Nils Axel Braathen OECD, Environment Directorate Nils-Axel.Braathen@oecd

1. Carbon-related taxation in OECD countries and interactions between cap-and trade systems and other policy instrumentsPresentation at the 11th Global Conference on Environmental TaxationBangkok, Thailand3-5 November 2010 Nils Axel Braathen OECD, Environment Directorate Nils-Axel.Braathen@oecd.org

2. Introduction • This presentation will address two largely distinct aspects of policies OECD member countries currently apply to address the threat of climate change: • CO2-related taxes applied to fossil fuels and motor vehicles. • Interactions between cap-and trade systems and other policy instruments (in particular when the instruments are applied to address climate change). • While my description primarily focuses on OECD countries, the comments I make should be just as valid for other countries as well.

3. Part ICO2-related taxes applied to fossil fuels and motor vehiclesFor more information on the use of environmentally related taxes in OECD countries, the new OECD book on Taxation, Innovation and the Environment will be presented in Panel session 18 tomorrow, at 10:50 am to 12:20 pm.

4. Tax rates on petrol and diesel I

5. Tax rates on petrol and diesel II • By far the highest rate of tax on petrol in the OECD, and the second highest rate on diesel, are levied in Turkey, one of the OECD countries with the lowest income per capita. • If the motor fuel taxes had been levied only to address greenhouse gas emissions, a tax rate of 0.6€ per litre petrol would correspond to a “carbon tax” of 256€ per tonne CO2emitted. • However, in practice, the taxes on petrol and diesel are of course levied for a number of other reasons, and one should not count all of them as “carbon taxes”. • Nevertheless, it is the full rate of tax that will influence the extent to which CO2 will be emitted.

6. “Carbon taxes” and total taxes levied on selected energy products in OECD countries01.01.2010

7. Tax rates per tonne CO2 emitted implicit in the excise tax rates on selected fossil fuels01.01.2010

8. One-off tax per vehicle as a function of CO2 emissions per km drivenPetrol-driven vehicles, 01.01.2010

9. Tax per year as a function of the vehicles’ CO2 emissions per km drivenPetrol-driven vehicles, 01.01.2010

10. Calculating tax per tonne CO2 emitted over a vehicle’s lifetime • Assume that a vehicle is driven 200,000 km over its lifetime. • For the recurrent taxes, assume that the lifetime is 15 years. • Calculating lifetime emissions: • Gram CO2 per km * 0.2 = tonne CO2 emitted over the lifetime • 180 g CO2 per km * 0.2 = 36 tonnes CO2 emitted over the lifetime • One-off taxes for a vehicle emitting 180 g CO2 per km: • If the tax is 7200€ per vehicle => (7200 / 36) = 200 € per tonne CO2 • Recurrent taxes for a vehicle emitting 180 g CO2 per km: • If the tax is 540€ per year => (540 / 36) * 15 = 225 € per tonne CO2 • (The amount would be lower, if discounting of future tax payments was taken into account.)

11. CO2-related tax rate differentiation in one-off motor vehicle taxes € per tonne CO2 emitted over the vehicle lifetime, petrol-driven vehicles

12. CO2-related tax rate differentiation in recurrent motor vehicle taxes € per tonne CO2 emitted over the vehicle lifetime, petrol-driven vehicles

13. Tax per tonne CO2 emitted over a vehicle’s lifetime, selected emission levels per kmPetrol-driven vehicles, 01.01.2010

14. The case for CO2-related differentiation of motor vehicle taxes I • In a “perfect world”, one can question the need for CO2-related differentiation of motor vehicle taxes. • As there is a direct link between the carbon content in the motor fuels used and the CO2 emissions of a given vehicle, it could be more efficient to just apply a tax reflecting the carbon content of different fuels. • Differentiation of a tax on vehicle purchases only affect (directly) the decisions of those that buy a new vehicle – and it has no (or little) impact on how much the vehicles are used. • Differentiation of recurrent vehicle taxes can affect the decision to continue to own both new and old vehicles – but will also have no (or little) impact on how much the vehicles are used.

15. The case for CO2-related differentiation of motor vehicle taxes II • However, the world is not quite perfect. • It is e.g. possible that consumers are “myopic” – i.e. that they don’t take future fuel consumption much into account when buying a new car. • It can also be “politically easier” to introduce a (possibly revenue-neutral) CO2-differentiation in vehicle taxes than to introduce (only) “sufficiently high” motor fuels taxes. • However, the degree of differentiation of vehicle taxes applied in some countries can seem out of proportion to the CO2 abatement incentives provided elsewhere in the economies.

