We propose a global refunding scheme as a new international approach to addressing climate change. A global refunding system allows each country to set its carbon emission tax, while aggregate tax revenues are partially refunded to member countries in proportion to the relative emissions reduction they achieve within a period. Nationally determined environmental policies and global refunding create increasing incentives to reduce emissions and may achieve e±ciency and equity objectives of global climate policy.

Hans Gersbach

English

Research Papers in Economics

CER-ETH - Center of Economic Research at ETH Zurich
Economics Working Paper Series
Eidgenössische Technische Hochschule Zürich
Swiss Federal Institute of Technology ZurichThe Global Refunding System and Climate
Change
Hans Gersbach
CER-ETH - Center of Economic Research
at ETH Zurich and CEPR
Z¨ urichbergstrasse 18
8092 Zurich, Switzerland∗
This version: December 2006
Abstract
We propose a global refunding scheme as a new international ap-
proach to addressing climate change. A global refunding system allows
each country to set its carbon emission tax, while aggregate tax rev-
enues are partially refunded to member countries in proportion to the
relative emissions reduction they achieve within a period. Nation-
ally determined environmental policies and global refunding create
increasing incentives to reduce emissions and may achieve eﬃciency
and equity objectives of global climate policy.
∗I would like to thank Clive Bell, Juergen Eichberger, Martin Hellwig, Till Requate
and workshop participants in Frankfurt and Heidelberg for helpful comments.1 Introduction
The threat of climate change to the well-being of future generations appears
to be substantial. A host of scientiﬁc studies indicate that, together with
other human-induced greenhouse gas emissions, cumulated carbon dioxide
emitted by the burning of fossil fuels is leading to warmer surface tempera-
tures. Higher temperatures can have a signiﬁcant impact on the functioning
of ecosystems and the well-being of future generations. Although most cur-
rent estimates of the marginal damage costs of carbon dioxide emissions
suggest that very stringent abatement does not pass the cost-beneﬁt test,
such estimates are incomplete and may not capture some of the downside
risks.1 In particular, the probability of large-scale damage appears to be not
negligible (see e.g. Goulder and Pizer (2006), Stern (2006) and Tol 2006)).
As greenhouse gases tend to disperse themselves uniformly around the
globe and emission reduction is thus a global public good, international co-
ordination is crucial. It is, however, diﬃcult to achieve. The Kyoto Protocol,
the ﬁrst large-scale eﬀort to reduce greenhouse gas emissions, has been crit-
icized for being ineﬀective (see e.g. Nordhaus (1999), Boehringer and Vogt
(2003), Schelling (2002), and McKibbin and Wilcoxen (2002)). Since it limits
trading to a small part of the world and ignores the intertemporal dimension,
the Kyoto Protocol promises only modest progress in slowing global warm-
ing. We suggest an alternative international framework that allows countries
to determine their climate policy at a national level, but which creates static
and, in particular, powerful dynamic incentives for abatement through global
refunding, as outlined in the next section.
1Some of the missing impacts are likely to be positive, others are negative, and the
impacts vary considerably across regions (see e.g. Tol (2006)).
2Refunded emission payment schemes for particular industries within a
country have been justiﬁed in Gersbach and Requate (2004). They show
that such schemes can yield ﬁrst-best outcomes under imperfect product
market competition if the marginal damage from pollution exceeds output
distortions.2 Refunding of emission taxes has been applied, for instance, in
Sweden, for nitrogen oxide (NOx) emissions from large stationary sources.
We propose a global refunding scheme for countries in which each country
has discretion over its emission tax.
Our proposal represents an alternative to the Kyoto Protocol. Various
other approaches to international coordination have been suggested. These
are comprehensively discussed and assessed in Aldy, Barrett, and Stavins
(2003) and Nordhaus (2006).3 The distinguishing features of our proposal
are: nationally determined environmental policies, global refunding, and ac-
celerating incentives to reduce greenhouse gas emissions over time.
2Gersbach (2002) shows that a self-ﬁnancing tax-subsidy scheme can help to overcome
hold-up problems in regulation when investing, clean ﬁrms receive subsidies ﬁnanced by
taxes imposed on non-investing, polluting ﬁrms.
3Fundamental guidelines for treaty-making are derived in Sandalow and Bowles (2001).
32 The Global Refunding System
We propose to establish a global refunding scheme (henceforth GRS) that
works as follows:
• Countries decide whether they want to join the GRS. A country joins
GRS if it accepts the rules and levies a minimal carbon emission tax.
• In each period, each country belonging to the GRS independently de-
termines its level of taxes on CO2 emissions. Emission taxes are the
sole policy instrument a country is allowed to adopt.4
• All tax revenues are collected in a global fund.
• GRS refunds each period a share of the accumulated wealth to the
participating countries.
• Each participating country obtains a annual refund in proportion to its
share in total CO2 emissions reduction achieved in the period under
