Carbon Tax and Carbon Leakage:
Policy Options
Carolyn Fischer
Resources for the Future
October, 2011
Why might a carbon price alone
not be enough?
• Pre-existing taxes distort labor (and capital) markets
– Higher prices from regulation lower real wage, reducing
labor supply and tax revenue: “Tax Interaction”
– It matters how we use the revenues
• Incomplete regulatory coverage
– Higher product prices can cause substitution towards
unregulated goods or imports: “Carbon leakage”
– It matters how we treat energy-intensive trade-exposed
(EITE) sectors
• Other market failures
– Imperfect competition, technology spillovers, barriers…
Fischer-Fox Emissions and Trade
Model
• CGE model based on GTAPinGAMS-EG
– Static, 2004 base year
• Key features
– Labor-leisure tradeoff
– Improved emissions data: process emissions, feedstocks,
and baseline calibrated to EIA
– Calibrated global fuel supply elasticities
• Crude oil is slightly inelastic, while coal and now gas are elastic
• Compare scenarios for unilateral U.S. policies with
equivalent global emissions outcomes
The Importance of Revenue
Recycling
0
U.S. welfare cost of reductions (millions of $2004)
2
4
6
8
10 12 14 16 18 20 22 24 26 28 30
-10,000
-20,000
-30,000
-40,000
Recycle
Transfer
-50,000
-60,000
-70,000
-80,000
-90,000
Percentage reduction in U.S. emissions (net of leakage)
% Change in Production, of which Change in Net
Exports (20% Reduction Target, 100% Recycling)
Options for Coping with Leakage
• Making the carbon tax global (best)
• Effects of other options can depend on how the
remaining revenues are being used!
Option (1): Output-based rebating
• Could be implemented by requiring compliance
payments above a (refundable) performance
standard
– Still like a subsidy
• Mitigates product price increase, which dampens
leakage but also conservation incentives
– Best applied narrowly to EITE sectors
• Also dampens tax interaction, but less effectively
than a broad-based tax cut
– Rebates in electricity more costly than recycling, but may
be better than transfers
Option (2) : Border Carbon Adjustment
• Taxing imports based on a measure of their carbon
content (and refunding for exports)
• Ensures consumers pay carbon-inclusive price,
regardless of origin
– Dampens leakage but maintains conservation incentives
• Costly if implemented too broadly
– But can improve cost-effectiveness if applied narrowly to
EITE sectors most vulnerable to leakage
– Controversial, but BTA may be more likely to pass WTO
muster in combination with a carbon tax than tradable
permits
Stylized policy scenarios
• Unilateral U.S. policy
• Coverage: 1) Comprehensive
2) Energy intensive only
Abbreviation
Scenario Description
A0 (G0) 100% recycling (transfers)
OBR to EITE (direct+indirect emissions for each sector),
remaining 85% of revenues recycled (transferred)
OBR to EITE+ELE (direct emissions for each sector),
A2 (G2)
remaining 50% of revenues recycled (transferred)
BCA for EITE+ELE imports (direct+indirect emissions for each
A3 (G3)
sector), 100% of revenues recycled (transferred)
A1 (G1)
Sensitivity of U.S. Welfare Changes
to Stringency of Emissions Reduction Target (Millions of 2004 USD)
Compared to 100% recycling
20,000
15,000
• U.S. prefers OBR to EITE with rest recycled
–
–
10,000
less leakage, improved terms of trade
little effect on carbon price
5,000
0
0
2
4
6
8
10
12
14
16
18
20
22
24
26
-5,000
-10,000
-15,000
-20,000
-25,000
-30,000
• Extending OBR to ELE
–
–
–
33% higher carbon price
less leakage than full recycling (A2 > A0)
Less tax interaction than transfers (G2 > G0)
28
30
A0
A1
A2
G0
G1
G2
Sensitivity of U.S. Welfare Changes
to Stringency of Emissions Reduction Target (Millions of 2004 USD)
Compared to 100% recycling
20,000
15,000
• U.S. prefers OBR to BCA for EITE sectors
10,000
5,000
0
0
-5,000
-10,000
-15,000
-20,000
-25,000
-30,000
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
A0
A1
A3
G0
G1
G3
Sensitivity of Global Net Welfare Changes
to Stringency of Emissions Reduction Target (Millions of 2004 USD)
Compared to 100% recycling
10,000
5,000
• Global welfare highest with BCA + recycling,
while recycling generally preferred to OBR
0
0
2
4
6
8
10
12
14
16
18
20
-5,000
-10,000
-15,000
-20,000
-25,000
-30,000
• If revenues are transferred,
OBR and BCA both preferred to
no treatment of EITE sectors
22
24
26
28
30
A0
A1
A3
G0
G1
G3
Conclusions and Caveats
• OBR and BCA have potential to improve efficiency
and reduce leakage from unilateral climate policy
– If appropriately circumscribed
– Must phase out OBR as more trade partners regulate CO2
• Not recycling the revenue is costly
• Serious practical challenges for both OBR and BCA
– defining appropriate metrics for eligibility, consistent
units of production, benchmarks that do not mute the
effectiveness of the carbon price, embodied carbon calcs
• Most models (like ours) lack sufficient sectoral detail
to capture these issues.
Thanks!
• Fischer, C. and A.K. Fox. 2010. “On the Scope for
Output-Based Rebating in Climate Policy: When
Revenue Recycling Isn’t Enough (or Isn’t
Possible)” RFF DP 10-69.
• Funding from the ENTWINED Program of the
Mistra Foundation gratefully acknowledged.