Minimizing Carbon Leakage under Open Trade: Strategies for the Allocation of Pollution Permits

Transcription

1 Minimizing Cabon Leakage unde Open Tade: Stategies fo the Allocation of Pollution Pemits Caolyn Fische Resouces fo the Futue 1616 P Steet, NW Washington, DC Alan K. Fox Alan.Fox@usitc.gov U.S. Intenational Tade Commission 500 E Steet, SW Washington, DC Key Wods: emissions tading, output-based allocation, tax inteaction, cabon leakage JEL Classification Numbes: Q2, Q43, H2, D58, D61

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3 Minimizing Cabon Leakage unde Open Tade: Stategies fo the Allocation of Pollution Pemits Caolyn Fische and Alan Fox * Intoduction Building on the geneal equilibium analysis conducted by the authos in Output- Based Allocations of Emissions Pemits: Efficiency and Distibutional Effects in a Geneal Equilibium Setting with Taxes and Tade, (2004) this pape sets out to expand on one of the cental findings of the fist pape. Fo a cap-and-tade scheme, in the absence of othe maket failues, lump-sum distibutions of emissions pemits, like auctions o gandfatheing, ae equally efficient. Meanwhile, output-based allocation (OBA) is an inefficient mechanism, due to the implicit output subsidy ganted, which discouages consevation as a means of emissions eduction. Howeve, in a second-best wold with tax and tade distotions, OBA does have featues that make it appealing fom an economic efficiency standpoint. Fist, it mitigates the pice ises that tend to exacebate pe-existing tax distotions to the labo maket. Second, OBA potentially esults in much lowe ates of cabon leakage fom the implementing county to the est of wold. It may also pevent leakage towad unegulated sectos within the subject economy. Finally, fom a political standpoint, it may help minimize the political difficulties of achieving emissions eductions goals, given competitiveness concens. Still, tadeoffs exist between achieving these diffeent goals. This pape will analyze these potential tadeoffs of choosing diffeent allocation mechanisms in ode to achieve oveall emissions eductions goals while minimizing inta- and intenational leakage and minimizing the taditional measues of welfae loss associated with emissions eductions. To lend geate cuency to the analysis, eductions will be consideed in the famewok outlined by the Climate Stewadship Act of 2003, cosponsoed by Senatos John McCain and Joseph Liebeman. The goal of the pape is to popose cetain ules fo identifying sectos and mechanisms fo minimizing the costs of * Alan Fox is with the Office of Economics of the United States Intenational Tade Commission, Washington, DC. The opinions and ideas expessed heein ae solely those of the authos and do not epesent in any way the views of the U.S. Intenational Tade Commission o any of its individual Commissiones.

4 boade emissions eduction when consideing the inteaction of one county's emissions policies with unegulated emissions and labo maket distotions in othe counties. The analysis is caied out in a modified GTAP famewok augmented with a labo-leisue choice. Such a famewok allows fo the consideation of how distotionay tax instuments may be offset by evenues geneated fom pemit auctions o may be exacebated by policies that aise pices. The cuent implementation employs the GTAP vesion 6 (Release Candidate) database. Desciption of Model The model and simulations in this pape ae based on vesion 5 of the GTAPinGAMS package developed by Thomas Ruthefod and documented fo vesion 4 of the dataset and model in Ruthefod and Paltsev (2000). The GTAP-EG model seves as the platfom fo the model outlined hee. Fische and Fox (2004) was based on the same model. This pape extends that model, adapting the famewok to employ the latest available GTAP database, Vesion 6.0 Release Candidate. This allows us to update the analysis to 2001, the base yea of the latest GTAP database. Two featues ae added to the GTAP-EG stuctue to allow us to model the impact of an output-based pemit allocation scheme. Fist, the appopiate stuctue fo simulating an output-based allocation scheme must be incopoated into the model. Next, the household is given a labo-leisue choice so that labo taxes ae distoting. This distotionay tax allows us to conduct simulations ecycling evenue fom pollution pemits to offset the distoting tax instument. Tax instuments ae also selectively incopoated into the famewok of the model, so that the tanspot sectos may be teated diffeently fom othe heavy uses of enegy. This allows fo a modeling appoach moe consistent with that poposed in the McCain-Liebeman legislation. Incopoating Output-Based Allocation Seveal changes need to be made to the GTAP-EG code to incopoate outputbased allocation of pollution pemits. The pofit function is not diectly accessible in the MPSGE famewok. Instead, we incopoate output-based pemit allocation though the poduction function as a tax/subsidy, combining it with side constaints on the values of μ and e to duplicate the effect on the pofit function above. Additionally, we ceate an additional composite fossil fuel nest to poduction. This allows us to incopoate the pollution pemit as a Leontief technology, allowing us to tack pollution pemits though the model. 2

