1. Carbon Tax Guide: A Handbook for Policy Makers
Introduction
Darragh Conway, Climate Focus
Overview for "Carbon Tax Guide: A Handbook for Policy Makers“
Webinar
March 5, 2017

2. Background: The making of the Carbon Tax Guide

3. Background Partnership for Market Readiness Carbon Tax Guide
Purpose of Carbon Tax Guide: A practical tool for policy makers to determine:
Whether a carbon tax is the right instrument to achieve their policy aims…
…and how to design and implement a carbon tax.
Primary target audience: policy makers in PMR Participant countries, but broader relevance to other jurisdictions, experts and civil society groups
Prepared by: Climate Focus; School of Public and Environmental Affairs, Indiana University; and Gnarly Tree Sustainability Institute
The purpose of the Carbon Tax Guide is to provide a practical tool for policymakers and other policy leaders and influencers that helps them determine whether a carbon tax is the right instrument to achieve their policy aims and to support them in designing and implementing a tax that is best suited to their specific needs, circumstances and objectives.
The Guide is expected to be of equal relevance to high-level policymakers and legislators, and technical experts in governments, the private sector, NGOs or international organizations who are directly or indirectly involved in the design and implementation of carbon taxes.

4. Key principles
Country-driven approach: the right design options will depend on national context and priorities.
Agnostic approach: options assessment and how-to tool – not promoting one approach over others.
These are the principles that were adopted early on and helped define the approach taken in the Carbon Tax Guide
It was recognized that, although some approaches may have advantages over others, there is never only one right approach, and governments in practice will need to adapt their approaches to the circumstances of their jurisdiction.

5. Expert review (countries, international organizations)
Methodology
Desk research
Questionnaires
Interviews
Expert review (countries, international organizations)
Desk research: both academic (theoretical) literature and empirical study of existing carbon taxes
Questionnaires sought to obtain insights on prevalence of different approaches taken by governments and, importantly, motivations and objectives behind these approaches. Seven full responses obtained – useful insight, if not comprehensive.
Interviews: more in-depth discussion of specific issues that are interesting in respective jurisdictions, e.g. where they have taken different approaches or have had particular success or challenges in a given area.
Expert review: both detailed outline (zero draft), second (advanced) draft and draft case studies were reviewed by multiple experts from governments, international organizations (World Bank, OECD, IMF, UNFCCC), NGOs (Green Budget Europe) and universities (University of Zurich).
All in all, input was provided from 16 national and sub-national governments,

6. Jurisdictions consulted
Questionnaires
Interviews
Case study review
France
Ireland
Japan
Mexico
Turkey
South Africa
Switzerland
Australia
Brazil
British Columbia
Chile
Costa Rica
Sweden
United Kingdom
Finland
India
List of jurisdictions that provided input to the Carbon Tax Guide, in particular the case studies prepared for the respective jurisdictions
Several jurisdictions that do not currently have carbon taxes but are considering adopting them were also interviewed. These interviews focused on their deliberation process, and identifying the main factors that are being considered for their decision.
Efforts were made by the authors and the World Bank to obtain feedback from all jurisdictions for which case studies were prepared; however, in some cases no responses were received

7. A Guide of Three Parts
The Carbon Tax Guide is comprised of three parts:
The main document, the Carbon Tax Guide, which includes the main substantive content, including the synthesis.
The synthesis, as a separate downloadable document.
The Appendix, which includes the detailed case studies of existing carbon taxes undertaken as part of the research for the Guide.
Available for download from:

8. The Carbon Tax Guide at a Glance

9. Introducing carbon taxes
What is a carbon tax?
“A carbon tax is a tax that explicitly states a price on greenhouse gas emissions or that uses a metric directly based on carbon (that is, price per tCO2e).”
Which can be described by the formula… x =
Carbon tax
Though several different definitions of carbon taxes have been formulated to-date, for the purposes of the Guide we adopt the following guiding definition, based on that used in the World Bank’s State and Trends of Carbon Pricing, as stated here.
While this definition is used as the guiding basis for the analysis in this Guide, it is also applied with some flexibility. Several jurisdictions have adopted taxes with the stated goal of furthering climate policy, even though the price is not directly linked to GHG emissions. A case in point is India’s Clean Environment Cess, which places a tax on coal. These taxes are for the purposes of this Guide also considered to in effect be carbon taxes. At the same time, some jurisdictions have adopted carbon taxes that, while linking the level of the tax to the carbon content of fuels, do not precisely calculate the tax for each fuel based on its carbon content, as is the case for example in Mexico. All of these taxes should nonetheless be properly considered carbon taxes, and are so considered in this Guide.
Other taxes, such as those listed here, may have the effect of incentivizing emission reductions, but are not properly considered carbon taxes.
What is not a carbon tax?
Excise taxes on fuel
VAT
Taxes on emitting goods (e.g. vehicles)

