Dynamic Carbon Leakage and Taxation with Depletion and Discounting

Florian Habermacher: This treats various aspects of unilateral carbon taxation in presence of exhaustible fuels. A method to disentangle terms-of-trade and pollution components of the committed optimal unilateral tax on exhaustible fossil fuels is provided. The method is used to replicate the optimal dynamic green tax path in a numerical model. We discuss de nitions of leakage rates and their relation to optimal taxation and welfare. It becomes apparant that leakage e ects are crucially related to intrinsically dynamic aspects such as the time discount rate and future technological and political developments. In a calibrated, dynamic fuel market model with empirical fuel extraction cost curves we study leakage and optimal unilateral tax paths for the OECD. They vary strongly with model assumptions. The strong curvature of marginal oil extraction costs from empirical estimations, and coal liquefaction providing a dirty backstop speci cally for oil, as well as a clean backstop for fossil fuels tend to have strong e ects on the evolution of leakage rates. Leakage e ects can be very large, even if future emissions are discounted. The rates di er strongly across fuels and optimal unilateral oil and coal taxes can have opposite signs; not much is left of the idea that carbon taxes should be uniform. Notably, liquefaction can lead to negative leakage rates from oil emission reductions and consequently optimal oil emission taxes above the WTP for global emission reductions. In presence of an endogenous clean backstop, in contrast, oil savings tend to prolongate the fossil fuel era and increase global fossil fuel emissions. This can imply leakage rates above unity and negative optimal unilateral oil emission taxes, whilst for coal, limited leakage warrants positive taxes. Green Paradox e ects tend to lead to increased present value emissions for anticipated taxes. That the welfare relevant leakage rate even for current taxes varies so strongly with discounting and longer term developments causts doubt on the bulk of the existing leakage literature which limits the attention to the next few decades and hardly aggregates e ects of a current tax in terms of net present value.