E/C.18/2019/CRP.4
Distr.: General
2
April 2019
Original: English
Committee of Experts on International
Cooperation in Tax Matters
Eighteenth session
New York, 23-26 April 2019
Item 3(c)(i) of the provisional agenda
Environmental tax issues
Note by the Secretariat
Summary
This note includes two draft chapters that it is proposed would form part of a handbook on
carbon taxation, FOR DISCUSSION by the Committee.
The two chapters deal with the design of a carbon tax; and administrative issues arising from
the introduction of a carbon tax.
The Subcommittee will also provide an oral presentation on the experience of Chile in
implementing a carbon tax, to illustrate the relevance of the inclusion of country experiences
in the handbook. Committee members are encouraged to liaise with the Coordinator in case
they would like to facilitate the inclusion of additional case studies in the handbook.
1. The Committee, during its 16
th
Session (New York, 14-17 May 2018), endorsed the
recommendation of the coordinator of the Subcommittee on Environmental tax issues
(Subcommittee), for their work to initially focus on issues related to carbon taxation.
2. Within this framework, the Subcommittee presented the Committee, at its 17th Session
(Geneva, 16-19 October 2018), with a summary outline of a handbook aimed to provide
guidance on the design and implementation of carbon taxation. Such guidance would be
primarily directed at developing countries which are considering the introduction of a carbon
tax.
3. To advance discussion on the content of specific chapters of the handbook, the
Subcommittee met in Paris on 21-22 January 2019, hosted by the International Chamber of
Commerce). The following topics were discussed in detail:
a. Designing a carbon tax, including (i) issues related to taxing power; (ii) the definition
of the scope and tax base; (iii) the determination of tax rates; and (iv) the identification
of the taxpayer.
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b. Interaction of carbon tax with other measures, including (i) other environmental policy
instruments; (ii) other relevant taxes; (iii) tax subsidies and competition policies; (iv)
consumption subsidies; and (v) existing international agreements.
c. Conceptual approach to carbon taxation, including economic theory framework,
environmental issues, and the definition of carbon tax.
d. Administrative issues arising from the introduction of the carbon tax.
e. Country experiences: Chile and Sweden.
4. Following discussion, two draft chapters (on design and administration) were substantially
advanced, and are ready for discussion by the Committee to provide guidance. Issues which
will need further discussion within the Subcommittee are indicated in [square brackets] in the
text below.
5. Additionally, for the information of the Committee, the Secretariat requested inputs from
the Subcommittee in view of a capacity development Workshop on Selected Issues in Tax Base
Protection and Tax Measures in Support of the SDGs For Developing Countries, to be held in
Nairobi on 10-14 June 2019. The regional workshop will feature the participation of
approximately 40 tax officials of countries in Sub-Saharan Africa, and include a peer-learning
session on environmental taxation. The Secretariat will design a questionnaire, in consultation
with the Subcommittee, to survey the experiences of participating countries in implementing
taxes with an environmental component, and identify needs for capacity development. The
questionnaire might also be a useful instrument to explore additional case studies to be included
in the handbook.
6. During the Committee Session, the Subcommittee will also provide an oral presentation on
the experience of Chile in implementing a carbon tax, to illustrate the practical relevance of the
inclusion of country experiences in the handbook. Committee members are encouraged to liaise
with the Coordinator in case they would like to facilitate the inclusion of additional case studies
in the handbook.
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Handbook on Carbon Taxation – Chapters for discussion
Table of Contents
Chapter VII: Designing a Carbon Tax ............................................................................................. 6
7.1 Taxing power [Draft in progress] ......................................................................................... 7
7.2 Scope of the carbon tax and defining the tax base [Draft as of 28 March 2019] ................. 7
7.2.1. What are we going to tax? ............................................................................................ 7
7.2.2 The Fuel Approach ........................................................................................................ 8
7.2.2.1 Basic concept
............................................................................................................ 8
7.2.2.2 What fuels can be taxed with the Fuel Approach? ................................................. 9
7.2.3.1 Basic concept .......................................................................................................... 10
7.2.3.2 What fuels can be taxed with the Direct Emissions Approach? .......................... 11
7.2.3 When will the carbon tax be levied and who faces the price of the tax? .......................... 12
7.2.3.1 A carbon tax vs direct taxation
.............................................................................. 12
7.2.3.2 Methodologies to calculate the tax ........................................................................ 13
Basing the tax on carbon content ............................................................................... 13
Hands-on – how to do calculate the tax ..................................................................... 14
The tax rates are in tax law expressed in weight or volume units ............................. 15
It is possible to differentiate based on fuel quality .................................................... 16
Measuring actual emissions ....................................................................................... 16
7.2.3.3 Who will pay the carbon tax and when?
............................................................... 17
Basics to consider when deciding on the tax payer ................................................... 17
Ensure that there is a price signal .............................................................................. 18
When will the tax be due – point of regulation ......................................................... 18
Let the tax be due later in the distributional chain ..................................................... 20
When a carbon tax is based on the Direct Emissions Approach ............................... 24
7.2.3.4 Who faces the price of a carbon tax?
..................................................................... 24
7.2.4 Tax coverage, possible exemptions and thresholds........................................................... 25
7.2.4.1 Theory and practice
................................................................................................ 26
7.2.4.2 Policy options to address concerns over competitiveness, carbon leakage and
distributional effects
............................................................................................................ 28
Exemptions and other measures to reduce carbon tax rates ...................................... 31
7.2.4.3 Other measures to protect competitiveness and address distributional risks
...... 32
7.2.4.4 Introducing a carbon tax: Two-level tax systems and setting of thresholds ....... 33
7.2.5 How to treat carbon content in fuels of biomass origin? ................................................... 35
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7.2.5.1 IPCC Climate Change Emission Reporting .......................................................... 36
7.2.5.2 Low blends of ethanol and biodiesel into petrol and diesel ................................. 36
7.2.5.3 Take account of the biomass part of petrol and diesel when calculating the
carbon tax rate
..................................................................................................................... 37
7.2.5.4 Finland – an example of a jurisdiction with an innovative view of future carbon
taxation
................................................................................................................................. 37
7.2.6 Checklist for defining a tax base ....................................................................................... 38
7.3 Tax Rates [Draft as of 1 April 2019] ....................................................................................... 39
7.3.1 Introduction ....................................................................................................................... 39
7.3.2 Setting the Rates ................................................................................................................ 41
7.3.2.1 Pigouvian Approach – internalising external costs
.............................................. 41
7.3.2.2 Standards and Price Approach – to reach a specific carbon reduction target ..... 44
7.2.2.3 Revenue Target Approach ...................................................................................... 45
7.2.3.4 Benchmarking Approach ........................................................................................ 47
7.2.3.5 Benchmark comparison with trading partners ...................................................... 50
7.3.3 Temporal Development of the Tax Rate ........................................................................... 51
7.3.3.1 The role of politics
.................................................................................................. 51
7.3.3.2 Tax Rate during the Initial Phase of a Carbon Tax .............................................. 51
7.3.3.3 Development of the Tax Rate after its implementation........................................ 53
7.3.4 Tax Rates and Country Specific Considerations ............................................................... 54
7.3.5 Key Considerations ........................................................................................................... 55
Chapter IX: Administrative Issues in the context of Carbon Taxation [draft as of 1 April 2019] . 57
9.1 Introduction .............................................................................................................................. 57
9.2 Types of administrative issues to consider .............................................................................. 57
9.2.1 Domestic issues ................................................................................................................. 58
9.2.1.1 Regions and municipalities
.................................................................................... 59
9.2.1.2 Utilize the existing taxation systems ..................................................................... 59
9.2.1.3 Capacity building .................................................................................................... 60
9.2.1.4 Stakeholder involvement ........................................................................................ 60
9.2.1.5 Clarify roles and expectations, communicate ....................................................... 60
9.2.2 International ...................................................................................................................... 60
9.3 When to address the administrative issues ............................................................................... 61
9.3.1 Before implementation ...................................................................................................... 62
9.3.1.1 Regulation
............................................................................................................... 62
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9.3.1.2 Data availability ...................................................................................................... 62
9.3.1.3 Timing ..................................................................................................................... 62
9.3.2 During implementation ..................................................................................................... 63
9.3.2.1 Tax audit and collection
......................................................................................... 63
9.3.3 After implementation ........................................................................................................ 64
9.4 Operational hints ...................................................................................................................... 65
9.4.1 Optimize the process of digitalization ............................................................................... 65
9.4.2 Enhance Corporate Social Responsibility in the private sector ........................................ 66
9.4.3 Other hands-on hints ......................................................................................................... 66
9.5 Solutions found in a comparative analysis ............................................................................... 67
9.5.1 The Swedish fuel approach ............................................................................................... 67
9.5.2 The Emissions Approach in Chile ..................................................................................... 67
9.6 Conclusion ............................................................................................................................... 68
9.7 References for Chapter 9 ......................................................................................................... 68
Annex 1 – Economic theory background ....................................................................................... 70
A1.1 Pigouvian Approach: Theory versus reality .......................................................................... 70
A1.2 Marginal Abatement Cost Curves ......................................................................................... 70
A1.3 Revenue Target Approach wrestling with Theory ................................................................ 72
A1.4 Carbon Tax Rates .................................................................................................................. 73
A1.5 Bibliography for Annex 1 ..................................................................................................... 74
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Chapter VII: Designing a Carbon Tax
Motives for introducing carbon dioxide taxation, commonly referred to as a carbon tax, has
been discussed in chapter xxx. Once a decision has been made to consider such a tax, the
policymaker is faced with a number of choices, see a brief overview in figure below.
Figure: Stages of Carbon Tax Design and Interlinkages between Design Options
Source: Partnership for Market Readiness. 2017. Carbon Tax Guide: A Handbook for Policy Makers. World
Bank, Washington, DC.
[Figure provisionally placed in this section; however, as it shows the whole process of designing a
carbon tax, it might be moved to an earlier chapter (for example the conceptual framework) and
referred to here.]
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7.1 Taxing power [Draft in progress]
7.2 Scope of the carbon tax and defining the tax base [Draft as of 28 March 2019]
7.2.1. What are we going to tax?
The simple answer, to the question of what we are going to tax, is emissions of carbon dioxide.
Carbon dioxide amounts to roughly 80 per cent of the total greenhouse gas emissions (GHG)
emitted globally and already this fact speaks highly in favour of starting out by focusing
taxation on these emissions. This limitation as to the type of emissions to be covered in this
handbook has already been set in chapter II.
Figure Global Greenhouse Gas Emissions by Gas [to be updated with more recent graph
and figure]
Figure: Global Greenhouse Gas Emissions by Gas
Source: IPCC 2010.
Carbon dioxide enters the atmosphere mainly through burning of fossil fuels (such as coal,
natural gas, and oil), solid waste, trees and wood products. Carbon dioxide is removed from
the atmosphere when it is absorbed by plants or in ocean waters as part of the biological carbon
cycle or artificially in a framework of carbon capture and storage. Taking these facts into
account, there are two basic approaches when considering what to tax. One is focusing on a tax
by volume or weight units of the fuels giving rise to emissions when combusted (“the Fuel
Approach”), where the tax rate is based on standardized amounts of carbon content in those
fuels. The other includes measuring the emissions directly as they occur from the burning of
such fuels (“the Direct Emissions Approach”). There are pros and cons with both approaches
and the design choice depends on the national prerequisites in a specific jurisdiction. A
discussion will follow below, where also examples will be given from tax systems currently in
force in different jurisdictions.
While carbon dioxide by far accounts for the vast part of greenhouse gases emitted from
combustion of fuels and thus merits the focus of this handbook, also smaller amounts of nitrous
oxide and methane are emitted during the combustion, depending on the type of fuel and
method of combustion. Emissions of other greenhouse gases than carbon dioxide can be
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converted into carbon dioxide equivalents (CO
2
e) to enable a comparison between the
emissions and some jurisdictions using the Direct Emissions Approach in their carbon tax
design are applying this method to also include these other greenhouse gases in their tax
scheme.
True enough, there are examples of jurisdictions, which have introduced taxation of also
fluorinated greenhouse gases, so-called f-gases, the most common ones being
hydrofluorocarbons (HFC) and perfluorocarbons (PFC).
1
However, f-gases are generally used
for refrigeration systems. This means that such taxation would not relate to the burning of fuels
and the tax design would need to be found outside of a system of taxing fuel products or actual
emissions from the combustion of the fuels and therefore merit different considerations that
are beyond the scope of this document.
7.2.2 The Fuel Approach
7.2.2.1 Basic concept
Currently the predominant method of carbon taxation in jurisdictions worldwide is to levy a
carbon tax on specific fossil fuels, primarily oil, gas and coal, and their derivative products.
The tax would in principle be levied at a point close to the extraction of the fuel (in a mine or
crude oil extraction site) or at importation into the jurisdiction. However, most tax schemes
applicable today to some extent allow that the tax due upon extraction or importation is
suspended during part of the distributional chain, if the fuels are handled by approved bodies.
This means that the tax in these cases is levied when the fuels are leaving such an established
tax suspension arrangement.
A general tax rate has been pre-calculated and laid down in the tax law, based on the average
fossil carbon content of the fuels, not on the actual emissions occurring from the consumption
nor considering any emissions occurring during the production of the fuel. It should be stressed,
however, that in the case of fuel combustion there is a sufficiently close relation between carbon
content and carbon dioxide emissions. The tax rates of different fossil fuels are usually
presented in the national tax law expressed in commonly used trade units. This is a transparent
and well-established practice to express tax rates on fuels. Such tax rates are easy to apply for
operators as well as for the Tax Agency. The calculation of the tax rates will be further outlined
in more detail in chapter 3.2.
Some jurisdictions have chosen to limit the scope to only certain fuels or cover only the
consumption in certain sectors.
[Possible to add a picture of fossil fuels, such as oil, natural gas and coal]
1
Denmark and Norway for instance, tax emissions of carbon dioxide as well as f-gases, while Spain is an
example of a jurisdiction with a tax solely on f-gases at national level.
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7.2.2.2 What fuels can be taxed with the Fuel Approach?
Box: Examples of fuels subject to a Fuel Approach carbon tax in different jurisdictions
Seven states in the European Union have introduced national carbon taxes covering all motor
fuels, coal and the bulk of commercially available liquid and gaseous fuels used for heating
purposes. The carbon tax has been added to an already existing general excise duty scheme,
either as part of the general excise duty or as a separate tax.
For various reasons, countries may choose to only tax certain fuels. Iceland only taxes petrol,
diesel and heating gas oil. In India and the Philippines only coal is taxed, while Mexico taxes
coal and petroleum products (not natural gas) and Costa Rica all fossil hydrocarbons. On the
other hand, natural gas as motor fuel and coal are exempted from the carbon tax coverage in
Colombia. The carbon tax in Argentina covers all major fossil fuels used in motor fuels or for
heating purposes with the exemption of natural gas and liquified petroleum gas used for heating
purposes.
Basing carbon taxation on fuels has the administrative advantage of being able to use the
general system of fuel taxation. Such systems already exist in some form in many jurisdictions.
The naming of this instrument may vary between jurisdictions – tax, excise duty, levy being
the most common ones.
For the Member States of the European Union, there is a harmonized tax framework for
taxation of fuels,2 which the EU Member States are obliged to follow in their national tax
implementation. This means that the seven EU Member States which have chosen to introduce
a specific carbon tax are using the fuel tax base of this EU directive. It consists of all motor
fuels, coal and the bulk part of all commercially available liquid and gaseous fuels used for
heating purposes. The current EU framework does not oblige the Member States to levy a
carbon tax, but if a Member State decides to introduce such as tax it is considered as a duty
covered by the harmonized EU tax framework.3
The EU Member States which have introduced a carbon tax have generally added it to an
already existing general excise duty (sometimes referred to as an energy tax), either as part of
the general excise duty (e.g. in France) or as a separate tax (e.g. in the Nordic countries4). The
same situation can apply in non-EU jurisdictions, as taxing energy to some extent has over the
years become a common source of revenue raising across the world. There are different
2
Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for the taxation of
energy products and electricity, see
https://eur-
lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2003:283:0051:0070:EN:PDF. The products to be taxed
are listed in Article 2 of the directive. For more info on carbon tax rates in the EU Member States, see the
European Commission’s on-line information tool Taxes in Europe Database (TEDB) at
https://ec.europa.eu/taxation_customs/economic-analysis-taxation/taxes-europe-database-tedb_en.
3
See Article 4.2 of Directive 2003/96/EC.
4
The legal provisions for the separate taxes are in some Nordic countries laid down in the same legal act and in
others in separate legal acts.
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approaches of how to treat the interaction between these two different taxes. Sweden, for
instance, over the years has chosen to significantly increase its carbon tax share of the total tax
on energy products. Most other EU countries have, however, added a smaller – but in most
cases increasing level – carbon tax on top of their already existing taxation of energy products.
The same goes for Lichtenstein, Norway and Switzerland, which are European countries
outside the EU. Although the carbon taxes in Switzerland and Lichtenstein are not levied on
road fuels, which are only subject to an excise duty not specifically based on the carbon content
of the fuels.
The carbon tax base in Iceland consists of petrol, diesel and heating gas oil, as these are the
only fossil fuels available in the market in that country. Outside the EU, some countries, for
instance India, Mexico, the Philippines and Zimbabwe, have chosen to tax only a few fuels. In
the case of India and the Philippines only coal is being taxed, while Mexico taxes coal and
petroleum products. The Colombian carbon tax base consists of natural gas and other petroleum
products. Although not specifically designed as a carbon tax, an example of a country having
introduced a levy only on certain fuels is Zimbabwe, where only petrol and diesel are taxed.
The carbon tax in Argentina covers all major fossil fuels used as motor fuels or for heating
purposes with the exemption of natural gas and liquified petroleum gas used for heating
purposes.
Costa Rica is the Latin American pioneer in carbon taxation, as the country has had such a tax
since 1997. The Costa Rican tax base is fossil hydrocarbons, which means an application of
the Fuel Approach. However, the carbon tax rate is not related to the fossil carbon content of
the hydrocarbons, but rather by a percentage (currently 3.5) of the market price of the
hydrocarbons.
The reasons behind these different approaches are often found in the national contexts, such as
existent administration systems or the fact that the chosen fuels amount to the bulk part of
carbon emissions. Competitive concerns for certain sectors or geographical parts of society can
also play a role, see further discussion on possible tax exemptions below in section XXXX.
7.2.3 The Direct Emissions Approach
7.2.3.1 Basic concept
An approach, which has attracted increasing attention, is to rely on direct measurements of
emissions from certain types of stationary installations/facilities. This is the case in Chile and
Singapore.
Normally emissions from large electricity and industrial plants are targeted by the tax and those
facilities may often already by subject to requirements to measure emissions by IPCC
regulations or even more stringent national environmental codes.
