Greening tax system, and border adjustment measures

At the Leaders Summit on Climate in April, major countries announced 2030 greenhouse gas pollution reduction target. Japan has declared a 46% decrease from fiscal year 2013. According to the estimates by the Japan Center for Economic Research with 2018 as the base year, Japan will implement a 38% reduction. The reduction is smaller than 43%－45% in the US, 50% in the UK and 44% in the European Union (excluding UK), but it is far more ambitious than the previous target (26%).

Major developed countries have set a common target of virtually zero emissions by 2050. The “shadow price”, which indicates the strength of restrictions on emissions, is the carbon price required to achieve the target; it is possible to calculate its value at least in theory. Carbon pricing (CP) can be broadly categorized into emissions trading and carbon tax.

However, in reality, it is not easy to calculate the carbon price needed to achieve the target. This is because it is necessary to take into account the emission reductions due to changes in industry structures such as digital transformation (DX) as well as the countries not committed to decarbonization targets.

In May, a subcommittee of the Environment Ministry announced the impact of changes in energy prices on emissions. Japan has imposed a carbon tax, namely the “tax as countermeasures against global warming” (anti-warming tax) of 289 yen per ton of carbon dioxide (CO2) emissions, which was superimposed on the existing petroleum and coal tax. It was reported that its CO2 reduction effect was 3.2 million tons in the fiscal year 2019. To realize a carbon-free society by relying only on price effects, a carbon tax of 93,000 yen is required.

If it is possible to reduce emissions by 80% by transforming the industry structure centered on DX, the required carbon tax will be about 13,000 yen (according to the Medium-term Forecast by the Japan Center for Economic Research). This estimate suggests that the active use of mutual complementarity between green growth and DX is indispensable not only for expediting the recovery from the COVID-19 crisis, but also for achieving medium-to long-term growth targets.

If the existing energy tax system is converted to a carbon tax based on CO2 emissions, aimed at implementing “green tax system”, the carbon tax that matches the current tax revenue (4.7 trillion yen) will be slightly over 4,000 yen. If the carbon tax is gradually raised to 13,000 yen under the green tax system, the tax revenue will peak at 6 trillion yen in the fiscal year 2034 and will be zero in the fiscal year 2050.

Even if the existing tax system is maintained and the carbon tax is superimposed on the anti-warming tax, the tax revenue from fuels in the transportation sector such as gasoline with a high tax rate, will be zero in a carbon-free society. In any case, greening the energy tax system is an indispensable policy agenda.

If the CP system is established in major developed countries, the increase in emissions by countries with loose carbon regulations (carbon leakage) will become a problem. There are two ways to prevent it. The first is a “free allocation” of emissions that allows for carbon tax exemption. The other is the “carbon border adjustment measures”, which impose a domestic carbon tax on goods imported from countries with weak carbon regulations and refund the carbon tax on exports from home country.

If border adjustments are introduced, free allocation will no longer be required and either a shift to pay-in allotment or a carbon tax will be implemented. Carbon tax refunds on exports are needed to maintain international competitiveness, but what would happen, if major advanced economies introduce similar CPs? It should be noted that there is also an option to tax imports with no exports refunding if the priority is given to reduction of emissions, while securing tax revenues.

(The english translation of the article was published in the Nikkei morning edition 2021/5/21.)