Going it Alone

1
Going it Alone
2
What should we do if we are worried about leakage?

1. Manipulate our domestic policies so as to limit
   leakage
2. Apply Border Tax Adjustments (BTAs)

3
Re 1 What does the set of possible policy tools
look like anyway?
4
Policy Toolbox

• Command and Control
• Regulator dictates which technologies firms use
  (e.g. you must install a scrubber)
• Emission caps

5
Emission/input taxes

• E.g. BC Carbon Tax
• To be Revenue neutral By law, government must
  show---via annual accounting budget--how all of
  the carbon tax revenue flows back to individuals
  and businesses as tax reductions.
• Since carbon emissions closely related to fuel
  inputs, BC is simply taxing the fuel inputs
• Selected Carbon Tax Rates by Fuel      
• UNITS FOR TAX TAX RATE JULY 1, 2010
• Gasoline /litre 4.45
• Diesel /litre 5.11
• Jet Fuel /litre 5.22
• Natural Gas /cubic metre 3.80
• Propane /litre 3.08
• Coal - high heat value /tonne 41.54
• Coal - low heat value /tonne 35.54

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Tradable permits (a.k.a. Cap and Trade)

• E.g. EU Emission Trading System (ETS)
• currently covers close to half of the EU's
  emissions of CO2 and 40 of its total greenhouse
  gas emissions (covers large emitters including
  utilities and industry)
• allocations
• Currently, installations get trading credits from
  national allowance plans (i.e. federal
  governments). (In phase 1, most allocations were
  free)
• Besides receiving this initial allocation, an
  operator may purchase EU and international
  trading credits.
• Excess permits can be exchanged/sold within ETS
  countries either privately, using a broker, or on
  the spot market of one of Europe's climate
  exchanges.
• Excess permits/credits can also be banked or
  borrowed for/against use in another year within
  the same trading period
• emission credits are given out for a sequence of
  several years---a trading period at once
• combined with banking borrowing, this allows
  flexibility in the event of extreme summers and
  winters

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Proposed Changes to ETS

• In January 2008, the European Commission proposed
  a number of changes (starting 2013)
• centralized allocation (no more national
  allocation plans) by an EU authority
• auctioning a greater share (60 ) of permits
  rather than allocating freely
• inclusion of other greenhouse gases, such as
  nitrous oxide and perfluorocarbons.
• Also, the proposed caps for the 3rd Trading
  Period foresee an overall reduction of greenhouse
  gases for the sector of 21 in 2020 compared to
  2005 emissions.
• 2012 ETS extends to airline industry

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California AB 32

• California will use a cap and trade system, with
  the program to begin by 2012.
• Goal is to reduce California emissions to 1990
  levels by 2020, and an 80 reduction from 1990
  levels by 2050.
• In December 2007, the California Air Resources
  Board approved the 2020 emission limit of 427
  million metric tons of carbon dioxide equivalent
  (MMTCO2E) of greenhouse gases.

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Western Climate Initiative

• Regional Cap and Trade program
• Partners Arizona, British Columbia, California,
  Manitoba, Montana, New Mexico, Ontario, Oregon,
  Quebec, Utah, Washington
• Goal reduce regional GHG emissions to 15 percent
  below 2005 levels by 2020.
• Gradual implementation by January 2012 will
  cover two-thirds of total emissions in the WCI
  jurisdictions by 2015, 90 percent of the GHG
  emissions in WCI states and provinces.
• Allocating permits Each WCI Partner
  jurisdiction will have an emission allowance
  budget under the cap-and-trade program that is
  consistent with its jurisdiction-specific
  emissions goal for 2020. Each Partner has the
  flexibility to decide how best to allocate its
  allowance budget within its jurisdiction. The
  WCI design calls for a minimum auction level of
  10 at the start of the program, increasing to at
  least 25 by 2020.
• Compliance self-reporting paired with third
  party validation of reported emissions. If a
  facility or entity does not have sufficient
  emissions allowances to cover its emissions, a
  penalty of three allowances will be assessed
  for each one they are short.

