NARRATION TRANSCRIPT

MODULE 2:
PREPARING FOR CARBON TAX ADOPTION

FRAME 1

Welcome to Module 2 of the e-course on Carbon Taxation! In this module, we set out to differentiate
common policy objectives associated with carbon taxes, describe factors for framing the national
context and outline criteria for evaluating carbon tax design.

FRAME 2

The Paris Agreement entered into force on 4 November 2016. To date, over 160 parties submitted the
so-called Nationally Determined Contributions, or NDCs, which lay out what measures each
government is planning to take to mitigate and prepare for climate change.

About half of the NDCs explicitly mention carbon pricing, the large majority of which envisage some
type of international scheme. A smaller share of that group is considering domestic carbon pricing as
well.

FRAME 3

The Carbon Pricing Dashboard (developed by the World Bank with Ecofys) is a practical online tool
that visualizes existing and emerging carbon pricing initiatives.

Find out which countries are preparing for potential adoption of carbon pricing schemes with the help
of the online tool. For example, on the right side of the tool, under the “STATUS” section, click on
“under consideration”. On the map, you can zoom into the region of interest or click directly on a
country or sub-national jurisdiction to learn more about what the respective governments are doing.

FRAME 4

Consider Turkey and Vietnam. Both countries initiated formal deliberations on pricing carbon in their
jurisdictions. Despite their geographical distance, they are considering a similar approach. Which
one? Let’s explore with the help of the tool.

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FRAME 5

Before a government proposes the adoption of a carbon tax, it is important to engage in a process
which examines all available options and considers them in light of the relevant context.

Engaging in this process early on ensures that the tax is well-designed and responds to both policy
objectives and national circumstances. This shall enhance political acceptability of the tax and reduce
the likelihood that substantial overhauls will be needed in the future.

The three questions shown here are regarded as key before examining more technical details of
carbon tax design. It is important to note that they are closely related and, when designing a carbon
tax, they should be considered together. For instance, the principles of carbon tax design will
reinforce policy objectives, while policy objectives will be influenced by national circumstances.

FRAME 6

Within the course of this module, we examine main policy objectives, national contexts and principles
of carbon tax design.

FRAME 7

Carbon taxes have the potential to achieve a range of different policy objectives. The relative
importance a government places on these objectives is a crucial factor in informing policy makers’
design choices. An essential first step in carbon tax design is to clearly define the objectives the
government seeks to achieve through the tax.

While most governments considering the adoption of a carbon tax will have a fairly clear idea of high-
level objectives such as “reducing GHG emissions” or “raising revenue”, the definition of these
objectives should go further and consider the specific targets pursued within these general objectives
as well as their relative importance.

This section first discusses four main objectives that drive carbon tax adoption – GHG emission
mitigation, revenue raising, low-carbon development benefits and increased efficiency of the tax
system – and the specific objectives to be determined in each case.

Jurisdictions can pursue the four objectives in concert as they are not mutually exclusive. However,
given their interdependent nature, trade-offs may arise.

FRAME 8

With countries and subnational jurisdictions adopting quantifiable mitigation targets – whether as
absolute targets or as a range of relative and intensity-based targets – carbon taxes are becoming an
increasingly prominent policy tool to achieve them. The more specific an emissions objective pursued
is, the better the tax can be designed to support it.

The first and most obvious specific objective a jurisdiction must determine is the emissions target it
seeks to achieve and over what time frame it is pursued. Most countries have already defined such
targets as part of their Nationally Determined Contributions, as well as through national or subnational

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climate policies and strategies. Targets may apply to the whole economy, to specific sectors only or to
both.

FRAME 9

A second feature to determine is the emissions trajectory the jurisdiction seeks to achieve over time
or, in other words, the rate at which it wishes emissions to decline, or the date by which emissions
should peak, plateau and subsequently decline. The two figures illustrate potential emission reduction
trajectories in jurisdictions with the same absolute emission reduction target.

