1

China’s Carbon Pricing: Status and

Prospect

CAO Jing

School of Economics and Management

Tsinghua University

Presented at MCC “Closing the Carbon Price Gap: Public Finance and Climate Policy”

May 22-23, Berlin

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China’s Challenge

China’s current development model is “unbalanced, uncoordinated

and unsustainable”

– Chairman Xi Jinping, November 2013 (3rd Plenum, 18th

Central Committee)

2

China burns as much coal as the rest of

the world consumed (3.8 bil. ton in 2011):

• Resource tax on coal: too low (0.4$ per ton)

China is the biggest carbon emitter

• China (2.5 bil. tC) vs US (1.5 bil. tC) in 2011,

7 ton CO2 per capita (exceed world average)

China – Rising Death Toll Due to Local

Air Pollution

• World Bank (2007): 750,000 excess death per

year

• Chen et al. (PNAS, July 2013): long-term

exposure to air pollution contribute to

enormous loss of life expectancy (five year

less in northern China vs. southern)

Blueprint of Environmental Policy Reform under

the New Leadership

“establishing … the market’s decisive function in

resource allocation,”

“reform of the fiscal system and stabilization of tax

burdens,”

“improvement of tax revenue systems,”

“sustainable social security systems,”

“protection of ecology and the environment,”

“implementation of paid-for resource use systems,” and

“energy saving.”

------from the third Plenary Session of the 18th

Central Committee in November 2013

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Why and how will China pursue Carbon Pricing?

We have a fiscal and economic imbalance problem: distorted

tax system, large local debt, not sustainable:

• Distorted price signals in the fiscal system: heavy capital and VAT tax, low

resource and energy tax, lead to low quality and imbalance economic growth

• Local fiscal system: Rely too much on land lease, not sustainable, housing

bubble, very big local government debt (about 31-42% of GDP, various estimates)

• Single Child Policy for more than 30 years, Aging Population require more social

security, current SS fund is in deficit (95.9 bil. In 2013 and 156.3 bil. In 2014,

fiscal support counts for about 3% of Total tax revenue)

• Rapid Urbanization: 240m people migrating to cities by 2025; Urban population

rising from around 50% today to around 70% by 2025

• Energy Security: China must curb its own carbon emissions, irrespective of what

other countries act

• China is vulnerable to the effects of climate change.

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Why and how will China pursue Carbon Pricing?

Avoid “Lock-in” in Physical Capital and Infrastructure, Household

Consumption and Life-Style, as well as Fiscal and Governance

Structure; otherwise future reform gets harder

Carbon Pricing: part of the fiscal and imbalance solution

From Mandates to Market-based Instrument: less cost effective

(NOx removal in 12th FYP, much difficult thanSO2 removal in the 11th

FYP), urge shifting to market based instrument

China’s Trial Program on Cap-and-Trade: 5 cities, 2 provinces,

within city/province trading, May extend to National Trading if Pilots

are successful

China attempt to initiate new round of green fiscal reform (three

are relevant to carbon pricing):

Resource Tax Reform, Pollution Levy to Environmental Tax,

Gasoline Tax Reform, Carbon Tax

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7

Beijing

Tianjing

Shanghai

Hubei

Chongqing

Guangdong

Shenzhen

China’s Pilot Trading (Five Cities, 2 Provinces, 1 bil. CO2 emissions, about 7-10% of total)

Qingdao

(voluntary)

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China’s Pilot Trading (Comparison)

Region

Covered

CO2

Emissions

(Mt)

Share of

total

Emissions

Number

of

Covered

Entities

Coverage

Threshold

(tCO2/year)

Historical

Emission

Period

Covered Sectors

Beijing 58 50% 490 >10,000 2009-2012

17 Manufacturing Sectors,

Commercial Building, financial,

hotel, education, etc.

Tianjin 112 45% 197

>20,000 for

inudstry,

>10,000 for

other

2010-2011 Manufacturing Sectors, Oil and

Gas Exploration, Buildings

Shanghai 90 60% 191 >20,000 2009-2012

Manufacturing Sectors, Textiles,

Commercial Buildings, fianncial,

hotel, airlines, harbors, airports,

railway, etc.

Hubei 117 33% 107 >120,000 2010-2011 Manufacturing Sectors,

Automobile

Guangdong 209 42% 830 >20,000 2010-2012

Manufacturing Sectors,

Commercial buildings,

transporation and construction

Shenzhen 32 40% 635 >5000 2009-2011 26 Manufacutring Sectors

Chongqing N.A. N.A. N.A. >20,000 2008-2010 N.A.

Note: Heat and electricity, iron and steel, nonferrous metal, petrochemicals and chemical, pulp and paper, glass and

cement, these sectors are covered in all pilot systems.

