Climate Change 2001: Working Group III: Mitigation

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8.3 Costs of Domestic Policy to Mitigate Carbon Emissions

Particularly important for determining the gross mitigation costs is the magnitude of emissions reductions required in order to meet a given target, thus the emissions baseline is a critical factor. The growth rate of CO₂ depends on the growth rate in GDP, the rate of decline of energy use per unit of output, and the rate of decline of CO₂ emissions per unit of energy use.

In a multi-model comparison project that engaged more than a dozen modelling teams internationally, the gross costs of complying with the Kyoto Protocol were examined, using energy sector models. Carbon taxes are implemented to lower emissions and the tax revenue is recycled lump sum. The magnitude of the carbon tax provides a rough indication of the amount of market intervention that would be needed and equates the marginal abatement cost to meet a prescribed emissions target. The size of the tax required to meet a specific target will be determined by the marginal source of supply (including conservation) with and without the target. This in turn will depend on such factors as the size of the necessary emissions reductions, assumptions about the cost and availability of carbon-based and carbon-free technologies, the fossil fuel resource base, and short- and long-term price elasticities.

With no international emission trading, the carbon taxes necessary to meet the Kyoto restrictions in 2010 vary a lot among the models. Note from Table TS.4¹⁶ that for the USA they are calculated to be in the range US$76 to US$322, for OECD Europe between US$20 and US$665, for Japan between US$97 and US$645, and finally for the rest of OECD (CANZ) between US$46 and US$425. All numbers are reported in 1990 dollars. Marginal abatement costs are in the range of US$20- US$135/tC if international trading is allowed. These models do not generally include no regrets measures or take account of the mitigation potential of CO₂ sinks and of greenhouse gases other than CO₂.

However, there is no strict correlation between the level of the carbon tax and GDP variation and welfare because of the influence of the country specifics (countries with a low share of fossil energy in their final consumption suffer less than others for the same level of carbon tax) and because of the content of the policies.

The above studies assume, to allow an easy comparison across countries, that the revenues from carbon taxes (or auctioned emissions permits) are recycled in a lump-sum fashion to the economy. The net social cost resulting from a given marginal cost of emissions constraint can be reduced if the revenues are targetted to finance cuts in the marginal rates of pre-existing distortionary taxes, such as income, payroll, and sales taxes. While recycling revenues in a lump-sum fashion confers no efficiency benefit, recycling through marginal rate cuts helps avoid some of the efficiency costs or dead-weight loss of existing taxes. This raises the possibility that revenue-neutral carbon taxes might offer a double dividend by (1) improving the environment and (2) reducing the costs of the tax system.

Table TS.4: Energy Modelling Forum main results. Marginal abatement costs (in 1990 US$/tC; 2010 Kyoto target)
Model	No trading				Annex I trading	Global trading
	US	OECD-E	Japan	CANZ
ABARE-GTM	322	665	645	425	106	23
AIM	153	198	234	147	65	38
CETA	168				46	26
Fund					14	10
G-Cubed	76	227	97	157	53	20
GRAPE		204	304		70	44
MERGE3	264	218	500	250	135	86
MIT-EPPA	193	276	501	247	76
MS-MRT	236	179	402	213	77	27
Oxford	410	966	1074		224	123
RICE	132	159	251	145	62	18
SGM	188	407	357	201	84	22
WorldScan	85	20	122	46	20	5
Administration	154				43	18
EIA	251				110	57
POLES	135.8	135.3	194.6	131.4	52.9	18.4
Note: The results of the Oxford model are not included in the ranges cited in the TS and SPM because this model has not been subject to substantive academic review (and hence is inappropriate for IPCC assessment), and relies on data from the early 1980s for a key parametization that determines the model results. This model is entirely unrelated to the CLIMOX model, from the Oxford Institutes of Energy Studies, referred to in Table TS.6. EMF-16. GDP losses (as a percentage of total GDP) associated with complying with the prescribed targets under the Kyoto Protocol. Four regions include USA, OECD Europe (OECD-E), Japan, and Canada, Australia and New Zealand (CANZ). Scenarios include no trading, Annex B trading only, and full global trading.

One can distinguish a weak and a strong form of the double dividend. The weak form asserts that the costs of a given revenue-neutral environmental reform, when revenues are devoted to cuts in marginal rates of prior distortionary taxes, are reduced relative to the costs when revenues are returned in lump-sum fashion to households or firms. The strong form of the double-dividend assertion is that the costs of the revenue-neutral environmental tax reform are zero or negative. While the weak form of the double-dividend claim receives virtually universal support, the strong form of the double dividend assertion is controversial.

Where to recycle revenues from carbon taxes or auctioned permits depends upon the country specifics. Simulation results show that in economies that are especially inefficient or distorted along non-environmental lines, the revenue-recycling effect can indeed be strong enough to outweigh the primary cost and tax-interaction effect so that the strong double dividend may materialize. Thus, in several studies involving European economies, where tax systems may be highly distorted in terms of the relative taxation of labour, the strong double dividend can be obtained, in any case more frequently than in other recycling options. In contrast, most studies of carbon taxes or permits policies in the USA demonstrate that recycling through lower labour taxation is less efficient than through capital taxation; but they generally do not find a strong double dividend. Another conclusion is that even in cases of no strong double-dividend effect, one fares considerably better with a revenue-recycling policy in which revenues are used to cut marginal rates of prior taxes, than with a non-revenue recycling policy, like for example grandfathered quotas.

In all countries where CO₂ taxes have been introduced, some sectors have been exempted by the tax, or the tax is differentiated across sectors. Most studies conclude that tax exemptions raise economic costs relative to a policy involving uniform taxes. However, results differ in the magnitude of the costs of exemptions.

8.4 Distributional Effects of Carbon Taxes

As well as the total costs, the distribution of the costs is important for the overall evaluation of climate policies. A policy that leads to an efficiency gain may not be welfare improving overall if some people are in a worse position than before, and vice versa. Notably, if there is a wish to reduce the income differences in the society, the effect on the income distribution should be taken into account in the assessment.

The distributional effects of a carbon tax appear to be regressive unless the tax revenues are used either directly or indirectly in favour of the low-income groups. Recycling the tax revenue by reducing the labour tax may have more attractive distributional consequences than a lump-sum recycling, in which the recycled revenue is directed to both wage earners and capital owners. Reduced taxation of labour results in increased wages and favours those who earn their income mainly from labour. However, the poorest groups in the society may not even earn any income from labour. In this regard, reducing labour taxes may not always be superior to recycling schemes that distribute to all groups of a society and might reduce the regressive character of carbon taxes.