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Relative Merits

• Command and Control
• Compliance relatively easy to monitor
• Emission Caps
• Give firms flexibility with regard to how they
  reduce emissions
• Regulators have control over total emissions
  released
• Taxes
• Flexibility
• Firms have to pay for emissions actually released
• Creates incentives for firms to innovate
• Eliminates implicit subsidies to pollution
  intensive industries
• (Satisfies Polluter Pays Principle (PPP) and
  equity concerns)
• Induces efficiently sized industries

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Cap and Trade

• Allocate emission permits
• Auction, grandfathering, or rebates
• Permits are tradable
• Advantages
• Auctioning satisfies PPP
• Flexibility
• Incentives to innovate
• gives the biggest polluters a license to
  continue bad practices simply by paying off
  smaller, greener companies (Money, August 26,
  2010)
• High-cost abaters can use permit market to access
  efficient technologies of low-cost abaters
• Lowers total cost of achieving a given emission
  target at industry and/or country-level
• Cap gives regulators control over total
  emissions

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Digression

• As of Fall 2010, the US effectively tabled plans
  for nationwide cap and trade
• Instead, attention has been focused on
  clean/renewable energy mandates
• i.e. require that utilities provide
  obtain/generate some minimum fraction of
  electricity from renewable (biofuels, wind,
  solar) or low-carbon (hydro-electric, nuclear)
  sources

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Issues surrounding Green Energy Mandates

• only targets electricity generation
• in US leaves out 60 of GHG emissions
• raises relative price of electricity for
  businesses
• who might substitute on-site generation via coal
• version of within-country leakage
• doesnt necessarily generate jobs
• if wind turbines are produced abroad, the new
  jobs are created overseas
• Better than nothing?
• maybe not creates vested interests thatll later
  oppose broader, alternate policies

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If employ biofuels

• raises global cost of grains/feedstocks
• biofuel production might itself be highly carbon
  intensive

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End of digression regarding renewable mandates
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Disadvantages of Cap and Trade

• Markets need to be thick in order to avoid
  monopoly/monopsony
• suggests small nations need to be part of a
  larger permit-trading bloc)
• Price volatility
• Permit prices vary from year to year
• Possible Solutions
• Price ceilings permit reserve
• Price floor/Minimum price guarantee
• Options markets for emission permits

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Politics

• Any system that imposes new costs on industry
  (without the promise of offsetting gains in
  market share) will face political opposition
• Partial Solution
• give industry some of the permits for free

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Methods for allocating free emissions

• Graduated tax, E.g.
• 0/tonne for first Y tonnes
• 10/tonne for next X tonnes
• 30/tonne thereafter
• Allocations/Rebates
• lump sum
• allocate some permits to firms gratis
• based on historic activity
• based on average emissions per unit of output in
  a given sector
• output based rebates
• each firms rebate a function of own output
• input based rebates

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How might we manipulate domestic policies so as
to

• prevent leakage
• alleviate competitiveness concerns

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Rebates

• Provide rebates (free permits) to Energy
  Intensive Trade Exposed (EITE) Sectors
• Some estimates suggest, on average, US EITE firms
  need less than one third of their permits
  allocated for free in order to maintain baseline
  profits

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How should we allocate Rebates?

• Lump Sum
• maintains firm profitability
• compliance costs partly/entirely offset by gift
  of free (re-sellable) permits
• efficient
• firms pay entire marginal cost of producing
  additional units
• Canadian firms lose competitiveness
• firms will pass along permit costs to consumers
  in form of higher prices

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Output based rebates

• Profitability
• Abatement Efficiency
• because firms can re-sell permits, they will
  still internalize costs of polluting
• will make the right trade-off between emissions
  and abatement
• Efficiency
• firms receive additional free permits for every
  additional unit of output
• thus output-based rebates are implicit subsidies
  to output
• result firms will produce too much output
• Competitiveness
• the implicit subsidy allows Canadian firms to
  charge less, remain more competitive

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Caveats

• Rebates redirect permit value toward industry and
  away from other uses, such as revenue recycling
• If permits were auctioned off, the revenues could
  be used to reduce other distortionary taxes such
  as income and business taxes
• GATT-legal?
• output-based rebates are implicit production
  subsidies

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And since were talking about GATT-legality
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2. Apply Border Tax Adjustments (BTAs)

• Slap taxes onto imports of goods from countries
  that arent doing something about climate change
• Problem
• will taxes on embodied carbon violate WTO rules?

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Background on the WTO?