16. Part II Interactions between a cap-and-trade system and other policy instruments addressing CO2 emissions

17. Types of impacts of ‘flanking instruments’ • A number of countries are applying ‘flanking instruments’ to address CO2-emissions from sources covered by the ‘cap’ of a CO2-emissions trading system. • This section will address • Impacts of such instrument mixes in the short run; for a given cap • Impacts on CO2 emissions • Impacts on energy security • Impacts on other types of emissions • Impacts on economic efficiency • Impacts of such instrument mixes on future caps; in the medium to long term

18. Short-term impacts on CO2 emissions • As long as the ‘cap’ remains unchanged, the ‘flanking instrument(s)’ would cause further abatement efforts by some emission sources, but – given the ‘logic’ of a trading system – this would automatically lead to a reduction in permit prices and increased emissions from some other source(s) included in the trading system. • This point has very important implications. • For example, given that the EU ETS covers electricity generation, additional policy instruments that address electricity use or the CO2 emissions caused by electricity generation are unlikely to affect total EU CO2 emissions.

19. Short-term impacts on energy security I • It is sometimes contended that ‘flanking measures’ improve the “energy security” of a country or the wider region. • For example, building wind turbines in EU countries is said to reduce the region’s dependence on fossil fuel imports. • At first sight, this could seem correct: Wind turbines are driven by wind – not by coal, natural gas or fuel oil. • However, replacing a coal- or gas-fired power plant with a wind turbine will necessarily increase CO2 emissions from some other source(s) covered by the trading scheme.

20. Short-term impacts on energy security II • And these CO2 emission-increases can only stem from increased use of fossil fuelsamong these ‘other’ sources. • This could either be due to an increase in ‘activity levels’ • e.g. more fossil fuel-based power plants • … or due to an increase in the CO2 intensity of a given activity level … • e.g. substitution of a coal-fired power plant for a gas-fired one • … or due to a combination of the two. • The share of renewables in the EU energy would thus not be much altered (and total energy use could increase).

21. Short-term impacts on other emissions • Still another argument used to ‘defend’ the use of ‘flanking’ instruments is that those instruments would alsoaffect other types of emissions (e.g. SO2, NOx and particulates) stemming from the CO2 emission sources – “co-benefits” • However, it is not given that there would be any net ancillary benefits. • The reason is similar to the previous points: • The ‘flanking’ instruments would cause increased use of fossil fuels ‘elsewhere’ among the trading sources. • The net impact on e.g. SO2, NOx and particulate emissions will depend on the relative emission intensities of the sources that reduce and the sources that increase their CO2 emissions.

22. Short-term impacts on economic efficiency • In spite of the arguments presented thus far, there can be economic efficiency arguments for applying ‘flanking instruments’ if they effectivelyaddress other market failures: • information barriers, • market power in relevant markets, • split incentives between landlords and tenants, etc. • It is also well-known that there are positive externalities related to R&D and technological innovation. • There are, hence, arguments for applying ‘flanking instruments’ to promote new technologies that help abate CO2 emissions – also while the cap remains unchanged – if the expected benefits exceed the expected costs.

23. Impacts on future caps; in the medium to long term I • It is also important to address the impacts of ‘flanking’ instruments on the ‘strictness’ of the cap in the future. • ‘Flanking instruments’ certainly can create the conditions to tighten the cap in the future, but whether this actually occurs will depend on a range of factors, e.g. the political economy conditions surrounding energy policy in the long term. • In this regard, it is important how the ‘flanking instruments’ can be expected to affect current and future allowance prices.

24. Impacts on future caps; in the medium to long term II • The caps under EU’s 20-20-20 decision were the result of a political process, rather than being necessarily based on careful estimation of the related costs. • However, it is quite possible that future caps will be ‘endogenous’, meaning that they will (partly) be based on assessments of the expected costs of achieving them. • In the US SO2 allowance trading system, the number of allowances was significantly reduced in response to lower-than-expected allowance prices.

25. Impacts on future caps; in the medium to long term III • If a ‘flanking instrument’ effectively contributes to lowering current and/or expected future allowance prices, by helping to overcome current market failures in an efficient way, and/or by cost-effectively stimulating development of new abatement technologies, it could contribute to a stricter cap for future years. • If not, it would pull in the opposite direction.

26. Impacts on future caps; in the medium to long term IV • We are also facing an important policy failure: • Policy makers have not felt it feasible to tighten the cap of the EU ETS enough to raise the price of carbon emissions to the level that would cause technological change on the scale needed to address the threat of major climate changes. • In such a situation, it can make sense to facilitate the setting of a stricter cap in the future by applying ‘flanking instruments’ – but it is important to assess both ex ante and ex post whether the additional instruments in practice can be expected to lower the cost of reducing the capped emissions (or in fact have done so).

27. More information • www.oecd.org/env/taxes • www.oecd.org/env/policies/database • www.oecd.org/env/taxes/innovation • www.oecd.org/greengrowth • Nils-Axel.Braathen@oecd.org