Source: Zhang et. al (2014), http://www.tanpanfang.com

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Shenzhen

Beijing

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Traded Volume (tCO2) Price

RMB

RMB

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0,00

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10,00

Beijing Guangzhou Shanghai Shenzhen Tianjing Hubei

Average CO2 Price (euro/tCO2)

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Beijing Guangzhou Shanghai Shenzhen Tianjing Hubei

Average DailyTraded Volume (tCO2/day)

Summary on China’s Pilot Trading

• Pilot trading now covers about 1 billion tons of CO2, roughly

10% of China’s total emission

• Cover major energy-related sectors, buildings, some including

transportation

• Direct emissions + Indirect emissions from electricity (generated

within or imported from other regions)

• Coverage threshold varies from 5000 ton CO2/year (Shenzhen)

to 120,000 ton/year (Hubei)

• Initial allocation: virtually all are grandfather free allowances,

except Shenzhan has a small number of allowances auctioned.

– Historical Emissions are computed differently, Beijing and Shanghai

(2009-2012), Tianjing and Hubei (2010-2011), Shenzhen (2010-2012),

Chongqing (2008-2010)

– Allocation were distributed annually for Beijing, Tianjing, Hubei and

Guangdong, but Shanghai and Shenzhen issue allowances once at the

beginning of 2013-2015

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Prospect for National-wide Emission Trading

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• The earliest Time Line: Nation-wide (likely to be launched during

13th Five Year Plan, 2016-2020)

• The success or failure of bottom-up designed pilot program will

to a large extent determine the fate of national emission trading

and design format

• Regulatory barriers:

• So far no clear national law specifies mandate for establishing an

ETS at the national level

• Enforcement regime is still too weak: fine is only 10,000 to

100,000yuan per enterprise (Shanghai), 20,000 – 30,000 yuan

(Chongqing), or 3 – 5 times of emission gap - compare with EU

ETS (200 euros per ton)

Main Challenges

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• The price signal is not fully effective, especially for

many SOEs, which get compensation or subsidy from

the government, SOEs’ price elasticity is smaller than

other firms (Karplus and Cao, 2013)

• Many end-use energy prices are fixed (such as

electricity)

• Similar challenges with the pilot sulfur trading which is

unsuccessful, need capacity building on defining

emission right, permit allocation, trading rules,

monitoring, enforcement and accountability.

• City level trading: high transaction cost, thin market,

few deals, carbon emission data is not public (2005

survey data is still not released), baseline is difficult to

evaluate

Main Challenges

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• With the small scale, thin market, less cost saving,

how to integrate future markets and extend to nation-

wide is also an concern

• The cap and allowance are basically set given the

companies reported, penalty for non-compliance is

still weak.

• When extending to nation-wide trading, observing the

importance of reporting historical emission and lack of

reliable emission data, firms may report higher

historical emissions for requesting higher free

allowance. MRV is still in early stages.

• Leakage issues during the pilot stage.

Green Fiscal Reform – Plan and Time Table

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Motivation Relevant Tax Time

Paid-for Resource Use Resource Tax (Coal, Oil

and Gas)

Oil and Gas (5-10%,

implemented now as 5%)

Coal (low unit tax): reform

to ad-valorem tax

Enhance Renewables Feed-in-Tariff on Wind

and Solar

Implemented

Discourage Vehicle

Emission and

Congestion

Gasoline Tax and

Congestion Fee

Gasoline Tax (1 Yuan/Litre)

Congestion fee(under

discussion)

Reducing local pollution Environmental Tax (Levy

Fee to Tax Reform)

Forthcoming Soon

Reducing Carbon

Emissions

Emission Trading Pilot Stage (7 regions,

10% emissions)

2016: May start National

Regime

Carbon Tax (may

combine with Resource

Tax)

N.A.

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19

Harvard-Tsinghua

China Project:

Costs and Benefits

of Carbon Taxes

(and Sulfur

Mandates) in

China

MIT Press,

December 2013

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Assessment Framework

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Analytical Models

Effects of Carbon Tax

Benefit: Avoided mortality

and morbidity

Economy 33-sector general equilibrium model

Emissions Bottom-up inventories

Atmosphere GEOS-Chem model

Effects on Public Health

PM2.5 & ozone

Electricity, Iron & Steel, and Cement Plant-by-plant databases

Benefit: Reduced CO2

Effects on Rice, Corn, and Wheat

ozone

Benefit: Rise in grain yields

Cost: Indirect general

equilibrium effects

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Defining Future Carbon Tax Scenarios Six prospective policies and a base case for 2013-2020:

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Scenario Time Path of Carbon Tax Use of Revenues

F1 Tax of 30 yuan/ton of CO2 (in 2007 yuan) all

years 2013-2020

Lump-sum to households

F2 Tax of 10 yuan/ton in 2013 rising to 50

yuan/ton in 2020

Lump-sum to households

F3 Tax of 10 yuan/ton in 2013 rising to 100

yuan/ton in 2020

Lump-sum to households

F4 Same as F2, 10 yuan/ton in 2013 rising to 50

yuan/ton in 2020

Cut tax rates on enterprise

income

F5 Same as F2, 10 yuan/ton in 2013 rising to 50

yuan/ton in 2020

Output Updating Subsidies to

EITE industries, rest to

households

F6

Same as F2, assuming a global carbon tax is imposed, border tax adjustment Lump-sum to households

