Biofuels, tax policies and oil price: insights from a dynamic CGE model

The 2009 Directive on Renewable Energies (called RED) has set up ambitious targets concerning biofuels consumption in the European Union. This paper addresses this issue in the case of France, focusing on alternative tax policies designed to stimulate biofuels consumption. Our main objective is to determine under what circumstances tax policies could help the French government to achieve the 2020 biofuels consumption mandate. A common response is to increase taxes on fossil fuels in order to enhance the price competitiveness of their renewable substitutes on the fuel market. However, recent studies (Timilsina et al., 2011a; Barker et al., 2008; Weber et al., 2005) have shown that the way the government uses the tax revenue is a key determinant. Indeed, recycling the tax revenue to households through a lump-sum rebate is not an efficient strategy since the impact on biofuels consumption is limited, even with higher tax rates. Hovewer, when the tax revenue is used to finance a biofuel subsidy, the market penetration of biofuels increases significantly. On the other hand, some studies underline the role of oil prices in the expansion of biofuels worldwide. Timilsina et al. (2011b) show that if oil prices rise 150% from their 2009 levels by 2020, the resulting penetration of biofuels would be 9%. But they don’t take into account the context of rising oil prices into a tax policy analysis. With these questions in mind, we propose to go further and to combine both features, tax policies and rising oil prices, into a same model. The aim is to determine the minimal level of additional taxes on fossil fuels needed to achieve the 2020 biofuels target when oil prices increase. On the other hand, we take into account the budgetary constraints of the government by eliminating the differential tax rate between fossil fuels and renewable fuels. To do it, we increase the level of the excise-tax on biofuels by 35% in order to observe if the 2020 biofuels target could be also reached under this assumption. For this purpose, we develop a multi-sector, recursive dynamic computable general equilibrium (CGE) model calibrated on 2009 French data. Standard CGE models take into account the various inter-linkages between economic sectors and are particularly useful for the evaluation of tax policies. Our first scenario consists in designing different tax schemes on fossil fuels. We compare the level of additional taxes required to reach the 2020 consumption target when the tax rate increases progressively and when the rise is less graduated. Then, in a second scenario, we wonder which would be the level of taxes on fossil fuels to reach the 2020 consumption target when the excise-tax rate on biofuels is increased. In a third scenario, we combine the precedent simulation with an exogenous increase of oil prices with the assumption that future evolution of oil prices will follow the trend observed on the past period. This paper also investigates the economy-wide effects of these alternative scenarios, notably on the agricultural sector. Indeed, the impacts of a larger expansion of biofuels may increase the agricultural outputs, while an exogenous increase of oil prices may lead to an output drop. Finally, we introduce explicitly biofuels by-products in the analysis, notably oilseed meals, in order to check if their presence reduces the price impacts of the biofuel production. Indeed, recent studies (for e.g. Taheripour et al., 2010) have shown that the presence of by-products could mitigate the price impacts of biofuel production. Results of scenarios 1 and 2 suggest that the target could be achieved with acceptable levels of taxation. Nevertheless, scenario 2 implies higher tax rates on fossil fuels and larger but limited welfare losses. The needed level of additional taxes is lower when it is analyzed in a context of rising oil prices, as it was expected. Besides, we find that the development of biofuel consumption only partially offsets the depressive effect of oil prices on the agricultural output. The introduction in the model of biofuels by-prducts reveals smaller changes in agricultural prices, particularly in the livestock sector, confirming that models that omit by-products may overstate the economic impacts of biofuels mandates.