The UK Climate Change Levy and Ecological Tax Reform Professor Stephen Smith Department of Economics University College London

Outline What the UK has done CCL and the ideal carbon tax Carbon taxes and emissions trading The way forward: taxes and/or trading?

The UK’s climate change programme Three linked elements Climate Change Levy Climate Change Agreements UK Emissions Trading Scheme

The Climate Change Levy Announced in 1999 Budget Introduced April 2001 Tax per unit of energy Applies to industrial and commercial energy use, not households Revenue-neutral introduction. £1billion annual revenues finance cut in employers’ payroll tax (NICs)

Climate Change Levy tax rates Pence per kWh$ per tonne C Gas Coal Electricity LPG0.07n.a.

Climate Change Agreements Negotiated agreements between industry groups and government 46 energy-intensive sector (6000 companies) have CCAs CCA members qualify for 80% reduction in CCL In return, undertake to meet quantitative target for reduction in energy use or CO2 emissions Targets may be absolute (tonnes) or relative (tonnes per unit output). Compliance possible through reduced energy use, or trading. Were some targets “hot air”?

Motor fuel taxes in the UK Motor fuel taxed much more heavily than other fuels throughout EU UK has the highest rates of motor fuel excise in the EU No fuel duty preference for diesel Fuel duty “escalator” (FDE) between 1993 and Introduced as climate-related measure, abandoned after fuel protests. Over FDE raised fuel prices in real terms by 17 p/litre (petrol) and 21 p/litre (diesel). FDE fuel price rise equivalent to carbon tax of $405 /tonneC (petrol) and $440 /tonneC (diesel).

How do these taxes compare to a systematic carbon tax? An ideal carbon tax would: Tax fuels in proportion to their carbon content Apply uniformly to all sectors (industry, households, etc) Have no exemptions for energy-intensive sectors Exempt non-fuel uses Tax fuel inputs to electricity generation Tax carbon at a rate equal to marginal damage costs of CO2 emissions Be levied worldwide at the same rate

The optimal carbon tax rate Most studies estimate the marginal damage costs of current carbon dioxide emissions at $5-20 /tonne C Some are much higher, over $100 /tonne C Uncertainties are mainly downside risks (“nasty surprises”) UK government uses £70 (approx $105) / tonne C for policy assessment Reasons for differences in estimates of marginal damage costs of current CO2 emissions Assumptions about physical processes (the “science”) Assumptions about economic responses (adaptation, policy, etc) Scope of the analysis (countries included, time horizon, etc) Welfare criteria (discount rate, distributional weights)

The role of CCAs and trading in the UK system UK Emissions Trading Scheme began March World’s first large-scale greenhouse gas trading scheme “Direct” participants: 34 successful bidders in March 2002 auction Descending clock auction, budget £215 million. Purchased approx 4 million tonnes C. Market clearing price £ Equivalent to £17.79 ($27) /tonneC over the life of scheme. “Agreement” participants – firms within CCAs can achieve compliance by trading Market price has fluctuated, but always well below auction price. Currently about £2.50 ($3.75) /tonneC

What role for taxes in future climate change policy? EU Emissions Trading scheme will provide systematic market-based approach to climate change policy. Is there still a need for energy taxes? Strong case for taxes within climate change policy package, for three reasons: Permits tend to be issued free, which foregoes revenues, and hence potential “double dividend” benefits Taxes provide a safety net, reducing risk of overgenerous “hot air” permit allocation Future international agreements should discuss carbon prices, and not just quantity targets. Co-ordinated carbon taxes would be a simpler agreement to define, implement and monitor.