1. Introduction.   Carbon taxes and, more generally, taxes on greenhouse gas emissions, are a widely advocated means of reducing such emissions to address anthropogenic climate change – see, for [...]]]> I prepared these notes for a conference at Peking University, Beijing that I will be attending this coming Saturday. It is late in the day but comments are very welcome.

1. Introduction.   Carbon taxes and, more generally, taxes on greenhouse gas emissions, are a widely advocated means of reducing such emissions to address anthropogenic climate change – see, for example, Metcalf and Weisbach (2009).  I examine the positive and normative effects of a generic ‘carbon’ tax that covers the various greenhouse gases, with respect to its tax incidence and welfare effects including ‘double-dividend’ arguments.   I also consider the appropriate choice of carbon tax base – issues of the breadth of the tax are considered as well as whether it should be levied on a ‘destination’ or ‘origin’ basis in an open economy. Then I provide an evaluation of the case for a carbon tax rather than an emissions trading scheme. It is clear that although the analysis focuses on design issues for carbon taxes that many of the same issues arise with respect to emission trading schemes.  The discussion closes with conclusions and final remarks.

The advantages of using economic instruments over direct regulations to manage external costs are well-known and not discussed at length here.  The objectives of public environmental policy should not only be to restrict socially damaging carbon pollutions but, also, to do this at minimum cost, where cost includes the cost impacts of the tax and the costs of abating the pollution.  This cost information is often best assessed by the individual firms in an economy who can often make more economically efficient adjustments to priced carbon emissions than could a planner who sought to regulate these firms but who was unaware of their specific costs.  

2. Tax incidence and welfare consequences.  Carbon taxes on the burning of fossil fuels are typically motivated as measures to internalize the climate change externalities associated with carbon emissions.  Consider their role in a stylized market where a good – for specificity take the empirically-important case of ‘electricity’ – is produced using a mix of more or less carbon-intensive technologies and then sold to consumers and firms.  Suppose the market is competitive.

If the demand for electricity is D and, given the marginal private production costs (MPC) and the absence of any carbon tax or other restriction on carbon emissions, quantity E₁ of electricity is sold at price P₁.  As this electricity is produced, marginal social costs (MSC) arise comprising the MPC incurred by resident producers plus the external social costs, borne both by residents of the economy and by those living elsewhere in the world. The pollutants are an externality but they are also a global ‘public bad’ because the CO₂ released into the earth’s atmosphere as a consequence of burning fossil fuels contributes towards damaging climate change.  These social costs are difficult to assess accurately because it is known that the emissions potentially pose the threat of a catastrophic non-marginal social costs (Weitzman, 2009). Yohe et al (2007) provide an estimated average of marginal social cost of carbon at $43/tC but this estimate has the large standard deviation of $83.  These substantial uncertainties motivate some to determine taxes that will meet carbon reduction targets although there then emerge uncertainties about how various tax rates will impact on emissions.

A consequence of the external costs is that, from the viewpoint of optimizing the difference between local private benefits and global costs, electricity production E₁ is socially excessive and is sold at an excessively low price P₁.  A measure of the deadweight losses associated with this excessive production is the triangle marked DWB.

The classical Pigovian approach to eliminating these deadweight losses is to levy a tax T on electricity production which raises the PMC experienced by electricity producers to MSC.  This increases prices from P₁ to P* = P₁+T and reduces electricity production to E*. Imposing this tax provides a welfare gain to the society in the sense that the global deadweight losses, DWL, are eliminated.

It is not necessary to suppose that different production technologies here have the same carbon emissions intensities so that they therefore face the same emission costs.  Firms with CO₂ abatement technologies will abate to the point where marginal abatement costs equal the optimal emission tax so that, across firms who continue to produce, marginal abatement costs will be equated guaranteeing economic efficiency – the socially desired level of output E* will be met at minimum cost.  Firms without abatement technologies will go out of business if their output is redundant to demands met at the tax-inclusive price by lower cost producers.

Seven comments:

(i)  For this analysis to plausibly describe the gains from an activist tax policy, residents of the society considered must value the gains enjoyed by the world as a whole from carbon pollution reduction.  In short, tax revenue gains from such a policy are not by themselves sufficient to compensate for the reduced production and consumption surpluses experienced as a consequence of the tax – apart from the environmental gains there is an excess burden from this tax.  The reduction in unpaid social costs as a consequence of the tax however exceeds the excess of surpluses lost over revenue gained if and only if residents attach positive value to the deadweight losses DWL that are experienced globally.

This is simply recognizing that the external costs here accrue to residents and, for a small open economy, primarily to the rest-of-the-world.  To include them in a particular country’s social welfare function requires first the assumption that the CO₂ emissions are in fact damaging. It also supposes either some degree of altruism towards the world at large or perhaps the objective of adherence to a target specified by a global agreement that seeks to address global emissions.

