CARBON TAX GUIDE A Handbook for Policy MakersCARBON TAX GUIDE A Handbook for Policy Makers MARCH 2017CARBON TAX GUIDE A Handbook for Policy Makers MARCH 2017 2017 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone 202-473-1000; Internet www.worldbank.org Some rights reserved 1 2 3 4 19 18 17 16 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of cutive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other ination shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to the Publishing and Knowledge Division, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax 202-522-2625; e-mail pubrightsworldbank.org. Design Eszter Bodnar DESIGNCARBON TAX GUIDE A HANDBOOK FOR POLICY MAKERS 3 ACKNOWLEDGMENTS This Carbon Tax Guide was prepared for the Partnership for Market Readiness PMR, by a team of consultants from Climate Focus, the University of Indiana, School of Public and Environmental Affairs SPEA, and the Gnarley Tree Sustainability Institute GTSI. Pauline Kennedy World Bank provided substantive and managed the project. The lead authors of the Carbon Tax Guide were Darragh Conway Climate Focus and Kenneth Richards SPEA. Stephanie Richards GTSI led the preparation of the tech- nical appendix. Several contributing authors also provided substantial s Paul Keenlyside, Szymon Mikolajczyk and Charlotte Streck Climate Focus, and Justin Ross, Antung Anthony Liu, and Ahn Tran SPEA. In addition, the following persons provided valuable re search, editing, and other kinds of support in the pre- pa ration of the Carbon Tax Guide Leo Mongendre, Sai Sindhura Mamillapalli, Ingrid Schulte, and Sebastian Mller Climate Focus; Elisabeth Andrews, Keyao Sun, Jingyao Gu, and Zoya Atiq SPEA; and Yu Song, Delaney Bolger, and Logan Pfeiffer GTSI. We sincerely thank those government experts who shared their practical insights and knowledge relating to carbon tax design and implementation through meetings, inter views, and review of the Guide. These include Kate Hancock, Gareth Prosser, and Matthew Stuchbery Australia; Aloisio de Melo and Ludmila Vidigal Silva Brazil; Anne Foy British Columbia; Nicola Borregaard, Francisco Javier Pinto Pardo, Juan Pedro Searle, Paula Tassara, and Nicholas Westenenk Chile; Felipe De Leon Costa Rica; Jean Giraud France; Malin Ahlber and Nadine Pauly Germany; Shweta Kumar India; Ciran Conroy, Gerry Kenny, and Ambrose Murray Ireland; Reo Kawamura, Toshiali Nagata, and Yuji Mizuno Japan; Juan Carlos Arredondo, Soffia Alarcon Diaz, Saul Pereyera Garcia, Victor Hugo Escalona Gmez, Carlos Muoz-Pia Mexico; Ingrid Hoff Norway; Memory Matchingambi, Sharlin Hemraj, and Deborah Ramalope South Africa; Susanne kerfeldt, Henrik Hammar, Mats-Olof Hansson, and Johan Nylander Sweden; Andrea Burkhardt Switzerland; and Sila Guiance and Joanna Wain United Kingdom. We also wish to acknowledge and peer review provided by a range of other experts Claudia Dias Soares Green Budget Europe; Ian Parry IMF; Richard Baron, Nils-Axel Braathen, Floren Flues, and Kurt Van Dender OECD; Perumal Armugam and Phillip Eyre UNFCCC; and Martina Zahno University of Zurich. Finally, we thank colleagues at the World Bank Group who also reviewed the report and provided useful and feed back Adrien de Bassompierre, Dirk Heine, Blanca Moreno-Dodso, Maja Murisic, Grzegorz Peszko, and Suphachol Supachalasai. The Guide including the Technical Appendix was edited by Inge Pakulski.CARBON TAX GUIDE A HANDBOOK FOR POLICY MAKERS 4 LIST OF ACRONYMS AFOLU Agriculture, Forestry, and Other Land Use BAU Business As Usual BCA Border Carbon Adjustment CCS Carbon, Capture and Sequestration CDM Clean Development Mechanism CER Certified Emission Reduction CGE Computable General Equilibrium model CPI Consumer Price Index EITE Emission-Intensive Trade-Exposed ETS Emissions Trading System EU ETS European Union Emissions Trading System EU European Union FAO Food and Agriculture Organization of the United Nations GATT General Agreement on Tariffs and Trade DGP Gross Domestic Product GHG Greenhouse Gas IEEP Institute for European