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WP/14/174八 IMF Working PaperHow Much Carbon Pricing is in Countries Own Interests?The Critical Role of Co-BenefitsIan Parry,Chandara Veung,and Dirk Heine*Parry and Veung:Fiscal Affairs Department,IMF;Heine:University of Bologna.We are grateful to Jorge Alvarez,Tim Callen,Alfredo Cuevas,Vitor Gaspar,Michael Keen,Francisco Roch,Carlo Sdralevich,and Roman Zytek for very helpful comments and suggestions on an earlier draft.INTERNATIONAL MONETARY FUND 2014 International Monetary FundWP/14/174IMF Wo r king Pa pe rFiscal Affairs DepartmentHo w Muc h Ca r bo n Pr ic ing is in Co unt r ie s,Own Int e r e st s?The Cr it ic a l Ro l e o f Co-Be ne f it sPr e pa r e d by Ia n Pa r r y,Cha nda r a Ve ung,a nd Dir k He ineAuthorized fbr distribution by Michael KeenSeptember 2014This Wo r king Pa pe r sho ul d no t be r e po r t e d a s r e pr e se nt ing t he vie ws o f t he IMF.The views expressed in this Working Paper are those of the author(s)and do not necessarily represent those of the IMF or IMF policy.Working Papers describe research in progress by the author(s)and are published to elicit comments and to farther debate.Abst r a c tThis paper calculates,for the top twenty emitting countries,how much pricing of carbon dioxide(CO2)emissions is in their own national interests due to domestic co-benefits(leaving aside the global climate benefits).On average,nationally efficient prices are substantial,$57.5 per ton of CO2(fbr year 2010),reflecting primarily health co-benefits from reduced air pollution at coal plants and,in some cases,reductions in automobile externalities(net of fuel taxes/subsidies).Pricing co-benefits reduces CO2 emissions from the top twenty emitters by 13.5 percent(a 10.8 percent reduction in global emissions).However,co-benefits vary dramatically across countries(e.g.,with population exposure to pollution)and differentiated pricing of CO2 emissions therefore yields higher net benefits(by 23 percent)than uniform pricing.Importantly,the efficiency case fbr pricing carbons co-benefits hinges critically on(i)weak prospects fbr internalizing other externalities through other pricing instruments and(ii)productive use of carbon pricing revenues.JEL Classification Numbers:H23,Q48,Q54,Q58Keywords:carbon pricing;co-benefits;air pollution;fuel taxes;top twenty emittersAuthors E-Mail Address:Iparryimf.org;daraveunggmai ;dheineposteo.de3Contents PageAbstract.2I.Introduction.4II.Defining and Measuring Nationally Efficient CO2 Prices.6A.Analytical Framework.6B.Data.11C.Results.18D.Fiscal Considerations.25III.Conclusion.28Figures1.Net Benefits from a Pre-Existing Fuel Tax.72.Net Benefits from a CO2 Charge on an Individual Fuel.103.CO2 Emission Shares and Intensity,2010.124.Contribution of Fuels to CO2 Emissions,2010.135.Pre-Existing Fuel Taxes/Subsidies,2010.146.Non-CO2 External Costs by Fuel,Net of Taxes/Subsidies,2010.157.Nationally Efficient CO2 Prices due to Domestic Co-Benefits,2010.198.Emissions Reductions,and Sources of Reductions by Fuel Type,2010.209.Breakdown of Nationally Efficient Carbon Price by Fuel Type,2010.2110.Net Benefits from Nationally Efficient and Uniform Pricing,2010.2311.Revenue from Nationally Efficient Carbon Prices,2010.2612.Net Benefits from Carbon Pricing Accounting for Fiscal Linkages,2010.29Box1.Other Externalities from Energy Use.9AppendixMethodology Underlying non-CO2 External Damages.30References.34I.IntroductionThere has been much agonizing over achieving the collective benefits from addressing global climate change.However,pricing carbon dioxide(CO2)emissions from fossil fuel use can produce important national co-benefits.Most obviously,as carbon charges reduce use of coal,natural gas,and petroleum products,this reduces the amount of people killed by outdoor air pollution,currently estimated at 3.7 million a year worldwide.1*To take another example,if congestion,accidents,and other externalities from motor vehicle use are not fully internalized through other pricing policies,again there are potentially significant cobenefits to the extent that carbon charges reduce vehicle use.The potential for co-benefits suggests that countries need not wait on internationally coordinated efforts if some carbon mitigation is in their own national interests-that is,the domestic environmental benefits exceed the CO2 mitigation costs,leaving aside climate benefits.1 See WHO(2014),though not all of these deaths are due to fossil fuel emissions,and some are jointlydetermined with indoor air pollution.These considerations raise three important questions for policy.First,what scale of CO2 pricing is in countries5 own interests and how this would affect CO2 emissions?Ideally non-CCh externalities would be internalized through other policies,including charges for air emissions from coal and for peak-period driving on congested roads.However,until such policies are comprehensively implemented(likely a long time given that no country presently has anything like fully corrective charges)it