## 2. Taxes on final consumption of energy

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---

### I. Introduction
- Purpose: examines the policy discussion concerning the use of energy taxes for macroeconomic goals.
- Proposals summarized:
  - Energy taxes proposed to achieve macroeconomic objectives of output and employment and as vehicle for fiscal deficit reduction.
  - Environmental benefits presented as a supplementary argument.
- Core conclusion previewed:
  - Macroeconomic objectives are likely to be met more effectively by broad-based taxes rather than energy taxes.
  - This is not a rejection of energy taxes per se, but a statement that using these taxes cannot be justified on macroeconomic grounds.
- Contextual policy references:
  - European Commission White Paper "Growth, Competitiveness, Employment" (December 1993) suggested reducing charges on labor and compensating with increases in other taxes, including energy taxes.
  - U.S. administration proposed a BTU tax in early 1993 as part of deficit reduction; compromise resulted in a tax on final consumption of gasoline.
- Paper structure:
  - Section II: revenue-neutral substitution of energy taxes for other taxes (e.g., payroll/social security).
  - Section III: output effect.
  - Section IV: employment effect.
  - Section V: importance of identifying policy objective in choosing tax instruments.
  - Final section: conclusions.

### II. The Macroeconomic Case for Energy Taxes
- Double dividend argument:
  - Energy/environment taxes provide environmental benefits by reducing externalities and generate revenue that can be used to reduce other distortionary taxes.
  - Chart (Pigouvian Tax "Double Dividend") illustrates: first dividend = net social gain (area BDE minus BCE); second dividend = revenues raised without marginal social excess burden (area OABC).
- Explicit cautions:
  - The double dividend can be valid but does not justify using energy taxes for promoting macroeconomic objectives.
  - Most energy taxes are not equivalent to Pigouvian taxes and can impose their own efficiency costs.
- Testimony and claims cited:
  - Testimony to U.S. Senate Finance Committee (April 1993) argued energy taxes move energy prices toward full costs and are "corrective" rather than distortionary.
  - European Commission White Paper (1993) suggested environmental taxes may be envisaged to offset reductions in statutory charges designed to reduce labor costs.
- Fiscal cost comparisons and numeric estimates:
  - Example claim: in the United States it is estimated that the social cost of raising $1.00 of revenue is perhaps $1.50 whereas environment taxes raise revenue with a zero marginal social cost.
  - Browning (1987) range: marginal cost of public funds in the United States lies in the range of $1.32 to $1.47.
- Key normative point:
  - Even if revenues are raised with low social cost, that alone does not mean energy taxes are best for promoting output and employment.

### III. Energy Taxes and Economic Output
- Objective for output promotion:
  - A revenue-neutral reform substituting energy taxes for existing taxes must reduce the effective tax burden on the private sector to promote output.
- Core argument:
  - There is a reasonable presumption that an energy tax reform is inferior to alternative tax reforms in reducing the effective tax burden.
  - Energy taxes may reduce aggregate social cost but the component that matters for output is the abatement cost incurred by polluters (the excess burden BCE in the Chart).
- Excess burden definition and origin:
  - Excess burden = tax payment plus excess burden; arises from tax-induced substitution effects that modify production/consumption decisions away from pretax efficient choices.
  - Excess burden from energy taxes takes the form of abatement costs because private sector reduces energy use.
- Considerations favoring broad-based taxes over energy taxes:
  - Broad-based taxes generally impose lower excess burden than narrow-based taxes because they do not alter relative prices as much; a VAT is likely to impose a lower excess burden than an energy tax.
  - An energy tax raising the same revenue as a broad-based consumption tax will require a considerably higher tax rate because of the smaller base; excess burden increases more than proportionally with the tax rate.
  - Form of the energy tax matters: a tax on final gasoline consumption may be more efficient, in a macroeconomic context, than a BTU tax because it does not affect producer input or savings and investment choices.
- Exceptions and caveats:
  - If energy is subsidized initially (as in many developing countries and transition economies), eliminating subsidies and imposing energy taxes may be efficient.
  - If environmental externalities harm productivity, energy taxes can raise productivity and output to the extent they alleviate damage; in many developing countries environmental damage from fossil fuel consumption imposes substantial economic costs.
- Empirical evidence and modeling:
  - Most studies support the presumption favoring broad-based consumption taxes.
  - A European Commission study suggested the opposite ranking (favoring an energy tax over an income tax with the VAT least preferred).
  - General equilibrium results (United States example, Goulder (1992)):
    - Using carbon tax revenues to finance reductions in marginal personal or corporate income tax rates reduces the excess burden of a carbon tax by 25 to 32 percent compared to lump-sum return of revenues.
    - The excess burden of the carbon tax is 15 percent lower than otherwise because of the pre-existing low relative taxation of fossil fuel industries in the United States.
  - General conclusion from models: carbon and other energy taxes impose relatively high excess burdens; costs increase more than proportionally with the tax rate.
- Interim conclusion:
  - Although using energy tax revenues to reduce distorting taxes can reduce efficiency costs, this does not by itself justify preferring energy taxes over broader-based tax reforms for output promotion.

