CARBON TAX GUIDE A Handbook for Policy Makers CARBON TAX GUIDE A Handbook for Policy Makers MARCH 2017 CARBON 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 Executive 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 information 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: [email protected]. Design: Eszter Bodnar (www.visilio.com) DESIGN CARBON TAX GUIDE: A HANDBOOK FOR POLICY MAKERS 3 ACKNOWLEDGMENTS This Carbon Tax Guide was prepared for the Partnership (British Columbia); Nicola Borregaard, Francisco Javier for Market Readiness (PMR), by a team of consultants from Pinto Pardo, Juan Pedro Searle, Paula Tassara, and Climate Focus, the University of Indiana, School of Public Nicholas Westenenk (Chile); Felipe De Leon (Costa Rica); and Environmental Affairs (SPEA), and the Gnarley Tree Jean Giraud (France); Malin Ahlber and Nadine Pauly Sustainability Institute (GTSI). Pauline Kennedy (World (Germany); Shweta Kumar (India); Ciran Conroy, Gerry Bank) provided substantive input and managed the project. Kenny, and Ambrose Murray (Ireland); Reo Kawamura, Toshiali Nagata, and Yuji Mizuno (Japan); Juan Carlos The lead authors of the Carbon Tax Guide were Darragh Arredondo, Soffia Alarcon Diaz, Saul Pereyera Garcia, Conway (Climate Focus) and Kenneth Richards (SPEA). Victor Hugo Escalona Gómez, Carlos Muñoz-Piña Stephanie Richards (GTSI) led the preparation of the tech- (Mexico); Ingrid Hoff (Norway); Memory Matchingambi, nical appendix. Several contributing authors also provided Sharlin Hemraj, and Deborah Ramalope (South Africa); substantial inputs: Paul Keenlyside, Szymon Mikolajczyk Susanne Åkerfeldt, Henrik Hammar, Mats-Olof Hansson, and Charlotte Streck (Climate Focus), and Justin Ross, and Johan Nylander (Sweden); Andrea Burkhardt Antung Anthony Liu, and Ahn Tran (SPEA). (Switzerland); and Sila Guiance and Joanna Wain (United Kingdom). In addition, the following persons provided valuable re­­­search, editing, and other kinds of support in the pre- We also wish to acknowledge input and peer review pa­­­ration of the Carbon Tax Guide: Leo Mongendre, Sai provided by a range of other experts: Claudia Dias Soares Sindhura Mamillapalli, Ingrid Schulte, and Sebastian Müller (Green Budget Europe); Ian Parry (IMF); Richard Baron, (Climate Focus); Elisabeth Andrews, Keyao Sun, Jingyao Nils-Axel Braathen, Floren Flues, and Kurt Van Dender Gu, and Zoya Atiq (SPEA); and Yu Song, Delaney Bolger, (OECD); Perumal Armugam and Phillip Eyre (UNFCCC); and Logan Pfeiffer (GTSI). and Martina Zahno (University of Zurich). We sincerely thank those government experts who shared Finally, we thank colleagues at the World Bank Group their practical insights and knowledge relating to carbon tax who also reviewed the report and provided useful input design and implementation through meetings, inter views, and feed back: Adrien de Bassompierre, Dirk Heine, and review of the Guide. These include Kate Hancock, Blanca Moreno-Dodso, Maja Murisic, Grzegorz Peszko, Gareth Prosser, and Matthew Stuchbery (Australia); Aloisio and Suphachol Supachalasai. The Guide (including the de Melo and Ludmila Vidigal Silva (Brazil); Anne Foy Technical Appendix) was edited by Inge Pakulski. 4 CARBON TAX GUIDE: A HANDBOOK FOR POLICY MAKERS LIST OF ACRONYMS Agriculture, Forestry, and Other Land AFOLU MNC Multinational Corporation Use BAU Business As Usual M&E Monitoring and Evaluation BCA Border Carbon Adjustment MRV Measuring, Reporting and Verification National Atmospheric Emissions CCS Carbon, Capture and Sequestration NAEIS Inventory System CDM Clean Development Mechanism NGO Non-governmental Organization CER Certified Emission Reduction NO Nitrogen Oxide Computable General Equilibrium x CGE (model) OAIS Old-Age Insurance System CPI Consumer Price Index Organisation for Economic OECD EITE Emission-Intensive Trade-Exposed Co-operation and Development Metric tons of carbon dioxide ETS Emissions Trading System tCO e 2 equivalent European Union Emissions Trading Particulate Pollution that is 2.5 EU ETS PM2.5 System micrometers or less in diameter EU European Union PMR Partnership for Market Readiness Food and Agriculture Organization of FAO RPS Renewable Portfolio Standard the United Nations General Agreement on Tariffs and Pollutant Release and Transfer GATT PRTR Trade Register DGP Gross Domestic Product SARS South Africa Revenue Service GHG Greenhouse Gas SCC Social Cost of Carbon Institute for European Environmental United National Framework IEEP UNFCCC Policy Convention on Climate Change Intergovernmental Panel on Climate IPCC U.S. REP United States Regional Energy Policy Change VAR Vector autoregressive (models) NDC Nationally Determined Contribution VAT Value added tax MAB Marginal Abatement Benefit World Business Council for WBCSD MAC Marginal Abatement Cost Sustainable Development MEB Marginal Emissions Benefit WRI World Resources Institute MW Megawatt WTO World Trade Organization TABLE OF CONTENTS 5 Synthesis TABLE OF CONTENTS Introduction SYNTHESIS: CARBON TAXES IN BRIEF 9 Introducing the design process 10 Deciding Whether to Adopt a Carbon Tax Adopt a Carbon When is a carbon tax the right choice? 10 Setting the stage for tax design 12 Designing carbon taxes 13 Evaluate outcomes and review 19 Capitalizing on carbon taxes’ potential 21 Preparing for Carbon INTRODUCTION 22 Adoption Tax 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 Carbon Modeling 2.1 Introduction 26 Taxes 2.2 Introducing carbon taxes 27 2.3 Carbon taxes and policy instrument options 29 Defining the Tax Base Tax PREPARING FOR CARBON TAX ADOPTION 41 3.1 Introduction 42 the Tax Rate the Tax 3.2 Determining policy objectives 42 Determining 3.3 Framing the national context 47 3.4 Principles of carbon tax design 52 MODELING CARBON TAXES 56 Tax of the Carbon Effects 4.1 Introduction 57 Unwanted Avoiding 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 Determining Use of Revenues DEFINING THE TAX BASE 74 5.1 Introduction 75 5.2 Scope of taxation 75 5.3 Crosscutting consi­­de ra­­tion – administration and MRV 85 Ensuring Oversight and Compliance 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 Evaluating Policy Outcomes 7.1 Introduction 100 7.2 Understanding leakage, competitiveness, and distributional impacts 100 7.3 Assessing leakage and distributional risks 102 7.4 Designing