Base

Case

Absent any carbon tax policy, only existing

policies

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Scenario F2 in 2020: 10 Y/ton in 2013, 50 Y/ton in 2020

Lei (2013)

Translating Changes in PM2.5 and Ozone

Under Carbon Tax F2 into Avoided Health Damages

23 23

Scenario F2 in 2020: 10 Y/ton in 2013, 50 Y/ton in 2020

Mapping Reduced Crop Damages

from Ozone Reductions: Wheat

Comparison of Effects of Carbon Tax F2 and F3 in 2020:

50 ¥/ton vs. 100 ¥/ton

24 24

Variable Scenario F2: Scenario F3:

10Y rising to

50Y/ton

10Y rising to

100Y/ton

Percent change in 2020

GDP -0.14% -0.33%

Consumption 0.27% 0.39%

Investment 0.01% -0.04%

Coal Use -23.00% -37.20%

CO2 Emissions -18.90% -30.80%

PM10 Emissions -15.70% -25.30%

SO2 Emissions -21.40% -34.50%

NOX Emissions -16.60% -26.90%

Avoided Premature Deaths Cases in 2020

Lower Estimate (Acute PM2.5 Effect) 19,300 33,100

Upper Estimate (Chronic PM2.5 Effect) 88,700 148,900

Billion yuan in 2020

Increased Wheat, Rice, Maize Production 15.7 28.3

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Comparing Effects of Carbon Taxes F2 and F4 in 2020:

Lump Sum Rebate vs. Tax Cut

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Comparing Effects of Carbon Taxes F2 and F5 in 2020:

Lump Sum Rebate vs. Subsidies to Energy-Intensive Sectors

Potential Revenue Spending (rarely studied)

• Special Environmental Fund on conventional pollution treatment

(PM2.5 and ozone)

• Recycling with Other taxes, such as VAT, Enterprise Income Tax

• Special funding support for feed-in-tariff and other low-carbon R&D

(potential research area on endogenous modeling

• Current Fiscal Support for Social Security Gap is 303.8 bil. RMB

this year, carbon tax revenue is about the same size (2.9% of total

tax revenue) ,

• Like resource tax, set at local tax, so the revenue can be used to

reduce local government debt, relieving pressure from land selling

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Summary: Impacts of Carbon Tax

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• Carbon Tax: Not only cost effective, but also a potent multi-pollutant strategy

• Substantial Co-benefits.

• The carbon tax revenues will allow a cut in existing taxes, reducing the loss of

output, and helping with tax reform goals.

• Win-Win and double dividend may exist for Green Growth.

• More politically feasible policy (output updating subsidy for EITE and HH lump-sum

transfer) has slightly smaller environmental benefits, but boost both consumption

and investment

• Using Scenario F4 (fully compensate enterprises) to simulate national trading

market using Beijing’s design (50% emissions covered, 99% cap on electricity and

96% cap on other sectors), roughly 19yuan/tCO2 to achieve the cap (compared

with our 21 yuan/tCO2 as carbon tax scearnio F4 in 2015)

• In practice, may become high resource tax on coal (another potential reason for

double dividend) for currently inefficient light taxation on coal (eg.big coal rents,

Shenhua group in China; by different definition – Post tax energy subsidy (Parry,

2013 IMF report), top 2nd in the world, 279 billion US dollars, 3.23% GDP in 2011 ).

Other Comments

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• Carbon Tax may partly mitigate tax evasion in China

– Carbon tax, if used to reduce pre-existing labor tax, may broaden the tax base,

reduce the welfare cost (Bento, Jacobsen and Liu, 2012; Markandya et. al,

2013)

– According to a report from State Council, China suffered tax evasion worth an

estimated one trillion yuan (US$157 billion) in 2011.

– “Countries with high levels of tax evasion (China and India), might benefit by

shifting tax base to taxes (like carbon tax) that are difficult to evade.” (Liu, 2012

RFF paper).

• Tax Incidence:

– Gasoline Tax: Progressive in China (Cao, 2011, in Sterner (ed.) Do Fuel Taxes

Hurt the Poor? )

• Rich People: Very high Gasoline Price Elasticity (-0.74) (Cao, Ho and Liang, 2014

working paper)

• Poor People: No Car, only indirect consumption (public transport)

• Suits Index (0.35 with direct, 0.20 with both direct and indirect, 2007)

– Carbon Tax: Regressive but can be Progressive with Cuts and Transfer

Program (Cao 2013, in Man (ed.) China’s Environmental Policy and Urban

Development )

• How to combine with national emission trading?

– Sector coverage? Double counting issues?