Environmental Policy IPCC Intergovernmental Panel on Climate Change NDC Nationally Determined Contribution MAB Marginal Abatement Benefit MAC Marginal Abatement Cost MEB Marginal Emissions Benefit MW Megawatt MNC Multinational Corporation ME Monitoring and uation MRV Measuring, Reporting and Verification NAEIS National Atmospheric Emissions Inventory System NGO Non-governmental Organization NO x Nitrogen Oxide OAIS Old-Age Insurance System OECD Organisation for Economic Co-operation and Development tCO 2 e Metric tons of carbon dioxide equivalent PM2.5 Particulate Pollution that is 2.5 micrometers or less in diameter PMR Partnership for Market Readiness RPS Renewable Portfolio Standard PRTR Pollutant Release and Transfer Register SARS South Africa Revenue Service SCC Social Cost of Carbon UNFCCC United National Framework Convention on Climate Change U.S. REP United States Regional Energy Policy VAR Vector autoregressive models VAT Value added tax WBCSD World Business Council for Sustainable Development WRI World Resources Institute WTO World Trade OrganizationTABLE OF CONTENTS 5 Synthesis Introduction Deciding Whether to Adopt a Carbon Tax Preparing for Carbon Tax Adoption Modeling Carbon Taxes Defining the Tax Base Determining the Tax Rate Determining Use of Revenues Ensuring Oversight and Compliance uating Policy Outcomes Avoiding Unwanted Effects of the Carbon Tax TABLE OF CONTENTS SYNTHESIS CARBON TAXES IN BRIEF 9 Introducing the design process 10 When is a carbon tax the right choice 10 Setting the stage for tax design 12 Designing carbon taxes 13 uate outcomes and review 19 Capitalizing on carbon taxes’ potential 21 INTRODUCTION 22 1.1 Background growing interest in carbon taxes 22 1.2 Purpose of this Guide 22 1.3 How to use this Guide 22 DECIDING WHETHER TO ADOPT A CARBON TAX 26 2.1 Introduction 26 2.2 Introducing carbon taxes 27 2.3 Carbon taxes and policy instrument options 29 PREPARING FOR CARBON TAX ADOPTION 41 3.1 Introduction 42 3.2 Determining policy objectives 42 3.3 Framing the national context 47 3.4 Principles of carbon tax design 52 MODELING CARBON TAXES 56 4.1 Introduction 57 4.2 Uses of modeling analysis 57 4.3 Overview of modeling approaches 57 4.4 Partial economic and technology models 59 4.5 Systemic economic and technology models 65 4.6 Choosing among the modeling approaches 70 DEFINING THE TAX BASE 74 5.1 Introduction 75 5.2 Scope of taxation 75 5.3 Crosscutting consi de ra tion – administration and MRV 85 DETERMINING THE TAX RATE 89 6.2 Basis for the carbon tax rate 90 6.3 Dynamics of the tax rate 95 AVOIDING UNWANTED EFFECTS OF THE CARBON TAX 99 7.1 Introduction 100 7.2 Understanding leakage, competitiveness, and distributional impacts 100 7.3 Assessing leakage and distributional risks 102 7.4 Designing measures to mitigate unwanted impacts 106CARBON TAX GUIDE A HANDBOOK FOR POLICY MAKERS 6 Synthesis Introduction Deciding Whether to Adopt a Carbon Tax Preparing for Carbon Tax Adoption Modeling Carbon Taxes Defining the Tax Base Determining the Tax Rate Determining Use of Revenues Ensuring Oversight and Compliance uating Policy Outcomes Avoiding Unwanted Effects of the Carbon Tax LIST OF BOXES Box 1. The FASTER Principles for Successful Carbon Pricing 13 Box 2. Technical Note Carbon Taxes vs. ETSs 34 Box 3. Implications of GHG Mitigation Objectives for Carbon Tax Design 43 Box 4. Implications of Revenue Objectives for Carbon Tax Design 44 Box 5. Implications of Objectives Relating to Low-Carbon Development and Local Environmental Benefits for Carbon Tax Design 45 Box 6. Implications of Objectives Relating to Tax System Efficiency for Carbon Tax Design 46 Box 7. Implications of Government Capacity and Rule of Law for Carbon Tax Design 48 Box 8. Case Study Liberalization of the Mexican Energy Market and the Carbon Tax 50 Box 9. Implications of Emissions Profile and Economic Context for Carbon Tax Design 51 Box 10. Case Study Stakeholder Engagement in Designing the South Africa Carbon Tax 51 Box 11. Implications of Political Feasibility and Public Opinion for