The Effect of Fossil Energy and Other Environmental Taxes on Profit Incentives for Change in an Open Economy: Evidence from the UK.

Abstract

This paper is in the tradition of those which use input-output techniques to analyse fossil energy and environmental taxes. We put forward the view that, for a country which is open to trade at given world prices and adopts national taxes, the key mechanism for bringing about change in the short term is not through prices and, ultimately, consumer decisions but through profits and producer decisions. This mechanism provides incentives for producers to substitute more environmentally conserving production techniques and to switch productive resources from, say, energy intensive goods to less energy intensive ones. In this respect the paper seeks to deal with a specific set of circumstances which are far from applicable to every economic sector. As such it seeks to complement the existing, more widely applicable literature – to focus on the role of profits as a key short run transmission mechanism by which energy taxes effect changes in producer behaviour. We produce evidence to show that the UK is almost certainly open to trade and unlikely to be able to influence world prices for a range of economic activities. Using this as a working assumption we examine the impact of current environmental taxes in the UK on profitability for a wide range of economic sectors. We then de-compose the overall effect of these environmental taxes on profits into that part attributable to fossil energy taxes and that to other environmental taxes. In general we find fossil energy taxes to be much more significant in their effect on profits and that they introduce significant variations between sectors in the profit incentives to switch productive resources away from energy intensive activities. This paper seeks to address the way in which fossil energy and other environmental taxes provide short run profit incentives to reallocate resources within the domestic economy. It does not address carbon leakage (the transfer of production to other countries which have weaker policies on emissions).