A Carbon Tax to offset excess emissions through the funding of renewable energy projects: Illustrated by the automotive industry
"If you cannot measure it, you cannot improve it."—Lord Kelvin
Carbon tax, as a GHGE mitigation tool, is widely expected to reduce energy use, improve energy efficiency, while at the same time stimulate the development of renewable energy. Yet, most carbon tax proposals today suffer from some shared defects, such as their propensity to slowing economic growth, decreasing social welfare, damaging the competitiveness of related industries and leading to carbon leakage .
Also, most carbon tax proposals lack a clear cause-to-effect line of sight on how carbon pricing will help reduce the overall emissions. Indeed most of the research on carbon tax impact on GHGE, relying on the concept of the Pigovian tax , was based on simulations of different scenarios, using mainly the so-called general/partial equilibrium approach  . Very few have carried out empirical studies of the impact of carbon tax, and those that did showed that carbon tax, as implemented in most countries, had by itself little to no significant long-term impact on GHGE reduction       . This impact is further reduced when it comes to meeting relatively short-term national GHGE targets such as the ones agreed to at the historical Paris Agreement.
What we propose is to have two separate carbon taxes; (i) a Carbon Tax for Emissions Target (CTET) applied only to excess emitters to fund short-term offsetting of excess emissions relative to the emission reductions targets, and (ii) a Carbon Tax for Emissions Damage (CTED), applying to all emitters and used towards longer-term GHGE mitigation and adaptation.
We present a mathematical model that cascades the national emission targets down to the industrial sectors and the individual firm within each sector, and offers the foundation for a novel tax proposal that is (i) goal-driven, (ii) science-based, (iii)equitable, (iv) comparable and (v) actionable.
Is this proposal for a practice or a project?
What actions do you propose?
We propose implementing two different taxes;
- one (CTET) of about $230/t of excess emissions that will be imposed on commercial emitters whose emission intensity exceeds the target intensity of their industrial sector. It will be used to offset the excess emissions through the sponsoring of renewable energy projects.
- another (CTED) of $30/t of all emissions that will be imposed to all the emitters regardless of whether they’re meeting the target emission intensity of their respective sector.
Setting the CTET:
The CTET amount of $230/t was set on the cost basis of a 10 kW PV solar panel system, at about $3.26 per watt, and which produces about 14 MWh of electricity . Assuming a depreciation of 20 years, it amounts to a system cost of about $115/MWh/yr of clean electricity ($32,600/20/14). Considering that it takes about 2 MWh of fossil-fuel produced electricity to generate 1 t-CO2-e, this sets the cost of offset to $230/t-CO2-e. The CTET could be further reduced by assuming a strategically appropriate mix that includes wind and geothermal which are 21% or 43% cheaper respectively . Assuming the mix of 72%, 21% and 7% for wind, solar and geothermal respectively as published by the EIA on April 2017, that would yield a CTET amount of $188/t-CO2 .
The second tax (CTED) is similar to the traditional flat carbon tax, which we propose here to set to a fixed $30/t, and which will be imposed on all the emitters at the point of sale. Those tax revenues could be be used for long-term climate mitigation and adaptation measures, such as additional subsidies towards large scale adoption of renewables, energy efficient buildings and households, research and development (R&D) investment, etc.
A key differentiator is that both taxes will be imposed in proportion to the company sales in the country in which the taxes are imposed, instead of in proportion of the actual GHG emissions in that country. This eliminates the possibility of carbon leakage by moving the company’s production facilities to so-called “pollution havens”.
How will it work?
We have started by assuming that the total GHGE of any given country is well known and measured in t-CO2-e. We restrict our emissions to Scope 1 and Scope 2 only. Scope 3 emissions are excluded to avoid double-counting.
In our analysis, we use the revenue-based emission intensity metric defined as the ratio of t-CO2-e to the operating revenues in millions of dollars ($M) generated at the entity level and at the overall sector level. While widely used in reporting frameworks such as GRI . emission intensity is currently neither explicitly recommended by GRI or being consistently adopted across firms or industry sectors.
We argue in this proposal that revenue is not only a fair and practical common denominator to use between companies within the same sector, it's also the most appropriate from four separate standpoints:
(i) Revenue is a proxy for external economic value-add, while GHGE is a proxy for the external environmental cost, GHGE/Revenues ratio becomes a proxy of a society-centric cost/benefit ratio. Other internal metrics such as units of production, EBIDTA or other forms of profit fail to capture the true external economic value created by the company. They also fail to offer the basis for an apple-to-apple comparison with other firms in the same sector.
(ii) From a practical aspect, revenue is a well-defined and readily available number that every company already tracks and documents according to global standards.
(iii) From an economic efficiency perspective, we argue that the traditional approach of carbon taxing based on absolute emissions creates disincentives that undercut its perceived efficiency. For example, asking every company to cut 30% of their emissions by 2030, or 2.14% per year, would unfairly penalize the fast-growing companies who might be grabbing market share from their higher intensity competitors thanks to their greener practices and more innovative technologies, and whose faster growth is actually driving a net decrease in emissions by the overall sector. This penalty could stifle innovation and slow down the growth of those companies, which in turn undercuts the policy’s impact overall.
