GreenREFORM is intended to be used to assess the societal costs of meeting the government’s target of reducing Denmark’s net greenhouse gas emissions by 70% compared to 1990 by 2030. It is therefore crucial to have a well-defined measure for this type of cost. It is essential to be able to measure the total costs of such a transformation of the Danish economy, but it is also important to be able to compare the deadweight loss of different policy measures.
The goal is to establish a theory-based welfare measure. The choice of modeling strategy for households consumption and savings in GreenREFORM is influenced by this. We want to have households in GreenREFORM that have both good short-term and long-term properties, and that are specified in such a way that an welfare measure can be derived.
The welfare objective used is a so-called Equivalent Variation measure (EV measure). The EV measure indicates, at a given shock to the economy, how many billion kroner households would need to receive in the base year to be indifferent to the shock. In this way, welfare effects are measured through many channels, such as price distortions and losses of various forms of income (wages, capital income, transfers, etc.). Any effects of the public sector’s financing method can be analyzed (higher taxes, increased public debt, lower public consumption, etc.).
An element that distinguishes the welfare measure in GreenREFORM from many similar measures is the calculated effect of changes in stock prices. In GreenREFORM, industries are modeled as corporations that finance their investments through a combination of debt and self-financing. The value of the industry’s share capital is measured as discounted future earnings. When the model is shocked, the stock price changes. In GreenREFORM, it is assumed that a share of the total share capital is owned by Danish households. The EV measure therefore measures the effect of these changes in stock prices on household welfare. This is a potentially important effect in a model that is built to calculate large shocks to the economy. If, for example, a tax almost closes down an industry, the capitalization effect of this will be measured in the welfare measure via this channel.