Who will pay for the energy transition?

The transition from an energy system dominated by fossil fuels to an emissions-free one would require billions of dollars of investment in new production, distribution and consumption equipment around the world.

New investment could support millions of new construction and manufacturing jobs, but policymakers are struggling to decide whether to recover the costs from consumers or taxpayers.

In most countries, the cost of providing energy products and services, including gas, electricity, other heating fuels and road fuels, is normally recovered from users in the same way as other services. and goods.

But the proposed energy transition is likely to be costly, with a high share of the initial investment costs for new generation units, transmission and distribution systems, and consumer equipment such as electric vehicles.

Low-income households already spend a much higher share of their income on energy services and would be particularly hard hit if costs were recovered in the normal way.

In the United States, for example, the poorest households in the second of the fourth decile spent an average of 10-14% of their after-tax income on gas, electricity, other heating fuels, and road fuels in 2019.

In contrast, the wealthiest households in the seventh to ninth deciles spent only 5-6% of their after-tax income on the same energy items.

The precise details differ in other countries, but the poorest households almost always spend the majority of their income on basic energy services for heating, cooking, lighting and surface transportation.

As a result, cost recovery exclusively through utility bills and the private purchase of new consumer equipment, such as heating systems and electric vehicles, will hit the poor hardest unless they do. receive government support.

In many cases, the proposed transition would trade higher initial investment costs for lower long-term fuel bills, for example by replacing gasoline-powered private cars with battery-powered vehicles powered by energy. wind turbine.

But the poorest households are the least able to bear the initial investment costs and risk ending up with obsolete and increasingly expensive energy products.

If not managed with care, the energy transition could worsen energy inequalities and energy-related poverty.

The alternative is to shift some of the costs of the energy transition from consumers to taxpayers, as most taxes are paid by households in the top income deciles.

In general, governments have the option of subsidizing spending on new generation, distribution and use equipment, or reducing taxes and increasing transfer payments to low-income households to offset energy costs. higher.

The interplay between the energy transition and the rest of the tax and spending system is critically important – this is what makes it so politically controversial and why plans to achieve it remain so vague. Some proponents of ambitious emission reductions have attempted to separate transition policies from broader issues of taxes and spending, including carbon prices and taxes, in order to reduce political opposition.

But the two problems are not really separable. To be credible, transition plans must specify who will bear the associated costs and how.

This level of detail is just as important when considering plans for the mature energy systems of the United States, European Union and Britain as it is for China, India and other consumers of the United States. fast growing energy.

If consumers have to pay the full costs of the transition, the poorest will have much less income to spend on other items, which will likely be untenable for elected officials.

If some or all of the costs are passed on to taxpayers, however, taxes are expected to rise significantly, and raising taxes is always politically difficult.

Additional revenues could be generated by imposing new carbon taxes or increasing levies on existing taxes, most of which affect income and expenditure.

Some expenses could be capitalized by borrowing from households or the government and reimbursed by higher interest payments.

Borrowing is always politically easier than increasing tax revenue, so it is generally a more attractive option for policymakers.

The loan would also spread the capital costs over time and this is how much of the existing energy system was initially financed. But higher borrowing by households or governments would still leave consumers, taxpayers or both with higher income payments in the future.

Regardless of how the transition is paid for, the associated costs raise important distribution issues, which are central rather than incidental to the process.

These questions are so delicate that they explain why policymakers in most advanced economies are reluctant to provide details on how to move to a zero-emission energy system, even if they strongly endorse the end goal.

Credible energy transition strategies must therefore contain a detailed financial trajectory explaining how they will be paid as well as an emissions trajectory.

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