 2008 and intermediate rowth rates of GDP. Comparin Central ase and Optimisti allows us to examine the impliations of hih GDP rowth (without inreases of enery demand), while omparin the Central ase and Pessimisti allows for onsiderin the effets of hiher GDP rowth rates if they also entail hiher enery demand. The BaU forward projetion of enery demand determines CO 2 emissions and eletriity onsumption prevailin in The trends in enery demand and GDP in the BaU senario are assumed to emere under ontinuation of urrent limate and enery poliy measure. Table 3 shows the poliies that are ative in the BaU. We assume that by 2030 the Swiss emissions tradin system (ETS) is oupled with the European Union s ETS assumin that industries requirin emissions permits under the ETS an trade them with the EU ETS at a prie of 42 CHF/tCO Poliy senarios ENVIRONMENTAL TARGETS Switzerland has set itself enery and limate poliy tarets for 2030 beyond what is ahievable with urrently installed poliies: reduin CO 2 emissions by 40% relative to 1990 levels and reduin eletriity onsumption by 3% relative to The former is in line with emission paths to reah Swiss limate poliy tarets for 2050, the latter reflets a desire to manae eletriity onsumption in liht of the planned phase-out of nulear power. Table 2 shows the redutions from BaU levels required to reah these tarets. STEERING VS. PROMOTION Our poliy senarios are desined to reflet two fundamentally different paradims of reulation for reduin enery use: a steerin approah that rests on eonomi inentives arisin from taxes on emissions and enery use and a promotion approah that builds on promotin and 12

13 Table 3: Overview of instruments in poliy senarios BaU Steerin Promotion Instruments taretin CO 2 emissions CO 2 tax on thermal fuels 84 CHF/ton CO 2 Endoenous a BaU level CO 2 tax on motor fuels 0 CHF/ton CO 2 Endoenous a BaU level Emissions standards for new passener vehiles Exoenous b BaU level 20% below BaU Subsidies for buildins proram 300 mio. CHF 0 Endoenous Emissions tradin system Exoenous BaU level BaU level Instruments taretin eletriity onsumption Eletriity tax 1.3 Rp./kWh Endoenous BaU level Subsidies for open ompetitive biddin 50 mio. CHF 0 Endoenous Effiieny standards for eletrial applianes Exoenous b BaU level 20% below BaU Notes: Endoenous means that the level of the instrument is determined endoenously within the model to meet the respetive (emissions or eletriity) taret. a Followin Landis et al. (2016), the tax on motor fuels is set to be 0.4 times the endoenous level of the tax rate on thermal fuels. b The effets from effiieny standards are onsidered to the extent that they are refleted in the benhmark data, i.e. we do not employ an expliit instrument to represent these standards in the BaU. mandatin measures for savin enery. 12 The senario details are follows: Steerin represents a omprehensive market-based reulation based on eonomy-wide CO 2 and eletriity taxes. Taxes are set endoenously to meet the respetive poliy tarets for CO 2 and eletriity. Setor-speifi subsidy prorams taretin enery use in household heatin and industrial setors are abolished. CaC reulation (emissions standards for vehiles and effiieny standards for eletrial applianes) are kept are their BaU levels. Promotion represents narrowly foused reulation whih limits where-flexibility by the enhaned use of CaC instruments and inreased reliane on subsidizin enery savins in speifi parts of the overall eonomy. CO 2 and eletriity taxes are kept at their BAU levels. The strineny of standards for vehiles and eletriity applianes are inreased by 20%, and poliy tarets for CO 2 and eletriity are met by inreasin subsidies in the setor-speifi prorams. Table 3 summarizes our senario assumptions. Note that while both senarios involve the use of MBIs, their desin in terms of setoral overae differs sinifiantly. Also, we deliberately deided aainst inludin a pure MBI or a pure CaC senario. This hoie is motivated by poliy relevane. First, even in liht of a future shift towards more inentive-based reulation, it seems hihly unlikely that emissions standards for vehile and effiieny standard for eletrial applianes would ease to exist. Seond, existin taxes on CO 2 and eletriity, if anythin, are expeted to inrease makin the ase of a pure CaC reulation without taxes politially uninterestin. We next desribe in more detail eah reulatory instrument inluded in the Steerin and Promotion senarios. 12 The desin of our senarios is also motivated by the disussion in Switzerland about the transition from a promotion-based to steerin-based system of enery and limate poliy (Federal Counil, 2015a,b). 13

14 Market-based instruments (MBIs) BROAD-BASED MBIS: TAXES ON CO 2 EMISSIONS AND ELECTRICITY CO 2 taxes are levied in proportion to the CO 2 emissions intensity of fuels onsumed by industrial and household setors. In the BaU and the Promotion senarios, eletriity taxes and CO 2 taxes on thermal fuels are fixed and motor fuels are exempt from the tax. In the Steerin senario, the tax on motor fuels is 0.4 times the tax on thermal fuels. 13 Revenues from taxin CO 2 emissions assoiated with industrial enery use are returned to industries in proportion to the wae bills (throuh redutions on the soial seurity bill). Revenue from taxin CO 2 emissions of households are returned to onsumers by refundin eah Swiss resident an equal lump-sum amount. Eletriity demand is taxed at the same rate throuhout the eonomy and taxation revenue is returned aordin to the same rules as CO 2 tax revenues. SECTOR-SPECIFIC MBIS: SUBSIDIES IN THE BUILDINGS PROGRAM To promote enery savins in the heatin of residential buildins, the Swiss overnment subsidizes investments in enery savin equipment throuh the Buildins Proram ( Gebäudeproramm ). Under the buildins proram, house owners who improve the insulation of their buildins reeive support per area where insulation is improved. 