Once these external costs are recognized by citizens the externality tax itself implies no deadweight losses – it instead reduces socially damaging behavior to efficient levels.   Therefore revenues can be used to cut other taxes which are distortionary providing what, at first sight seem to be, a ‘double dividend’ benefit as discussed below.

(ii) In a closed economy it makes no difference, from the viewpoint of tax incidence, whether the tax on electricity consumption is levied on consumers or producers.  Then the division of the burden of the tax between the economy’s producers and consumers depends on the price elasticities of demand and supply for electricity not on the nominal incidence of the tax.  The effective incidence of the tax is borne primarily by electricity producers if the absolute value of the demand for electricity is much more elastic than supply – this is likely to be the situation in the short-run – whereas it is borne primarily by consumers in terms of higher prices if supply elasticities are much greater than the absolute value of demand elasticities as is likely longer-term.

The relative size of these elasticities is an important issue in determining who should receive income or other compensations for the impact of the tax.  Again if demand is relatively inelastic then compensations should be directed to consumers whereas, if supply is relatively inelastic, it is this sector that suffers most from the tax impact and hence suppliers might plausibly be considered for compensation.

The irrelevance of the nominal incidence of a tax breaks down in an open economy where consumption and production of outputs may arise outside an economy. This is discussed below.

(iii) Longer-term supply effects on supply will be more pronounced than short-term effects.  Longer-term there will be switches between existing technologies towards those which are less carbon polluting and incentives to innovate new low carbon intensity technologies.  Indeed the current and future tax-inclusive prices of output delivered using carbon-intensive technologies will be a key informational requirement in establishing the commercial viability of new long-lived technologies. The competitiveness of renewable technologies and nuclear power as well as carbon capture and storage technologies becomes easier to assess once carbon taxes are in place.

Longer-term both supply adjustments and demand shifts will help an economy adjust away from carbon-intensive technologies.

(iv) Capital stocks used in activities, such as electricity generation, are long-lived creating a time-consistency issue for those designing carbon taxes in market economists with populist elected politicians.   In short, firms using such capital stocks are subject to ‘hold-up’ by these politicians who, they will understand,  have incentives to first introduce carbon taxes to drive the commercialization of low-carbon-intensity technologies and then, once this is done and shifts toward low carbon intensity technologies have been made, to cut such taxes to win public approval.  Firms who understand this may be reluctant to make the substantial new investments required.  This difficulty needs to be addressed by setting up independent institutions with the authority to credibly commit to carbon taxes longer-term.  Alternatively, the capital investments required can be publicly supplied so that the costs of potential ‘holdup’ are internalized.

 (v) Carbon taxes will impact on resource markets – directly on markets for carbon-based fuels and indirectly on the demand for substitute resources such as nuclear fuels, solar power and their complementary capital resources.  Demands for carbon-intensive fuels will decline and there will be increased demands for the substitute resources and the substantial capital stocks they need to draw on as well as reduced demands for inputs complementary to the burning of fossil fuels.  Overall there should be a substantial increase in demands for capital in the power generation sector that should impact on the global cost of capital resources. In general these types of intersectoral effects are particularly important in open economy contexts as will now be discussed.

(vi) A key issue concerns how taxes are initially enacted and how they are subsequently adjusted to reflect tighter emission targets and also new information about the costs of carbon emissions and of abatement.  Should taxes be gradually introduced from low levels and on a narrow tax base with many producers protected by ‘grandfathering’ provisions or should the economy be exposed to distinctly high taxes on a broad base ‘cold turkey’?  Once taxes are introduced their value should increase at the rate of return on capital since their effects are broadly similar to quotas established under an emissions trading scheme and, for such quota assets to be held, their values must increase at the same rate as other capital assets.  Metcalf and Weisbach (2009, p17-22) argue for ‘cold turkey’ policies that will motivate firms to begin making adjustments now.  With respect to the impacts of new information significant abatement opportunities involve long-term investments so that tax rate revisions on the basis of new information do not need to occur frequently.

(vii)  Carbon taxes are often advanced with unrealistic objectives of revenue neutrality objectives.  In fact public revenue needs may change when such taxes are introduced because of the need to compensate workers displaced from certain carbon-intensive industries and because of the need to fund public investments in R & D.

The detailed impacts of imposing carbon taxes on an economy are complex given spillover effects onto both consumer and factor markets.  The best way of accounting for such effects is by using computable numerical equilibrium models which account for intersectoral linkages.  Such models can account for the effects of spending the tax revenues received in various ways. For example, an issue is whether using such revenues to cut other distortionary taxes in the economy – such as income or excise taxes – will provide additional gains in the form of ‘double dividend’ benefits  (Fraser & Waschik, 2010).  There are no simple answers here so empirical analyses are essential. Using carbon tax revenues to cut other excises could have indirect effects in increasing the demands for polluting goods.  Imposing carbon taxes reduces the real income of workers thereby, by itself, increasing the distortionary effects of income taxes on labor (Sandmo, 2009, 17-18).

