15 Jul 2008

How to Set a Carbon Tax

In this post, TokyoTom says:
As for the setting the level of carbon taxes, you [Bob] and Gene keep assuming that there is a global government that sets taxes in a vacuum. Instead, we have a multi-player game, where any politically sustainably prices are set at levels that the chief emitters are willing to agree to.
Although TT appears to say that big players will agree on the level of tax, I add that it's easily possible that taxes will vary by country, first, because it is a question of sovereignty and second, because taxes will bite at different rates in different places, i.e., taxes must vary from country to country if they are going to be effective.

The downside to this logic (many tax rates instead of one tax rate) is that it invites "destructive tax competition" among countries competing to be the site of polluting industries as well as inviting free-riding, i.e., "our citizens will not be taxed, but we will benefit from the carbon reductions that result from you taxing your citizens."

So -- one rate or many rates? Please comment.


Kevin Dick said...

Seems like this would make a great essay question in a class that covers collective action ;-)

From a practical standpoint, I think you're right. It will be impossible to get agreement on a single global tax rate in a time frame that will do any good.

IIRC, the literature on international trade shows that bilateral and regional trade agreements are generally more effective than global ones. Assuming this, it seems like the best way to go is for the US, Europe, Canada, Japan, and Australia to negotiate a common tax rate among themselves. Then work with Russia, China, and India on their rates. Then pressure the remaining smaller industrialized and developing countries to set theirs.

I see at least 3 tiers of rates emerging. But you need to have common rates in countries that are close substitutes for each other from the perspective of businesses and consumers.

Silas Barta said...

I'm not sure I follow. Isn't your real question that of how to prevent the defectors (from the global agreement) from lifting their own carbon taxes? (Pardon the redundancy.)

If so, it's simple: everyone else slaps a general tariff on that nation's goods, sufficient to make up what they should have been paying in carbon taxes.

The question of how to enforce an agreement on tax rates, is separate from what tax rate is necessary on each country to get them to join such an agreement. The destructive tax competition doesn't happen at this stage because they require buy-in from others as a condition of joining the agreement.

Am I making any sense whatsoever, or did I miss your point entirely?

David Zetland said...

@Kevin -- I agree that different tiers are a likely outcome. Simple enough to understand/administer, yet allowing differentiation.

@Silas -- I agree that tariffs can work as a "punishment" for defectors (those who "lift" the tax so that nothing remains), but I can see some potential for ugly trade protectionism as well as "local content" problems. It may be better to impose the highest tariff for any country that is not charging a domestic tax. You'd also have to have external enforcers to police tax payments (instead of bribery/fraud). This system is better than cap and trade but it would be like a global VAT -- pretty intensive accounting required....

TokyoTom said...

David, thanks for pushing this forward. I have taken the opportunity to expan my thoughts here:


I've got to run but will come back later.

TokyoTom said...

David, here`s the hyperlink:

Can Pigovian taxes be Coasean? - The case of climate negotiations

TokyoTom said...

David, my principal point was that, in the context of climate change, a Pigovian tax is really just a device for implementing a bargain to be reached in Coasean fashion among the major emitting nations.

I would not expect that all nations agree to the same precise tax rate or structure, or even to use primarily taxes as opposed to cap and trade. The countries are all situated differently, and it might very well be that the governments agree, for purposes of reaching a deal (and grounds of equity and efficacy), to a varying range of treatment. Some might start even before others.

But in any case, an ability to evaluate what each nation undertakes, and to measure and incentivize compliance, would be needed.

The worry that you have about tax competition and defecting are precisely why we haven`t reached a climate deal yet. This reinforces my point that this is a Coasen deal-making, and unlikely initially to lead to high taxes.

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