Report on Economic Quantitative Ex-Ante Assessment of Proposed Policy Mixes in the EU

The purpose of deliverable D6.2 is to support with a quantitative economic assessment the evaluation of a set of policies scrutinized within the DYNAMIX project, aiming to promote decoupling of resources use from GDP and material efficiency within the EU. The analytical tools used for the investigation are three macro - economic models, ICES, MEMO and MEWA, all belonging to the category of Computable General Equilibrium modelling, but with complementary characteristics. More specifically: they all provide a sectoral representation of the EU economic system and endogenous price formation. In practice, they can assess direct and indirect policy effects on the whole economic system and the full macroeconomic feedbacks, beyond the sector initially subjected to the policy intervention. However, ICES representing the EU with a country detail, is better suited to capture intra and extra EU trade effects. MEWA and MEMO consi der the EU as a single region, but differently from ICES, offer a more realistic representation of technological change, feature forward looking agents and have a richer representation of labour supply choices. The policies examined by the different models and their slightly different implementation, due to the differences in the models’ sectoral and functional details, are summarized in the table below. [Table 1 DYNAMIX Quantitative Economic Assessment Policy Matrix.] The first two policies examined - a material tax and a tax aimed at internalising environmental externalities - are based on different designs and implementation strategies. Nonetheless, their common trait is the breadth. They have direct and indirect effects on many sectors, and thus have impacts clearly detectable on the overall EU GDP. The strongest message from the analysis is that the cost of the policy crucially depends upon (a) the sensitivity of the production system to the dynamic incentive to dematerialize induced by the policy signal, i.e. ultimately upon the reaction (or availability) of technological progress and (b) the use of tax revenues, i.e. on the implementation of an appropriate revenue - recycling scheme. A combination of technological progress in response to the tax with a reduction in labour taxation can indeed, according to the modelled outcomes, end up stimulating economic growth (a maximum 8% GDP gain in 2050) and increasing material efficiency (in a range between 12 to more than 70% in 2050), reaping a material “double dividend”: more GDP and lower material use. Without these two factors, however, especially when taxes are rebated lump - sum to households, the policy can be particularly depressing for EU GDP ( - 5% ), and, as a further drawback, might even worsen, rather than increase material efficiency in many material intensive sectors of the economy. This can happen when the reduction in economic activity outpaces the decline in material use at the sectoral level. All in all, the tax shift fosters a huge transformation of the production system. Therefore, notwithstanding final net GDP gains, material intensive sectors would be highly penalized (a good example is the iron and steel sector which may experience a production decline up to 60% when exposed to a material tax). This calls for a careful designing and planning of the policies devising a set of accompanying measures to smooth the most adverse social effects. Increasing public investment for R&D dedicated to material efficiency, whether financed through increases in labour, corporate or value added taxation, seems to have the highest potential to boost GDP among the three policies and is also the least burdensome for material intensive sectors. In fact, final material use can also increase, as an economic “rebound effect” materializes with the “production scale” effect being larger than the “material use decline” effect. This raises a caveat: although supporting material efficiency R&D might seem the “optimal” policy to foster absolute decoupling, it should be accompanied by further regulation or incentives limiting material use or promoting dematerialized services. Despite the obvious differences, the tax to foster pesticide reduction, the increase in the VAT on meat and a targeted information campaign to influence food behaviour towards less meat intensive diets, address a group of sectors with a “low weight” in term of EU value added. Thus, their relevance is prominently sectoral. Raising the VAT on meat to the EU average VAT level can be successful in reducing meat consumption (between 2.5 and 14% in 2050). Meat industry exports are expected to increase in response to the decrease in world meat prices following the contraction of EU demand while effects on ‘Non - meat’ based food production in the EU is ambiguous but anyway moderate ( 0.7%, - 0.24% in 2050 depending on the model). Potential declines in ‘Non - meat’ based food production might occur when the demand contraction induced by the tax on household budget meets higher input costs as some meat products are used as intermediates also by the non - meat food industry. Again, final GDP impacts are determined by the use of VAT revenues. If they are rebated in a lump sum to households, GDP in the EU could decline by 0.05%; if labour taxes are reduced, GDP could increase by 0.35%. Comparable effects on meat industry production (a contraction by 6% in the ICES model) and slight GDP gains (by 0.04% in the EU in 2050) would be induced by the information campaign to shift food consumption habits. Notably, the effect on GD P is positive, rather than negative as in the VAT case, even without an accompanying reduction in labour taxes. This occurs as the recomposition of consumers’ preferences is not induced by any active tax policy which ultimately impacts household income, but just by the “persuasion” of consumers. In this sense, inducing “just” a substitution and not an income effect, the action of the campaign is less invasive. However, it has to be recognized that there is a huge uncertainty on the effectiveness of information campaigns and on the time they would need to accomplish the desired results. These issues are not considered in the current analysis though. The pesticide tax, finally, can reduce the use of pesticides (up to 10% in the models) while exerting a limited effect on the EU agricultural activity (which in 2050 contracts of the 0.08% - 0.8%) and an even smaller one on overall EU GDP. When changes are so small, however, it is possible that indirect effects prevail over direct effects. For instance, in some simulations, an increase, albeit small, in EU chemical sector production is observed. This is explained by the increase in agricultural production outside the EU favored by the higher prices of EU agricultural commodities, which brings about an increased demand for fertilizers and pesticides, including those produced in the EU, which are exported more. The policy thus would not induce a decrease in the negative externality, but its de-location abroad. These unintended secondary effects should thus be dealt with specific corrections. Like the material tax policy, the circular tax design aims to foster dematerialization, recycle and re-use, but with a much narrower scope as it focusses specifically on raw materials (excluding metals) extraction. In the light of the relatively limited economic relevance of the mining sector in the EU, policy effects are mostly felt by raw-material-intensive branches of the production system, while systemic effects are small. Not surprisingly, mining of non-ferrous minerals (experiencing a production contraction in the range of 7 - 35%) and the non-metallic minerals transformation sector (contracting 7 - 10% by mid-century) are the more heavily affected. Once again, revenue recycling mechanisms play some role. Nonetheless, the small volume of revenues available to be recycled does not allow for significant GDP and employment expansion. Similarly, the absence of recycling does not cause huge GDP impacts, although they remain slightly negative (-0.32% in 2050). The overall dematerialization potential of the policy, especially in the long term, is limited if compared to that for instance of the material tax, producing at best a 3% material efficiency improvement with respect to the reference scenario. The last policy examined, is the shift towards more “leisure consumption”. Its direct consequence is the decrease in the labour supply. Therefore, the price of labour (wages) will increase, leading to some substitution of labour with capital, energy and materials. In the short run, this will increase the capital - to - GDP ratio, energy - intensity and material intensity. However, in the long run, as the economy will produce less goods to be consumed, an absolute reduction in the use of energy and materials will occur along with the decline in GDP. Exports will also be penalized with potential negative consequences on the current account.