[Maybe an illustration showing emissions from a stationary installation?]
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Another approach is to structure a carbon tax to target carbon dioxide emissions regardless of
the type of fuel being used, normally from a certain group of stationary installations such as
factories, power plants and oil refineries. A variation on this approach is to focus on certain
processes and types of emissions. This approach allows for coverage of activities beyond fossil
fuel combustion and, therefore, also of GHGs other than carbon dioxide as well as of other
sources of pollution from certain installations. In this way, jurisdictions may be able to ensure
broader coverage, especially where a large part of their emissions are not fuel-based.
7.2.3.2 What fuels can be taxed with the Direct Emissions Approach?
Box: Examples of fuels subject to a Direct Emissions Approach carbon tax in different
jurisdictions
Chile introduced a green tax reform in 2017, which included a carbon tax, targeting emissions
from facilities with stationary sources comprised of boilers or turbines with a combined thermal
power of 50 MW. It covers around 40 per cent of emissions affecting 94 facilities from a range
of sectors. The carbon tax can be viewed as a Direct Emissions Approach carbon tax
In the San Francisco Bay Area and Singapore, the carbon tax is calculated from measured
emissions from certain large stationary installations. Several different greenhouse gases are
measured and converted into carbon dioxide equivalents.
An example can be found in Chile, which introduced a green tax reform in 2017. The reform
included the introduction of two new green taxes, namely a carbon tax and a local pollution
tax. Both taxes targets emissions from facilities with stationary sources comprised of boilers
or turbines, which individually or together have a thermal power of at least 50 MW. Even with
this fairly high threshold, over 40 per cent of the carbon dioxide emissions are covered by the
tax. While the carbon tax covers emissions of carbon dioxide, the local pollution tax covers
other local pollutants, namely PM (particulate matters, such as e.g. dust or smoke), NOX
(oxides of nitrogen) and SO2 (sulphur dioxide).
Although not as common as taxation of fuels, there are jurisdictions that have chosen to tax
direct emissions of carbon dioxide. The already mentioned Chilean carbon tax affect the same
establishments taxed for local emissions, excepting stationary sources which use renewable,
non-conventional means in which the primary energy source is biomass. In other words, also
by using a Direct Emissions Approach, the Chilean carbon tax only covers fossil carbon
emissions.
Other examples include the San Francisco Bay Area, which is the first local urban carbon tax
in the USA (in force since 2008) and the recently (1 January 2019) introduced carbon tax in
Singapore. Both these jurisdictions calculate the tax on measured emissions arising from
combustion of fuels in certain large stationary installations. By converting emissions from also
other greenhouse into carbon dioxide equivalents (CO2e) also such other greenhouse gases are
included in the taxation scheme.
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The San Francisco Tax is charged on emissions from installations which are subject to local
environmental regulations (permits), while the Singapore carbon tax requires any industrial
facility that emits direct emissions equal to or above 25,000 tCO2e annually to register as a
taxable facility and pay the carbon tax.
A similar approach is to focus on emissions from certain processes, as is done in South Africa,
where a carbon tax will come into force on June 1, 2019. The South-African carbon tax5 will
target CO2e emissions above a certain level from fuel combustion, electricity generation and
industrial processes as well as estimated fugitive emissions. While in principle using a Direct
Emissions Approach, the emissions taxed will be calculated based on emissions factors pre-
determined according to a methodology approved by the relevant authority. The tax law also
lays downs standard values in case such a methodology does not exist for a specific activity.
These installations in many cases are already obliged to measure their emissions and report
them according to the IPCC framework. There may also be national requirements in place,
following environmental regulation schemes. To implement the Direct Emissions Approach a
measurement, reporting and verification system is necessary (so-called MRV). This requires
cooperation between national tax administrating authorities and agencies with environmental
and technical knowledge to be able to control and monitor the measurement of the emissions
to ensure tax control. All parties to the Paris Agreement will be obliged from 2024 to report
their emissions using the guidelines of the Paris Rulebook. Although developing countries with
limited capacity initially may report with flexibilities, parties will over time increase the
accuracy of the inventory of national emissions, thereby also increasing the possibility to
implement a well-designed carbon tax. One of the principal advantages of the Direct Emissions
Approach would therefore, while more difficult to implement, be that it will strengthen the
countries’ MRV capabilities which is required for a range of international commitments and
local policies.
[For feedback by the Committee: as the direct emissions approach is less diffused, should the
Subcommittee keep the current level of detail presented in this chapter throughout the
handbook, or expand discussion further?]
7.2.3 When will the carbon tax be levied and who faces the price of the tax?
7.2.3.1 A carbon tax vs direct taxation
Box: Special characteristics of a carbon tax compared to a direct tax
5
For further information about the South-African carbon tax, see Republic of South Africa Carbon Tax Bill B-
46-2018
http://www.treasury.gov.za/comm_media/press/2018/2018112101%20Carbon%20Tax%20Bill%202018-B46-
2018.pdf.
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Direct taxes are normally paid directly by an individual or business relating to for example real
estate owned, or income gained by the individual or business. An indirect tax is levied on
particular goods or services and normally collected by a producer or retailer, not the final
consumer. The cost of the tax is passed on to the consumer as part of the purchase price of the
good or service. A carbon tax is thus an indirect tax.
Taxes
Direct taxes Indirect Taxes
Income Tax
Corporate Tax
Property Tax
Inheritance Tax
Wealth Tax
Excise Duties, e.g.
alcohol, tobacco, fuels,
emissions
Service Tax
Sales Tax/Value
Added Tax
Figure Direct vs Indirect taxes
Taxes are generally divided into direct taxes and indirect taxes. Direct taxes are imposed upon
a person or property and are normally paid directly by that person or property owner to a local
or national tax authority. Examples are property tax, income tax and tax on assets. An indirect
tax, on the other hand, is levied on particular goods or services and is collected and paid to the
tax authority by an entity in the supply chain (usually a producer or retailer). However, being
an indirect tax means that the producer or seller who pays the levy to the tax authority is passing
the cost of the tax on to the consumer as part of the purchase price of a good or service. There
are basically two kinds of indirect taxes, sales taxes (or value-added taxes) and excise taxes
which are typically imposed in addition to a sales tax or value-added tax.
This means that a carbon tax – whether levied on fuels by weight or volume or on actual
emissions – is an indirect tax and more precisely an excise tax (or in some jurisdictions is
labelled an excise duty). An excise is typically a per unit tax, costing a specific amount for a
volume or unit of the item, whereas a sales tax or value-added tax is an ad valorem tax and
proportional to the price of the goods. Another difference is that an excise tax typically applies
to a narrow range of products (such as alcohol or tobacco products or petroleum products).
Compared with a direct taxation system, there are some aspects that merit special consideration
when assessing how a carbon tax system may be set up in a country with little or no experience
of levying excise taxes. Aspects relating to when in the supply chain a carbon tax can be levied
and who faces the price of the tax are of particular interest and will be further discussed below.
7.2.3.2 Methodologies to calculate the tax
Basing the tax on carbon content
The most generally used choice of tax base is the carbon content of fuels, what we in this
handbook call the Fuel Approach. Such an approach has a high level of accuracy and can be
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used to design an administratively simple tax system, which serves the policy purpose of being
a cost-effective instrument to reduce emissions.
Most jurisdictions having introduced a carbon tax have relied on emission factors expressed in
terms of average carbon content of fuels to calculate the tax. What makes this simple, is that
there is a sufficiently close relation between carbon content and carbon dioxide emissions. This
major simplification does not imply any large errors in providing incentive to switch fuels to
reduce carbon dioxide emissions. Calculations made by Government officials based on the
average carbon content of the fuels can determine the tax rates laid down in the tax legislation.
No measurements of actual emissions are necessary. A jurisdiction introducing a carbon tax
can could thus choose to express their carbon tax rates by volume or weight units (such as litre
of petrol or tonne of coal) based on calculations of the average carbon content of the relevant
fuel. These are standard trade units and such an approach facilitates tax administration. The
method also broadly corresponds to the guidelines countries follow when reporting carbon
dioxide emissions to the UNFCCC (IPPC National Greenhouse Gas Inventories).
Hands-on – how to do calculate the tax
It is often relatively straight forward for a jurisdiction to select the appropriate emission factors
to be used for the tax calculations (see further box xx below
6
). This is the case if the number
of fuel qualities available on the market are limited and it could thus make sense to use an
average emission factor for several different heating gas oil products. In general, jurisdictions
are taxing the fuels only when they are used as motor fuels or for heating purposes, not when
the fuel product is used for non-combustion purposes – such as coal or natural gas being a
necessary component in certain industrial reduction processes or coal used in purification
filters. However, the calculation method as such does not prevent taxing also the fuel products
when used for such purposes.
To facilitate the understanding of implementing a carbon tax, an example is given in the box
below of how to calculate a tax rate per litre of petrol, by way of the prevailing method used
by jurisdictions having introduced a carbon tax.
6
Carbon dioxide (CO
2
) emissions can be expressed in kg/MJ since it is assumed that all the carbon content is
transformed to carbon dioxide after combustion (complete combustion in dry air). The carbon content of the
fuel is known. The emission factor is calculated by dividing the carbon content of the fuel (e.g. per m
3
) with
the percentage of carbon in carbon dioxide. The percentage of carbon in CO
2
is 27 per cent and is calculated
by dividing the molecular weight of carbon with the molecular weight of CO
2
. Since all carbon content in the
fuel is assumed to be converted to CO
2
, the same amount of carbon is present in CO
2
after combustion as in
the fuel before combustion.
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Box: How to calculate the actual carbon tax rate for a fuel with the Fuel Approach
Calculation of tax rates when based on standard carbon content of fuels
The rationale is that the carbon tax is applied to fuels and the tax rate expressed in the tax
legislation is calculated based on the fossil standard carbon content of the fuels but expressed
in volume or weight units (such as litre for petrol).
Carbon content [kg /unit] / 0,27
7
= Emission of CO
2
[kg/unit]
Emission of CO
2
[kg/unit] * general CO
2
tax level [currency/kg fossil CO
2
] = Tax rate
[currency/unit]
The carbon content of respective fuel is divided with the share of carbon in carbon dioxide
(0,27) in order to attain the emission factor of the fuel. The emission factor is then multiplied
with the general tax level, expressed in terms of currency per kilo of fossil carbon. The tax rate
is expressed as currency per unit.
Example, calculation of carbon tax rate on petrol in Sweden 2018
General carbon tax rate: 1.15 SEK per kg fossil carbon (=approx. xxxx US cents)
0.627 kg/litre / 0,27 = 2.323 kg/litre
2.323 kg/litre * 1.15 SEK kg/fossil CO
2
= 2.67 SEK/litre (= approx. xxxx US cents)
The tax rates are in tax law expressed in weight or volume units
There is no need to express the method of calculation in the legal carbon tax provisions.
However, to increase transparency the amount of tax per kg of fossil carbon, which is the basis
of the tax calculation, can be mentioned in the tax law or in other official regulations. For
example, the Swedish legislative tradition is to keep statutes as short and simple as possible
and provide additional explanations in the preparatory works (Government Bills). When the
carbon tax was first introduced in in Sweden in 1991, the relevant Government Bill thus
contained a detailed description of the method and emission values used by the Government
when calculating the actual tax rates for the description included a list of emission values used
for the different fossil fuels.
8
The actual tax rates in the law is expressed in commonly used trade units, which is a transparent
and well-established method in Sweden. This means weight or volume units. Such tax rates are
easy to apply for operators as well as for the tax authorities. The units used in Sweden are litre
7
0.27 is the share of carbon in CO
2
, calculated by dividing the molecular weight of carbon with the molecular
weight of CO
2
.
8
See Governmental Bill 1989/90:111 p. 150 (in Swedish), https://data.riksdagen.se/fil/0F185476-F338-4003-
A794-012E457C3B52.
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for petrol, m
3
(1 000 litres) for gas oil, kerosene and heavy fuel oil, 1 000 kg for LPG (liquefied
petroleum gas), 1 000 m
3
for natural gas and 1 000 kg for coal and coke.
It is possible to differentiate based on fuel quality
If, on the other hand, different coal qualities with significant differences in carbon content are
major energy sources in a country, it could make sense to set different tax rates based on the
carbon content for the various coal qualities. Further, the increased use in some jurisdictions
of motor fuels consisting of mixtures of fossil and biomass components can be a further
challenge to an administratively simple and easily controllable system, if the fossil carbon
content of the fuel is the base of the tax. Whether the biomass components add complexity to
a tax system is, however, dependent on the choice of the taxable event. If a finished product is
not established until it is leaving a fuel depot and is due to be taxed, regular bookkeeping will
enable the tax payer to pay the correct tax. Such a system has been applied in Sweden for many
years. An important political decision is whether the tax base ought to relate to the fossil carbon
content of fuels (which is the way the current IPCC (Intergovernmental Panel on Climate
Change) emission reporting is done today), or to carbon content in general, which also would
include biomass-based fuels, as for instance ethanol and biodiesel.
Measuring actual emissions
An alternative to a tax based on the carbon content of the fuel would be to measure the actual
emissions. This might seem to be a more accurate approach, but the number of emission sources
is often large and measurement systems are not precise, which implies high administration
costs. Also, in the case of taxes based on actual emissions rather than on the carbon content of
fuels, jurisdictions often need to establish new systems for monitoring, reporting and
verification. While such requirements already exist as regards to large industrial and power
installations in the UNFCCC national reporting guidelines, this is not the case for emissions
from either smaller plants or vehicles.
There are examples when a jurisdiction has chosen to let its carbon tax only cover emissions
from certain kinds of stationary installations, where the consumption of fuels take place. This
could be the case of large power plants. Here a tax on actual emissions may be an option. Chile
and Singapore are jurisdictions which have opted for this approach. In many cases such
installations would, due to regulations following the UNFCCC national reporting guidelines or
additional national environmental requirements, are obliged to measure their emissions and
using these values to determine the tax could be appropriate. However, if and when a
jurisdiction decides to enlarge the scope of the tax to also e.g. propellants, the measurement of
actual emissions arising from the combustion at the point of consumption would no longer be
feasible.
E/C.18/2019/CRP.
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Table. Some pros and cons of different methodologies to calculate the tax
Pros Cons
Average emission factors Administratively simple
Scope can include large part of
CO
2
emissions, in stationary
facilities as well as transport
Incentive is clear – Polluter
Pays (as tax is normally
included in fuel price)
No incentive to choose higher
quality fuels within the same
tax group
Other types of CO2e emissions
are outside scope
Does not develop MRV
Measuring actual emissions
Exact (not really) measurement
is probably less exact
Incentive is clear – polluter
pays
Develops MRV
Possibility of developing other
more complex instruments e.g.
Offsets, this may be important
for developing countries
Scope of non-fuel combustion
emissions
Costly to measure
Cannot be applied to small
facilities
Cannot be applied to transport
fuels
Administratively complex
7.2.3.3 Who will pay the carbon tax and when?
(Some illustration/graph including money/revenues might be included)
Box: What determines the choice of who will pay the tax and when?
Who will pay the tax depends on national conditions, such as for example if already existing
taxation of fuel exists, tax control capacity available, the organization of fuel distribution or
the types of fuels targeted by the tax. Degrees of the complexity of tax administration vs the
need to be able to carry out tax controls are key issues to consider.
For a Fuel Tax Approach design, there are examples globally of countries having chosen tax
payers in different stages of the distributional chain.
For countries having chosen a Direct Emissions Approach a close link to existing
environmental performance legislation has often been desirable.
Basics to consider when deciding on the tax payer
Emissions typically involves a range of actors operating at different points in the fuel supply
chain. In addition to determining which sectors or activities will be subject to the tax,
jurisdictions must also determine who will be responsible for paying the carbon tax to the
authorities. The actual payment of the tax – when and by whom – is a matter to be regulated in
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the carbon tax legislation. These issues are of interest to authorities set to administer the carbon
tax and in consequence also legislators considering how to design their tax legislation. This is
essential, contrary to what up until now seems to have been the key focus of literature namely
the issue of economic incentives for people and businesses to promote ecologically sustainable
activities. The latter discussion depends e.g. on the possibilities for the tax payer to transfer the
cost of the tax down the fuel supply chain and is not the key focus of this handbook.
There is no simple answer to which entity is best suited to be held responsible to pay a carbon
tax to the authorities and when that event is to occur. It obviously primarily depends on the tax
design approach chosen, but also to a large extent on already existing administration structures
in the jurisdiction and to what extent the jurisdiction would like to build on such existing
administration. It can also be noticed that many developing countries are adopting digital tax
declarations systems, which can significantly facilitate the tax administration while labour
resources can be concentrated on ex-post tax control in the forms of tax audits and spot-checks.
Jurisdictions choosing to design a carbon tax levied on fuels are likely to explore existing excise
duties on the relevant fuels and who is responsible for the tax payment. Choosing the same tax
payer for the new carbon tax will mean low additional administrative costs for both the tax
payers and the tax authorities.
If a Direct Emissions Approach is chosen for the design of a new carbon tax it would be natural
to choose as the tax payer the entity that generates the emissions. However, such a tax system
would most likely require new administrative practices for the tax authorities, including
necessary cooperation with environmental authorities to be able to carry out tax control. The
pros and cons of different administrative approaches will be further discussed in chapter xxx.
Ensure that there is a price signal
In determining the point of regulation, it is crucial to analyse which actors will bear the burden
of the tax and if they are responsive to the price signal. To ensure efficiency and environmental
effectiveness agents should respond by changing their behaviour. For a fuel distributor the price
signal is passed on to the final consumer, as the tax normally is fully transferred to the retail
price of the fuel. However, this is a consequence of trade agreements between sellers and
buyers of the fuel and nothing that is regulated in a tax act. If no change in behaviour occurs
the carbon tax will only raise revenues and not decrease emissions.
Another important aspect is the challenge associated with administering the tax, including
difficulties in monitoring, reporting and verification, often referred to as MRV. Due to
administrative complexities and the number of taxpayers, it would not make sense to let each
individual consumer, for example private persons consuming petrol in their car, be responsible
for paying the tax to the Government or other official body.
When will the tax be due – point of regulation
A distinction between upstream, midstream or downstream points of regulation is sometimes
used in economic literature to identify the point at which the tax is controlled or collected.
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However, we are refraining from using this terminology as it risks adding to confusion,
especially as these terms may have different meanings when used in different contexts.
A general principle for carbon tax systems levying a certain tax amount on fuels by weight or
volume unit, is that the fuels shall be taxed at the time of when the fuels enters the economy.
This normally coincides with production or importation. A strict application of such a system
is illustrated in figure xx below and it may be a good starting point for a country which already
administers some other kind of excise duty on the taxable fuels or has no prior experience of
administering excise duties.
