INTERNATIONAL MONETARY FUND

Market-Based Instruments for International Aviation and Shipping as a Source of
Climate FinanceBackground Paper for the Report to the G20 on ―Mobilizing Sources of Climate Finance‖

Prepared by staff of the International Monetary Fund and World Bank

November 2011

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Contents

Page

Glossary of Terms ..................................................................................................................... 4
I. Introduction .......................................................................................................................... 11
II. Background ......................................................................................................................... 14
A. Similarities and Differences: International Aviation and Shipping ....................... 14
B. Overarching Issues ................................................................................................. 20
C. Key Concepts: Incidence and Compensation ......................................................... 22
D. The Impact on Oil Prices ........................................................................................ 25
III. Policy Scenarios: International Aviation ........................................................................... 27
A. Scenarios ................................................................................................................ 27
B. Environmental Effectiveness .................................................................................. 28
C. Revenue .................................................................................................................. 30
D. Cost Considerations ................................................................................................ 31
E. Incidence ................................................................................................................. 32
IV. Policy Scenarios: Maritime ............................................................................................... 37
A. Scenarios ................................................................................................................ 37
B. Environmental Effectiveness .................................................................................. 37
C. Revenue .................................................................................................................. 38
D. Efficiency and Second Best Considerations ........................................................... 39
E. Incidence ................................................................................................................. 39
V. Implementation ................................................................................................................... 46
A. Fuel Taxes or an ETS? Economic Principles ......................................................... 46
B. Practical Issues ....................................................................................................... 49
VI. Conclusion ........................................................................................................................ 56
Tables
1. Impact on Fuel and Oil Prices of $1 Charge on a Subset of Fuels ...................................... 26
2. Estimates of the Price Responsiveness of International Air Travel by Trip Type .............. 29
3. Receipts in Developing Countries Under $25/ton CO2 Levy on International
Aviation Fuel ............................................................................................................... 36
4. Maritime Transport Costs by Product Category and Ship Segment ................................... 41
5. Ship Sizes, Numbers, and Associated Emissions ................................................................ 52
Figures
1. CO2 Emissions from Aviation and Maritime by Source .................................................... 17
2. Revenue from Taxes on International Aviation .................................................................. 30
3. Revenue from Taxes on International Maritime ................................................................. 38
Boxes
1. Recent Emissions Mitigation Efforts in the Aviation and Maritime Sectors ...................... 12
2. Other Features of the Tax Regimes for International Aviation and Maritime .................... 15
3. Legal Obstacles to Taxing Fuels Used in International Aviation ....................................... 19
4. Current International Taxes and Levies: The Air Ticket Solidarity Levy and theInternational Oil Pollution Compensation Funds ........................................................ 22
5. Assessing the Welfare Impact of Increased Transportation Costs ...................................... 24
6. The Impact on Oil Prices from Taxing International Aviation and Maritime Fuels ........... 25

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7. Second Best Taxation of International Aviation Fuel ......................................................... 32
8. Tourism and the Welfare Impact of a Fuel Charge ............................................................. 34
9. The Welfare Impact of a Charge-induced Increase in Import Freight Costs ...................... 42
10. Compensating for Increased Transport Costs on all Trade ............................................... 43
11. An Illustrative Rebate Mechanism for International Maritime Transport ........................ 45
12. Overview of Market-Based and Other Proposals for Reducing Ship Emissions .............. 47
13. International Aviation and the EU-ETS ............................................................................ 54
Appendixes
1. Some Basic Analytics of Compensation for Taxes on International Transport .................. 57
2. Optimal Aviation Ticket and Fuel Tax Rates...................................................................... 60
3. The Price Impact of a Selective Fuel Tax ........................................................................... 61
References ............................................................................................................................... 62

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Glossary of Terms
AGF. UN high-level advisory group on climate change financing.
BSA. Bilateral air service agreement.
Bunker fuel. Fuel for international aviation and maritime transport.
Demand elasticity. Percent change in the demand for a commodity or service in response to a
one percent increase in its consumer price.
ETS. Emissions trading system (or scheme).
EU-ETS. The ETS of the European Union.
Developed countries. Following the usage of the synthesis report, the term is used here to indicate
European Union countries that are members of the OECD and other Annex II countries that havepledged fast start climate finance. This includes 19 EU Member States as well as Australia, Canada,
Iceland, Japan, New Zealand, Norway, Switzerland, and the United States.
Developing countries. All countries other than developed countries defined as above.
ICAO. International Civil Aviation Organization.
IMO. International Maritime Organization.
IOPC Funds. International Oil Pollution Compensation Funds.
‘Legal’ incidence (or burden). Whoever is formally required, by law, to pay a charge or holdemissions allowances.
MBI. Market-based instrument (an emissions tax or ETS).
‘Real’ incidence (or burden). Measures whose real income is actually reduced as a result of a newpolicy.
Supply elasticity. Percent change in the amount supplied of a commodity or service in response to a
one percent increase in the price received by producers.
Charges, taxes, and levies. As used here, the term ‗charge‘ ‗refers to a mandatory payment of anamount related to carbon emissions, whether implemented as a tax, as a levy or through an emissions
trading system. By a ‗tax‘ is meant a compulsory payment that is not fully requited to those paying it.
(Thus payment for a service, including to a public agency, is not a tax if it covers the cost of providingthat service: such payments are ‗user fees‘). By ‗levy‘ is meant a charge that is fully rebated to thepayer, in cash or in kind; since the focus here is on raising climate finance, the term will be rarely
used, though this is not intended to prejudge the use of revenue in practice.