14 The support rates differ for different renovation measures: window replaement, insulation of walls fain outside, insulation of roofs, and insulation of walls fain unheated rooms. The proram is desined suh that also insulation measures that would have been ost-effetive without the subsidy reeive support. Our model distinuishes four different insulation measures: (i) insulatin windows or walls fain other unheated rooms in buildins heated by natural as, (ii) insulatin the same in buildins heated by heatin oil, (iii) insulatin walls fain outside or roofs in buildins heated by natural as, and (iv) insulatin the latter in buildins heated by heatin oil. Opportunities for these four insulation measures are represented by four fixed fators that toether with the neessary apital investments an supply savins in heatin fuel expenditures aordin to a CES prodution funtion (see Appendix B for details). Subsidies are iven in proportion to enery savins 15 and make insulation investments ost-effetive that would not have been without the subsidy. Rents on enery-savin apital, i.e. differenes between enery savins and insulation ost for the heapest insulation measures, arue to households that own buildins (either diretly or throuh investments in firms that own buildins). SECTOR-SPECIFIC MBIS: SUBSIDIES IN THE OPEN COMPETITIVE BIDDING PROGRAM To redue eletriity onsumption, the Swiss overnment subsidizes investments in enery savin equipment throuh the Open Competitive Biddin (OCB) proram ( Wettbewerblihe Ausshreibunen ). Under the OCB proram, investors apply for support if they plan a projet that will entail eletriity savins. Only the most ost-effetive projets (in terms of lifetime enery savins per unit of subsidy payment) are hosen until the budet of the OCB proram is depleted. The proram implements a strinent evaluation proess to avoid free-ridin behavior, i.e. the support of projets that would have already been profitable on their own. 13 Landis et al. (2016) find that for the Swiss limate poliy ontext, ost-effetive arbon priin poliies entail substantially lower taxes on motor fuels than on thermal fuels (by a fator of if other externalities suh as onestion or loal air pollution, are inored). This also reflets urrent Swiss poliy disussions (Federal Counil, 2015b) aordin to whih hih taxes on motor fuels are politially hihly ontentious. 14 The buildins proram also promotes measures for waste heat reovery, renewable enery supply, and the optimization of buildin utilities. Our analysis only inludes insulation measures. 15 This view of the buildins proram nelets the fat that within measures suh as, for example, window replaements, different enery savins an be expeted due to different pre-installed windows. By assumin the same support rate for all units of enery savin, our view of the proram assumes that eah unit of enery savin is ahieved by insulatin the same surfae area. We partially address this by distinuishin between renovations of houses heated with as or oil but admit that we may thus not apture the full heteroeneity of renovation projets in this respet. 14

15 Our model represents opportunities for investin in enery-savin measures throuh the OCB proram usin the same approah as for enery-savin measures throuh the buildins proram (see Appendix B for details). Rents on enery-savin apital, i.e. here the differene between enery savins and annualized investment ost, arue to owners of the firms Command-and-ontrol (CaC) measures We onsider two CaC measures. First, CO 2 emissions standards for new passener vehiles mandatin a minimum fuel effiieny that has to be met on averae in the fleet of new ars. Seond, effiieny standards for eletrial applianes mandatin a minimum enery effiieny in deliverin their servies to onsumers. In our model, enery servies vehile kilometers traveled in ase of emission standards and rooms lit, loads washed, et. in the ase of effiieny standards for applianes are represented as a CES areate of enery demand and applianes in whih demand for ars (applianes) an substitute for enery demand. This substitution reflets the possibility of produers to supply hiher quality devies whih redue enery demand. At the same level of enery effiieny, standards will entail more demand for enery servies and thus more demand for eletriity or emissions than taxes would, beause under a tax, the onsumer not only pays for hiher quality ars and applianes but also for hiher fuel and eletriity pries. In addition, note that standards, unlike taxes or subsidies, do not ause any revenues or expenses for the overnment Revenue-neutrality: balanin the overnment budet While enery and CO 2 tax revenue is reyled to industries and households, poliy-indued hanes in tax bases and finanin of the subsidy prorams will affet the overnment budet. As the provision of the publi ood, i.e. the overnment budet after transfer payments, has to remain onstant in order to enable a meaninful welfare omparison aross senarios, the model needs a means to balane the budet under poliy senarios. As the urrent politial disussion does not provide any information on how extended subsidy shemes