Carbon pricing is a cost effective instrument to meet emission reduction targets. The introduction of a substantial tax on industrial carbon emissions could be an important part of future climate policy. Proposals for a tax rate of â¬ 100 or â¬ 200 per tonne of CO2e in 2030 in addition to the carbon price in the EU Emissions Trading System (EU ETS) are not uncommon. However, implementing a national carbon tax has proven politically difficult (Stiglitz 2019, Dolphin et al. 2020). A major concern is that such a tax can harm national industrial activity. Another concern is carbon leakage – that is, the reduction in emissions achieved at the national level could (in part) be offset by an increase in carbon emissions in foreign countries with more favorable tax regimes.
In a recent paper (Bollen et al. 2021), we quantify both effects using the WorldScan Computable General Equilibrium (CGE) model, which includes the effects of world trade at a relatively detailed sectoral level. More precisely, we simulate the impact of four policy scenarios including a national carbon tax of 100 â¬ / tCO2e or 200 â¬ / tCO2e in 2030, with tax revenues either being returned as a lump sum to households or used as a targeted subsidy for reducing carbon emissions in Dutch industry. In the latter case, the additional costs of the carbon tax are partly offset, reducing the rise in cost prices and the loss of production for manufacturers. We assess the robustness of the effects for several model parameters, including trade elasticities, clean-up costs and EU ETS prices.
A cost-effective way to reduce national carbon emissions
Table 1 shows the environmental effects of a 100 â¬ / tCO2the carbon tax.1 Dutch industry’s carbon emissions fall by around 40%. That is to say that the tax leads to a reduction in industrial emissions of 58 Mt of CO2e in 2018 to 21 Mt CO2e in 2030, i.e. a reduction of 40% compared to the case without tax (36 Mt CO2e). This substantial reduction in emissions reflects that industrial companies have significant options for reducing emissions at relatively low costs.2 In addition, the rate of carbon emission reduction increases further if tax revenues are redirected to industry in the form of a targeted subsidy for emission reduction. The emission reduction effects are in line with recent empirical results on the EU ETS (DechezleprÃªtre et al. 2018).
Table 1 Reduction of carbon emissions thanks to 100 â¬ / tCO2e carbon tax for Dutch industry, compared to the case without tax, in 2030 (%)
Remarks: * Composition effect of the decrease in the activity share of carbon-intensive sub-sectors within industry. ** Effect of the decrease in the activity share of the industry as a whole.
Production losses for industry are modest
At 100 â¬ / tCO2The carbon tax has only modest economic effects. The production loss for Dutch industry is 2-3% (see table 2).3 This result is due to the fact that energy costs are only a relatively small part of the total input costs and the reduction curve is strongly convex (i.e. a large amount of emissions can be reduced with relatively inexpensive reduction options such as carbon capture and storage space). For chemicals and base metals, production losses are about twice as high as the rest of the industry because these sectors are more carbon-intensive and more sensitive to international competition. Previous empirical studies have also found zero or negligible competitiveness effects of carbon pricing (DechezleprÃªtre and Sato 2017, Verde 2020).
Table 2 Loss of production due to a 100 â¬ / tCO2e carbon tax for Dutch industry, compared to the case without tax, in 2030 (%)
Carbon leakage remains a potential concern
Despite the limited loss of production for Dutch industry, we see a substantial leakage of carbon emissions to foreign countries (see Table 3). At the carbon tax rate of 100 â¬ / tCO2e, the leakage rate indicates that 61% of the emission reduction achieved nationally is offset by an increase in carbon emissions elsewhere. The leakage effect is relatively large because the loss of production is mainly borne by non-European countries without binding or relatively moderate emission ceilings, such as China and India. Carbon leakage to these countries can be significant due to the differences in carbon intensity of industrial activities and the additional demand for fossil fuels.4 Nonetheless, carbon leakage can be reduced by about a third when tax revenues are used as a targeted subsidy for emission reduction. Sensitivity analyzes which include different trade elasticities, clean-up costs and EU ETS prices generally confirm the pattern of limited production loss for Dutch industry as well as substantial carbon leakage to foreign countries. Overall, our results are slightly higher than recent empirical estimates for the EU ETS (Verde 2020), although they are close to earlier estimates of the business model which take into account the effects of large shocks on carbon prices. (Branger and Quirion 2014, Carbone and Rivers 2017).
