Going it Alone

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)

Re #1: What does the set of possible policy tools look like

anyway?

Policy Toolbox

• Command and Control• Regulator dictates which technologies firms use (e.g. “you

must install a scrubber”)

• Emission caps

Emission/input taxesE.g. BC Carbon TaxTo 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, 2010Gasoline ¢/litre 4.45Diesel ¢/litre 5.11Jet Fuel ¢/litre 5.22Natural Gas ¢/cubic metre 3.80Propane ¢/litre 3.08Coal - high heat value $/tonne 41.54Coal - low heat value $/tonne 35.54

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

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

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.

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.

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

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

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

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

– doesn’t necessarily generate jobs• if wind turbines are produced abroad, the new jobs are

created overseas

– Better than nothing?• maybe not: creates vested interests that’ll later oppose

broader, alternate policies

If employ biofuels

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

intensive

End of digression regarding renewable mandates

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

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

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 firm’s rebate a function of own output• input based rebates

How might we manipulate domestic policies so as to

• prevent leakage• alleviate competitiveness concerns

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

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

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

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

And since we’re talking about GATT-legality …

2. Apply Border Tax Adjustments (BTAs)

• Slap taxes onto imports of goods from countries that aren’t doing something about climate change

• Problem– will taxes on embodied carbon violate WTO rules?

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”

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)

– extended scope of Standards Code• imposed a "necessity" clause: technical regulations shall not be more trade restrictive than necessary

to fulfill a legitimate objective (including environment)• process-related characteristics covered only so long as they leave a trace on traded product• "the agreement states that all standards set must be considered to be proportional to the problem

they are trying to solve" (Cole 2000, p.16)-- loaded!!• agreed to form the WTO!

(Seattle Round)

• Concerns over WTO and globalization in general came to a head in 1999

• Anti-globalization groups (including labor and env’l) called to protest at WTO ministerial meetings in Seattle

“The WTO poses a very real threat to this country’s and the world’s 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

Seattle Round cancelled

• But before we give the protestors all the credit, note that talks were likely to fail– Rich/Poor countries couldn’t agree on:

• labor standards (opposed by South)• further reductions in agricultural subsidies (Europe not

willing to discuss these in genuine)

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

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)

How do you “respect the requirements” of the GATT?

Article I Most Favoured Nation (MFN)

Article IIBound Tariffs

Article IIINational Treatment

Article XIQuotas

Article XX(g)

Have to treat all WTO-trade partners the same

Can’t 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 measures”…XX(g) relating to the conservation of exhaustible natural resources

Precedence*:shrimp-turtle dispute

*Precedence doesn’t have the same standing in International law as it does in some national courts

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 can’t

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

• even though on paper Section 609 looks flexible (i.e. turtle friendly), in action it isn’t: “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 “doesn’t take into consideration different conditions which may occur in the territories of those other members”

• the US didn’t permit imports of shrimp from countries that weren’t certified, even if the shrimp were turtle safe!

• countries denied certification don’t get to see the reasons why and have no opportunity for appeal

Conclusions• Legal interpretation: It’s okay to make market access

conditional on dealing with overseas production externalities----killing turtles as by-catch---but you can’t 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 don’t get certified to send shrimp anyways, and then evaluate those incoming goods on a shipment-by-shipment basis, isn’t that going to be prohibitively costly for either the importer or exporter, effectively nullifying or entrenching the certification process depending on who pays?

Other WTO-related precedents

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)

• “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)

• “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)

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

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

Montreal Protocol

• USA imposes a tax on ozone depleting chemicals (ODC) embodied in imported goods

• www.irs.gov/businesses/small/article/0,,id=186588,00.html#Chapter_04h

– use average ODC embedded in US product as baseline

• if there’s no comparable US product, then tax rate is 5%

– if an importer can verify lower ODC content, is entitled to a lower tax

Precedent?

• Imposes tax on embodied emissions• Has never been challenged

– either because everyone thinks WTO will uphold the tax

– or because it’s not worth anyone’s time to challenge

• quantities of embodied ODCs is now very low

Implications

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

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

• can’t impose penalties on non-signatories/ratifiers if haven’t ratified yourself!

– Canada: honour Kyoto commitments

What’s 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)

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”

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.

What’s 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?

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

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.

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)

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 didn’t ratify

Frankel continued: Don’t…• apply sanctions/adjustments unilaterally…get 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

I’m 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?– what’s 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. – it’s 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 it’s not an Annex I country. Can’t use

Kyoto-non-compliance to justify border adjustments

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)