10. Carbon taxes in the world
This evolving map shows how carbon taxes have been increasingly adopted over time. In particular, it is worth noting how the initial strong interest was followed by a long period during which very few new taxes were adopted. However, from 2008 onwards there is an increased and sustained interest, with new taxes encompassing an increasingly varied collection of countries and jurisdictions.
Note that Under Consideration category includes jurisdictions where the government is known to be actively considering proposing or adopting a carbon tax. It is worth noting that this is a conservative measurement. It does not include, for example, the various US States where carbon tax bills have been proposed through a number of different legal processes. It also does include countries such as China, which is formally planning to adopt a national ETS, but is reported to also be considering adopting a carbon tax as an alternative. It is also worth noting that several countries have adopted or legislated their carbon taxes without any major prior announcements, e.g. Colombia, Chile.

11. Carbon tax design at a glance
The design process – depicted in this figure– typically begins with comparing policy options and determining whether a carbon tax is the right instrument to meet the jurisdiction’s policy objectives. At this stage governments might also consider how the tax would fit in with the jurisdiction’s overall climate, energy and fiscal policy framework. Where it is decided to adopt a tax, jurisdictions often engage in preparatory work, defining specific policy objectives and thinking about the economic and institutional factors that will inform tax design. At this stage, jurisdictions will usually begin to consult and engage with stakeholders to understand their concerns and priorities.
Moving from preparation to design, there are five central design questions to consider. While each raises their own set of questions and decisions, there are a range of linkages between them (lower part of the figure), and designing the tax as a whole has many advantages. For instance, governments considering what is the right tax rate to support meeting a given emission target need to at the same time consider which sectors and emissions the tax will be applied to. Similarly, revenue use decisions can be designed to help win the support needed for a broader tax or a higher rate.
Throughout the process, economic modeling can be used to provide insights regarding the potential impacts of a carbon tax and of different design options on different policy goals. Modeling can also support the process of evaluation and review of the tax, which in turn leads into adjusting the various design elements based on how the tax performs in practice.

12. When is a carbon tax the right choice?
Carbon taxes have many strengths:
Market-based instrument – efficiency, flexibility
Stable, long-term price signal – investor certainty
Generate public revenues
Potential economic benefits
But suitability depends on context:
Most effective in more market-driven economies (and sectors)
Address economic barriers to mitigation (lack of incentive)
Policy mix – climate, energy, economic and fiscal policy
Carbon taxes have many strengths as a climate, energy or fiscal policy instrument. Nonetheless, they will be more suitable in some contexts than in others. Key factors include:
What are the main barriers to emission mitigation?
Carbon taxes work by putting a price on carbon, and so are a good choice to address situations where emitters do not have sufficient incentives to reduce emissions. Where there is a lack of mitigation opportunities available, on the other hand, non- price based policies may be needed to address the reasons these opportunities are not being capitalized upon.
What are the characteristics of key emitting sectors?
Carbon taxes are a flexible instrument that can be applied to a broad range of sectors, yet in some sectors applying a tax may be more challenging. Studying the emission profile of the jurisdiction and understanding the practical implications of applying a carbon tax in the key emitting sectors is therefore an important step in the decision-making process. The economic characteristics of the sector – for example how strongly the economy relies on markets – will also influence whether the price signal is likely to be effective in influencing emitters’ behavior.
Policy mix
Carbon taxes will typically form part of a larger climate, energy and fiscal policy mix. Understanding how these policies can complement, overlap with and counteract each other will facilitate effective policy design.

