A Quick Look At Sweden’s Carbon Tax
In this exercise I was asked to do the following regarding a particular carbon policy:
1) The coverage of the carbon policy. Discuss the sectors/fuels covered. Discuss, what sectors/ carbon equivalent emissions are exempted. How does the policy implement over time? Use the information about the policy’s coverage to inform an evaluation of the cost-effectiveness of the policy.
2) Discuss distributional effects of the policy. One of the primary concerns around a carbon policy is that by raising the price of energy it disproportionately impacts the poor. How do these policies address such distributional concerns?
A Quick Look At Sweden’s Carbon Tax
Origin and goals:
- The carbon tax was introduced when the Swedish energy tax system was reformed in 1991
- The 1980s had a focus on oil substitution and thus the tax system was designed to discourage oil use
- The goal: to reduce CO2 emissions and to spur innovation of industry
- How: The tax is levied as a specific tax on oil, coal, natural gas, bottled gas, and petrol
Climate change is such a big issue today. One can hear phrases like reducing carbon footprint multiple times on any given day. Truly environmental problems are abounding. A solution suggested and tried by some countries like Sweden (where 80 per cent of their contribution to greenhouse gases, came from carbon dioxide emissions) is implementing a carbon tax.
What is a carbon tax?
A carbon tax is a form of pollution tax used to cut greenhouse emissions and promote cleaner energy. It is meant to target carbon dioxide emissions from burning fossil fuels. Many prefer the CO2 tax for its simplicity and impartiality.
The problem with a carbon tax though is the distributional effects it has. Raising the price of energy inexplicably affects the poor. Does a carbon tax work? It appears so in the case of Sweden. Not only have they reduced their carbon emissions, their economy has grown by more than 44 per cent and in 2011 they were second in the world on economic competitiveness.
Sweden has been taxing carbon since 1991. The tax is believed to have encouraged innovation and the use of green heating technologies that have significantly phased out burning oil for heating. The CO2 tax has thus played a role for the country to be on target to achieve its commitment under the Kyoto Protocol.
What is the coverage of their carbon policy?
In 1991, Sweden introduced a carbon tax as a complement to the existing system of energy taxes (which were simultaneously reduced by 50%). The country focused on oil substitution in the 1980s and the tax system was designed to discourage oil use.
The tax was initially set at a general level of US$133 per ton of carbon. In 1993 however, competitive concerns changed the tax burden on the different sectors. The CO2 tax increased for consumers while in industry, taxes fell. This remains the same today. Industry, agriculture, forestry, and fisheries pay only about 21 per cent of the tax. Moreover, these sectors can receive additional reductions (and refunds) depending on the company’s value of sales versus their tax payment. In 2009, the country’s standard tax rate was the equivalent of US$105 per metric ton CO2 but for industry it was only at US$23 per metric ton CO2.6
The major taxed sectors in Sweden’s carbon tax system are natural gas, gasoline, coal, light and heavy fuel oil, liquefied petroleum gas (LPG), and home heating oil. The tax addresses the energy and transport sectors. Biofuels (including peat) are not taxed.
Is it cost-effective?
Being cost effective means achieving a specified goal at the lowest possible cost. To evaluate whether Sweden’s carbon tax is cost-effective or not begs the question what was the desired goal and how much should it cost.
The goal is obvious, reduce carbon emissions and the tax is effective in doing so. CO2 emissions have been falling in Sweden since the tax’s implementation in 1991. By 2008 Sweden’s emissions decreased by more than 40% since the 1980s.5
BUT are they reducing carbon emissions at low cost?
One way to tell if costs are being minimized is if the equimarginal principle is satisfied. The equimarginal principle can be simplified in this case as having the marginal abatement costs for all sources the same. Aggregating marginal abatement cost for each individual should then bring us to the appropriate tax. If this were the case, then the carbon tax would be uniform throughout Sweden. The amount of the tax, however, varies for different sectors. This indicates that they are most likely not reducing carbon at lowest possible cost.
If they did not do it that way, then more damaging fuels should be taxed more. However, the Swedish carbon tax fails reflect the actual level of carbon being emitted by fuels. Low fuel oil and heavy fuel oil for example were taxed at the same rate even though they cause different levels of environmental damage. If taxing sectors separately, the tax should obviously be higher for the fuel that causes more destruction. The tax may then be costly to a particular industry that may be paying higher than it should and the reverse is worse. If not taxed appropriately, a higher carbon emitting sector will be paying less than it should be and is most likely causing more damage because the tax is too low than it should be if it were cost effective.
Are there distribution effects?
As mentioned in the beginning, a major concern of a carbon tax is its distributional effects. The tax is used specifically to raise government revenue6. How does the country use the revenue? Does Sweden’s CO2 tax impact the poor positively or negatively?
Consumers pay the full effect of the tax and there does not appear to be any additional policy to address the concern. Even without running any type of analysis it is obvious that the CO2 tax must have negative effects on poorer households.
Where does the tax revenue go?
The Swedish carbon tax goes straight to government revenue.
I have not found anything that indicates the Swedish Government is still using the tax revenue to subsidize alternative energy sources but the regressive results can be lessened if consumers are able to convert to biomass fuels. Using biofuels for heating is deemed lower than the carbon tax. It would make sense then if they gave or are continuing to give incentives to consumers to make the switch to alternative energy by subsidizing their costs to do so.
With regards to the industry sector, remember they pay a much smaller tax compared to consumers. Could they be the recipients of the subsidy to change to energy sources for production? From the little literature that I have been able to read, it seems part of the revenue from the tax goes to research and development for biofuel and alternative energy.
Sweden has had a carbon tax since 1991. They were one of the first countries to implement such a policy. Even if the tax has negative distributional effects and has not been cost effective, it has been successful in reducing Sweden’s carbon emissions. It has also spurred the country to be in the forefront in using biomass and biofuels. Will they achieve their goal of being the world’s first oil-free economy by 2020? Only time will tell.