Carbon Leakage: A Medium- and Long-Term View

Future market developments determine the fate of fossil fuel carbon currently conserved unilaterally. Dynamic fuel depletion naturally suggests leakage rates approaching 100%. Reasons for lower leakage differ from what limits rates in previous studies. Discounting reduces present-value leakage as global emissions are delayed. Containing climate change requires future global political or technological breakthroughs to conserve some carbon forever. Early breakthroughs limit leakage but with late breakthroughs most unilateral emission reductions may be negated abroad. Future coal liquefaction suggests negative leakage rates for current mitigation, but a perfect backstop allows leakage above unity. Leakage rates and suggested taxes vary across fuels.

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Optimal Fuel-Specific Carbon Pricing and Time Dimension of Leakage

All current, and likely near-term future, climate protection measures only cover a limited fraction of global emissions. A single value attached to (independent of the source that generates it), for market based instruments such as CO2 taxes or cap-and-trade systems, is insufficient to account for the complex economic interlinkages between specific emission-generating activities and CO2 emissions throughout the world. First, static partial and general equilibrium models illustrate how different types of emissions are subject to specific General Equilibrium Translation Factors and leakage effects, which define the optimal pattern of fuel-specific, unilateral carbon taxes. The leakage, which implies that regional emission avoidance may partly be offset in other regions and time periods, depends on the type of resources involved and the characteristics of the markets in which they are traded. Second, a dynamic model accounting for fuel exhaustibility shows that the time-dimension is crucial and that the relevant medium-term leakage may be much larger than suggested static rates. Sensible leakage rates depend on discount rates for future emissions and on uncertain future technological and political developments. The traditional leakage literature does not explicitly consider these, even though in their absence overall leakage would approach 100 %. Instead, literature has mainly focused on static fuel supply curves and rates of contemporaneous leakage.

The numerical simulations show that in a business-as-usual scenario the optimal unilateral OECD climate tax rate on CO2 emissions from oil may be only half of the tax rate on emissions from coal. This is reverted if the CO2 intensive coal-to-liquids conversion processes become an important additional source of liquid fuels in future: negative leakage occurs and the optimal current climate tax on oil emissions may be up to two times the genuine regional willingness to pay for global emission reductions, even if the substitution of crude oil by synthetic liquids starts only in the future.

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The Law of Small Abatements: Prices over Quantities in Realistic Climate Policies

A fundamental question of high practical relevance for climate policy design is whether price controls such as CO2 taxes, or quantity restrictions such as emission quotas should be preferred. I show that as the reach of climate policies is limited in terms of either suboptimally low reduction targets or the policy’s extent over only parts of the world, the likelihood of price measures to be more advantageous in terms of minimizing uncertainty related welfare losses increases. The increase of the relative advantage of the price mechanisms over quantity measures may be more than proportional to the regional limitedness of the policy, suggesting that even for relatively important climate coalitions the identified factor implies a clear advantage for price measures. This analysis of the prices vs. quantities question is closer to so far on a high political level seriously discussed climate policies, not to speak of already implemented local or regional climate policies, than previous theoretical literature addressing the issue, which typically relied on the assumption of first bests (i.e. global) policies. Illustrating the main thought of the analysis, I explain why in the example of policies with an extent corresponding to the current Kyoto mechanism, the simple theoretical weighting of the price vs. the quantity approach seems to favor price mechanisms independently of the exact form of the global abatement cost and benefit curves.

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Climate Effects of Carbon Taxes, Taking into Account Possible Other Future Climate Measures

Increasing fuel extraction costs and global temperatures make it likely that in the medium-term future, technological or political measures against global warming will be implemented. In assessments of current climate policy, possible medium-term future developments, such as backstop technologies, are largely neglected, but such developments may crucially affect policy impacts. If such measures are implemented, a carbon tax introduced now may mitigate climate change to greater effect than recent reflections along the line of the Green Paradox would suggest. Notably, the weak and the strong version of the Green Paradox, related to current and longer-term emissions, may not materialise. Moreover, the tax may allow the demanding countries to extract part of the resource rent, further increasing its desirability.

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