Table 3 Carbon leakage due to 100 â¬ / tCO2e carbon tax for Dutch industry, compared to the tax-free case, in 2030
To note: * Defined as (increased carbon emissions outside the Netherlands / reduced carbon emissions in the Netherlands) Ã 100%.
The carbon taxes analyzed for the Dutch case are substantial (100 â¬ and 200 â¬ / tCO2e) and our analysis thus contributes to a better understanding of the impact of intensified climate policies in the world. In particular, the tightening of the EU ETS, as envisaged by the European Green Deal, could push carbon prices up to, for example, â¬ 100 per tonne of CO2e. Our study suggests that targeted subsidies for reducing carbon emissions can also help reduce the leakage rate in the European case. Future work on other anti-leakage measures, such as border tax mechanisms, is needed to improve the effectiveness of carbon pricing instruments.
Bollen, J, D Freeman and R Teulings (2018), âTrade Wars: Economic Impacts of US Tariff Hikes and Retaliation – An International Perspective,â CPB Backgrounder, November 19.
Bollen, J, D Freeman and R Teulings (2020), âTrade policy analysis with agravity modelâ, CPB reference document, July 17.
Bollen, J, A Deelen, S Hoogendoorn and A Trinks (2021), âCO2-heffing en verplaatsingâ, CPB backgrounder (in Dutch), 23 November.
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Carbone, JC and N Rivers (2017), âThe impacts of unilateral climate policy on competitiveness: evidence from computable general equilibrium modelsâ, Environmental economics and policy review 11 (1): 24-42.
DechezleprÃªtre, A, D Nachtigall and F Venmans (2018), âThe Joint Impact of the European Union Emissions Trading System on Carbon Emissions and Economic Performanceâ, Working Paper of the OECD.
DechezleprÃªtre, A, and M Sato (2017), âThe impacts of environmental regulations on competitivenessâ, Environmental economics and policy review 11 (2): 183-206.
Dolphin, G, MG Pollitt and DM Newbery (2020), âThe Political Economy of Carbon Pricing: A Panel Analysisâ, Oxford Economic Papers 72 (2): 472-500.
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1 The economic and environmental effects of a carbon tax of 200 â¬ / tCO2e are included in Bollen et al. (2020).
2 We verified the potential and costs of these carbon emission reduction techniques by performing a review of the most recent literature on emission reduction technologies in Dutch industry.
3 As industrial companies cannot fully pass on the additional costs of the carbon tax to their customers, the market price for the industry as a whole increases by 0.4%. As a result, Dutch industry is losing market share in world production, represented by a drop in exports (-2.4%). The degree to which exports respond to a change in price depends on the elasticity of price substitution – the Armington elasticity – which, according to recent empirical estimates, is around 6 for the whole industry ( Bollen et al. 2018, 2020). The drop in exports (i.e. the loss of production) is therefore equal to 6 (Armington elasticity) times 0.4 (increase in market prices).
4 A carbon tax for Dutch industry will reduce exports of carbon-intensive products to other European countries. Subsequently, these countries must increase their own industrial production and reduce their exports to meet domestic demand. In response, non-European countries like China and India are also increasing their industrial production to maintain consumption levels. However, China and India so far do not have binding emission ceilings and the carbon intensity of industrial activities is on average 2.5 times higher than in Europe. In addition, the additional production of industrial products will be accompanied by an increased demand for electricity which is often generated by the use of fossil fuels. As a result, carbon emissions in non-European countries like China and India can be five times higher than in Europe. Finally, additional production in these countries also generates GDP growth, resulting in additional traffic (often based on fossil fuels) and demand for services.