Conversely, we believe taxing according to emission intensities would provide the right incentives, and create the right competitive environment for all companies within a particular sector to seek to match the emissions of the production processes of their benchmark competitor, which in turn will improve their competitiveness and align their economic performance with their GHGE’s, hence improving the sector’s overall economic efficiency.
Illustration of the Theoretical Framework
Referring the reader to our paper by Jackson & Belkhir  for the detailed mathematical details, we show below in Figure 1 a graphical representation of our theoretical framework.
Assuming $230/t for the CTET and $30/t for the CTED, the two carbon taxes are then assessed as follow:
CTET = 230*( RIi,j -1)* Ii,j* US-Revenues
CTED = 30* Ii,j* US-Revenues
We apply this model to the global automotive industry. We divide Scope 1+2 emissions of all the 10 companies studied, by their 2015 aggregate revenues, yielding a sector emission intensity of Iauto= 31.36 t-CO2-e/$M. In order to meet the US emissions target by 2025, assuming an average annual market growth of 3% through 2025 , the target intensity of the whole sector is shown in Figure (2) below.
Figure 2: Projection of the emission intensity of the automotive sector that is required to meet the US GHGE reduction target.
In Figure 3, we plot the emission intensities of the 10 auto makers against the projected sector intensity in 2015, 2020 and 2025 required for the sector to meet the 2025 US GHGE reductions target. We observe that 2 of the 10 (GM and Honda) are already exceeding their 2015 sector emissions intensity, while only 3 car companies meet the 2020 required intensity level. BMW stands out as the industry benchmark with an intensity level of 14.3 t-CO2e/$M beating even the 19.26 targeted for 2025. Indeed, a remarkable result of this approach is that it enables the easy identification of the sector leader.
Figure 3: Emission intensities for the 10 big auto makers in 2015, shown with the emission intensity of the automotive sector in 2015, along with the projected levels in 2020 and 2025 that need to be achieved by the sector as a whole in order to achieve the US target reductions of 25% by 2025 compared to 2005 levels. (Source: ET Index Research.)
Now, taking into account their US revenues, we show in Figure 4 the amount of carbon taxes each of the companies would have to pay. The total collected CTET revenues would amount to about $410M and $190M from GM and Honda respectively for a total amount of US$600M can fund the generation of about 5,230 GWh/year of clean energy, hence eliminating 2.613 Million t-CO2e every year from fossil-based electricity generation and keep the country on track of its carbon commitments.
Furthermore, the CTET is bound to create internal incentives for GM and Honda to drive them towards lower emission intensity. These could include a variety of strategic options, such as (i) benchmarking against the sector leaders, e.g. BWM and Daimler, (ii) investing in new greener technologies, and/or (iii) improving their production efficiencies, etc. to avoid the CTET tax. On the other hand, the traditional response of passing on the tax to the consumer is no longer a viable one, as it will only reduce their competitiveness, translating into far more losses. Moving to a pollution heaven is not an option either since the tax is assessed at the point of sale and not the point of production.
Figure 4: US-based Carbon Tax scenario that would apply in 2015 to some of the automotive companies with sales in the US (US sales data was not easily available for missing companies).
Per the same example above, the CTED tax would amount to a total of $458M that would be invested in R&D in green technologies, dividends for low to middle income families and possibly long-term adaptation measures for the most exposed areas and populations to climate change impacts.
As far as the practical implementation of this proposal, each company will be required to report the target emission intensity of its sector, its own emission intensity, its total scope 1+2 emissions, and its global and US operating revenues. The above will then be used to determine the CTET and CTED taxes and remit them to the IRS.
Is it Fair?
It may be argued that it’s not fair to use revenue as a denominator when comparing the emission intensities of high-priced luxury manufacturers with lower priced manufacturers, and make the case instead that the higher revenue per vehicle will tend to lower their emission intensity, hence providing the luxury manufacturers with an unfair advantage.
We tested this hypothesis by looking at the correlation between emission intensity and average vehicle price in US dollars of the 10 companies above for 2015. When including Daimler and BMW, we found a Pearson correlation coefficient of -0.64. It should be noted however that the data set (10 companies) is too small conclude that this correlation level is significant. For instance, Daimler’s average price per vehicle was 31% higher than that of BMW ($58,346 v. $44,620), yet its emission intensity was also 36% higher as well (19.5 v. 14.3). When excluding Daimler and BMW, the correlation coefficient drops to -0.04 (practically negligible).
Nonetheless, we repeated our analysis of the sector average intensity of the automotive sector, excluding BMW and Daimler. This yielded a sector average emission intensity of 36.36 t-CO2e/$M (up from 31.6t-CO2e/$M), which would reduce the US CTET tax on GM and Honda to $297.2M and $108.5M respectively, amounting to a total of about $406M. The CTED tax remains unchanged to $458M.
Is it Efficient?