13. Setting the stage for carbon tax design
Policy objectives
GHG Emission Mitigation
Revenue raising
Low-carbon development
Fiscal efficiency
Defining policy objectives and having a clear picture of relevant national circumstances helps to support informed decision making
Policy objectives:
Firstly, it is important to define what broad policy objectives the governments seeks to achieve with the carbon tax
Secondly, it is important to identify specific goals within those objectives, e.g. what is overall mitigation target, are there specific targets per sector, what are trajectories etc.
Finally, governments will need to prioritise objectives and, in some cases, make trade offs between conflicting objectives
National circumstances:
Having a clear understanding of issues such as government capacities in relevant institutions, the economic structure of key sectors and the emissions profile of the jurisdiction can help understand the impacts and implications of different design choices dd
Government capacities
Economy
Emissions profile
National circumstances

14. Role of modeling Valuable tools to support decision making
Uses of models
Comparing carbon taxes to other instruments
Evaluating the broad impacts of alternative taxes
Determining sectoral responsiveness to carbon tax
Effects of tax rate decisions
Assessing potential effects on leakage and distribution
Modeling the effects of options for revenue use
Ex-post analysis of impacts
Types of models
Top-down
Bottom-up
Partial/ focused
Partial equilibrium models
Engineering cost studies
General/ systemic
Econometric and computable general equilibrium (CGE) models
Energy system optimizatio n models
Valuable tools to support decision making
Different models provide different insights – value of using multiple approaches
Time, resource and data intensive
Limitations: data, assumptions – use with caution
While many carbon taxes have been adopted without undertaking in-depth economic modeling, where sufficient data and resources are available models can serve as a valuable tool to help inform decision making. Models can help to gain insights into a range of issues that are relevant to carbon tax design, as listed here.
There are a range of different modeling tools available to jurisdictions seeking to answer these questions. They vary significantly in the approach they take, and each option comes with strengths and limitations that makes it more or less suited to answering different kinds of questions. The top-right table defines the different categories of models.
Despite their utility, models also have their limitations, and should be used only to provide guidance, not as the sole basic on which to make a decision.

15. Tax base – main approaches
In determining the base, a key distinction can be drawn between taxes applied on the import, purchase or sale of fossil fuels, and taxes on direct emissions.
Taxes on direct emissions can in turn be applied on a sectoral basis, to certain technologies or to certain processes
Most jurisdictions have opted for taxes on fuels, in large part because they are much easier to administer and in many countries can cover a large proportion of emissions. It is worth noting that the majority of carbon taxes that are not included on this list, such as those in Alberta and Colombia, are also applied on fuels.
However, it is important to note that many of the jurisdictions have actually applied carbon pricing both to fuels and direct emissions. The majority of the jurisdictions with taxes on fuels have an ETS that applies to direct emissions in industry and electricity generation. In addition, South Africa intends to complement its tax on direct emissions with a carbon tax applied to fuel used for transport. Mexico is also understood to be moving toward implementing an ETS in electricity generation and large industry, while keeping the carbon tax for other emissions.

16. Determining the tax base
Emissions profile
Emissions reduction opportunities
Responsiveness to price signals
Policy mix
MRV and administrative capacity
Political considerations
Legal authority
Determine scope
Determine point of regulation
In practice, the definition of the coverage across jurisdictions reflects a wide range of combinations of the approaches described above. This is because determining the right coverage is very context-specific and depends on a number of national circumstances (see further Chapter 3). Some of the most important of these are listed above.
In the case of taxes on direct emissions (as apposed to takes on fuels or other proxies), jurisdictions also need to decide how to apply legal responsibility for tax payment, and what thresholds to apply for inclusion.
For taxes on direct emissions:
Determine legal responsibility
Apply thresholds

