Greece is currently in one of the worst recessions in post war history and incomes are down across the board. Air pollution levels, however, are at their worst levels in decades. Major Greek cities like Thessaloniki and Athens are experiencing repeated spikes in the levels of PM10 exceeding 150 micrograms per cubic meter (50 is the standard). We often think that deteriorating air quality accompanies a growing and industrializing economy. Here the opposite is true. What happened?
In order to increase government revenue to service debt, several changes to the tax code were made. Gasoline taxes were raised to nearly 60%. Greece used to have some of the cheapest gas in Europe and all of the sudden they were amongst the highest in the world. As a consequence, VMT dropped since there are few competitive short run substitutes for gasoline as a transportation fuel. This should have improved air quality, not worsened it.
A little bit later, taxes on heating oil were raised to match the tax rate on gasoline. Property tax rates were raised significantly and are being collected via electricity bills. If you don’t pay, you run the risk of having your power turned off. These tax increases are unusual as we usually use income tax as the major source of government revenue. Yet in Greece, income taxes are hard to collect. Hence the strategy to collect taxes on necessities.
From the perspective of an environmental/energy economist this is interesting since what we are seeing here are significant changes in the price of liquid fuels (and maybe perceived changes in the price of electricity service). This is all compounded by a whopper negative shock to incomes. What Greeks have done in response to these changes is switch to wood as their major source of heating fuel. It’s cheap, yet incredibly dirty from a local air pollution perspective. Several bloggers have blamed a typical recession type income effect for this response. The story is appealing. Greeks have no money, hence they switch to lower per heating unit sources of fuel. As is often the case, this is not the whole story.
The basic economics of this are somewhat simple, yet it requires going back to one of the most dreaded lectures in any intermediate microeconomics class: the one dealing with the Slutsky equation, which decomposes a price change into two effects: An income effect – essentially as one good becomes more expensive you have less “real income” available overall. And a substitution effect – which implies that for a given level of happiness you substitute away from the more expensive good. Undergraduates question each year why they have to learn this. Here is why:
The higher tax on heating oil raised its price relative to that of fuelwood. If we assume that heating oil is a normal good (which is economics for you consume more of it if your income rises – holding everything else constant), its higher price means that people are substituting away from it and are consuming even less of it because of the price and crisis induced income effect. The story for fuelwood is similar. It is the relatively cheaper good and people are substituting towards more fuelwood consumption. If it is a normal good, then this substitution effect must be larger than the income effect (as they are working in opposite directions). If it is an inferior good (which is economics for you consume less of it if your income rises holding everything else constant) then you are consuming even more of it because of the price and crisis induced income effect. Either could be the case, but I would put my money on the latter explanation. The higher your income, the less likely you are to want to chop wood and lug it into your living room.
Why do we care? First off, air pollution is really bad for children, seniors and other populations. Michael Greenstone and many others have written about this. Second, this has implications for a carbon tax. If you tax carbon at the mine or well head and do a good job of increasing the price of coal, oil and natural gas you will in theory shift the fuel mix towards a lower carbon intensive mix. Since natural gas is cleaner than coal in terms of local air pollutants in most cases, you not only get carbon savings but also improved local air quality. However, in low income countries, where there is ample supply of hard to tax biofuels in the form of biomass and dung, a carbon tax might lead to increases in ambient air pollution concentrations which have significant and immediate negative consequences for the local and regional economy. Greece is just one example of this. I would like to see some of Greece’s excellent environmental economists use their connections to estimate these elasticities and quantify the overall welfare implications of this form of quasi Pigouvian, yet definitely not revenue neutral, taxation.
Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.