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would be encouraged and use of energy-intensive capital would be reduced. Hence, the reduction in economic growth would be held to a minimum. The tax rates shown in Table 1.3 reflect the many factors contributing to car. bon intensity.

cade of the study, both taxes and economic impacts will be relatively higher for that period. As energy demand growth tails off in the third decade, so does the observed impact of the proposed taxes. In Greece, on the other hand, growth will be consistently high throughout the 30 years, so carbon tax levels and their economic impact will also be consistently high throughout. Taking a snapshot of the economic impacts at the end of the 30-year period does not provide an accurate indication of the total impact of this tax scheme.

Under a carbon tax scenario, industrial natural gas prices will become fairly representative of an average industrial energy price. Sharply higher coal prices and moderately higher oil prices will shift the industrial market toward natural gas for direct fuel use. Industrial electricity applications are also expected to grow over the next 30 years. Electricity is expected to gain market share as the impact of higher fossil fuel prices is diluted by capital and operating costs, lowering the percentage price increase seen by consumers (see Table 1.4).

Imposing a Carbon Tax Multilateral adoption of emission targets for carbon dioxide from fossil fuel combustion will dramatically reduce annual emissions of carbon. The goal of stabilization at 1988 levels by 2000 will result in a 10.3% reduction from the baseline estimate. For the 12 countries studied, reducing emissions 10% below 1988 levels by 2010 will produce a total savings of 27.6% and achieving the ultimate goal of a 20% reduction will save 40% of the annual baseline emissions.

Finally, the retail gasoline price reflects a substantially smaller change from the base case than the percent increase in crude costs. Seve eral factors contribute: (1) wholesale gasoline on a per gallon basis bears the largest share of the fixed refining costs of all of the petroleum products; (2) federal, state and local taxes represent a large proportion of the delivered energy price (this is particularly true outside of the U.S.); and, (3) dealer margins are proj

Carbon taxes were imposed in each country such that substitution of lower carbon content fuels would be optimized, energy-efficiency

January 1992 5 Executive Summary

TABLE 1.4
Industrial and Transportation Prices
(Percentage Difference from the Base Caso)

Ind. Gas Price Ind. Electricity Price Motor Gasoline Price

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Executive Summary

TABLE 1.5
Cumulative Reduction In Total Energy and Carbon Emissions

Total Energy (1)

Carbon Emissions (1)
Country 95-2000 2001-10 11-2020 95-2020 95-2000 2001-10 11-2020 95-2020
.....:::80NTELLILIGID...8.0.500.000

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Impact of the Carbon Tax on the U.S. The carbon taxes required to achieve the targets in the U.S. translate into an eight- to tenfold increase in delivered coal prices and a doubling of delivered prices of oil and natural gas. A $700+ tax per ton also implies almost one trillion dollars in new federal revenues by 2020-over 8% of real output.

Revenue Recycling. The short- and long-run economic repercussions of carbon taxes are quite sensitive to the manner in which such revenues are recycled. Cuts in other taxes or increased public spending can be shown to have a decisive influence on the long-run standard of living and the distribution of income. The DOC mandated that all carbon tax revenues be recycled through reductions in personal income taxes. However, this choice rules out a large variety of positive alternatives that could be superior in their abilities to buffer the cyclical and trend losses in national income flowing from new carbon taxes. Tax incentives could be provided to accelerate in

Recycling via personal income tax cuts will produce a squeeze on business profits because higher energy costs will not be offset immediately by a cut in either corporate taxes or other costs. Unrealistic wage bargains will be an initial source of the problem, but there are other fundamental sources. Higher interest rates will shift income from borrowers to lenders, and the American household sector will remain a persistent net creditor to the business community throughout the forecast. These shifts in income flows will cause a gross change in the post-tax distribution of income and wealth.

1 While there no important policy considerations inherent in each approach, is not the purpose of this study to address the leave. A detailed look the macroeconomic consequenou o wlou approaches can be found in "Carton Tax Recycling. Converting Conta Into Benenta. Roge Brinner and presented the Energy Modeling Forum Contorena, Boulder, Colonde August 1801.

8 DRI/McGraw-Hill

Executive Summary

In addition, the sequence of ever-higher car. bon taxes will sustain a multi-decade recessionary impluse, holding capacity utilization rates lower and impairing the recovery of costs due to more intense competition among suppliers. Competition from alternative producers in developing nations, not burdened with heavy carbon taxes, will compound the downward pressure on business margins. Finally, real investment spending will be curtailed by the high capital costs and weak cash flow,

OECD and non-OECD partners in current trade, and the new taxes being imposed (or not, as in the Third World), DRI estimated that overseas cost pressures passed on in the prices of U.S. imports would range from 70% to 90% of those passed on by the U.S. in export prices. However, the oil import bill will be cut 15% by 2000, 33% by 2010 and 30% by 2020. Reflecting an array of offsetting and reinforcing changes in non-oil trade, the aggregate mere chandise trade position will show annual gains.

Output Potential. These shortfalls imply significantly lower productive potential for the nation. Potential real GNP will be approximately 3.5% below the baseline from 2010 onward; non-farm output per hour will be approximately 4.5% lower during the same interval. The household standard of living, measured by real disposable income, will be buffered temporarily from this loss by the tax policy and pre-tax income shifts. But a post-2020 correction is almost a certainty because the return on capital will be inadequate

This massive improvement will convert the U.S. from a large debtor to a substantial creditor. The annual U.S. current account will improve by almost $200 billion in 2010 and by over $650 billion by 2020 under the carbon tax scenario.

The most severe impacts of the carbon tax on real GNP will occur between the imposition of the tax in 1994 and 2013. Growth falls below trend levels, averaging 1.7% between 2000 and 2010 versus 2.1% in the base case. As the required rate of carbon tax increases abates in the final decade, growth recovers modestly. In 2010, real GNP will be 4.6% below the baseline. By 2020, this loss will moderate to 1.8%.

Inter-Study Comparisons The results of the present DRI study were compared with those of five others: a U.S. Department of Energy study recently completed, simulations with the PCAEO and DGEM models described in a 1990 Congressional Budget Office report, a 1991 OECD study using the GREEN model, and a 1991 Manne and Richels study based on the Global 2100 model. Each study evaluates policies under a different set of conditions.

Employment. The U.S. economy suffers a sig. nificant loss in employment as a result of the carbon tax. The loss in output would cost the U.S. an average of 600,000 jobs per year, thereby raising the average unemployment level by 0.4 percentage point. But both employment and the unemployment rate converge toward their base case level by 2020.

The first three examine the effects of taxes imposed unilaterally by the United States; the latter two are multilateral. In addition, the DOE, PCAEO, and Manne and Richels employed econometric models, while the DGEM and OECD studies used Computable General Equilibrium models (CGE). These types of models are built on divergent assumptions about the role of structural conditions in determining economic activity. A CGE model is organized around price and quantity movements that reflect market clearing processes. Econometric models, on the other hand, analyze the relationship between

Current Account Balance. On the plus side, the nation will benefit materially from an improvement in its terms of trade with oil exporters. Taking into consideration the roles of

January 1992 9

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