Administrative simplicity along with good possibilities for tax control are key issues to
consider. Keeping the number of tax payers to a minimum is another aspect to keep
administrative costs low, which often is desirable to the authorities as well as to the tax payers.
One option would be to establish a tax collection point very early in the fuel distribution chain,
that is the point of extraction (such as coal mine, oil drill, natural gas pipeline) or importation.
Choosing a taxation point at importation would also have administrative advantages, as the tax
collection can be combined with the collection of applicable customs duties to be paid upon
importation. Further, a resource-rich country can choose to let the tax, at least from the start,
be levied at the point of extraction, while a resource-poor country may feel it appropriate to
start with only taxing fuels at the point of importation.
However, while choosing a tax point as illustrated in figure xx could offer administrative
advantages in terms of a relatively few tax payers and better opportunities to conduct an
effective tax control, there are also some other aspects to consider. Crude oil and natural gas
largely dominate the imports of fuels to most countries and choosing a taxation point at
importation can make it difficult to differentiate the carbon tax between different qualities of
refined petroleum products (such as petrol, diesel, heavy fuel oil etc.). Although, here
Colombia offers an interesting example.
Example Colombia’s Carbon Tax
9
[May be put in a box]
Colombia introduced a carbon tax in 2017. The tax base consists of different refined petroleum
products, namely natural gas, liquified petroleum gas, petrol, kerosene, diesel and fuel oil and
the importer or producer of such products is the body responsible for paying the carbon tax to
the Government. In certain cases, the tax law gives the final consumer the right to ask for a tax
reimbursement.
Possible to coordinate tax collection with import duties
9
For more information on Colombia’s carbon tax please refer to the carbon tax legislation (Law 1819 of 2016
and the Decree 926 of 2017( Congreso de la República, 2016; Ministerio de Hacienda y Crédito Público, 2017)
http://es.presidencia.gov.co/normativa/normativa/DECRETO%20926%20DEL%2001%20DE%20JUNIO%20
DE%202017.pdf and Gutierrez Torres, Daniela (2017): Interaction between the carbon tax and renewable
energy support schemes in Colombia- Complementary or overlapping?, The International Institute for
Industrial Environmental Economics,
http://lup.lub.lu.se/student-papers/record/8927410.
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Coordinating tax collection with other tax objectives, such as import duties, could facilitate tax
administration. For a country choosing to collect a carbon tax upon importation, to coordinate
the collection with the collection of import duties due on the taxable fuels. Although not being
an explicit carbon tax, Zimbabwe applies a Petroleum Importers Levy on petrol and diesel,
which is collected in this way.10 Companies or individuals holding a procurement license to
import petroleum products in bulk into Zimbabwe are liable to pay this levy, which amounts
to USD 0.04 per litre.
Figure Example of a fuel tax design – tax payment early in the distributional chain
Note. Not applicable within the EU, as the major part of taxable events occur within a tax suspension regime system with
authorized traders under Directive 2008/118/EC, see further figure 2.
Let the tax be due later in the distributional chain
Choosing the same tax payer for the new carbon tax as an already existing excise duty on fuels
will mean low additional administrative costs. The carbon tax can be implemented as a new,
separate tax or be incorporated as part of an already existing excise duty levied on fuels. A
separate tax can be administrated in the same way as the already existing excise duty and would
not give rise to much more administration. As we have seen from the previous chapter, a carbon
tax designed by the Fuel Approach means that the tax is levied by weight or volume units, that
is the same as other excise duties are normally levied. Introducing a separate carbon tax will
10
https://www.zimra.co.zw/index.php?option=com_content&view=article&id=1201&Itemid=139.
E/C.18/2019/CRP.
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also make it possible for a Government to more clearly advocate to the public that the tax is a
climate tax.
Even if the general principle still is to levy a tax close to production or importation, many
jurisdictions have deviated from this principle. There may be several reasons for this. One is
the desire to be able to differentiate the tax rates depending on final use of a fuel, such as
between different sectors of the economy
11
. Another, which may be especially interesting in a
country with high tax rates, may be to facilitate trading of the fuels between approved operators
before reaching the final consumer. Negative liquidity effects on business may be avoided by
such a construction, as the tax will not need to be paid before the fuel has been sold to the final
consumer.
Example Norway’s Carbon Tax [May be put in a box]
Norway
12
is an example, where the liability to pay the carbon tax normally arises when the
goods are imported or produced. However, this is not always the case in practice. First,
production of taxable products in Norway must take place in and by an entity which has been
approved by the tax authorities, known as an approved tax warehouse. Liability to pay tax does
not occur until the goods leave the tax warehouse. An importer may choose to register in the
same way. This means that the registered tax payers can store the fuels without having to pay
the tax. The Norwegian tax system includes certain cases of exemptions and reduced rates.
These are either implemented as direct exemptions, which means that the registered importer
or producer sells the product without paying tax or at a lower tax rate. In other cases, a situation
like the abovementioned Colombian case, it is accounted for as an end-user can ask for
reimbursement of the tax.
Example Carbon Taxes within the EU Energy Taxation Framework
The bulk part of all commercially available fuels is subject to excise duty in the EU Member
States. Following the choice of the Member State, the excise duty may include a specific carbon
tax, currently seven Member States have chosen to do this. Such carbon taxes are in principle
chargeable at the time of:
• Production, including, where applicable, their extraction, of taxable goods within the
territory of the EU
• Importation of taxable goods into the territory of the EU.
However, a carbon tax in an EU country does not become chargeable until it is released for
consumption the Member State. This means:
• The departure of taxable goods, including irregular departure, from a tax suspension
arrangement.
11
See example Sweden different carbon tax rates for heating fuels used by industry and households and service
sector companies in chapter xxxx.
12
For more information, see for example https://www.oecd.org/ctp/tax-policy/taxing-energy-use-2018-
norway.pdf.
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• The holding of taxable goods outside a tax suspension arrangement where carbon tax
has not been levied pursuant to the applicable provisions of EU law and national
legislation.
• The production of taxable goods, including irregular production, outside a tax
suspension arrangement.
• The importation of taxable goods, including irregular importation, unless the goods are
placed, immediately upon importation, under a tax suspension arrangement.
This model is very similar to the one used in Norway. However, within the EU each Member
State has discretion as to where in the distribution chain the tax is liable, that is there is
flexibility in determining the extent of the tax suspension regime.
Some EU countries are applying rules which result in a relatively few tax payers, normally to
be found early in the distributional chain and operators further down the distributional chain
will not be involved in the tax collection. Tax rebates are in those cases normally administered
by the end users asking for a tax reimbursement. Another way could be to introduce approval
procedures for businesses, which under tax control may receive the fuels tax exempted.
While some EU countries, for example of Sweden (see below), allow large business consumers
to be tax payers, the EU legislation does not allow private individuals to register as tax payers.
This means, for example, that petrol stations selling motor fuels to households are not tax
payers but buy the fuels already taxed in a previous leg of the distributional chain.
Example Sweden – a system with low administrative costs
Sweden is a country with a population of 10 million people and has about 900 000 registered
business companies, among them about 55 000 industrial companies However only around 300
companies are registered warehouse keepers, who are authorised by the Tax Agency to
produce, receive and hold fuels under tax suspension and may also move such products under
the suspension regime to other warehouse keepers within Sweden or in other EU countries
without tax becoming chargeable. Criteria which determine if a company may be approved a
warehouse keeper status relates to for example its economic situation and being able to put
forward a sound and reliable business idea. The fuels must be stored in a specially approved
tax warehouse and the warehouse keeper must leave security, for example in the form of a bank
guarantee, for each movement of energy products as well as for 10 per cent of the fuels stored
on average for one year.
The fact that registered taxpayers are obliged to supply a guarantee to cover potential losses in
storage or transport provides a secure and tested system for ensuring that tax obligations are
met. Carbon taxes on fuels in other EU countries are also levied in this way.
Sweden is an example of a jurisdiction which extends the possibility to register as tax payers
also to large consumers, notably heavy industrial companies. The Swedish system is illustrated
in figure xx below. The Swedish system allows for these industrial companies to store fuels
under tax suspension and declare the tax once the actual consumption has occurred. If the
E/C.18/2019/CRP.
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consumption involves a tax exempted area of activity this means that the tax payer declares
zero tax, thus avoiding negative liquidity effects for the company which would have arisen if
the company would have had to buy the fuels at a price including the tax and ask for a tax
reimbursement after the consumption has taken place. A non-tax payer would have bought the
fuel at a price including the tax but can, if being eligible for a tax rebate, ask for a
reimbursement of the tax paid.
The Swedish carbon tax is collected in the same way as the energy tax applicable to fuels. This
means that the administrative costs can be kept low, both for the tax authority and for
businesses. The administration costs for the tax Authority amounts to 0,1 per cent of the total
revenues from energy and carbon taxes.
Figure Example Taxation points for the carbon tax in Sweden
Example – British Colombia’s Carbon Tax
British Colombia
13
is an example of a jurisdiction that has moved the event when the tax
becomes liable for payment and consequently also the tax payer down in the distributional
chain, by enlisting the fuel distributors as tax collectors. Any natural gas retail dealer or fuel
vendors must be appointed as tax collectors by the revenue authorities and are then responsible
13
For more information about the carbon tax in British Colombia, please refer to
http://www.bclaws.ca/civix/document/id/lc/statreg/08040_01
.
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for charging the tax to purchasers upon sale. Like the EU rules, the British Colombia scheme
allows for sales between registered dealers or vendors without tax becoming chargeable.
When a carbon tax is based on the Direct Emissions Approach
A carbon tax based on a Direct Emissions Approach requires the measurement or estimation
of actual emissions at the source. Therefore, the tax payers are likely to be those who controls
the production process that generates the emission, this can either the owner/renter of the
installation where the emissions occur or the business carrying out the activity requiring the
process from the installation giving rise to the emissions.
Measuring emissions at source does not necessarily involve actual measurement – although it
is better to do so – emissions can still be estimated, based on fuel inputs and carbon content
emission factors, but it does require the development of a measurement, reporting, and
verification (MRV) systems for emissions at source. This will inevitably require close
cooperation between Tax and Environmental Authorities, which may many times be difficult.
There are pros and cons of such an approach. The most obvious is that the tax on emissions is
explicit, which can facilitate the introduction of a carbon tax in a country where new taxes are
not easy to implement. On the other hand, it can lead to increased institutional complexity and
conflict in the shared responsibility for tax administration and tax control between Tax and
Environmental Authorities. Other advantages include that the MRV system developed will be
useful for a number of purposes over and above those necessary for green taxes, such as
developing inventories, enhancing domestic and international comparability, facilitating
management within companies, and even generating conditions to move towards more
sophisticated policy instruments such as such as compensation mechanisms, offsets, and/or an
emissions trading system.
7.2.3.4 Who faces the price of a carbon tax?
Box: Difference between who pays the tax and who bears the cost of the tax
In a carbon tax legislation rules are laid down as to what legal entity that will be responsible to
pay the tax to the Government (tax payer). A carbon tax is aimed to give consumers an incentive
to change their behaviour and consume less fossil fuels. Whether this effect is achieved depends
on if the tax payer can pass the cost of the carbon tax on to the consumers or not.
There is a difference between who is targeted by the tax and legally responsible for paying it,
and who bears the incidence of the tax. In economics, tax incidence or tax burden is the effect
of a particular tax on the distribution of economic welfare. The introduction of a tax drives a
wedge between the price consumers pay and the price producers receive for a product, which
typically imposes an economic burden on both producers and consumers. Tax incidence is said
to "fall" upon the group that ultimately bears the burden of the tax. The key concept is that the
tax incidence or tax burden does not depend on where the revenue is collected, but on the price
elasticity of demand and price elasticity of supply.
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Figure Direct vs indirect tax – who pays the tax and who faces the tax burden
In the case of a carbon tax, the tax incidence depends on whether the entities obligated to pay
the carbon tax can pass it on to consumers or not. If the entities can raise the product price to
compensate for the full amount of the tax, the whole tax incidence can be considered to fall on
the consumers. In this discussion, it is important to emphasize that changed consumer
behaviour is needed for the tax to fulfil the purpose of reducing emissions. If the product price
is not raised the producer will bear the full incidence of the tax, the consumption will remain
unaffected and the emissions of carbon dioxide will not be reduced.
There are several important issues to consider in this discussion. For instance, if a price
regulation exists, the entities might not have the possibility to increase the price to pass on the
burden of the tax. In this case the tax burden falls on the entities, reducing their profits. A
carbon tax under these circumstances will not reduce emissions in the short term, but solely
work as a fiscal tax. However, most entities act in markets where they will have possibilities
to pass on at least part of the increased cost of the tax to consumers. That means, in most
scenarios the incidence of the carbon tax will be split between the entities and the consumers.
There are, however, circumstances where companies are less able to transfer increasing costs
to consumers, for instance when facing an international competition. In these cases, it might be
plausible to discuss the need for exemptions and/or lower tax rates for certain sectors of the
economy. These issues will be further discussed in chapter X.X.
7.2.4 Tax coverage, possible exemptions and thresholds
One way of deciding the carbon tax coverage is to base it on targeted sectors, subsectors or
certain economic activities. In jurisdictions without any carbon pricing system already in place,
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a broader carbon tax will typically provide more opportunities and thus a more efficient
emission reduction. Circumstances will differ between jurisdictions and the most suitable
coverage of the carbon tax will depend on a range of factors, including e.g. the emissions profile
of the jurisdiction; other relevant tax policies; the structure of key sectors; and government
capacities for administering the tax. To attain emission reductions, it is important to analyse
what reductions are possible to achieve in the targeted sectors, and to what costs.
14
[This section
will be expanded in a later version of the draft]
7.2.4.1 Theory and practice
Although economic theory suggests a uniform carbon tax with wider base in terms of its
coverage would be the most efficient design, concerns commonly raised among stakeholders
that additional tax burden would lead to adverse effects on the competitiveness of domestic
industries – especially energy-intensive and trade-exposed firms – cause carbon taxes
introduced in practice to deviate from the theoretically ideal carbon tax. Several jurisdictions
have strived for a balance between fulfilling environmental objectives and accounting for the
risks of carbon leakage and securing the competitiveness of certain sectors being subject to
international competition. Despite the risk of undesired effects from carbon taxes on firm
competitiveness and carbon leakage in many cases are limited, such risks can constitute
significant political obstacles for the implementation of a carbon tax and need therefore to be
considered in the process of designing the tax. The impact of a carbon tax in different income
groups and geographical regions are other factors determining the acceptability of the tax.
The table below illustrates how carbon taxes in selected jurisdictions are designed with regards
to coverage and exemptions.
14
The influence of differences in marginal abatement cost curves is further discussed in relation to the use of
different tax rates in section 7.d.
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Table Carbon pricing mechanisms in selected countries
Country Year Description
GHGs
covered
Sectorial/fuel
coverage
Competitiveness considerations
or exemptions
Argentina 2019
The Argentina
carbon tax was
adopted 2017
as part of a
comprehensive
tax reform
proposal, and
entered into
force on
January 1,
2019. The tax
partially
replaces a fuel
tax that was
present before.
20 %
The Argentina
carbon tax
applies to CO2
emissions
from all
sectors and
covers almost
all liquid fuels
and coal.
The use of fossil fuels in certain
sectors and/or for certain purposes
is (partially) exempt from the
carbon tax, including international
aviation and international
shipping, export of the fuels
covered, the share of biofuels in
mineral oil and raw materials in
(petro)chemical processes. To
offset the fuel price increase by
the carbon tax, the tax on liquid
fossil fuels are adjusted at the
introduction. For mineral coal,
petroleum, and fuel oil, the tax
rate will start in 2019 at 10
percent of the full tax rate,
increasing annually by 10 per cent
to reach 100 per cent in 2028.
Colombia 2017
The Colombia
carbon tax was
adopted as part
of a structural
tax reform.
The Colombia
carbon tax was
launched in
2017.
24 %
The Colombia
carbon tax
applies to
GHG
emissions
from all
sectors with
some minor
exemptions,
and covers all
liquid and
gaseous fossil
fuels used for
combustion.
Tax exemptions apply to natural
gas consumers that are not in the
petrochemical and refinery
sectors, and fossil fuel consumers
that are certified to be carbon
neutral. Income tax does not need
to be paid over costs incurred as a
result of the carbon tax.
Mexico 2014
The Mexican
carbon tax is
an excise tax
under the
special tax on
production and
services. It is
not a tax on the
full carbon
content of
fuels, but on
the additional
CO2 emission
content
46 %
The Mexican
carbon tax
applies to CO
2
emissions
from all
sectors. The
tax covers all
fossil fuels
except natural
gas.
The tax is capped at 3 per cent of
the fuel sales price. Since 2017,
companies liable to pay the
carbon tax may choose to pay
with credits from CDM projects
developed in Mexico, equivalent
to the market value of the credits
at the time of paying the tax.
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compared to
natural gas
South
Africa
2019
The South
Africa carbon
tax is
scheduled to
come into
effect by June
1, 2019.
80 %
The South
Africa carbon
tax applies to
GHG
emissions
from the
industry,
power,
buildings and
transport
sectors
irrespective of
the fossil fuel
used, with
partial
exemptions for
all these
sectors.
For many sectors tax exemptions
starting from 60 per cent up to 95
per cent will apply. The level of
tax exemption depends on the
presence of fugitive emissions,
level of trade exposure, emission
performance, offset use and
participation in the carbon budget
program. Also, residential
transport is exempt from the
carbon tax. Companies may be
eligible for either a 5 or 10 per
cent offset allowance to reduce
their carbon tax liability.
Further examples…
Source: The World Bank Carbon Pricing Dashboard
7.2.4.2 Policy options to address concerns over competitiveness, carbon leakage and
distributional effects
There are several policy options that seek to address concerns related to the potentially adverse
effects of a carbon tax, see table below. The most popular set of policies focus on different
types of carbon tax payment reductions lowering the effective carbon tax via exemptions,
thresholds and reduced rates. Another set of policies in use include different support measures
to affected firms or sectors: output-based rebates or targeted support for resource efficiency
and cleaner production. Also, non-carbon tax reductions can be included in this group of
measures. A third category of policies consists of trade-related measures, such as border trade
adjustments, consumption-based taxation and international cooperation. International
experiences from this latter category is however limited, and it is in this discussion vital to
review the relationship between potential border tax adjustment measures and WTO
requirements.
Whereas the first two categories consist of measures that address both leakage and
distributional risks, measures in the third category focus primarily on leakage risks only.