consideration.5
• Non-refunded wealth of the GRS may either be saved and invested6 or
spent on particular projects in member countries to further accelerate
the reduction of greenhouse gases.
• In each period a country is allowed to exit. If a country leaves GRS, it
loses its right to refund.
• Decisions within GRS are governed by the majority rule.7
4This is initially a crucial condition. Later, it may be useful to abolish this requirement.
5To account for catching processes of developing countries and to avoid growth-harming
policies, one should adjust or normalize CO2 emissions by GDP growth. Several refunding
formulas are conceivable.
6It might be useful to focus on green funds.
7Various variants such as weighted and ﬂexible majority rules can be considered.
43 A Brief Assessment
In this section we brieﬂy assess the proposal. We follow the criteria outlined
in Aldy, Barrett, and Stavins (2003) for evaluating global climate policy
regimes:
1. environmental outcome;
2. dynamic eﬃciency;
3. dynamic cost-eﬀectiveness;
4. distributional equity;
5. ﬂexibility in the presence of new information;
6. participation and compliance.
We discuss the criteria in reverse order and start with the last criterion.
The advantage of the current proposal is that participation does not directly
imply high costs for member countries, as they have discretion over the emis-
sion tax beyond the minimal tax rate. Hence, the system is participation-
compatible. Moreover, GRS may make it easier for the United States to
participate. The system is also compliance-compatible. However, GRS re-
quires data on emission taxes and per-capita carbon emission levels among
member countries. On the one hand these data are diﬃcult to assemble and
on the other hand, they always leave scope for attempts to manipulate data
politically. This will ultimately require the creation of an international au-
thority that both controls and supervises data from member countries and
handles the refunding procedure.
The ﬂexibility of GRS is very high, as no targets or prices have to be
negotiated at the international level. The two parameters that govern the
5system are the minimal tax rate and the share of refunding, which can be
used to strengthen or weaken the incentives for member countries to reduce
emissions.8
Within GRS, distributional concerns can be addressed at two levels. First,
the refunding formula will have strong distributional implications. Depend-
ing on the refunding formula, either developing or industrial countries will
fare better.9
Second, wealth not refunded and accumulated can be used to support par-
ticular projects for reducing greenhouse gases in some countries.10 In general,
GRS is ﬂexible enough to allow for fairness concerns regarding the burden of
slowing global warming for the developing world. Of course, one has to be
aware that starting conditions in terms of CO2 emissions per capita or CO2
emissions per value added matter for the prospects to obtain refunds.11
Cost-eﬀectiveness is subsumed by dynamic eﬃciency, which is The most
important criterion. A global climate policy is said to be eﬃcient if it max-
imizes aggregate net beneﬁts over time. Any eﬃcient climate policy must
involve participation by all countries, with each country mitigating its emis-
sions to the point where its own marginal abatement costs equal the sum of
marginal beneﬁts globally. As there is high uncertainty regarding the esti-
mation of the beneﬁts and costs of global climate change, assessing eﬃciency
at a general level is impossible, and weaker criteria, such as the Kaldor-Hicks
8The question of the “optimal level of emission reductions” is the most diﬃcult and
controversial issue in the economics of climate change and estimates for appropriate price
penalties vary considerably (see e.g. Nordhaus 2006).
9Developing countries can beneﬁt from the system if population weights and emissions
reductions per value added are used in the refunding formula.
10A radical proposal would be to ﬁnance general support of developing countries by
GRS.
11Moreover, anticipation eﬀects could occur when countries wait with taxing emissions
until the scheme is implemented or the country decides to join GRS.
6criterion, are more appropriate in practical policy analysis. If we start from
the premise, supported by a variety of assessment studies, that a substantial
reduction of carbon emissions is eﬃciency-enhancing, then GRS is likely to
pass this test. Moreover, GRS scores high on helping to achieve broad par-
ticipation.
The near-term environmental eﬀectiveness of any new climate policy is
diﬃcult to assess. GRS is aimed at initially fostering participation and cre-
ating accelerating incentives for reducing emissions over time. Hence, the
environmental impact is expected to strengthen after the initiation of GRS.
Of course, this brief assessment cannot be a substitute for a more detailed
and analytical analysis of the system which we are developing.
4 Conclusion
As the current Kyoto Protocol appears to have little impact on global tem-
perature change, we propose a global refunding scheme as a new international
approach to addressing climate change. Since climate change is a global pub-
lic good there, are usually at best weak economic and political mechanisms
for resolving the issues eﬃciently and eﬀectively. The current proposal might
help to strengthen such mechanisms.
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