Energy Tax Reform in Time of Crisis - The Case of Energy-Dependent and Open Economies

Many arguments against higher energy taxes and environmental pricing assume that a unilateral reform will necessary harm the production costs and the purchasing power of households, and therefore, in the aftermath of the crisis, exacerbate the economic downturn. This paper considers the most extreme arguments which assume that no substitution possibilities away from energy are available in the short to medium run. Unemployment is due to non-clearing wages in the labour market and a shortage of demand in the product market. Under such circumstances, however, a tax shift from labour to energy can increase employment if external trade is sufficiently sensitive to production costs and if the reform succeeds in shifting the tax burden away from production costs to the final consumers’ incomes. When external trade is less sensitive to production costs, what matters the most is the domestic market. In that case, the effect is positive only if wages adjust to compensate the higher final energy bills of consumers, and thus, maintain the level of internal demand.