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EXECUTIVE SUMMARY
This paper responds to the request from the G20 to explore the potential for providing
climate finance from carbon-related charges on international aviation and maritime
transport—with a particular focus on minimizing the impact on developing countries1
and on issues of implementation.2 It extends the work of the High-level Advisory Group on
Climate Change Financing to the U.N. Secretary General (AGF, 2010a, b) by (1) clarifying
key issues of incidence and compensation, paying particular attention to the impact on lower
income countries; (2) examining key challenges to implementation; and (3) placing thesecharges in the context of the overall tax treatment and wider circumstances of these sectors.
The potential for climate finance and environmental gain
Market-based instruments (MBIs) for international aviation and maritime fuels—either
emissions (fuel) taxes or emissions trading schemes (ETS)—have appeal as an‗innovative‘ source of climate finance. These activities are currently under-charged3 from anenvironmental perspective: unlike domestic transportation fuels, they are subject to no excise
tax to reflect environmental damages in fuel prices. Since they correct an unpriced distortion
rather than exacerbating those from pre-existing taxes, MBIs for jet and international marine
fuels are likely a much more cost-effective way to raise finance for climate (or other)
purposes than are broader fiscal instruments. Furthermore, national governments do not havean obvious claim to the tax base for these fuels, given their use for international activities.
While there is in principle no reason why any funds raised by such a charge should not be
used for other purposes, the concern here is with their potential as a source of climate finance.
By 2020, a globally implemented carbon charge of $25 per tonne of CO2 on these fuels
could raise around $12 billion from international aviation and around $26 billion forshipping, while moderately reducing CO2 emissions from each sector by reducing fueldemand.4 Once in place, presumably the fuel charges would increase gradually over time topromote more aggressive emissions mitigation.
Compensating developing countries for the economic harm they might suffer from suchcharges—ensuring that they bear ‗no net incidence‘—is widely recognized as critical totheir acceptability. Such compensation seems to require—at most—40 percent of global
revenues, which would leave about $23 billion or more for climate finance or other uses.5
There is an important trade off here: the more extensive is compensation, the less public
revenue will remain for climate finance or other productive purposes.
1

The distinction between developed and developing countries as made here is defined in the Glossary.

2

A companion paper (IMF, 2011) responds to the request to look at domestic instruments for climate finance.

3

Usage of the terms ‗charge‘, ‗tax‘, and ‗levy‘ are explained in the Glossary.

4

All $ figures refer to U.S. dollars.

5

Some part of the revenue (perhaps 5–10 percent) should also be retained by the collecting agency to coveradministrative costs and provide performance incentives.

