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Dec042015

Benchmarking COP 21 – what could be the fiscal impact of fair carbon shares?

Author: Maia KingPhD Candidate at Queen Mary, University of London

The next big international meeting on climate change – COP 21 – is underway in Paris. Negotiations are complex and countries’ emissions targets – found in their Intended Nationally Determined Contributions (INDC) – are not always comparable. Might there be simple benchmarks against which costs and required financing can be compared? One such estimate and its potential fiscal implications are presented here.

This estimate is based on the simple idea of ‘fair carbon shares’ that has been suggested by some developing countries and analysts, and highlighted recently by the Financial Times. Fair carbon shares mean that each human being on the planet has an equal right to emit greenhouse gases. This idea has not been palatable for rich nations in previous negotiations, but it does allow benchmark country-level emissions rights to be calculated in a simple and transparent way. The illustrative numbers presented here should be seen only as a snapshot, based on simple assumptions and calculations, and each could be refined and the exercise undertaken more rigorously, for example as CGD have done in their ‘SkyShares’ approach. And if the costs and benefits to each country of this regime can be estimated, it is then possible to explore the fiscal impacts of fair carbon shares on government budgets.

The simple estimates (.xls) presented here suggest that ‘carbon flows’ – global transfers from fair carbon shares – could amount to over $300bn annually. This is calculated by first comparing national per capita carbon emissions to the world average (using 2011 WDI figures), which is used as a simple proxy for the level of emission rights countries might be allocated in a system based on population. This gives each country’s ‘carbon account’: countries are in ‘debit’ on their carbon account if they emit more per capita than the world average; and in ‘credit’ if they emit less. If these debits and credits were transferred between governments, the fiscal implications could be calculated by applying a carbon price to the carbon accounts. Illustrative values are generated here using a social cost of carbon (SCC) of US$25/tonne of CO2. Adding all the credits (or debits) together gives the figure for total global transfers of US $311bn. This compares to 2011 totals for ODA of $134bn, remittances of $480bn and FDI of $2.2trn (WDI), and 2013 fossil fuel subsidies of around $5trn (IMF).

The chart shows selected countries with the most to gain or lose from a per capita allocation of carbon emissions rights. The biggest gainers in absolute terms would be those with large populations and below-average per capita emissions. India would top the list with $93bn in credit, followed by Nigeria ($17bn), Bangladesh and Pakistan ($16bn each), Indonesia ($14bn) and Brazil ($12bn). Countries with the lowest emissions per capita, including many fragile states, would receive up to $116 per capita for selling their unused emissions rights. Meanwhile, countries facing the greatest costs would be those with large populations and above-average per capita emissions. The United States would top that list ($96bn), closely followed by China ($70bn), then Russia ($29bn) and Japan ($15bn). The United Kingdom would face a $4bn overall cost – equivalent to around $61 per capita, around a third of the aid budget. Of course, such sums would prompt countries to change their emissions behaviour, reducing the cash benefits to the gainers and costs to the losers.

The impact of carbon flows on government budgets may be even starker. As shown in the chart, carbon flows would represent only small proportions of government revenue for those countries in debit (no more than 5% for most countries), but could be very large for developing countries in relation to their low levels of government revenue. These additional resources could potentially have a large development impact, but should be budgeted carefully, since carbon flows would be expected to reduce to zero over the medium term as the global economy decarbonises completely. Arguably, carbon flows may need to be managed in a similar way to natural resource revenues.

What kind of institution could implement fair carbon shares? It would have to deal with the monitoring and sanctioning issues that often plague collective action problems. If these could be overcome, many institutional forms could be used, including a ‘cap-and-trade’ regime between countries, modelled carefully by CGD as depending on  the global ‘carbon budget’ – the finite amount of CO2 that can safely be released before catastrophic climate change occurs. Cap-and-trade has well known advantages, and there are wider implications of this system worth noting. In this instance it is country governments who would trade excess permits with each other (rather than firms, as in the EU ETS). This means that the price of emissions rights would incentivise all countries to implement policies to reduce emissions and invest in researching clean technologies, without further constraining the use of funds. In particular, the amounts paid to low-emitting countries selling excess permits would represent an additional fiscal resource to be distributed according to national priorities, while perhaps being subject to additional safeguards for countries with very weak public financial management systems. Both these effects of cap-and-trade would give countries significant freedom in setting climate policy, while retaining strong incentives to reduce emissions and invest in new technologies.

Carbon accounts calculated in this way have the clear advantage of simplicity. In practice, other factors could arguably affect the allocation of emissions rights too. For example, the figures here reflect the production of CO2, not its consumption. Nonetheless, this simple way of identifying which countries are in debit and which are in credit in their carbon accounts, and the possible fiscal implications, may be helpful to benchmark the outcomes of current negotiations. 

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