Should we lower VAT on electricity to reduce levels of consumption?

  • António Cardoso Marques
  • 23 June 2020

The idea of reducing VAT for modest electricity consumption was raised when preparing the 2020 State Budget; however, that was before the current health crisis resulting from the pandemic.

I feel very honoured to have the opportunity to contribute, for the first time, to ECO News. Besides, I am delighted to be able to provide a distinct perspective on a topic that currently has a broad consensus in the Portuguese political spectrum. It also appears on the European scene, with the European Commission praising the measure. I refer to reducing the VAT levied on electricity for consumers with lower levels of consumption.

The idea of reducing VAT for modest electricity consumption was raised when preparing the 2020 State Budget; however, that was before the current health crisis resulting from the pandemic caused by COVID-19. Now is the time to reconsider its execution, not only because the European Commission has given the green light to its implementation just now, but essentially because it is urgent to think about a strategy to accelerate the diversification of the electricity mix in the post-health crisis. Is this measure an important driver of energy transition, and is it the real green deal?

This measure has a noble intention, with environmental preservation at its core. By encouraging low electricity consumption, through the reward of reduced costs, this could provoke in the economic agents the desire to follow a path of more responsible consumption and, with this, contribute to reducing CO2 emissions while fighting against climate change.

Let us see then! This measure cannot be based on any assumption other than that more electricity consumed implies more use of fossil sources for its generation. Unfortunately, this ought to be a wrong premise. Should we not instead be thinking about putting our efforts into extending the energy transition? If the electricity consumed is produced from renewable sources, such as photovoltaic plants or wind farms, more electricity consumption will satisfy additional production needs or individual needs, and as such, it is an asset per se, given that it creates economic wealth.

More pressing will be the consequences of a measure that deviates from the modern benchmark of efficient Pareto policy design. Discrimination of consumers according to their level of electricity consumption can be unfair and environmentally irresponsible, contrary to what is claimed. It is a measure that can contribute to more energy poverty. In fact, consumers with a greater willingness to pay, those who could initiate and support the necessary transition to electric mobility by purchasing electric vehicles, could become less propense to do so. If the policy’s guidance is to reduce electricity consumption, then how can one simultaneously encourage electric mobility? By comparison with the actual dominant form of mobility, there are no different tax rates for consumers who consume 10 units, or just one, of fossil fuel in their thermal engine vehicles.

A genuinely protective measure of the environment, the economy, the interests of consumers and, fundamentally, the energy transition, is one that requires fewer fossil fuels backing up renewable sources. In principle, this backup is necessary if there is consumption in periods when renewable sources are scarce. What the measure should have, is a mechanism that encourages consumers to consume more when there is an ample supply of renewable generation, thus making consumption cheaper. At the same time, it should penalize consumption made in periods of low supply of electricity from renewable sources, making it naturally more expensive. This measure fails, therefore, because it forgets the notion of net demand of electricity.

Furthermore, can this measure increase energy poverty? It can produce negative effects which, overall, may outweigh the positive ones. Consumers with more financial resources can invest in their own photovoltaic systems and even hybrid and autonomous systems for their homes. In doing so, they are contributing to the reduction of emissions, it is true, but they are also tending to leave the grid, which in the long term may entail considerable costs for those who remain in it, given that the same costs of the grid have to be supported by fewer consumers.

In short, consumers react to stimuli, and the signals that are emitted by the public policy are critical. Past times come to mind when we only went part way with the energy transition. This strategy will only be successful if it is globally consistent. It should not be the aim only to reduce electricity consumption, as a healthy level is essential for the satisfaction of individual needs, for productive activities and, increasingly, for non-polluting mobility. So, what needs to be done is to reduce electricity consumption during specific periods and increase it in others; a strategy in which the inclusion of electric vehicles with their batteries is key. This measure now in question, is blind and will not achieve this goal.

My suggestion is to apply a national plan of photovoltaic installations for self-consumption, with mandatory smart metering and a commitment to stay connected to the grid. Such a plan will ensure that only a few will leave the grid, not compromising its reliability, and everyone could discipline their own consumption according to their own generation pattern (Marques, 2018). This is the best way to reduce the burden of their electricity bill and take care of the environment. Essentially, contrary to what is being tried, my idea is not to consume less, but to consume according to the instant availability of renewable sources. Moreover, since we have a collective challenge to reduce unemployment bought about by this pandemic, this plan would be a strong impetus for job creation once the industry’s local multiplier effect is proven.

Marques, A. C. (2018). ECONOMIA DA ENERGIA: Desafios, intervenção pública e gestão da procura de eletricidade. EDIÇÕES SÍLABO, Lisboa. ISBN: 978-972-618-949-7.

  • António Cardoso Marques
  • Full Professor of Economics, University of Beira Interior