Gas and Electricity Relief: What Makes Untargeted Policies So Expensive


Opinion of ZEW President Achim Wambach and ZEW Research Group Leader Holger Stichnoth

Opponents criticize that the support follows a “shotgun approach” by giving everyone an equal share of the aid. This criticism is not unjustified, as the costs are considerable, write Professor Holger Stichnoth and Professor Achim Wambach from ZEW Mannheim in their guest article.

The financial relief provided through caps on gas and electricity prices is kicking in. Opponents criticize that the support follows a “shotgun approach” by giving everyone an equal share of the aid. This criticism is not unjustified, as the costs are considerable, write Professor Holger Stichnoth and Professor Achim Wambach from ZEW Mannheim in their guest article.  

The first packages of the new relief programme will be delivered to households just in time for advent. The state reimburses the utility providers the instalment payments for the month of December, so that households don’t have to pay. The money comes in useful for the Christmas period. From March 2023, with retroactive effect on January and February, the actual cap will apply up to and including April 2024. Prices are capped at 80 per cent of the forecast annual electricity, gas and heat consumption. The forecast was made in September 2022.

While the government’s decision to launch a support programme during such a crisis is uncontroversial, the actual measures are being criticised for their lack of targeted precision. The programme for households only differentiates based on their previous year’s consumption, not on their financial means. As for corporate support, the co-chair of the gas commission is quoted as saying that she couldn’t have imagined supporting “such a broad price cap for the industry.” Subsidising according to the shotgun method.

Left pocket, right pocket?

But why exactly is this problematic? Surely it’s better if the money is given to households rather than used by the state itself, isn’t it? So to speak from the left pocket (it is taxpayer money, after all) to the right pocket. But the pocket has holes in it. 

To see this, it is worth taking a look at where the funds are coming from. The state finances the programme with taxes and loans, and the loans must be paid back at some point – with new taxes and loans. In the case of taxes, there are some that induce a desired behaviour. This is how a tobacco tax leads to lower tobacco consumption and a CO2 tax (in Germany as a CO2 certificate trading system) to less CO2 being emitted. Undesirable behaviour becomes expensive.

Then there are neutral taxes. Neutral in so far as they don’t cause any changes in behaviour. The currently planned windfall profits tax would be an example, at least in theory. The implementation of this tax won’t come without consequences – investors in the energy market will keep in mind that in the future, if things get serious, there is a danger that the state will tax these profits.

A large part of tax revenue comes from distorting taxes

However, a large part of tax revenue comes from distorting taxes, i.e. taxes which lead to undesired behavioural changes. The prime example is the impact of the income tax and tax splitting between married couples on the incentives to work for the second earner in the household, which is often the wife. Studies by ZEW, among others, show that abolishing the income tax splitting between married couples would lead to an increase in women’s working hours in the order of 240,000 full time jobs, as they would no longer be taxed the higher rate of the first earner.

These distorting consequences of taxes on economic activity are of a fundamental nature. It is estimated that for every 100 euros of income tax collected by the state, up to 30 euros of economic output is lost because of people working less, companies investing less or moving abroad because of taxes. This applies on average: the most distorted euro gained by the state costs more than another euro of economic output. Hence, these pockets are particularity holey.

Offsetting spending programmes with tax burdens

The federal spending programme should, to be economically correct, be offset by this high tax burden. Conceptionally, any additional budget burden is based on the taxes that distort the most. The state could indeed waive these taxes instead. This would set up a bill for the relief programme: The 200 billion euros in tax revenue that will be required in the future will be accompanied by a more than 200 billion euro reduction in economic activity, a good five per cent of total economic activity.

That isn’t to argue against a relief programme. Especially in times of crisis, it is sensible to support households and (certain) businesses, as this helps to prevent the economy collapsing further. Admittedly, it then particularly hurts when the distribution takes place in an untargeted manner as the funds were generated at such high cost.

Better data needed instead of shotgun approach

A business that can pass on the increased costs does not need to be subsidised at great expense. And it would also have been better for the households to consider their respective means. Future funding programmes, for example under the social climate income in environmental policy, should therefore avoid a shotgun approach. This requires better data and linking of these data, e.g. on household size and household income. This must now be prepared.

The German Council of Economic Experts must also face up to the blame for failing to look at the distorted costs of the programme. In its current report, the Council recommends raising the top tax rate, at least temporarily. While the report does not give precise numbers, an increase of a few percentage points seems likely. To get a feeling for the magnitudes, ZEW has carried out simulations that assume an increase of three percentage points for the two highest brackets of the income tax schedule, from 42 per cent to 45 per cent and from 45 per cent to 48 per cent, respectively.

Council recommends energy solidarity surcharge without addressing the costs

The first calculations from the ZEW-EviSTA simulation model show that such an increase would lead to additional revenues of almost 4.5 billion euros, which can then be used for support programmes. At the same time, however, the tax increase would reduce employment by around 10,000 jobs, because the higher tax would mean less net income remains from gross income. When including second earners in the calculations – income tax splitting between married couples being key – around 3,000 jobs are lost. The advantages of the revenue are reflected in the title of the document: “Managing the Energy Crisis in Solidarity”; the costs, however, are not addressed.