### Findings on output costs and comparative efficiency
- Goulder (1992) found that a broad-based consumption tax is far superior to a carbon tax.
- Goulder (1993) extends this analysis to consider the BTU tax and a tax on gasoline consumption proposed in the U.S. deficit reduction debate.
- Study conclusions (comparative output-costs, year 2000):
  - A consumption tax on gasoline would impose output costs equivalent to 82 percent of those of a BTU tax.
  - An increase in the personal income tax would impose output costs equivalent to 64 percent of those of a BTU tax.
  - An increase in the rate of corporate income tax would impose output costs equivalent to 32 percent of those of a BTU tax.
- Key drivers of higher output costs for energy taxes:
  - The relative narrowness of the energy tax bases—most of the higher output costs of the BTU tax flow from its relatively narrow base.
  - The fact that the tax is levied on gross output rather than on final or net output.

### Empirical and model-based counter-evidence
- European Commission study result:
  - Concluded that a carbon tax is more effective in promoting output (and employment) than an increase in personal income tax which, in turn, is superior to an increase in the VAT rate—results reverse earlier empirical findings.
- QUEST model explanations for carbon tax superiority:
  - Energy tax burden is shifted to oil exporters.
  - Europe can sustain a price increase for its manufactured exports (implying imperfect competition), generating a terms of trade gain and improved wage performance.
  - Losses in international market share for exports are more than compensated for by the increase in nontradable sector output.
- Caveats on QUEST results:
  - Tax incidence assumptions of the model are not spelled out and may be debatable.
  - The model assumes, for example, that social security taxes reduced as part of reform are borne entirely by firms.
  - Models of this construction are described as ill-suited to examining medium-term implications because their dynamics are ad hoc and intertemporal aspects of economic behavior are ignored.

### Energy taxes and employment
- Two potential avenues for energy-tax-induced employment gains:
  1. Output effect: tax reform reduces private-sector tax burden, increases output and employment—limited because energy taxes likely impose greater output losses than alternatives.
  2. Factor substitution: labor substitutes for capital/energy as labor becomes relatively more attractive—difficult because shifting taxes away from labor is hard.
- Incidence considerations determining whether energy-tax-for-labor-tax substitution reduces labor costs:
  1. Taxes on energy inputs
     - If goods produced with taxed energy inputs are tradable, labor (the immobile factor) will bear the major part of the energy tax burden.
     - Factors bear taxes according to elasticity of supply; less mobile factors bear more.
     - If energy tax is limited to nontradable goods, employment promotion is more plausible, but not guaranteed.
  2. Taxes on final consumption of energy
     - Consumers are most likely to bear taxes on final consumption of energy.
     - Taxation of final energy consumption raises consumer goods prices and reduces real wages, interacting with labor income taxes.
     - The after-tax real wage expression: (l-ty)w/(l+ti)p
     - The distortion to labor supply introduced by raising energy tax rates (or other taxes influencing the price level) is a function of (l-t,)/(l+ti).
     - Increases in taxes on final energy consumption may do little to help or may even harm employment prospects.
  3. International aspects of incidence
     - Joint imposition of energy taxes by major oil importers could shift burden to energy producers and, subject to supply-elasticity assumptions, lower oil prices—improving terms of trade and boosting employment in taxing countries but not providing anticipated environmental benefits.
     - International coordination can force internationally mobile capital to bear a greater share of the tax burden.
     - If energy taxes are borne by capital, the price of capital goods would increase, likely reducing capital formation and possibly lowering labor productivity, which could worsen unemployment depending on labor-market flexibility.

