France Plans to Quadruple Carbon Tax

July 27, 2015

After a year of parliamentary debates the French Parliament adopted an Energy Transition for Green Growth plan on Wednesday the 22nd of July. As part of this plan the carbon tax will almost quadruple for the current rate of €14.5/tCO2 to €56 by 2020 and increase to €100/tCO2 by 2030. The increased tax on carbon is expected to sharply increase the price of energy, which in turn should increase the price of most goods and services in France.

In addition to the carbon tax the plan calls for a gradual reduction of nuclear power generation by limiting production to 63.2 gigawatts but also promises not to phase out operating nuclear plants. The limitations placed on nuclear power and the carbon tax is expected to bring the mixer of renewable energy up to 32% of the energy market.

Taxes on energy are strongly regressive. Lower income households tend to spend more on energy as a percent of their budget than higher income households. Thus, taxing energy disproportionately affects lower income household.

As such, some tax economist have suggested implementing a reduced payroll or lower personal income tax as a means of compensate for the regressivity of a carbon tax. They argue that pairing the two taxes would not only reduce the regressivity of the tax but also reduce distortion in the labor market.

The problem with this argument is that labor is less responsive to tax changes than capital. Since most capital requires an energy source to operate, a tax on energy is often captured in the price of capital. As the price of capital increases, capital deepening and economic growth slows. In turn, productivity of labor falls, and wages fall along with it. This becomes a second layer of regressivity often overlooked.

As an alternative to reducing the payroll or individual income tax, the impact from carbon taxes could be offset with a tax reduction for capital. Several taxes directly affect the price of capital, including business income taxes, property taxes, and estate taxes. Reducing these taxes, while increase energy prices though the carbon tax, would mitigate the distortionary effects of higher energy prices on the economy.

In addition, green energy production tends to be more capital intensive than fossil fuel alternatives, such as gas turbines. Reducing the price of capital through reducing taxes on capital can encourage green energy production without necessarily targeting green energy through subsidies. In turn, the price of energy should also fall as more capital is used to generate energy.

If a country values lower emissions and is willing to pay the cost of higher energy prices, then smart tax policy can be used to reduce the economic pain. To lessen the pain of transitioning to green growth, France may want to be as ambitious with its tax code as it is with its energy policy.

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