17. Setting the tax rate Abatement target approach Revenue-target approach
Facilitates compliance with mitigation goals
Need for reliable MAC curves
Revenue-target approach
Social cost of carbon approach
Internalize social damage of GHG emissions
Economically efficient
Difficult to accurately calculate
Benchmarking approach
Benchmark according to:
Competitors in key markets
Similar economies
Countries with similar emissions profiles
International carbon prices
There are four main approaches to setting the original carbon tax rate, each of which is linked to different policy goals:
Abatement Target approach. Governments can set the tax rate so as to seek a certain level of emission mitigation. This approach is undertaken using marginal abatement cost curves, and so is reliant on the availability of sufficient and reliable information.
Revenue target approach. In cases where the jurisdiction is driven primarily by revenue raising associated with the carbon tax, the tax rate can be set so that it provides a specific level of revenue, though within constraints dictated by supply and demand. In the diagram shown here this effect is depicted as shifting the cost of production up, moving the supply curve from S to S’. Before the tax, the supply and demand curves, S and D, intersect at a point corresponding to the market price and quantity, P and Q. With the new, higher supply curve, S’, the new point of intersection is P” and Q’. The tax revenue is, therefore, the product of the tax rate, T, and the new (lower) quantity, Q’, i.e., T x Q’. These figures shows how the tax revenue (shaded area) changes with different levels of tax. Given an initial “medium” carbon tax (upper graph), there will be an expected revenue. It might be possible to increase the revenue by increasing the tax, but only within a range. The center and lower graphs illustrate that either very low or very high taxes, respectively, can lead to lower tax revenues.
Social cost of carbon approach. The “social cost of carbon” (SCC) approach involves abating emissions at a level that is consistent with the economically efficient use of resources, thereby balancing the costs and benefits of GHG emission abatement. The broad range of estimates associated with the SCC can prove challenging for jurisdictions that want to adopt this principle for setting carbon taxes. In practice, while several governments have calculated the SCC as an input into their policymaking processes for cost-benefit analyses, they have not tended to use them for the purpose of setting a carbon tax rate)
Benchmarking approach. Additionally, jurisdictions can benchmark according to tax rates in jurisdictions with similar circumstances or those who are competitors in key commodities affected by the tax. Alternatively, jurisdictions that have an ETS may choose to make some link between the carbon tax rate and the ETS price, for example through setting a limit on the differential between them at any given time.

18. Setting the price trajectory
Pre-defined increments
Increases pre-defined in legislation or policy
Provides certainty and facilitates investment
May be less flexible to changing circumstances
Examples : British Columbia, France, Sweden
Formula-based adjustments
Formula linking price with external circumstances, e.g. compliance with mitigation goals
Can link price to policy goals
Balance flexibility with predictability
Examples : Switzerland
Periodic revision
Annual or multi-annual revision by government or committee
Facilitates adapting to policy needs
Less certainty
Examples : Ireland
Ad-hoc revision
No revisions programmed
Less certainty
Revisions may be politically challenging
Examples: Mexico, Chile
The majority of jurisdictions have started with a relatively lower rate and increased this over time. This has been highlighted as an important factor in gaining support for the tax and providing industries and consumers time to adapt their behavior to the price signal, as well as being economically efficient.
Where possible, defining the trajectory of the tax rate – at least in broad terms – or linking the rate to external factors such as progress in meeting emission reduction targets helps to provide the certainty needed to invest in low-carbon technologies. It can also be valuable where rate increases would otherwise require new legislation or be subject to challenging political processes.
This slide shows the four main approaches to setting the trajectory and indicates their main pros and cons.
Many jurisdictions emphasize benefits of increasing carbon tax rate over time:
Allow market and economy time to adjust
Progressively increasing incentive

19. Avoiding unwanted effects
Carbon leakage
Emissions in the taxing jurisdiction are offset by an increase in emissions in jurisdictions without equivalent climate policies in place
No significant evidence of leakage occurring in practice
More relevant for taxes that include industry
Short-term vs. long-term competitiveness
Distributional impacts
Carbon tax falls disproportionately on certain groups, esp. vulnerable groups (e.g. low-income families, elderly, disadvantaged regions)
Most relevant for taxes targeting consumers (transport and heating fuels; electricity)
Impacts very context dependent, and so are value judgements (‘positive’ or ‘negative’
Leakage
There is little ex-post evidence of leakage occurring. It is generally accepted that other business costs will typically be far more significant determinants of competitiveness than carbon pricing
Short-term vs. long-term competitiveness: Losses in short-term competitiveness (and potential associated leakage) may be compensated by long-term competitiveness gains associated with being an early mover in adopting efficient forms of production.
Leakage tests: the criteria used to determine leakage risk (and consequent eligibility for leakage mitigation measures) have to-date mostly focused on two criterial: emissions intensity and trade exposure. However, a number of other criteria are relevant and integrating them may help provide a more accurate test of leakage exposure. They include: cost pass-through capacity, competitiveness of sector compared with other jurisdictions, level of carbon pricing or other energy taxes in competing jurisdictions and the mobility of capital.
Distributional impacts
Effects are very context dependent: in some countries carbon taxes may be progressive, falling disproportionately on high-income households. In others, they can (without compensating measures) be regressive, falling disproportionately on low-income households
Modeling can help predict (ex ante) and evaluate (ex post) impacts

