Ireland’s climate policy tends to focus on carbon taxation. What if we increased the tax, removed the subsidies, and used the funds strategically?
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Good stick, bad carrot: The clash between carbon taxation and fossil fuel subsidies

Ireland’s climate policy tends to focus on carbon taxation. What if we increased the tax, removed the subsidies, and used the funds strategically?

Human-induced emissions are warming the planet, causing adverse environmental effects. To address this, the Paris Agreement was ratified by 195 states and the European Union in 2015. It aims to limit global temperature rise to 1.5°C. Discussions typically focus on measures like carbon taxes to reduce emissions. However, the significant issue of fossil fuel subsidies remains overlooked.

In Ireland, a carbon tax was implemented in 2009, set to increase gradually to €100 per tonne of CO2 by 2030. However, the country continues to heavily subsidise fossil fuels, contradicting its climate goals. These subsidies amount to nearly six times the revenue generated by the carbon tax—one step forward for climate policy and six steps back for emission reduction.

What are fossil fuel subsidies?

Fossil fuel subsidies incentivise the use of fossil fuels through a financial support mechanism. These may include tax breaks on fossil fuels or fossil fuel-intensive production. In Ireland, there is, for example, a lower tax for diesel used in transportation services, a low (almost zero) tax rate on aviation kerosene, and a handout for electricity production. Figure 1 below shows the magnitude of fossil fuel subsidies at the EU27 level across different sectors.

Figure 1. Fossil fuel subsidies in the EU27 are based on the economic sector.
Credit. European Commission

Our paper asks, what if we removed the majority of fossil fuel subsidies in Ireland?

The I3E model

To address this query, we employed a Computable General Equilibrium (CGE) model, a tool depicting the economy mathematically. This model includes households, firms, and government, illustrating their interactions based on economic principles. Essentially, a CGE model analyzes how inputs and outputs flow among production sectors, shaping goods consumed by households. By introducing new policies into the model and comparing them to a business-as-usual (BaU) scenario, we can assess their impacts on emissions, the economy, and income distribution across households. Using a CGE model specific to Ireland, the I3E model, we simulated various scenarios.

These scenarios include removing all fossil fuel subsidies, increasing the carbon tax to €100, implementing both measures simultaneously, and revisiting fossil fuel subsidy removal while retaining the household energy allowance (a form of fossil fuel subsidy). Results from these scenarios were compared against the BaU case projected for 2030.

What are the impacts of removing fossil fuel subsidies?

The findings indicate that removing Irish fossil fuel subsidies and increasing the carbon tax to €100 have the same impact on emissions (a reduction of 16% each). The concurrent implementation of these measures leads to a 30% reduction. While emission cuts are similar, the economic ramifications differ. Removing fossil fuel subsidies adversely affects overall economic activity and investment more than increasing the carbon tax due to their larger sum. Conversely, subsidy removal has less impact on total employment and government debt, as it only targets specific production sectors.

This disparity in impacts across sectors poses political challenges. Furthermore, subsidy removal exacerbates decreases in disposable income and increases inequality, affecting low-income households more. However, excluding household energy allowances from subsidy removal can mitigate these effects without significantly altering emission reductions.

Using the additional revenues wisely

The results assume that funds saved from cutting fossil fuel subsidies and additional revenue from carbon tax hikes go toward general government spending. But what if we allocate them strategically? Can we achieve a double benefit, boosting the economy while reducing emissions? To explore this, we combined scenarios with either lowering wage taxes or production taxes (excluding previously subsidized sectors). We found that reallocating revenues can yield positive outcomes across the board. Recycling the substantial fossil fuel subsidy budget yields the most significant economic boost, while reducing wage taxes also shows promise due to low initial production tax rates and sector exclusions.

However, removing fossil fuel subsidies disproportionately impacts previously subsidized sectors, and wage reduction affects households in a manner that favours higher earners. Addressing these challenges requires additional policies to compensate affected sectors and households while still discouraging fossil fuel consumption overall.

Why do we still have fossil fuel subsidies?

Our findings suggest that removing fossil fuel subsidies won’t significantly harm the economy compared to increasing carbon taxes and recycling revenue can mitigate the negative impacts on vulnerable groups. So why persist with subsidies? Speculation points to powerful lobbying from subsidy-receiving sectors, insufficient research driving inertia, and Ireland’s tendency to align with hesitant global counterparts. However, the consensus at the United Nations Climate Change Conference of Parties (COP) last year favoured subsidy removal.

While the European Union and its Member States have well-defined targets for many aspects of their climate policy, from the share of renewable resources in energy production to the electrification of transportation, the missing element is a clear commitment to how governments should and will phase out fossil fuel subsidies.

Kelly de Bruin
Figure 2. Carrot and stick
Credit. Author

The way forward

The paper’s main conclusions and thus recommendations are that:

  1. Removing all Irish fossil fuel subsidies has similar emissions reduction impacts as the government’s carbon tax trajectory without having significantly greater impacts on the economy. Therefore, fossil fuel subsidy removal must also be included in climate action plans.
  2. Recycling revenues in both cases can lead to a double dividend. Therefore, governments should recycle their fossil fuel subsidy budget, in addition to their carbon tax revenues, to alleviate the adverse impacts on those most vulnerable to the policy change.
  3. Though this analysis can provide valuable insights concerning the impacts of fossil fuel subsidy removal in Ireland, it is not without limitations. Therefore, more research should be conducted on this topic to understand the impacts in greater detail.

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Journal reference

de Bruin, K., & Yakut, A. M. (2023). The impacts of removing fossil fuel subsidies and increasing carbon taxation in Ireland. Environmental and Resource Economics85(3), 741-782. https://doi.org/10.1007/s10640-023-00782-6

Kelly de Bruin is a Senior Research Officer at the Economic and Social Research Institute in Dublin, Ireland. Her research focuses on developing applied economic models, including Computable General Equilibrium (CGE) models and Integrated Assessment Models (IAMs). She investigates the economic and distributional effects of climate change policies, climatic impacts, and adaptation. She has worked extensively with global and local policymakers on climate change policy questions.

Aykut Mert Yakut is a Research Officer at the Economic and Social Research Institute and an adjunct Assistant Professor at Trinity College Dublin in Ireland. His research interests include social policies, income distribution, the labour market, migration, and climate change, using the Computable General Equilibrium (CGE) modelling technique. The current focus of his research is examining the interrelationships between the environment, energy, and the economy, particularly the distributional implications of climate change policies.