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Cross-cutting paper, Impact of CO2 taxes on GDP and emissions (Reyer Gerlagh and Stefan Schleicher)

This paper explores the effects of CO2 taxes on CO2 emissions, energy use, and GDP. It relies on a simulation exercise carried out as part of the TranSust network. In which eleven research partners cooperate on developing the next generation of economic models explicitly targeted to sustainability issues. For this paper, we grouped the models in computable general equilibrium (CGE), econometric, growth, and Energy System models. This break up allows us to see common patterns among models of the same kind, when assessing, for example, the marginal abatement costs of emission reductions. The aim of this study is to explore various models employed in Europe for the economic analysis of sustainability. For our information, we largely base our judgment on graphs on replies from the model makers to questions raised during various project meetings and contact by email. A more exhaustive comparison and assessment is an obvious objective of a future project to be defined.

We look at the (marginal) abatement costs from an aggregate perspective. More precisely, we define (marginal) abatement costs as the GDP loss (per ton CO2 reduced), following Weitzman and others who argue that GDP is the most proper measure available for welfare when measuring at one instant in time only (Weitzman, 1976). We note that our (marginal) cost estimates deviate from private (marginal) costs of emission reductions, where the latter is better captured by the level of carbon tax or the price of emission permits, since these price signals measure the marginal costs with which the individual is confronted, when deciding to emit more or less carbon. In addition we focus on the mechanisms of emission reductions. We analyze the paths for the carbon intensity of energy and energy intensity of output for different carbon tax scenarios. The issue here is whether emission reductions are achieved through energy savings, that is, an enhanced decrease in energy intensity, or through a switch from high-carbon to low-carbon fuels, that is, an enhanced decrease in carbon intensity, as a reaction to the imposition of a car-bon tax.

Whether emission reductions increase or decrease GDP cannot be linked to the model type, but is linked to the assumptions about how the income from the carbon tax is used. Only under tax recycling but not in all recycling schemes sometimes a double dividend is found. On the other hand, no model produced an increase in GDP without a smart tax-recycling scheme. The econometric models stand out as a group in two ways. First, emissions are relatively inelastic. Reduction levels reached through the common carbon tax scenarios are systematically lower for the econometric models, when compared to the other models. Second, and logically following there from, marginal income effects in terms of changes in GDP divided by changes in emissions are systematically higher.

As to the mechanisms of emission reduction, most models give an important role to energy savings. Some models also describe fuel switching between carbon-rich and carbon-poor fossil fuels, from coal to gas. Only a few models also describe the substitution of non-carbon fuels for fossil fuels, and in these models, decarbonization plays a major role for deep cuts in emissions.

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Economics School of Social Sciences
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