20. Measures to address unwanted effects
If jurisdictions determine that significant risks of leakage or negative distributional impacts exist, there are a range of measures available to mitigate those risks, as set out in the table here. It is important to carefully consider which measures are more effective. Measures that exempt or reduce the amount of carbon tax paid by certain entities essentially eliminate or reduce the price signal, and are therefore highly detrimental to the environmental effectiveness of the tax. Linking support measures to other factors such as outputs or the adoption of clean technologies are often more environmentally effective approaches.
Eligibility criteria: the criteria used to determine leakage risk (and consequent eligibility for leakage mitigation measures) have to-date mostly focused on two criterial: emissions intensity and trade exposure. However, a number of other criteria are relevant and integrating them may help provide a more accurate test of leakage exposure. They include: cost pass-through capacity, competitiveness of sector compared with other jurisdictions, level of carbon pricing or other energy taxes in competing jurisdictions and the mobility of capital.
Different impacts on revenue and environmental effectiveness
Importance of defining eligibility narrowly to avoid limiting effectiveness – going beyond emissions intensity and trade exposure

21. Determine use of revenues
Revenue neutrality
Rebates to households or businesses. Simple and transparent, and potentially politically popular.
Reductions in other taxes. Economically efficient and potentially politically popular.
Increased spending
General budget. Fiscally efficient; Often only permissible option, but can be room for spending guidance.
Earmarks. Climate or other specific uses. Provides certainty, but less efficient.
Debt reduction. Potential long-term benefits (reduced interest payments).
Forgoing revenue by permitting offsets. Cost containment, but reduced revenues.
There are three broad strategies available to governments deciding how to use carbon tax revenue: revenue neutrality, increased spending (including on debt reduction) and foregoing revenue by permitting entities to surrender offsets in lieu of tax payments:
Revenue neutrality can be achieved by returning revenues to households and businesses through direct rebates. These can be provided equally to each taxpayer or targeted at specific groups such as low-income households or trade-exposed businesses. Revenue neutrality can also be achieved by using the revenue to reduce other taxes such as labor or corporate taxes. This approach is commonly considered to be the most economically efficient way to use carbon tax revenue, although in some contexts increased spending or reducing public debt can also have important economic advantages.
Where governments decide to use revenue to increase spending they may direct it toward the general budget or earmark it for specific purposes such as supporting environmental programs or increasing welfare support. Even funds deposited in the general budget may eventually be used for specific purposes linked to the tax. Other jurisdictions may use the funds for reducing the deficit or paying off national debt.
Governments can also decide to forego part of their revenue by allowing taxpayers to surrender offsets as a substitute for paying (part of) their carbon tax obligations. Where domestic offsets are used, this has the effect of re-directing funds from the government (tax revenues) or sectors covered by the tax to non-covered sectors (investment in emission mitigation), though how much funding will eventually be invested in non-covered sectors will depend on a range of factors, in particular the offset price.

22. Oversight and compliance
Relative administrative simplicity of carbon taxes – existing systems and structures
Design choices impact institutional needs
Sectoral scope – Taxes on direct emissions require MRV
Complimentary policies
Maximizing compliance:
Designing for compliance – simple, transparent and tailored to local context
Effective penalties
One of the advantages of carbon taxation as a policy option is that jurisdictions will already have a revenue collection framework and a revenue body in place, and to the extent possible, jurisdictions will seek to align the administration of a carbon tax with existing frameworks and institutions.
Nonetheless, additional capacities are often needed, and in particular where more complex designs are in place. Downstream taxes on direct emissions will also require the development of systems for the accurate measurement, reporting and verification (MRV) of emissions. Including additional features, such as measures to address unwanted effects or provide flexibility, will in most cases require additional institutional capacities to manage these programs.
Existing systems for ensuring compliance with tax obligations – including audit procedures and penalties for non-payment – will also often be used for enforcing the carbon tax. At the same time, compliance can also be encouraged in the design of the tax itself, for example through simplicity and transparency and matching design with government capacities.

