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Even though concerns about adverse distributional implications for the poor are one of the most important political challenges for carbon pricing, the existing literature reveals ambiguous results. For this reason, we assess the expected incidence of moderate carbon price increases for different income groups in 87 mostly low- and middle-income countries. Building on a consistent dataset and method, we find that for countries with per capita incomes of below USD 15,000 per year (at PPP-adjusted 2011 USD) carbon pricing has, on average, progressive distributional effects. We also develop a novel decomposition technique to show that distributional outcomes are primarily determined by differences among income groups in consumption patterns of energy, rather than of food, goods or services. We argue that an inverse U-shape relationship between energy expenditure shares and income explains why carbon pricing tends to be regressive in countries with relatively higher income. Since these countries are likely to have more financial resources and institutional capacities to deal with distributional issues, our findings suggest that mitigating climate change, raising domestic revenue and reducing economic inequality are not mutually exclusive, even in low- and middle-income countries.
Carbon dioxide removal (CDR) moves atmospheric carbon to geological or land-based sinks. In a first-best setting, the optimal use of CDR is achieved by a removal subsidy that equals the optimal carbon tax and marginal damages. We derive second-best subsidies for CDR when no global carbon price exists but a national government implements a unilateral climate policy. We find that the optimal carbon tax differs from an optimal CDR subsidy because of carbon leakage, terms-of-trade and fossil resource rent dynamics. First, the optimal removal subsidy tends to be larger than the carbon tax because of lower supply-side leakage on fossil resource markets. Second, terms-of-trade effects exacerbate this wedge for net resource exporters, implying even larger removal subsidies. Third, the optimal removal subsidy may fall below the carbon tax for resource-poor countries when marginal environmental damages are small.
We analyze how conventional emissions trading schemes (ETS) can be modified by introducing “clean-up certificates” to allow for a phase of net-negative emissions. Clean-up certificates bundle the permission to emit CO2 with the obligation for its removal. We show that demand for such certificates is determined by cost-saving technological progress, the discount rate and the length of the compliance period. Introducing extra clean-up certificates into an existing ETS reduces near-term carbon prices and mitigation efforts. In contrast, substituting ETS allowances with clean-up certificates reduces cumulative emissions without depressing carbon prices or mitigation in the near term. We calibrate our model to the EU ETS and identify reforms where simultaneously (i) ambition levels rise, (ii) climate damages fall, (iii) revenues from carbon prices rise and (iv) carbon prices and aggregate mitigation cost fall. For reducing climate damages, roughly half of the issued clean-up certificates should replace conventional ETS allowances. In the context of the EU ETS, a European Carbon Central Bank could manage the implementation of cleanup certificates and could serve as an enforcement mechanism.