DEMAND-BASED ENERGY POLICIES

I pointed out in a previous chapter that supply-based energy policies in support of unconstrained growth were associated with the concentration of the energy sector and the centralization of policy-making. The major role in energy policy-making was played by the fiscal system through the use of subsidies and targeted taxation.

Supply-based Energy Policy: Subsidies

The total value of energy subsidies depends on methodology and coverage. According to the OECD (2022), in 2021 energy subsidies in 51 countries, including the most advanced and the most populous countries, amounted to nearly $700 billion. Perhaps more significantly, in real dollars they were down by only 2.4 percent over the past eleven years. In 2021, 43 percent of total subsidies were directed at oil, 24 percent at natural gas, 3 percent at coal, and 30 percent to electricity generation.¹

Total subsidies are generally disaggregated into three main categories, based on the beneficiaries: producers, consumers, and a combination of the two (general services subsidies).  Consumer subsidies are generally aimed at reducing the price of energy paid by the end user and are found mostly in lower income countries to enhance affordability for basic necessities. Producer subsidies are more commonly offered in more industrialized countries with energy production sectors and take a variety of forms from cash grants, to tax breaks, to loans at favorable rates, and even special treatment regarding access to reserves, exploration, and extraction. General services subsidies are largely in the form of publicly-financed R&D and the construction of infrastructure. Energy subsidies are overwhelmingly directed at consumers: in 2019 they accounted for 86 percent of the total, with 9 percent going to producers and the rest for general subsidies.² Even in the case of producer subsidies, oil companies are the main beneficiaries. In 2013-14, 46 percent of the direct spending and tax breaks for energy producers was received by oil producers, with 26 percent going to natural gas, 12 percent each for coal and electricity generation, and 3 percent to others³.

Supply-based Energy Policy: Taxes

Governments collect a substantial amount of revenue from energy taxes. According to the OECD,⁴ in 2018 the taxation of energy in OECD countries generated government revenue equivalent to 1.6 percent of GDP. If we include sales taxes, which are excluded from the above calculations because they do not affect the relative price of energy, the percentage rises to about 2. Since total revenues in the OECD accounted to 33 percent of GDP in 2019, revenues from energy taxes amounted to 6 percent of total revenue. Most of this revenue (82 %) originated from traditional excise taxes on fuel, with ETS (emission trading schemes) and carbon taxes adding 11 percent and taxes on electricity 7 percent. Excise taxes on fuel have a long history and were originally introduced to finance the construction and maintenance of roads and often their revenue was specifically earmarked for that purpose. Only more recently new energy taxes �" particularly ETS and carbon taxes �" have been introduced with the explicit rationale of curbing greenhouse gas emissions. In 2020, carbon taxes were imposed in 30 jurisdictions and ETSs were operational in 31 jurisdictions.

Taxes on fuel are very ineffective instruments for reducing energy consumption because energy consumption is not very responsive to changes in prices. The price increase needed to generate substantial reductions in energy consumption would lead to political suicide for any politician advocating it. Jessica Green (2021) reviewed a large number of studies on the effect of carbon pricing (carbon taxes and ETSs) on CO2 emissions. She concluded that their effect is minimal, ranging between 0% and 2.0 percent per year.⁵ By comparison it is worth noting that limiting global warming to 1.5 degrees centigrade would require a reduction of emissions by 45 percent between 2010 and 2030. Indirect evidence on the ineffectiveness of taxes on fossil fuels is offered by the IEA’s projections of CO2 emissions. These emissions actually increased from 32.9 Gt in 2010 to 36.6 Gt in 2021. The IEA projects that under the “stated policies” scenario, they will hardly change from 2021 to 2030 and by 2050 will be only 13 below their 2021 level and 3 percent their level in 2010.⁶

Energy taxes may also generate distributional effects as they may not impact to the same degree people with different economic capacity. A study of 21 countries by the OECD found that the distributional effect of energy taxes varies among different energy types. This study concluded that taxes on transportation fuels (largely excise taxes) are roughly proportional to income, taxes on heating fuel are slightly progressive, and that the most regressive are the taxes on electricity.⁷ Since over 80 percent of revenue from energy taxes originates from excise taxes, one may conclude that energy taxes are roughly proportional.