5 In the oiginal GTAP-EG model, the teatment of enegy goods does not allow fo tacking of pemits by secto. In ode to tack pollution pemits, we need to ensue that one pemit is demanded fo each unit of cabon that entes into poduction. This is accomplished by sepaating out the enegy goods into a sepaate activity, a Leontief technology combining the polluting inputs with pemits, into a new composite good (labeled ffi in the code fo fossil fuel input). The composite of pemit and enegy input is then included in the poduction block fo the output good (y). The next step is to incopoate a distotion in the fom of an endogenous tax into the secto s poduction function. This tax, z, will allow us to mimic the impact on the fim of an output-based subsidy. This is accomplished by including constaints to establish values fo μ, e, and the elationship between z, μ, and e. μ i, = The sectoal unit demand fo pollution pemits, μ, is defined as fe χ fe, i, φ fe, i, y i, whee χ is the cabon coefficient fo final enegy good fe { coal, oil, gas} in secto i fe, i, of county. The vaiable φ fe, i, epesents the demand of the fossil fuel input. That is, the unit demand fo pemits is equal to the unit demand fo cabon. The allocation of pollution pemits is defined simply as the baseline unit demand fo cabon multiplied by the pecentage cap ( κ ) on emissions: e i, χ fe, i, = κ fe yi, Note that the paamete i y, does not appea in the MPSGE epesentation in Appendix A. This is because the baseline value of output in the pogam is calibated to 1. The net demand fo pemits and the tax instument in the poduction function ae then tied togethe though a final constaint: [ e ] y z i, pi, = γ μi, i, That is, the unit tax/subsidy on output is equal to the value of the net unit demand fo pollution pemits. The MPSGE epesentation of these equations can be found in Appendix A. 3

6 This allocation mechanism is only active within those industies/sectos that demand cabon-containing fuel as an intemediate input. Within the GTAP-EG model, this excludes the following sectos: Coal; petoleum and coal poducts; cude oil; natual gas; mining; and dwellings. Final demand fo enegy poducts is also subject to emissions pemitting. The pemits fo these activities ae feely taded in the same maketplace as ae those initially allocated based on output. We have a system whee all pollution is subject to pemitting and all pemits ae tadable within the county. The diffeence lies in how pemits ae distibuted in the baseline and how evenues ae ecycled. Incopoating Labo-Leisue Choice The GTAP-EG model has also been extended by incopoating a labo-leisue choice into the household s decision. The pocedue is documented in Fox (2002). Incopoating a labo-leisue choice allows us to teat the labo tax as a distoting tax, hence giving us a distoting policy instument to offset with auction pemit evenues. Since we have no data on labo taxes within the GTAP-EG database, we assume a labo tax ate of 40 pecent within Annex B counties and a 20 pecent tax ate within all othe counties and the Rest of Wold. McCain-Liebeman Pemitting Stuctue To lend geate cuency to the simulation esults, we choose to follow the geneal outline of the cap-and-tade scheme found in the Climate Stewadship Act of 2003, S.139, heeafte efeed to by the names of its co-sponsos, Senatos John McCain and Joseph Liebeman. 1 McCain Liebeman teats a much boade spectum of aibone pollutants, but this pape will concen itself only with CO 2 emissions. All efeences to pollution in this pape ae to the cabon equivalent of these CO 2 emissions. McCain-Liebeman foesees two classes of fossil fuel consumes who ae diectly affected by a cap-and-tade scheme. Fist, majo point souce emittes (those esponsible fo moe than 10,000 metic tons of CO 2, o about 2,700 metic tons of cabon) ae subject to a cap-and tades system whee emittes ae ganted an allocation of pemits popotionate to thei histoical emissions. We model this as a simple cabon pemit equiement on the use of all final enegy goods in the model coal, efined petoleum poducts, o natual gas. Unfotunately, ou database only povides infomation on the size of sectos, not on the 1 Fo a moe complete analysis of McCain-Liebeman, see Pize and Kopp (2003). 4