23. Oversight and compliance – main responsibilities
The functions for administering a carbon tax can broadly be understood under three headings: determining tax liability, overseeing tax administration and tax enforcement. The figure in focus here identifies the main tasks that can be expected to arise in each of these areas. The figure that is presented briefly but not focused on shows the links between tax implementation and the policy formulation and rulemaking stage. These latter functions tend to follow the general policymaking procedures in each jurisdiction, and these are not considered in detail in the Guide.

24. Design choice interactions
While each design element raises their own set of questions and decisions, there are a range of linkages between them, as shown in this figure, and designing the tax as a whole has many advantages. For instance, governments considering what is the right tax rate to support meeting a given emission target need to at the same time consider which sectors and emissions the tax will be applied to. Similarly, revenue use decisions can be designed to help win the support needed for a broader tax or a higher rate.

25. Evaluate and review
Rationale: Assess progress and facilitate adaption and improvement: “learning by doing”
Carbon taxes are often characterized by “learning by doing”, and getting the design right will often require jurisdictions to make adjustments over time. As such, after implementation of a carbon tax jurisdictions should plan to conduct reviews of program performance and impacts. They may also choose to build procedures for adjustments into the process.
There are a number of different types of review and each has a respective role in the policymaking process. Impact evaluations assess the performance of the tax and support the other reviews; comprehensive reviews are designed to amend fundamental elements of the carbon tax; while regular reviews to amend administrative or technical elements of the carbon tax. Jurisdictions will often try to design impact evaluations to feed into comprehensive reviews and allow for evidence-based decision making. Jurisdictions should also identify a process for making adjustments where needed. Minor adjustments may be delegated to administrative authorities or even programmed to occur automatically, while more substantial adjustments might be reserved for legislators.

26. Approaches to adjustments
Automatic adjustments
Link adjustments to specific factors, e.g. meeting mitigation targets, inflation, GDP;
Predictable and transparent, but inflexible
Administrative adjustments
Delegate responsibility for certain adjustments to agencies or executives
Useful for adjustments involving administrative procedures, appeals processes, MRV programs, and conflicts with other statutes and programs.
Legislative adjustments
Often used for major adjustments, e.g. coverage, exemptions
Often slow and less predictable
A primary reason to conduct reviews is to identify opportunities for adjustments to the carbon tax program. There are various approaches to managing the modification process, and these are set out in this slide.
In both the review process and management of adjustments to the carbon tax design, policymakers should be aware that covered entities benefit from predictability in their tax liabilities. For this reason, jurisdictions should seek review and adjustment processes that balance both flexibility to respond to experience and changes in circumstances, and provide as much predictability as possible. Systems with clearly defined processes and responsibilities for review and adjustment will tend to provide “predictable flexibility.”

27. Conclusions Can greater cooperation facilitate stronger ambition?
Renewed and growing interest. Sustained momentum over last decade
(Almost) three decades of experience. Large knowledge base
Flexible and adaptable. Increasing variety in designs and approaches
Multiple benefits. Well-designed carbon taxes can bring environmental, economic and fiscal benefits
Recent years have seen carbon taxes solidify their position among the foremost policy instruments for addressing climate change.
Experience over the past two and half decades has shown that, when designed well, they provide a powerful and efficient tool for reducing GHG emissions, raising revenue and achieving economic and development benefits.
The increasingly diverse range of designs that has emerged highlights that carbon taxes can be molded to fit each jurisdiction’s particular legal, economic and social context, and to fulfil a number of different roles within its overall climate, energy and fiscal policy mix. The increasingly diverse experiences also provide a large knowledge base from which other jurisdictions can build.
As countries begin to move toward implementation of NDCs assumed under the Paris Agreement, the momentum on carbon taxes seems likely to continue. As an increasingly
Greater coordination on carbon pricing also has the potential to increase their effectiveness in meeting policy objectives. Such cooperation could provide the conditions that allow governments to adopt carbon prices that are increasingly comprehensive and provide ambitious price signals that incentivize the transformational shifts in investment patterns needed to move toward truly low-carbon development paths.
Can greater cooperation facilitate stronger ambition?