Welfare and inequality impacts of carbon pricing and compensation schemes on fuel poor households in Styria, Austria

Abstract

Carbon pricing is a core pillar in the policy mix required for the transition to carbon neutrality. Carbon pricing raises energy prices and related service costs, but distributes the burden unequally among the population, which though can be mitigated by accompanying compensation schemes. For the example of the Austrian Province of Styria, we analyze the impacts of national carbon pricing for heating and motor fuels. Using the Exact Affine Stone Index (EASI) demand system and applying different definitions of fuel poverty, we compare how five compensation schemes mitigate impacts on fuel poor households. Uncompensated carbon pricing has nearly twice the negative welfare impacts on fuel poor households than on the average Styrian household, in particular if they live in rural regions and if the fuel poverty definition includes transport expenditures. All analyzed compensation schemes achieve similar carbon emission reductions as uncompensated carbon pricing, but additionally reduce inequality and increase overall welfare. In particular, they increase welfare among poor households and dampen the negative welfare impacts of uncompensated carbon pricing on the wealthiest. Accounting for low income in fuel poverty definitions and compensation schemes yields the highest welfare benefits. Price changes in motor fuels are the dominant impact channel, emphasizing the importance of considering transport in the debate on vulnerability to carbon pricing.