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Under a more flexible approach with a floor price of $15 per tonne, annual revenues
raised would be approximately $14 billion (after setting aside the same proportion forcompensation). Conversely, revenues would be higher under more aggressive emissions
pricing, say $40 per tonne of CO2; but securing international agreement would doubtless becorrespondingly more challenging.
MBIs are the best instruments from an environmental perspective. Under the auspices of
the International Civil Aviation Organization (ICAO) and the International Maritime
Organization (IMO), both industries are taking important steps to improve the fuel efficiencyof new planes and vessels and economize on fuel use during operations. Nonetheless, raisingfuel prices through MBIs would reinforce these efforts while also reducing the demand fortransportation (relative to trend) and promoting retirement of older, more polluting vehicles.
The principles of good design of MBIs for international aviation and maritime activities
are the same for other sectors. For emissions trading, this means auctioning allowances toprovide a valuable source of revenue, and including provisions to limit price volatility. For
emissions taxes, it means keeping the focus on environmental considerations and applying the
tax to fuel (rather than passenger tickets, or arrivals/departures). In either case, a critical issue
in containing policy costs is to use revenues (whether for climate finance or other purposes)
productively, for socially desirable spending, fiscal consolidation, or to reduce broader taxes
that distort incentives for work effort and capital accumulation.
Failure to price emissions from either industry should not preclude pricing emissions in
the other. Though commonly discussed in combination, the two sectors are not only different
in important respects—for example, ships primarily carry freight while airlines primarily
serve passengers—but they also compete directly only to a limited degree. Nonetheless,simultaneous application to both is preferable, and could enable a common charging regime(further enhancing efficiency).
Cooperation, incidence, and compensation
Extensive cooperation in designing and implementing international transportation fuelcharges would be needed—especially for shipping—to avoid revenue erosion anddistortions. Underlying the current tax-exempt status of fuels used in internationaltransportation fuels is a fear that unilateral taxation would harm local tourism, commerce, andthe competitiveness of national carriers, raise import prices and reduce the demand forexports, as well as leading fuelling to take place in countries without similar policy measures.
When governments set emission charges unilaterally, they are under pressure to set lower
rates than in other countries, so as to protect their domestic industries and revenues. Some
degree of international coordination is thus needed. In the case of international aviation, evenan agreement with substantially less than universal coverage—for example one that exempted
some vulnerable developing countries—could still have a significant effect on global
emissions and considerable revenue potential, given the relatively limited possibilities for
carriers to simply re-fuel wherever taxes are lowest. For maritime fuels, however, globally7
comprehensive pricing is more critical, since vessels can more easily avoid a charge by refueling at ports where charges do not apply.
Globally imposed charges combined with compensation of adversely affected developing
countries appears consistent with both industry and UNFCCC principles. Both the IMO
and ICAO are firmly committed to principles of uniform treatment of ships and flag States,
and carriers and nations, respectively. A globally applied charge would be consistent with
this, and could be reconciled with the UNFCCC principle of common but differentiatedresponsibilities and respective capabilities by appropriate compensation schemes. Moregenerally, combining a global charge with targeted compensation provides an effective way to
pursue both efficiency and equity objectives.
Ensuring ‗no net incidence‘ for developing countries requires close consideration of the‗real‘ incidence of these charges. That real incidence—who it is that suffers the consequentloss of real income—can be quite different from who it is that bears legal responsibility forthe payment of the charge; and they may well be resident in different countries. It is the real
incidence that matters for appropriate compensation, and this is sensitive to demand andsupply responses that will vary across countries according to their share of trade by sea andair, the importance of tourism, and so on.
Jet and marine fuel prices might not rise by the full amount of any new charge on theiruse. Some portion of the real burden is likely to be passed back to oil refiners and oil
producers. However, if refiners can shift production from these fuels to other oil products
fairly easily (which seems plausible), this pass back is likely to be modest; a charge of 10
cents per liter on fuels used in both sectors might then increase the price to operators by about
9.5 cents per liter.6
Even with full pass-through to fuel prices, however, the impact on final prices ofaviation services and landed import prices—and on the profitability of the aviation andmaritime industries—is unlikely to be large. A charge of $25 per tonne of CO2 might raise
average air ticket prices by around 2–4 percent and the price of typical seaborne imports byaround 0.2–0.3 percent. The modest scale of these effects means that the real burden on theinternational aviation and shipping industries is likely to be small—and, in any case, reflects a
scaling back of unusually favorable fuel tax treatment (see below) rather than the introductionof unfavorable treatment. The overall burden imposed by a $25 per tonne CO2 price is thus
likely to be small. Further work is needed to identify possible outlying cases, but the broad
picture is one of very modest impacts.
Nonetheless, there may be a need to provide adequate assurance of no net incidence on
developing countries by providing explicit compensation. Significant challenges arise indesigning such a scheme because of the potential jurisdictional disconnect between the points
at which a charge is levied and the resulting economic impacts—especially for maritime
transport. Practicable compensation schemes require some verifiable proxy for the economic
6

For consistency, the fuel unit is taken to be a liter throughout the paper. In practice, maritime fuel is priced andbought in metric tonnes.

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impact as a key for compensation. While more work is needed to identify good (i.e.
reasonably accurate and acceptably verifiable) proxies, enough has been done to giveconfidence that they can be found. Fuel take-up provides a good initial basis in aviation, andsimple measures of trade values may have a role in relation to maritime. The prior and insome respects deeper issue is to understand the extent of compensation required.
Fully rebating aviation fuel taxes to tourist destinations in developing countries (orgiving them free allowance allocations) may be over-compensation—that is, would makethem better off by participating in such an international tax agreement (prior to even receiving
any climate finance). Most of the incidence of taxes paid on jet fuel disbursed in developing
countries is likely borne by passengers from other countries. Developing countries—including
tourist destinations—might then receive more than adequate recompense if revenues collectedin those countries were fully passed to them. However, additional analysis is required toarrive at a fully confident assessment of the overall economic impact on developing countries
and how this may vary between tourist and other destinations.
In contrast, rebating maritime fuel taxes to developing countries may not provide
adequate compensation. Unlike airlines, shipping companies cannot be expected normally totank up when they reach their destination. Some countries—hub ports like Singapore—disperse a disproportionately large amount of bunker fuel relative to their imports, while theconverse applies in importing countries that supply little or no bunker fuel, including
landlocked countries.7 Revenues from charges on international maritime fuels could instead
be passed to or retained in developing countries in proportions that reflect the extent andperhaps nature of their trade activities.8
More generally, compensation could be could also be linked to relative per capita
income; and could be larger for low-income countries in which higher fuel prices are aparticular concern. Much detailed work remains to be done to design compensation
schemes, but practicable approaches can surely be found.

Implementation
Implementing globally coordinated charges on international aviation and/or maritime
fuels would raise significant governance and practical issues. New frameworks would beneeded to govern the use of funds raised, to determine how and when charges (or emissions
levels) are set and changed, to provide appropriate verification of tax paid or permits held and7

In principle, this problem can be addressed if hub ports only claimed fuel tax rebates when ships unload, or if
importing countries could claim rebates for fuel purchases by unloading ships associated with that trip. But thisapproach is administratively complex when one shipping voyage has multiple country destinations.
8

As for instance in the import-based rebate mechanism proposed by IUCN (2010) and WWF (2011). Stochniol(2011) also provides country-specific estimates of the compensation implied by this scheme based on a country‘sshare of imports by sea and air. For instance, Ethiopia‘s annual rebate would be $6 million if the revenue raisedby carbon pricing for international maritime transport were $10 billion (i.e. 0.06 percent of $10 billion). The
rebate and attribution keys for all countries have been submitted to the IMO in WWF (2011).

