Determining the environmental effects of indirect subsidies: integrated method and application to the Netherlands

Abstract

The term ‘environmentally damaging subsidies’ covers all sorts of direct and indirect subsidies with negative consequences for the environment. This article presents a method to determine the environmental impact of these subsidies. It combines a microeconomic framework with an environmental impact module. The method is particularly useful for analysing indirect subsidies. These are often hidden, and therefore, not recognized as subsidies. Use of the method will provide a basis for formulating corrective policy. The method is applied to several important subsidies in the Netherlands, in agriculture, energy and transport sectors. The results reveal large environmental effects, which deserve serious attention from policy makers. To illustrate the specific features of the method, its application to a particular subsidy, namely the exemption of excise taxes on aviation fuels, is presented in full detail.

Notes

¹ This does not mean that we dismiss CGE models as irrelevant, but simply that for the single sector effect of specific subsidies a partial equilibrium framework can provide a good (direct) approximation of the magnitude of overall (including indirect) effects. This would be less evident in the case of policies or scenarios directly affecting large parts (multiple sectors) of the entire economy, such as in the case of climate change (Kokoski and Smith, 1987).

² Input–output models might be considered as well, as they allow capturing interactions among sectors. A main disadvantage is, however, that they do not describe prices (and implicitly assume fixed prices), so that they cannot analyse behavioural effects due to price and cost changes. As a result, these types of models are unsuitable to assess the environmental impacts of subsidies.

³ Some studies directly combine econometric analysis with a partial equilibrium model to assess the impact of government policies like subsidies (e.g. Giosa et al., 1999; Ostbye, 1998).

⁴ These categories are based on the Environmental Performance Indicators (EPI) method. See VNCI (2001).

⁵ Price reaction of demand (or supply)’ means: the absolute change in the demanded (supplied) volume that occurs in reaction to a given price change. ‘Price elasticity of the equilibrium volume’ means: the relative change in the demanded volume (with respect to the equilibrium state) as a result of a relative price change of 1%.

⁶ In reality, the increase in the ticket price might be slightly smaller because in addition to operating costs the ticket price covers overhead costs, profit margins, travel agency costs, etc. The assumption to pass on fuel costs fully to ticket prices is realistic as long as the share of fuel costs is not a dominant part of the operating costs. Ten per cent is not considered to be dominant. Only when fuel costs would continue to rise and hence operating costs would make up a larger part of prices, it would be recommendable to assume that fuel costs are not fully passed on to ticket prices with, for example, 50%.