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Economics IA Commentary – Market Failure

Household energy bills will increase by �50 as the impact of green taxes triples over a decade, new research shows.

By James Kirkup, Political Correspondent, Published: 12:01AM BST 17 Aug 2010

The sum the Government levies from energy use will rise to more than �16 billion by 2020, a think tank has estimated.

Policy Exchange, which has close links to Conservative ministers, calculated that the cost of green taxes, surcharges and other levies on energy will go from �5.7 billion this year to �16.3 billion in 2020.

In 2020, some �6.4 billion of the total will come from levies applied to domestic energy consumption. That is up from �2 billion today.

The increase will add �40 to the average household gas bill and �8 to an electricity bill, according to data from the Department of Energy and Climate Change.

Household energy bills are increased by a number of Government environmental policies, including the Renewables Obligation and other levies applied to energy usage to fund low-carbon power generation.

Energy companies also face charges for schemes including the European Union’s Emissions Trading Scheme, costs which are then passed on to customers.

“Green” levies are meant to increase the price of carbon-emitting energy use, with the aim of funding alternative sources and encouraging consumers to change their behavior.

Much of the money raised by such levies does not end up with the Treasury, but “green taxes” are regarded with suspicion by some consumers, who regard them as a disguised revenue-raising measure.

Simon Less, Policy Exchange’s head of environment and energy, said that the various environmental charges should be considered taxes by another name.

“The funding for these policies may come through energy bills, rather than the tax man, but it is a tax, and an increasingly large one paid by individual households and firms. Its scale makes it even more important that this money is used in the most efficient way possible.”

Warning about need to gain public support for measures to combat climate change, his report says that “raising taxation through energy bills, rather than, say, using income tax, is relatively regressive, because the poorest households tend to spend a larger proportion of their income on energy.”

Dr Less also said they funds that are supposed to go to renewable energy sources are often spent inefficiently.

He said: “Climate change is a major threat. It needs to be tackled as a priority, and that will be expensive. But the public and industry will not put up with paying such large sums if the money is going to be wasted.”

Last week, The Daily Telegraph highlighted the latest “green” charge to be applied to British businesses, the Carbon Reduction Commitment, which will require big companies to buy “permits” for their carbon emissions.

Thousands of those companies are facing large fines if they fail to register with the new scheme before a deadline next month.

The articles discusses that although ‘green taxes’ are applied to fund low-carbon power generation with the ultimate aim of encouraging consumers to tap alternative energy, they will increase the cost of household energy bills by �50 by 2020.

Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid. Negative externalities occur when such production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. Households consuming carbon-emitting energy can be considered to be a negative externality as it affects the rest of society and even a nearby country which is outside the ‘consumption market’. Many a time, the government will impose a tax on those who create negative externalities attempting to correct market failure.

The graph shows negative externality of consumption, where MPB (marginal private benefit) is much higher than MSB (marginal social benefit).The consumption of pollution-emitting energy can be represented by the demand curve MSC (marginal social cost) in the diagram. This curve shows the spillover costs on society with each additional unit of consumption. Consumption is at Q1 and not at the optimal, Q* indicating over consumption leading to welfare loss to society. In order to correct this, ‘green taxes’ are being introduced in an effort to bring consumption to the optimal. This would however result in the optimal price to shift from P* to P2, which is relatively higher.

Carbon emissions refer to the release of Carbon dioxide gas into the atmosphere when fossil fuels like gas, oil, or coal are burnt. In a natural carbon cycle, carbon dioxide is re-absorbed by plants and trees but currently, the burning rate is faster than the absorption rate. Global warming is the direct negative consequence and the government has to invest in new research technologies to avert further crises. In UK, there are a number of governmental environmental policies, like the Renewables Obligation and other ‘green levies’ which are used to fund low-carbon emission energy.

According to the article, ‘Green taxes’ would rise threefold, from �5.7 billion in 2010 to �16.3 billion in 2020. In the coming years, as world population rises, so will energy consumption, carbon emissions and its negative effects; these taxes will follow suit.

In the short run, the tax increases might not be very large and hence would not cause a great decrease in quantity demanded. In the long run however, as the taxes rise to a sizeable amount, then the deterrent action will ensue; consumers will now be discouraged from consuming carbon based energy and shift to alternative sources.

However, In reality this is only partially true. The tax will be most effective on households with lower income, as this tax will cover a larger percentage of their income. The tax will not be as effective on wealthy households since it would be just a negligible amount in their budget and they will not think twice before spending on goods that cause negative externalities.

Another disadvantage of such a ‘taxation’ method is achieving the right level of taxation so that private cost will exactly equate with the social cost. The government cannot accurately put a monetary value on the private benefits and cost of firms; in fact, a certain financial figure on the value of externalities such as the cost to natural habitat, long-term effects of ozone layer depletion or even that of the human life for that matter, is rather hard to arrive at. All in all, all that the government and other environmental agencies can hope to achieve is the correct direction of movement towards the optimum level of output.

A more effective step the government could take is to impose a complete ban on certain forms of energy consumption that produce large quantities of emissions or issue marketable pollution permits. The latter case of Carbon emissions’ trading has been gaining momentum in many countries now and is a central feature in Kyoto Protocol and the European Union Carbon Emissions Trading Scheme which started in full in 2005. This new approach involved the issuance of limited volume of pollution rights which are sold to companies that pollute. The incentive is that if the company pollutes less, then they can sell their excess permits in the secondary market. As the number of permits being issued is carefully reduced year by year, total carbon emission can be curbed efficiently and simultaneously the path towards greener energy alternatives can be also be paved.


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