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to monitor and implement any compensation arrangements. While the EU experience
indicates that agreements on taxation can be reached, it also shows how sensitive are thesovereignty issues at stake. One possibility is to link an emissions charge on internationaltransportation to the average carbon price of the largest economy-wide emission reduction
scheme, for instance, so limiting the need for a separate decision process. The various detailed
proposals being considered by the IMO suggest that practical issues can be resolved. There
could indeed be some role for the ICAO and IMO, with their unparalleled technical expertisein these sectors, in implementing these charges, though there are other possibilities.
The familiarity of operators and national authorities with fuel excises suggests that
implementation costs would be lower with a tax-based approach than with an ETS.
Collecting fuel taxes is a staple of almost all tax administrations, and very familiar tobusiness; implementing trading schemes is not. Ideally, taxes would be levied to minimize thenumber of points to control—which, broadly, means as upstream in the production process as
possible. If taxation at the refinery level is not possible, the tax could be collected as fuel isdisbursed from depots at airports and ports, or directly from aircraft and ship operators.
Implementation would be simplest—and environmental efficiency greatest—if no distinction
were made between fuels in domestic and international use. Indeed, eliminating thedifferentiation imposed at present should in itself be a simplification.
Policies could be administered nationally, through international coordination or in somecombination of the two—with the appropriate institutions for monitoring andverification depending on the approach taken. For example, national governments might
be responsible for implementing aviation fuel charges or trading schemes on companies
distributing fuel to airlines, with some of the receipts transferred to a climate finance fund. Allrevenue-raising MBI proposals being considered by IMO, on the other hand, assume a global
charge or ETS.9 Flexibility may well be needed to accommodate various national
circumstances by, for example, allowing certain countries to opt for national collection that is
linked to an international approach.
For aviation, the current fuel tax exemptions are built into multilateral agreements
within the ICAO framework and bilateral air service agreements, which operate on abasis of reciprocity.10 Though consideration of the challenges these present is needed,amending the Chicago Convention and associated resolutions would remove these obstacles,
although the EU experience on intra-union charging seems to suggest the possibility ofovercoming them without doing so. An alternative approach would be to use an ETS in this
sector, although the consistency of this with international aviation agreements is currently the
subject of litigation. For marine fuels, there are no formal agreements prohibiting excise
taxes, so there appear to be no legal obstacles to fuel charges in this sector.
If regional emissions trading programs develop for international transportation (e.g., in
the European Union) giving away free allowances is especially problematic. Not only9

A precedent is the International Oil Pollution Compensation Funds of the IMO.

10

See ICAO (2000).

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does this forego revenue, it provides windfall profits for covered airlines or ships that would
likely increase resistance to the introduction of fuel charges in other countries.
While implementation details need further study, especially in terms of governance, it isclear that feasible operational proposals for pricing international aviation and maritime
emissions can be developed.

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I. INTRODUCTION
1.
This paper responds to the request from the G20 to explore the potential for
raising climate finance from charges on fuels used in international aviation andmaritime transport—with a particular focus on minimizing the impact on low-income
countries and on issues of implementation. The paper makes but does not linger on the casefor introducing some form of carbon pricing in these sectors. This is widely recognized, given
their growing share of emissions and their exclusion from both national fuel tax regimes andfrom the quantified country-level emissions targets under the 1997 Kyoto Protocol.11 In part,
this reflects the difficulty of allocating emissions from sources that are internationally mobile
and, moreover, arise largely in international waters and airspace.12 The focus here, instead, ison the consequences of, and possibilities for, introducing such charges.
2.
In doing so, the paper extends the analysis of such charges by the High-level
Advisory Group on Climate Change Financing to the U.N. Secretary General (AGF,
2010a and b). That analysis was focused on the revenue potential of these charges. The
analysis here, consistent with the request from the G20, takes forward the debate in three mainways.
3.
First, the paper clarifies and, where possible quantifies, the key issue of‗incidence,‘ paying particular attention to the impact on lower income countries.
Specifically, it examines whether reasonably practicable compensation rules can be found thatwould be sufficient to ensure that developing countries are made no worse off by the global
adoption of such charges.
4.
Second, the paper examines key challenges to implementation and reaches broadconclusions on how these might best be addressed. These range from fundamental issues ofsovereignty and governance that can be no more than raised here through to questions ofroutine administration and legal frameworks, on which clearer views can be reached.
5.
Third, the analysis places these charges in the context of the wider circumstancesand characteristics of these sectors. It stresses that, while the sectors are commonly grouped
together and do indeed have important similarities relevant to carbon pricing issues, they also
have important differences, including their treatment under national tax systems.
6.
The focus is entirely on MBIs, whether in the form of carbon taxes or emissions
trading schemes (ETSs). Under the auspices of the ICAO and the IMO, and as will besummarized below, efforts are underway to reduce CO2 emissions through technical andoperational measures; by, for example, efficiency improvements to new planes and ships.
While constructive and important, such efforts can—as in other sectors—have only limited
environmental effectiveness, and will need to be supported by carbon pricing schemes. More
11