is entirely appropriate to price CO2 emissions for domestic co-benefits(prior to assessing additional measures warranted by global concerns).Second,given cross-country heterogeneity in co-benefits(and medium-run constraints on internalization of co-benefits through other policy instruments),efficiency requires differentiated carbon prices across countries,with prices higher in countries with greater co-benefits per ton of CO2 reductions.The question is whether the extra benefits from nationally efficient carbon pricing,compared with uniform pricing(resulting,for example,from linking trading systems),are empirically large-if so,this suggests the potential superiority of pricing regimes allowing countries to choose their own emission prices(ideally subject to some agreed minimum price reflecting global climate damages)over agreements inducing all countries to price emissions at the same rate.The third question is how much revenue is raised from nationally efficient CO2 pricing and how revenue use might affect the net benefits from pricing co-benefits in different countries.In the latter regard,prior literature(e.g.,Goulder et al.1999,Parry et al.1999)emphasizes the large differences in costs between carbon pricing policies where revenues are used productively-most obviously to lower the burden of income and other taxes that distort the level of economic activity and its compositionversus carbon pricing policies(like trading systems with free allowance allocations or carbon taxes with low-value earmarks)that fail to exploit efficiency gains from recycling opportunities.5This paper seeks to address the above three questions2,though the main fbcus is on assessing nationally efficient CO2 prices,that is,prices reflecting domestic(non-intemalized)environmental benefits per ton of CO2 reductions.These prices are based on country-level estimates of(non-CO2)environmental damages by fossil fuel product from Parry et al.(2014),and a simple spreadsheet model populated with fuel use,price,and tax/subsidy data,along with simple rules of thumb for the responsiveness of fuel use to carbon pricing.Results are provided for the top twenty CO2 emitting countries,collectively accounting for 80 percent of current,energy-related,global CO2 emissions.2 A further issue,not examined here,is that international emissions offset programs become less attractive from a national perspective to the extent they reduce domestic CO?abatement and hence domestic co-benefits(e.g.,Nemet et al.2010).3 Some other studies discussed below also provide estimates of health co-benefits from reducing CO2,thoughnot fbr all the twenty countries considered here and leaving aside prior fuel taxes/subsidies and broaderexternalities.The main findings can be summarized as follows.As regards the first question,the nationally efficient CO2 price is typically quite large,for example,$63 per ton-estimated for year 2010 and in US$for that year-in China,and averages$57.5 per ton among the top twenty emitters.For comparison,a US government study(US IAWG 2013)puts the global damage from CO2 emissions at$35 per ton,and CO2 prices in the European Unions Emissions Trading System have been below$10 per ton since January 2013.In most cases,co-benefits primarily reflect reduced air pollution deaths from less coal use,though in some cases they primarily reflect reduced road fuel subsidy distortions and reduced vehicle externalities.In a few cases(where health damages from coal are limited and motor fuel excises are broadly in line with,or exceed,non-carbon externalities)nationally efficient CO2 prices are around$10 per ton or less,and negative in one case(Brazil,where fuel taxes currently overcharge for domestic externalities).Imposing nationally efficient CO2 prices reduces total CO2 emissions fbr the top-twenty emitters by 13.5 percent below baseline levels(a reduction in global emissions of 10.8 percent).3*On the second policy question,net economic benefits are increased by 23 percent under nationally efficient CO2 prices rather than a uniform price(fbr the same 13.5 percent reduction in emissions from the largest twenty emitters).This is a significant(though not dramatic)gain and reinforces the pragmatic case for flexible pricing regimes when cobenefits,or more generally fiscal needs and political feasibility differ across countries,or when equity concerns(given constraints on international transfers)warrant lower prices fbr lower income countries.As regards the third policy question,on average revenues are large,almost 2 percent of GDP across the top twenty countries.Moreover,if revenues from nationally efficient carbon prices are used to cut broader income taxes,the overall benefits from carbon pricing can increase substantially,on average by about 100 percent(this is the double dividend5 6which can occur when the full range of distortions from the broader fiscal system is properly considered).But if revenue recycling benefits are forgone,the costs of carbon pricing are substantially higher,and actually