Generic emission pricing

Emission pricing starts at the current ETS, and develops emission pricing along the three dimensions as specified in Table 4: domain expansion; level of administrative implementation moving upstream; and variability reduced leading to predictability rising emission price levels. The first step is to transform the Market Stability Reserve into an explicit price floor system, with the price floor rising in time. As long as there is a surplus in the market the price ceiling is not relevant.

The ceiling can however be set now already as a safeguard against a later price explosion. This operation is combined with a domain expansion, first covering all coal and gas and, more complicated, all non-transport oil and oil products use. For effective and simple implementation, a shift from the administration of actual emitters to their upstream primary suppliers is required.

This can be done in one move, towards EU natural gas production and imports and coal production and imports. The number of regulatees then is very small as compared to the number of emitters: a few thousand against in the order of a hundred million, now including all small emitters. The rising price floor is not yet a tax, like the rising UK Price Floor Tax is, but a quantity measure leading to a predetermined price level. The difference in functioning is small however.

The bandwidth between price floor and ceiling is set at zero; there is no good reason to have a bandwidth in a price based system: the single price indicates the scarcity of available emission space in society best. Price variation diffuses the price signal and increases public and private implementation costs. Trading systems are expensive short term already as compared with tax-like single price systems, and the reduced long term investment guidance by price volatility increases real costs of emission reduction dynamically. The experience built up allows next for a swift expansion in the transport domain, planned in advance but maybe implemented a few years later, then covering all fossil resources upstream only. With fully upstream application the permit character remains a hindrance to administrative efficiency. Yearly sales then are to be matched after closing the year administratively with the required amount of permits, with the firms involved in primary production and with (certified) importers. The administrative implementation can better shift from a firm oriented yearly implementation to a direct transaction oriented implementation, similar to how VAT and excises on products like alcoholic beverages are administered. This fits into taxing experience which goes back for centuries in all countries in Europe and in most countries of the world. The permit system is transformed into a tax system in this last administrative step. Any firm importing coal, gas or oil products has to pay the emission tax, for each transaction, linked to the VAT-administration. As with all other taxes the administrative implementation is at member state level, and proceeds are distributed over member states according to their shares in EU CO2 emissions.

The emission tax is implemented upstream at primary production and import of fossils and derived fossil energy products (as also proposed for example by (Metcalf 2008) for the US), and refunded upon export of such products and upon approved CCS, paid from tax proceeds. All fossil CO2 emissions are taxed this way. Less clear system definitions were discussed in (Victor 1992).

The tax and refund at external borders are not border tax adjustments but administrative elements of the EU emission tax (confusingly named Border Carbon Adjustments by (Droege 2011)). The administrative implementation is at member state level. The tax is not Pigovian,

equating it with marginal damages, but follows (Baumol 1972), set at a level to reach the climate goal. The tax may best be linearly rising, like the British Columbia Emission Tax (Min-Fin-BC 2014) and UK Price Floor Tax (Revenue&Customs 2012 (2010)), to an amount of in the order of €350 in 2050, but see different reasoning in BOX 2. As total proceeds are distributed over member states according to their share in total EU emissions, there is a national incentive not to ‘forget’

emissions as that would mean forgoing income.

There might be a different route from pure cap to an emission tax, by first expanding the UK Price Floor Tax to more countries, as a coalition of the willing. With the principle broadly implemented, the EU could employ a similar dynamic approach could be to have the UK Price Floor Tax model expanded to all other countries, avoiding the tension of specific competitive disadvantages between the UK and other willing countries. The volume based cap system then would evolve into a fully price based system, as the fixed (lowering) volume of the cap would have become irrelevant for the price, as long as there is oversupply. The high enough price of the price floor tax would make sure that the cap remains irrelevant for a long time to come. This double system could easily be simplified into a uniform encompassing emission tax. In developing a strategy this line would not come up. Introducing the emission tax in this indirect way involves the development of a double instrument system with substantial complexity, as the UK price floor tax has shown, easily leading to unexpected obstacles on this path.

The permit proceeds transformed into tax proceeds, one way or another, are distributed between the member states (and countries joining in the EU system) based on their share in actual total EU emissions. The lower a country’s emissions are, the lower is its share. With the rising price set at the level required for deep reductions, the total tax proceeds will first rise, towards the mid Thirties roughly, and will then decrease. How these tax proceeds work out on overall economic activity depends mainly on how they are used, especially in terms of reducing other taxes, see (Meyer and Meyer 2013).