Article 2(2) requires Annex I countries to ―...pursue limitation or reduction of greenhouse gases...working
through the International Civil Aviation Organization and the International Maritime Organization,
respectively.‖
12

These difficulties were evident in the attempt of the Subsidiary Body for Scientific and Technical Advice of
the UNFCCC to provide such an allocation, arriving at eight possibilities, none fully satisfactory (see, e.g.,
Heitmann and Khalilian 2011, who estimate the pattern of payment by country that these would imply).

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to the point in addressing the request from the G20, existing measures do not raise revenue forclimate finance.
7.
Both the ICAO and the IMO are discussing the potential use of MBIs. In October2010 the ICAO General Assembly adopted Resolution A37-19 establishing broad principles
for the design and implementation of MBIs that could be introduced at a regional level forinternational aviation. Within IMO, MBIs have been considered in depth for a number ofyears and various countries and observer organizations have developed proposals on MBIs forshipping and these proposals are to be considered and developed further at the next MEPC
meeting of March 2012, when also continued impact assessments will be considered. This
paper therefore draws on the important work already undertaken by both organizations (seeBox 1 for additional discussion).
Box 1. Recent Emissions Mitigation Efforts in the Aviation and Maritime Sectors
Aviation
In October 2010, the ICAO Assembly adopted Resolution A37-19, a comprehensive policy to reduce GHG emissions.
Aspirational goals under this resolution include a 2 percent annual fuel efficiency improvement up to year 2050 and a
medium-term goal of stabilizing global CO2 emissions at 2020 levels. Aside from MBIs (see below), measures to meetthese targets include improving the fuel economy of new planes; replacing less efficient aircraft; improving theoperation of existing flights in ways that economise on fuel; development of a global CO2 certification standard foraircraft; and facilitating the development and deployment of sustainable alternative fuels for aviation. 1 The Resolution
also emphasizes the development and submission of States‘ action plans, covering information on CO2 emissions
reduction activities and assistance needs, and the development of processes and mechanisms to assist States incontributing to the global efforts.
The Assembly also agreed on a set of guiding principles for the design and implementation of MBIs, such as
minimizing carbon leakage and market distortions, avoiding double charging for aviation emissions, and fair treatmentof aviation relative to other sectors. Based on further studies, the 2013 Assembly will explore the possibility of a
global MBI scheme for international aviation.
Maritime
The IMO has been pursuing the control of greenhouse gas (GHG) emissions from international shipping through a
global approach to ensure a level playing field and avoid carbon leakage. As a result, mandatory treaty provisions to
reduce GHG emissions from international shipping were adopted at IMO in July 2011 by adding a new chapter onenergy efficiency to the regulations on prevention of air pollution from ships contained in MARPOL Annex VI, andmaking mandatory the Energy Efficiency Design Index (EEDI) for new ships and the Ship Energy Efficiency
Management Plan (SEEMP) for all ships in operation.2 These regulations apply to all ships of 400 gross tonnage andabove and are expected to enter into force on 1 January 2013. By 2020, it is estimated there will be annual emission
reductions of up to 180 million tonnes of CO2, about 10 percent or more below baseline levels (IMO, 2011b).
IMO has also made noteworthy progress towards establishing an MBI. The report of an expert group established toundertake a feasibility study and impact assessment of a number of proposed schemes (see below) was presented to theMarine Environment Protection Committee (MEPC) in September 2010. The ten proposals under review range fromlevy/charge type of instruments with global collection and administration, via emission trading systems with
100 percent auctioning (global or national), to schemes based on individual ships‘ efficiency in fuel use and operation.
There are also proposals for compensatory schemes and other ways to ensure no net incidence for consumers andindustries in developing countries. In 2009, the MEPC indicated a general preference for the greater part of revenues
generated by an MBI for international shipping to be used for climate change purposes in developing countries.
_____________________________
1
Prior fuel economy improvements have reduced the fuel consumption rate of modern aircraft by 20–40 percent belowthat of aircraft produced 20–30 years ago (Giblin report, 2005).
2

The EEDI is a non-prescriptive, performance-based standard that leaves the choice of technologies in a specific ship
design to the industry as long as the required level is met. The level will be tightened every five years to match
technical development and is agreed as a 10 percent reduction for ships built from 2015 to 2020; 20 percent reduction
for ships built between 2020 and 2025; and a 30 percent reduction for those built after 2025, calculated over the
average efficiency level for ships built between year 2000 and 2010.

