Gas and electricity relief: What makes the watering can policy so expensive

Created: 03/12/2022 09:02

By: Prof. Achim Wambach

Achim Wambach (left) and Holger Stichnoth © Maximilian Litzka

The relief for households and companies through gas and electricity price brakes is starting to take hold.

Critics complain that this promotion is done "through the watering can".

And not without reason - because the economic costs are considerable, write Prof. Holger Stichnoth and Prof. Achim Wambach from the ZEW in Mannheim in the guest article.  

The first packages of the new relief programs will arrive at households in time for the Advent season.

The public sector reimburses the suppliers for the advance payments for the month of December, so that households do not have to make them.

They can put the money to good use during the Christmas season.

From March 2023, with retrospective effect on January and February, the actual brake will apply up to and including April 2024. The prices for 80 percent of the annual consumption of electricity, gas and heat forecast in September 2022 will be capped.

Even if it is not disputed that the public sector launches support programs in such a crisis, the specific measures are criticized for their lack of accuracy.

The programs for households only differentiate according to the previous year's consumption, but not according to the financial capacity of the household.

When it comes to corporate support, the co-chair of the gas commission is quoted as saying that she could not have imagined supporting "such a broad price brake for industry".

Promotion with the watering can.

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Left pocket, right pocket?

But why exactly is this problematic?

It's certainly better if the money goes to households than if the state uses it itself, isn't it?

From the left pocket, so to speak (it's taxpayer money, after all), into the right pocket.

But the bag has holes. 

To see this, it is worth taking a look at where the funds are coming from.

The state finances the programs with taxes and loans, although the loans have to be repaid at some point – with new taxes and loans.

If you look at the taxes, there are those that induce a desired behavior.

A tobacco tax leads to less tobacco consumption, and a CO2 tax (in Germany as CO2 certificate trading) leads to less CO2 being emitted.

Undesirable behavior becomes more expensive.

Then there are neutral taxes.

Neutral in that they do not cause behavioral changes.

The currently planned random profit tax would be such a candidate, at least in the textbook.

This tax will not be without its effects when it is implemented – investors in the energy market will keep in mind that in the future, if things get serious, there is a risk that the state will then also be able to tax profits.

Most tax revenue comes from distorting taxes

However, a large part of tax revenue comes from distorting taxes, i.e. taxes that lead to undesirable changes in behaviour.

The prime example is the impact of wage tax and spouse splitting on the work incentives of the second earner in the household – often the wife.

Studies from the ZEW, among others, show that the abolition of the spouse splitting would lead to an increase in the working hours of women in the order of 240,000 full-time jobs, since they are no longer taxed at the high tax rate of the first earner.

These distorting effects of taxes on economic activity are of a fundamental nature: it is estimated that for every 100 euros in income tax that the state collects, up to 30 euros in economic output are lost because people work less or companies invest less or abroad because of the tax wander off

This applies on average – the euro with the highest distortion that the state takes costs more than another euro in economic output.

The pockets are particularly holey.

Offset spending programs against tax burdens

The spending programs of the federal government should – economically correct – be offset against this high tax burden.

Conceptually, any additional budgetary burden is based on the taxes that distort the most.

Instead, the state could waive these taxes.

This puts the relief program in perspective: the EUR 200 billion in tax revenue that will be required in the future will go hand in hand with a reduction in economic output of more than EUR 200 billion, a good 5% of total economic output.

That does not speak against a relief program.

Especially in times of crisis, supporting households and (some) companies makes sense, as this helps to prevent the economy from collapsing even more.

However, it is particularly painful when this distribution takes place with the watering can, since the funds were received so "expensively".

more on the subject

Recession and crisis: 2023 - a year to forget?

Europe's looming energy disaster: How Germany is alienating its partners with billions in aid

Despite economic growth in Germany: why the cake is smaller than we think

Better data instead of watering can

A company that can pass on the increased costs does not need to be subsidized at great expense.

And it would have been better for the households to also take into account their respective capacities.

Future funding programmes, for example as part of climate money in climate policy, should therefore do without the watering can.

This requires better data and a linking of this data, for example on household size and household income.

This must now be prepared.

The German Council of Economic Experts must also face up to the accusation of not looking at the distorting costs of a program.

In its current report, the Advisory Council recommends an increase in the top tax rate for wage income from 42 percent to 45 percent and a corresponding increase in the tax on the wealthy to 48 percent.

Economic experts recommend energy solos without addressing the costs

First calculations with the ZEW-EviSTA simulation model show that such an increase would lead to additional income of almost 4.5 billion euros, which can then be used for funding programs.

At the same time, the tax increase would reduce work output by around 10,000 jobs, because the higher tax would mean less net than the gross.

Calculated down to the second earners - keyword spouse splitting - then around 3,000 jobs will be lost.

The advantages of the income can be found in the title of the report - "Solidly overcoming the energy crisis" - the costs are not discussed.

About the authors: Professor Achim Wambach has been President of the ZEW – Leibniz Center for European Economic Research in Mannheim since April 2016.

Wambach has been a member of the Monopolies Commission since 2014 and also its chairman between 2016 and September 2020.

The economist is also a member of the Scientific Advisory Board of the Federal Ministry of Economics, which he chaired from 2012 to 2015.

Prof. Holger Stichnoth is head of the research group “Inequality and Distribution Policy” at the ZEW and professor conventionné at the University of Strasbourg.

His main areas of work include family economics and the study of inequality over the life course.