3. Choice of a tax base.  The choice of a tax base involves choosing the optimal breadth and coverage of the tax as well as whether to tax producers or consumers.  The breadth issue involves trading off the benefits of increased inclusiveness against administrative and collection costs.  In countries such as the US it is estimated that, by collecting carbon taxes upstream, 80 per cent of emissions can be covered by taxing fewer than 3000 taxpayers and that 90 per cent can be covered at moderate cost (Metcalf and Weisbach, 2009).  This concentration is due to the 80 per cent contribution of energy use in US emissions.   Globally energy plays a smaller percentage role in total emissions because of a more significant role for land use changes, especially deforestation, and agriculture in stimulating emissions in developing countries. Ways of including forestry and agriculture in the tax base are of particular significance for developing countries.

The benefits from a broader tax base include the greater revenues yielded which reduce the costs on individual firms taxed under a narrower base.  The offset is the greater political opposition that a broadly-based tax is likely to generate despite the lower tax impacts.

In a closed economy setting the choice between taxing producers and consumers is largely irrelevant but in an open economy – where a country can buy or sell outputs from another and where capital resources are mobile and hence can relocate internationally – it matters profoundly.  The analysis to follow makes particular sense for industries other than the electricity sector which typically produces a non-internationally traded good.  It applies, for example, to steel, cement or alumina production – for specificity take the case of steel.

Steel exports from a country which taxes its carbon emissions will face higher costs, on this account alone, compared to production from countries which do not mitigate emissions. Such exports face a competitive disadvantage in international markets simply because globally desirable carbon mitigation objectives are being pursued.  Similarly, the competitiveness of locally-produced steel in a local market will suffer if carbon emissions are taxed locally but not in countries supplying competing steel outputs.   In each case the products of countries taxing emissions will experience a competitive disadvantage as a consequence of the tax compared to the products of countries which do not.  In addition, firms in a country subject to carbon taxes may have incentives to relocate to countries without such a tax – to relocate to ‘pollution havens’.

These phenomena are instances of ‘carbon leakages’ since the output diversions and the relocations mean that carbon pollutions simply shift towards countries which do not tax such emissions.  The resulting carbon pollution shifts from a point where it is taxed to where it isn’t and the countries which do mitigate lose industrial employment and output as well as facing costly structural readjustments without a global environmental improvement occurring.

The empirical extent of such leakages is the subject of considerable controversy – for many industries the cost increases from a carbon tax are small because energy costs are a small fraction of total costs. In other cases such as transportation and electricity, which are energy intensive, carbon leakages are irrelevant because the goods or services are not internationally traded.  In a few key sectors – steel, aluminum and cement – leakages are likely to be important. Babiker (2005) argues that, indeed, such leakages may be greater than 100 per cent of their original levels.

 This said it cannot be denied that the notion of significant leakages does discourage some developed countries from actively moving towards carbon pricing. For example, the United States refused to ratify the Kyoto Protocol largely because developing countries were not obliged to mitigate their emissions under it. The US saw loss of competitiveness and carbon leakages as an important issue.

Clarke (2009) has suggested taxing carbon emissions on a consumption (or carbon destination) basis rather than taxing the emissions on a production (or carbon-origin) basis. In short, one taxes goods that involve carbon emissions in their production on the basis of where they end up being consumed – their destination – rather than where they are produced – their origin.  This means that carbon-intensive exported goods are exempt from taxes while imports of carbon-intensive goods must be subject to border tax adjustments which make their tax treatment consistent with that of locally-produced goods.

The issue of designing an open economy tax base is difficult.  Metcalf and Weisbach (2009) argue for a modified destination basis but without tax exemptions for exports (ibid, p24) because such exemptions would lead to a diversion of output to exports thereby creating leakages (ibid p53). The standard way of providing such compensations however is to make them lump-sum which protects the incomes of exporters.  In addition, Metcalf and Weisbach argue that taxes on imports from countries which do not mitigate would punish countries that didn’t mitigate by leaving them disadvantaged.  That is not clear – countries which hold out in the face of mitigation efforts by others may gain residual leakage benefits by being shorter on the list of possible ‘pollution havens’ (Clarke, 2010 forthcoming).  

There are however several advantages from a pure destination-based scheme compared to a pure origin-based scheme:

(i)  The use of border tax adjustments levied on imports of untaxed carbon-intensive goods seems consistent with the rules of the GATT-WTO which generally disapprove of taxes on traded goods (Taniotti et al., 2009). 

(ii)  Adverse competitiveness effects due to carbon leakages from countries which tax carbon emissions to those which do not are eliminated. Exports are exempt from taxes, the competitiveness of local taxed carbon-intensive goods are secured by the border tax adjustments and firms have no incentive to relocate from countries which do mitigate to non-taxing countries in order to export to the countries which do mitigate – ‘pollution havens’ become less relevant.