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8.
The focus throughout is on globally applied charges. Previous work has stressed
the potentially significant distortions that could follow from applying any charge
differentially, whether by country, carrier, vessel, or route.13 Reinforcing these technicalconsiderations—especially salient, as discussed below, for international maritime transport—
established principles of the international aviation and maritime industries also attach
considerable importance to non-discrimination and equality of treatment. Rather than revisit
these issues, it will simply be assumed here, except as indicated, that charges are applied in a
uniform manner to all fuels used in international aviation or maritime transport.
9.
A strategy combining globally imposed charges with compensation to adversely
affected developing countries is consistent with both industry standards and UNFCCC
principles. Both the IMO and the ICAO are firmly committed to principles of uniform
treatment of carriers and nations. A globally applied charge would be consistent with this, andcould be reconciled with the UNFCCC principle of common but differentiated responsibilities
and respective capabilities by a system of compensatory transfers. More generally, combining
a global charge with targeted compensation provides an effective way to pursue both
efficiency and equity objectives.
10.
The structure of the paper is as follows. The next section compares and contrasts
key features of the international aviation and maritime industries, discusses the rationale andfeasibility of MBIs, and examines core issues of ‗incidence.‘ Sections III and IV examine
specific policy scenarios for the two sectors, taken individually, and the implications forrevenue and developing country incidence. Section V discusses specifics in the choice among
MBIs and in the implementation of these policies. Section VI briefly sums up.

13

See for instance AGF (2010b), IMO (2010), and Keen and Strand (2007).

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II. BACKGROUND
A. Similarities and Differences: International Aviation and Shipping
11.

There are important similarities between these two sectors. Both industries

Account for a sizable and likely growing share of global emissions. In 2007,
international aviation accounted for around 1.5 percent of global emissions andinternational shipping for around 2–3 percent.14 The share of the sectors in global
emissions could expand rapidly.15



Are effectively exempt from any charge on their fuel use, in contrast to normal
practice for domestic transportation activities.



Pay various ‘user fees’ for services received. In the aviation sector, such fees include
airport landing and take-off fees, slot charges, costs of using airport facilities, airtraffic control, and security charges.16 In maritime, payment is made for an analogous
range of services, such as anchorage dues, channeling dues and pilotage charges. User
fees of these kinds, though important and appropriate in practice, are essentially a costof doing business like any other. They are not discussed further here as they are notdesigned to raise public revenue for the government (net of the costs of ancillary
services).

Provide potential tax bases that are hard to allocate to particular countries. This andthe fact that such activities are currently undertaxed from an environmental
perspective have made fuel use in these sectors a prominent candidate as source ofinternational finance.

Are subject to other tax rules that differ from normal practice. As discussed inBox 2, aviation receives favorable treatment under VAT regimes, while shipping
receives favorable corporate tax treatment. To varying degrees therefore, emissions
from both industries are too high for two distinct reasons: the failure to charge forenvironmental damages and the excessive demand for transportation due to special tax
exemptions.

14

See (AGF, 2010b) and IMO (2009).

15

According to AWG-LCA (2008), CO2 emissions from the aviation and maritime sectors (domestic as well asinternational) could, if unchecked, account for 10-15 percent of the global total by 2050. Accurately projecting
the future emissions growth is difficult however, not least because the industries themselves are taking measures
to reduce emissions intensity.
16

The ‗taxes and charges‘ item shown on air tickets is often misleading, as it can contain a plethora of items
including surcharges for high fuel prices, landing fees, and airport security services that are not ‗taxes‘ in thesense of being unrequited payments to a sovereign power.

15

Box 2. Other Features of the Tax Regimes for International Aviation and Maritime
Aviation. In most countries, international ticket sales are zero-rated under the VAT or general sales taxes (anyvalue added tax airlines pay on their inputs is fully refundable), while domestic air travel is not. 1 This reflects aview of the services provided as being essentially exports, and partly too wider difficulties in taxing
international services that are especially acute in international transport. 2 Exclusion of services provided tobusinesses is not of great concern, in that the logic of sales taxation is that business use should in any event not
be taxed, so as not to distort production decisions: VAT charged to business users, in particular, would in
principle be credited or refunded. It is a general principle of tax design to avoid charges on input purchases bybusinesses (other than those reflecting externalities from their activities—precisely the purpose of a carbon
charge): such taxes distort input choices and can lead to tax-driven vertical integration. Excluding purchases by
final consumer from sales taxation is more problematic.
Maritime. Shipping is now often subject to ‗tonnage‘ tax regimes: they are taxed, that is, not on accountingbased profits but by a presumptive charge related to a vessel‘s net tonnage. 3 These special regimes are inpractice seen as more favorable than the normal corporate tax regime. They have become increasingly
common, and are now applied by several major countries (including, for instance, Denmark, Greece, theNetherlands, Norway, the United Kingdom, and the United States).4 The proliferation of these regimes—
recognized as a form of state aid in the European Union, but permitted under stated conditions 5—is a clear andin many cases explicit response to intense tax competition in the sector, initially in response to favorable tax
regimes in countries maintaining open registers6 but now more general.7___________________
1

In contrast, domestically application of the VAT or sales tax is common, though sometimes at reduced rates: mostEU member charge below the standard VAT rate on domestic aviation (an exception being Germany which charges
the normal rate of 19 percent), though Argentina, India and Pakistan charge ad valorem ticket taxes on domestic
flights in the range 10-20 percent, and Peru charges ad valorem taxes on both domestic flights and international
flights departing from the country (see Keen and Strand 2007). It is a conventional presumption of sales tax designthat the consumption of all goods and services is best taxed at a uniform proportionate rate; there are some exceptions
to this general theoretical proposition, but nonetheless it serves as a practicable benchmark for policy design (asdiscussed for instance in Crawford et al., 2010).
2

