What is a carbon tax?
A carbon tax is a tool that harnesses the power of the market to lower the emissions that contribute to climate change. A carbon tax works by charging a fee for every ton of CO2 emissions produced. The fee can be charged to fuels such as coal, oil and natural gas (based on the expected emissions from those fuels) or based on measurements of CO2 emitted from major pollution sources such as power plants. Either way, the CO2 tax will discourage activities that produce high amounts of CO2 and make conditions more favorable for all low- and zero-carbon alternatives.
In the energy sector, sources that use fuels that are more carbon-intensive (e.g., coal and fuel oil) would pay a higher carbon tax per unit of energy consumed than those that burn natural gas. Sources that rely exclusively on renewable energy (e.g., solar, wind energy, hydropower) would not be subject to the tax.
Sources affected by the carbon tax will have a strong motivation to invest in low-carbon solutions that cost less than the tax, such as energy efficiency measures and lower-emitting technologies. Such investments will lead to cost savings and improve economic competitiveness in the marketplace. Final consumers such as households and commercial establishments will also have an incentive to lower emissions. This could mean finding ways to use less electricity through efficiency and conservation. They would also have a natural incentive to reduce the carbon intensity of the products they purchase.
A carbon tax casts a wide net, encouraging lower carbon decisions across the affected sectors and at every step in the value chain. There is no need for the government to separately regulate emissions from each sector or sub-sector.
All solutions that cost less than the carbon tax would be encouraged, fostering competition and encouraging innovative solutions. Considering the level of the tax and the availability and cost of alternatives, a carbon tax empowers the private sector and private citizens to decide which solutions will work best. The government can make use of the revenues generated to further the objectives of the tax or fulfill other priorities.
Why do we need carbon tax?
Macedonia, along with all the other nations of the world, has signed the Paris Agreement, which aims to keep global temperature increases to well below 2 degrees C and prevent the worst impacts from climate change. By 2050, Macedonia can already expect higher temperatures in summer months, increases in heat waves, and increased frequency and intensity of droughts. An increase in temperatures of 2 degree C would put 6 of Macedonia’s 7 ski resorts at a high risk of not being able to rely on snow. The global community needs to make substantial changes this decade to keep temperature increases closer to 1.5 degrees C.
A carbon tax will help Macedonia contribute to the global climate solution. It is a tool that can help the country fulfill its climate change commitments and EU accession policy goal.
Under the Paris Agreement, Macedonia has committed to an ambitious goal to reduce greenhouse gas emissions 51% below 1990 levels by 2030. Moreover, accession to the EU will eventually require participation in Europe’s long-standing carbon market, the EU Emissions Trading System (EUETS). The EUETS limits greenhouse gas emissions from the electricity, industry and domestic aviation sectors by allocating a limited number of allowances that can be bought and sold among participants. Affected sources pay the market price to purchase enough allowances to cover their emissions. This price is currently around €45 per ton of CO2 emissions, and is expected to increase to between 56 and 89 EUR per ton by 2030. An advantage of an ETS is that the level of emissions is certain (capped by the total allowances made available), though the cost of compliance is not.
While Macedonia could adopt a cap-and-trade system similar to the EUETS, doing so would take considerable time and funding to develop the required infrastructure (e.g., monitoring and reporting systems, registry, trading platform, allowance allocation methodology) and build the capacity required to implement the program. Further, the market incentive under an emissions trading system can be volatile and would not offer certainty on cost.
Another alternative, Macedonia could regulate each sector (and sub-sector) individually. However, this would entail the government making choices on technologies and efficiency standards for a range of applications. While some such new technology standards can be quite effective, there is a risk the government will require measures that are too expensive or suboptimal. Devising such regulations could also be time-consuming and would require periodic updates to avoid locking in outdated technologies.
On balance, it makes sense to start with a CO2 tax, which could set the desired market signals right away and allow for a gradual increase in the tax in support of goals related to the Paris Agreement and EU accession. Implementing a tax would build experience in the country with carbon pricing and afford time to set up systems and build capacity needed to join the EU ETS at a later date.
What should the price be?
Considering the results of a carbon tax study supported by the UNDP, a carbon tax that starts at around 8 EUR per ton of CO2 in 2025 and rises to 28 EUR per ton of CO2 in 2030 would make substantial progress towards reaching national emission reduction goals in the energy sector. This level of ambition is similar to that being considered across the energy community. It should also be noted that Montenegro has already imposed a cap-and-trade system with a price floor of 24 EUR/ton.
