Taxing CO₂ and subsidising biomass: Analysed in a macroeconomic and sectoral model

This paper analyses the combination of taxes and subsidies as an instrument to enable a reduction in CO2
emission. The objective of the study is to compare recycling of a CO2 tax revenue as a subsidy for biomass use as
opposed to traditional recycling such as reduced income or corporate taxation.
A model of Denmark's energy supply sector is used to analyse the e€ect of a CO2 tax combined with using the
tax revenue for biomass subsidies. The energy supply model is linked to a macroeconomic model such that the
macroeconomic consequences of tax policies can be analysed along with the consequences for speci®c sectors such
as agriculture. Electricity and heat are produced at heat and power plants utilising fuels which minimise total fuel
cost, while the authorities regulate capacity expansion technologies. The e€ect of fuel taxes and subsidies on fuels is
very sensitive to the fuel substitution possibilities of the power plants and also to the extent to which expansion
technologies have been regulated.
It is shown how a relatively small CO2 tax of 15 US$/tCO2 and subsidies for biomass can produce signi®cant
shifts in the fuel input-mix, when the expansion of production capacity is regulated to ensure a ¯exible fuel mix. The
main ®nding is that recycling to biomass use will reduce the level of CO2 tax necessary to achieve a speci®c emission
reduction. Policies to ensure a more intensive use of such relatively expensive renewable energy sources as biomass
could be implemented with only small taxes and subsidies. # 2000 Published by Elsevier Science Ltd. All rights
reserved.