|
Article Excerpt
"The U.S. must engage in an energy efficiency program that takes effect without delay and has meaningful bite. As long as developing countries can point to the U.S. as a free rider there will not be serious dialogue about what they are willing to do. I prefer carbon and/or gasoline tax measures to permit systems or heavy regulatory approaches because the latter are more likely to be economically inefficient and to be regressive."
--Lawrence Summers, former U.S. Treasury Secretary, currently Professor at Harvard University (from "Practical Steps to Climate Control," The Financial Times, May 28, 2007).
"Frankly, a Kyoto-type framework--one with global quantitative emissions targets allocated among countries ... is not feasible. The only approach that will fulfill the conditions and relieve countries' apprehensions regarding sovereignty and free riding is one in which all countries agree to penalize their carbon emissions in such a way that, over time, an internationally harmonized carbon price prevails. Consequently, the negotiation's focus would not be on emissions quotas but on the harmonized carbon-price trajectory.
Of course, carbon taxes (on burning fossil fuels) would provide the easiest way for countries to comply with the system, and each country could then decide what to do with the tax revenue. Some might make their carbon tax revenue-neutral by reducing other taxes. The regime would allow countries (or associations of countries such as the EU) to comply with the internationally agreed-upon carbon price by means of their own national cap-and-trade systems. It would also let poor countries move toward the agreed trajectory of carbon prices more slowly than rich countries.
If you're worried about climate change but don't like carbon taxes, think about the messy or even impossible alternatives!"
--Ernesto Zedillo, former president of Mexico, currently Director of the Center for the Study of Globalization at Yale University (from "Carbon Prices, Not Quotas," Forbes, March 24, 2008).
INTRODUCTION
There is widespread agreement on the desirability of a globally based effort to mitigate emissions of greenhouse gases (GHGs), particularly the primary gas, carbon dioxide (C[O.sub.2]), with the ultimate objective of stabilizing atmospheric GHG concentrations. (1) Of course, there is much dispute on how rapidly to scale back global C[O.sub.2] emissions. For practical policy purposes, however, the immediate issue is how to develop an international climate policy regime with a robust emission mitigation effort as its centerpiece, one that can progressively incorporate rapidly industrializing nations, and that can adjust over time as more is learned about the science, economics, and technological change that characterizes the climate change problem.
For mitigating GHG emissions, economists favor emission taxes and cap-and-trade systems. Most of the policy discussion has focused on cap-and-trade systems, with the introduction of the European Union's Emission Trading Scheme (ETS), and the emphasis on trading in most climate bills currently pending in the U.S. Congress. However, as the quotes by Secretary Summers and President Zedillo suggest, and we argue below, there is a potentially strong case for carbon taxes. The policy landscape is not void of carbon taxes, as evident by the use of such taxes in northern Europe since the early 1990s, the recently implemented carbon tax in the province of British Columbia, and a couple of bills in the U.S. House of Representatives. And even if additional governments do not implement C[O.sub.2] taxes in the near term, it is important to assess the possible case for transitioning to a tax-based system over the longer haul. Thus, it is critical to understand how to design a C[O.sub.2] tax at a domestic and international level, and compare its advantages and disadvantages with a cap-and-trade approach. Since--in the political discourse--cap-and-trade is often heralded as a market-based approach, it is worth noting at the outset that both systems are equally market-based, in the sense that their effectiveness relies in affecting market behavior through emissions pricing.
This paper begins by comparing C[O.sub.2] taxes and emissions trading from a domestic perspective across a broad range of criteria of potential concern to policymakers. (2) Next we briefly discuss some further issues in the practical design of a domestic C[O.sub.2] tax. Following that we turn to issues in implementing C[O.sub.2] taxes at the global level. We then offer some concluding remarks.
ISSUES IN THE CHOICE OF CONTROL INSTRUMENT--A DOMESTIC PERSPECTIVE
In choosing among alternative instruments, there is a wide array of criteria of potential concern to policymakers. These include cost-effectiveness, the ability to deal with uncertainty over emission abatement costs, and the incidence of the emission mitigation policy, particularly the distribution of costs borne by different household income groups and by industries. We discuss the appropriate stringency of domestic climate policy later.
Even evaluating policies on a single criterion alone can be tricky. For example, the overall cost and distributional impacts of C[O.sub.2] taxes depend critically on what the government does with the revenues collected from those taxes. Further, satisfying one criterion may limit the government's ability to address another criterion. For instance, using some C[O.sub.2] tax revenues to provide compensation to politically influential groups may raise the overall costs of the policy, by reducing revenues that might otherwise have been available for cutting other taxes that distort economic activity. Finally, comparing C[O.sub.2] taxes and cap-and-trade systems in their "pure" form does not do justice to the full spectrum of policy options. Policymakers may modify either instrument's design, at least to some extent, to exploit apparent advantages of the other instrument.
This section takes each of the major criteria in turn and discusses to what extent, if any, they imply a strong case for preferring C[O.sub.2] taxes to other emissions mitigation instruments, primarily cap-and-trade systems. (3)
Cost-Effectiveness
We start with cost-effectiveness, using the more traditional and narrow definition of cost that encompasses only changes in economic efficiency in the markets directly affected by the emission mitigation policy. This notion of cost essentially reflects the loss of benefits to fossil fuel users, less savings in production costs from reduced fossil fuel supply. Under this narrow definition, emissions taxes and cap-and-trade systems can essentially be viewed as equivalent instruments. This equivalency breaks down, however, when we account for abatement--cost uncertainty, and for how policies interact with the broader fiscal system (see below).