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Table Overview of Measures to Address Leakage and Distributional Effects
Category
Measure
Strengths
Drawbacks
Examples
Reducing carbon tax payments
Exemptions Relatively straight
forward to implement
Can be directly
targeted at affected
industries
Unlikely to present
international legal
challenges
Can be made
contingent upon
emission reduction
agreements
Negative price signal of
tax
Difficult to determine
appropriate level and
extent ex ante
Risk of domestic legal
challenge from non-
exempted industry
Loss of tax revenue
Contrary to polluter pays
principle
British Columbia,
Japan, South
Africa,
Switzerland
Reduced
rates
Sweden, France
Rebates on
carbon tax
payments
Denmark, Ireland,
Finland
Offsets
Incentive for emission
reductions in
uncovered sectors
Incentivize private
investment in
emission reductions
Administratively complex
Reduced tax revenues
Environmental integrity
challenges
Mexico, South
Africa
Support measures
Output-
based
rebates
Retain price signal
Strong leakage
protection
High and uncertain costs
to public budget
Significant data
requirements
Reduce incentive to
shift to other products
Sweden (NO
x
tax)
Support
programs
Retain price signal and
offer additional
emission reduction
incentive
Popular with industry
groups
Flexible in design, as
can take the form of
grants of tax credits,
loans, guarantees etc.
Costly to public budget
(though often less than
exemptions)
May present challenges as
far as complying with
state aid rules is
concerned
South Africa,
Australia, Ireland,
Switzerland,
Japan
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(Non-
carbon) tax
reductions
Retain price signal
Potential for net
positive effect on
business and economy
Cost to public budget
Difficult to target directly
at affected entities
British Columbia,
France
Flat
payments
Retain price signal
Simple for citizens to
claim
Popular with general
public
Potential for net
positive social and
economic benefits
Cost to public budget
Trade related measures
Border
carbon tax
adjustments
Maintain price signal
for domestic industry
Prevent free-riding by
companies from non-
taxing jurisdictions
Do not put pressure on
public budgets
Politically unpopular
internationally and risk
damaging international
relations
Administratively
challenging
Potential negative
economic impacts on
importers
May be challenged as
trade barrier under WTO
or other trade law, though
well-designed measures
can likely be defended
California ETS
Consumpti
on-based
taxation
Effectively address
competitiveness and
leakage risks
Extend pricing to
extraterritorial
emissions
Lower legal/political
risks than border trade
adjustment
Limited experience to
date with application to
climate (although
standard for taxation of
other “bads” like tobacco
and alcohol)
Administratively complex
for design options with
best environmental
effectiveness
None
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Internation
al
cooperation
Retains domestic price
signal
Leverages domestic
carbon price to
encourage carbon
pricing in partner
jurisdictions
No domestic
administration needs
Difficult to negotiate
across many countries, so
may be unworkable for
sectors with large
numbers of international
competitors
None
Adapted from Miria A. Pigato, Editor. 2019. Fiscal Policies for Development and Climate Action.
International Development in Focus. Washington, DC: World Bank and Partnership for Market
Readiness (PMR) 2017. Carbon Tax Guide: A Handbook for Policy Makers. World Bank, Washington,
DC.
Exemptions and other measures to reduce carbon tax rates
Most jurisdictions have, for political reasons, either fully exempted or implemented a lower
carbon tax rate in the case of some fuels and/or sectors. To ease the implementation of the tax
some exemptions can be temporary or step-wise phased out, in some cases –depending on
national circumstances– they can be part of a long-term policy design.
While concerns for reduced competitiveness and carbon leakage may justify that certain
industries face different tax rates, exemptions also have unwanted side effects. The economic
purpose of carbon taxes is based on the consideration that emitters of carbon dioxide impose
costs on others, without paying for the resulting damage that occurs. Carbon taxes aim to
equalize private costs with social. Exemptions undermine this aim, thereby limiting the
efficiency and effectiveness of the tax. The first attempt of a carbon tax in France was rejected
by the National Constitutional Council in 2009, since it deemed that multiple tax exemptions
and thus differences of treatment was not consistent with the legislator’s purpose.
Furthermore, countries without experience in carbon pricing may want to strive to grant the
least exemptions/price differentiations possible in order to avoid administrative complexity and
thereby reduce implementation costs. Key to the administration of a simple system, is to consult
widely with the different actors within society (business, industry, consumers, economists,
regulators from different fields) and get their input prior to introducing the tax, to avoid a web
of exemptions.
It is thus crucial for policymakers to consider alternatives to exemptions and to balance the
negative effects with the need to protect certain sectors of great importance to the economy. If
exemptions are part of the tax design, policymakers may want to attempt to minimize their
environmental and economic costs. This can be achieved by making targeted exemptions and,
if possible, timebound with regular reviews.
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Box: What sectors to exempt – some examples
To be able to properly address any potential adverse effects of a carbon tax, it is important to
thoroughly analyse how and to what extent such effects are likely to occur. Each jurisdiction
faces different circumstances that need to be considered.
A common distinction is to exempt installations in sectors included in an emission trading
scheme, as consumption of fuels in such installations are already covered by another economic
instrument aimed to incentivize less emissions of carbon dioxide. This line of action has been
chosen by for example Denmark, France, Ireland and Portugal regarding emissions covered by
the EU ETS.
In other jurisdictions fuels or sectors considered to be of certain importance to the economy
has been exempted from the carbon tax. One example is Switzerland, where only fuels used
for heating purposes (not propellants) are taxed. The UK Climate Change Levy (CCL), which
can be considered as a climate tax although it is calculated on the energy content of fuels rather
than the content of carbon, has chosen a somewhat different approach by only levying the CCL
on business consumption, thus exempting households from the levy altogether.
Another example of a jurisdiction complementing the tax by a measure to reduce undesired
distributional consequences is the British Columbia Climate Action Tax Credit, which helps
offset the impact of the carbon taxes paid by individuals or families.
/More examples?/
7.2.4.3 Other measures to protect competitiveness and address distributional risks
In addition to exemptions and rebates, various types of support measures can be used to reduce
the overall financial burden of entities subject to the carbon tax. Such measures can be targeted
to specific industries or have a broader coverage. For example, it might be possible to use
reduce other taxes, lower employer contributions to labour costs, or implement other
government programs in order to maintain the competitiveness of an important sector of the
economy. The durability of measures can also differ, depending on their purpose. There may,
for instance, be a need to combine short-term relief for industries and long-term incentives for
them to adapt by adopting cleaner and more efficient technologies. Other policies to address
concerns about adverse impacts may include various trade related measures such as border tax
adjustments and consumption-based taxation.
Introducing a carbon tax as a part of a wider tax reform can also provide an opportunity to
implement measures to be taken to address distributional (income and/or geographical)
concerns related to the impact of the carbon tax.
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Box: Country examples of carbon taxes being introduced and developed as part of a
larger tax reform
Examples to be added: E.g. Sweden and examples from Latin America (Argentina, Chile,
Columbia, Mexico), others?
7.2.4.4 Introducing a carbon tax: Two-level tax systems and setting of thresholds
To date, a carbon tax has been implemented in close to 30 national or subnational jurisdictions
with different tax approaches to protect competitiveness and address distributional risks. A
two-level tax system, and/or the adoption of thresholds are two examples of exemptions that
can be found in many jurisdictions.
In a two-level carbon tax system different carbon tax rates apply to different parts of the
economy, and such a system is easier to administer than lowering the tax rates for individual
sectors in the economy. A two-level tax system can be a feasible design leading to over-all
better environmental results, as the politically acceptable alternative could be a general carbon
tax for all operators set at low level to protect the domestic industry, which is subject to
international competition.
Box: Country examples of a two-level carbon tax
When designing the Swedish carbon taxation system, two carbon tax levels were introduced.
This was to avoid negative effects to the domestic industry and carbon leakage. The lower
carbon tax level was applied to fuels used for heating purposes by the industry. The lower tax
level has, since the introduction of the tax in 1991, been phased out in Sweden and was fully
abolished in 2018. Such a lower tax level has been the prerequisite for a high tax level for
other sectors and one important cause of the emission reductions achieved in the high taxed
sectors.
15
15
Hammar & Åkerfeldt, CO
2
Taxation in Sweden – 20 Years of Experience and Looking Ahead, 2011,
https://www.globalutmaning.se/wp-content/uploads/sites/8/2011/10/Swedish_Carbon_Tax_Akerfedlt-
Hammar.pdf.
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Figure Development of the Swedish Carbon Tax. General level and industry level. Industry level outside the EU
Emissions Trading Scheme (EU ETS) since 2008. (Source: Government Offices of Sweden)
A two-level system can, as has been seen in Sweden, contribute to substantial emission
reductions in the high taxing sectors. Also, Denmark has a differentiated carbon tax system,
where business pays a lower carbon tax rate than households. The British Columbia
Government provides carbon tax relief to commercial vegetable, floriculture, wholesale
nursery and forest seedling greenhouses. The Greenhouse Carbon Tax Relief Grant (GCTRG)
covers 80 per cent of the carbon tax paid on natural gas and propane used for greenhouse
heating and carbon dioxide production to be used for crop fertilization. The UK as well as
several jurisdictions applying a specific carbon tax, such as Denmark, also give businesses tax
reliefs on the condition that they enter into voluntary agreements leading to the achievements
of environmental protection objectives
A threshold is a minimum level of activity that will trigger responsibility for paying the tax,
that is, a minimum level of emissions per entity for the taxation to apply. The purpose of a
threshold is often to reduce the costs of reporting and administration.
Box: Country examples of thresholds
An example of thresholds is the later abolished Australian Carbon Pricing Scheme, where
emissions were taxed at the point where they were released into the atmosphere. The threshold
was decided to 25,000 tCO
2
e in order not to burden smaller facilities with reporting obligations.
Another example is Chile, where the carbon tax is only applied on fuels used in industrial and
power generation plants of a certain capacity (above 50 MW). Such a technical condition is
easily observable, whereas an emissions threshold require that a level of reporting is already in
place.
/More examples/
To examine the potential need of a threshold several characteristics can be analysed. One of
them is the proportion of emissions derived from small emitters. If there are many small sources
of emissions in sectors covered by the carbon tax, a relatively low threshold may be needed to
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ensure that a significant proportion of emissions is covered by the tax. The cost of reporting in
relation to the tax amount, the capabilities among firms to administer a carbon tax, and the risk
for intersectoral leakage are other important aspects to consider. A threshold could also provide
small firms with incentives not to grow to avoid the tax.
In the case of carbon taxes thresholds applied directly to emissions are common and where a
carbon tax is applied at a point where the number of actors is relatively high and their size and
capabilities vary significantly. By contrast, jurisdictions that apply their tax to fuels at the level
of distribution (downstream) typically do not apply thresholds. Applying a tax to fuels normally
does not require direct measurement of emissions and is often built upon existing excise taxes,
thereby making thresholds less necessary. Applying thresholds in these cases could also create
market distortions by encouraging consumers to purchase from smaller wholesalers.
7.2.5 How to treat carbon content in fuels of biomass origin?
Box: Fuels of biomass origin
This handbook does not aim to offer a recommendation as to whether a jurisdiction ought to
include some or all fuels of biomass origin in their carbon tax base.
The focus in most jurisdictions having introduced carbon taxation has been to focus on fossil
fuels. Therefore, fuels of biomass origin would not be covered by the tax. However, low blends
of ethanol and biodiesel into petrol and diesel are often subject to the same carbon tax rate as
their fossil equivalents, due to administrative reasons and in some case legal constraints when
combining a tax exemption with another policy measure. Some jurisdictions although take
account of the biomass part when calculating the tax rate for the petrol and diesel mixture.
Maybe include illustration of liquid biofuels
An important political decision is whether the tax base ought to relate to the fossil carbon
content of fuels, or to carbon content in general, which also would include biomass-based fuels,
as for instance ethanol and biodiesel. Without making any formal recommendation the
Subcommittee would like to highlight the implications of including biofuels in the tax base.
Such a framework could give the carbon tax more of fiscal character as it prevents tax payers
from switching fuel to lower their costs for taxation.
Some jurisdictions consider a switch to biofuels as part of the solution towards a low-carbon
economy, while other jurisdictions are more inclined to see problem with an increased use of
biomass fuels. It is outside the scope of this handbook, but it can be mentioned that concern
about not subjecting biomass fuels to a carbon tax has been raised in the public debate. Motives
for such an approach can, for instance, be found in the reports from the OECD concluding that
policy support for biofuels contributes little to reduced greenhouse-gas emissions and other
policy objectives, while it can be seen as one of several factors contributing to raise
international prices for food.
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7.2.5.1 IPCC Climate Change Emission Reporting
The current IPCC Intergovernmental Panel on Climate Change emission reporting
16
is done
based on emissions from combustion of fossil fuels and the IPCC has stated that 75 per cent of
the changes in the temperature in the atmosphere during the past 25 years relates to the
combustion of fossil fuels. The remaining 25 per cent is due to changes in land use, primarily
deforestation. Using biomass energy is not contributing to an increased atmospheric
temperature, when biomass is continuously being rebuilt to an extent that in the long run
corresponds to the emissions occurring at the combustion of biomass. By calculating a carbon
tax on the content of fossil carbon in the fuels, the Polluter Pays Principle (PPP) is fully
integrated in the design of the tax. It would not make sense to levy it generally on the carbon
content of fuels, as this would not be an instrument targeted to reduce fossil carbon dioxide
emissions. As only fossil fuels result in net increases of carbon to the atmosphere, such a tax
helps to reduce the use of fossil fuels and thus reach set global climate targets.
Sweden is among those countries where the principle of not subjecting biofuels to a carbon tax
has been prevailing since the introduction of such a tax back in 1991. A restriction to applying
this principle only to biofuels fulfilling certain established sustainability criteria has since been
introduced, following mandatory EU legislation. The reasoning behind the Swedish approach
is – in line with the theory just outlined – that combustion of sustainable biofuels does not
result in a net increase of carbon in the atmosphere and hence are not subject to carbon taxation.
However, applying a carbon tax only on fossil emissions is not a Swedish invention. The EU
has set climate targets and work is globally carried out based on the 2015 Paris Climate
Agreement. Only consumption of fossil fuels increases the net emissions of carbon and
therefore, there is a need to strive towards reducing the global use of fossil fuels.
7.2.5.2 Low blends of ethanol and biodiesel into petrol and diesel
While the general principle of only taxing emissions from fossil fuels seems to be prevailing
in jurisdictions having introduced a carbon tax, some simplifications have been made for
administrative reasons. This means that low blends of ethanol into petrol and FAME (biodiesel)
into fossil diesel in many countries are taxed by the same rate per litre fuel, as if the fuel mixture
would have been of 100 per cent fossil origin. This is particularly true if countries have
introduced another economic instrument, such as a quota obligation scheme, to ensure certain
amounts of biofuels on the market. Almost all EU countries have now introduced national quota
systems for biofuel blending into petrol and diesel and this has normally meant that the excise
duties on petrol and diesel are the same, regardless of the content of biomass fuels in the
propellant. EU state aid provisions put legal constraints on EU Member States’ possibilities to
combine a quota obligation scheme with tax exemptions.
16
For further information see IPCC Guidelines for National Greenhouse Gas Inventories,
https://www.ipcc.ch/report/2019-refinement-to-the-2006-ipcc-guidelines-for-national-greenhouse-gas-
inventories/.
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Depending on where in the distribution chain a carbon tax is to be levied jurisdictions may also
encounter administrative problems if aiming to enable a tax exemption for example for low
blended ethanol. However, this is a tax design problem and there are solutions to be found,
such as extensive bookkeeping and verifications or legal definitions of the level of a low blend
to be eligible for a tax refund.
7.2.5.3 Take account of the biomass part of petrol and diesel when calculating the carbon
tax rate
In some countries, such as Sweden and France, the carbon tax per litre of such propellants have,
however, been calculated to take account of the blend of biomass fuels following a quota
obligation
17
. However, the use of pure or high blended liquid fuels of biomass origin, which
as of yet amounts to low volumes in most countries, are often exempted from applicable carbon
taxes. Another example is British Colombia, where the carbon tax since apples to ethanol at
the same rate as petrol and to biodiesel and renewable diesel at the same rate as diesel or light
fuel oil. However, wood and other solid biofuels are not subject to carbon tax neither in any
EU country nor in British Colombia.
7.2.5.4 Finland – an example of a jurisdiction with an innovative view of future carbon
taxation
Finland was the first country in the world to introduce a carbon tax in the early 1990’s and like
the other Nordic countries, the carbon tax is in Finland a key component in the country’s
pathway to a low-carbon and eventually carbon neutral society. An increased use of sustainable
biofuels as part of the national energy and climate strategy comes natural for a country with
major natural forest resources. Starting out with one single carbon tax rate based on the fossil
carbon content of fuels, Finland has during the last decade step-wise differentiated its carbon
tax according to the performance of biofuels, giving a full carbon tax exemption for the
environmentally best biofuels – sometimes referred to as second generation or advanced
biofuels – and applying different levels of carbon taxation for other biofuels based on
parameters laid down in EU legislation
18
.
The key parameter in the Finnish system is still emissions of fossil carbon dioxide. However,
when classifying biofuels in three levels of the carbon tax, the legislator has based these levels
on life cycle values
19
providing how much life cycle carbon dioxide emissions reduction is
17
For Sweden, see for example PPP presentation from September 2017 available at
www.government.se/carbontax
.
18
Directive 2009/28/EC of the European Parliament and of the Council of 23 April 2009 on the promotion of
the use of energy from renewable sources and amending and subsequently repealing Directives 2001/77/EC
and 2003/30/EC, https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:32009L0028.
19
A life-cycle analysis (LCA) of the production of fuels is a technique to assess environmental impacts
associated with all the stages of a product's life from raw material extraction through materials processing,
manufacture, distribution, use, repair and maintenance, and disposal or recycling. There have been studies
made in recent years comparing energy and carbon balances for production and use of different fuels. From
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achieved relative to equivalent fossil fuels. Biofuels that fail to meet set sustainability criteria
are subject to the same carbon tax as the equivalent fossil fuel, as there is deemed to be no
savings in fossil carbon dioxide emissions. Biofuels that meet set sustainability criteria (e.g.
agriculture origin/first generation biofuels are subject to a carbon tax rate corresponding to 50
per cent of the carbon tax applicable to the equivalent fossil fuel. Finally, no carbon tax is
levied in Finland on second generation biofuels made of waste, residues, lignocellulose, etc.,
as these fuels in average are calculated to have carbon dioxide emissions savings of over 50
per cent. The current Finnish carbon tax design may not be the first choice for a country starting
out designing a new national carbon tax system, due to the complexity of an LCA approach
when setting tax rates for different fuels, but it shows the possibilities of adapting a Fuel
Approach tax system along the way.
7.2.6 Checklist for defining a tax base
In the previous sections, several important choices when designing a carbon tax have been
highlighted. These are summarized below.
