How to tax aviation and shipping emissions

The central focus of climate talks that concluded last year in Lima has been on building wide agreements to restrict national emissions of greenhouse gases. But some important emissions are hard to allocate to individual nations: Those from international aviation and shipping. These currently constitute about 4% (and rising) of global carbon emissions, and are subject to almost no charges. This current state reflects heavy resistance to such charges, from industry and many governments, but also tax competition: Taxing these sectors by any one country can be hard due to their geographic mobility and international nature.
Aviation fuels have only recently been included in the European Union’s Emission Trading System (EU-ETS), and only for intra-EU flights. International air tickets are largely untaxed in most countries, and zero-rated under the VAT. This surprises air travelers, given the taxes and charges they often see included in international air ticket prices; but most of these are user fees of some sort, for security or airport-related services. International shipping is also very lightly taxed, largely due to tax competition. Large ships can travel huge distances on a single fuel tank, and easily reroute to refuel more cheaply; and special regimes in shipping mean that the corporate tax burden can be much lighter than in other sectors. All this not only gives these industries an undue edge over other transport modes, but worsens climate problems.

Good for Revenue, Good for the Environment, Good for Economic Efficiency

In a recent article we show large prospective gains for the environment, government revenues, and in easing non-climate tax distortions, from imposing global charges on aviation and maritime emissions at levels that are a reasonable reflection of the climate damage they do. A global charge of $25/ton CO2 would raise around $12 billion from international aviation, and $25 billion from shipping.  The initial reduction in global carbon emissions would be modest (less than 5%), but environmental effectiveness would improve over time as charge levels are raised and cleaner technologies developed. Air ticket prices would increase by only 2-4 percent for a $25/ton CO2 charge. For international sea transport, most import prices would rise by less than 1%. And the gains simply from easing the anomalous tax treatment of these sectors can be significant.

There are many good uses to which this additional revenue could be put. Even after compensating lower income countries (LICs) to offset potential burdens, it could contribute substantially toward meeting high income countries’ commitments to mobilize $100 billion a year by 2020 for climate finance in LICs (linked). Given the conceptual and political difficulties in allocating emissions and revenue from border-crossing activities to particular countries, this seems a natural way to help collectively finance the commitments.

Which precise mechanism is used to price carbon emissions in these sectors—cap-and-trade or carbon tax—is less important than getting certain basic design features right. Keys here are to cover and thus discourage international emissions from the sectors as widely as possible, ensure the revenue potential is realized (minimizing free allocations of rights, or exemptions), and establish stable, predictable long-run carbon prices.

A carbon tax or ETS for international aviation and maritime emissions could be implemented in different ways. Collecting fuel taxes is fundamental for most governments; and activities in these sectors are subject to close tracking by oversight bodies (the International Civil Aviation Organization (ICAO) and the International Maritime Organization (IMO)). More serious challenges are to agree on carbon prices (and their revision), and design incentive and monitoring mechanisms to ensure that all do their part. Setting a minimum rather than harmonized carbon price might help to encourage participation. Experience also shows that agreements can more easily be reached among smaller groups of countries rather than globally, with the hope of forming a basis for later expansion.

Managing the Politics

The main obstacles to progress are political. One thorny issue is the UNFCCC principle of “common but differentiated responsibilities” in climate policy. The relative ease with which fuel price differences can be exploited in these sectors  means that wide participation in such pricing schemes is needed for them to be effective (especially for shipping, where tanking in alternative jurisdictions is easy). This raises the possible need to compensate developing countries (which account for at least a third of emissions from each sector) for the higher costs, in order to induce their participation. That could be accomplished if developing countries’ governments keep their domestically collected aviation fuel taxes. (This might even over-compensate them, as airlines’ costs may well be largely passed forward to high-income passengers at tourist and business hub destinations.) For shipping, rebates could be in proportion to countries’ value or volume shares of global maritime trade.

It was only after a long political struggle that carbon emissions from intra-EU fights were finally included in the EU-ETS. The ICAO is now scheduled to propose a global aviation emissions charge scheme by 2016. But further progress with practical implementation has been slow, with widespread resistance to simple tax measures, and demands that revenues be allocated largely to the respective industries. A deeper engagement of finance ministers from large emitters could help mobilize the process, while providing them a way to address a part of current fiscal revenue shortfalls. Seriously addressing these issues before the Paris COP this year would represent a great advance for the global climate policy agenda.

This post first appeared on The World Bank Let’s Talk Development Blog. 

Publication does not imply endorsement of views by the World Economic Forum. 

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Author: Jon Strand is a senior economist in the World Bank Development Research Group’s Environment and Energy Team.

Image: An aircraft comes into landing during sunset at East Midlands airport. REUTERS/Darren Staples