While in country A, emissions are reduced gradually from the base year (2015) to the target year
(2030), in country B, emissions rise slightly, before peaking, plateauing and then declining to the
target. Naturally, in country B, the decline happens much faster once it sets in because it needs to
compensate for the country’s growth since 2015 to be able to meet the same target. In addition, its
total emissions over the period 2015-2030 are substantially higher than in country A. Since the
intended trajectory affects how much emission reduction a jurisdiction seeks to achieve over a period
of time, it influences the modalities of a carbon tax over time. For instance, a jurisdiction may expand
the tax to more sectors or gradually increase the tax rate to achieve a certain emissions trajectory.

FRAME 10

As well as defining the emission reduction target and trajectory, it is important for policy makers to
consider the role or contribution of the carbon tax in achieving the target. Carbon taxes can be the
central instrument or a complement to a range of policies to achieve mitigation objectives.

It is common for countries and subnational jurisdictions to tax goods and processes that produce
greenhouse gas emissions. Think of electricity or excise fuel taxes for example.

Originally, some of these taxes may have been designed to raise revenue rather than reduce
emissions. For example, in the past, fuel taxes usually added a certain amount on the price of a liter
of fuel rather than linking the tax to the carbon content. Given that, in effect, such taxes disincentivize
emitting activities, they are commonly included in the so-called “effective carbon rate”.

For instance, by calculating the effective carbon rate, jurisdictions can understand the interactions of
these different instruments in creating a price signal for a given sector. The effective rate is the sum of
energy taxes, carbon taxes and ETSs costs on a given fuel.

FRAME 11

The better a jurisdiction can define what policy mix it will use to achieve its objectives in various
sectors, the better positioned it will be to define the carbon tax in a way that fits its intended
contribution.

However, using multiple policies in parallel in the same sector to create financial incentives can be
inefficient as they increase administrative costs. Governments sometimes do this because, for
example, the incentive of any one alone is not enough, or they want to balance instruments that raise
revenue with those that cost money, or they have to meet multiple objectives.

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FRAME 12

Broadly speaking, raising carbon tax revenue can have two motives. One relates to generating
additional revenue, for example to support general government spending or specific purposes. The
other motive is to use carbon taxes as a substitute for other sources of revenue.

Several jurisdictions have adopted “revenue-neutral” carbon taxes since they allow them to reduce
taxes in other areas, for example labor or corporate taxes.

Revenue-neutral designs are sometimes framed as environmental tax shifts. Such tax shifts evoke
the idea of taxing bads, such as air pollution, rather than goods or desirable outcomes, such as labor
or income.

FRAME 13

Within the broad objective of raising revenue, two questions stand out:

 How will the revenue be used?

 How much revenue is sought for each specific area of funding?

The responses to these questions affect the design of a carbon tax. Let’s see how in the next two
sections.

FRAME 14

Governments have used resources for a wide range of purposes. The decision to use revenue for an
explicit purpose is usually informed by a specific rationale. Can you match purposes and rationales for
the cases presented?

FRAME 15

The amount of revenue sought will have an impact on carbon tax design. For example, where
significant revenue is sought, governments may choose to include more sectors, or those with the
highest level of emissions and/or highest ability to pay.

FRAME 16

Besides the central objectives of emissions mitigation and raising revenue, several jurisdictions cite a
range of aims relating to low-carbon development or environmental protection as additional objectives
behind the introduction of a carbon tax.

In many developing countries, incentivizing the development of new or nascent economic sectors or
addressing local environmental issues are often more immediate and pressing political objectives
than greenhouse gas mitigation.

Carbon taxes can support these and other policy objectives in two major ways. Firstly, they can
provide an incentive for shifts in behavior and investments. Think of carpooling, higher usage of public
transportation or investments in renewable energy and the retrofitting of buildings.

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Secondly, they can raise revenue that can be used to fund programmes or incentives that further
support those aims. Examples include financing innovative pilot projects in the transport sector or
installation of smart meters in homes that optimize electricity usage.

Importantly, these two effects can be mutually reinforcing. The incentive provided by the tax combined
with the incentives funded by tax revenue work like carrots and sticks that support the government’s
policy.

FRAME 17

Carbon taxation can be a powerful trigger to improve the efficiency and effectiveness of the tax
system. But what does that mean? Looking at the benefits presented here, can you distinguish actual
and false benefits in relation to the tax system?

FRAME 18

As carbon taxes have been in use for over two decades, there is evidence suggesting lower tax loss
levels for carbon and similar taxes on fuels, as compared to most other taxes.