Th foregoing discussion suggests that the blunt instruments of energy policy associated with supply-based policies have marginal effects on energy consumption, CO2 emissions, and the distribution of the tax burden. These taxes are simply instruments for raising revenue. The national subsidies that are financed by these revenues may help expand energy production but have little effect on the energy prices paid by consumers because the prices of fossil fuels are determined in the international market either by free forces of global demand and supply or by cartels, as in the OPEC + with crude oil. Supply-based energy policies also generate as special combination of shared interests. Multinational energy companies benefit from tax and subsidy programs that support the expansion of energy supply but do little to curb demand; governments gain from maintaining a stable tax base from a slow changing energy demand; and politicians can count on large political donations from the overflowing coffers of grateful energy companies. Supply-based energy policies not only are ineffective in dealing with the rising costs of energy proliferation �" environmental, international conflicts, economic, and social �" but are part of a system with a built-in mechanism of shared-interests that prevents the implementation of effective policies. In other words, they cannot be instruments of effective solutions because they are part of the problem. If we really care about the future of this planet, international peace, and a better quality of life for our descendants, we need a radically different approach. In the rest of this chapter, I sketch the outline of an alternative that rests on demand-based policies.

Outline of Demand-Based Energy Policies

 Demographic and technical developments in renewable energy favor a coordinated decentralization of energy policy-making. On the demographic side, the main development is the trend towards increasing degrees of urbanization.  Currently over 4 billion people (56% of the global population) live in urban centers and by 2050 this share is projected to rise to 70 percent.⁸ Also, 44 urban centers have populations in excess of 10 million, and their combined population amounts to 10 percent of the global total. By comparison, nearly 60 percent of 234 countries contain less than 10 million people and only 39 countries have a population greater than Tokyo. In the phase of world history where the energy supply was dominated by fossil fuels, the nature of the dominant energy resources favored a concentration of energy production which, in turn, facilitated the centralization of energy policy. Renewable energy sources are technically flexible and offer the choice of centralized or decentralized production. As the role of renewable energy in the energy mix expands, so do the opportunities for urban areas to get involved directly in the production and distribution of energy. Moreover, in the context of demand-based energy policy, urban centers possess a variety of policy instruments more suitable for targeting and with greater potential effectiveness than the general tax instruments used in supply-based policies.

In addition to coordinated subsidiarity, demand-based energy policies rest on the principle of functionality. All goods and services produced perform a variety of functions in the process of satisfying consumer demand. Generally, but also specifically to various forms of energy, we can identify three main functions: the satisfaction of basic human needs, the fulfillment of elective human wants, and conspicuous consumption. Demand-based energy policy differentiates the fiscal treatment of these three functions with respect to both taxation and subsidization.

Taxation

Central/Regional/Provincial Governments. Let us start with energy policies designed and administered by the central or regional government and focus first on taxation. As mentioned earlier, these governments levy two types of taxes: carbon taxes and sales/excise taxes. The former are general taxes based on the carbon content of fossil fuels. They are generally collected upstream (coal suppliers, oil refineries, and natural gas processing plants) or middle stream (electricity generation). Because they are related to the natural characteristics of specific fossil fuels, they cannot distinguish among the three functions noted above. They can only distinguish among fuel types, for example, a special tax treatment of heating oil. They are effectively a new revenue source for government as they generate minor effects on both energy consumption and the distribution of the tax burden by income class. Their potential as effective instruments of decarbonization rests largely with the way their revenue is allocated, an issue that will be discussed later in this chapter.  