(iii) Incentives for non-mitigating countries to mitigate are enhanced at least to the extent that carbon tax revenues now accrue to them rather than to countries which impose destination-based carbon accounting on their untaxed imports.

(iv) There are improved incentives for countries, such as the United States, to unilaterally mitigate their emissions given their past reluctance to do so based on a cost-benefit analysis of the consequences of unilateralism given prospects of carbon leakages.  Paradoxically, while features such as border tax adjustments are viewed negatively by developing countries such as China and India, they provide advantages to countries which will suffer great harm from climate change and which would gain national advantage were developed countries, such as the United States, to mitigate because they became less fearful of the consequences of unilateral carbon charging for their national competitiveness.

The major disadvantage of selecting a consumption tax base is that it leaves untaxed carbon-intensive exports from mitigating to non-mitigating countries. Since these products will then face reduced demands in their country of export – petroleum and coal exporters which tax on a consumption basis will demand less of such fuels themselves – the net outcome will be an improvement in the terms of trade for carbon importers given induced price falls of such commodities.  This is a type of global macroeconomic carbon leakage that reflects the fact that concerted action to mitigate by fuel exporters will reduce the price of such fuels in countries which do not mitigate their emissions.

This might not be a decisively adverse implication of destination accounting.  The use of this accounting can be viewed as a precursor to fully-fledged, origin-based accounting which is certainly a long-term ideal since, if uniformly implemented, it removes the need for costly border tax adjustments and high transaction cost, export-rebate exemptions.   Computing border tax adjustments is non-trivial since the adjustments are country and technology specific. For example, it would not make sense to impose a border tax adjustment on imported alumina that was produced using non-polluting hydro-power.  Similarly exempting exports is complex since such exemptions cannot be ad valorem without inducing a switch from production for domestic to production for export again creating a basis for leakages.  Provisional use of a destination-based system might encourage imitative mitigation efforts and ultimately a switch to a global origin-based system.

4. Carbon taxes versus emission trading schemes.   There are distinctive and complex issues that affect the choice between carbon taxes and an emissions trading scheme (ETS) in open economies. Hence the issue is first discussed in an idealized closed economy – one not involved in international trade – and this is then followed by the case of open economies.

In a closed economy control of carbon emissions can be realized by a tax on carbon emissions or by a quota on total emissions per period which can be freely traded.  It is  always possible to select a carbon emissions quota which, assuming market conditions remain stable, will realize the level of emissions realized with any carbon tax.  

An ETS involves initially allocating the aggregate quota in some way to carbon emitters and then allowing it to be freely traded in an emissions market.  Those who value the quota most will pay most for it so it should end in its highest value use thereby realizing economic efficiency.  If the carbon quotas are initially auctioned to the highest bidding emitters then, again abstracting from uncertainty, the fiscal implications of an ETS are identical to the corresponding carbon tax – ignoring differential collection and administrative costs both policies yield identical revenue.  Under these conditions the choice between a carbon tax and an ETS is of second-order importance.  The important issue is to control emissions and each of these approaches yields the same outcome.

The analysis changes if policy-makers are uncertain about demands for carbon emissions because of uncertainty over production costs or the demand for carbon-intensive outputs.  If a carbon tax is set with uncertain demands or costs then the resulting extent of emission control becomes random and the achievement of exact emission targets unlikely.  If, alternatively, a particular quota is set but the demand for output is uncertain then the equilibrium carbon price becomes random.  The question then becomes which type of uncertainty is preferred.

Some claim that a randomly varying and highly uncertain carbon price makes it difficult for those seeking to commit to long-lived and irreversible capital investment decisions. It might also promote increased short-term volatility in energy prices creating the potential for poor decisions and suggesting a case for a fixed carbon tax.  This claim can be overstated since there are opportunities to hedge carbon price uncertainty in futures markets and the viability of long-lived investment projects depends on long-term carbon price trends rather than short-term fluctuations.  In addition, if the price variability reflects the health of the macro-economy – with carbon prices being lower in recessions and higher in booms – then price variability has the desirable feature of acting as an automatic economic stabilizer with charges rising in boom periods and falling back during recessions. 

Protection against very sharp carbon price hikes following unexpected surges in fuel demands – for example those that might occur as a consequence of a cold northern hemisphere winter – can be addressed using dual tax-cum-emission trading schemes.  Here an ETS operates under normal conditions but a price-ceiling is set for emission permits with a government agency being prepared to stand in the market to deliver unlimited emission quotas at the ceiling price.

There is also a fear – partly induced by evidence of ethical misbehavior in financial markets during the recent GFC – that futures markets in carbon prices might be subject to manipulation via insider trading by those, for example, involved in the power generation sector. Taxes are also seen as a more flexible policy instrument that is less vulnerable to evasion and corruption (Shapiro, 2007).