1. Subject of the tax – the decision of whether to measure and tax direct emissions or use
the more common method of taxing fuels.
2. Point of regulation – at which point in the supply chain are the actors responsible for
paying the tax.
3. Legal entity – connected to the point of regulation is the matter of which legal entity
who will be responsible for paying the tax.
4. Sectors and activities – the discussion of which sectors and activities in the economy
that are subject for the tax and what the consequences will be.
5. Exemptions and thresholds – the point of creating a general tax design without
negative side effects, for instance in form of carbon leakage.
6. Treatment of biomass – the issue of how to treat emissions from biofuels.
After deciding on the approach in the issued singled out above a potential tax base can be
defined. It is strongly recommended to thoroughly analyse the size and characteristics of the
tax base prior to the tax implementation, in order to achieve the desired effects.
an environmental point of view this approach may seem desirable, especially as it could give incentives to
reduce emissions from production of the fuel.
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7.3 Tax Rates [Draft as of 1 April 2019]
7.3.1 Introduction
Implementing a carbon tax is a learning by doing process because the impacts of the tax are
difficult to predict in advance. Hence, it is better to start a carbon tax at any level before waiting
any longer, because it is not necessary to find an accurate tax rate right from the beginning.
However, if the desired goal will not be reached after a certain period it is crucial to adjust the
tax rate. Therefore, the tax rate needs an adjustment, if a specific reduction goal was not
achieved during the past period. This trial-and-error approach could help to increase the
accuracy of the tax rate. There are also economic theories and approaches that could be used
in determining the tax rate.
Setting the rate of a carbon tax is an essential decision when designing this tax. The level of
the tax rate has direct implications for both its effectiveness the economy as it influences market
prices. As a consequence, setting the tax rate merits careful consideration and this chapter will
point out key aspects to consider when making this decision.
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Figure XX: Prices in implemented carbon pricing initiative
Source: World Bank, Ecofys (2018). State and Trends of Carbon Pricing 2018. © World Bank.
https://openknowledge.worldbank.org/handle/10986/29687 License: CC BY 3.0 IGO.
The figure above shows carbon tax rates in force in 2018. Thus, examples of various policy
strategies followed by different jurisdictions can be seen from the figure. The variety of tax
rates in force ranges from less than one US $ / tCO2e to over one hundred dollars. It is worth
remembering that the higher tax rates currently applicable in some jurisdictions were not set at
once, but rather achieved in a step-wise manner over longer periods of time. Despite that, most
initiatives levy relatively low carbon tax rates below US $ 30.
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However, in order to reach the temperature target agreed upon by the Paris Agreement, the
High-Level Commission on Carbon Prices proposed a carbon price of at least US $ 40 – 80 /
tCO2 by 2020 and US $ 50 – 100 / tCO2 by 2030. A brief comparison with the current state of
the art of carbon taxation will show that these are quite high prices to achieve in a relative short
time period, which is why it is important to start right away. However, even low initial tax rates
can serve as a starting signal, since the tax rate can be adjusted to a level, which is in line with
environmental targets after its implementation. Therefore, getting the system started with a low
initial carbon tax rate could create the basis for a – from an environmental perspective –
successful carbon tax.
We will in the following chapter look at the different techniques and practical discussions in
literature to define a tax rate in numerical terms. In order to provide guidance, the following
chapter deals with technical criteria regarding the determination of the tax rate. In addition,
both, the abatement costs and the cost curve are relevant factors to consider in this respect.
Moreover, it will also deal with technical questions regarding the development of the tax rate
over time and with various political issues, such as increasing or reducing the rate.
Subsequently, the chapter also discusses certain country specific characteristics of carbon
taxes.
7.3.2 Setting the Rates
7.3.2.1 Pigouvian Approach – internalising external costs
Emitters of CO2 emissions are responsible for the climate change. However, the emitters are
not usually held accountable for the costs which are caused by climate change. Therefore, there
are hardly any monetary incentives to reduce emissions. One approach to solving this problem
is to implement a carbon tax which follows the Polluter Pays Principle. The tax must
correspond to the amount of the costs incurred by the actions of the polluter. Thereby, the
carbon tax imposes a charge on CO2 emissions equivalent to the potential cost of climate
change in future. Thus, the polluter finally bears the costs of climate change. As a consequence
of the tax, financial incentives are created, to minimize CO2 emissions. The Pigouvian
approach can help to determine the tax rate of a carbon tax in order to follow the Polluters Pays
Principle.
Although the Pigouvian approach only works in theory and has not been used for setting the
tax rates in any jurisdiction, it represents an interesting theory. This theory involves reducing
CO2 emissions through the full internalization of external costs of environmental damages
through taxes. It is based on the consideration that emitters of CO2 emissions impose costs and
disservices on others, without paying for the resulting damage that occurs. External costs occur
as a result of the actions of economic actors, which affect other parties (e.g. society). If there
is no price signal on pollution the polluter does not pay for the damage. Thus, market failure
may occur, as the private and social cost and interests do not coincide. It is possible to
internalize external costs by setting a tax rate which exactly represents the external costs of an
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action. Thereby, the tax equalizes the costs of an economic actor (private costs) to the costs of
society (social costs). As a result, the polluters finally bear all costs occurring as a result of
economic actions.
According to economic theory, the tax rate of a Pigouvian Tax should be set equal to the
marginal social cost of the pollution. This marginal social cost of pollution represents the
damage that occurs by producing an extra unit of a specific good (e.g. one-ton CO2). In
consequence, the price for the activity causing the pollution which is responsible for the
external effects will rise. This results in a situation where the demand for the underlying activity
decreases as a result of higher prices.
Box XX: Technical Note: Pigouvian Approach
Source: Kettner-Marx/Kletzan-Slamanig 2018
The graph illustrates the working of a Pigouvian Tax. The horizontal axes represent the amount
of output produced by the polluting factor. The vertical axis represents the market price. The
marginal benefit curve (MB) measures the marginal benefit (benefit from the production of
each additional unit) which arises for society for each level of production. The marginal private
cost (MPC) represents the marginal costs (costs of each additional unit) which can be attributed
to the producer. Finally, the marginal social costs (MSC) measures the marginal costs (costs of
each additional unit) for the society. The MSC are composed of the MPC and the costs of the
externality. Point A represents the market equilibrium with the quantity Q1 and the price P1
which arises without any market intervention. However, point A is not optimal for society as
its costs are not considered completely at the level of the producer. As a result, the costs exceed
the social benefit. In order to correct market failure, a tax (t) at the level of the marginal external
cost could be introduced. Thereby, the MPC will be shifted to the MSC at point B, which
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represents the social optimum. At this level, production is reduced to Q2 at the new price P2.
At point B, the MSC equals the value of the MB.
Although the Pigouvian Approach makes sense from an economic perspective, the
implementation of a Pigouvian Tax faces many limitations in reality. Ideally, the tax rate of a
Pigouvian Tax represents exactly the external cost. But the valuation of the externalities is a
difficult task. This is because complex economic models are necessary to determine the social
cost of carbon. One difficulty in calculating the exact social costs of carbon is the necessity to
combine the work of climate scientist and economists. Various assumptions and forecasts must
be made in order to calculate the costs of climate change. This might include damages, which
are directly related to climate change, as well as other costs, such as adaption and mitigation
costs resulting from it. Moreover, assumptions regarding adaption and technological change
and the choice of the discount rate
20
also, have a significant impact on the calculation.
However, even the most complex model is not capable to reflect reality and is subject to
uncertainty. (see Annex 1 for further reading)
Many economists have tried to calculate the costs of climate change. Regarding the social costs
of one-ton CO2, the calculations ranges from 10 $ to several hundred $ per ton CO2. The wide
spectrum shows how difficult it is to define the “exact” tax rate for a carbon tax. This is because
it is unrealistic that even the most complex economic models are capable of calculating the cost
of climate change, as there are many uncertainties. However, in order to follow the Pigouvian
Approach the determination of the “exact” tax rate is necessary. Therefore, the Pigouvian
Approach can only exist in theory. Hence, it is questionable if the Pigouvian Approach is
feasible in practice because it is very technical and will take a great resource effort to calculate.
Although the practical implementation of the Pigouvian Approach seems unrealistic, the theory
can play a crucial role when developing a practical solution, which may help to internalise the
external costs. The core statement of the Pigouvian Approach is that emitters of CO2 should
contribute to the cost of the damage resulting from their action. The internalization of the costs
of climate change is undoubtedly a promising measure for climate change mitigation. However,
a more practical approach, which does not follow the exact mathematical solution, may be
feasible to determine the tax rate of a carbon tax.
Box XX: Carbon Taxes and the Nobel Prize
William Nordhaus was one of the first economists who combined economic and climate related
models. Thereby, he created an Integrated Assessment Model, which describes the interplay
between the economy and climate. Nordhaus supports the idea of implementing carbon taxes.
His research has shown that carbon pricing via ETS or carbon taxes is an efficient way of
lowering CO
2
emissions. In 2018, Nordhaus received the Nobel Prize in Economics. The Nobel
committee recognized with the award the economics of climate change, which underlines the
relevance of a carbon tax.
20
The discount rate refers to the rate that future costs and benefits are discounted relative to current costs.
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Nordhaus’ model is often used to simulate how the economy responds to climate change.
Moreover, his Integrated Assessment Model can also be used to calculate the cost of climate
change. This data can help to define the tax rate of a carbon tax. In addition, the model provides
a methodological framework to examine the consequences of various climate change policies,
like carbon taxes. The practical relevance of the model was demonstrated through the
application by the IPCC, who referred to the work of Nordhaus when calculating the costs of
climate change. (IPCC 2018).
7.3.2.2 Standards and Price Approach – to reach a specific carbon reduction target
Moreover, it is also possible to set the tax rate without an underlying economic theory. A more
practical approach would be to set the tax rate corresponding to a specific carbon reduction
target through the Standards and Price Approach (also known in literature as Baumol/Oates
approach). This approach is feasible if the primary purpose of a carbon tax is to meet a specific
emission reduction target. Emission targets could be set in national law or as a political
commitment, see chapter XX on the administration of the tax. Moreover, an emission reduction
target can be based on the nationally determined contributions under the Paris Agreement
within the United Nations Framework Convention on Climate Change. The basic idea is to set
the carbon tax rate at a level that is expected to be necessary, in order to reach a specific
emission reduction target.
The economic idea behind the Standards and Price Approach corresponds to the Pigouvian
Approach. The first step is to define an emission reduction target (Standard). After the target
is set, a tax (Price) will be implemented in order to reach the goal. The tax rate will then be
adjusted according to a trial and error policy in order to reach the set standard. Thereby, the
initial carbon tax rate could be determined by any economic model or on a technology-based
approach (e.g. Marginal Abatement Costs Curves (MACC) – see Annex for further reading).
The main advantage of this method, compared to the Pigouvian Approach, is that it is not
necessary to find the mathematically exact tax rate, as the emission reduction goal is the focus
of this approach.
Box XX: Standards and Price Approach in practice
A Standard and Price Tax on waste helped Denmark to achieve a solid waste reduction of 26
% between 1987 and 1998. The tax was levied per ton of solid waste, which was produced, for
example, from the industry or construction activities. The purpose of the tax was merely to
affect the behaviour. The tax was introduced to support a national plan to increase the recycling
rate to 54 % in 1996. The Danish authorities did not attempt to evaluate the externalities
associated with waste treatment. This means that no economic model served as a basis for the
tax rate. Tax rate adjustments helped to reach the targeted standard. The tax rate gradually
increased from DKr 40 / ton to DKr 375 / ton in 2000. Therefore, the tax can be seen as a tax
that followed the principles of the Standards and Price Approach.
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Source: Andersen, M. & Dengsøe, N. J Mater Cycles Waste Manag (2002) 4: 23.
Thus, implementing a carbon tax is a learning by doing process because the impacts of the tax
are difficult to predict in advance. However, adjustments are crucial, if a specific reduction
goal was not achieved during the past period. Therefore, a trial-and-error approach could help
to increase the ecological effectiveness of the tax. This policy could overcome economic
modelling limitations, by following a trial-and-error policy. Although the Standard Price
Approach helps to overcome economic limitations, the approach seems to be difficult to
implement in practice. As politicians must follow this approach over several periods.
7.2.2.3 Revenue Target Approach
Different policy objectives may encourage jurisdictions to implement carbon taxes. Besides
environmental considerations, the main motive for some jurisdictions to implement carbon
taxes is to generate considerable tax revenues. In 2018, the total value of all carbon taxes and
ETSs which are worldwide in force was US $ 82 billion, which represent a 56 % increase
compared to the 2017 value of US $ 52 billion. In British Columbia, the carbon tax amount to
3 % of the province`s budget. Therefore, carbon taxes could serve as a substantial source of
government revenue, which could be spend in different ways. One example would be to spend
the revenue on social programmes for poor households in order to avoid unwanted effects of
the carbon tax. Moreover, the revenue can help to fund public transport systems, R&D
programmes for low carbon technologies, or for grants to switch to renewable energy systems
(see chapter V).
Box XX: Tax revenue - a driver for the implementation of a carbon tax
One of the main reasons for the implementation of the carbon tax in Chile was to raise tax
revenue to fund education programmes. The Chilean carbon tax was within the framework of
a broader fiscal reform in Chile. The fiscal reform modified the income tax system considerably
and implemented a carbon tax. The fiscal reform was estimated to collect US $ 8.3 billion in
total. The government experts calculated in advance that the carbon tax will generate a tax
revenue of US § 168 million. However, the government did not define a specific revenue target
in advance, which had to be met with the carbon tax.
Moreover, it is possible that jurisdictions set the tax rate in a way that maximises their tax
revenue or that generates a specific level of revenue. Therefore, jurisdictions could try to adjust
the tax rate of a carbon tax in order to reach a targeted tax revenue. For example, a jurisdiction
may decide in advance to reach a specific tax revenue with the carbon tax. This decision has a
strong impact on the tax, because the choice of the tax rate has a direct impact on the tax
revenue. Thereby, the tax rate can be set within the dedicated market forces (supply and
demand). In order to actively shape and influence the tax revenue, the revenue target approach
also requires a lot of economic data to be available in order to reach a specific revenue target
(see Box XX Price Elasticities). This is because the level of tax revenue generated from a
specific tax rate depends on the demand and supply curve of carbon-intense products.
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Box XX: Price Elasticities
In order to follow the revenue target approach, it is crucial for policymakers to know the price
elasticity for products that are subject to the carbon tax. In economics price elasticity measures
the responsiveness of the demand after a change in the price. Studies have shown that the price
elasticity of fuels is relatively inelastic in the short-term. This means that the demand responds
disproportionately low to changes in the price. This is partly due to the fact that emitters can
hardly change their habits in the short term. However, in the long-term, studies have shown
that the elasticity is higher, which means that the demand responds to price changes (Abenezer
Zeleke, A., 2016).
Economists need this data to calculate and estimate a tax rate, which generates a targeted level
of revenue. However, it is unrealistic to predict the tax revenue of a specific tax in advance.
This is one of the biggest downfalls as the revenue target approach is quite complex. Therefore,
it is arguable that the revenue target approach is not appropriate for jurisdictions with a lack of
resources, which are planning to introduce a carbon tax, because of its high degree of
complexity and uncertainty. Besides that, the revenue target approach may be a useful policy
strategy as the increased tax revenue may be used for funding social programmes to reduce
poverty.
Box XX: Revenue target approach
The revenue target approach is based on the microeconomic theory. The graph below illustrates
the supply (S) and demand (D) curves. In the initial scenario, market equilibrium emerges at
the intersection of both curves. At this point, the market produces the quantity Q at a price of
P. However, the market equilibrium changes after the implementation of a tax (t). The supply
curve is shifting because of the increasing cost of production. As a result, a new equilibrium
will be reached at the intersection of S’ and Q’. The tax revenue is calculated by multiplying
the new quantity Q’ by the tax rate t. In practice, setting the carbon tax rate through the revenue
target approach is a tricky task, because the tax revenue depends on many economic factors
(price elasticity, market power, economic situation), which have to be taken into account. (For
more information see Annex.)
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Source: Partnership for Market Readiness. 2017. Carbon Tax Guide
However, once the CO
2
emissions decreases the tax base of a carbon tax may eroding.
Therefore, a targeted tax revenue cannot be maintained over time (see Annex for further
reading). Moreover, the revenue target approach could be seen in a critical light from an
environmental point of view. According to economic theory, the primary aim of carbon taxes
is to internalise external costs and not to raise the tax revenue for the government. Limiting
global warming at 1.5° C would require an emission reduction pathway which reaches zero net
emissions around 2050. Following this pathway would mean that the carbon tax revenue would
be zero in 2050. This example shows that the revenue target approach is – at least in the long
term – in conflict with emission reduction targets. However, in the short- to medium-term
carbon taxes may generate a considerable amount of tax revenue. Therefore, the revenue target
approach could be a useful tool for countries that consider implementing carbon taxes.
7.2.3.4 Benchmarking Approach
Setting a carbon tax rate requires significant economic data. An alternative approach to a highly
time consuming and costly process is to base the tax rate on a benchmark analysis. Overall,
around 30 jurisdictions impose taxes on carbon in 2019. Those jurisdictions could serve as a
model by setting a tax rate for carbon taxes. Thereby, policymakers can rely on the work of the
OECD and The World Bank who publish carbon tax rates and trends of carbon pricing from
several jurisdictions on a regular basis (OECD, 2018; The World Bank, 2018). The table below
illustrates a selection of carbon tax rates, which are currently in force (see a complete list in the
Annex).
Jurisdiction Covered
Nominal tax rate in November 2018
US $ / tCO
2
British Columbia
26.74
Chile
5
Colombia
4.92
Denmark
27.07
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Finland
70.64
France
50.81
Japan
2.56
Mexico
2.73
Norway
59.87
Singapore
3.7
Sweden
126.83
Switzerland
99.71
Ukraine
0.01
Figure XX: Selection of nominal carbon tax rates in November 2018
Source: Data based on Carbon Pricing Dashboard, Data based on The World Bank available at
https://carbonpricingdashboard.worldbank.org/map_data.
According to the table, the carbon rates ranges from US $ 0.01/ t CO
2
e (Ukraine) to around US
$ 127 / tCO
2
e
(Sweden). The wide spectrum of tax rates which are in force is an indicator that
different policy strategies are followed by carbon taxes.
The benchmarking approach relies on an analysis of the tax rates as well as the tax design of
other jurisdictions. It is important to mention that the implemented taxes differ from each other.
