22 Apr 2016

The Problems With Carbon Tax “Border Adjustments”

Climate Change, Shameless Self-Promotion No Comments

This is counterintuitive for even academic economists, so if you’re into this stuff, don’t miss it. Here’s a key part:

The RFF [Resources for the Future] study does not so much come down against the use of border adjustments to mitigate the problem of “leakage,” but rather the authors are pointing out that economists have not yet fully recognized just how complicated the problems are. “Intuitive” results may in fact be wrong.

It would take too much space to fully summarize their various arguments, but let me at least give a flavor. In the first place, it makes a difference whether the underlying carbon tax (which is only imposed by some governments) is levied on extraction, production, or consumption. If some governments impose a tax on the extraction of carbon-intensive fuels, then the global (pre-tax) price of energy rises. This causes fossil fuel production to increase in non-carbon-taxing jurisdictions, which is a form of leakage on the supply side.

On the other hand, if a carbon tax is imposed by some governments on consumption, then the global (pre-tax) price of energy falls, which induces more consumption of fossil fuels in the non-carbon-taxing jurisdictions, which is a form of leakage on the demand side.

Already we can see that different governments would collect different amounts of revenue based on the form of a carbon tax, and that these different forms would induce different worldwide effects. In principle, border adjustments could help offset this leakage.

However, once you begin formally modeling these processes, you see that all kinds of outcomes are possible. For example, the authors can construct a scenario in which a country with large oil and gas resources and a domestic carbon tax on production would hurt the welfare of its people if it then added border adjustments, even though one might have originally thought that such an adjustment could only make things better.

(To give some of the details: This outcome could occur because initially, before the border adjustments, the government is implicitly getting foreigners to shoulder some of the cost of its domestic tax, due to the higher world price of energy that even foreign consumers must pay. But with border adjustments, energy can continue to flow to consumers in non-taxed jurisdictions with no impediment, and so there is no reason for their price of energy to rise. Therefore, once the border adjustments have been added, the taxing government is concentrating the brunt of its tax on its own people. Given that the government is going to levy a domestic carbon tax, then, in this scenario we can see that adding border adjustments makes its own citizens poorer.)

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