Another claim is that setting carbon taxes offers lower potential for special interest groups in market economies to make claims for special treatment in terms for free or generous quota allocations under an ETS that would not occur with a tax.  This seems unproven since the same interest groups can equally well argue for tax exemptions. Generous free quota allocations transfer wealth between different groups in an economy but do not undermine the environmental efficacy of an ETS, as well as the potential for the scheme to be revenue neutral by offering compensations, but it is not clear that similar costly defects will arise from selective tax exemptions.

An argument sometimes advanced for an ETS rather than carbon taxes is that carbon quotas sold have value as assets in the hands of their owners. These owners would defend such a scheme in order to preserve such value thereby improving the longer-term credibility of an emissions control scheme.   This again seems unproven since governments have shown themselves to be reluctant to abandon lucrative tax bases such as fuel excises.

The case for targeting emission levels via an ETS is mainly that it assures a certain level of emissions control. This is of particular concern in an international setting where countries agree to target a certain emissions cut as part of a comprehensive agreement.   Climate scientists know the level of global cuts necessary to offer high confidence of achieving certain desired climate targets. For example the widely-advocated target of restricting warming to 2^oC means that a global climate agreement must provide an arithmetic framework for achieving such reductions by aggregating agreed on cuts by individual nations.

In an integrated world economy there are distinctive arguments for and against an ETS alternative to carbon taxes.  Two arguments have particular merit: 

(i) An ETS permits global distributional fairness. With an ETS there is the important advantage of being able to allocate carbon emission quotas internationally to reflect the different development needs of nations while retaining efficiency in emissions reduction.  A major concern of developing and emerging countries is that they currently have low levels of emissions per capita compared to developed countries. A claim by countries, such as China and India, is that they should be entitled to increase their aggregate emissions – coupled with substantial energy intensity reductions – to a point where their per capita emissions and energy consumption levels are comparable with developed countries.  This objective is consistent with an ETS provided that an asymmetrically large level of emission quotas is given to developing countries for a transitional period while their energy consumption levels are catching up to those of developed countries.

Because emission quotas are valuable assets this is essentially a resource transfer from developed to developing countries.  Substitutes for such a resource transfer could, alternatively, be income transfers or low cost access to new low carbon intensity production technologies from developed countries.

The desired size of the transfers here is bounded by the requirement that all countries should enjoy welfare gains from jointly mitigating emissions after paying or receiving transfers. This rejects the views of Bhagwati (2010) and others who claim that compensations must be paid to developing countries on the grounds that the cumulative emissions of the developed countries were very large and now it is the turn of the developing countries to enjoy the same entitlement.   This argument is factually questionable  – when changes in land use is also taken into account, the developing regions of the world have actually been responsible for some 45 per cent of total carbon dioxide emissions since 1850 (Houghton, 2008) and, even were this not so, past emissions imply no culpability when damages were then not recognized. In addition, most of the polluters who caused these damages are deceased.  The issue is not compensation for past misdeeds but to devise a comprehensive, collective, international agreement where all participants will gain.

(ii) Traded international carbon quotas can drive cost efficiency.  If quotas are internationally tradable then developing countries have incentives to rely on low carbon technologies and to sell unused quotas in international markets.  This can yield further efficiency gains. With enough trade in such quotas their price will be driven to equality internationally suggesting that emissions reductions will be occurring in areas where they can be achieved at lowest cost – such trade has been estimated to reduce the costs of emissions reductions by 20 per cent (Tony Blair and Associates, 2009). Emissions reductions would then be achieved with global economic efficiency.

A carbon tax can be set differently in different countries to accommodate distinct national circumstances but, if this is done, global emissions reductions efforts are necessarily inefficient since different carbon prices will prevail in different countries. That carbon emissions are being valued differently in different countries implies foregone opportunities to trade and hence economic inefficiency.  Nordhaus (2006) proposes harmonized taxes across countries with income compensations or technology transfers from wealthy to poorer countries and with complete exemptions for very low income countries but seems to offer no mechanism which determines the requisite scale of the transfers. 

The advantages of international trade in carbon emission quotas to reduce the global costs of emissions reduction have been questioned.  An additionality requirement for such trade to improve efficiency is that when a quota is purchased a corresponding emissions reduction must occur on the part of the vendor and that this reduction would not have occurred in the absence of an ETS.

The issue of verification of emissions reductions proved to be a stumbling block in the recent Copenhagen negotiations. In particular neither China nor India agreed with the United States on verification procedures.  The notion that emissions reductions are not reductions that would have occurred without free trade and an ETS is a well-recognized difficulty of the Kyoto Protocol approved current Clean Development Mechanism.

5. Conclusions and final remarks.   Carbon taxes are Pigovian taxes which seek to address the global costs associated with carbon emissions.  They have significant effects on markets for goods which utilize carbon-intensive inputs and on markets for these inputs themselves as well as substitute and complement inputs.

