Assessing Vulnerability of Selected Sectors under Environmental Tax Reform: The issue of pricing power

This paper investigates pricing power, an important criterion for identifying sectors that would be vulnerable under environmental tax reform. Environmental tax reform, defined here as introduction of carbon taxes alongside reductions in labour taxes, could bear heavily on sectors that are energy intensive and highly traded, in particular if their options for adapting technology are limited. However, a sector with pricing power has less to fear as, rather than having to conform to the world price, it can set its price to accommodate a tax mark-up. To assess pricing power, a model of long-run price setting is specified and tested. Significant and plausible results emerged from this exercise, indicating that pricing power as a major aspect of a sector's relative vulnerability can be assessed. Of the six sectors analysed, the Basic metals sector had least pricing power and the Non-metallic minerals sector had most. As proxies for the world price, the German price tended to matter more than the US price. Thus, competitiveness fears are reduced not just where there is good potential for adapting technology but also if application of environmental tax reform is EU-wide.