Excise taxes are mainly levies on fuel used in transportation. Because the demand for gasoline and diesel is unresponsive to changes in their prices, excise taxes operate primarily as revenue-raising instruments. They were initially introduced by central/regional/provincial governments for the purpose of financing the construction and maintenance of the road network �" their revenues were sometimes earmarked for those specific purposes �" and continue to serve that purpose. Therefore, they may be viewed as a form of user fee paid for the use of the road, approximated by the consumption of fuel. The tax rates are often differentiated among the various fuels �" gasoline, diesel, marine fuel, and aviation fuel �" depending on their energy content. General sales taxes impact the demand for energy through two channels: the tax on fuels, and the tax on the equipment that uses the energy. Let us consider the transportation sector. The transportation services demanded by consumers require two main components: the fuel and the equipment that uses the fuel to deliver the desired services. Sales taxes are usually imposed at the same rate on both components. Because in the case of transportation fuels sales taxes are levied in addition to excise taxes, a uniform tax rate makes sense. The transportation equipment, however, offers the opportunity for rate differentiation based on the functions identified above, especially in the case of passenger transportation. Let us consider the example of the United States. The U.S. Department of Transportation identifies five categories of passenger transportation (aside from buses and trains): car (mostly sedans), car SUV, van, pick-up truck, and truck SUV. Following the 1973 oil crisis, there was a general shift towards smaller and lighter vehicles. In 1980, 83.5 percent of light-duty vehicles were cars, and 12.7 percent pick-up trucks. There were no car SUVs, and vans and truck SUVs had shares of roughly 2 percent each. Two major trends evolved over the following four decades: SUVs replaced sedans and all light-duty vehicles became heavier.  By 2019, the share of cars fell to 33 percent while that of car SUVs and truck SUVs rose to 12 and 36 percent, respectively. Also, from 1985 to 2019 the average weight of all light-duty vehicle increased by nearly one-third from 3,271 to 4,287 pounds.⁹ Because weight affects fuel efficiency (miles per gallon) and fuel consumption for a given number of miles travelled per person annually, heavier vehicles should bear a higher sales tax burden. This higher tax burden could be in the form of a surtax based either on weight or on vehicle category.

Regional/provincial governments have additional policy tools. In the transportation sector they levy fees for driver licenses and for vehicles registration. For driver licenses there is already differentiation between various categories of vehicles, mainly to separate the use of passenger (mainly light-duty) from commercial (heavy-duty) vehicles. Differentiation of fees also exists with respect to vehicle registrations, usually based on weight. Even if raising these fees and increasing the differential based on weight does not affect motor vehicle ownership and the preferences for heavier cars, the revenue they would generate could be used towards the implementation of other demand-based initiatives.       

Three trends have dominated tax policy over the past half a century: (1) reductions in corporate taxes, (2) reduction in the level and progressivity of personal income taxes, and (3) expansion of the base of consumption taxes with a corresponding narrowing of the number of tax rates. In the presence of large consumption externalities and increasing associated environmental, economic, and social costs, this approach to consumption taxes leads to inefficient taxation. If we lived in a historical era where the atmospheric concentration of greenhouse gases was low  and energy was not an instrument of geopolitical conflict, rising energy consumption, especially for fossil fuels, would not be a major concern. We don’t live in that world. The atmospheric concentration of greenhouse gases is already high enough to generate increasingly catastrophic weather events, and international conflicts directly or indirectly related to energy resources are intensifying. In this environment it is imperative to use all tools at our disposal to constrain energy consumption and that includes the reform of inefficient taxation.

Local Government. Local governments have limited taxing powers, but have control over one major tax: the real property tax. This tax is generally levied for the purpose of financing local schools and other local services. Because real property taxes are treated simply as revenue-raising instruments, they are generally levied at a fixed rate (called mill rate because it is expressed as dollars per $1,000 of assessed property value) on a pre-determined assessed value (tax base). Both the estimation of the tax base and the value of the tax rate vary by jurisdiction and tax schemes may also include special credits or deductions. The structure of this tax could be modified to serve also energy policy objectives.  A major trend over the past seventy has been the increase in the dwelling space per person resulting from the increase in the size of the average dwelling and the decline in the size of households. In the United States, for example, the former more than doubled from about 1,000 square feet in 1950 to over 2,000 square feet in 2019 while the latter fell by 28 percent from 3.5 in 1950 to 2.5 in 2019.¹⁰ (As a result, the dwelling space per person nearly tripled during the same period. In 2019, each person on average occupied the space that in 1950 housed a three-member household. This large increase in dwelling space per person required additional energy consumption. Moreover, in advanced economies with multiple earners in a household, the energy used for heating and cooling the extra space, which represents half of the dwelling’s energy consumption, is largely a waste because the dwelling is empty for most of the day.