Carbon Tax Design 52 Box 12. Technical Note Price Elasticities of Demand 60 Box 13. Technical Note Estimating Tax Revenue in Agnostia 61 Box 14. Technical Note Exogenous and Endogenous Variables 66 Box 15. Comparison of Approaches to Implementing a Carbon Tax 79 Box 16. Technical Note Setting a Carbon Tax at the Social Cost of Carbon SCC 91 Box 17. Case Study Linking the Tax Rate to Emission Reduction Targets in Switzerland 96 Box 18. Case Study Linking mptions and Rebates to Agreements in Denmark and Switzerland 108 Box 19. Technical Note BCAs – The Risk of a WTO Legal Challenge 112 Box 20. Case Study Iran and Budget Neutrality 116 Box 21. Technical Note How Do General Taxes Lead to Social Costs 117 DETERMINING USE OF REVENUES 114 8.1 Introduction 115 8.2 Options for revenue use 115 8.3 Revenue use in practice 126 ENSURING OVERSIGHT AND COMPLIANCE 131 9.1 Introduction 132 9.2 Defining institutional arrangements 132 9.3 Measuring, reporting, and verification MRV 138 9.4 Designing for compliance 143 UATING POLICY OUTCOMES 150 10.1 Introduction 151 10.2 Understanding the rationale of reviews 151 10.3 Types of reviews 152 10.4 Adjusting carbon tax programs following review 156 APPENDIX A GLOSSARY OF TERMS 159 ANNEX 4A EXAMPLE ECONOMETRIC AND HYBRID MODELS OF CARBON PRICING 162 ANNEX 4B EXAMPLE CGE MODELS OF CARBON PRICING 164TABLE OF CONTENTS 7 Synthesis Introduction Deciding Whether to Adopt a Carbon Tax Preparing for Carbon Tax Adoption Modeling Carbon Taxes Defining the Tax Base Determining the Tax Rate Determining Use of Revenues Ensuring Oversight and Compliance uating Policy Outcomes Avoiding Unwanted Effects of the Carbon Tax LIST OF FIGURES Figure 1. Carbon Taxes in Operation, Scheduled, or under Consideration as of February 2017 9 Figure 2. Stages of Carbon Tax Design and Interlinkages between Design Options 11 Figure 3. Carbon Taxes in Operation, Scheduled for Implementation, or under Consideration as of February 2017 28 Figure 4. Environmental Policy Instruments Designed to Address Externalities 31 Figure 5. Carbon Taxes vs. ETSs 34 Figure 6. Elasticity of Demand for Energy and Reductions in Energy Use 36 Figure 7a Steadily Declining Emissions 43 Figure 7b Emissions Peak, Plateau, Decline 43 Figure 8. Relative Global Use of Energy in 2010 49 Figure 9. Sankey Diagram of World GHG Emissions by Sector, End Use, and Gas in 2005 49 Figure 10. Sankey Diagram of Estimated Energy Consumption in the United States in 2015 Quads 50 Figure 11. Marginal Abatement Cost Curve MACC for Carbon Emissions Reduction in Hypothetical Jurisdiction 63 Figure 12. Estimated MACCs for Reducing Emissions from Deforestation in Kalimantan, Indonesia 2014–23 64 Figure 13. General Categorization of Potential Points of Regulation for Fossil Fuels 80 Figure 14. The Gasoline Petrol Supply Chain 81 Figure 15. Setting the Carbon Tax Rate through the SCC Approach Figure 16. SCC Values Used in Ex Ante Cost-Benefit Analyses of Public Policies 92 Figure 17. Setting the Carbon Tax Rate through the Abatement Target Approach 93 Figure 18. Setting the Carbon Tax Rate through the Revenue Target Approach 94 Figure 19. Revenue as a Percentage of GDP from a Hypothetical US30 per tCO2e Emissions in 2012 115 Figure 20. Steps for Establishing Institutional Arrangements for a Carbon Tax 132 Figure 21. Institutional Roles and Tasks for Carbon Tax Implementation 133 Figure 22. Key Design Elements of a GHG Measuring, Reporting, and Verification MRV System 138 Figure 23. The Public Policy Cycle 152 Figure 24. Organization of Reviews 153 Box 22. Technical Note Are the Social Costs of All Taxes the Same 118 Box 23. Technical Note Can Carbon Taxes Reduce the Social Costs of Raising Revenue 119 Box 24. Technical Note Are Carbon Taxes Stable Sources of Revenue 120 Box 25. Case Study British Columbia and the Revenue-Neutral Approach 120 Box 26. Contrasts in Revenue Use 122 Box 27. Case Study Ireland Carbon Tax – Used to Raise Money to Repay National Debt Arising from Financial Crisis 123 Box 28. Case Study Offsets in the Mexico Car