An emission tax on GHG emissions requires domestic emitters to pay a fixed fee, or tax, for every tonne of CO2eq of GHG released into the atmosphere. Such a fee would encourage reductions in GHG emissions in response to the increased price associated with those emissions. In particular, measures to reduce emissions that are less expensive than paying the tax would be undertaken.
Since every emitter faces a uniform tax on emissions per tonne of CO2eq (if energy, equipment, and product markets are perfectly competitive) this would result in the least expensive reductions throughout the economy being undertaken first (IPCC, 1996, Section 11.5.1; Baumol and Oates, 1988). In the real world, markets, especially energy markets, deviate from this ideal, so an emissions tax may not maximize economic efficiency. Rather, the efficiency of an emissions tax should be compared with that of alternative policy measures. Criteria other than efficiency, such as distributional impacts, are likely to influence the design of the emissions tax where this is the chosen policy. Although equity considerations could be, in theory, better addressed through other redistribution mechanisms, in practice most energy and emissions taxes apply differential tax rates to different sources.
An emissions tax, unlike emissions trading, does not guarantee a particular level of emissions. Therefore, it may be necessary to adjust the tax level to meet an internationally agreed emissions commitment (depending on the structure of the international agreement; see Section 6.3). The main economic advantage of an emissions tax is that it limits the cost of the reduction programme by allowing emissions to rise if costs are unexpectedly high (IPCC, 1996, Section 184.108.40.206; see also Section 220.127.116.11).
An emissions tax needs to be adjusted for changes in external circumstances, like inflation, technological progress, and increases in emissions (Tietenberg, 2000). Inflation increases abatement costs, so to achieve a target emission reduction the tax rate needs to be adjusted for inflation. Fixed emissions charges in the transition economies of Eastern Europe, for example, have been significantly eroded by the high inflation (Bluffstone and Larson, 1997). Technological change generally has the opposite effect, reducing the cost of making emissions reductions. Thus, technological change generally increases the emissions reductions achieved by a fixed (real) tax rate. New sources increase emissions. If the tax is intended to achieve a given emissions limit, the tax rate will need to be increased to offset the impact of new sources (Tietenberg, 2000).
Implementation of a domestic emissions tax touches on many issues (Baron, 1996). Policymakers must consider the collection point, the tax base, the variation or uniformity among sectors, the association with trade, employment, revenue, or R&D policies, and the exact form of the mechanism (e.g., an emissions tax alone or in conjunction with other policy measures). Each of these can influence the appropriate design of a domestic emissions tax.
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