The structure of real property taxes could incorporate an energy policy component by using the principle of functionality described above. Residential dwellings serve the main purpose of providing comfortable shelter accommodation to individuals and families. It is largely a technical issue to establish a standard shelter level and the corresponding living space. This standard would be taxed at a uniform rate, which would vary by jurisdiction. Any dwelling space in excess of the standard would be taxed at a higher rate with a graduated rate structure based on brackets of living space per person. This change would not encroach on the shelter rights of individuals, but would simply impose a price for the privilege of using excessive living space, which causes additional energy consumption and costly externalities.   

Local governments also have the capacity to regulate and to impose fees. In the transportation sector, they can charge fees for the privilege of using a motor vehicle within their boundaries and regulate the hours of operation, and they can determine parking fees. They can also make choice regarding the extent of the public transportation system, the vehicles used, and the price charged. Several large and medium cities have already experimented with a variety of policies. Originally introduced largely for the purpose of lowering congestion, these measures also reduce energy consumption and greenhouse emissions.

The most extreme example of these experimental cities is Singapore which establishes a quota on how many cars can be owned in the city-state. Potential car owners then bid for a certificate that gives them the right to own a car (certificate of entitlement or COE). Currently the price of this certificate is $106,000. When we add registration fees and taxes to the COE and the price of the car, owning a new hybrid Toyota Camry in Singapore would cost $183,000 compared to about $30,000 in the US.¹¹ It should be stressed that in Singapore the anti-congestion and emission effects are generated by the quota and not by the price system through the COE. The price system simply serves the purpose of allocating a fixed number of COEs.

A different but comprehensive system is used in Milan. This Italian city uses what is called cordon/area pricing to restrict access to the city center by motor vehicles, and the instrument is a fee for each vehicle entering the protected zone. In addition, certain vehicles are denied permission to enter: those that use low grades of gasoline and diesel, and private vehicles longer than 24.6 feet. By contrast, the following types of vehicles are exempt for the fee: EVs, motorcycles, scooters, public transit and emergency vehicles, and vehicles used by persons with disabilities.

France uses a sticker system (Crit’Air) with six different colors to all motor vehicles to indicate the level of emissions by each type of vehicle. In Paris, vehicles with the top two pollution-indicating stickers are not allowed to enter the city center. In addition, in periods of high pollution levels in the city, any type of vehicle may be stopped from entering the city center. In those cases, public transportation is provided free of charge.      

The city of Freiburg does not allow private parking spaces. Instead, there is a community car park located at the outskirts of the residential area where parking spaces are valued at 18,000 euros each. To facilitate travel to the city and reduce its cost, bicycle lanes were built and public transit is provided at low cost.¹²

In the case of residential energy use, an important policy instrument is zoning, especially in North America. A major feature of suburbia in North America is the existence of sprawling suburbs composed almost entirely of single houses. For example, in the United States three-quarters of residential dwellings are single-detached houses. These houses are more energy and resource intensive than multi-family units: land, financial cost, construction materials, public infrastructure, transportation, water use, and energy consumption. In the United States, the average energy cost per household living in a single-detached house in 2015 was double that of an apartment.¹³ A study for England concluded that the energy score for apartments (72) was 16 percent higher than the score for single-detached houses (62).¹⁴ The main reasons for the greater energy efficiency of apartments are their smaller area and fewer walls exposed to the elements. Local governments can reduce energy consumption by the residential sector through zoning laws that raise population density and through building regulations.          

All levels of government have the power to control energy consumption in public buildings that they own or operate. Local government have additional tools of energy demand policies through their power to regulate construction standards and energy practices by businesses. The effect of taxation and regulation on energy demand can be amplified through the judicious use of the funds raised.

Incentives      

The revenue raised by governments usually goes into a general revenue fund and competing demands determine its allocation. A system of demand-based energy policies requires a more targeted approach through the implementation of collaborative subsidiarity which contains two major components.

