Emission Taxes

One obvious way to control greenhouse emissions globally is to put a tax on emissions of CO2e. The tax would need to be the same per tonne of CO2e across countries and sectors. All emitters facing the tax would reduce their output of gases so that the cost of reduction of the last tonne of CO2e they emitted equals the emission tax. This is so because the cost of control of pollution rises with the level of control, so that if the cost of control is greater than the tax at the margin then the units controlled are cut back. If the cost of control of the last unit is less than the tax, then more units are controlled. The tax is a very efficient instrument because all polluters are motivated to cut to a point where their marginal abatement cost equals the tax, and the cost of exercising controls across the board is minimized.

Prominent economist Nordhaus (2007) supports a tax system because of the cost uncertainties of quantitative limits on emissions, and because the public receives revenues from the taxes that can be applied to minimize social problems caused by the tax. The UK's Climate Change Levy is a direct carbon tax.

For an effective and efficient global tax policy there are two conditions:

• The rate of carbon tax needs to be uniform across countries, developed and developing alike;

• The level of tax needs to reflect the marginal damage cost of CO2e emissions, that is the damage caused by the emission of one extra tonne of CO2e to the atmosphere.

A question is how uniform taxes could be applied to developed and developing countries, given the equity and welfare implications of taxes in the latter (Aldy et al., 2003). Moreover, there is already a raft of different taxes across countries applying to fossil fuels. For example, gasoline taxes tend to be relatively heavy in Europe compared with the US (Babiker et al., 2003). It can be concluded that the fundamental and universal tax reform across countries that is needed to make the tax on the carbon content of fuels uniform, would be very difficult to achieve politically, given the budgetary and socioeconomic implications.

The second condition for an effective tax is its link to the marginal damage cost, or marginal social cost of CO2e emissions. The marginal social cost represents the optimal carbon price or optimal carbon tax, given that it balances the incremental costs of abating CO2e emissions with the incremental benefits. But estimates of marginal social costs in the literature are many, and they vary greatly. Tol (2007) reviewed 211 published estimates under business-as-usual (that is with no comprehensive system for reducing emissions in place). The peer-reviewed studies reported ranges from —US$0.6 to $136 per tonne of CO2e, with a mean around $35 and a standard deviation of $66. A major cause of the variations is the choice of discount rate. The difficulties posed by the choice of discount rate are summarized in Box 1.1.

An illustration of how changes in the discount rate can produce very different results in calculating the marginal cost of emissions, and therefore the benefit of marginal abatement, is illustrated by the change in present value of $100 in a hundred years' time, at different discount rates (see Table 1.1).

Apart from the different equity weightings adopted in different studies,

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