7 size of individual fims with those sectos. We theefoe assume that the coveed sectos ae coveed in thei entiety. The sectos subject to the cap ae petoleum and coal poducts (efined); natual gas; ion and steel industy; chemical industy; non-feous metals; non-metallic mineals; and pape, pulp, and pint. This ovestates somewhat the magnitude of coveed pollution, depending on the distibution of fim size within each of these sectos. The second tanche of pemits elate to cabon emissions oiginating fom tanspotation fuels such as gasoline, diesel, and jet fuel. Ou model and database lack the sectoal and commodity detail to pemit analysis by fuel type. Instead, we equie that majo uses of tanspotation fuels (ai tanspot, wate tanspot, othe tanspot, and household demand) pay a pice fo efined petoleum poducts that eflects the cost of obtaining the necessay pollution pemits. This both undestates and ovestates the coveage of emittes. It ovestates coveage by including all consumption of petoleum and coal poducts, whethe o not the poduct is a tanspot fuel. Howeve, it also undestates coveage, because it excludes tanspot fuels used by sectos that aen t coveed by the fist tanche above o ae tanspot sectos (e.g., gasoline and diesel consumed by the constuction industy). Howeve, since final demand and the tanspot sectos ae coveed, we believe that the substantial majoity of such emissions ae coveed. McCain-Liebeman calls fo the fomation of a Climate Change Cedit Copoation (CCCC) to ovesee the tanspot fuel allocation. We handle this tanche by teating it as a simple lump-sum tax ebate to the epesentative household. Pemit Allocation Mechanisms A total of fou allocation mechanisms ae employed to exploe the implications of the McCain-Liebeman poposal. In addition to a simulation designed to match the legislation as closely as possible, we conside seveal altenative scenaios with slightly diffeent mechanisms and implications. McCain-Liebeman Gandfatheing: The legislation calls fo gandfatheing of pemits to the coveed industies, while poviding fo the fomation of a Climate Change Cedit Copoation (CCCC) to eceive pollution pemits on behalf of final demand and the tanspot sectos (ai, wate, and othe). We have intepeted this as applying a tax on puchases made by households and tanspot sectos of petoleum and coal poducts, with pemit evenue being ebated back to the epesentative agent in the model though a lump-sum tax. The coveed industial sectos ae teated diffeently, eceiving a 5

8 gandfatheed allocation of pemits popotional to thei histoical cabon usage. The coveed sectos ae listed above in the discussion of the McCain-Liebeman legislation. Fiscal balance in the model is maintained by adjusting the labo tax ate (set at 40 pecent in the benchmak). Auction Industial Pemits: Pemits fo industial uses ae auctioned, and the evenue is used to educe the distoting labo tax. Pemits assigned to the CCCC ae teated as in the gandfatheing scheme, with evenue ebated to the epesentative agent. Output-Based Allocation Based on Histoical Usage: Pemits ae allocated to fims based on output shaes in coveed sectos, secto shaes ae based on histoical emissions, and govenment evenue is held constant though a labo tax. Pemits assigned to the CCCC ae teated as in the gandfatheing scheme, with evenue ebated to the epesentative agent. Output-Based Allocation Based on Value-Added: Pemits ae allocated to fims based on output shaes in coveed sectos, secto shaes ae based on histoical shaes of value added, and govenment evenue is held constant though a labo tax. Pemits assigned to the CCCC ae teated as in the gandfatheing scheme, with evenue ebated to the epesentative agent. Cabon Leakage though Tade Flows Tailoing Allocation Mechanisms To Minimize Leakage Balancing Leakage Minimization against Welfae Maximization Conclusion Note: A Complete Vesion of this pape will be available at the GTAP Confeence o may be equested diectly fom the authos 6

