Who Bears the Load? Carbon Taxes and Electricity Markets

Abstract

This paper studies how a carbon tax differentially affects the welfare of electricity producers and consumers, also known as incidence. In so doing, I develop a new framework to estimate the incidence of input taxes that accounts for incomplete pass-through to retail prices, imperfect competition, and heterogeneity in marginal costs of producers. Leveraging exogenous variation in the level of the Australian carbon tax, I then apply this framework to the context of the National Electricity Market in Australia. I find that 95 to 97 percent of the welfare cost from changes in the carbon tax falls on electricity consumers. The large burden borne by consumers is driven by full pass-through of increases in wholesale electricity prices to retail electricity prices in combination with negligible decreases in aggregate profits for electricity producers. Simulations show that incorporating heterogeneous firms is particularly important when market demand is elastic.