The emerging norm is to tax international services according to the place of residence of the purchaser (see for
instance Keen and Hellerstein, 2010), which raises particular difficulties of implementation in relation to sales to
final consumers. The alternative approach of zero rating only sales to businesses is made difficult by the need for thejurisdiction of sale to verify the status of taxpayers abroad.
3‗Net‘ tonnage refers to a ship‘s displacement space for holding cargo (whereas ‗gross‘ tonnage refers to its total
displacement space). The precise form of such taxes, and conditions attached, vary, but common features include a
rate that falls with tonnage (on the grounds that smaller ships on shorter routes tend to be more profitable). Many
countries also provide exemption for capital gains on ships, and preferential personal tax and social contributions forlabor.
4

A more complete listing is in Ernst and Young (undated), which notes that ―The main advantage of tonnage tax
regimes is the very low effective tax rate of on average less than 1 percent when the shipping industry is doing well.‖5Commission Communication (2004) 43—Community Guidelines on State Aid to Maritime Transport.

6

Sometimes referred to as ‗flags of convenience‘.

7

That analogous regimes have not appeared in international aviation may reflect the standard principle in double tax
treaties that airlines are taxed only by the country of residence.



Are governed by international treaties (under the auspices of the ICAO and IMO),
and are subject to close control for safety and security reasons. The ICAO and the
IMO may also (but need not) play a role in monitoring emissions pricing policies forinternational transportation.

16

Cause local pollution and other adverse side effects. Take-offs and landings at
airports contribute to local air pollution, noise, and congestion. Maritime operations
can have a range of negative environmental impacts, such as oils spills and transportof invasive species in ballast water, and also contribute to local air quality problems,for example in port cities.17 A charge on fuel use could go some way towards
addressing these problems, but would not be the best-targeted instrument; this aspectis therefore considered no further.18

The bulk of emissions from the two sectors (especially for shipping) are associatedwith international activities and the majority of emissions are from services todeveloped countries. As indicated in the top panels of Figure 1, an estimated83 percent of maritime emissions are from international activities while for aviation
this share is 62 percent. The main reason for this is that goods transport, which isoverwhelmingly international, dominates shipping while people transport dominatesaviation (middle panels of Figure 1).19 Fuel disbursed in developed countries
accounted for about 65 percent of total aviation emissions (35 percent is fromdisbursements in developing countries) and 60 percent for maritime.20 In aviation,
about 12 percent of all flight activity (in terms of fuel consumption) consists of purecargo flights, but a similar fraction of fuel consumption can be ascribed to freight
carried by passenger planes.21

Make an essential contribution to a well-functioning global economy. Around
90 percent of all world trade, by tonne-kilometer, for instance, is carried by ship.

17

See Keen and Strand (2007) and Corbett and Fishbeck (2001) respectively for a discussion of these broaderside effects from aviation and maritime.
18

For example, location-specific, peak-peak pricing is generally far more effective for alleviating congestion,and vehicle emissions standards for reducing local pollution (see Parry et al. (2007) for a discussion of
appropriate instruments in the context of automobile problems). In any case, IMO is introducing requirementsthat will reduce considerably the sulphur content of heavy fuel oil from 2.7 percent to 0.5 percent by 2020,
which will encourage new refining processes.
19

Fishing, while largely conducted in international waters, is considered a domestic activity (as it pertains toparticular nations; and catches are largely landed in the individual nations). Most ferry traffic is international.
Cruise traffic where cruisers travel to at least two nations is considered international.
20

There is some disagreement over these shares for maritime activity. Faber et al. (2010) suggest that about onethird of emissions are attributed to ships arriving in non-Annex 1 countries, suggesting that about one-third
might be allocated to their own use. AGF (2010b), Table 6, on the other hand claims that more than 50 percent
of maritime emissions should be attributed to non-Annex I countries. Stochniol (2011b) calculates the overall
share of global imports by ‗developing‘ (non-Annex II) countries to 40 percent, which is that assumed here.
21

See Bofinger (2011), Appendix II.

17
Figure 1. CO2 Emissions from Aviation and Maritime by Source, 2007
Maritime--Domestic vs. International

Aviation--Domestic vs. International

Domestic,
17.0%

Domestic,
38.0%
International,
62.0%

International,
83.0%

Maritime--Goods vs. Passengers

Aviation--Goods vs. Passengers

Goods, 24.0%

Fishing, 5.4%
Passenger,
9.5%

Other, 7.0%

Passenger,
76.0%

Goods, 78.2%

Aviation--Developed vs. Developing

Developing,
35.0%

Maritime--Developed vs. Developing

Developing,
40.0%

Developed,
65.0%

Developed,
60.0%

Sources: ICAO (2009a), IMO (2009, 2010).

12.