Currently, subsidies to energy producers are provided primarily by central governments either through tax breaks or direct payments. In industrialized countries, an increasing share of energy subsidies is directed at renewable energy, particularly solar. More recently, many jurisdictions are introducing or expanding cash payments for the purchase of electric vehicles (EV) with the aim of decarbonizing the transportation sector. The parameters of these consumer subsidies vary among jurisdictions. For example, in the United States the maximum subsidy is $7,500 per vehicle (electric pug-in or fuel cell) purchased by individuals and businesses. To be eligible for the credit, a vehicle must have at least 7 kwh of battery capacity, a gross weight not exceeding 14,000 pounds, must have been assembled in the U.S., and met certain materials and battery component conditions. Also, at the individual level, purchaser eligibility is constrained by the following income thresholds: maximum income of $300,00o for a married couple with joint filing, $225,00 for the head of a family, and $150,000 for everyone else.¹⁵     

These types of subsidies are inefficient for a variety of reasons. First, their potential as tools of de-carbonization at the moment is limited by two factors. They require materials in short supply for the batteries and the large expansion the electrical grid and charging stations. Second, they deliver partial de-carbonization because fossil fuels account for 60 percent of electricity generation globally and 50 percent in OECD countries. Second, the purchases of EVs are concentrated in selected economic-demographic groups. For example, in the United States 75 percent of EV owners are men; 54 percent are owned by 55 years and older; 57 percent belong to people with income above $100,000; and 87 percent of EV owners are White. In effect, most of EVs are owned mainly by middle-aged well-to-do White men.¹⁶ Moreover, a recent Bloomberg survey of EV ownership indicates further concentration as 14 percent of respondents owns more than 1 EV, 6 percent own 3 or more EVs, and 9 percent of more recent EV purchasers own a hybrid.¹⁷ Because the number of miles driven by second and third cars is a fraction of those by the primary vehicle, this pattern of EV ownership greatly reduced the decarbonization potential of EVs. An electric vehicle parked in driveway is not a decarbonizing machine; it is a symbol of conspicuous consumption. As currently structured, subsidies for the purchase of EVs are costly, have no effect on energy consumption, and deliver only modest de-carbonization gains.

To make these subsidies more effective, they need to be directed at facilitating the purchase of EVs by low and middle-income people who use them as their primary vehicle. Instead of placing limits on the income of the purchaser, the subsidy should be confined to the compact and subcompact cars. It should be large enough to make EVs competitive with traditional cars. Under the current system, governments collect no extra revenue from heavier vehicles and offer incentives for them if they don’t use fossil fuels. Therefore, it generates a negative impact on the government’s budget. Under the suggested demand-based approach, the targeted subsidy for EVs is partly or totally offset by the surtax on heavier traditional vehicles. A program aimed at expanding the affordability of smaller EVs has been announced in France. Under this program, the government would buy qualified EVs and would offer them for a three-year lease at 100 euros per month to lower income consumers. To qualify for the program the consumer must have income below 20,850 per year and the EV must cost less than 47,000 euros, weigh less the 2.7t tons, and meet the new environmental guidelines.   

Local governments, particularly those of medium and large cities, have additional demand-based policy tools. A policy based on the best features of existing experiments would be the most effective. For example, city dwellers could be charged a fee for owning a car differentiated for heavy traditional vehicles, small traditional cars, and heavy EVs; the city core could be off-limits to private motor vehicles; only small EVs would be allowed entry into the city; public community parking spaces would be built at the outskirts of residential areas; and public transit would be free for everyone. Here cooperative subsidiarity could play an important role with a combination of central government conditional grants to local governments and administration by the latter.     

There are three main types of subsidies for the residential sector: energy-efficient renovations, heating-cooling systems, and renewable energy (mainly solar and wind). The last item will be discussed later in this chapter. The first item involves a variety of issues which may differ geographically. This is another potentially fruitful avenue for cooperative subsidiarity because the local governments have the knowledge of local conditions and the technical capacity to administer appropriate policies, but may lack the financial capacity to implement them. Heating/cooling is the largest single determinant of residential energy consumption, accounting generally for half of the total. Therefore, it should be a main target of demand-based energy policies directed at the residential sector. An effective policy in this area would be the provision of free heat pumps for low-income individuals and families, a policy that could be extended to apartments housing low-income tenants.  Here too cooperative subsidiary would be the most effective delivery arrangement.