FRAME 19

Having defined the policy objectives sought by the carbon tax, it is important for policy makers to have
a clear picture of the relevant national context. Country circumstances affect a wide range of
decisions, from whether to adopt a carbon tax, to determining the tax design options that are best
suited to the jurisdiction.

In your view, what are major country circumstances to consider around decisions on carbon taxes?
Write them down in the notebook!

We will come back to this later.

FRAME 20

Early consideration will be particularly important for circumstances that are not immediately obvious
and therefore require further investigation. Major factors are government capacity, the economy’s
emissions profile, economic context and political feasibility.

These factors will have the greatest influence on carbon tax design.

FRAME 21

Carbon pricing designs vary significantly in terms of their administrative complexity. Different carbon
taxes themselves require different degrees of oversight and monitoring.

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The determination of the required capacities has to be based on the needs of different design options.
For example, whether the tax is applied upstream on fuels or downstream on emissions significantly
determines administrative needs.

Similarly, adopting features such as offsets, conditional rebates or emissions trading systems will
require additional administrative capacities to flat-rate solutions.

On the other hand, studying the experience of jurisdictions with similar circumstances and speaking to
counterparts in those jurisdictions can also help to understand how these needs play out in practice.

Where it is not obvious that existing country capacities match up to the needs of given design options,
governments can use a range of capacity needs assessment tools, or integrate capacity building into
the design of the carbon tax.

FRAME 22

Before engaging in the details of carbon tax design, it is worthwhile for jurisdictions to do some
preliminary data gathering.

Mapping GHG emissions in the jurisdiction is central to determining where the largest emissions
sources are, and therefore where the tax may have the biggest impact on emission reduction and
revenue raising.

Jurisdictions’ emissions can be broken down by economic sector or by emission sector as defined by
the Intergovernmental Panel on Climate Change, or IPCC.

The more disaggregation is possible in mapping emissions, the more useful it will be for policy makers
deciding on what to direct the carbon tax at.

FRAME 23

To better understand the potential impact of a carbon tax on emissions, jurisdictions can engage in
economic analyses, which can range from simple study of elasticity of demand in key markets to
advanced modeling of the entire economy, thus capturing the interaction across sectors.

When using price signals as an instrument, policy makers need to ensure that prices are indeed
formed by liberal markets. Some jurisdictions have therefore introduced carbon taxes together with
broader liberalization of the energy sector.

FRAME 24

In jurisdictions with high public concern over climate change and support for green industry, carbon
taxes can enjoy significant public support. However, carbon taxes can be unpopular in jurisdictions
where addressing climate change is a lower priority and the tax burden is already considered to be
high.

It is therefore worthwhile for jurisdictions to conduct a general assessment of the political climate
through stakeholder consultations before deciding to move forward. Continuous assessments
throughout the process of designing, adopting and reviewing the carbon tax are also useful.

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FRAME 25

There are concrete design options that policy makers can choose to increase acceptance among
stakeholders. Consider the choices shown here. Experience with carbon taxes suggests that some of
them are particularly conducive to foster public acceptance. Can you tell which ones?

FRAME 26

We have reached the end of this section. Remember the factors you wrote down in the notebook? To
summarise, let’s compare them with the discussion in the previous sections.

FRAME 27

As discussed in the previous sections, jurisdictions can prepare for the carbon tax design process by
identifying and prioritizing their objectives, and by clarifying the salient elements that define the
national context for the new tax. In addition to this, it is useful for governments to have a set of criteria
to evaluate alternative carbon tax designs that will meet their policy objectives.

The Organisation for Economic Co-operation and Development and the World Bank have developed
a set of principles to guide carbon pricing design generally – the FASTER principles.

While the principles provide a solid foundation, they are not necessarily exhaustive. Policy designers
will need to add or customize principles to their jurisdictions’ specific contexts, including their social
values, priorities and circumstances. For example, legal feasibility may be relevant to determining
whether a particular design option is permitted by relevant national laws and administrative structures.

FRAME 28

How can policy designers use the principles in practice? Consider the following series of questions.
Each one of them specifies what challenges the FASTER principles seek to respond to during design.
Drag and drop the principles accordingly!