The suggested carbon price trajectory is estimated to be sufficient to make alternative energy sources (natural gas, renewables) cost-competitive in the electricity and heat production sectors, facilitating the shift away from coal-fired generation. It should be noted that a higher carbon tax trajectory was also evaluated. However, while that price would come closer to meeting the national climate goals for the energy sector, the incremental cost was deemed to be too expensive.
In addition to considering the cost and emissions reductions that would be achieved by the carbon tax, the decision on the level of the carbon tax should also consider carbon pricing decisions elsewhere in the region. If Macedonia adopts a carbon price and its neighbors do not follow suit, this could put Macedonia’s businesses at a competitive disadvantage (imports would replace some domestic production) and reduce the emissions benefits of the tax (known as “emissions leakage” as emissions from imports would increase). The modeling study suggests that Macedonia could adopt a smaller carbon tax (8 EUR/ton) without seeing competitiveness or leakage impacts, but that it will be important for the region to move forward together in adopting higher carbon prices. Accordingly, Macedonia should prioritize outreach to its neighbors in advocating for its recommended carbon price path.
A final note on the level of the carbon price relates to how it is imposed. Macedonia should adhere to the following design principles:
- Make the price increase gradual. A price path that increases gradually over time will minimize shocks. This means setting the price to increase incrementally each year.
- Publicize the price path years in advance. Providing up-front certainty on the price path will allow businesses and consumers to plan their investments over time, considering how the price will rise in the future. Setting the price trajectory in advance would also avoid political pressures to lower the tax that could arise from a more ad hoc approach.
How much CO2 can it reduce?
A CO2 tax would be the single most important measure to meet the country’s Paris Agreement climate commitments. This is because the price incentive from the tax would encourage implementation of many low-cost measures identified across the energy sector without having to devise individual policies and measures targeting each opportunity.
Without a carbon tax, energy sector emissions in Macedonia will decline overall by about 3 percent from 2017 levels in 2030 due to planned energy efficiency measures in the residential, commercial and industry sectors, as well as construction of new renewable energy for electricity generation. These investments are expected to counteract the overall growth in energy demand over that timeframe. However, after 2030, emissions would be expected to increase again, mostly as a result of new coal consumption related to increased industrial production. By 2040, emissions are projected to be 6 percent higher than 2017 levels.
Implementing a CO2 tax in Macedonia and the surrounding region as suggested will reduce CO2 emissions in Macedonia’s energy sector by about 40 and 42 percent below 2017 levels in 2030 and 2040, respectively. Most importantly, the carbon tax levels evaluated are sufficient to prompt the existing Bitola coal-fired power plant to repower with natural gas; with a CO2 tax, the modeling finds that the TPP Bitola and Oslomej coal plants are not economically viable after 2025. However, the tax would also lead to enhanced energy efficiency and renewable investments across the energy sector. In the case that the CO2 tax is not adopted by other countries in the region, some of the expected renewable energy would not be built, and would be replaced by power imports. This is why regional action should be considered in setting the carbon price.
Who is affected by the tax?
It is recommended to apply the tax upstream, at the point where fuels enter the economy. In most cases, this would mean the point that the fuel is first imported into the country. In the case of lignite, it would be taxed at the point where lignite is mined. This approach builds on existing regulatory experience (e.g., the method of applying the existing excise and environmental taxes) and ensures that the tax covers all energy sector emissions across the economy.
This approach means that the tax affects all users of energy: electricity and heat producers; industrial, commercial and residential energy users; and transportation systems. Energy users would all see the market signal from the carbon tax and be motivated to find ways to lower their emissions. Capturing a broad set of energy users would help ensure that low-cost solutions are not overlooked. It should be noted that an adjustment would be needed to ensure that fuels used as inputs to products (e.g., petrochemical feedstocks, plastics) would be reimbursed for the CO2 taxes paid since these fuels are not combusted.
By applying the tax equally to all fuels based on the CO2 emissions they are expected to produce, a carbon tax puts all fuels on a level playing field. This approach avoids economic distortions that can happen when some fuels and sectors are taxed and others are not. For example, if power sector emissions are taxed and transportation fuels are not, this would have the effect of discouraging use of electric vehicles relative to other transportation options. Likewise, taxing electricity and heat but not industrial users of energy could lead more industrial sources to self-generate, reducing the emissions from the tax. (This is another form of leakage.)
What would the proposed tax levels mean for fuel prices?