### Policy instruments, objectives, and trade-offs
- Two central policy-design questions:
  1. What is the policy objective?
  2. What is the best tax instrument to achieve that objective?
- European Commission carbon-tax history (as described):
  - First proposal aimed at stabilizing European carbon dioxide emissions at 1990 levels by the end of the decade.
  - Second proposal intended to promote growth and employment by replacing taxes on labor.
- Identified trade-offs:
  - The same instrument (carbon tax) is unlikely to meet environmental and macroeconomic goals effectively when used simultaneously.
  - Macroeconomic concerns led to special provisions in Commission proposals to maintain international competitiveness, which reduced environmental effectiveness:
    - Graduated tax reductions for energy-intensive firms (available to firms for whom energy costs exceed 8 percent of value added).
    - Tax incentives and temporary exemptions for firms undertaking energy-saving investment.
    - Conditional introduction of tax in Europe on similar measures being adopted by other OECD countries.
- Environmental-effectiveness requirement:
  - Tax must be levied on use of fossil fuels at all stages, including productive inputs; omitting such stages reduces environmental effectiveness but may be needed to limit macroeconomic costs.

### Conclusions and policy recommendations
- General conclusions:
  - It seems unlikely that energy taxes are the best available tax instrument to pursue macroeconomic objectives, even though macroeconomic objectives have motivated their introduction in many proposals.
  - This is not a case against energy taxes per se; rather, energy taxes should be targeted to policy objectives (including environmental goals) where they may be appropriate.
- Policy recommendations:
  - First: Energy taxes should be targeted to policy objectives, including environmental goals, where they may be the appropriate tax instrument.
  - Second: Tax reform should focus on use of broad-based taxes to reduce the excess burden of the tax system.
  - Third: The scope for taxes to address labor market problems directly is limited.
- Additional interpretive points:
  - Policymakers are primarily concerned with economic activity and employment; thus the conventional "double dividend" argument becomes less relevant because the second dividend consists of an excess burden (lower output and employment) partly offset by environmental benefits.
  - There is a reasonable presumption that energy taxes will impose a greater excess burden than alternative taxes such as broad-based consumption taxes like a VAT.
  - It is unlikely that shifting from taxes on labor to energy taxes will substantially reduce the relative tax burden on labor.

*Source: _ppaa9409 - 2. Taxes on final consumption of energy_*

### 2. Taxes on final consumption of energy

### 2. Taxes on final consumption of energy

### I. Introduction
- Purpose: examines the policy discussion concerning the use of energy taxes for macroeconomic goals.
- Proposals summarized:
  - Energy taxes proposed to achieve macroeconomic objectives of output and employment and as vehicle for fiscal deficit reduction.
  - Environmental benefits presented as a supplementary argument.
- Core conclusion previewed:
  - Macroeconomic objectives are likely to be met more effectively by broad-based taxes rather than energy taxes.
  - This is not a rejection of energy taxes per se, but a statement that using these taxes cannot be justified on macroeconomic grounds.
- Contextual policy references:
  - European Commission White Paper "Growth, Competitiveness, Employment" (December 1993) suggested reducing charges on labor and compensating with increases in other taxes, including energy taxes.
  - U.S. administration proposed a BTU tax in early 1993 as part of deficit reduction; compromise resulted in a tax on final consumption of gasoline.
- Paper structure:
  - Section II: revenue-neutral substitution of energy taxes for other taxes (e.g., payroll/social security).
  - Section III: output effect.
  - Section IV: employment effect.
  - Section V: importance of identifying policy objective in choosing tax instruments.
  - Final section: conclusions.

### II. The Macroeconomic Case for Energy Taxes
- Double dividend argument summarized:
  - Energy/environment taxes provide environmental benefits by reducing externalities and generate revenue that can be used to reduce other distortionary taxes.
  - Chart (Pigouvian Tax "Double Dividend") illustrates: first dividend = net social gain (area BDE minus BCE); second dividend = revenues raised without marginal social excess burden (area OABC).
- Explicit cautions:
  - The double dividend can be valid but does not justify using energy taxes for promoting macroeconomic objectives.
  - Most energy taxes are not equivalent to Pigouvian taxes and can impose their own efficiency costs.
- Testimony and claims cited:
  - Testimony to U.S. Senate Finance Committee (April 1993) argued energy taxes move energy prices toward full costs and are "corrective" rather than distortionary.
  - European Commission White Paper (1993) suggested environmental taxes may be envisaged to offset reductions in statutory charges designed to reduce labor costs.
- Fiscal cost comparisons:
  - Example claim: in the United States it is estimated that the social cost of raising $1.00 of revenue is perhaps $1.50 whereas environment taxes raise revenue with a zero marginal social cost.
  - Browning (1987) range: marginal cost of public funds in the United States lies in the range of $1.32 to $1.47.
- Key normative point:
  - Even if revenues are raised with low social cost, that alone does not mean energy taxes are best for promoting output and employment.

