Dr. Kelly de Bruin:

I thank the Chair for the invitation to appear before the committee. I am the head of the climate economy modelling team at the ESRI. I am joined by my colleague Dr. Farrell.

This committee is considering the budgetary implications of the report prepared by the Commission on Taxation and Welfare. We will provide insight relevant to chapter 13 of this report, which focuses on moving to a low-carbon economy. It is important policies be targeted towards correcting for specific market failures. Well-designed climate policy ensures we can achieve the required emissions reductions while minimising disruption to economic and social activity. In doing so, we must ensure the distribution of this burden is fair. I will give a sense of the current work being conducted at the ESRI concerning the Irish carbon tax and fossil fuel subsidy removal and convey our results regarding these issues. Our goal is to provide insight to guide policy formation.

To contextualise our results, a general understanding of our methods will be useful. Hence, I will first give a short, non-technical overview of our model, the Ireland environment, energy and economy, I3E, model, which was applied to research these issues. The I3E model is an intertemporal computable general equilibrium, CGE, model, that reproduces the structure of the economy in its entirety. It includes production sectors, households and the Government, among others. The model quantifies the nature of all existing economic transactions among diverse economic agents. According to microeconomic behaviour, producers and consumers maximise their profits and utility given their budget constraints. In other words, a CGE model examines how inputs and outputs flow between production sectors of the economy and result in final goods consumed by households.

The explicit modelling of sectorial interlinkages makes it possible to investigate the wider economic impacts of a specific shock or policy through the different transmission channels in the economy. Therefore, CGE models have become a standard tool for empirical analysis. They are widely used to analyse the welfare and distributional impacts of policies whose effects may be transmitted through multiple markets and channels in the economy. Such secondary impacts are of critical importance in the case of climate policies.

The first recommendation we will discuss concerns the gradual increase of the carbon tax to €100 per tonne in 2030 and clarity on the tax path post 2030. Our research has extensively examined the impacts of carbon taxation. The results from the I3E model show that the proposed carbon tax increase has the potential to reduce emissions by approximately 16% by 2030 when compared with the absence of an increase. The associated economic costs are limited, with an estimated cumulative decrease in real GDP by 2030 of 1.4% and a 2% decrease in real Government revenues. There may be economic benefits if carbon revenues are recycled to reduce other taxes in the economy, with our analysis finding an increase in real GDP as well as reduced emissions, but with larger impacts on Government revenues.

Much evidence exists to examine the distributional impact of carbon taxation. When considered in isolation, a carbon tax is found to have a regressive impact, that is, the cost constitutes a greater share of the budget for a low-income household. With a responsive government welfare system, the carbon tax increase need not increase inequality across households and can be net progressive.

The second recommendation we consider is the equalisation of the rate of excise duty on petrol and diesel. Our estimates show this could lead to an almost 4% decrease in emissions, a 0.3% decrease in real GDP and a negligible impact on real Government revenues by 2030.

The third recommendation we will comment on is the reduction of fossil fuel subsidies. Our work shows that the full removal of fossil fuel subsidies has a similar impact on emissions to the planned increase in carbon taxation, namely, a 16% decrease by 2030. Real GDP impacts are slightly higher than the carbon tax increase, with an estimated 1.6% decrease by 2030. Given the high level of fossil fuel subsidies, the increased revenue created by removing fossil fuel subsidies is higher than the increased revenue from the higher carbon tax. Therefore, the removal of fossil fuel subsidies will result in a smaller reduction in real Government revenues compared with a carbon tax increase, at 0.2% compared with 2%. The economic impacts are, however, distributed more evenly with carbon taxation, where certain sectors will face large impacts under fossil fuel subsidy removal. These sectors would need support in this transition. As for fossil fuel subsidies to households in the form of fuel allowances, we find that the removal of these subsidies has negligible economic and emission reduction impacts as they are not directly connected to energy use. However, this is a highly regressive policy, given poorer households would face large negative impacts.

We would also like to draw members’ attention to an additional issue not specifically discussed in the report. We believe the EU emissions trading system, ETS, price will be of pertinent importance for the Irish economy and the Government budget. The EU ETS price, as projected by the EU, will increase to about €430 by 2030. Should this be realised, it will have considerable impacts on the Irish economy and Government revenues. Although this policy is determined at EU level, we believe the associated impacts for Ireland should be considered in more detail. Currently, the Government receives a large share of these EU ETS revenues and this stream of revenue should be considered when discussing the budgetary impacts of moving to a low-carbon economy.

The fiscal impacts of these recommendations on public balances are dependent on the secondary impacts. Policies can be designed to increase revenues but may lead to a decrease in net Government revenues due to the economy’s response to these policy changes. Receipts of sales taxes, wage taxes and corporation taxes decrease due to the dampening economic impacts of policies, which can outweigh the increase in carbon tax receipts or the reduction in fossil fuel subsidies.

The economic and budgetary impacts of a carbon tax or fossil fuel subsidy removal will strongly depend on the policy design. A well-designed carbon tax and revenue recycling scheme can assist in reaching other policy goals, such as economic growth and inequality reduction, in addition to emissions reduction. The design should carefully consider the effects of policy-induced behavioural change of households, enterprises and the Government in the transition to a low-carbon economy.

We wish the committee every success. We will be happy to assist it in the coming months.