One may also argue that breaking down emissions goals to sectors may be economically inefficient, as some high-energy consumption sectors, such as petroleum, may end up with a higher abatement cost than lower-energy consumption sectors. While this may be true, it is also true for the across-the-board tax that is based on absolute emissions. This inefficiency has led most countries with a carbon tax policy to provide some exemptions for high-energy consumption sectors, which in turn have undermined the impact of the tax on GHGE . Our CTET approach, on the other hand, taxes only the excess emissions of the firm relative to its sector, while holding the whole sector to a specific reduction curve. WE believe this approach will be more effective in stimulating the kind of competitive pressures, innovations and managerial behaviors that will enable the companies in any sector to bring their emission intensity in lockstep with the sector’s intensity or lower.
Staying on the Curve
Staying on or beating or beating their sector’s intensity curve becomes the name of the game for any related company. What does that mean for the automotive companies that we have analyzed? In Figure 5, we show the indirect impact of CTET in driving reductions in emissions for the total sector from 2015-2025. Our model forecasts a drop from 37 to 30.6 Millions t-CO2 from 2015-2025, or net reduction of 17.3% during that period.
Figure 5: Forecast of Total sector emissions based on the impact of the CTET tax.
Per our projections in the automotive sector, the CTET direct impact will be the elimination, through the financing of renewable energy projects, of about 31.14 Millions t-CO2 over the 10 year period, amounting to about 8.47% reduction in total emissions. In addition, we expect the indirect impact of CTET to drive down the sector’s emissions by another 17.3% by that same period, with a total net reduction amounting to 25.76%. This corresponds roughly to meeting the US commitments under Obama’s Clean Power Plan in half the time.
Who will take these actions?
For the US as an example, Congress will have to enact these policies, and mandate the IRS to assess and collect the taxes. Mandatory reporting of audited global and US operating revenues as well as Scope 1+2 emissions will be required from every commercial entity that sells products or services to the US. In the case of multinational companies with a high level of diversification among industry sectors, e.g. Samsung, Mitsubishi, Dupont, BASF, etc., reporting of revenues and emissions will be required at the sector or divisional levels.
Each company will be required to report the target emission intensity of its sector, its own emission intensity, its total scope 1+2 emissions, and its global and US operating revenues. The above will then be used to determine the CTET and CTED taxes and remit them to the IRS.
Where will these actions be taken?
These actions must be taken and managed at the federal level of each country that made a commitment to the Paris Agreement and committed to a clear emission target by a certain date.
In addition, specify the country or countries where these actions will be taken.
Every one of the 195 countries that signed the Paris Agreement.
In addition, specify the country or countries where these actions will be taken.
No country selected
No country selected
No country selected
No country selected
No country selected
What impact will these actions have on greenhouse gas emissions and/or adapting to climate change?
The CTET tax will enable for the first time the ability to establish a clear line of sight between excess emissions and the financing of renewable energy projects to precisely offset those excess emissions within one year from assessing the tax. Applied to the automotive sector, our model shows that the direct and indirect impact of the CTET could amount to as much as 25.7% in net reductions of emissions in the overall sector by 2025 compared to 2015 levels. This corresponds roughly to meeting the US commitments under Obama’s Clean Power Plan in half the time. While the application of our approach was exemplified by the automotive sector, its applicability is valid for any other commercial sector.
Unlike most proposals, this one presents two separate taxes for two distinct objectives. While the CTET is exclusively targeted to help a country achieve its emission targets commitments, the CTED is also set aside for long-term mitigation and adaptation measures. The particular use of the funds could include R&D of green technologies, subsidies for green enterprises, development of smart cities, sustainable and resilient infrastructures, etc.
This proposal will achieve optimal impact if applied on a global scale. Not only will it help each country achieve its emissions targets more or less concurrently with the others, it will also establish a level field and a common reporting framework that will bring the reporting of GHGE, that is today still voluntary, to a comparable level of completeness, transparency and materiality as financial accounting.
What are other key benefits?
See previous section on Impact/Benefits.
What are the proposal’s projected costs?
Zero or marginally low costs of setting up the reporting database and issuing the reporting requirements to all the participating commercial entities.
CTET: 1-20 years where the implementation happens in year 1, and impact and benefits can be realized in year 2 and beyond, until all entities have reached and continue be in compliance with the national emissions targets.
CTED: 5-50 years for the funding, and implementation of the longer term measures for remediation and adaptation.
About the author(s)
Dr. Lotfi Belkhir is a physicist, inventor, entrepreneur and a scholar. He is currently the Endowed Chair in Eco-Entrepreneurship at the Walter G. Booth School of Engineering Practice at McMaster University. Dr. Belkhir’s current research and teaching have for core mission the advancement of a sustainable society through innovation, entrepreneurship, design and policy. Dr. Belkhir is a regularly featured speaker on the subjects of Entrepreneurship, Innovation, Sustainability and Corporate Social Responsibility at many venues. He holds a Ph.D. in physics and a Master’s in Management of Technology. Originally from Algeria, Lotfi is fluent in English, Arabic and French.
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