### III. Energy Taxes and Economic Output
- Objective for output promotion:
  - A revenue-neutral reform substituting energy taxes for existing taxes must reduce the effective tax burden on the private sector to promote output.
- Core argument:
  - There is a reasonable presumption that an energy tax reform is inferior to alternative tax reforms in reducing the effective tax burden.
  - Energy taxes may reduce aggregate social cost but the component that matters for output is the abatement cost incurred by polluters (the excess burden BCE in the Chart).
- Excess burden definition and origin:
  - Excess burden = tax payment plus excess burden; arises from tax-induced substitution effects that modify production/consumption decisions away from pretax efficient choices.
  - Excess burden from energy taxes takes the form of abatement costs because private sector reduces energy use.
- Considerations favoring broad-based taxes over energy taxes:
  1. Broad-based taxes generally impose lower excess burden than narrow-based taxes because they do not alter relative prices as much; a VAT is likely to impose a lower excess burden than an energy tax.
  2. An energy tax raising the same revenue as a broad-based consumption tax will require a considerably higher tax rate because of the smaller base; excess burden increases more than proportionally with the tax rate.
  3. Form of the energy tax matters: a tax on final gasoline consumption may be more efficient, in a macroeconomic context, than a BTU tax because it does not affect producer input or savings and investment choices.
- Exceptions and caveats:
  - If energy is subsidized initially (as in many developing countries and transition economies), eliminating subsidies and imposing energy taxes may be efficient.
  - If environmental externalities harm productivity, energy taxes can raise productivity and output to the extent they alleviate damage; in many developing countries environmental damage from fossil fuel consumption imposes substantial economic costs.
- Empirical evidence and modeling:
  - Most studies support the presumption favoring broad-based consumption taxes.
  - A European Commission study suggested the opposite ranking (favoring an energy tax over an income tax with the VAT least preferred).
  - General equilibrium results (United States example, Goulder (1992)):
    - Using carbon tax revenues to finance reductions in marginal personal or corporate income tax rates reduces the excess burden of a carbon tax by 25 to 32 percent compared to lump-sum return of revenues.
    - The excess burden of the carbon tax is 15 percent lower than otherwise because of the pre-existing low relative taxation of fossil fuel industries in the United States.
  - General conclusion from models: carbon and other energy taxes impose relatively high excess burdens; costs increase more than proportionally with the tax rate.
- Interim conclusion in this section:
  - Although using energy tax revenues to reduce distorting taxes can reduce efficiency costs, this does not by itself justify preferring energy taxes over broader-based tax reforms for output promotion.

*Source: _ppaa9409 - 2. Taxes on final consumption of energy_*

### conclusion that energy taxes are the best tax instrument to promote economic

### conclusion that energy taxes are the best tax instrument to promote economic

### Findings on output costs and comparative efficiency
- Goulder (1992) found that a broad-based consumption tax is far superior to a carbon tax.
- Goulder (1993) extends this analysis to consider the BTU tax and a tax on gasoline consumption proposed in the U.S. deficit reduction debate.
- The study concludes that the output costs of employing these energy taxes exceed by a significant margin the costs of increasing personal or income taxes and, by a bigger margin, the use of a broad-based consumption tax.
- Comparative output-cost equivalents (in the year 2000):
  - A consumption tax on gasoline would impose output costs equivalent to 82 percent of those of a BTU tax.
  - An increase in the personal income tax would impose output costs equivalent to 64 percent of those of a BTU tax.
  - An increase in the rate of corporate income tax would impose output costs equivalent to 32 percent of those of a BTU tax.
- Key drivers of higher output costs for energy taxes:
  - The relative narrowness of the energy tax bases—most of the higher output costs of the BTU tax flow from its relatively narrow base.
  - The fact that the tax is levied on gross output rather than on final or net output.

### Empirical and model-based counter-evidence
- A European Commission study concluded that a carbon tax is more effective in promoting output (and employment) than an increase in personal income tax which, in turn, is superior to an increase in the VAT rate—results that are the reverse of earlier empirical findings and counter-intuitive relative to theoretical discussion.
- The QUEST model explanations (as summarized in the source) for carbon tax superiority:
  - Energy tax burden is shifted to oil exporters.
  - Europe can sustain a price increase for its manufactured exports (implying imperfect competition), generating a terms of trade gain and improved wage performance.
  - Losses in international market share for exports are more than compensated for by the increase in nontradable sector output.
- Caveats on QUEST model results:
  - Tax incidence assumptions of the model are not spelled out and may be debatable.
  - The model assumes, for example, that social security taxes reduced as part of reform are borne entirely by firms.
  - Models of this construction are described as ill-suited to examining medium-term implications because their dynamics are ad hoc and intertemporal aspects of economic behavior are ignored.