9 Table 1: Initial Pemit Allocation fo Coveed Sectos (thousands of metic tons of cabon) Value- Secto Histoical Added Agicultue Coal Petoleum and coal poducts (efined) 126,269 5,675 Cude oil Natual gas 15,336 12,667 Electicity 621, ,386 Ion and steel industy 10,299 61,543 Chemical industy 99, ,254 Non-feous metals 5,976 33,612 Non-metallic mineals 14,877 72,613 Tanspot equipment Pape-pulp-pint 13, ,654 Tade magins Othe tanspot Wate tanspot Ai tanspot Communication Othe machiney Othe mining Food poducts Wood and wood-poducts Constuction Textiles-weaing appael-leathe Othe manufactuing Commecial and public sevices Climate Change Cedit Copoation 423, ,237 Total 1,329,641 1,329,641 7

10 Table 2: Initial Pemit Allocation fo Coveed Sectos (thousands of metic tons of cabon) Auction All + Ltax GF Fims + Ltax OBA Hist + Ltax OBA VA + L Tax County Quantity Pecent Quantity Pecent Quantity Pecent Quantity Pecent United States -3, , , , Canada Euope 4, , , , Japan 1, , , Othe OECD Fome Soviet Union Cental Euopean Associates China (incl. HK & Taiwan) India Bazil Othe Asia Mexico + OPEC -2, , , , Rest of Wold

11 Table 3: Cabon Emissions by Secto (thousands of metic tons) Auction All + Ltax GF Fims + Ltax OBA Hist + Ltax OBA VA + L Tax Secto Baseline Quantity Pecent Quantity Pecent Quantity Pecent Quantity Pecent Agicultue 12, Coal Petoleum and coal poducts (efined) 126,269-17, , , , Cude oil 4, Natual gas 15, Electicity 621, , , , , Ion and steel industy 10, Chemical industy 99,509-8, , , , Non-feous metals 5, Non-metallic mineals 14,877-1, , , , Tanspot equipment 4, Pape-pulp-pint 13,074-1, , Tade magins 17, Othe tanspot 168,972-15, , , , Wate tanspot 9, , , Ai tanspot 119,663-15, , , , Communication Othe machiney 3, Othe mining Food poducts 12, Wood and wood-poducts 2, Constuction 2, Textiles-weaing appael-leathe 3, Othe manufactuing 3, Commecial and public sevices 31, Final Demand 260,543-11, , , , Total 1,566, , , , ,

12 Table 4: Cabon Leakage as a Pecentage of U.S. Reduction County Auction All + Ltax GF Fims + Ltax OBA Hist + Ltax OBA VA + L Tax Canada Euope Japan Othe OECD Fome Soviet Union Cental Euopean Associates China (incl. HK & Taiwan) India Bazil Othe Asia Mexico + OPEC Rest of Wold Total

13 Table 5: Change in Poduction by Secto Auction All + Ltax GF Fims + Ltax OBA Hist + Ltax OBA VA + L Tax Secto Baseline Pice Quantity Pecent Pice Quantity Pecent Pice Quantity Pecent Pice Quantity Pecent Agicultue 221, Coal 32, , , , , Petoleum and coal poducts 145, , , , , Cude oil 39, , , , , Natual gas 49, , , , , Electicity 258, , , , Ion and steel industy 142, , Chemical industy 716, , , , , Non-feous metals 110, , , Non-metallic mineals 127, , , , Tanspot equipment 661, , Pape-pulp-pint 391, , , , Tade magins 2,456, , , , Othe tanspot 459, , , , , Wate tanspot 49, Ai tanspot 161, , , , , Communication 384, Othe machiney 787, , , Mining 34, Food poducts 744, Wood and wood-poducts 227, Constuction 1,351, , , , , Textiles-weaing appael-leathe 270, Othe manufactuing 705, , , Commecial and public sevices 6,666, , , , , Dwellings 758, , , Total 17,953,375-70, , , ,

