GTAP Conference 2004: Transportation

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Transportation in an Economy-Wide Cap and Trade
System The Role of Pre-existing Taxes
Presented by John Reilly Joint Program on the
Science and Policy of Global Change,
Massachusetts Institute of Technology,
IPIECA Transportation and Climate Change
Baltimore, Maryland, 12-13 October 2004

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The Basic Story

• Ideal policy instruments (cap and trade)are ideal
  only in an economy with no other distortions and
  externalities
• Taxes that mainly raise revenue, unrelated to an
  externality (air pollution) or marginal cost of
  providing a service (e.g. use of highway) cause
  economic loss.
• Economic terminology--deadweight loss
  associated with revenue raising taxes.
• A new policy, e.g. climate policy, can interact
  with these taxes and greatly increase the cost of
  the policy.
• First best solutions (emissions trading,
  economy-wide coverage of cap) may then be cost
  efficient.
• Examples
• EU exemption of transport
• EU emissions trading with Japan to meet Kyoto

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Distortions in Fuel Markets
100/tc direct cost of 50, distortion cost of
800-1200
EU GAS tax of 2.80-3.80/gal.800 -1200/tc
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First Example

• EU Emissions Trading System (ETS) from 2005-2007
  extended into Kyoto Period
• what happens if extended to other sectors, or if
  e.g. transportation remains exempt from the cap
  while economy still meeting Kyoto cap (no
  emissions trading beyond EU)
• Note 2005-2007 (ETS) is not binding if countries
  projected reference emissions levels are
  accuratehot air in several countries more than
  enough to cover small reductions in others
• C-Price 00.000, so not much interaction with
  anything.

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Another Example

• EU-EXT (EU 15 plus Accession Countries)
• Economy-wide Cap and Trade
• What happens if emissions trade opens with Japan
• We are assuming other Kyoto Parties meeting
  targets independently US meeting Bush intensity
  target

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One more Simple Example

• US, Japan, EU all cutting carbon emissions by a
  hypothetical 25 from reference levels.

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Can lead to very different results across
countries Example JPN, EU, US Reduce C by 25
from 2010 Reference
Japan Economy about 40 of US
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Trading Welfare-Worsening?

• EU firm at margin reduces at 205 per ton
• JPN firm at margin permit purchase worth 323
• Suppose clearing price is 250
• EU firm gains 45 by selling.
• JPN firm gains 73 by buying instead of reducing
• But Social cost of EU reduction is 586, in Japan
  539
• EU loses 586-250336
• JPN gains539-250289
• On net, trading causes a loss of 336-28947
• In fact, we get this result when we open up
  Extended EU emission trading with Japan

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Summary

• Transportation is highly distorted by
  pre-existing policies.
• Fuel Taxes in Europe/Japan unrelated to
  externalities, or poorly related
• US fuel tax a user charge for highway
  construction?
• CAFE and CAFE-type programs also a
  distortioneffects not included
• Uncontrolled air pollution/congestionperhaps
  work the other way but...
• Very different policies in different
  countriesuniform climate policy therefore not
  uniformly efficient
• Case can be made that EU transport should be
  exempt from carbon policy until carbon price
  approaches 1000 or more in the rest of the
  economy.
• Side-insight from converting EU fuel tax levels
  to carbon tax-equivalent.
• Carbon-equivalent taxes of 1000 have not so far
  displaced the internal combustion engine.
• Vehicle fleet differs in Europe but with high
  enough income preferences for private automobiles
  appears to win.
• Those private automobiles are smaller, more fuel
  efficient and may be driven less but are still
  internal combustion engines.