### Energy taxes and employment
- Two potential avenues for energy-tax-induced employment gains:
  1. Output effect: tax reform reduces private-sector tax burden, increases output and employment—limited because energy taxes likely impose greater output losses than alternatives.
  2. Factor substitution: labor substitutes for capital/energy as labor becomes relatively more attractive—difficult because shifting taxes away from labor is hard.
- Incidence considerations determining whether energy-tax-for-labor-tax substitution reduces labor costs:
  1. Taxes on energy inputs
     - If goods produced with taxed energy inputs are tradable, labor (the immobile factor) will bear the major part of the energy tax burden.
     - Factors bear taxes according to elasticity of supply; less mobile factors bear more.
     - If energy tax is limited to nontradable goods, employment promotion is more plausible, but not guaranteed.
  2. Taxes on final consumption of energy
     - Consumers are most likely to bear taxes on final consumption of energy.
     - Taxation of final energy consumption raises consumer goods prices and reduces real wages, interacting with labor income taxes.
     - The after-tax real wage expression in the source: (l-ty)w/(l+ti)p
     - The distortion to labor supply introduced by raising energy tax rates (or other taxes influencing the price level) is a function of (l-t,)/(l+ti).
     - Increases in taxes on final energy consumption may do little to help or may even harm employment prospects.
  3. International aspects of incidence
     - Joint imposition of energy taxes by major oil importers could shift burden to energy producers and, subject to supply-elasticity assumptions, lower oil prices—improving terms of trade and boosting employment in taxing countries but not providing anticipated environmental benefits.
     - International coordination can force internationally mobile capital to bear a greater share of the tax burden.
     - If energy taxes are borne by capital, the price of capital goods would increase, likely reducing capital formation and possibly lowering labor productivity, which could worsen unemployment depending on labor-market flexibility.

### Policy instruments, objectives, and trade-offs
- Two central questions for policy design:
  1. What is the policy objective?
  2. What is the best tax instrument to achieve that objective?
- European Commission carbon-tax history (as described in the source):
  - First proposal aimed at stabilizing European carbon dioxide emissions at 1990 levels by the end of the decade.
  - Second proposal intended to promote growth and employment by replacing taxes on labor.
- Trade-offs identified:
  - The same instrument (carbon tax) is unlikely to meet environmental and macroeconomic goals effectively when used simultaneously.
  - Macroeconomic concerns led to special provisions in Commission proposals to maintain international competitiveness, which reduced environmental effectiveness:
    - Graduated tax reductions for energy-intensive firms (available to firms for whom energy costs exceed 8 percent of value added).
    - Tax incentives and temporary exemptions for firms undertaking energy-saving investment.
    - Conditional introduction of tax in Europe on similar measures being adopted by other OECD countries.
- Environmental-effectiveness requirement: tax must be levied on use of fossil fuels at all stages, including productive inputs; omitting such stages reduces environmental effectiveness but may be needed to limit macroeconomic costs.

### Conclusions and policy recommendations
- General conclusions:
  - It seems unlikely that energy taxes are the best available tax instrument to pursue macroeconomic objectives, even though macroeconomic objectives have motivated their introduction in many proposals.
  - This is not a case against energy taxes per se; rather, energy taxes should be targeted to policy objectives (including environmental goals) where they may be appropriate.
- Policy recommendations summarized:
  - First: Energy taxes should be targeted to policy objectives, including environmental goals, where they may be the appropriate tax instrument.
  - Second: Tax reform should focus on use of broad-based taxes to reduce the excess burden of the tax system.
  - Third: The scope for taxes to address labor market problems directly is limited.
- Additional interpretive points:
  - Policymakers are primarily concerned with economic activity and employment; thus the conventional "double dividend" argument (environmental benefit plus revenue without efficiency loss) becomes less relevant because the second dividend consists of an excess burden (lower output and employment) partly offset by environmental benefits.
  - There is a reasonable presumption that energy taxes will impose a greater excess burden than alternative taxes such as broad-based consumption taxes like a VAT.
  - It is unlikely that shifting from taxes on labor to energy taxes will substantially reduce the relative tax burden on labor.

*Source: _ppaa9409 - conclusion that energy taxes are the best tax instrument to promote economic*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/ppaa/_ppaa9409.pdf_