• After WWII countries agreed to create IMF, World
  Bank ITO.
• ITO failed in US Congress
• Interim agreement General Agreement on Tariffs
  and Trade (GATT)
• Goal was to prevent descent into protectionism
  that was believed to have prolonged Great
  Depression.
• GATT was an agreement.
• World Trade Organization (WTO) came into being in
  1995.
• WTO is an organization designed to administer
  GATT as well as GATS and TRIPs.
• 153 members, including US, EU, China, India,
  Japan, Cuba, ...
• Founding principles
• forum for discussion (not a government)
• is about promoting free trade, nothing else
  (expect intellectual property...)
• MFN
• tariff binding
• Some important rules
• Product Restrictions must satisfy National
  Treatment and be scientifically valid
• Process Restrictions only apply to domestic
  production
• can restrict trade to protect animal, plant and
  human health, or to prevent exhaustion of natural
  resources, but all policies must be least trade
  restrictive

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Rounds

• New trade rules negotiated in Rounds
• Last successful was Uruguay Round 1986-1994
• further tariff reductions (40 reductions,
  average tariff DCs falls from 6.3 to 3.9)
• Some movement on agriculture
• industrialized countries committed to 20
  reduction in agric. subsidies
• NTBs disallowed in agric (except import quotas)
• prohibited new agric tariffs
• scheduled a mandated increase in access for
  overseas goods (but increases were slow and
  incomplete)
• Addressed NTBs
• illegalized export subsidies (except for
  agriculture)
• Introduced three additional trade agreements
  meant to govern
• services (GATS)
• investment (MAI? which failed)
• trade related intellectual property rights
  (TRIPS)
• must grant 20 year patents
• must allocate resources to enforce patents
• no grey imports
• preliminary research suggests that in the SR LDCs
  lose from TRIPs and USA, in particular, gains
• in LR everyone gains but the developed countries
  disproportionately so (LDCs gain only a little)

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(Seattle Round)

• Concerns over WTO and globalization in general
  came to a head in 1999
• Anti-globalization groups (including labor and
  envl) called to protest at WTO ministerial
  meetings in Seattle

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The WTO poses a very real threat to this
countrys and the worlds environment. It is
particularly important that you act now - the WTO
is meeting in Seattle.... People worldwide are
organizing to put a stop to WTO expansion until
its trade policies protect, rather than harm,
people and the environment. The World Trade
Organization and the Environment A Citizen
Action Guide
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Seattle Round cancelled

• But before we give the protestors all the credit,
  note that talks were likely to fail
• Rich/Poor countries couldnt agree on
• labor standards (opposed by South)
• further reductions in agricultural subsidies
  (Europe not willing to discuss these in genuine)

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Current Doha round

• Amongst other things, Doha talks stalled because
  G20 (developing countries) have banded together
  to demand improved access to developed country
  markets, while industrialized countries remain
  intractable
• US now pursuing regional trade agreements
• Expanded IPRs

37
WTO claims not to interfere with environmental
policies

• Under GATT rules, WTO Members can adopt measures
  to protect the environment and human health and
  life as long as such measures comply with GATT
  rules, or fall under one of the exceptions to
  these rules. This right to adopt measures has
  been affirmed by panels and the Appellate Body
  time and again. In the US Gasoline case, for
  example, the Appellate Body concluded that WTO
  Members have a large measure of autonomy to
  determine their own policies on the environment
  (including its relationship with trade), their
  environmental objectives and the environmental
  legislation they enact and implement...and that
  autonomy is circumscribed only by the need to
  respect the requirements of the General Agreement
  and the other covered agreements (WTO website)

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How do you respect the requirements of the GATT?
Article I Most Favoured Nation (MFN) Article II Bound Tariffs Article III National Treatment Article XI Quotas Article XX(g)
Have to treat all WTO-trade partners the same Cant raise existing tariffs Once a good is in your country (i.e. duties have been paid), it has to be treated the same as like domestic products No quantitative restrictions allowed Exceptions to the rules
Any article XX exception has to satisfy the
chapeau Subject to the requirement that such
measures are not applied in a manner which would
constitute a means of arbitrary or unjustifiable
discrimination between countries where the same
conditions prevail, or a disguised restriction on
international trade, nothing in this Agreement
shall be construed to prevent the adoption or
enforcement by any contracting party of
measuresXX(g) relating to the conservation of
exhaustible natural resources
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Precedenceshrimp-turtle dispute
Precedence doesnt have the same standing in
International law as it does in some national
courts
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Shrimp v. Turtles

• Nov 21, 1989 US Congress passes Section 609 of
  US Public Law 101-162, essentially banning import
  of turtle unfriendly shrimp.
• Pakistan, India and Thailand complain to WTO,
  claiming US cant refer to XX(g) of GATT because
  turtles not exhaustible.
• WTO sides with complainants.
• US appeals on grounds that endangered
  exhaustible.
• Moreover, since the turtles spend some time in US
  waters, they are a US resource.
• WTO Appellate body agrees with both these
  arguments, and agrees that the law is even-handed
  (same rules for domestic as for foreign
  producers) but says that the way the US applies
  Section 609 constitutes unjustifiable
  discrimination
• US negotiated exemptions with some countries, but
  not others

