Making CO2 Pricing Socially Fair – Economy and Ecology


The EU is pursuing ambitious climate targets which can only be achieved through a palpable increase in the prices of greenhouse gas emissions. However, this step leads to a loss of income and purchasing power for certain groups of people and regions in the EU. To alleviate the resulting social tensions, some form of compensation will be needed – both within and between EU member states. If this does not happen, political dead ends will be the inevitable result.

Higher CO2 prices lead to lower greenhouse gas emissions. Through greenhouse gas pricing, the discharges of the corresponding emissions are reduced thanks to two main actions. First, products containing CO2 must be made more expensive, with “CO2” being a generic term for all climate-damaging greenhouse gases that are released into the atmosphere by human activity. When the price is higher, the demand for products containing emissions decreases, their supply then decreases and CO2 emissions are reduced accordingly.

Second, companies adapt their production tools to take into account the higher price of CO2. Where possible, they use low-emission machinery and production processes. In addition, they accelerate the development of technologies that reduce emissions. Ideally, companies’ adaptation strategies lead to green growth, in which the quantity of products increases and at the same time the volume of emissions decreases.

How CO2 pricing works in Europe

To meet the EU’s climate targets, higher CO2 prices are inevitable. The The EU’s goal is to reduce CO2 emissions by at least 55% by 2030 from 1990 levels. However, this will only be successful if emissions prices rise rapidly and drastically. Therefore, in its “Fit for 55” strategy presented in mid-July 2021, the European Commission defined measures that would lead to such a rise in prices.

Concerning the future level of the European price of CO2, two measures should be mentioned.

On the one hand, the criteria for activities which will require emission certificates will be broadened. This will affect emissions generated by road traffic, heating and cooling of buildings and shipping. These emissions were previously excluded from the European Emissions Trading System (EU ETS).

Higher emission prices make emission-intensive products, such as energy and many consumer goods, more expensive.

On the other hand, the EU ETS is now reducing the maximum annual volume of emissions, i.e. the number of emission certificates, at a faster rate. Between 2013 and 2020, the quota cap was reduced by 1.74% per year. For the period 2021-2030, an annual reduction of 2.2% was initially envisaged. It has now been set at 4.2% and could be even higher in the coming years. In the event of a shortage of emission allowances, an increase in the prices of these certificates, that is to say, an increase in the price of CO2, is to be expected.

Why redistribution policies are needed

Higher CO2 prices affect income distribution. Higher emission prices make emission-intensive products, such as energy and many consumer goods, more expensive. This can mean a noticeable loss of purchasing power, especially for low-income households, as they spend above-average shares of their disposable income on products emitting greenhouse gases (especially energy). ). This increases the risk of poverty.

This will result in sectoral difficulties for companies and their employees. Economic sectors with high capital intensity are particularly at risk. High use of physical capital (machinery, buildings, etc.) is usually accompanied by high energy consumption, which in turn leads to high greenhouse gas emissions. Examples include energy supply and petroleum refining companies as well as the production of metals, glass and paper. In these areas there is the threat of loss of competitiveness, which can lead to plant closures and unemployment.

An increase in the price of CO2, absolutely imperative for climate protection, thus leads to a change in the distribution of income. It affects not only individual groups of people, sectors and regions of a country, but also entire national economies.

For example, in the event of a higher CO2 price across the EU, the Eastern European economies should accept disproportionate production and income losses, as their production facilities run on fossil fuels to a greater extent than those of the western EU member states. This means that political resistance is inevitable – both within and between individual EU countries. In order to mitigate these effects as much as possible, redistribution policies are necessary.

Compensation of persons

There are many instruments that can be used to ease internal political tensions: lump-sum payments to all citizens and businesses, needs-based transfer payments, subsidies, tax cuts and the provision of free public services, including the public investments needed to achieve this, to name a few. just a little bit. These measures should be financed by revenues from the price of CO2. This serves the purpose of reducing emissions and is not levied for the purpose of increasing government revenue. The reimbursement of these revenues to the population is therefore justified – and only logical.

Before choosing the appropriate policy instruments, however, a crucial question must be addressed: What loss of income is considered by society to be so severe that it requires compensation? The answer to this question depends on socio-political value judgments and cannot be answered in purely scientific terms. In a democracy, this decision must therefore be taken within the framework of a political debate involving the whole of society. However, it is also clear that a social consensus that satisfies all population groups will not be possible. Policy makers must therefore disclose and justify the criteria underlying their distributive policy decisions.

One thing is quite clear: without higher CO2 prices, the EU’s emission reduction targets cannot be met.

Once the question of which groups of people or sectors to receive compensation has been answered, the appropriate policy instruments can be selected. If all citizens are to receive financial compensation, a flat rate per capita is an option – as it exists in Switzerland. Differentiated payments to particularly affected households are also possible – for example, a subsidy for commuters who need greater mobility or an increase in the housing allowance for low-income households. Social security contributions could be reduced to ease the financial burden on workers and businesses. This would increase the disposable income of private households and, at the same time, reduce non-wage labor costs for businesses.

State compensation

Due to the different emission intensity of production in different EU countries, compensation payments between EU Member States, in the sense of burden sharing, are also necessary. They could be financed by the revenues generated within the framework of the future carbon tax at the borders. With a rising price of CO2, high emission EU companies lose their price competitiveness compared to suppliers from countries that have no or only low prices for CO2. In order to counter this drawback, imports would be invoiced at the emission price applicable in the EU according to their CO2 content.

One thing is quite clear: without higher CO2 prices, the EU’s emission reduction targets cannot be met. However, to ensure that mandatory pricing of climate-damaging greenhouse gases is also accepted by society as a whole, social hardships must be cushioned.

However, this does not mean that any loss in purchasing power and income can be compensated. Where the line lies between socially acceptable – and therefore non-compensable – losses and socially unacceptable costs is a normative question that cannot be answered solely in terms of economic externalities. However, it is indisputable that low-income households should receive transfer payments in order to avoid serious economic disadvantages in access to energy and mobility.

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