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Getting Energy Prices Right. from Principles Getting Energy Prices Right From Principle to Practice Ian Parry, Dirk Heine, Eliza Lis, and Shanjun Li INTERNATIONAL MONETARY FUND ©International Monetary Fund. Not for Redistribution © 2014 International Monetary Fund Cataloging-in-Publication Data Joint Bank-Fund Library Getting energy prices right : from principle to practice / Ian Parry, Dirk Heine, Eliza Lis, and Shanjun Li. – Washington, D.C. : International Monetary Fund, c2014. pages ; cm Includes bibliographical references. ISBN: 978-1-48438-857-0 1. Power resources—Prices. I. Parry, Ian. II. Heine, Dirk. III. Lis, Elisa. IV. Li, Shanjun. V. International Monetary Fund. HD9502.A2 G48 2014 Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its member countries. Please send orders to: International Monetary Fund, Publication Services P.O. Box 92780, Washington, DC 20090, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201 E-mail: [email protected] Internet: www.elibrary.imf.org www.imfbookstore.org ©International Monetary Fund. Not for Redistribution Dedication This book is dedicated to Gary Becker, in appreciation of his inspiring teaching and long-time support of my work on environmental taxes; as my thesis chairman in the early 1990s, he encouraged me to model carbon taxes. Gary had agreed to write an endorsement for this book before his untimely death, his main reserva- tion being the risk that environmental tax revenues might be overused for low- value spending. Ian Parry iii ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Contents Foreword ix Acknowledgments xi Abbreviations xiii 1 Summary for Policymakers 1 2 Energy Systems, Environmental Problems, and Current Fiscal Policy: A Quick Look 11 Overview of Energy Systems 11 E nvironmental Side Effects 14 F iscal Policies Currently Affecting Energy and Transportation 24 3 Rationale for, and Design of, Fiscal Policy to “Get Energy Prices Right” 31 P olicy Instrument Choice for Environmental Protection 31 F urther Design Issues 44 Summa ry 60 4 Measuring Pollution Damage from Fuel Use 65 C O2 Damage 65 L ocal Air Pollution Damage 67 Summa ry 90 5 Measuring Nonpollution Externalities from Motor Vehicles 101 C ongestion Costs 101 A ccident Costs 111 Road Damage Costs 115 Summa ry 117 6 The Right Energy Taxes and Their Impacts 131 C orrective Tax Estimates 131 Impacts 142 Summary 145 7 Concluding Thoughts 165 Glossary 167 Index 173 v ©International Monetary Fund. Not for Redistribution vi Contents Tables 4.1. Examples of Mortality Risk Valuations Used in Previous Government Studies 81 5.1. City-Level Travel Delays and Other Characteristics, Region Average, 1995 103 5.2. Country-Level Travel Delays and Other Characteristics, Region Average, 2007 104 5.3. Reviews of Empirical Literature on the Value of Travel Time (VOT) 107 Figures 1.1. Corrective Fuel Taxes to Reflect Environmental Costs, Selected Countries, 2010 6 1.2. Impacts of Fuel Tax Reform, Selected Countries, 2010 7 2.1. Primary Energy Consumption per Capita, Selected Countries, 2010 12 2.2. Electricity Consumption per Capita, Selected Countries, 2010 12 2.3. Motor Vehicle Ownership Rates, Selected Countries, 2010 13 2.4. Share of Final Energy Use by Fuel Type, Selected Countries, 2010 14 2.5. Carbon Dioxide (CO2 ) Emissions per Capita, Selected Countries, 2010 15 2.6. Urban Population, Selected Countries, 2010 15 2.7. Projected Global Energy-Related CO2 Emissions 18 2.8. Projected Long-Term Warming above Pre-Industrial Temperatures from Stabilization at Different Greenhouse Gas Concentrations 19 2.9. Air Pollution Concentrations, Selected Countries, 2010 21 2.10. Air Pollution Deaths by Region, 2010 22 2.11. Vehicles and Road Capacity, Selected Countries, 2007 23 2.12. Road Deaths, Selected Countries, 2010 24 2.13. Revenue from Environment-Related Taxes as Percent of Total Revenue in OECD Countries, 2010 25 2.14. Excise Tax Rates on Motor Fuels, 2010 26 2.15. Subsidies for Fossil Fuel Energy by Region and Fuel Type, 2011 27 3.1. Illustrated Sources of Fossil Fuel CO2 Reductions under Different Policies 35 3.3.1. Shape of the Air Pollution Damage Function 39 3.2. Price Experience in the European Union Emissions Trading System 43 3.3. Distributional Incidence of Energy Subsidies 58 4.1. Baseline Mortality Rates for Illnesses Whose Prevalence Is Aggravated by Pollution, Selected Regions, 2010 75 4.2. Value of Mortality Risk, Selected Countries, 2010 81 4.3. Damage from Coal Plant Sulfur Dioxide (SO2 ) Emissions, Selected Countries, 2010 82 4.4. Damage from Coal Plant Sulfur Dioxide (SO2 ) Emissions, All Countries, 2010 84 ©International Monetary Fund. Not for Redistribution Contents vii 4.5. Damage from Ground-Level Nitrogen Oxide (NOx ) Emissions, Selected Countries, 2010 85 4.6. Estimated SO2 Damage Relative to China Using the Intake Fraction Approach, 