As mentioned earlier, renewable energy provides opportunities for decentralized energy supply. Cities of any size have enough rooftop area to produce most if not all of their electricity needs. The policy issue is determining the best arrangements for optimizing the way to harness this energy. The provision of electric power to the ultimate consumer involves three major steps: generation, transmission, and distribution. Under current systems, all three components are centralized. Renewable energy, particularly solar, offers the opportunity for coordinated de-centralization. Each large urban area could have its own electric company which would control the generation and distribution of electricity throughout its metropolitan area. It would be connected to the national grid whose main job would be to ensure the stability of the electricity supply over a certain geographical area. This decentralization would also apply to the subsidization of electricity generation within a given metropolitan area through a program of cooperative subsidiarity where the central government would offer conditional grants and the local government would administer them. For example, a city could require all new residential, commercial, and industrial buildings to install solar panel on their roofs or solar roofs. The costs of these installations would be paid by the city utility through an interest-free loan. The building owners would pay the city utility the standard rate on their electricity consumption until the “loan” is fully paid. The gains from electricity generation thereafter would accrue to the building owners. With this scheme, the city utility would incur no cost (it would borrow the funds at no interest from the central government), the building owners would initially experience no additional cost and later on would gain from the “free” electricity. The cost of expanding solar electricity generation would be limited to the interest foregone by the central government. In the absence of central government assistance, the “loan” by the city utility could include interest. This approach could be extended to existing buildings, but this time on a voluntary base. In this case, it may be necessary to include some financial incentives. There may simpler or more efficient approaches. The important point is that renewable energy promotes the decentralization of energy policy and its implementation which would be facilitated by programs of cooperative subsidiarity.

Up to know I have compared supply-based and demand-based energy policies in terms of their environmental and economic impacts. These two approaches also differ with respect to human behavior and its moral compass. This issue is discussed in the final chapter.

 

Notes

¹OECD, 2022, Fossil Fuel Support Is Still Growing.

²Ieva Barsauskaite, 2022, “Background Note on Fossil Fuel Reforms,” International Institute for Sustainable Development, Figure 2.

³United Nations Environment Program, 2019, “Measuring Fossil Fuel Subsidies in the Context of Sustainable Development Goals,” Figure 3.

⁴OECD.Stat, Taxing Energy Use for Sustainable Development: Energy Tax Revenues and Reform Potential.

⁵Jessica F Green, 2021, “Does Carbon Pricing Reduce Emissions?: A Review of Ex-Post Analyses,” Environmental Research Letters, Vol. 16, No. 4.

⁶IEA, 2022, World Energy Outlook 2022.

⁷OECD.iLibrary, “The Distributional Effects of Energy taxes,” OECD Taxation Working Papers.

⁸The World Bank, Urban Developments: Overview.

⁹U.S. Department of Transportation, 2021, National Transportation Statistics, Table I-20; EPA, 2022, The 2021 EPA Automotive Trends Report, Figure 3-5 and Tables 3.1, and 3.2.

₁₀ Giuseppe Ruggeri (2022), “Household Energy Consumption in the United States”, RePec Econpapers No. 36n9k, Tables 4 and 5; Giuseppe Ruggeri (2022), Work and Leisure in America, Friesen Press, p. 85).

¹¹NBC News, 5 October 2023, “It Now Costs $106,000 to Be Allowed to Buy A Car in the World’s Most Expensive City for Drivers”.

¹²Adeline Bailly, January 2018, “How Can UK Cities Clean Up the Air We Breathe?” Center for Cities.

¹³Michaels Energy, 14 April 2015, “Multi-Unit versus Single-Family Detached Houses Energy Use”.

¹⁴Seven Capital, 19 October 2022, “Energy Efficiency: How Do Apartments Compare to Houses?”.

¹⁵IRS, Credits for New Vehicles Purchased in 2023 of After.

¹⁶Inspire, Advanced Transportation (2 January 2023), “Who Owns EVs Today? EV Ownership Trends and Changes 2021,” EV Consumers Behavior Report Rundown.

¹⁷Kyle Stock (15 November 2022), “The Wrong Americans Are Buying Electric Cars,” Bloomberg.