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Developing countries, border taxes & distributive justice

The following contains a global policy proposal for a climate change agreement – it is provisional and I welcome comments.

Developing countries are up in arms about demands – backed by threats of retaliatory tariffs or ‘border tax adjustments’ (BTAs) –  that they mitigate their Greenhouse Gas Emissions (GGEs). But BTAs can be implemented along with transfers based on emission entitlements to ensure both efficiency and distributive justice in dealing with GGE externalities.

This article from China Daily sets out (i) China’s attitude to the use of BTAs (as discussed in the previous post) to ‘punish’ countries which do not impose taxes on their greenhouse gas emissions (GGEs) and (ii) to the specific Provisions in the Waxman-Markey (W-M) bill propose doing just that after 2025:

“Developed countries’ proposals to impose ‘carbon tariffs’ on imports will violate WTO rules and go against the spirit of the Kyoto Protocol, the Ministry of Commerce said on Friday…..

The US, Canada and the European Union (EU) have put forward proposals to ‘level the playing field’ by raising import duties on countries not making the same effort.

The W-M bill, passed by the lower house of Congress on June 26, empowers the government to take action against trading partners that fail to meet US emission standards and thereby gain competitive advantage – but not before 2025.

‘If others don’t impose a cost on carbon, then we (some manufacturers) will be at a disadvantage … we would look at considering perhaps duties that would offset that cost,’ US Energy Secretary Steven Chu said. Carbon-intensive imports for the US include mechanical and electrical goods, steel, paper and aluminum-related products…..

Chinese officials and analysts said the US move was another kind of ‘trade protectionism’.”

There is justice to the Chinese claim that these taxers have unfair distributive implications though the claims of protectionism are only justifiable if the taxes set do not reflect unpriced GGEs. The claim that they are illegal under the Kyoto Protocol is an unusual one since these changes are envisaged to take effect well after that Protocol expires – indeed the taxes would not be imposed until 2025.

Setting taxes to internalise global externalities promotes global economic efficiency but can have adverse distributional effects on particular countries which standard economic theory suggest can be accounted for by means of compensatory lump-sum transfers.   If China and other developing countries are to be goaded into imposing carbon taxes then they should be compensated for this imposition given the vast inequalities* in income and per capita energy consumption levels between developed and developing countries.

Ignoring the myriad of computational issues that reflect the fact that outputs have diverse technological origins and utilise intermediate inputs there are two broad possible ways carbon prices can be used to introduce BTAs.

  • Destination accounting. One approach is to charge on a consumption basis – charging for or taxing GGEs on the basis of where the goods containing these emissions are consumed – the destination principle. Then exports of carbon intensive goods would all need to be subject to BTAs at the border of their destination. All imports would likewise be subject to a BTA on arrival in a country. Such things as free emission quotas given to exporters would have no impact on this arrangement.  Of course consumption-based taxes might be levied on domestic producers for ease of collection purposes but the intention is that their effective incidence falls on consumer. The destination principle implies a complex BTA regime since all imports containing GGEs would need to be subject to BTAs and the destination country would collect all of these taxes.
  • Origin accounting. The alternative approach uses production-based charges utilising the origin principle.  Now all outputs in an economy would be taxed given the carbon emissions they create.  There would now only be the need for BTAs if other countries did not charge carbon emissions on their exports appropriately – if for example they grandfathered exemptions from pricing foir exporters – in which case the country of destination would collect the revenue on exports. BTAs would have a more restricted scope than using destination accounting.

Whichever of these approaches is used – most countries seem to envisage origin-based accounting but many are moving to grandfather their exports – the latter would need to be responded to with BTAs by importing countries. Paradoxically the recent WTO-UNEP report endorses the destination principle so most imports would presumably be subject to a tax that was analogous to a consumption tax or excise:

“BTAs are considered by tax experts to be a means to implement in a government’s fiscal policy the “destination principle”, according to which goods are taxed in the country of consumption.  The overall economic objective of a BTA is to level the playing field between taxed domestic industries and untaxed foreign competitors by ensuring that internal taxes on products are “trade-neutral”.” (p.100).

Moreover with respect to a cap-and-trade scheme an endogenous carbon charge not a tax would be implemented:

“In such cases, importers would have to submit emission allowances or certified emission credits to cover the emissions created during the manufacturing process of the imported good; or they would be allowed to purchase allowances in the domestic emission trading markets on equal terms with domestic industries.” (p.101)

It seems strange to endorse the destination principle since literally this means that BTAs would be the norm on all imports rather than an exceptional policy measure taken when countries do not appropriatetely mitigate. Moreover, why would countries allow exports to be taxed in this way – if they levied the GGE charge themselves on all their outputs in accord with origin-based accounting they would collect the tax.

With a cap-and-trade scheme carbon charges would be market determined and would vary through time. They would also depend on the product definition, the specific technology used to produce the product and on the country which produced it. This is a far more complicated tax than a standard consumption or excise tax. A country may have as comparable emissions trading scheme but may grandfather exemptions to particular products it exports.