exceed co-benefits.This underscores the key reservation about environmental taxes,namely the risk that revenues are used for low-value purposes一 combining carbon taxes with offsetting reductions in other taxes avoids this risk.The usual caveats about parameter uncertainty apply-due to data constraints and uncertainties(e.g.,over pollution/health relationships or the valuation of health effects)cobenefits may be measured with considerable imprecision,though sensitivity analyses suggest the general flavor of the results is robust(if anything,co-benefits may be significantly understated here due to conservative assumptions).Terms of trade effects,which can lower national(but not global)welfare for fuel exporters,are however excluded,as are emissions leakage issues4,and adjustment costs from resource re-allocations across sectors.It should also be noted that that the measurement of energy subsidies used here(accounting for just over half of the nationally efficient CO2 price in Saudi Arabia,for example)is not universally accepted,subsidies vary year-to-year with international fuel price volatility,and for practical purposes it may make more sense to reform the subsidies first,before implementing(more opaque)carbon pricing schemes.4 Usually leakage refers to partially offsetting increases in CO?emissions in other countries without carbon pricing as energy-intensive,trade-exposed firms relocate away from countries with carbon pricing.More generally,some of the domestic air pollution benefits might be offset if coal production relocates to neighboring countries and the pollution crosses borders.5 Other fossil fuel products(e.g.,diesel for farm and construction vehicles),are not included as their non-CO2 external costs have not been consistently estimated across countries,though their inclusion in the analysis would not have a major impact on the results.The rest of the paper is organized as follows.Section 2 discusses a straightforward formula for the nationally efficient CO2 price and country-level data needed to implement it.Section 3 presents the main results.Section 4 introduces broader fiscal linkages.Section 5 offers concluding remarks.II.Defining and Measuring Nationally Efficient CO2 PricesA.Ana l y t ic a l Fr a me wo r kThis sub-section discusses the welfare effects of carbon pricing in the presence of fuel taxes/subsidies and environmental externalities and(very basic)formulas to be estimated.(i)AssumptionsA very simple comparative static model of fossil fuel use in a particular country is used where Xi denotes the consumption of fuel,pi is the pre-tax supply price,and i indexes four possible fuels-coal,natural gas,gasoline,and diesel used by road vehicles.57The fuel market prior to carbon pricing is shown in Figure I.The height of the demand curve at any point is the benefit to fuel users from an extra unit of consumption(e.g.,the benefit,net of travel time costs,from vehicle travel from an additional liter of gasoline),while the height of the supply curve reflects the costs(payments fbr labor,capital,energy,and resources to extract,transport,and process fuel,or import it)of producing an extra unit.The fuel demand curve is taken as linear over the relevant range for analytical convenience,which is a reasonable approximation given the scale of fuel reductions considered here.In addition,the fuel supply curve is taken to be perfectly elastic-allowing for an upward sloping supply curve would dampen fuel responses to carbon taxes,but perhaps only modestly in the longer run when supply curves tend to be relatively flat(e.g.,Bovenberg and Goulder 2001).Suppose there is a pre-existing excise tax of t per unit on fuel z,6 so the consumer fuel price is 访+and fuel consumption is Compared with the zero-tax case,consumer(or fuel user)surplus is lower by trapezoid abed,while the government gains rectangle abed in tax revenue,leaving a welfare cost of triangle bee(welfare costs,correctly measured to account fbr linkages with the broader fiscal system,are discussed later).6 tj excludes any value added or general sales tax,as these taxes apply to consumer goods in general and therefore do not affect(to an approximation)affect the consumption of the fuel relative to other consumer products.8Suppose also that fuel use is associated with a domestic environmental cost(i.e.,excluding CO2 damages)per unit of z”For coal and natural gas these costs primarily reflect mortality risks to people exposed to the air pollution produced by combusting these fuels.For gasoline and road diesel,the costs also include those imposed on others from the extra road congestion,accident risk,and road damage due to the driving associated with additional fuel use.In measuring these externalities,account is implicitly taken of existing regulations,fbr example fbr emissions control technologies or vehicle safety,through their effects on observed emission rates,traffic fatalities,etc.Box 1 discusses further externalities from fu
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