2010 86 4.7. Estimated SO2 Damage Relative to China Using the TM5-FASST Model, 2010 87 4.8. SO2 Emissions Rates at Coal Plants, 2010 90 5.1. Value of Travel Time, Selected Countries, 2010 108 5.2. Congestion Costs Imposed on Others per Car-Kilometer, Selected Countries, 2010 109 5.3. Congestion Costs Imposed on Others per Car-Kilometer, All Countries, 2010 110 5.4. External Accident Costs per Vehicle-Kilometer, Selected Countries, 2010 115 5.5. External Accident Costs per Kilometer Driven, All Countries, 2010 116 6.1. Corrective Coal Tax Estimates, Selected Countries, 2010 132 6.2 Corrective Taxes for Air Pollution at Coal Plants with and without Control Technologies, Selected Countries, 2010 133 6.3. Breakdown of Air Pollution Damages from Coal by Emissions Type, Selected Countries, 2010 134 6.4. Corrective Coal Tax Estimates, All Countries, 2010 135 6.5. Corrective Coal Tax Estimates with Uniform Mortality Values, Selected Countries, 2010 136 6.6. Corrective Natural Gas Tax Estimates for Power Plants, Selected Countries, 2010 137 6.7. Corrective Natural Gas Tax Estimates for Power Plants, All Countries, 2010 138 6.8. Corrective Gasoline Tax Estimates, Selected Countries, 2010 139 6.9. Corrective Gasoline Tax Estimates, All Countries, 2010 140 6.10. Corrective Diesel Tax Estimates, Selected Countries, 2010 141 6.11. Potential Revenue from Corrective Fuel Taxes, Selected Countries, 2010 143 6.12. Reduction in Pollution-Related Deaths from Corrective Fuel Taxes, Selected Countries, 2010 145 6.13. Reduction in Energy-Related CO2 Emissions from Corrective Fuel Taxes, Selected Countries, 2010 146 B o x e s 2.1. Broader Environmental Effects beyond the Study Scope 16 3.1. Environmental Effectiveness of Alternative Instruments: Further Examples 33 3.2. Defining Economic Costs 37 3.3. Shape of the Air Pollution Damage Function 39 3.4. Coverage of Energy Products under the Value-Added Tax (VAT) 40 ©International Monetary Fund. Not for Redistribution viii Contents 3.5. Environmental Tax Shifting in Practice 41 3.6. Unintended Consequences and Market Price Distortions 45 3.7. Examples of Distance-Based Charging for Vehicles 49 3.8. Reconciling Fiscal and Environmental Objectives in Vehicle Taxation 52 3.9. Pay-as-You-Drive Auto Insurance 53 3.10. The Energy Paradox Controversy 56 4.1. Intake Fractions: Some Technicalities 69 4.2. The Human Capital Approach 77 4.3. Determinants Other than Income of Mortality Risk Valuation 78 4.4. Emissions Factors from the GAINS Model 88 5.1. Broader Costs of Congestion 102 Annex Tables 4.1.1. Country Classifications for Baseline, Pollution-Related Mortality Rates 91 4.2.1. Damage from Local Air Pollution, All Countries, $/ton of Emissions, 2010 92 5.2.1. Cities in the City-Level Database (Used to Extrapolate Congestion Costs) 119 5.3.1. Regression Results for City-Level Average Delay 121 5.3.2. Regression Results for Kilometers Driven per Car 122 5.4.1. Ratio of Congestion Cost with Multiple Vehicles Relative to Costs when Cars are the Only Vehicle 123 6.2.1. Corrective Fuel Tax Estimates, All Countries, 2010 149 6.2.2. Fiscal Impacts of Tax Reform, All Countries, 2010 153 6.2.3. Health and Environmental Impacts of Tax Reform, All Countries, 2010 157 6.2.4. Estimates of Current Fuel Excise Taxes, All Countries, 2010 161 ©International Monetary Fund. Not for Redistribution Foreword The enormous improvement in global living standards over the past 100 years could not have happened without the energy derived from the world’s vast depos- its of fossil fuels. Yet, the intense use of energy derived from such sources has brought side effects that pose major social, political, and economic challenges. The imperative is now to find ways to diversify and reduce the use of energy while continuing to eliminate poverty and promote inclusive growth. Within its man- date, the Fund is playing a part in this discussion. Indeed, energy policies are not new territory for the Fund. We have been em- phasizing the large fiscal benefits from removing harmful fuel subsidies for many years, primarily with an eye to saving money for the taxpayer. However, as the external effects of energy use have reached a macrocritical level—whether from environmental degradation, higher food prices, or the threat of climate change— the Fund’s advice has also evolved. Policymakers face a wide array of options for meeting energy challenges. Given the powerful incentive effect that prices have on economic behavior, the applica- tion of basic tax principles is critical. “Getting prices right” means that taxes on fossil fuels should be set at a level such that energy prices reflect their associated environmental side effects. This economic principle is widely accepted; however, putting it into practice is by itself an intellectual challenge. Here lies the unique contribution of this book.
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