under the buildins proram would be finaned if the volume of subsidies exeeds the revenue from CO 2 taxation, we assume a budet balanin mehanism that impats the inome distribution amon households as little as possible Simulation results This setion presents the main results from our ounterfatual poliy analysis. We first fous on omparin the areate eonomi osts and the effetiveness of poliies to redue CO 2 emissions and eletriity onsumption. We then present the distributional impats of the various poliy measures detailin how different soio-eonomi roups of households would be affeted. To hek to what extent our results depend on our baseline assumptions, we then ondut sensitivity analysis by employin alternative assumptions for those Areate effiieny ost Table 4 reports the areate welfare osts for the two poliy senarios. Throuhout, we measure welfare osts as the hane in Hiksian equivalent variation relative to the BaU in A first important 16 Our model does not distinuish between different vintaes in neither the ar fleet nor the stok of eletrial applianes but assumes that more strinent standards redue the fuel (eletriity) demand aross the whole vehile fleet (stok of applianes). 17 Speifially, we use a uniform tax on household inome from apital, labor, and overnment transfers after other taxes. The hane in disposable inome from this tax auses the same perentae hane for all households, beause the same rate applies to all households and it does not ause any hanes in labor supply or apital endowment aordin to our model. 18 The welfare measure used throuhout this study exlusively fouses on eonomi ost. In partiular, we abstrat from any environmental benefits due to, for example, averted limate impats or hanes in loal air pollution. Also, our welfare alulations 15

16 Table 4: Areate welfare effets (annual ost relative to BaU) in % a in bill. CHF in CHF per household Steerin Promotion Notes: a The areate welfare hane, Γ, is omputed as a Benthamite (utilitarian) soial welfare funtion simply areatin welfare hanes aross households without inequality aversion: Γ = H h=1 ω h100(u h 1), where h is the household index, H the total number of households in the sample, ω h the sample weihts for the survey data, and u h the utility level under the poliy situation (where the BaU utility level is normalized to unity). insiht is that a sizeable dearbonization of the Swiss eonomy is possible at modest osts; the osts of reduin CO 2 emissions by 40% by 2030 (relative to 1990) rane between 0.23% and 1.19% of annual onsumption or about billion CHF per year. For the averae household the annual ost amount to CHF. 19 Importantly, however, the eonomi osts of suh a dearbonization is shown to sinifiantly depend on the hoie of poliy instruments. Ahievin the same redutions in CO 2 emissions and eletriity onsumption is about 5 times less ostly under the Steerin ompared to the Promotion senario. The additional ost imposed by relyin on promotion instruments suh as the Buildins Proram and the OCB rather than usin broad-based taxes amounts to about 4.24 billion CHF per year for the Swiss eonomy. This orresponds to an exess burden of CHF per year for an averae Swiss household. The reasons that the Promotion senario is farin worse in terms of eonomi ost are that the standards and subsidies taret only frations of enery demand in the eonomy and do not allow markets to equalize marinal osts of reduin demand for eletriity and CO 2 emissions aross setors. Also enery servies under the Promotion senario are heaper than under effiient taxes on eletriity and CO 2 emissions at the same levels of enery effiieny. Thus, houses, ars, and applianes need to be more enery effiient than they have to be under the Steerin senario to reah the same tarets Deomposition of areate ost impats Fiure 3 deomposes the total welfare hane into effets throuh the inidene hannels inome and ommodity pries. The welfare loss in the Steerin senario is to a lare extent driven by a redution in fator inome whereas under the Promotion senario welfare is muh less affeted by hanes in apital and labor inome. A positive inome impat in the Steerin stems from transfers reeived throuh reylin some of the CO 2 and eletriity tax revenues to households. Under the Promotion senario, the effets on the soures of inome side are neliibly small. The osts under the Promotion senario larely materialize throuh the need to finane the subsidy instruments whih is refleted by the need to hold the overnment budet neutral (i.e., inome hane due to equal-yield overnment payments). As the use of expliit tax instruments under the Steerin poliy pakae inrease onsumer pries, some of the welfare osts are due to prie impats whereas this is effet is nearly zero under Promotion as onsumer pries for enery are not muh affeted (see further disussion in the ontext do not take into aount the effets from reduin non-environmental externalities suh as, for example, onestion due to hanes in the demand for transportation servies. There is evidene in the literature that the o-benefits from enery and limate poliies aimed at reduin fossil fuel use (see, for example, Thompson et al., 2014) an be substantial. While a areful ontext-speifi evaluation of the presene and likely manitude of suh additional benefits is needed, the findins from the o-benefits literature suests that our welfare metri may be appropriately interpreted as providin an upper bound for ost. 19 Note that when reportin money-metri welfare osts, we always refer to CHF in the base year. 16