Reforming Emissions Trading Schemes in Times of Multiple Crises - Towards More Social Justice in European Carbon Pricing

In Germany, major parts of the revenues from the national fuels ETS were initially redistributed by, amongst others, an increase of the commuter tax allowance, a reduction of the renewable energy support apportionment, and an increase of the housing allowance by 10%. 

An early DIW study estimated, however, that these measures only partially compensated for the energy price increases and also showed that low-income households would suffer a much higher net burden of 1% of their income compared to only 0.4% of high-income households. As a response to the critique, the new coalition government announced a climate dividend, the "Klimageld", to be implemented from 2023 as the major redistribution means of the German fuels ETS. However, many details of the redistribution are still to be decided, so the starting date of January 2023 remains questionable. In addition, on the downside, in the third relief package, the German government recently announced the suspension of the national ETS carbon price increase from €30 to 35 planned for 2023, which will also reduce respective revenues for redistribution.

A comprehensive solution

Both theoretical social justice considerations and recent empirical studies indicate that an equal per capita dividend would be the preferred solution to protect low-income households from overwhelming carbon price burdens. Unpublished calculations by the renowned Mercator Research Institute on Global Commons and Climate Change show that such a dividend is very effective in compensating the regressivity of carbon pricing. At a €50carbon price, a per capita equal redistribution in Germany would lead to a net reduction of consumption expenditures of the lowest income decile by 0.75%, while the highest income decile would face a 0.5% increase. This performance is significantly better than all other tested alternatives including the ones implemented initially in Germany. 

Obviously, a more targeted direct transfer differentiated by income would deliver an even better redistributional effect, but the administrative complexity and resulting extra costs of such an approach are considered unreasonable. In addition, an equal per capita dividend would be best in line with the idea of equal rights to the use of the natural environment, outlined in detail in Peter Barnes’ 2001 book "Who Owns the Sky?". More fundamentally even, the dividend approach would also comply with the criteria laid out by John Rawls in his 1971 seminal "Theory of Justice", where he defined justice as fairness. He calls for equality in terms of rights and freedom, chances and opportunities, while accepting inequalities for income and capital only within clearly defined, narrow boundaries (Difference Principle).

Going beyond the 25%, e.g., by increasing the dedicated percentage within the EU ETS 2 or even using parts of the EU ETS 1 revenues, would not only allow for cost compensation, but also for a more comprehensive and consistent application of fundamental social justice concepts. This is particularly true considering that the EU ETS 1 alone has raised over €118 billion since 2008, and 2020 alone saw an annual revenue of €19 billion; and this was before the dramatic carbon price increase in 2021 and the proposed expansions of ETS in the future.

Not least, a new survey by DIW underlines the public support for such a measure in Germany. Amongst several alternatives for redistributing German fuel ETS revenues including, amongst others, an increase in the commuter tax allowance and further investments in renewable energies, an equal per capita "Klimageld" received the biggest support rate (43%) in a representative online survey conducted in August 2022.

In sum, ETS are already playing a key role in domestic climate policy due to their proven environmental and economic merits. And while social justice challenges have been raised more vocally in the recent past due to exploding energy prices caused by the Russian war against the Ukraine, both the EU and Germany have already taken on the challenge and proposed remedies such as the EU Social Climate Funds and the German "Klimageld". A more comprehensive and consistent approach, however, would redistribute a majority of, if not all ETS revenues back to the public on an equal per capita basis. This would not only make ETS more socially just, but it would also significantly improve the social acceptability of program expansion and further price increases.

Copyright: Loic VENANCE / AFP