Working Paper

Carbon Tax Competitiveness Concerns: Assessing a Best Practices Carbon Credit

Feb 27, 2017 | Wayne B. Gray, Gilbert E. Metcalf

Summary

A "best practices" output-based credit on the corporate income tax for carbon tax payments could address competitiveness concerns while also providing incentives for capital investments that lower the emissions intensity of firms within sectors.

Key Findings

  • There is considerable variation across sectors in both their average emissions intensities and the shape of the within-sector distribution of those intensities.
  • Controlling for variation across industries and regions, establishments that are older, larger, and less productive tend to have higher emissions intensities.
  • Carbon credits could provide compensation for firms in energy-intensive, trade-exposed sectors, with considerable variability in the share of carbon taxes returned across sectors, depending on the within-sector distribution of emissions intensities.
  • Output-based credits are likely to create better incentives for firms than a deduction on the corporate income tax for carbon tax payments. The latter reduces the marginal incentive of the carbon tax by the corporate income tax rate—by over one-third.
  • These carbon credits are large enough in some sectors, relative to sector-average corporate income taxes owed, that firms in many sectors would not be able to utilize all of their carbon credits, even under the less generous rebate plans.
  • Within sectors, there is considerable variability across firms in the ability to use their carbon credits, but much of this variability derives from firms that have zero or negative tax liability, who wouldn’t be able to use any carbon credits anyway.

Abstract

This paper considers how industry-focused revenue rebating could be used to address competitiveness and leakage concerns arising from a unilaterally imposed carbon tax. Building on previous work, it investigates how firms in specific energy-intensive, trade-exposed (EITE) sectors would fare under various carbon crediting approaches. Specifically, it focuses on the use of output-based carbon credits tied to best practices in the sector and considers its efficiency and administrative characteristics. It also investigates whether firms have sufficient tax appetite to use such a credit. Our analysis shows that there is considerable variation across sectors in average emissions intensity as well as variation in the shape of sector-specific intensity distributions. Establishments that are older, larger, and less productive tend to have higher emission intensities. A "best practices" carbon credit for firms in EITE sectors could provide compensation for firms and mitigate competitiveness issues to some extent. Some firms, however, would not be able to utilize all of their carbon credits due to insufficient tax appetite. The share of unused credits falls with the stringency of the rebate plan. We also compare crediting with deductibility and find the latter has weaker incentive effects for reducing emissions.