The emission tax level is based on intended emission reductions. The empirical relation between rising tax level and emission reduction is soft, being conditional on electricity market institutions, on climate technology development and on all more general developments in society, including economic growth. Predictions are not well possible but some conditional cornerstones can be established, like a tax level where natural gas will outcompete coal in electricity production, where heat pumps with seasonal storage can outcompete gas heating, and where electric cars become competitive with combustion cars. To take the coal and gas example, assume zero (!) real cost for coal based electricity, and assume a carbon tax of €400. The real cost of natural gas based electricity production then would have to rise from current €55 per MWh to above €181 to keep some coal based electricity in the market, see for numbers Table 6. Such back-of-the envelope computations are more enlightening than modelling exercises for long term reasoning, as price predictions are not well possible. Coal would be out of the electricity market long before that

€400 tax level, and natural gas probably as well, as renewable systems become more attractive in static considerations and more attractive to invest in longer term. Of course the outcomes will substantially depend on electricity market design as well, see below. There is no clear single tax level connected but a level rising long term to in the order of 300€ per tonne of CO2 in 2050 seems a reasonable middle of the road estimate, with 400€ as a high estimate on the required level.

Setting the emission price at 50€ in 2020, rising by 5€ per year would lead to the 200€ price level

by 2050. Going for more safe would be a price rise by 10€ per year, leading to a price of 350€ per tonne by 2050.

These emission prices may seem substantial but getting emission reductions with other means in principle leads to substantially higher real costs, estimated with different modelling types at a factor two in the transport domain (see (Anderson, Parry et al. 2011) and more generally (Parry, Evans et al. 2014)) and similar doubling of costs with economic modelling using technology specific instrumentation (Deetman, Hof et al. 2014). The tax proceeds are used for tax reductions, greening the tax system, see (Andersen and Ekins 2009). Preferably the most economically disturbing taxes are the reduced, and reductions may be used for some redistribution, to compensate for undesirable income effects. A review of actual emissions development towards 2035 is built into the emission pricing regulations. If by then emissions have not been reduced enough, an increase in emission prices is due, and vice versa. Because of reduced volumes by then this emission tax is a less heavy burden on society. The place of CCS in the emission pricing system is similar to exports. Wherever authorized CCS takes place, the refund is paid, from the EU level of total emission tax proceeds, before distribution to the country level. The authorization may involve CCS outside EU boundaries, as in Norway in the Sleipner field. That is currently the only large scale CCS option in Europe with a somewhat proven safety record, with 20 years of controlled experience funded substantially by the Norwegian emission tax. It would require an extensive CO2 transport system with a monopolistic character. The base structure would therefore be set up through public provision, if overall cost estimates for CCS would indicate this route to emission reduction. (Mikunda, Kober et al. 2014) see this option as essential for long term climate policy, with action required now to make this option feasible, see (Scott, Gilfillan et al. 2013).

A further adjoining pricing instrument might relate to the road transport sector, the national fuel taxes. Such taxes existed already before the climate problem was perceived. EU coordination of national fuel taxes is not an instrument of climate policy, as it now is seen as being the case a bit (’20 %’), assumption based only. That element is out with EU, reducing EU level policy to just a single-market operation, to reduce tax competition. This of course helps structurally to enable countries to raise fuel taxes somewhat in a less mutually adverse manner, like many other policies may also be relevant for emissions. In the long term effective climate policy will reduce fuel excises to near zero, solving this tax competition issue fully.

There are many more climate emission relevant policies, rules and regulations, ranging from tax rules on company person-car use to insulation rules for buildings. These just are not part of climate policy in this Institutionalist Instrument Strategy. Neither are personal tastes in consumption and life time working hours the subject of climate policy instrumentation, though together constituting a most decisive single determinant of long term climate emissions. Using 1% of productivity rise not for growth but for leisure would reduce emissions roughly by 50% in the next 70 years, with given technologies. However, with technologies changed by climate policy instruments towards near zero emission, that 50% reduction would dwarf to near zero. Reducing working hours therefor is not subject of long term climate policy instrumentation, how useful it might be if climate policy is not successful. Through similar reasoning, with different outcome, the redesign of electricity markets is a key instrument in the Institutionalist strategy: without it key emission saving technologies will not emerge. Of course, climate considerations may play their role in more complex considerations involved in broader developments. Using Life Cycle Analysis of products in decisions on consumption and consumption style may make well make

sense. Calling LCA a climate policy instrument seems one step too far, certainly too far for long term climate policy instrumentation. Making the social security system, the pension systems, tax systems, health care, child care, holiday regulations, etc. all part of climate policy instrumentation seems the end of climate policy, however well intended the broadening might be. Long term instrumentation has emission reduction as its focus. The combination of emission tax and corresponding electricity market may have indirect effects already relevant medium term, like shifting consumption culture away from high emission products and services.

The internalization of climate emission in prices is the main dynamic influence on long term technology development and market development. It also works in the public level as for moving spatial planning and research planning in a more climate relevant direction. The influencing role of climate policy is there but in a limited way, being next to energy considerations, amenity considerations, general international competitiveness considerations, etc.