On the Relative Roles of Fossil Fuel Prices, Energy Efficiency, and Carbon Taxation in Reducing Carbon Dioxide Emissions: The Case of Portugal

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 with endogenous growth and a detailed modeling of public sector activities. We show that to achieve ambitious domestic reductions in emissions, given the expected evolution of international fossil fuel prices, the roles of promoting energy efficiency and of a new significant carbon tax are fundamental. More importantly, promoting energy efficiency improvements and the new carbon tax have significantly different economic and budgetary effects. Energy efficiency improvements achieve reductions in emissions while promoting economic performance at the risk of increasing public and foreign debt. The new carbon tax in turn achieves reductions in emissions at the risk of jeopardizing economic performance while the effects on public and foreign debt are more favorable. This being the case, the relevance of pursuing both strategies in tandem is clear. Finally, domestic efforts toward promoting energy efficiency and the introduction of a new carbon tax need to be calibrated in function of the expected evolution of international fossil fuel prices. This evolution has significant effects on emissions and thereby on the measure of the additional effects required from the domestic authorities. It also has negative effects on economic performance while it may have more positive effects on the evolution foreign and public debts, which provide important leeway for the implementation of the domestic policies without generating a negative impact on the levels of indebtedness assuming that the public sector curtails spending appropriately in response to the increasing opportunity cost of public funds.