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• even though on paper Section 609 looks flexible
  (i.e. turtle friendly), in action it isnt in
  practice when giving/denying certification the
  competent government officials only look to see
  whether there is a regulatory program requiring
  the use of TEDs of one that comes within one of
  the extremely limited exceptions available to
  United States shrimp trawl vessels.
• application doesnt take into consideration
  different conditions which may occur in the
  territories of those other members
• the US didnt permit imports of shrimp from
  countries that werent certified, even if the
  shrimp were turtle safe!
• countries denied certification dont get to see
  the reasons why and have no opportunity for appeal

42
Conclusions

• Legal interpretation Its okay to make market
  access conditional on dealing with overseas
  production externalities----killing turtles as
  by-catch---but you cant make access conditional
  on using a particular abatement measure---TEDs
• Plus, you need to try to negotiate an agreement
  before you move to a unilateral trade ban.
• Effectiveness if you must allow countries that
  dont get certified to send shrimp anyways, and
  then evaluate those incoming goods on a
  shipment-by-shipment basis, isnt that going to
  be prohibitively costly for either the importer
  or exporter, effectively nullifying or
  entrenching the certification process depending
  on who pays?

43
Other WTO-related precedents
44
Superfund

• United States Superfund Amendments and
  Reauthorization Act of 1986
• a.k.a. Superfund Tax
• Superfund is a trust fund for cleaning up toxic
  waste sites with absentee/defunct polluters
• Tax rate is low a few dollars per ton of the
  taxed chemicals and substances (OECD 2006 p.100)

45

• The Superfund chemical excises applied to the
  sale or use of certain chemicals that were listed
  in a Schedule to the Act.
• Its application also extended to untaxed
  chemicals manufactured using the taxed chemicals
  as feedstock.
• imports of these final goods were subject to
  the tax, and exports were similarly rebated, as
  long as taxable chemicals constituted at least
  50 of the chemicals used to produce the final
  substance, by weight or value. (OECD 2006 p.100)

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• The significance of the BTA mechanism in the
  Superfund Tax was that the tax was calculated by
  reference to the amount of chemicals used in the
  manufacturing process it was not necessary for
  all of the atoms contained in the taxable
  chemical to be physically incorporated into the
  final substance, and the tax rate was not
  adjusted if only a portion of the original
  chemicals were actually present at the end. Thus
  it was a true process-based BTA. (OECD 2006
  p.100)

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GATT challenge

• European Community, Canada and Mexico challenged
  Superfund Tax via GATT
• Their arguments
• the spirit of the tax was to reflect damage
  created during production of the final goods
• since any damage produced during European
  production was inflicted on Europeans, not
  Americans, the tax overeaches the US
  jurisdiction
• moreover, US exports are exempted
• violates stated goal of the tax and Pollutier
  Pays Principle

48
GATT Panel

• The GATT panel ruled that the Superfund Tax could
  stand on the following grounds
• 1) the tax was designed to raise revenue, not
  create incentives, and was imposed on like
  products
• 2) the polluter pays principle is irrelevant
  anyway for the GATT and
• 3) the inputs were taxed based on use, not
  value, and constituted part of the final
  product. (Fischer, Hoffman Yoshino 2002
  http//rff.org/RFF/Documents/RFF-DP-02-28.pdf

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Montreal Protocol

• USA imposes a tax on ozone depleting chemicals
  (ODC) embodied in imported goods
• www.irs.gov/businesses/small/article/0,,id186588,
  00.htmlChapter_04h
• use average ODC embedded in US product as
  baseline
• if theres no comparable US product, then tax
  rate is 5
• if an importer can verify lower ODC content, is
  entitled to a lower tax

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Precedent?

• Imposes tax on embodied emissions
• Has never been challenged
• either because everyone thinks WTO will uphold
  the tax
• or because its not worth anyones time to
  challenge
• quantities of embodied ODCs is now very low

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Implications

• Ruling potentially opens the door for trade
  barriers targeting overseas production processes
  if
• Negotiations fail
• Theres a transboundary externality
• Least trade restrictive route is pursued

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So unilateral policies more likely to pass muster
with WTO if

• countries first make a genuine attempt at
  negotiations
• USA Ratify Kyoto or its successor
• cant impose penalties on non-signatories/ratifier
  s if havent ratified yourself!
• Canada honour Kyoto commitments

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Whats likely to fly?