The carbon tax would be applied to each type of fossil fuel used in the country on the basis of the relative amounts of CO2 released when the fuels are burned for energy. Comparing CO2 emissions from fossil fuels on an apples-to-apples basis (tons of CO2 per Petajoule of energy), domestic lignite is the most carbon intensive fuel, emitting 107.9 kt CO2/PJ and natural gas is the least carbon intensive, emitting 55.1 kt CO2/PJ.
The actual tax rates for each fuel would be expressed using different units, depending on how the fuels are typically sold in the marketplace. As a result, the actual rates charged for each fuel can only be directly compared against fuels that use the same metric. For example, the rates show that diesel has more emissions per liter than petrol, and therefore would be charged a higher tax rate. Estimated tax rates for each fuel are shown in the table below, considering the recommended CO2 tax levels of 8 and 28 EUR/ton.
Estimated carbon tax levels, applying emission factors and assumed carbon prices
It is important to consider that the government could choose to rebate all or a portion of these payments to those that may be disproportionately impacted by the carbon price. This is one option for use of revenues generated by the carbon tax.
How would these higher fuel prices impact households?
On average, higher energy prices stemming from the carbon tax are expected to increase household expenditures for electricity, heat and transportation fuels by 93.50 EUR in 2030. However, because incomes are also expected to increase between now and 2030, the impact of this increase on household budgets would be smaller than what it would be today.
Based on forecasts of disposable income derived from the UNDP-sponsored modeling study, it is projected that income levels will increase by 2030 for all income categories. The table below shows income levels by category (e.g., the top 20 percent of disposable income earners is labelled as Q5, and the next 20 percent of disposable income earners is labelled as Q4, and so on) in order to illustrate how the energy price increases will affect different income groups. The energy price increase resulting from the carbon tax has the biggest impact on the lowest 20 percent of income earners, where the added costs amount to 1.4 percent of disposable income in 2030.
Estimated disposable income by income quintile and impact of total energy price increases in 2030
To mitigate the impact to households that would be disproportionately impacted by the carbon tax, the government should consider delegating a portion of the carbon tax revenues to provide a rebate of the cost increase for the lowest income groups. This can be done in a way that preserves the carbon tax incentive to use less energy and shift away from carbon intensive electricity, heating and transportation sources.
What are some options for using the carbon tax revenues?
A carbon tax will generate revenues the government can use for any number of purposes. Based on the UNDP-sponsored modeling, the revenues are estimated at 60.4 million EUR in 2025 and 137 million EUR in 2030. However, the actual amounts of revenues collected could be higher or lower depending on how energy users respond to the tax.
While these revenue levels are substantial, there are likely to be competing demands for these funds. The choices made by the government on use of revenues could make the overall carbon tax package more (or less) attractive to the public. Therefore, the government should be strategic in how the revenues are deployed.
Considering good practices from other jurisdictions, the following options for use of revenues should be considered:
- Compensating low-income consumers. A high priority should be to use tax revenues to mitigate regressive effects of a carbon price by compensating the expected energy cost increase to the lowest-income energy consumers. This could be particularly important in Macedonia considering that household electricity prices are expected to increase over the next decade as subsidies are phased out.
- Compensating workers that may be disproportionately impacted by the CO2 tax. Temporary training and compensation could help workers in affected industries such as coal mining transition to other job opportunities. The need for these supports should be evaluated considering existing social programs.
- Compensating industries at risk of losing market share due to the carbon tax. Industries that are carbon intensive and exposed to international trade (due to high amounts of exports and/or imports) may be at risk of losing market share in the case that Macedonia adopts a carbon price and its trading partners do not. Accordingly, Macedonia could consider temporarily protecting such industry sectors, considering compensation levels provided to industries under the European Union Emissions Trading System.
- Investing in additional emissions reductions. This could be emissions reductions in the sectors covered by the tax (i.e., the energy sector) and/or sectors that are not covered by the tax. If it is desired to reinvest revenues in emissions reduction opportunities in the energy sector, the government may wish to focus those investments on overcoming barriers to private sector investment in low- and zero-carbon solutions. This would boost the impact of the carbon tax.
- Lowering marginal tax rates. Under this option, governments would use funds to lower the rates of existing taxes (e.g., income taxes). In this way, taxes on “goods” (income) are replaced with taxes on “bads” (CO2). This approach can lower the overall costs of the carbon tax on the economy.
Find out more:
Carbon Tax Roadmap
Carbon Tax Assessment Report
Macedonian enhanced Nationally determined contributions