In the context of the narrow definition, cost minimization requires equating marginal abatement costs across all emission sources. Options include the following.
1. Switching to fuels with lower, or zero, carbon content. In the power sector, for example, this would involve substituting coal-fired generation with generation from natural gas, nuclear, hydro, wind and solar power.
2. Adoption of energy-conserving technologies to lower fuel requirements per unit of economic activity. In the transportation sector, for example, this would include incorporation of technologies to improve vehicle fuel economy. In the residential sector, it would include upgrading the efficiency of lighting, heating and cooling systems as well as adoption of more energy-efficient appliances.
3. Reducing overall demand for energy-intensive activities, for example, traveling less or living in smaller homes.
4. Sequestering carbon to partly offset emissions, through carbon capture and storage technologies at coal plants or other industrial facilities, and expanding forested land or modifying agricultural techniques to sequester carbon in soil.
In principle, when all firms and households face a common price per unit of C[O.sub.2] embodied in fuels and energy-intensive products, then no additional policies can lower the total cost of attaining a specified policy goal. These cost-minimizing conditions could be largely achieved under a C[O.sub.2] tax applied upstream in the fossil fuel supply chain, with corresponding tax credits for downstream sequestration. This tax, which would be levied in proportion to a fuel's carbon content, would be largely passed forward into the price of coal, natural gas, and petroleum products and, therefore, ultimately embodied into the price of electricity and other energy-intensive products. This Carbon Added Tax system, along the "carbon chain," would work much in the same way as a typical Value Added Tax under the standard credit-invoice system, along the value chain. (4)
The same efficiency conditions could also be met under an upstream cap-and-trade system, where firms require allowances to cover the carbon content of fuels they mine or process--with the market price of allowances established in permit trading markets. This price is then passed forward into fuel prices. With competitive markets, and appropriate crediting provisions for downstream sequestration, there is very little difference between emission taxes and cap-and-trade systems, in terms of the emission mitigation that they encourage. (5)
Direct regulatory instruments, like mandates to install specific emissions control or energy-saving technologies, or requirements on the performance of firm production, fail to meet the cost-minimizing criterion. Compared with a C[O.sub.2] tax or cap-and-trade system, and for the same economy-wide emission goal, some abatement opportunities are over-burdened under direct regulation, while others are under-exploited or not exploited at all. (6)
Implications of Abatement--Cost Uncertainty
Uncertainty over the future costs of emissions abatement is inevitable as costs will vary with fuel prices, the strength of domestic energy demand, unpredictable advances in energy-saving technologies, etc. Abatement costs, however, will also depend on the choice of emissions control instrument. C[O.sub.2] taxes fix the price of emissions and, therefore, the marginal costs of abatement, while allowing the quantity of emissions to vary with economic conditions. In contrast, a pure cap-and-trade system fixes the quantity of emissions, leaving marginal abatement costs to fluctuate with economic conditions.
From the perspective of maximizing expected economic welfare, C[O.sub.2] taxes have an advantage over cap-and-trade systems. C[O.sub.2] taxes and cap-and-trade systems both affect the flow of emissions, although it is the atmospheric stock of gases that drive climate change damages. The stock changes slowly, because of the long atmospheric residence of C[O.sub.2] (on average about a hundred years). For example, the Mauna Loa record dating to 1959 shows that atmospheric C[O.sub.2] concentrations grow about one to two parts per million (ppm) annually, on a pre-industrial base of about 270 ppm. Since global emissions in any given year have a proportionately small impact on the stock of C[O.sub.2], the marginal benefits of abatement are essentially perfectly elastic.
[FIGURE 1 OMITTED]
Figure 1 illustrates the potential welfare effects of ex ante efficient policies in this setting (based on Weitzman (1974)). [MC.sup.E] is the expected marginal cost schedule for emissions abatement, while MB is the marginal benefit from abatement. If marginal costs turn out to be higher than anticipated, [MC.sub.H], then the efficient amount of abatement is [Q.sub.H,] while if costs are lower than expected, [MC.sub.L], optimal abatement is [Q.sub.L]. A Pigouvian emissions tax of [T.sup.*], equal to marginal benefits, automatically generates these efficient abatement levels, regardless of the position of the marginal cost curve. In contrast, under a fixed emissions cap of [Q.sup.E], abatement will be excessive if marginal costs are higher then expected, or too low if marginal costs are lower than expected, resulting in deadweight losses, relative to the emissions tax, shown by the shaded triangles in Figure 1. In fact the welfare differences between carbon emissions taxes and cap-and-trade systems can be striking. For example, simulations in Pizer (2002) and Newell and Pizer (2003) find that a C[O.sub.2] tax could result in welfare gains up to five times those of the expectation--equivalent cap-and-trade system. (7)
Alternatively, if the policymaker aims to minimize the present discounted value of costs for limiting emissions released into the atmosphere over a long period of time, then emission taxes again have the advantage over cap-and-trade. An emissions tax rising at the rate of interest over time (net of the "depreciation rate" of atmospheric accumulations of emissions) will equate the present value of marginal abatement costs across different periods. In contrast, under a pure allowance system, abatement will be excessive (and allowance prices too high) in periods when meeting the fixed cap is more costly than average, while abatement will be too low in other periods when the marginal costs of meeting the cap are lower than average.
However, modifying a cap-and-trade system to incorporate some of the price-stabilizing characterizes of an emission tax can mitigate some of the welfare...
|