For example they are levied on different levels of the production chain, some of them include
exemptions for certain industries, while others have not implemented any exemptions. In
addition to that, some carbon taxes are levied on certain transactions while others are directly
related to emissions (see chapter XX). Moreover, also jurisdictions by itself are hardly
comparable as they have different framework conditions, policymakers should consider which
jurisdictions are in a comparable situation when designing their tax rates. For example, it would
not be appropriate for a country to set the tax rate on the basis of the data of another country
with a completely different background or national prerequisites. Regarding the selection of
comparable jurisdictions, the following factors may be taken into account:
• policy objective
• economic background
• purchasing power
• demographic factors
• political background
• energy production
• geographic distribution
• tax system
The list only shows some examples and ideas, which factors may be relevant in order to identify
jurisdictions that are appropriate for benchmarking. It is also important to consider current
trends and international developments of carbon taxes in a benchmarking analysis. This could
help policymakers to connect international developments with discussions on a national level.
Generally, the number of carbon taxes in force have increased considerably over the last years
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(see Figure XX). Thereby, jurisdictions with completely different background have
implemented carbon taxes. The rising number of carbon taxes in force indicates the crucial role
that carbon taxes have as a climate policy instrument. In the meantime, carbon taxes are
widespread, which facilitates the application of the benchmarking approach considerably.
Policymakers all over the world can rely on more examples of carbon taxes or at least carbon
tax initiatives, which are implemented in comparable jurisdictions.
Figure XX: Number of implemented carbon taxes
Source: State and Trends of Carbon Pricing 2018
https://openknowledge.worldbank.org/bitstream/handle/10986/29687/9781464812927.pdf?sequence=5&isAllo
wed=y
Another interesting aspect is that studies from the OECD have shown that taxes on fossil fuel
products have been rising over the past years. For example, Alberta, British Columbia, Finland,
France, Iceland and Switzerland have increased – some of them significantly –their carbon tax
rates in 2018. This recent development could encourage the implementation of an ambitious
carbon tax rate.
Box: Examples of carbon tax rate changes 2018:
• 2017/2018: Alberta’s carbon tax from CAN $ 20 / tCO
2
e (US $ 16/tCO2) in 2017 to CAN
$ 30/ tCO2 in 2018;
• British Columbia’s carbon tax increased from CAN $30 / tCO
2
e to CAN $ 35 / tCO
2
2018
in 2018;
• Finland’s carbon tax rate increased from € 58 / tCO
2
to € 62 / tCO
2
in 2018;
• Iceland carbon tax increased to approximately ISK 3500 / t CO
2
in 2018;
• Switzerland’s carbon tax increased from CHF 84 / tCO2e to CHF 96 / tCO2
Source: The World Bank, 2018. “State and Trends of Carbon Pricing 2018”.
0
5
10
15
20
25
30
Number of implemented carbon taxes
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However, the benchmarking approach is questionable from an environmental perspective,
because the carbon tax rates in jurisdictions, which have already implemented a carbon tax, are
in most cases significantly lower than the tax rates, which would be required to achieve the
Paris temperature target. The OECD concluded that at the current pace of time, carbon prices
would only meet the real social costs in 2095. Therefore, much more ambitious tax rates are
needed. Consequently, it is questionable if the current carbon tax rates are appropriate for a
benchmarking analysis.
For example, the High-Level-Commission on Carbon Prices proposed a carbon price level of
US $ 40–80 / tCO
2
by 2020 and US $ 50–100 / tCO
2
by 2030. In practice, low carbon tax rates
are the result of political compromises. Currently, only the tax rates in six countries (Finland,
France, Liechtenstein, Norway, Sweden and Switzerland) are higher than US $ 40.
Accordingly, most jurisdictions, which have implemented a carbon tax, are facing a gap in
order to reach the Paris goals.
Box: OECD Effective Carbon Rates
The OECD publishes the effective carbon rates for 42 OECD and G20 countries, on a regular
basis. The effective carbon tax rate is the sum of three components: specific taxes on fossil
fuels, carbon taxes and prices of tradable emission permits. In its report, the OECD measures
the carbon pricing gap, which represents the difference between actual effective carbon rates
and a benchmark rate. Today, the benchmark is EUR 30 and it is estimated to increase to a
midpoint of EUR 60 in 2020. EUR 60 also serves as a low-end estimation for 2030. The carbon
pricing gap indicates to which extent the benchmark is not reached. A small gap is an indicator
that the effective carbon tax rate is close to the benchmark.
According to the OECD, carbon prices are too low to slow climate change to the degree
countries have pledged. In 2018 the effective carbon tax rates in all 42 jurisdictions are priced
76.5 % below even the lowest benchmark of EUR 30. Therefore, most jurisdictions do not
reach even the lowest estimated costs of society. However, the carbon pricing gap has improved
from 83 % in 2012. But 46 % of the emissions are still not taxed at all. The OECD concluded,
that more needs to be done to steer economies along a decarbonized growth path.
Source: OECD, Effective Carbon Rates 2018: Pricing Carbon Emissions Through Taxes and
Emissions Trading
7.2.3.5 Benchmark comparison with trading partners
Another important factor to consider is the carbon tax level of key trading partners and
competing jurisdictions. Policymakers may be concerned about introducing carbon taxes,
which are, compared to carbon taxes applied in those jurisdictions, where the key trading
partners operate, very high. Comparably high taxes may have a negative impact on a state’s
economy (see chapter VIII v.). The benchmark approach also takes into account the tax rate
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level of competing jurisdictions in order to reduce the risk of carbon leakage. Political concerns
regarding carbon leakage and competitiveness are in practice key factors for setting the tax
rate. Thus, setting a carbon tax rate is finally a political decision. For example, the initial tax
rate for the Norwegian carbon tax rate was entirely based on political negotiations.
Furthermore, the political landscape in a jurisdiction is crucial in the decision-making process.
Policymakers should accompany the political decision-making process by providing economic
input and data. This input could be based on the benchmark approach as well as on the other
approaches covered in this report. However, the choice of methodology is not important as
long as the carbon tax policy is developed and deployed over time until it gets to a level that is
sufficient to meet the Paris Agreement commitments.
7.3.3 Temporal Development of the Tax Rate
7.3.3.1 The role of politics
The chapter has discussed various approaches for setting a carbon tax rate. Those approaches
can help jurisdictions to create a policy strategy. Thereby, it is clear that this will include the
involvement of political compromise. However, economic theories and various approaches will
play an important role in the political process. Even more important is the strategy that was
agreed upon. Thereby, the broadest political consensus should be found in order to avoid that
the tax rate does not become subject of short-term political considerations.
A long-term implementation is crucial for the effectiveness of a carbon tax, since only with a
long term strategy planning security for investors can be ensured. This is because investors and
actors must rely on the political commitment to support the green development for the next 10
to 50 years. Moreover, a long term strategy will impact also other areas of government
administration, like for example the policies administered for the exploration of mineral
resources, if it is a resource rich country, environmental goals, and contracts signed by the
public administration.
7.3.3.2 Tax Rate during the Initial Phase of a Carbon Tax
It is important for policymakers to consider the temporal dynamics of the tax rate during the
introduction phase of a carbon tax. There are different policy strategies behind imposing a
carbon tax rate and its modification in the first periods: One strategy is to introduce an initial
tax rate, which remains on the same level for the next periods (“static carbon tax rate”). Another
strategy is to adjust the tax rate over time to soften the impacts of the sudden implication of a
carbon tax. In order to do, so policymakers may decide to apply a lower tax rate in its initial
year (“ramp up introduction”). If a jurisdiction has decided to apply a slow ramp up strategy
the tax rate would be gradually increased until the tax rate has reached the desired level. Ideally,
the desired carbon tax rate is effective from an environmental point of view. This is the case if
the tax rate is capable to contribute to an emission reduction pathway, which is in line with the
Paris agreement. Under the ramp up strategy, it is easier to adjust and anticipate carbon taxes.
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The economy would have more time to invest in alternative and environmentally friendly
technologies and would not face major economic shocks.
For example, British Colombia followed a ramp up strategy. British Colombia introduced a
carbon tax at a rate of CAD $ 10 / tCO2 in July 2008. The province then gradually increased
the tax rate within the next four years per CAD $ 5 each year, reaching its target level at CAD
$ 30 in 2012. Another approach is taken by France, which introduced a carbon tax in 2015.
Thereby the legislator determined the rising tax rate for each year up to 2021 when it will reach
€ 56 / t CO2. The French legislator also defined the tax rate for 2030 at € 100. The tax rates
between 2021 and 2029 are not defined yet, which leaves the legislator room to respond to
economic developments. Singapore has also implemented a carbon tax with an initial tax rate
of S $ 5 / tCO2 in 2019. The intention of Singapore is to increase the tax rate gradually to S $
5 - 10 / tCO2 in 2030. It is not necessary to define the exact trajectory to a specific tax level.
However, it is from an environmental point of view important to define the future targeted tax
level when introducing a carbon tax. Only then, emitters will respond to the future carbon price
from the beginning of the implementation of the carbon tax. A gradual increase of the carbon
tax rate seems politically desirable, as it is easier to gain political support for a gradual
implementation. Nevertheless, the ramp up strategy has also notable risks. First, the
environmental effect is limited in its initial phase, due to relatively low tax rates. Second, low
initial tax rates may stick due to political considerations.
Therefore, jurisdictions may decide to follow strategy static carbon tax rate, which means that
the carbon tax rate stays the same after its introduction. The biggest advantage of a static carbon
tax rate is that it maximizes the anticipation effect of the carbon tax: If the carbon tax would
be implemented without a ramp up strategy, emitters will start to adjust their behaviour
immediately. Moreover, a static carbon tax rate gives the market a stable and predictable price
signal, which facilitates investments. The price stability of carbon taxes is one of the
advantages of a carbon tax compared to an ETS in which the price depends on market forces.
Consequently, the carbon tax triggers its full impact earlier in time. Therefore, a static carbon
tax rate is more effective from an environmental point of view. However, the environmental
effectiveness depends mostly on the amount of the tax rate. A low tax rate is not effective from
an environmental point of view independent from the policy strategy after its implementation.
However, one argument opposing a static carbon tax rate is that the implementation of a carbon
tax can trigger an economic shock in carbon-intense industries or among poor households (see
chapter XX). Sudden increases in prices after the implementation of a carbon tax would be the
consequence. Emitters would not have time to adjust their behaviour in advance in order to
avoid negative consequences for their business. Another argument against a static carbon tax
rate is that it may face more political opposition than a ramp up strategy by those who are
affected by the tax. Moreover, another argument against the turkey approach is that individuals
should act without trying to predict sudden future government policies. Taxpayers should rely
on current law, which means that it would be unfair to change the compliance obligations. This
argument is more a political than a legal argument because tax law is changing all the time and
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there is probably in most jurisdictions no legal basis which hinders the legislator of changing
the law. However, it is thinkable that the constitutional law in some jurisdiction restricts the
(sudden) implementation of taxes, which are not covered by constitutional empowerment.
7.3.3.3 Development of the Tax Rate after its implementation
Setting the rate of a carbon tax is not a one-time task in the initial phase. It is an ongoing process
which requires constant adjustments. This is because setting a carbon tax rate is always subject
to uncertainties, since the exact impact of the tax is not predictable in advance. Therefore, it is
crucial to change and evaluate carbon tax rates over time. Thus, tax rate adjustments in
consequence of a trial and error policy are crucial for policymakers. Moreover, new available
scientific data and information could help to re-shape the tax rate in order to reach a specific
goal with a carbon tax. For example, the underlying assumptions or economic models, which
have served as a basis for modelling the carbon tax could be outdated because of new scientific
results. From an environmental point of view, it is essential to adjust the tax rates over time.
Economic developments (e.g. inflation) or recent international developments on carbon taxes
may change basic assumptions, which were made in the past (see Box XX). Furthermore,
changes in a jurisdiction’s climate mitigation target or a change in public support may occur.
Hence, setting tax rates for carbon taxes is an ongoing process that never ends. However, from
a practical point of view changing the tax rate will always be a time-consuming process, as it
requires negotiations and a political decision-making process.
Box XX: Tax Rate and Inflation
Even if the tax rates remain constant, jurisdictions may decide to index the carbon tax rate to
inflation to ensure a stable environmental effect. This is because of inflation, which could lead
to the situation that a constant tax rate weakens over time. To maintain the effect of the carbon
tax, adjustments are necessary to compensate inflation. Therefore, for example, the
Netherlands, Denmark and Sweden have indexed their carbon and energy taxes to inflation in
order to maintain the price signal of their tax rates.
Therefore, policymakers may decide to implement predetermined adjustments formulas within
the law. The law could include specific criteria or scenarios which could trigger changes in the
tax rate. One example could be that the tax rate automatically increases if specific reduction
targets are not meet. Moreover, economic factors like GDP growth or exchange rates
developments could be used as triggering factors. Switzerland has implemented reduction
targets in its national carbon tax. The tax rate is raised by a predetermined formula in advance.
The exact predomination of the adjustment formula is crucial in order to avoid another
legislative procedure by the parliament. In the case of Portugal, the national carbon tax has
incorporated an annual adjustment, which is dependent on economic criteria. However,
predetermined adjustment formulas may raise constitutional concerns in some jurisdictions.
Furthermore, policymakers may decide to periodically review the carbon tax rate for example
via a special committee. Thereby, experts may report the impacts of the carbon tax within the
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past periods on an annual basis. Past experiences and available information about future
developments allow those expert committees to draft concrete proposals for tax rate changes.
The composition of the panels may differ in each jurisdiction. Those committees may only be
composed of experts or of various stakeholders, which are involved. For example, Norway is
reviewing its carbon tax rate on a yearly basis. During this process, the Norwegian carbon tax
rate has been increased over the last years. Also, Ireland reviews the status of their national
carbon tax rate on a yearly basis.
Thereby, Ireland reviews the performance of the tax and takes into account international trends
of carbon pricing. One advantage of reviewing processes is that it provides for more flexibility
compared to a strict adjustment formula. However, annual reviews require also a political
process. Therefore, a broad political commitment to the reviewing process could help to shield
tax rate adjustments from political interventions. Hence, tax rate changes for carbon taxes
should rather be based on environmental than on political considerations in order to realise the
full potential of carbon taxes. Furthermore, overall stable political conditions are crucial for a
favourable investment climate in green technologies.
7.3.4 Tax Rates and Country Specific Considerations
Special consideration may occur when setting a carbon tax rate for a specific country because
it may not be in a comparable situation with other countries that have implemented a carbon
tax. For example, less developed countries, which may have a weak economic performance
and a low Human Development Index, are not comparable to rich countries. Therefore,
especially for less developed countries, certain characteristics must be taken into account. For
example, they may suffer from a development lag, which limits their taxing ability. Economic
growth and development are essential for poor countries to fight widespread poverty.
Therefore, some countries might be concerned that high carbon taxes may potentially slow
down the future economic development. This is because extremely poor countries need access
to basic services and infrastructure. Additionally, resource rich countries may feel dependent
on carbon-intense industries like, coal, oil, cement, steel and aluminium. Therefore, they might
be concerned that climate protection counters their economic growth and development. In
practice, countries have special economic and demographic characteristics, which need to be
taken into account when setting a tax carbon tax rate.
However, carbon taxes may be essential for countries, which are poverty stricken. The revenues
from a carbon tax can support poverty reduction to develop their infrastructure in an
environmentally friendly way. Well-designed carbon taxes could support economic poverty
reduction. In addition to that, recent technology developments (e.g. massive cost reductions for
renewable energy sources) have also created the opportunity for countries with a high
expansion requirement for power plants to benefit from environmentally friendly technologies
and leapfrog fossil fuel technologies. For example, small-scale solar energy and wind grids
offer new possibilities to provide energy to remote rural areas, at lower costs than gridded
electricity or small-scale diesel generators. Thereby, carbon taxes can support countries to
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establish an innovative energy infrastructure in a cost efficient and environmentally friendly
way. Therefore, carbon taxes can also stimulate innovation, which could create economic
opportunities for countries with a variety of different backgrounds. For example, Singapore
mentioned the stimulation of low-carbon innovation as an additional objective of its carbon
tax. Building a low-carbon infrastructure could help to avoid negative side effects of fossil-
based development, such as air pollution, which is a severe problem in some countries.
However, trade-offs between economic development and emission reduction may exist in some
countries. Examples would be countries, which are strongly dependent on carbon based energy
resources and on energy imports. In such cases, the imperative of development and poverty
reduction may justify lower carbon tax rates in the short time. Lower tax rates could help to
support a smooth transition from a carbon-based economy to a low carbon economy. Moreover,
lower carbon tax rates in some countries may also be justified by the lower purchasing power
in those countries. A lower purchasing power would lead to the situation that a given tax rate,
which is derived from the tax rate of a developed country would be more burdensome for
countries who are poverty stricken. Therefore, carbon tax rates, which are applied in rich
countries, may not be suitable or overshooting for less developed countries. Moreover,
empirical studies have shown that the price elasticity of fuel products in poor countries is higher
than in rich countries, which means that the demand for fuel products reacts higher on price
changes. Therefore, lower carbon tax rates may be justified by the specific economic situation
of some less developed countries as the impact of a price change in fuel prices is higher than
in rich countries.
Summing up, various factors support the idea of lower carbon tax rates in some countries.
However, this conclusion does not mean that also poor countries should not implement carbon
taxes. Well-designed carbon taxes can play a major role in a sustainable development in all
countries. Therefore, carbon taxes are promising tools in achieving the UN Sustainable
Developments goals by 2030.
7.3.5 Key Considerations
• Setting a tax rate for a carbon tax is one of the most important decisions in designing a
carbon tax. Carbon tax rates should, ideally, be consistent with the targets of the Paris
Agreement. Policymakers may rely on economic data to set the rate. However, in
practice, a trial-and-error strategy may be feasible as there is a lack of clarity about the
exact social costs of carbon. In addition to economic approaches, policymakers may
also design a carbon tax via a benchmarking analysis or by designing the tax rate with
the purpose of achieving a specific revenue target.
• As implementing a carbon tax rate is a learning by doing task and new information are
available on a regular basis, carbon tax rates may be subject to an ongoing evaluation
process. It is important that environmental considerations are superficial in order to
achieve the full potential of a carbon tax. However, all approaches within this chapter
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should not be seen in isolation. Policymakers should balance the different approaches
in order to reflect country-specific considerations.
• It does not really matter at an initial stage, whether the price is set at a low or a high
level as compared to other countries, or to the international targets. In fact, most
countries will start at a low price and increase it over time. What is important is for
countries to have well defined carbon pricing policies that they can rely on for the next
10 to 50 years.
• Countries will price carbon according to their historic commitment to pricing carbon.
Therefore, being prepared to adopt and commit to a carbon price now may be
determinant to the country’s furtherance of a higher and more significant carbon tax
rate in the middle to long-term.
• However, at the end, setting the tax rate is a political decision. From an environmental
point of view, instead of waiting any longer to find the most appropriate tax rate, which
will be enormously challenging in practice, a rate should be agreed upon. This rate
should subsequently be evaluated and adjusted accordingly if necessary.