• punitive tariffs and import bans are out
• unnecessarily trade restrictive
• So far, WTO has resisted claims that countries
  without active climate policies are implicitly
  subsidizing their products and thus are eligible
  for anti-dumping duties
• but BTAs that impose on imported goods the same
  costs as domestic goods might be viable
• are akin to BTAs regarding VATs (value-added
  taxes)

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What would a BTA look like?

• Calculate the carbon content of imported goods
• Multiply by Canadian carbon price
• Subtract carbon taxes already paid by producer
• Charge the difference as a border carbon
  adjustment or border tax adjustment

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Problems with BTAs

• How do we calculate the carbon content of
  imported goods?
• Difficult to obtain details on oversees
  production techniques
• Could use
• Canadian emission averages for similar Canadian
  products
• Best Available Technology as a baseline
• Complication
• How do we treat the implicit emissions associated
  with electricity use? Implicit emissions vary
  considerably depending on source hydro vs coal.

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Whats the implicit carbon tax abroad?

• What if the trade partner regulates carbon via
  command and control regulation?
• How would we calculate the implicit carbon tax
  paid abroad?
• What if foreign firms are regulated via
  marketable permits and their permit price drops?
  Do we impose a higher BTA on their goods?

57
Proposals

• Exempt countries/overseas sectors that have
  active, comparable climate policy and/or lower
  emission intensity than domestic competitors
• Complications
• Violate MFN rules?
• Carbon-laundering
• Suppose Canada makes imports from carbon-pricing
  countries BTA-exempt
• Exporters in non-pricing countries will have
  incentive to route semi-finished products through
  pricing countries, add minimum necessary
  value-added to satisfy local-content rules, and
  then export final goods to Canada BTA-free

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Suppose Canada grandfathers some permits

• Do we need to grant equivalent concessions to
  imported goods?
• Using average-tax-paid by Canadian competitors
  will be inefficient
• Marginal carbon tax will be lower for imports
  than for domestically produced goods
• Charging full tax will likely violate National
  Treatment rules
• Similarly, requiring importers to purchase
  Canadian permits for each tonne of embodied
  carbon will likely violate National Treatment as
  well as raise price of Canadian permits.

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Other issues

• Should carbon taxes be rebated to exporters?
• might be GATT legal (even despite rules against
  export subsidies)
• combined with BTAs on imported goods, an export
  rebate would effectively implement a
  consumption-based carbon tax.
• But runs counter to goal of limiting emissions of
  course
• may undermine the case for BTAs on imports
• Note there may be a distinction between rebates
  of carbon taxes (which are taxes) and permit
  costs (since buying the permits is required by
  regulation and so permit costs are not
  technically taxes)

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Frankel (2008)

• Target taxes at most energy-intensive tradeables
• fuels (coal)
• certain energy-intensive goods
• aluminum, cement, steel, paper, glass, iron,
  and/or chemicals
• Only apply border adjustments to countries not
  complying with Kyoto/successor commitments, or
  which didnt ratify

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Frankel continued Dont

• apply sanctions/adjustments unilaterallyget
  other countries on side too
• calculate emission intensity presuming foreign
  firms use same production processes as domestic
  competitors
• allow politicians to get involved in determining
  when/how border adjustments to be applied
• sanction a country via trade barriers
• target goods removed more than 1 degree from
  energy production
• use subsidies (either outright or permit
  allocations) to energy intensive domestic firms
  believed to be put at a competitive disadvantage
  by domestic climate policy

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Im less sanguine than Frankel about what will be
GATT-legal

• how to calculate equivalent taxes?
• how to calculate the emission intensity of
  ROW-produced stuff?
• whats the equivalent of US taxes?
• what if the US grandfathers some of its permits?
• or uses non-linear pricing?
• Frankel points to the Montreal Protocol, which
  prescribes sanctions against non-signatories, as
  evidence that sanctions might be an option
• but these sanctions were never used.
• its not clear whether WTO would have upheld such
  sanctions, since they would be applied against
  countries that did not agree to the MEA in the
  first place
• So how should we deal with China?
• Biggest greenhouse gas emitter, but its not an
  Annex I country. Cant use Kyoto-non-compliance
  to justify border adjustments

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Other options

• GHG performance standards (Hufbauer et al 2009)
• stipulate a maximum carbon footprint for goods
  sold in your country
• probability of a challenge is lower if the
  footprint is the same as some global standard
  (not one that arbitrarily favours domestic
  producers)