Border tax adjustments and tariff‐tax reforms with consumption pollution

• Author: Panos Hatzipanayotou,Nikos Tsakiris,Michael S. Michael
• Date: 01 December 2019
• DOI: http://doi.org/10.1111/jpet.12407
• Published date: 01 December 2019

J Public Econ Theory. 2019;21:1107–1125. wileyonlinelibrary.com/journal/jpet © 2019 Wiley Periodicals, Inc.

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1107

Received: 15 February 2019

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Accepted: 18 October 2019

DOI: 10.1111/jpet.12407

ORIGINAL ARTICLE

Border tax adjustments and tariff‐tax reforms

with consumption pollution

Nikos Tsakiris

1

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Panos Hatzipanayotou

2,3

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Michael S. Michael

3,4

1

Department of Economics, University of

Ioannina, Ioannina, Greece

2

Department of International and

European Economic Studies, Athens

University of Economics and Business,

Athens, Greece

3

Center for Economic Studies and the Ifo

Institute of Economic Research (CESifo),

Munchen, Germany

4

Department of Economics, University of

Cyprus, Nicosia, Cyprus

Correspondence

Panos Hatzipanayotou, Department of

International and European Economic

Studies, Athens University of Economics

and Business, 76, Patission street, 104 34

Athens, Greece.

Email: hatzip@aueb.gr

Abstract

We develop a model of a small open economy, where

pollution per unit of consumption between domestically

produced and imported quantities of the same good

differs. We show that the first‐best policy combination

calls for consumption taxes on all polluting goods, and

border tax adjustment (BTA) measures, that is, tariffs or

import subsidies. We identify conditions under which

well‐known tariff‐tax reform policies for developing

economies, such as a consumer‐price‐neutral piecemeal

reform of trade and a consumption tax, and a consumer‐

price‐neutral reform of all trade and consumption taxes

improve welfare. We also evaluate whether reforms of

trade taxes alone are superior to consumer‐price‐neutral

reforms of trade and consumption taxes.

KEYWORDS

border tax adjustments, consumption‐generated pollution, optimal

taxation, trade and consumption tax reforms

JEL CLASSIFICATION

F13; F18; H20; H21

1

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INTRODUCTION

Nowadays, consumption and residential activities are considered important sources of pollution

emissions such as carbon dioxide, sulfur dioxide, and solid waste accumulation, for example,

Hu and McKitrick (2016).

1

In many cases, the same consumer needs are satisfied by different

commodities produced in different countries using different materials and technologies. The

1

In their study they note, “…According to the US Environmental Protection Agency (EPA 2012), nearly one‐half of the emissions of smog‐forming volatile

organic compounds (VOCs), more than half of the nitrogen oxides (NOx) emissions, and about half of the toxic air pollutant emissions in US are generated from

consumption of such different varieties of the same product produced in one country or

imported, satisfying the same consumer needs, may generate different rates of pollution per

unit of consumption. For example, different brands of automobiles, air‐conditioners and other

electrical appliances, tires, and so forth, produced by different firms in different countries, have

different energy requirements and thus they are attributed to different energy classifications.

2

To address this phenomenon, we construct a theoretical model of a competitive small open

economy producing and consuming many traded goods. We assume that consumption of all

commodities generates pollution emissions, while their production is a clean activity. The

distinctive element in this model is that pollution per unit of consumption between

domestically produced and imported quantities of the same good differs. Within this

framework, we show that the first‐best policy combination requires (a) consumption taxes on

all polluting goods. While consumption taxes on imported and on domestically produced

quantities of the same good are the same, they differ across commodities depending on their

rates of pollution per unit of consumption; (b) free‐trade for all exportable goods, and (c) a tariff

(import subsidy) or free‐trade on an importable if pollution per unit of imports consumption is

higher (lower) or the same with pollution per unit of consumption of the domestically produced

quantities of this good.

Consumption pollution can be local, for example, affecting land and rivers in the country, or

transboundary, for example, CO

2

emissions. There are reasons why a small economy that

cannot affect world commodity prices and does not generate noticeable damages to the global

climate, as a result of its own emissions, has a strong interest in curbing the levels of its

pollutants. One reason is that various polluting activities, for example, coal‐burning and the use

of cars running on fossil fuels, generate not only “global”pollutants such as CO

2

emissions

responsible for global warming but also a number of other airborne and water contaminating

toxics, for example, mercury, lead, sulfur dioxide and other heavy metals and particulates,

which generate health and environmental damages to a large extent local in their effects.

Another reason is a small country’s commitment to curb the levels of its own emissions,

negligible or not in regard to their impact on global climate, as a result of its membership in

global climate initiatives. For example, small countries such as Austria, Cyprus, Luxembourg,

and Malta are among the signatories of the Paris Agreement to reduce greenhouse emissions,

until their total eradication, the so‐called premise of “zero fossil fuels,”and their replacement

with renewable and alternative cleaner energy sources.

Studies which examine the optimal policies under consumption pollution externalities

propose that for small open economies, the first‐best policy combination requires an emission

tax to control for the consumption pollution externality, and free trade, for example, see Krutilla

(1991), Gulati and Roy (2008), Copeland (2011). However, more often than not, for political or

political economy reasons emission taxes may be set at suboptimal levels. For example, the

implementation of Pigouvian emission taxes is infeasible in the presence of lobbying activities

by large polluters, corruption, weak administrative capacity or technical and economic reasons,

for example, see Eisenbarth (2017), McAusland (2008), Fullerton and West (2002). In these

cases, governments can resort to other forms of taxation such as consumption and trade taxes.

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motor vehicles. …. For OECD countries, up to 90% of the total carbon monoxide (CO

2

) is from the source ‘road’(OECD Statistics 2012)…. The emissions related

to consumption of energy in US are accountable for about 71% of US carbon dioxide emissions….”

2

Electrical devices are classified in seven energy classes (from A to G), depending on the energy they consume toward the energy they attribute.

3

Real‐world evidence attests to the use of consumption taxes, for example, taxes on energy‐consuming products, vehicles, mineral oils, and on transport fuels, to

encourage more environmentally responsible economic and recreational activities. For example, OECD (2014, pp. 135–160), reports: Per liter total taxation

(VAT plus all other non‐VAT taxes) as a percentage of the total price of premium unleaded gasoline: Australia 33.1, Canada 29.28, Germany 58.08, the UK

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TSAKIRIS ET AL.