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Chapter IX: Administrative Issues in the context of Carbon Taxation [draft
as of 1 April 2019]
9.1 Introduction
A substantial shift in the conceptualization of domestic tax systems is necessary to redirect
them towards sustainable development, coherent with both the UN Agenda 2030 and the Addis
Ababa Action Agenda. This is urgent and will affect both the domestic and the international
tax architecture. All the available administrative means must serve these common goals.
The recent inter-institutional collaboration among all competent international organizations
(e.g. Inter-agency Task Force on Financing for Development
21
) should be followed in a similar
way at a national level. The full capability of well-interrelated tax systems, applied by
cooperative administrations, should be neither under nor over-estimated. Leaving aside an
optimistic or pessimistic approach, now there is a real chance to jointly devise domestic
instruments that help reaching global sustainability.
The design and implementation of environmental policies should be in line with the country’s
international commitments (i.e. such as the UNFCCC Paris Agreement). Improving taxation
requires the political will to adopt the right mix of tax policies, and to develop the
administrative capacity to implement them effectively
22
. A strong political will is often
required and some decisions may affect the status quo of the administrations involved.
Administrative reform is costly and usually there is resistance. However, for the success of
green initiatives this process cannot be avoided. Any proposed change will probably shake the
inertial distribution of powers, to public authorities operating in newly convergent areas.
Therefore, to achieve a more efficient administration, determination is crucial, both internally
and through international cooperation.
Having decided to introduce a carbon tax, what are the important administrative issues to
consider? This chapter will outline those issues and give practical examples on how they have
been dealt with by different jurisdictions. It is essential for a jurisdiction to develop an efficient
administrative capacity to meet national objectives as well as international commitments. This
can be done, both internally and through international cooperation, as mutual administrative
assistance could be expanded to cover environmental taxation. Eventually this mechanism
could support the introduction of a global CO
2
tax in the long run.
9.2 Types of administrative issues to consider
Broadly, domestic issues can be considered separately from international ones. Once the
domestic structure to implement the environmental tax effectively is in order and functioning,
21
See http://www.un.org/esa/ffd/ffd-follow-up/inter-agency-task-force.html#5
22
Committee of Experts on International Cooperation in Tax Matters: The Role of Taxation and Domestic
Resource Mobilization in the Implementation of the Sustainable Development Goals, Seventeenth session,
Geneva, 16-19 October 2018, Item 3(c)(x) of the provisional agenda. Other matters for consideration
E/C.18/2018/CRP.19, p.4.
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then cooperation with other countries can be pursued and adequately fitted in the existing
international system (e.g. exchanging relevant information for tax purposes).
9.2.1 Domestic issues
Tax administrations have a central role in the design of a carbon tax (see chapter 7 for a
discussion on design). It surpasses traditional tax schemes focused mainly on
discovering/auditing, determining and collecting/recovering the tax debt by including
environmental considerations. The adoption of a more extensive approach is now critical. The
administrations when exercising their competences should consider, to the extent possible the
environmental impacts (i.e. negative or positive externalities) caused by economic activities.
The amount of revenue collected should somehow reflect the environmental costs or savings
produced.
To achieve this broader objective the existing tax structure can be adapted progressively,
considering the administrative capabilities in each organization/agency. National
circumstances are influenced by historical evolution. Notwithstanding this, some paths for
further administrative development are discussed below.
It may be useful to centre initial efforts on administrative collaboration: from the more
technical, through the sector oriented, to the intra-territorial one.
Administrative collaboration may be built up stepwise:
1. Technical
2. Sectoral
3. Intra-territorial
Internally, the collaboration of the tax administration/agency with other financial authorities
23
would be advisable. These responsibilities may be organised differently. In some jurisdictions
the tax collection and auditing may be handled by independent tax authorities, while in other
jurisdictions those tasks are handled by special sections within the Ministry of Finance.
Working hand in hand with the national authority in charge of budgetary administration is of
interest in the case of environmental taxes, or other taxes with an environmental incentive (e.g.
encouraging certain environment-friendly behaviours in income taxes). It clearly affects two
main issues: the determination and assessment of the environmental tax expenditures, and the
effect of any implemented earmarking policies.
In addition, it is may be necessary to explore the opportunities to strengthen and develop
effective the relations with other administrations with relevant competence. This is especially
important if the tax design chosen is the Direct Emissions Approach, where the tax base
depends on measured emissions. The strategic partners are those authorities experienced in the
23
In this context, “financial authorities” are intended to include all the administrative bodies that intervene in
the procedures, both from the revenue and the expenditure side at the Ministry of Finance.
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sector where the tax is meant to have an impact. This may entail joint work with environmental
experts, or even with more detailed areas of specialization: energy, transport, agricultural,
timber, housing, waste or health, among others. The interconnectedness of carbon taxation with
the goals outlined in the 2030 Agenda is clear, and tax policies are considered supportive of
the SDGs if they help realize one or more SDGs without jeopardizing others.
Example: If the tax is targeting transport fuels, avenues for cooperation can
be found in the interaction with port and airport authorities, e.g. Landing and
Take-off (LTO manoeuvres) in commercial aviation and possible reductions
in case of using winglets (or sharklets).
It is important to decide which Ministry takes the lead in implementing environmental taxation,
and the relationship with other Ministries if another ministry/agency acts as a coordinating
agency for the tax. For example, in terms of tax administration, the Chilean Ministry of the
Environment oversees the administration of the Register of Boilers and Turbines, for the
purpose of identifying the facilities subject to green taxes.
Another relevant point is who has been tasked with drawing up any guidelines (protocols) that
establish the rules that must be followed by the tax payers.
In the case of Chile, where the tax base is emissions it is necessary to monitor, report, and
verify the emissions of the facilities subject to the tax, the Office of the Superintendent of the
Environment stipulates minimum operating requirements, quality control specifications, and
assurance mechanisms for emissions monitoring or estimation systems used for emissions
declarations; it is also responsible for compiling all information necessary for calculating the
tax payable.
[Text will later be added with more examples, in particular related to the Fuel Approach tax
design]
9.2.1.1 Regions and municipalities
In a context of territorial regional decentralization (e.g. regions or municipalities), there is an
obvious need to stress collaboration – as noted above, horizontally at each level of government,
and at the same time, vertically ensure coherence.
9.2.1.2 Utilize the existing taxation systems
The Ministry of Finance is normally in a privileged position to design the carbon tax, as the
budgetary process allows the interactions with relevant agencies. It has contacts with many
competent authorities for distinct substantive matters (such as, agriculture, energy or transport),
and information is already being channelled through inter-territorial levels of government.
Accordingly, reinforcing certain pillars, utilising information already collected, and, if needed,
asking for some more details, may be a good strategy.
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9.2.1.3 Capacity building
The investment in the continuous qualification of human resources enrolled in the
Administration is necessary, promoting new broad views and relational abilities among tax
officials. Moreover, the different needs of countries at different levels of development and in
different situations, and the different levels of capacity of tax officials must be recognized. At
certain point, tax authorities probably will need to acquire specialized expertise.
9.2.1.4 Stakeholder involvement
However, one cannot rely exclusively in a closed administrative circuit to achieve the
successful implementation of a carbon tax. To comply effectively, the tax administration
should ensure the inclusion of other stakeholders in the process, as they may adjust their own
administrative or management structure to better apply the tax.
To be successful, the implementation of environmental taxation requires the support of
consumers as well as business operators and NGOs. In practice their participation is relevant
to manage the system fluently. Here the risk of capture by strong groups cannot be ignored. In
this sense, public authorities operating in the same sector are more easily captured than tax
authorities, which are somehow distant from all the economic agents. At the end of the day,
the process of educating taxpayers and consumers in the transition to a green economy, though
slow, is the key to success. Accomplishing the maturity of a well-informed public opinion takes
time, to promote understanding of a new tax approach. This task should be started as quickly
as possible to pave the way for future environmental reform.
9.2.1.5 Clarify roles and expectations, communicate
When developing the initiative, it is always important to clarify the expected distribution of
roles and to facilitate public awareness of the process (e.g. Who does what? Where to make an
application, or show proof of action required?). If an administrative structure is already set to
manage indirect taxation of fuels, it can be easily used to implement carbon taxation (see
chapter 7 for a detailed discussion).
Some efforts on capacity building can be made through workshops on the registry,
quantification, and emissions reporting systems, or on the progress of the project (for Public
Relations representatives from various organizations). The dialogue with the stakeholders can
explain the scope of the reform to the public and discuss the challenges the new processes
might present (e.g. even through webinars on carbon pricing instruments and the CO
2
tax).
9.2.2 International
As countries are not isolated when facing the desire to utilize carbon pricing to develop in a
greener direction, it is convenient to look for other useful comparative experiences and share
efforts. This could be the case both for governmental and legislative bodies preparing the
carbon tax legislation, as well as for the Tax Authorities when implementing the legislation.
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Here the participation in several specialized fora with a global perspective may facilitate the
interaction with other entities (administrations, chambers of commerce, inter-governmental
meetings, conferences, academia, etc.). In this sense, regional organizations in the Network of
Tax Organisations to enhance the efficiency and effectiveness of tax administrations worldwide
and could be useful
24
.
It is necessary to identify the existing domestic administrative structures familiarised with
taxation and environmental issues, maintaining simultaneously a connection with the
international sphere. This is valid either for the fuel approach or the emissions approach, and
should be considered in parallel both from Government decision-making bodies and the
administrative units charged with the implementation.
In this sense, lessons can be learnt on how to integrate policies smoothly, also bearing in mind
the international arena, from the National Contact Points established in the framework of the
OECD Guidelines for Multinational Enterprises, as they are able to deal with environmental
and taxation matters. In the same line of thinking, the investment authorities are often assessing
the conditions to attract Foreign Direct Investment and are used to explain the applicable legal
regime combining several economic, environmental and social factors.
Lastly, in a regional framework it is quite common that mainstreaming policies find areas of
intersection (e.g. environmental and fiscal policies in the European Union). The decision-
making bodies and procedures that allow the concerned administrative representatives’
intervention should not be neglected at all. The process for composition of interests to deliver
fair rules, caring for their practicability, is essential. This shows that already existing regional
cooperation instruments (such as a trade zone) can serve to jointly build a carbon tax on, for
instance, common energy taxation.
As a result of prior legislative coordination among States, international tax cooperation may be
growing in scope to address urgent goals in the global political agenda. The most efficient tax
administrations will soon show their impact on society through the management of
environmental taxation, communicating the green-related funding results. These efforts in the
field of the international tax cooperation should be universal in approach and scope and should
fully consider the different needs and capacities of all countries
25
.
9.3 When to address the administrative issues
Once there is political will to introduce an environmental tax, administrative issues
immediately appear as a continuum in time that cannot be overlooked (e.g. margin for
discretion, timing, combination with other schemes or possible review).
24
The members represent tax administrations in Africa, the Caribbean, members of the Commonwealth, Europe,
Francophone countries, Islamic countries, Latin America, the Pacific and West Africa. E/C.18/2018/CRP.19,
p.7.
25
E/C.18/2018/CRP.19, p.5.
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9.3.1 Before implementation
One initial guideline for the development of environmental taxation is simplicity. This value
should be defended at every level, being adapted to the different capabilities of Small and
Medium Enterprises, or Multinational Enterprises. Keeping in mind the proportionality in the
requirements leads to acceptability by the citizenship, and helps public administrations to
render a better service, avoiding unnecessary workload (devoting their efforts only to deal
directly with the useful data acquired for the purpose sought). Fairness depends, to a great
extent, on the time spent and the quantity of management efforts demanded to reach the
objectives, both seen from the public and the private perspective
26
.
Preparing an overview of present tools that might be useful for implementing a new
environmental tax must be considered. It is wise to check the efforts made in a certain field due
to some policies already in force. For example, if there is already a fuel tax in place it may be
a simple task to also apply a carbon tax. If you, on the other hand, have decided to base your
tax on emissions, some minor adaptations to accessible reporting obligations (e.g. register or
book-keeping), and the option to take advantage of some measurement modes (by comparison
of certificates or logbooks) may be key for the administrative implementation.
9.3.1.1 Regulation
The type of regulation to approve is another relevant point of discussion, as it relates to the
margin left for administrative discretion and may hinder the need of certainty. The legal order
in each country must be considered, finding a balance between flexibility and equality
(reflecting carefully on the value of prior administrative resolutions and their publicity). It is
useful to count on a strengthened legal framework that enables the policy design and
administration reform, to the extent politically possible, to help balance revenue agency powers
and the rights of taxpayers. The tax rules should be understandable by taxpayers, and they
should be able to easily obtain clear indications on how they should comply with them in
specific cases.
9.3.1.2 Data availability
In order to set the necessary administrative procedures for applying the tax, it may be
convenient to check if the administrative data available is sufficient to develop a manual for
the registration, or to offer guidance documents pointing out the administrative requirements
necessary for correct implementation
27
.
9.3.1.3 Timing
Provided that a relatively simple scheme, benefiting from some formal declarations, is defined
to give the authorities the green light, the next question is when to put the environmental tax
26
For a more detailed explanation on the design, please, see chapter 7.
27
See also chapter 7 on data intensity of different design choices.
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measure in place
28
. The convenience of offering an adaptation period cannot be denied (not
only for companies, but also for the public administrations involved). Once the determination
of the Government to make a move towards the sustainability through green taxation is shown,
a sensible calendar for implementation helps in the transition. The changes in the private
organizations to fit a new scenario can even be made with the sole official announcement of
the implementation of an environmental tax in the following years at the end of the legislature
term.
9.3.2 During implementation
The clarity in the designation of the competent authorities, and spreading information about
any eventual change affecting them is decisive. The public perception of proximity and
transparency may be as important as the content of the regulation itself. A frequent dialogue
with the agents may be beneficial to better understand the needs and the improvements made
in each specialized sector. Ultimately it can result in a modification to make rules more suitable
in accordance with actual business life.
Along the implementation phase, the possible combination with other economic instruments
operating in the same field should be considered (e.g. replace or add CO
2
instruments).
9.3.2.1 Tax audit and collection
Another realistic question is how to collect the environmental tax. Thinking about the tax
payment is also relevant when implementing the polluter pays principle. Additionally, the
compensation for environmentally-friendly behaviours can be anticipated through justified tax
expenditures. To make political decisions to that end, gathering precise information is
necessary. The tax expenditures may help the introduction of the tax in a soft mode. Later, by
reducing them, it can be elevated. Additionally, the tax expenditures may reflect certain
valuable contributions made to protect the environment as provided by the legislator, and
should be taken into account accordingly by the tax administration when managing the
collection process, checking that the justified reduction is applied in a proportionate manner in
the tax debt.
A balance should be made with the pros and cons for the administrations and the taxpayers
involved in the design phase. Depending on the point of regulation and the tax approach (fuel
or emissions) they will face different obligations. If needed, a reporting period can be decided
in the tax law or in other relevant regulation issued by the competent authority. It may vary
depending on the country’s tax traditions (a month, quarter of a year, or even yearly can be
considered). Probably, from an administrative perspective and due to some common taxpayers’
practice with other indirect taxes (such as value added tax), a periodic tax can be easier to
manage through quarterly returns. It allows adjustment to the real circumstances of the activity
carried out. I.e. in case of starting the polluting activity after or ending before the calendar year
28
See also discussion about the proper timing for implementation in chapter 2 (to be written).
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a proportional adjustment can be made in the payment finally required. Alternatively, the
Government gets revenues more often if it is set monthly, as well as cash flow.
Taxpayers care that the collection system is fair and that evasion is effectively dealt with, as
well as whether revenues are used in areas that they value. For example, in Chile, the process
has also entailed expanding and strengthening the capacity of environmental agencies,
establishing protocols for determining procedural responsibilities, creating more robust
information systems, and improving inter-ministerial coordination. The new institutional
infrastructure implements the tax in an effective manner and brings with it an institutional shift,
allowing the development of new capacities, knowledge, and tools to improve the quality and
efficiency of environmental management, which may be used in the future to pursue more
sophisticated environmental protection mechanisms.
9.3.3 After implementation
The tax measure applied by the Administration must be subject to a process of monitoring.
There might already be suitable systems in place that can be utilised for this, or a review
mechanism for evaluation can be established. The authorities in charge to do so and the effects
of the review must be stated. This review could even originate an adjustment of the tax rate.
In a process of sustained improvement, not only the auditing of correct data given in tax
declarations, but also the checks done by the administrations to deliver better environmental
results are monitored by different institutions (such as statistical bodies or departments within
the ministries). Therefore, it is important to clarify to whom the tax administration will report
on this topic.
For example, where it exists, the Court of Auditors may help with the control of efficiency of
the administrative actions, e.g. when reviewing the tax incentives granted for environmental
purposes. If there is a regional body (such as the European Union Court of Auditors) a coherent
approach among the competent auditing institutions can be sought.
In order to ensure that the carbon tax fulfils its objectives, certain checks need to be made at
every stage in the implementation. This relates to checking the environmental effectiveness,
the burden on companies and their competitiveness, the distributional effects to be socially fair,
the overall economic efficiency and the feasibility. In an ever-changing environment that
affects taxpayers and tax administrations, the existing structures should be recalibrated to
confront real risks.
Remember to consider these issues:
1. Environmental effectiveness
2. Burden on companies
3. Competitiveness
4. Distributional effects
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5. Overall economic efficiency
6. Feasibility
In Chile the new taxes have resulted in the design and construction of a new institutional
structure, which includes the implementation of a registration system for sources subject to
taxation and a system to measure, report, and verify emission levels. Once the new measures
are in place, the government expects continued discussion over future tax increases or other
possibilities such as sophisticated carbon pricing instruments like offsets and/or tradable
emission permits.
Other delicate issue for administrative consideration is the possibility to enforce the regulation,
in economy-sensitive sectors (e.g. mining in certain developing countries). Political
considerations may influence the design of the rules, but the technical application must follow
the administrative procedures, unless a carve-out clause is inserted. In addition, the regulatory
consistency regarding regulations applicable to different sectors is a virtue. See chapter 7 for a
discussion on exclusions or phase-ins.
Another topic that deserves a brief mention is the need to open administrative windows for the
revision of claims (prior to judicial review), to avoid conflicts that are time and resources
consuming.
9.4 Operational hints
9.4.1 Optimize the process of digitalization
The digitalization of the economy and new technologies provides opportunities to increase
efficiencies and save costs in public financial management. Supporting tax administration and
collection, access to more and better data, as well as improved data management systems can
also lead to better policy design. While digital information supports administrations in
improving the enforcement of existing rules and facilitates compliance, access to broader
information can also drive better tax policies and offer opportunities to reduce inequalities
through a fairer allocation of the tax burden among citizens.