The choice of a carbon tax base is of importance in an open economy where carbon leakages can arise.  Leakages associated with loss of competitiveness of a mitigating country’s exports and its import-replacement sectors as a consequence of carbon taxes can be offset by using a consumption or destination basis for taxing – by exempting exports from taxation and by imposing border tax adjustments on untaxed imports.  This also reduces the incentive of firms to relocate to pollution havens compared to the case where origin accounting is used.  A difficulty with using a consumption basis is that by reducing mitigating country demands for carbon-intensive outputs it reduces the prices of such goods thereby inducing general macroeconomic carbon leakages in non-mitigating countries.

The case for using a carbon tax is often contemplated with an ETS alternative in mind.  There are various arguments for each policy approach but a strong advantage of an ETS over a carbon tax is that it facilitates the assignment of reduced mitigation obligations on developing countries while still being consistent with economic efficiency.  In addition if carbon quotas are internationally tradeable it reduces the global costs of mitigating emissions.  A difficulty of trading global carbon quotas lies in verifying the bona fides of actual deals.

To many the key issues of concern in the climate change debate are those of securing a workable global environmental agreement rather than specific concerns over design of a carbon tax or use of an alternative policy such as an ETS. There has been a neglect of such international strategic issues in the preceding discussion.  However there are important implications of carbon charging design for broader issues of negotiating such an agreement.

The strategic implications of appropriately selecting a carbon tax base seem to be a particularly important issue. A key issue is the additional incentives it offers developed countries to unilaterally mitigate their emissions. In addition, an integrated international carbon emissions market offers cost savings which can be shared among all participants and also can be designed to protect the legitimate development objectives of emerging economies.

 References

M. Babiker, 2005,’Climate Change Policy, Market Structure and Carbon Leakage’, Journal of International Economics, 65, 421-455.

J. Bhagwati, 2010, ‘A New Approach to Tackling Climate Change’, Financial Times.com, February 22, 2010. Online at  http://www.ft.com/cms/s/0/c9ee09b0-1fe7-11df-8deb-00144feab49a.html.

Office of Tony Blair (2009), ‘Breaking the Climate Deadlock: Cutting the Cost – The Economic Benefits of Collaborative Climate Action ’. University of Cambridge, September.

Online at  http://blair.3cdn.net/16ee85353ed6f87d1f_uem6iykby.pdf

H. Clarke (2009a), ‘Carbon Leakages, Free Riders and International Climate Change Agreements’, mimeographed, 2009.

H. Clarke (2010), ‘Trade Policy and the Global Environment’, Surveys and Perspectives Integrating Environment and Society, forthcoming.

H. Clarke (2010b), Strategic Aspects of International Climate Change Agreements, Australian Journal of agricultural and Resource Economics, forthcoming June. 

R.A. Houghton, 2008, ‘Carbon Flux to the Atmosphere from Land-Use Changes: 1850-2005’ in TRENDS: A Compendium of Data on Global Change. Carbon Dioxide Information Analysis Center, Oak Ridge National Laboratory, U.S. Department of Energy, Oak Ridge, Tenn., U.S.A. Online at

 http://cdiac.ornl.gov/trends/landuse/houghton/houghton.html.

G. Metcalf & D. Weisbach, 2009, ‘The Design of a Carbon Tax’, University of Chicago Law & Economics, Olin Working Paper No. 447, University of Chicago, Public Law Working Paper No. 254,  January.  

 W. Nordhaus, 2006, ‘After Kyoto: Alternative Mechanisms to Control Global Warming’, American Economic Review, 96, 2, 31-34.

R.J. Shapiro, ‘The Carbon Tax: The Alternative to Carbon Trading’, Growth, 59, November 2007, 66-75.  Online at:

http://www.businessspectator.com.au/bs.nsf/Article/The-great-carbon-debate-8XBYH?OpenDocument

A.. Sandmo, ‘The Scale and Scope of Environmental Taxation’, Discussion Paper SAM18, Department of Economics, Norwegian School of Economics and Business Administration, October, 2009. 

L. Taniotti, A. Olhoff, R. Teh, B. Simmons, V. Kulacoglu & H. Abaza, 2009, Trade and Climate Change: A Report by the United Nations Environment Programme and the World Trade Organisation,  UN and WTO, Switzerland.  Online at:

http://www.wto.org/english/res_e/booksp_e/trade_climate_change_e.pdf

I. M. Fraser & R. Waschik, 2010, ‘The Double Dividend Hypothesis in a CGE Model: Specific Factors and Variable Labour Supply’, La Trobe University Working Paper.

M.L. Weitzman, 2009, ‘The Extreme Uncertainty of Extreme Climate Change: An Overview and Some Implications’, mimeographed, October.  Online at:

http://www.economicsclimatechange.com/2009/12/extreme-uncertainty-of-extreme-climate.html

G. W. Yohe,  R.D. Lasco, Q.K. Ahmad, N.W. Arnell, S.J. Cohen, C. Hope, A.C. Janetos and R.T. Perez, 2007, ‘Perspectives on Climate Change and Sustainability’ in M.L. Parry, O.F. Canziani, J.P. Palutikof, P.J. van der Linden and C.E. Hanson (eds) Climate Change 2007:  Impacts, Adaptation and Vulnerability. Contribution of Working Group II to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge, UK,  811-841.

