Using emissions trading schemes to reduce heterogeneous distortionary taxes: The case of recycling carbon auction revenues to support renewable energy

We examine the economic impacts of using the revenues from environmental taxation to reduce a pre-existing distortionary tax in a multisector economy where the environmental regulation and pre-existing distortionary tax apply heterogeneously across polluting sectors. With a numerical framework including a detailed sectoral disaggregation, we quantify these in the specific case of the European Union where carbon pricing coexists with electricity levies employed to support renewable energy. We find that using auction revenues from the EU Emissions Trading System (ETS) to reduce the national levies results in a 1.8% ETS carbon price increase but a 5.9% drop in the non-ETS carbon constraint. While the energy intensive sectors often benefit from electricity levy exemptions, the combination of these exemptions and of the recycling of carbon auction revenues to support renewable energy makes the ETS sectors worse off than if carbon revenues are transferred to households. In aggregate, the recycling option analysed here results in a GDP gain due to its impacts on the non-ETS sectors, the reduction of the electricity levy and associated distortionary effects.

Automated summary

This study examines the economic impacts of using environmental taxation revenues to reduce distortionary taxes in a multi-sector economy. The findings suggest that using auction revenues from the EU Emissions Trading System (ETS) to reduce national levies results in an increase in ETS carbon prices but a decrease in non-ETS carbon constraint. Additionally, the combination of electricity levy exemptions and the recycling of carbon auction revenues to support renewable energy negatively affects ETS sectors. Overall, the recycling option analyzed here leads to a GDP gain due to its impacts on non-ETS sectors and reduction of electricity levies.