The digitalization may support domestic resources mobilization and the transition to a low
carbon economy. Nowadays it is producing changes both in private and public organizations.
They are refining their strategies in accordance with the new possibilities to carry out their
missions better.
Several national experiences of a fuel approach tax show, with a clever design, the tax
administration can manage a carbon tax at a low administrative cost (e.g. Sweden).
In the future, with intelligent systems, the amount and nature of the available data could even
better ensure knowledge of real costs and benefits through the connectivity of financial and
non-financial information. And the increase in data granularity will be the key to fight
inequality, once greater traceability becomes feasible in many sectors (regarding consumption
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or emissions). To achieve the Sustainable Development Goals, a legitimate and smart use of
tax data will be possible.
The role of an integrated digital international tax administration could be devised, exploiting
pilot experiences that some regional organizations are currently providing.
At the national level, administrations would need to ensure sufficient investments not only in
their own capacities to take advantage of digitalization, but also in ensuring access and
inclusiveness of all individuals and businesses.
9.4.2 Enhance Corporate Social Responsibility in the private sector
It is true that the administrative schemes should be proactively adapted and re-characterized to
better contribute to sustainability. However, social responsibility is not only a matter of concern
for public administrations. Joint efforts are needed and a greater involvement of the private
sector should be explicitly sought by administrations.
Somehow, a door should be opened to appraise individual and collective interests as well. This
could be embraced either in the strictly fiscal area, or in extra-fiscal domains by means of sound
coordinated tax incentives for private activities investing in global public needs.
This demand is in line with the public-private partnership necessary for achieving the
Sustainable Development Goals (under SDG 17). The constructive approach counting on
responsible stakeholders has already proved right in other sectors. In addition, transparency is
an important attribute of national institutions (SDG 16).
CSR strategies of cooperative compliance for paying the tax due can be extended to other
edges, e.g. by providing data that affect the tax treatment in accordance with the environmental
impact. Instead of suffering the so-called indirect tax pressure referred to registers, reporting
obligations, use of labels and certificates, the digital information duly connected may do the
rest.
The opportunity to work together to create a new technical mechanism should be taken. The
new deal fosters the development of working relationships between ministries and agencies,
forges new public-private relationships, and forms robust foundations of knowledge and
information for implementation of the environmentally related tax measure.
9.4.3 Other hands-on hints
Other hands-on hints could include the following activities:
• Explore and make an alternative use of data already available, though collected for
other purposes.
• Maximize the use of existing administrative systems, allowing wise flows of
information and providing place and time for foreseeable beneficial interactions.
• Tag carbon tax onto existing legislation.
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• Use regional cooperation as basis for joint tax introduction and save on administrative
cost and competitiveness concerns.
9.5 Solutions found in a comparative analysis
9.5.1 The Swedish fuel approach
While an assumption could be that a carbon tax needs to include measuring emissions, this is
not the case if a carbon tax is designed based on a fuel tax approach (See further in chapter 7)
Such a design can give a jurisdiction an equally efficient, and less costly, tax system.
The Fuel Approach way of carbon taxation is to pre-calculate tax rates in tax law based on
average fossil carbon content for different fuels. There are significant administrative
advantages by this approach, low administrative costs, can build on existing tax administration
in many cases. An example of a copy of a Swedish carbon tax declaration shows the simplicity
of it all (text and example will be further elaborated at later stage).
In the Fuel Approach Design the need for environmental knowledge for the Tax Authority is
small, if even non-existent. What the Tax Administration basically needs is how to calculate
and audit the number of litres sold by the taxpayer. This is an ordinary task Tax Authorities are
familiar with. Of course, the need for further expertise may be more significant if a country
chooses to implement exemptions or reimbursement schemes, e.g. for business performing a
certain environmentally-friendly activity, carbon capture and storage, etc., but that is not the
prime objective for a country starting out with a carbon tax.
9.5.2 The Emissions Approach in Chile
For the sake of simplicity, some indirect indicators whose existence is easy to verify can be
adopted initially e.g. number of boilers & turbines, and maintained until reporting obligations
are improved with the passage of time. The move from an objective estimation of the taxable
base to a more exact direct determination depends on the capability to promote a better
adjustment of measurement operations.
In the long run, the inclusion of some benefits in the taxable base can be considered to install
devices as desired by the administration, to make the control easier and adapt the amount due
to the real circumstances.
Alternatively, labelling, certification procedures and voluntary standards (e.g. EMAS Eco-
Management and Audit Scheme or ISO 14000) can be used as a reference.
Apart from the obligation to file the forms approved by environmental authorities, or to keep a
book of records with respect to emissions, automatic analysers may help verifying the
deduction of actual costs in more accurate manner.
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9.6 Conclusion
The above-mentioned administrative issues are key to successful implementation of a carbon
tax, either following a Fuel or an Emissions Approach. Therefore, policy makers should pay
careful attention to the adaptation of the existing organizational structure and invest in
improving the capacity of the personnel. This will allow tax authorities to work more efficiently
with the other stakeholders in this process towards sustainability.
Carbon taxation promotes positive behavioural changes. An approach involving the whole
Government offices is convenient, counting also with the private sector collaboration and other
stakeholders to devise a sound administrative strategy in accordance with what has been
explained above.
The United Nations Tax Committee may place greater emphasis on aspects of taxation, which
aim to promote positive behavioural patterns. Taxation plays a fundamental role in the
achievement of the SDGs, which goes beyond financing. That is the case of environmental
taxation.
Whole-of-government approaches take on additional significance because implementing
environmentally related taxes requires cooperation amongst many different agencies and
ministries (as it happens with Illicit Financial Flows). To achieve relevant benefits, there also
needs to be cooperation between the private and the public sector, and appropriate support by
government authorities.
Environmental taxes allow State agencies to consolidate their information exchange
mechanisms. They can create a new institutional architecture through the development of
technical and administrative capabilities, which lays the foundation for the development of
more sophisticated tools in the field of environmental management. The tax administration
should track all these changes.
9.7 References for Chapter 9
Taxation and The Environment: The Challenges for Tax Administration (The Australian
Perspective), Critical Issues on Environmental Taxation, Volume II: International
Comparative Perspectives (IV NATIONAL EXPERIENCES WITH ENVIRONMENTAL
TAX INSTRUMENTS)
DE CENDRA DE LARRAGÁN, F.J.: An Analysis of Spain's Legal Framework for the
Promotion of Electricity from RES and Energy Efficiency: Positive Effects Achieved So Far
and Remaining Legal, Administrative, and Structural Barriers, Critical Issues on
Environmental Taxation, Volume VI: International and comparative Perspectives. Innovation,
Technology, and Competitiveness
GRAU RUIZ, M.A.: “Climate change-related action and non-productive investments in the
European Union”, Innovation Addressing Climate Change Challenges, Market-Based
E/C.18/2019/CRP.
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Perspectives, Critical Issues in Environmental Taxation, Edward Elgar Publishing Ltd.,
Cheltenham, pp. 154 a 168, 2018.
GRAU RUIZ, M.A.: “Tax expenditures to promote environmentally responsible investment”,
Environmental Pricing. Studies in Policy Choices and Interactions, Critical Issues in
Environmental Taxation, vol. XVI, Edward Elgar, Cheltenham, 2015, p. 100 – 114.
PAVEL, J.; VÍTEK, L.: Administrative costs of the Czech system of environmental charges,
Critical Issues on Environmental Taxation, Volume VI: International and comparative
Perspectives. Innovation, Technology, and Competitiveness
PIZARRO, R.; PINTO, F.; AINZÚA, S.: Chile´s Green Tax Strategy; Institutional
Infrastructure for Green Taxes; Creation and Implementation of a Measurement, Reporting and
Verification (MRV) System, Chile’s Green Tax; Capacity-building for the implementation of
Chile’s Green Tax, Ministerio de Medioambiente - Gobierno de Chile & GIZ.
https://www.4echile.cl/mercado-global-del-carbono-chile/
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Annex 1 – Economic theory background
A1.1 Pigouvian Approach: Theory versus reality
Although the Pigouvian Approach makes sense from an economic perspective, attention should be
paid to several difficulties associated with its implementation. First of all, it is important to define
which types of externalities it should be covered (Chapter Tax Base). Therefore, it is important to
determine the tax base carefully, as it has a considerable impact on the tax rate. However, the more
difficult part is to determine the marginal value of pollution. Assuming that the tax tackling all
externalities deriving from CO2, following the Pigouvian Approach means that the rate should
exactly represent the MSC of one ton CO2, which occurs at any point in future.
The valuation of externalities will be the most difficult task if policymakers follow the Pigouvian
Approach. The MSC of CO2 are usually calculated with Integrated Assessment Models (IAM).
Those models combine economic models with climate/environmental related system models. IAM
simulates the expected costs along various emission pathways, due to increases in CO2 emissions.
The most important IAM are PAGE (Hope 2011), DICE (Nordhaus and Boyer 2013), FUND (Tol,
1997) and Rice (Nordhaus and Yang 2013). Regarding CO2 emissions social costs of carbon range
from 10 $ to several hundred $ per ton CO2. However, this wide spectrum of results shows how
difficult it is to find the tax rate which represents the exact marginal external costs. This is due to
the fact that even the most complex model is subject to uncertainty, as it does not reflect reality.
Therefore, it is unrealistic to find the “exact” tax rate, which, however, would be necessary in order
to apply the Pigouvian Approach. Uncertainty is one of the main reasons why tax rates do not
usually follow the Pigouvian Approach.
The broad range of estimations of the MSC usually is challenging for policymakers, as it is difficult
to agree on a specific rate. However, the government concluded that the approach is not feasible as
no rate could be agreed upon. Finally, the government followed the benchmarking approach, as the
international carbon tax rates which are currently in force are the result of political and economic
considerations. Besides the uncertainty, it is necessary to adjust the tax rate over time, as the MSC
will rise due to increasing concentrations of CO2 in the atmosphere. Therefore, following the
Pigouvian Approach requires raising tax rates over time. Moreover, the Pigouvian Approach
requires monitoring each individual emitter which is crucial for the rate setting. However, this is
unrealistic as it would require complete documentation of all CO2 emission. In addition to that,
policymakers are at risk of receiving biased information by the polluters, which would further lead
to uncertainty regarding the cost estimations which are crucial for the Pigouvian Approach.
A1.2 Marginal Abatement Cost Curves
MACC represent the costs that occur in order to reduce the pollution by one unit. MACC usually
compare various options/technologies that may be part of following a decarbonisation pathway and
shows the impact of these alternatives. MACC are derived from engineering-style analyses of the
costs of individual technologies of practice. The costs of each available technology are estimated
together with the proposed emission reductions which are predicted for it. In a second step, all
technologies will be sorted in ascending order of cost. Each technology will then be plotted to sum
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the cumulative predicted emissions abatement at or below any specific abatement costs at a specific
point in time. Policymakers may rely on MACC which are published by economists, research
organizations or consultancies (Nauclér, T., Enkvist, P. A., 2009). In 2013, the World Bank
published a MACC for the power sector of Nigeria, which could serve as a reference MACC for
countries with a comparable economic background (Cervigni, Raffaello, Rogers J. A., Henrion M.,
eds. 2013). However, jurisdictions may also develop own MACC for certain sectors/industries of
their economy by estimating the abatement costs of GHG in their jurisdiction.
Figure XX: Hypothetical MACC
Source: Partnership for Market Readiness. 2017. Carbon Tax Guide
Graph 2 shows a hypothetical MACC pathway for a specific point in time. Each bar represents a
technology, in which the width is dependent on the annual emissions reduction potential which
results from the use of each technology. The bars are sorted from the lowest to the highest marginal
abatement costs. MACC also includes technologies with negative abatement costs, which means
that the application of those technologies could help save money. The biggest advantage of MACC
is that the curves inform policymakers about the range of technical options which are available and
the cost of each technology.
For example, if a jurisdiction aims at reducing 400 megatons CO2, a tax rate of US $ 40 / t CO2
would be necessary. The target will be reached, as it is cheaper for economic actors to mitigate
their emissions by using technologies which have lower abatement costs than to bear the tax rate
of US $ 40 / t CO2. According to economic theory, the acceptable level of pollution will be reached
in a least-cost approach. This is due to the fact that the total abatement costs in the economy will
be minimised by setting a tax rate which achieves the predetermined emission reduction goal.
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Market forces will make sure that economic actors reduce their emissions as long as their abatement
reduction costs are lower than the implemented tax rate. As a result, cost-efficient technologies will
be implemented. In case the MACC of an economic actor is higher than the tax rate, it is cheaper
for the actor to pay taxes. The height of each graph describes the average cost of reducing the
emissions by one ton CO2.
However, it is difficult to determine the MACC of a specific jurisdiction as the MACC is a
relatively simple approach which focuses on technologies. The starting point for the creation of the
MACC is the formation of an initial emission baseline and the selection of a baseline technology,
which will be replaced by alternative technologies. However, defining a baseline technology is not
an easy task as there are many carbon-based technologies available, which makes assumptions
necessary. Secondly, it is necessary to make assumptions regarding the specific abatement options
(lifetime, price e.g.) and how to price future costs and benefits of those technologies, which requires
the determination of a discount rate. Besides those considerations, the model can also miss
important factors such as the interactions between various technological alternatives as well as
interactions between producers or consumers and the market power of certain actors. For example,
MACC curves do not cover behavioural and transaction costs, such as cultural constraints,
acceptance of new technologies, or access to financial resources. Moreover, it is hard to predict
how economic players react in reality. This is because of asymmetric information between the
economic actors and market failure due to imperfect competition. For instance, it is possible that
some economic actors will use their market power in order to influence the market outcome
according to their wishes. However, those microeconomic feedbacks, as well as macroeconomic
factors (economic development) are not covered by the MACC curves. Thus, more complex models
taking into account additional factors (eg systematic approaches which also consider interactions
of different elements) could be used. Moreover, also the most complex model cannot fully reflect
reality. Therefore, it is unrealistic to predict the exact emission reduction which results from a
specific tax rate.
According to the Standard Price Approach it is, however not necessary to find a model which
accurately reflects economic reality. This is due to the fact that the Standard Price Approach follows
a trial-and-error policy which means that the tax rate will initially be set according to the MACC.
A1.3 Revenue Target Approach wrestling with Theory
If policymakers follow a specific revenue target approach it is crucial for them to know the supply
and demand curves, as they have a strong impact on how the market responds to taxes. Different
tax levels lead to a change in the quantity of tax revenue. However, it is not possible to always
increase the tax revenue through higher tax rates. This is due to the fact that two contrary effects
are responsible for changes in revenue. First, the tax base decreases because higher tax rates result
in a lower level of demand. In contrast to this effect, higher tax rates lead to higher tax revenue.
Both factors have an impact on the total tax revenue. If the effect of the decline in demand as a
result of higher taxes is higher, it is possible that the total tax revenue decreases when increasing
the tax rate. Having said that, it is also possible that the tax revenue increases by raising tax rates
in situations in which the effect of the higher tax rate is higher than the decline in demand. This
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statement holds true for situations in which the tax rates are relatively low. The tax revenue can be
maximized by setting the tax rate at a level at which the additional tax revenue from the higher rate
equals the loss in tax revenue from the decrease of the quantity.
Another relevant contrary effect which can affect the total tax revenue is the interaction in the
demand of other products as a result of the implementation of a carbon tax. As mentioned above
the elasticity of fuel products is at least in the short time low. This means that the demand does not
immediately responds disproportionately to price changes. However, each economic actor has only
a limited amount of money available for spending. As a result, it is possible that the demand for
other products after the implementation of a carbon tax, may decrease. This could lead to the
situation that the tax revenue which results from the consumption of other products (eg VAT) may
– in the short-time – decreases through the implementation of carbon taxes. Policymaker should,
therefore, also consider changes in the consumption of other products in order to reach the desired
revenue target in total.
Moreover, it is important that carbon taxes are levied on various different types of fuel and carbon
intense products such as diesel, petrol, gas and coal. As the carbon content of each product differ
and each product has its own demand curve, the impact of a carbon tax may vary. Therefore,
maximizing the tax revenue for one product through a specific tax rate does not necessarily
maximize the revenue for different products. One solution would be the application of different
carbon tax rates for each product. However, from an environmental point of view, this approach is
inefficient as it undermines the controlling effect of a carbon tax. In addition to that, different tax
rates for different products are also inconsistent with the least-cost approach as the price signals
are not applied consistently. In addition to that different tax rates would raise the complexity in the
administration of the tax, which may be difficult for some countries with a lack of resources to
monitor as this would require additional resources.
A1.4 Carbon Tax Rates
The following graph gives an overview of all nominal carbon tax rates which were in force in
November 2018. [Note that this is a provisional list which is subject of an ongoing revision by the
authors.]
Jurisdiction Covered
Tax rates November 2018
US $ / tCO
2
Alberta
22.92
Argentina
10
British Columbia
26.74
Chile
5
Colombia
4.92
Denmark
27.07
Estonia
2.28
Finland
70.64
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Carbon Pricing overview
Source: Data based on Carbon Pricing Dashboard, Data based on The World Bank available at
https://carbonpricingdashboard.worldbank.org/map_data.
A1.5 Bibliography for Annex 1
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across the EU-28”, Swedish University of Agricultural Sciences, Working Paper 11/2016.
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Cervigni, Raffaello, Rogers J. A., Henrion M., eds. 2013. “Low-Carbon Development:
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Harrison, K. 2013. “The Political Economy of British Columbia`s Carbon Tax”. OECD Working
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Hope, C.W., 2006. “The marginal impact of CO2 from PAGE2002: an integrated assessment
model incorporating the IPCC's five reasons for concern.” Integr. Assess. J. 6 (1), 19-56.
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WIFO Working Paper 554/2018.
France
50.81
Iceland
28.87
Ireland
22.79
Japan
2.56
Latvia
5.13
Liechtenstein
95.71
Mexico
2.73
Newfoundland and
Labrador
15.27
Norway
59.87
Portugal
7.80
Singapore (in force 2019)
3.7
Slovenia
19.71
Spain
22.79
Sweden
126.83
Switzerland
99.71
United Kingdom
23.25
Ukraine
0.01
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Nauclér, T., Enkvist, P. A., 2009. ”Pathways to a Low-Carbon Economy – Version 2 of the
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above pre-industrial levels and related global greenhouse gas emission pathways, in the context
of strengthening the global response to the threat of climate change, sustainable development, and
efforts to eradicate poverty [Masson-Delmotte, V., P. Zhai, H.-O. Pörtner, D. Roberts, J. Skea,
P.R. Shukla, A. Pirani, W. Moufouma-Okia, C. Péan, R. Pidcock, S. Connors, J.B.R. Matthews,
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