14 Table 6: Change in Tade (millions of 2001 dollas) Auction All + Ltax GF Fims + Ltax OBA Hist + Ltax OBA VA + L Tax Secto Impots Expots Impots Expots Impots Expots Impots Expots Agicultue Coal , , , ,799 Petoleum and coal poducts (efined) 249-1, ,523-1, ,682 Cude oil -9, , , , Natual gas Electicity Ion and steel industy Chemical industy 2,429-5,454 2,239-5, ,467 5,741 Non-feous metals Non-metallic mineals ,338 Tanspot equipment Pape-pulp-pint ,628 2,657 Tade magins Othe Tanspot 1,639-2,455 1,587-2,450 2,343-3,215 2,674-3,492 Wate tanspot Ai tanspot 2,824-5,005 2,769-4,997 3,545-6,057 3,632-6,078 Communications Othe machiney -1,050 1,397-1,077 1, ,300 Mining Food poducts Wood and wood-poducts Constuction Textiles-weaing appael-leathe Othe manufactuing ,185 Commecial and public sevices -1,249 3,804-1,300 3, , ,365 Total -5,349-7,466-6,355-8,259-4,695-6,773-3,935-7,243 12

15 Table 7: Pecentage Change in U.S. Labo Demand, Leisue Demand, and Wage Rate Secto Auction All + Ltax GF Fims + LtaOBA Hist + Ltax OBA VA + L Tax Agicultue Coal Petoleum and coal poducts (efined) Cude oil Natual gas Electicity Ion and steel industy Chemical industy Non-feous metals Non-metallic mineals Tanspot equipment Pape-pulp-pint Tade magins Othe Tanspot Wate tanspot Ai tanspot Communications Othe machiney Mining Food poducts Wood and wood-poducts Constuction Textiles-weaing appael-leathe Othe manufactuing Commecial and public sevices Commecial and public sevices Total Demand fo leisue Real wage ate Labo Tax Rate Region Auction All + Ltax GF Fims + LtaOBA Hist + Ltax OBA VA + L Tax United States 39.19% 40.81% 40.27% 39.47% Canada 40.00% 40.00% 40.00% 40.00% Euope 40.00% 40.00% 40.00% 40.00% Japan 40.00% 40.00% 40.00% 40.00% Othe OECD 40.00% 40.00% 40.00% 40.00% Fome Soviet Union 40.00% 40.00% 40.00% 40.00% Cental Euopean Associates 40.00% 40.00% 40.00% 40.00% China (incl. HK & Taiwan) 20.00% 20.00% 20.00% 20.00% India 20.00% 20.00% 20.00% 20.00% Bazil 20.00% 20.00% 20.00% 20.00% Othe Asia 20.00% 20.00% 20.00% 20.00% Mexico + OPEC 20.00% 20.00% 20.00% 20.00% Rest of Wold 20.00% 20.00% 20.00% 20.00%

16 Bibliogaphy Complainville, Chistophe and Dominique van de Mensbugghe. (Apil 1998) Constuction of an Enegy Database fo GTAP V4: Concodance with IEA Enegy Statistics, Manuscipt. Pais: OECD Development Cente. Fische, Caolyn. (1999) Rebating Envionmental Policy Revenues: Output-Based Allocations and Tadable Pefomance Standads, Manuscipt. Washington, DC: Resouces fo the Futue. Fische, Caolyn, and Alan K. Fox. (2004) Output-Based Allocations of Emissions Pemits: Efficiency and Distibutional Effects in a Geneal Equilibium Setting, Discussion pape Washington, DC Resouces fo the Futue. Fox, Alan K. (2002) Incopoating Labo-leisue Choice into a Static Geneal Equilibium Model, Woking pape. Washington, DC: U.S. Intenational Tade Commission. Ruthefod, Thomas F. and Segey V. Paltsev (Septembe 2000) GTAPinGAMS and GTAP- EG: Global Datasets fo Economic Reseach and Illustative Models, Woking pape. Boulde, CO: Depatment of Economics, Univesity of Coloado. 14