Major issues are defeating the forces of denialism in the [...]]]> While many have devoted time and effort trying to predict what will come out of the Copenhagen meetings I have largely elected to wait-and-see.  Even that is difficult – this article from Bridges I found useful. It is the first in a series and I will update.

Major issues are defeating the forces of denialism in the US and reconciling the ‘common but differentiated responsibilities’ of developed and developing countries while not destroying agreement edfficiency.  Many of these issues relate to trade and trade policy.  

My attitude has remained fairly constant on these issues for some time. In essence I endorse orthodoxy.  I favour strong emissions controls in all countries with compensatory transfers of emission permits to developing countries.  Emissions permits should be traded in an international market based on a countries greenhouse gas emission consumption so border taxes on imports from countries without mitigation measures in place are essential.

“The evidence [...]]]> The hacked emails from the University of East Anglia on climate change – a good survey of the material is here - have been enthusiastically – though unconvincingly – used to support climate change skepticism.  In my view the hack is a non-event. The NYT has a sensible summary of the implications of this material:

“The evidence pointing to a growing human contribution to global warming is so widely accepted that the hacked material is unlikely to erode the overall argument. However, the documents will undoubtedly raise questions about the quality of research on some specific questions and the actions of some scientists”.

Much of the critical comment seems to revolve around what is seen as attempts to conceal the claimed fact that ‘warming stopped in 1998’.  The decade following 1998 was the warmest since temperature measurements have been recorded so this is a ridiculous claim.  I have documented the promulgation and demolition of this particular fallacy before.   In essence temperatures have continued to rise on average but are subject to considerable year-to year variability. And that is it – the supposedly wicked leaked emails on this issue merely reflect this fact!

Joe Romm at Climate Progress summarizes the implications of this inconsequential event although I think his attack on the NYT article is over the top – it is a factual news report.

The CPRS is an Emissions Trading Scheme.  Depending on the type of agreement reached in Copenhagen in December Australia has agreed to unconditionally cut its carbon emissions by 5% by 2020 which is equivalent to a 27% reduction in per capita terms. [...]]]> This is the basis of remarks I made to Red Symons today on 774 Melbourne ABC.

The CPRS is an Emissions Trading Scheme.  Depending on the type of agreement reached in Copenhagen in December Australia has agreed to unconditionally cut its carbon emissions by 5% by 2020 which is equivalent to a 27% reduction in per capita terms. There are conditional targets to cut by much more if the rest-of-the-world agrees to do the same – so if the world targets a 450 ppm GGE target Australia will cut its emissions by 25%.  

The CPRS will come into operation in July 2011 though, through to July 2012, there will be a fixed price of $10 per tonne CO₂.  After July 2012 permits to pollute greenhouse gases will be auctioned to the highest bidder.  These emission permits will be in restricted availability so they should sell for $23 per tonne in 2010 with a 5% 2020 target. 

These permits will be sold to businesses which emit more than 25,000 tonnes of CO2 annually – about 1,000 in all or 75% of Australia’s emissions.  This will be a cost to these businesses some of which will be absorbed by firms and some of which will be past onto consumers.

At $23 per ton the overall effect on the CPI will be about 1.1% with much of this effect concentrated on electricity and other energy prices.  Electricity prices should rise by around 20% in first 2 years of scheme.

Consumers will be compensated for income losses sustained because of the CPRS will be more than compensated via reduced tax payments provided their incomes are not large.  For example, a couple earning a single income with 2 kids will be more than compensated provided their income does not exceed $100,000.

The agricultural sector has recently been permanently exempted from the scheme but cansell carbon credits.

Trade-exposed businesses that are emissions intensive gain a growing stock of emissions permits through time.

The idea is to provide signals to consumers and firms regarding the damage their carbon–based energy consumption is doing to the environment and to provide incentives to cut back on such energy use.  Households will have incentives to use energy smart appliances and insulate their homes.  Electricity producers will have incentives to provide non-fossil-fuel based electricity or to use fuels such as gas with lower carbon emissions.

Gradually the permissible level of emissions will be reduced. The government has committed to a reduction of 60% by 2050 but the reduction needs to be greater than this if we are to cut our emissions in a way that is consistent with the world limiting its emissions to 450 ppm.

It is 20 days until the Senate vote on the CPRS and 31 days to the meetings in Copenhagen.  The deceptions coming from the Liberal and National [...]]]> Rudd lets the Coalition have it and he is correct. An excellent speech – to the point and accurate – with sound economics – I have a strong intuition about who wrote it.  

