CO2 Prices on Heating Protect Climate at a Low Cost
ResearchZEW Policy Brief on the Federal Government’s Climate Package
In Germany, the buildings sector ranks high in terms of its amount of both final energy consumption and greenhouse gas emissions. Putting a price on CO2 emissions is the most effective tool when it comes to curbing the sector’s high amount of harmful emissions. In turn, subsidies and regulatory requirements could largely be done without. The Climate Action Plan recently proposed by the federal government exacerbates social inequality via its redistribution effect. To counteract this, a per capita relief for taxes or social welfare contributions could be introduced to benefit especially low-income households. These are the findings put forward by researchers at ZEW Mannheim and the Leibniz Institute of Ecological Urban and Regional Development (IÖR) in Dresden in their latest policy brief on the federal government’s climate package.
According to the researchers, the climate package’s novelty for the buildings sector lies in the introduction of a national emissions trading scheme for the German heating fuels market as well as fuels used in transportation. If consumers are forced to pay a price for harmful emissions, the social cost of their heating behaviour would be directly reflected in their account balances. This creates a strong incentive to take steps in order to save energy. For example, heating could be used more sparingly in private households, or heating systems could be retrofitted.
Once the demand for climate-friendly technologies increases, this creates additional incentives for firms to invest in such technologies. In contrast to legal regulations, such a scenario leaves it to households and firms to decide which measures they want to take to reduce emissions at the lowest possible cost. CO2 pricing therefore beats its alternatives in terms of cost-efficiency. “This is why it is essential that a CO2 price be used as a key instrument in the buildings sector in order to curb emissions effectively and at a low cost, for consumers in particular,” says ZEW President Professor Achim Wambach, acting head of the ZEW Research Department “Environmental and Resource Economics, Environmental Management”.
Regulations and subsidies make climate protection more expensive
As an added bonus, emissions trading allows policymakers to determine the amount of CO2 emissions permissible in a given time frame. Consequently, the prices would form on the market via trading with CO2 emission certificates. However, the federal government’s plans only intend for this kind of quantity control to come into effect from 2026 at the earliest. In the meantime, the package stipulates a fixed price which is to be gradually increased. In this regard, the effect of the planned emissions trading system for heating fuels would, in its initial stages, be akin to a tax.
Rather than allowing market-based regulation in the form of a CO2 price to take full effect, the federal government’s climate package is primarily a continuation of previous approaches which combine command and control regulation and subsidies. According to the researchers from ZEW and IÖR, this makes climate protection needlessly costly. All too often, public funds for the promotion of green technologies are wasted because, for instance, home owners and landlords would have invested in new heating systems anyway, even if these were not subsidised. Such free-rider effects weigh on the federal budget but do not lead to better climate protection.
Higher standards for buildings’ energy efficiency don’t necessarily reduce CO2 emissions to the desired extent either: the phenomenon that households in more energy-efficient buildings have a higher consumption is known as the rebound effect. As insulation and modern heating technologies make heat less expensive, consumption thereof increases. CO2 prices, on the other hand, have the opposite effect. Higher heating costs mean that retrofitting energy systems will pay off for proprietors.
The climate package exacerbates social inequality
The federal government’s plans to reduce the Renewable Energy Sources Act (EEG) levy will relieve households in proportion to their electricity consumption. As high-consumption households will benefit more from such a measure, this would fail to incentivise energy saving. “From an economic perspective, it would make more sense to introduce a per capita relief similar to the Danish example. Another option would be to relieve citizens via social welfare contributions as per the Swiss model,” recommends ZEW economist Kathrine von Graevenitz, PhD, one of authors of the ZEW policy brief. She is also critical of the plans concerning subsidies for real estate investments: “Home ownership ratios vary substantially across the various income groups. Subsidies for real estate proprietors would therefore mainly benefit affluent households. The vast majority of low-income households rent rather than own a property, which is why they would lose out on this measure.”
Hence, the climate package exacerbates social inequality. Because low-income households spend a larger share of their income on heating, they will suffer a double disadvantage. On the one hand, their energy bills will increase disproportionately. On the other hand, their status as tenants means that they cannot apply for subsidies. Granted, the federal government aims to split the burden of CO2 costs between landlords and tenants. Yet this does not necessarily relieve tenant households, because proprietors are able to surcharge the amount of costs incurred by burden-sharing elsewhere. Moreover, such a measure could inhibit the incentivising effect of CO2 pricing. If tenants and landlords each carry half of the costs, this might hamper the desired effect of promoting energy saving in the buildings sector.
Finally, the researchers propose to develop a concept for the evaluation of the measures so as to identify deficits in the environmental and climate policies of the buildings sector and to make them more effective through according improvements.
