Tuesday, July 21, 2009

The Indo-US carbon emissions controversy is another reason to favor carbon taxes

This blog has consistently argued in favor of carbon taxes over cap-and-trade measures to control the emission of greenhouse gases. The disagreement between the US and India on how to address the challenge of greenhouse gas emissions and its possible consequences adds further weight to the view that carbon taxes are the way ahead.

The Indian government has reiterated its opposition to any binding limits on carbon emissions. It claims that its per capita carbon emissions are only a fraction of that of the US and other developed nations and any binding limits on emissions would adversely affect its economic growth.

Two recent developments - a WTO decision to permit a broad set of border-tax arrangements (border adjustment measures) by countries implementing cap-and-trade systems for greenhouse gases against those not adopting such measures and the adoption of a cap-and-trade system for curbing carbon emissions by the US which contains a provision to impose border tariffs on those not limiting emissions - are cause for serious concern for developing countries like India. They may have had the effect of crystallizing a national climate change policy that adopts both carbon taxes and cap-and-trade.

Through the American Clean Energy and Security Act 2009, the US has effectively adopted a two-prong strategy to address the climate change challenge - domestically it will use cap-and-trade measures while externally it will resort to carbon taxes on its trade partners who do not commit to binding targets. A recent NYT editorial even points to precendents for using trade measures for environmental goals - the Montreal Agreement to curb the use of ozone-depleting gases included trade controls on such substances.

I am inclined to believe that the WTO decision, which legitimizes the corresponding provision in the Waxman-Markey Bill, will soon replace traditional issues that divide developed and developing countries - tariffs, labor standards, agriculture subsidies etc - and become the epicenter of global trade negotiations. Developing nations cannot be faulted if they view carbon tariffs, in the guise of border adjustment measures ostensibly to provide level-playing field to local industries, as a back-door entry of protectionism by developed economies.

I have argued that a carbon tax is cheaper, much more economically efficient, creates far less incentive distortions, and simpler to administer. The aforementioned developments and the dangers of protectionism and retaliatory actions that could seriously undermine global economic integration, lends further weight to the superiority of carbon taxes over cap-and-trade measures. Given the practical difficulty of getting developing countries like India to embrace the cap-and-trade mechanism and agree to binding carbon emission targets, carbon taxes look the only agreeable alternative.

Universal and standard carbon taxes on all greenhouse gas emitting goods and services would neither favor nor disadvantage any set of countries over the rest. Since greenhouse gas emissions and its impact on climate change are a global negative externality, it is only appropriate that every product and service inflicting this external cost ought to be taxed, so as to internalize the resultant costs. By dis-incentivizing the activity or product that generates greenhouse gases, it will ensure that the ultimate objective of reducing such emissions is achieved. Further, by being indifferent to the location of the industry generating the greenhouse gases, it eliminates problems like unequal playing field for different national industries and distortions like shifting of industries from one country to another.

The developed economies generally set the agenda for negotiations on various global issues multi-lateral forums like the WTO, IMF, Kyoto Protocol etc. However, this may be a great opportunity for India to lead the developing countries in setting the agenda for the next round of world trade and climate change negotiations by campaigning for a global carbon tax to contain greenhouse gas emissions. Clearly defined proposals on carbon tax as an alternative to cap-and-trade will also ensure that developing countries are not seen as being merely obstructionist but being constructive in addressing one of the most important challenges facing the world.

Update 1
It appears that the emissions reporting in the US is murky, in so far as the claims on reductions achieved is "murky".

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