It is 20 days until the Senate vote on the CPRS and 31 days to the meetings in Copenhagen.  The deceptions coming from the Liberal and National Parties, the lies told by the IPA and the other delusionists, that have reached a crescendo in recent weeks, are designed to prevent national and international deals on climate change.  The protagonists in these debates exclude practising climate scientists and include a mix of suckers and fools who deserve contempt more than sympathy. Nor is it useful – or a successful evasion – for some of them to say that they agree AGW is a problem but then to deny every attempt to deal with it.  It is a fact that many in the Liberal Party only support moves to deal with AGW because they see votes in it – I have heard these sentiments directly myself. (Update: Many like Nick Minchin are outright denialists. Watch Malcolm and the Malcontents on Four Corners tonight for an update).

Climate change is a problem that 4,000 principled IPCC scientists recognise and one that can be addressed at relatively low cost. It would be irresponsible to avoid taking action now.  There is no credible evidence from denialists or sceptics that negates the core science claims and procrastination has continued for too long.  As Rudd argues:

‘Climate change skeptics in all their guises and disguises are not conservatives. They are radicals. They are reckless gamblers who are betting all our futures on their arrogant assumption that their intuitions should triumph over the evidence.  The logic of these skeptics belongs in a casino, not a science lab, and not in the ranks of any responsible government’.

This is an accurate characterisation. If the Liberals and Nationals continue to oppose the ETS legislation in the Senate they lose credibility as a responsible alternative government for Australia.  They would be rejecting legislation they they themseves endorsed while in government. Even former PM John Howard admits the current ETS is close to the one he proposed:

“So I’m scratching … even with the ETS, what Mr Rudd is proposing is not all that different from what I took to the last election.”

If the Coalition vote against the CPRS then they were either unprincipled in the past in adopting election policies that they really did not agree to or unprincipled now in rejecting policies that they previously supported.  They will come be recognised as such irrespective of the outcomes in Copenhagen and, irrespective of recent shifts in world public opinion against dealing with AGW, they will be recognised as part of the team of wreakers who helped prevent an agreement to deal with an international crisis.  

It is time to stand and be counted.  In my view Malcolm Turnbull should resign as Leader if the Liberal Party refuses to endorse a program close to that proposed by the Rudd Government’s CPRS.   It is not worthwhile attempting to lead a party composed of suckers, fools and hypocrites.  You wouldn’t want them to be the national government and they won’t be anyway given such a cowardly, dishonest stance.

More from John Quiggin.

We need to resolve the current negotiation deadlock:

“That deadlock consists of an approach by rich countries which collectively involves inadequate emissions reductions and unwillingness to make financial commitments without being able to approve the plans for [...]]]> Nic* Stern  sets out what is needed in Copenhagen and why the prospects for a cooperative agreement that works are not insurmountable.

We need to resolve the current negotiation deadlock:

“That deadlock consists of an approach by rich countries which collectively involves inadequate emissions reductions and unwillingness to make financial commitments without being able to approve the plans for developing countries to move to low-carbon growth. And on the part of developing countries, an unwillingness to make commitments on reductions without a clear indication of financial support from the rich countries, together with an unwillingness to have their own plans for low-carbon development determined by, or subject to the approval of, the rich countries. The developing countries also find the level of commitment by rich countries to domestic reductions in the next two decades both too small and unconvincing”.

 We must do four things:

1. First, recognise required global emissions targets. To avoid an increase in global average temperature > 2˚C, we need to reduce annual worldwide emissions from the present level of 50 gigatonnes of CO2E to no more than 20 gts by 2050. There are various trajectories but none allow any more than 35 gts by 2030. These are the key targets.  Planned national emissions must be consistent with them.

2. Rich countries must reduce emissions by at least 80% by 2050, compared with 1990. Developing countries, including China and India, also need to limit and decrease their emissions, but in ways consistent with continued economic growth and reduced poverty. (Predictably climate skeptics scoff at the difficulty of meeting such targets).

3. Global annual emissions must be cut to between 44-48 gts of CO2 by 2020 to give a reasonable chance of avoiding a temperature increase of more than 2˚C.

4. Rich countries should give developing countries US$100 billion per year for mitigation and US$100 billion per year for adaptation by the 2020s.  Measures should include those to prevent deforestation and low-carbon growth plans.

“If we can get to grips with these issues, then we can achieve an agreement that is effective, efficient and equitable. It will allow us to avoid the profound risks of climate change, to overcome poverty worldwide and to usher in an exciting new era of prosperity based on sustainable low-carbon growth. Through innovation and investment in new greener and more energy efficient technologies in the next two or three decades, we can create the most dynamic period of growth in economic history. And what is more, a low-carbon world will also be quieter, cleaner, more energy-secure and more biologically diverse. Let us not allow mistrust, pessimism and lack of ambition to prevent us from achieving these aims. Instead let us have real vision and leadership in both developing and developed countries which seize the opportunities offered by Copenhagen, for us, our children and future generations”.  Wow, eh!

* Lord Stern to other than close personal friends! He’s a good lad!