Assessing Impacts of the EU ETS 2 and Direct Compensations for Households in Czechia

The extension of the EU Emissions Trading System to buildings, road transport, and small industry (EU ETS 2) introduces carbon pricing in sectors previously exempt from EU-wide emissions pricing while generating revenues for climate and social policies. However, higher energy prices are expected to disproportionately affect vulnerable households, particularly in Central and Eastern Europe. This paper examines the distributional impacts of ETS2 on households in Czechia, considering differences by income, heating source, and municipality size, and evaluates the potential of existing tax and welfare instruments to mitigate these impacts. Using Household Budget Survey and EU-SILC data, household-level expenditure increases under an allowance price of 55/tCO2 (2025 prices) are modeled, assuming direct effects only, full price pass-through and no behavioural responses. We confirm the regressive burden of ETS2, ranging from 1.58% of disposable income for the lowest income decile to 0.50% for the highest, even though higher-income households face the largest absolute cost increases. The heating source emerges as a major, yet often overlooked, determinant of household vulnerability, with substantially higher costs for households relying on coal and natural gas. The main contribution consists in the model of direct compensation linked to existing policy instruments, namely an increased taxpayer credit, a higher energy allowance, and automatic pension indexation. All measures have progressive distributional effects, with the combined package compensating 4.6 million households at an estimated annual fiscal cost of 13 billion CZK, approximately half of Czechia s projected annual ETS2 revenues. The findings demonstrate the importance of accounting for heating technologies and spatial differences in assessing ETS2 impacts and show that realistic compensation mechanisms can substantially reduce adverse distributional effects while remaining fiscally feasible.