Reducing Carbon Emissions in Portugal: The Relative Roles of Fossil-Fuel Prices, Energy Efficiency, and Carbon Taxation

We assess the relative role of fossil-fuel prices, energy efficiency and carbon taxation in achieving climate policy goals using a dynamic general-equilibrium model of the Portuguese economy featuring endogenous growth and a detailed modeling of public-sector activities. Given the expected evolution of international fossil fuel prices, we show that to reach ambitious domestic reductions in emissions, it is fundamental to promote energy efficiency and to levy a significant carbon tax. Improving energy efficiency and implementing a new carbon tax have significantly different economic and budgetary effects. More energy efficiency reduces emissions and boosts economic performance, but increases public and foreign debt. In turn, the new carbon tax reduces emissions at the risk of jeopardizing economic performance, while the effects on public and foreign debt are more favorable. Thus, the relevance of pursuing both strategies in tandem is clear. We estimate that under the reference-price scenario, a steady energy efficiency gain of 2-2.5% and a carbon tax of at least 35 euro per tCO2 are required to achieve the stated goal of reducing carbon dioxide emission by 2030 by an amount equivalent to 40% of the emissions in 1990. These views were fully integrated in a proposal presented by the Commission for Environmental Tax Reform [CRFV (2014)] to the Portuguese Government in September 2014 and then discussed in Parliament in November 2014, before enacting a new carbon tax on January 1st, 2015.