Costs and Benefits of a Carbon Policy for China Jing Cao Tsinghua University Mun S. Ho, Dale Jorgenson Harvard University Coping with Copenhagen – Chinese Challenges in Defining a Climate Policy Oct. 15-16, Beijing

Introduction China fossil fuel use is source of 2 problems Severe air pollution and environmental damage in China and regionally Air pollution is estimated to cause 100,000 -750,000 premature deaths annually. (Cao, Ho and Jorgenson, 2008 and World Bank 2007). Greenhouse gas emissions contributing to global climate change. Of total world CO2 from fossil fuel use, China contributed 18% and U.S. 24% in 2004. Netherlands EPA calculated China is top of the carbon dioxide list in 2006 In Recent JEEM 2008 (May), Auffhammer Maximilian (UC Berkeley) predicted that China’s CO2 growth is about 11% for 2004-2010, exceeding GDP growth

Introduction – Fossil Fuel Effects (continued) Coal use is responsible for 55% of TSP and 82% of SO2 from combustion and non-combustion sources in China in 2002. Coal use is responsible for 96% of TSP and 93% of SO2 considering combustion emissions alone. Coal use is responsible for 79% of CO2 from fossil fuel combustion (71% of CO2 from fossil fuel burning and cement production combined). That is, liquid fuels contribute relatively more to CO2 than to local pollution.

Introduction – Emission of SO2 in China (mil. tons) Note there is a kink here due to the changes in the definitions

Introduction – Carbon Emissions; total (mil. tons) and per capita (kg Introduction – Carbon Emissions; total (mil.tons) and per capita (kg./person)

China’s Carbon Intensity (Carbon from fossil fuel combustion and cement)

Carbon Tax Policy for China？ Coping with Copenhagen – Chinese Challenges in Defining a Climate Policy Global Perspective: Harmonized Carbon Tax Policy? Richard Cooper (Harvard): propose a global carbon tax, the Clinton Administration calculated in 1998, if China, India etc included in trading, the trading price would be $23 /ton C to achieve Kyoto Protocol 7

Carbon Price? Source: http://www.pewclimate.org/eu-ets. 8 The red curve shows prices for allowances that could be used to cover emissions through December 2007. The abrupt drop in price in April 2006 followed the release of actual emissions data, which was lower than expected, making available allowances less sought after. Price dropped to zero during 2007 because facilities could not use those allowances after December 2007. The black curve shows prices for allowances that would be delivered in December 2008 for use during the second phase (2008 through 2012). Source: http://www.pewclimate.org/eu-ets. 8

Carbon Price? 9

Carbon Tax Policy for China？ China Perspective: More likely to Impose Carbon Tax or Energy Tax, rather than joining the Global Emission Trading System with binding cap commitment In this study, we try a relatively smaller 10$/ton C and a 20$/ton C carbon tax Embedded Carbon and Border Tax Implications? Need to calculate carbon content for each commodity Difficult to work out what carbon content is for imports from various countries 10

Aims of study of national impacts of carbon control policies Analyze impact on industry output, prices and energy use Impact on carbon emissions Impact on aggregate GDP and Consumption Impact on growth over time Impact on emissions of TSP and SO2; hence impact on health That is, the costs and benefits of policies: costs: lower consumption and GDP benefits: lower local pollution and lower global greenhouse gas emissions. 11

Model China CGE Model – A Recursive Solow CGE Model Based on Most Recent 2002 Official I-O Table and Social Accounting Matrix Representative household, assume fixed labor supply Assume “Two-Tier” plan-market capital market Armington assumption for modeling international trade Pre-existing taxation in the second-best setting Intake-Fraction methods to estimate for environmental health damages 12

A Simple Carbon Tax Policy: Methodology to Analyze Impacts Scenario 1: A “Unilateral Tax” on Consumption of Carbon, which is equivalent to a tax on domestic coal, oil, gas and on imported coal, oil and gas uses. Establish a base case path of the economy using a multi-sector growth model of China with no carbon policy. Note the energy use, carbon emissions and local health damages in each year of the base path. Simulate a new path where a carbon tax is placed on fossil fuel consumption. This tax is applied to consumption so imported fuels are taxed but imported manufactured goods are not subjected to a carbon tax. The revenues from the new carbon tax is used to lower all existing tax rates so that government consumption is equal to the base case level. 13

Base Case Simulations 14

Counterfactual Simulations – First Year Impacts % 15

Counterfactual Simulations – Impacts in 2030 % 16

Counterfactual Simulations – GDP Impacts % 17

Industry Impacts on Output – First Year 18

Industry Impacts on Price – First Year 19

Other Alternative Tax Scenarios Scenario 2:A “Unilateral Tax” Plus Import Offset, i.e. a tax coal, oil and gas, and a tax on imported goods equal to the net tax on domestic goods. I.e. a tax imposed on embedded carbon contents of the goods. Scenario 3: A “Unilateral Tax” Plus Import Offset and Export Rebate, i.e. Give export a subsidy equal to the net embedded carbon tax. 20

Key Method: Estimate Embedded Carbon Intensity by Commodity/Sector Data: China Input-Output Table 2002 (Export Carbon Intensity) and US Input-Output Table 2002 (Import Carbon Intensity) Using Use Matrix U, we can derive “Activity Matrix” Using Make Matrix V, we can determine the relationship between industry output and commodity supply The vector of industry output is denoted by . the vector of industry output is the row sum, the vector of commodity output is the column sum, 21

Method (cont’) where is the identity matrix. is known as the Leontief inverse, or the “commodity total requirements matrix”. It tells us that to produce a vector E of final demand commodities, the economy must produce a vector Q of gross output of commodities. In particular, this formulation expresses the additional outputs required to produce an extra unit of good i for final users. Thus we can define “commodity total requirement” vector 22

Method (cont’) where denote the total carbon emissions due to producing one unit of i, and is the vector of carbon coefficients with non-zero entries only for the primary fuels. Consider that oil and gas are used as feedstock in the production of chemicals and other non-combusted products where is the combustion ratio 23

Carbon Intensity by Sector Thus we can calculate carbon intensity by sector, and this would be the basis to calculate embedded carbon content for China’s export. Ho, Morgenstern, and Shih (2008) recently worked out the embedded carbon intensity by sector for the United States, and in this study we use this data to calculate embedded carbon intensity for China’s imports. 24

Carbon Intensity by Sector (metric ton C/yuan) 25

Unilateral + Import Tariff Unilateral + Import Tariff + Export Rebate Preliminary Simulation of Alternative Carbon Policies (Impacts in 2030) Scenario 1 Unilateral Scenario 2 Unilateral + Import Tariff Scenario 3 Unilateral + Import Tariff + Export Rebate GDP ++ + 0+ Consumption 0- - Investment CO2 -- Other Pollutions /Health Damages 26

Thank You ! 27

Preliminary Simulation of Alternative Carbon Policies (Impacts in 2030) - optional Scenario 1 Unilateral Scenario 2 Unilateral + Import Tariff Scenario 3 Unilateral + Import Tariff + Export Rebate GDP ++ + 0+ Consumption 0- - Investment CO2 -- Other Pollutions /Health Damages Scenario 4 Border Tax (Revenue Kept in China) + 0+ 28