Progressive Optimal Technology-based Border Carbon Adjustment (POT BCA) - A New Approach to an Old Carbon Problem

Abstract

The idea of Border Carbon Adjustment (BCA), which makes it possible to transform the standard tax on carbon emissions from production (origin principle) to a tax system imposed at the point of consumption (destination principle), has received a considerable amount of attention from academia and policymakers. In this paper, we go back to the source of environmental destination-based taxation and generalize the results of Markusen (Journal of International Economics, 5, 15–29, 1975) for optimal tax and tariff by extending domestic environmental policy on both goods featuring positive carbon intensities. Following Jakob et al. (Environmental and Resource Economics, 56(1), 47–72, 2013) we remove the strategic term from the optimal tariff and deal with the so-called optimal carbon tariff, targeting primarily environmental externality. Further, we develop a handy approximation for optimal tax and optimal carbon tariff structure in a multiple good setting. Such trade taxation is, however, likely to face further legal obstacles, which may hinder its implementation. This motivates us to adjust the results accordingly and to include refunds for low-carbon investments in a ‘dirty’ country granted proportionally to the difference in carbon intensities between trade partners. This new scheme, known as Progressive Optimal Technology-based Border Carbon Adjustment (POT BCA), mitigates several legal problems and increases political acceptance compared to the ‘standard’ BCA. It can also be seen as advantageous from the economic point of view: it mimics the performance of the optimal carbon tariff while aiming to decrease foreign carbon intensity over the long term.

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Notes

  1. 1.

    An equivalent tool is a carbon tax on fossil fuels set proportionally to their carbon content. Please note that each ton of carbon contains 3.67 tons of CO2 [58].

  2. 2.

    Please note that an equivalent price-like effect can be achieved by the implementation of quantity-based permits with a “safety valve,” which allows the sale of unlimited carbon permits at a pre-defined price [24].

  3. 3.

    Costs incurred by companies due to CAC regulation relate to the technology upgrades to reach the allowable emissions level, whereas MBIs require companies to pay monetary compensation for each unit of CO2 emitted into the atmosphere [27, 47].

  4. 4.

    This broad definition encompasses two different types of carbon leakage: “strong” and “weak.” “Strong” CL refers to the emission increases in countries with weak or no environmental policy due to carbon restrictions in other countries. Typical channels of “strong” CL include: the energy market (lower demand for fossil fuels in carbon-restricted areas drives their international price down, which, in turn, encourages higher consumption of fossil fuels in countries with no carbon policy in place), production and investment (domestic products become more expensive due to the internalization of carbon costs and are thus less competitive in comparison to goods imported from countries without carbon regulation. Thus, in the long run, domestic producers shift their production to the countries with no carbon constraints). The scope of “weak” CL is much broader since it does not include any causality condition. Most frequently, “weak” CL is calculated as the net emission transfer between mitigating and non-mitigating areas [34].

  5. 5.

    Taxation at the border can be executed according to (a) true carbon content, (b) best available technology, (c) dominant production method, or (d) average technology in importing or exporting country [21].

  6. 6.

    Please note that the idea of BCA has gained strong support among important politicians such as the former President of France, Nikolas Sarkozy, or current US Secretary of State John Kerry[53].

  7. 7.

    Please note that a CO2 emission tax imposed at the point of production (origin principle) combined with BCA is equivalent to the CO2 emission tax imposed at the point consumption (destination principle) [13], which results directly form the following equality: c o n s u m p t i o n=p r o d u c t i o ne x p o r t s+i m p o r t s. This form of tax should not be confused with a “consumption tax” on emissions generated during the consumption activity. For a discussion of consumption taxation, please see, e.g., [35].

  8. 8.

    This can be compared to sectoral carbon tax reliefs that were implemented within the EU ETS in the industrial sectors most prone to the carbon-leakage problem (e.g., the cement industry).

  9. 9.

    Please note that the derivatives with respect to a particular variable are written with a subscript.

  10. 10.

    10 Please notice that \(U_{{C^{A}_{Y}}}/U_{{C^{A}_{X}}}\) is well-defined since \({C^{A}_{Y}}\) and \({C^{A}_{X}}\) can be computed from E x 1,I m 1 and \({Y^{A}_{1}}\).

  11. 11.

    Please recall that in the optimal carbon tariff by Jakob et al. [25] the term responsible for the change of TOT was deleted.

  12. 12.

    Please note that environmental Border Adjustments on excise tax, e.g. on particular chemicals (Superfund Amendments and Reauthorization Act) or on Ozone Depleting Chemicals (ODCs) have been successfully implemented for many years [21]. However, it is highly likely that similar regulation of carbon emissions will be much more complicated due to their high economic impact.

  13. 13.

    In general, subsidies are not allowed under WTO legislation. Primary products are exempted from this based on the assumption of an “equitable share in world trade” [45].

  14. 14.

    Please note that developing countries with relatively dirtier technology such as China, represented in our model by country B, are generally interested in reducing carbon intensity of their production as long as this does not constitute a significant financial burden that could threaten their economic development. In fact, decreasing carbon intensity and energy intensity are among the main goals of China’s 12 th Five-Year Plan [30].

  15. 15.

    As the reader may note, the statement and analysis remain true if the environmental factor is added to the welfare function of country B under the assumption that reducing carbon intensities by B lowers its emissions. Following the theory of Environmental Kuznets Curve (EKC) we may expect that the environmental quality will start to influence the welfare function of country B after its income per capita reaches a particular level [16, 38].

  16. 16.

    Please recall that we defined our trade parameters I m and E x from the point of view of country A. Thus, I m denotes imports of good Y from country B to A.

  17. 17.

    Due to changes in the production possibility frontier (PPF) resulting from technology upgrade, which would require strong assumptions (which are thus easy to challenge), we do not model this process, but use a static comparative analysis at different points in time keeping PPF unchanged as a useful simplification.

  18. 18.

    According to the latest findings, local air pollution caused by burning coal poses a very serious health risk to Chinese citizens, see [43].

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Acknowledgments

I would like to thank Reimund Schwarze for awakening my interest in the topic and Robert Marschinski, Friedel Bolle for insightful information and comments. Further, I am very grateful to anonymous reviewers whose remarks helped me to improve the paper. Last but not least, I would like to thank the Energy and Resources Group at UC Berkeley - and David Anthoff in particular - for their kind hospitality and for creating a great atmosphere to work in. The study received support from the Viadrina International Program for Graduates (VIP), which is gratefully acknowledged. The VIP is promoted by the German Academic Exchange Service (DAAD) and funded by the German Federal Ministry of Education and Research.

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Correspondence to Gabriela Michalek.

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Michalek, G. Progressive Optimal Technology-based Border Carbon Adjustment (POT BCA) - A New Approach to an Old Carbon Problem. Environ Model Assess 21, 323–337 (2016). https://doi.org/10.1007/s10666-015-9484-0

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Keywords

  • Border Carbon Adjustment
  • Optimal production tax
  • Optimal import tariff
  • Green transfers
  • Climate policy