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Technologies, Policies and Measures for Mitigating Climate Change

international agency that would impose a GHG emissions tax on participating countries. Alternatively, countries could agree that each would levy comparable GHG emissions taxes domestically. The agreement to create an international GHG emissions tax agency would need to specify both the tax rate(s) and a formula for distributing the revenues from the tax.30

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clear that there must be a reasonable probability of detecting and penalizing those responsible for unauthorized emissions. This, however, does not distinguish a tradable quota system from any other international agreement on emissions reductions.

Under an international tradable quota system, participating countries could use whatever domestic policies they preferred to achieve compliance. For example, a country might employ tradable permits, a domestic tax or regulations. Where a domestic tradable permit system exists, the government could allow permit holders to trade directly on the international market. If a domestic carbon tax is used, the efficient tax rate for the coming period would be the (unknown) quota price for that period.

A harmonized tax requires that each country impose the same tax rate. Due to differences in resource endowments, consumption patterns, climate change impacts and other factors, this tax rate may not be the most appropriate from a national perspective, thus side-payments are likely to be required to secure broad participation. Under a harmonized tax system, the reallocation of tax revenues could involve lump-sum payments; whereas under the international tax system, the agreement could There is some experience with the use of tradable permit specify what shares of the international tax revenues would go schemes within countries, whereas international tradable quota to each participating country. In principle, international trans- systems so far have been applied only on a small scale (e.g., the fers could be negotiated to yield the same international distrib-international CFC production quota trade and the CFC conution of the tax in either case. A GHG emissions tax imposed by sumption quota trade within the European Union). an international agency would impinge on national sovereignty and would therefore be difficult to negotiate.

A uniform tax rate for all countries is required for reasons of cost-effectiveness but, given different existing energy tax regimes in participating countries, this could become very complex.

9.3.2 Tradable Quotas31 (SAR III, 11.5.4)

Countries could negotiate national limits on emissions of GHGs either voluntary or legally binding targets/quotas-to be achieved by specific dates. These could be negotiated for a single gas, for a group of gases, or as an aggregate CO, equivalent. A more comprehensive approach allows more flexibility and larger cost savings.

Given differences in marginal emission control costs among countries, allowing international trade of emission quota would reduce the cost of achieving compliance with national emission limits regardless of the initial allocation. Each country would be expected either to reduce its emissions, or to purchase quota from other countries so that the sum of these two was not more than its national emission limit.

The national quota allocations can be used to address distributional issues and to draw countries into the agreement. Most proposals for allocating emission quota among countries envisage proportionately higher reductions in national emissions by industrialized countries and slower rates of emission growth by developing countries. Thus, international negotiations will seek quota allocations that do not harm Annex I countries with economies in transition and non-Annex I countries, and that distribute the burden equitably among Annex I countries.

An international tradable quota system presupposes the existence of one or more markets where quota can be traded. For a trading scheme to be effective in controlling emissions, it is

Under an international tax agreement, the tax rate is known but the effect on emissions is uncertain and the international transfer payments may or may not be known, depending on how they are defined in the agreement. Except for the effects of carbon leakage, a tradable quota system has a known effect on emissions, but quota prices and the distributional effects of the quota trade are uncertain, so protection against unfavorable price movements may need to be provided. 32 This means that the benefits of known effects on emissions in a tradable quota system must be bought at the price of some distributional uncertainty.

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All GHG emissions (adjusted for their heat-trapping potentials and atmospheric lifetimes) should be taxed (and carbon sequestration subsidized) at the same rate in all countries. As discussed earlier, it may not be practical to design a tax (rebate) that covers all of the sources (sinks).

"Defining quotas as the right to emit a given quantity once reduces the risk of a present government selling future emission rights that might not be honoured by future governments. This also reduces the possibility of large countries gaining power to distort the quota market. 32If only a limited set of countries is involved, carbon leakage must be taken into account in both the tax and tradable quota cases.

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Technologies, Policies and Measures for Mitigating Climate Change

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countries could shift production of carbon-intensive goods toward other countries, thus increasing their emissions. Second, the mitigation actions would lower world demand for carbon-intensive fuels and reduce the world price for such fuels bence increase the use of (thus the emissions from) these fuels in non-participating countries. Third, the abatement actions could affect incomes in cooperating countries and so reduce imports from other countries which could, in turn, lower their income and emissions. Fourth, investment flows and exchange rates also could be affected, with unpredictable impacts on emissions.

Leakage is measured in terms of net GHG emissions relative to the emissions reduction in cooperating countries; estimates vary widely (SAR III, 11.6.4.2).

What can be done to reduce emission leakage? Basic trade theory suggests that (treating the cooperating countries as a single entity and the rest of the world as another single entity) a tariff should be imposed on imports of carbon-intensive products, or their exports should be subsidized, depending on whether the cooperating countries are net importers or net exporters before the mitigation actions are implemented. Alternatively, a production subsidy (tax) and consumption tax (subsidy) could be implemented in the cooperating countries instead of the import tariff (export subsidy),33

Application of border tax adjustments, such as import tariffs or export subsidies, while theoretically appropriate for reducing leakage, pose a number of practical problems. Determining the emissions associated with the manufacture of a particular product, hence the border tax adjustment, is likely to be very complex because of differences in the fuel mix and production techniques used in different regions. Furthermore, the appropriate border tax adjustments may not be compatible with current multilateral trading rules. Likewise, implementing production and consumption subsidies and taxes at the appropriate level in all cooperating countries, given the differences in their existing tax systems, is likely to prove practically impossible (SAR III, 11.6.4.3).

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Technologies, Policies and Measures for Mitigating Climate Change

Table 19: Selected examples of economic instruments to mitigate GHG emissions.

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Technologies, Policies and Measures for Mitigating Climate Change

enforcement and, if the international agreement is non-global, taxes. Trading systems that use government-issued permits (such insignificant carbon leakage.

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as the sulfur dioxide allowance trading system in the U.S.) have lower transactions costs than do systems that use self-defined credits. Permits appear to have a distinct advantage in creating the basis for a futures market that could enable more efficient spreading of the risks associated with changing emissions targets. For a tradable permit system to work effectively, relatively competitive conditions must exist in the permit (and product) market. Should a firm control a significant share of the total number of permits, it might attempt to manipulate permit prices to improve its position in the permit or product market (e.g., by withholding permits, thus forcing others to cut production or keeping new entrants out). These risks can be reduced by government auctioning of permits and other mechanisms. Little information is available on the administrative costs for monitoring, enforcement and management of an international tax system, internationally harmonized taxes or a tradable quota system.

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Under a GHG tax, the tax rate is known but the effect on emissions is uncertain, and the distributional effects may or may not be known. A tradable permit system has a known effect on emissions, but permit prices and the distributional effects through trade are uncertain. A system of harmonized domestic taxes could involve an agreement about compensatory international financial transfers, as well as about adjustments required to compensate for differences in pre-existing tax structures. To be effective, a system of harmonized domestic taxes also requires that participants not be allowed to implement policies that indirectly increase GHG emissions.

A tradable quota scheme allows each participant to decide what domestic policy to use. The initial allocation of quota among countries addresses distributional considerations, but the exact distributional implications cannot be known beforehand, since the quota price will only be known after trading begins. Under a tradable quota scheme, the resulting global emissions will be known with certainty for a global agreement and, net of carbon leakage, for a non-global agreement.

An exception, of course, is when a source has received enough permits gratis to cover its emissions. Even in this case, however, it will be subjected to an implicit marginal cost of emissions, since reducing emissions would allow it to sell more permits.

Appendix A

BASELINE PROJECTIONS

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