Financing a renewable energy feed-in tariff with a tax on carbon dioxide emissions: A dynamic multi-sector general equilibrium analysis for Portugal

Abstract

Renewable energy production subsidies alleviate the pressure on electricity prices associated with carbon and energy pricing policies in the process of decarbonization and electrification of the Portuguese economy. Our simulation results show that a feed in tariff financed by a carbon tax leads to adverse macroeconomic as well as adverse and regressive distributional welfare effects. On the flip side, however, we show that use of the carbon tax revenues to finance a feed in tariff is an improvement over the simple carbon tax case along all the relevant policy dimensions. The feed in tariff mechanism when added to the carbon tax leads to better environmental outcomes at lower costs both in terms of the economic and social justice implications. The policy implications are clear. First, because of its adverse economic and distributional effects, a carbon tax should not be used in isolation. The use of the revenues to finance a feed in tariff dominates the simple carbon tax case in all dimensions. Second, the search for an appropriate recycling mechanisms beyond a feed in tariff is an issue as important as the carbon tax itself as it pertains to the potential reversal of the adverse effects of such a tax.