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On carbon taxes vs. an ETS

John Quiggin recently (i) attacked consumption-based bases for levying carbon charges and (ii) defended cap-and-trade schemes against ‘equivalent’ carbon tax schemes.  On (ii) I don’t substantively disagree but on (i) I do. I responded on his blog. Here is an improved statement of my position.

John suggested firstly that endorsing a consumption-based set of charges was ‘defeatism’ since it amounted to assuming that other countries would not act to charge. My response is that other countries such as India and China – are not acting to charge and are unlikely to do so any time soon.  Moreover, they have so far suggested that they will not act soon – in China’s case up until 2030 or 2050. Despite some noises, India, which has vastly lower energy consumption/head than China, will probably respond equivalently or with even greater delays in controlling its emissions.

Of course if all countries did act equivalently in levying production-based taxes then so should we. There are then no carbon leakage issues either directly from trade or from footloose polluters.  In a world where a global emissions agreement based on production is endorsed I agree that a preference for production-based quotas is sensible.

But an advantage of a consumption-based charge in the world we live in can be transitional. If a consumption-based charge is levied then countries like China will face the price of their exports increasing by the amount of the border tax. But this tax will accrue to countries like Australia who import the goods. China would surely see the advantage of levying the tax itself.

Of course, as under the Waxman-Markey Bill, the border tax would be imposed whenever China did not levy internationally-comparable carbon charges on all its production not only the exported output so that incentives would be in place for China to tax all Chinese outputs. 

Indeed the incentives are for China to tax production itself and to urge Australia to do the same. Then we get to John’s (and indeed my) preferred scenario.  A production-based system is preferable longer-term since, in a uniformly-enforced consumption-based system, all carbon intensive imports would need to be taxed – no mean feat given differences in source country technologies and carbon intensities. I develop these arguments at greater length here.

A  carbon-based tax would generate much less revenue than a production based tax because Australia exports goods with a great deal of carbon embodied.  That is plausibly true but it would be interesting to do a calibration of the size of the discrepancy. Australia imports many carbon intensive final consumer and producer goods from China.  Of course, at the global level there is no difference in the revenues between production and consumption based carbon taxes.

In my view we should urge all countries to shift to production based taxes eventually by levying consumption-based charges now.  Countries such as China should be urged to levy charges on their own consumptions by providing compensations and finance to them (in income, technology transfer etc) from developed countries. In fact the offerings of technical assistance made under the Waxman-Markey bill and by the Europeans can be seen as a first step in this direction. Again see here.

On the issue of the choice between a cap-and-trade ETS and an ‘equivalent’ tax, like John I have been rather indifferent. It is obviously more important to get one of these operating than none. On balance I have gone for ETS for the standard reasons –a definite carbon emission outcome results.  But I think concerns about carbon price instability are of concern.

John Quiggin has argued in earlier posts that variable carbon prices can act as an automatic tax stabilizer which bites when the economy is booming but impacts less during recessions. I think that is so. But carbon prices are also a signal for what amount to large sunk investment decisions for firms. A lot of noise in these prices might lead firms to delay investments in carbon friendly technologies for quasi-option values reasons.  A power station thinking about an expensive carbon capture and storage retrofit that will be a huge burden if carbon prices wane might show increased reluctance to undertake the retrofit and may have incentives to delay action. That might be privately optimal but socially disadvantageous.

I worry too about the huge new created financial markets in carbon. Won’t these be subject to asymmetric information and insider trading issues from energy and power suppliers?

Finally, there are grounds for being somewhat pessimistic about the prospects for agreements at Copenhagen or soon thereafter. It may be that an internationally decentralized set of national taxes – with developed countries taxing most and developing countries taxing least – has greater chance of getting agreement among very different countries. This might be so even if the globally optimum is a global cap-and-trade with transfers.

6 comments to On carbon taxes vs. an ETS

  • […] of these operative than none. On equilibrise I hit absent for ETS for the … View post: Harry Clarke » On copy taxes vs. an ETS Posted in Uncategorized | Tags: choice, ets, for-the, get-one, have-been, have-gone, […]

  • There are two types of BTA: you can put a carbon levy on imports, or you can avoid putting a carbon levy on exports. A consumption based approach is more or less the same as doing both. Putting a levy on imports but not exempting exports has the advantage that the coverage of a carbon price is greater.

    Measures that link trade to mitigation of global warming are important because of the difficulties in getting cooperation to reduce emissions. It is easier to get cooperation on trade because a coalition that maximises its collective benefit on trade imposes a negative externatity on other countries; a coalition that maximises its collective benefit by reducing emissions more imposes a positive externality on other countries. By linking the two issues it could make a big difference for achieving cooperation.

    However, an international environmental agreement is unlikely to get very far if it is not fair. If high per capita emitters attempt to use trade to get developing countries that are low per-capita emitters to reduce their emissions, it could backfire. IMO we need to link trade with cooperation on global warming, but we also need to be very careful about how we do it.

  • hc

    Peter, My preference now is for a consumption-based tax (no taxes on exports, BTAs on untaxed imports) everywhere with lump-sum compensations to poor countries. That provides efficiency with equity. Once everyone moves go for production basis with same sorts of lump-sum compensations.

  • Harry, I do not have a detailed understanding of the debate, but with respect, you (and other economists) seem to be pretty late to the party with the concern that a floating carbon price makes long term investment decisions in “clean” technology very risky.

    This is surely a really fundamental issue. It’s of limited use having a system that sets a fixed goal but actually discourages the main way to get there.

    Of course, carbon taxes could also be open to variation over time, but at least before a government makes a major change, there is the possibility of debate about its effects. But with a floating carbon price, there is just perpetual uncertainty for the long term return on investments. Am I wrong somewhere in that reasoning?

  • hc

    Steve an ETS will minimise the costs of achieving a prescribed level of emissions control and will secure a certain emissions level. The debate about the tax alternative has surfaced because of doubts about Copenhagen.

    I have long supported an ETS but wavering a bit and listening to critics of an ETS. Either an ETS or a tax is, of vcourse, a mile better than doing nothing.

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