Ultimately world quotas on carbon emission levels need to be reduced over time so that sought-after GGE targets are hit. A modest target of the Garnaut-Stern type would be 550 ppm by 2050 but an environmentally preferred target would be 450 ppm. 

Getting countries to agree to BTAs might then be achieved by providing large shares of the gradually diminishing global greenhouse gas emission quota to poorer and emerging countries and to make this quota tradeable internationally in order to achieve a common carbon price or tax.  This would simply be a cap-and-trade scheme with international trade in quotas. Countries that did not levy the appropriate internationally-determined carbon charge would then be subject to border tax adjustments that reflected the going international carbon price.

The quota assigned to China for example might be consistent with China growing its energy use but at twice the going growth rate. Poorer countries like India might be given quotas that were initially at least more generous than this.

As per capita incomes and energy intensities converge closer toward those of developed countries shares of the aggregate quota might be split to equate per capita emissions.

China is currently pursuing policies that are broadly consistent with these emission targets but it seems resolutely opposed to a cap-and-trade scheme and levying emission charges. This article from China Daily summarises the current Chinese policy stance – it is cut the energy intensity of production so that Co2 emissions peak around 2035 at 8.8 billion tons, compared with around 5.5 billion tons in 2010.  From 2035 to 2050, emissions would remain stable or decline marginally.

It might be that key developing countries would accept the idea of BTAs by arguing that they would be compensated for their effects.  Developed countries could buy quotas from China and then, if desired, not use them providing incentives for better than planned GGE reductions. This might bolster some weak aspects of the modest 550 ppm targets embodied in the Stern and Garnaut reviews by providing additional incentives to cut emissions to lower steady state targets.

*Consider some emission facts: China is the world’s biggest emitters of CO2 (from fossil fuel burning) with aggregate emissions being 6 billion tons annually marginally eclipsing the US at 5.9 billion tons in 2008.   But the US has 6 times the per capita energy consumption.  China has 4.4 times the US population with 1.3 billion. Chinese per capita incomes (PPP) in 2008 were $5963 compared to US incomes of $46,859.

The same comparisons can be drawn with India with total population of 1.2 billion.  Its aggregate CO2 emissions are ‘only’ 1.3 billion tons – the fourth largest global emitter – but only one-sixteenth the per capita energy consumption levels of the US. Indian per capita incomes were $2762.

The third biggest emitter is Russia with population 102 million,  with aggregate emissions of 1.7 million tons and with 57 per cent of US per capita energy consumption. Russian per capita incomes were $15,922.

3 comments to Developing countries, border taxes & distributive justice

  • conrad

    “If China and other developing countries are to be goaded into imposing carbon taxes then they should be compensated for this imposition given the vast inequalities”……”Developed countries could buy quotas from China and then, if desired, not use them providing incentives for better than planned GGE reductions”
    Surely, if this did happen, it would increase unemployment (one of China’s pet hates), since it means China would have to get out of some dirty human-capital intensive industries, and they would end up with an even greater amount of foreign reserves, which they already have too much of (and would the industries simply shift to other countries like Indian which would produce stuff even less efficiently than China?).
    On a practical level, it also seems to me that most rich countries that matter at the moment are so broke, it’s hard see where they would get the money to buy carbon credits from poor countries anyway. Is the US government going to cough up $100 billion so that China doesn’t pollute as much, even though they already owe them a trillion? I don’t think so. I therefore can’t see that being a viable solution to try and cap the emissions of poor countries.

  • hc

    Conrad, China is actively promoting renewables and seeking to restrain growth in its emissions. This proposal would reward intensified efforts in this regard and might fund things such as non-carbon based sources of energy. Chinese emissions based on energy consumption are of the order of 6 billion tons of C02. Reducing this by 5% – roughly the assumed annual growth in Chinese emissions under say the Garnaut emissions proposal – would require reductions of 500 million tons. At a carbon price of $20/ton that would cost about $12 billion. This would not seem an impossible burden to keep China’s emissions constant. (My arithmetic deserves checking here!)

    It certainly does not look impossible.

    I am unclear how these transfers might be disbursed to consumers in China who would have to bear enhanced energy costs as a consequence of this charging.

  • conrad

    I’m still not clear whether pumping more money into China via this sort of scheme is really going to do anything.

    At a guess (you surely know better than me on this), I would think that China is already investing as much as it can into renewables (it’s certainly a high priority if you read the Chinese/HK papers), and that the reason we are not seeing more is that for their energy needs, they are already at point of diminishing returns, so any more money is not going to get used effectively. Surely, given their energy needs and the gargantuan pollution problems that already exist, which you have probably noticed trying to look at birds through smog, if there was a decent method for generating clean energy that was even close to the cost of coal, they would be trying to use it rather than building all these new power stations. Thus, what I think will reduce their pollution will be new technologies that allow really cheap energy production that will be developed in many different countries, and subsidies will really only affect their purchases of these at the margin.