Feed-in-Tariff backfires: implicit carbon pricing and inter-fuel substitutionin manufacturing

Partial energy taxation, such as fuel or electricity taxes, is gaining momentum in recent years, but such taxes may result in additional demand for non-taxed, substitute energy goods. In this research, we analyze the effect of the Japanese renewable levy, a prime example of implicit carbon pricing, introduced in 2012. Using data on Japanese plants between April 2004 to March 2020, we utilize the existence of a partial exemption scheme from the tax, and instruments for identification. Our results show that the levy had undesirable consequences, as it is associated with a rebound in emissions for certain sectors where electricity and fuels are substitute (iron & steel, +52%; pulp &paper, +13%). This rebound is explained by a greater share of electricity generated onsite, powered by fossil fuel. We show that the levy provided an incentive for plants to switch from clean (gas) to dirty (coal, oil) fuels. While the tax is generally correlated with gains in electricity and energy efficiency, these efforts are not enough to offset there bound in emissions. Our results shed light on the effect of partial energy taxation on the manufacturing industry, and suggest the need for explicit and complete forms of carbon pricing.