The equity and efficiency effects of energy subsidy cost-recovery

Abstract Energy subsidies, such as renewable energy price supports or energy efficiency subsidies, are commonly recovered via surcharges on energy consumption; either a flat-rate household charge or a surcharge on the price per unit of electricity. This paper compares the equity and efficiency effects of commonly-employed methods by calibrating a social welfare function according to societal preferences for inequality sourced from the empirical literature. When comparing a flat-rate household charge with a surcharge on the price per unit, we find that an electricity price surcharge is welfare maximising in the majority of considered circumstances. It is less regressive, despite the obvious price distortion. We quantify the welfare loss of this price distortion for a 2015/16 Irish case study. Switching from a flat-rate household charge to a price surcharge reduces consumer surplus by an additional 0.7% to 3%, depending on the price elasticity of demand. There is a strong distributional effect. Under likely rates of price elasticity, switching from a flat-rate household charge to a price surcharge results in an annual average welfare gain of €8.31 for households in the first (lowest) quintile of the income distribution, whilst households in the fifth (highest) quintile incur a loss of €11.83. We find that while efficiency grows in relative importance as the magnitude of the subsidy cost increases, equity still outweighs the efficiency loss in many circumstances given likely societal preferences for inequality. Should policy costs be negative, a flat-rate levy is welfare-maximising under all conditions.