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I. Executive Summary

The first assessment report of the Intergovernmental Panel on Climate Change, issued in August 1990, states that “emissions resulting from human activities are substantially increasing the atmospheric concentrations of the greenhouse gases: carbon dioxide, methane, chlorofluorocarbons (CFCs) and nitrous oxide. These increases will enhance the greenhouse effect, resulting on average in an additional warming of the earth's surface." The Department of Commerce contracted with DRI/McGraw-Hill to research the economic implications of proposed international policies designed to mitigate this environmental change.

In the international debate over possible climate change, a number of measures to reduce greenhouse gas emissions have been proposed. This study focused on one of these proposed remedies, the taxation of fossil fuels based on the level of carbon dioxide (CO2) each emits in combustion.

Study Design

DRI designed a set of economic and energysector scenarios to simulate the effects that such a tax would have on the economies of the 12 major OECD countries (the U.S., Canada, the United Kingdom, France, West Germany, Spain, Greece, Italy, Sweden, the Netherlands, Japan, and Australia). It was assumed that each country would be given 30 years from the introduction of the tax to comply with hypothetical CO2 emissions reduction goals established by the international community.

The study was performed by forecasting baseline economic and energy variables, and then estimating the same variables for a specified Carbon Tax Scenario. DRI/McGraw-Hill

employed its country energy, country macroeconomic, and world economic models to identify the appropriate level of carbon taxes for each of the 12 OECD countries specified. The carbon tax scenario was designed to force the OECD-12 to stabilize their carbon emissions at the 1988 level by 2000, and then reduce emissions to 10% less than the 1988 level by 2010 and 20% less than the 1988 level by 2020. Carbon taxes were phased in beginning in 1994, increasing as needed by country to meet the incremental carbon emission reduction targets.

The Department of Commerce (DOC) asked DRI to assume that the tax would be revenue neutral, with tax revenues returned to each country's economy through reductions in personal income taxes. All the remainder of the report's contents, including the base case economic scenarios for each country, estimates of the carbon taxes required to achieve the 20% reduction by 2020, and the estimates of economic effects, are based on DRI's assumptions (explicit and implicit) and DRI's analysis using its proprietary econometric models. DRI's economic assumptions, descriptions of the economic developments in each country studied, and the economic models employed for the analysis do not necessarily reflect the official views of the Department or the Administration.

The carbon content for each major fuel source was the basis for calculating fuel-specific taxes. The average carbon content (expressed in tonnes of carbon per tonne of oil equivalent, or toe) for each fuel is: oil products, 0.837 tonnes carbon/toe; solid fuels, 1.076 tonnes carbon/toe; natural gas, 0.641 tonnes carbon/toe.

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Executive Summary

Study Methodology

Baseline Determination. DRI expanded its normal 20-year forecast horizon to almost 30 years, so that long-term impacts of the carbon tax could be captured. Expansion of the time horizon allowed more government-proposed programs and energy-related options to be implemented. Many of these significantly affect capital spending plans (e.g., the expansion of the nuclear power program in the U.S., as proposed by the current Administration). Initial Carbon Tax Simulation. Each country analyst made trial runs with the country energy model, varying carbon tax rates until, through resulting fuel price increases, fuel demands reached levels that were roughly consistent with emission targets.

Initial Economic Simulation. The resulting energy prices and demands were fed into the national macro models along with compensating personal tax reductions.

Iterative Energy/Economic Simulations. The economic results were fed back into the national energy models. Insofar as these modified economic inputs threw the energy solutions off their targets, the whole solution process was repeated until consistency was achieved. World Economic Model Consistency Check. A final consistency check on the multilateral solutions was made with the World Economic Model, particularly with regard to trade flows and balances of payment. Inconsistencies were corrected by modifying the energy/macro model solutions.

Population Growth. While population growth
for the 12 countries studied will average 10.6%
between 1988 and 2020, individual growth
rates will vary greatly. The U.S. will experi-
ence the greatest absolute population increase
and associated direct requirement for in-
creased energy. Canadian growth will be
42.1% while the Italian population will actual-
ly decline 3% over the same period.

Per Capita Income Growth. A rising stan-
dard of living is associated with a greater need
for energy. Current and forecasted living
standards differ significantly among the 12
OECD countries. The United States, which
currently has living standards 20% to 30%
higher than those in Europe or the Pacific,
can be expected to see only moderate growth
in per capita income. On the other hand, both
Greece and Spain are expected to see living
standards improve significantly over the study
time-frame. As with population growth, high-
er growth here will lead to higher energy and
emissions growth.

Output Growth. Growth in output (measured as GNP in the U.S., Japan and Germany and as GDP in Australia, Canada and the rest of Europe) reflects the need for absolute energy growth in an economy. For the countries being studied, base case output growth varies from 64% to 163% over the 30-year forecast period. The higher the expected growth, the greater the pressure to increase energy use and associated carbon emissions. High output growth leads to higher carbon tax levels and higher economic costs.

Energy Intensity of Output. Energy intensity, or the average amount of energy consumed in creating a unit of national income, also varies greatly across the 12 nations (Table 1.2). Improving (reducing) energy intensity provides all nations with a means of reducing energy use without reducing output. Improving energy efficiency is an avenue best used by relatively inefficient, high intensity users.

Fossil Fuel Reliance. Countries relying heavily on fossil fuels for current or future energy

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requirements stand to face major energy-sector dislocations when carbon taxes are implemented. Countries that can shift a small portion of their energy requirements to some form of renewable energy may be able to attain required reductions with lower tax levels and less economic output loss. But those nations with little access to renewable energy will find requirements to reduce CO2 emissions by even small amounts very difficult to meet.

Fossil Fuel Mix. Fossil fuels vary in the levels of CO2 emitted when burned, with coal having the highest CO2 per Btu, followed by petroleum and natural gas. Countries currently relying heavily on coal either now or for future energy requirements could reduce CO2 emissions by switching to either oil or natural gas. Countries relying on natural gas cannot achieve reductions by fossil fuel switching, and stand to face both a requirement to implement a higher carbon tax and the possibility of incurring greater economic costs. Access to future sources of natural gas can significantly reduce the requirement for higher carbon taxes in some countries.

Current Emission Intensity. Required emissions reductions are based on current (1988) levels. Therefore, nations with higher levels of CO2 emissions per total energy have more options to exercise as the use of fossil fuels becomes more expensive with carbon taxes. The easier it is to attain the emissions reductions, the lower the tax that must be imposed.

Existing Energy Taxes. Today, existing energy taxes vary quite considerably, both among fuels and sectors within an individual country and among different countries. Delivered fuel prices reflect current tax and subsidy policies that governments use to achieve national, sectoral or fuel-specific objectives. In the United States, for example, the carbon taxes were added to existing energy taxes, such as the federal and state gasoline taxes.

Energy Growth Profiles. Projected future energy demand growth patterns play an important role in both the level of carbon taxes required to achieve specified emission reductions, and the cumulative economic effects that they generate. For the U.S., where demand growth is greatest in the second de

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