But there are also important differences:

Maritime services are an input to production, rather than final consumption, to agreater extent than is international air travel. More than 90 percent of international
maritime activity is goods transport and less than 10 percent is people transport (IMO,
2009). For aviation, in contrast, 88 percent is people transport and only 12 percent
freight; some of this people transport will be for business use, but only about 10
percent of global passenger kilometers are flown in first or business class (even though
30 percent of airline passenger revenue comes from these classes).22 Recognizing toothat some business travelers fly economy, perhaps as much as 80 percent of transport
by air is for leisure and is thus final consumption, while the corresponding share oftransport by sea is no more (perhaps less) than 10 percent. This distinction has
implications for the appropriate treatment of these industries in the broader fiscal

22

See Keen and Strand (2007), table 12.

18
system (Box 2). It also implies that competition between the two sectors is fairly
limited. So that failure to levy a carbon charge in one industry does not significantly
weaken the case for charging one on the other.23


Reflecting this, key aspects of the impact on developing countries are different in thetwo cases. For maritime, the key concern is the effect on import and export prices; foraviation, a central concern has been the impact on tourism. Though there are otherdimensions of interest, the focus below will be on these and (since this will affectsome low income countries) the impact on fuel prices.



The proximate reasons for zero fuel taxation are different. There are significant legal
obstacles to taxing fuel used in international aviation: Box 3 elaborates. There appear
to be no similar legal obstacles to charging for fuels used in international shipping,
there being no formal bilateral agreements prohibiting excise taxes (IMO, 2011).
Instead, the zero taxation of international maritime fuel appears to reflect informal
convention and tax competition for a highly mobile tax base.24 It could be that thesame tax competition would result in zero fuel taxes on international aviation even in
the absence of legal prohibitions: dealing with the bilateral agreements, whilenecessary to impose taxes in the sector, may well not be sufficient.

The location at which fuel is taken up (one candidate point of collection for any
charge) is internationally mobile making widespread adoption of any charge
important—especially for maritime fuels. Large ships, which account for the bulk ofcarbon emissions in shipping, can undertake very long voyages on a single bunkeringof fuel, and carrying fuel need not add substantially to their costs.25 For aviation, thetax base is less than perfectly mobile because bunkering excess fuel in low-tax
jurisdictions can be costly.26 Moreover, tourist destinations have, to varying degrees,
some elements of uniqueness, so taxing flights to some country destinations, but notothers, may only cause a moderate re-location of flight activity.

23

The emissions-intensity per dollar of cargo is broadly similar for both modes: although the emissions per tonneof cargo are much higher for airlines, the value per tonne is also much higher (Stochniol 2011, pp. 10). Therefore
if, for example, a minor portion of the value of shipping cargo (in response to higher maritime fuel prices) wereinstead shifted as additional air cargo, the offsetting increase in emissions would be modest.
24

The only attempt to impose a tax on bunker fuels appears to have been that in California in 1991, when an
8.5 percent sales tax was imposed. In the course of only two months, more than 70 percent of the bunker market
disappeared from California, as ships switched to fuelling elsewhere, notably in Panama. The tax was removed
in 1992 (Michaelowa and Krause, 2000).
25

A Panamax bulk carrier can travel between Sydney and Singapore four times on a single fuelling (AGF,
2010b). Container ships and other volume carriers may take fuel for an entire round-the-world voyage tanking in
ports with competitive prices because these ships use fuel as ballast and replace it with water as the fuel isconsumed.
26

A plane travelling from Singapore to Saudi Arabia can carry only 25 percent of the fuel needed for the return
trip (AGF 2010b). Also, excess fuel can add substantial weigh to planes which in itself increases fuelconsumption.

19

Box 3. Legal Obstacles to Pricing Fuels Used in International Aviation
These arise from both multilateral and bilateral agreements:

The 1944 Chicago Convention, under the auspices of the ICAO, itself prohibits only the taxation of fuel arriving inaircrafts‘ tanks. But subsequent ICAO resolutions, consolidated in 1999—having essentially the same effect astreaty provisions—enjoin contracting States to grant reciprocal exemption of fuels taken up for international
aviation (commercial and private).1 The rationale for these provisions is the ―development and expansion ofinternational trade and travel.‖
Bilateral Air Service Agreements (BSAs)—of which there around 4,000—differ, but generally provide similar
exemption.2

Amendment of the Chicago convention requires approval by a two-thirds majority (128 States), and would not bebinding on States that did not subsequently ratify it. Importantly, the ICAO Council has indicated that it would review its
policies if its present position on environmental charges and taxes were to change in some relevant way. 3
Amending BSAs to allow for the reciprocal taxation of fuels, however, can be straightforward—it would not benecessary to reopen or renegotiate them all. Where a BSA is silent over its own amendment (as for instance is the model
US BSA), Vienna Convention rules apply and reciprocal taxation could simply be introduced by mutual consent. EU
Member States have the right to tax fuel used on flights between them, by mutual consent. 4
The 1999 ICAO resolution also requires contracting States ―…to reduce …and make plans to eliminate…all forms oftaxation on…international transport by air, including taxes on gross receipts…and taxes levied directly on passengers or
shippers.‖ In practice, many countries maintain and indeed have increased such taxes.
Whether the Chicago Convention and related instruments apply to ETS permit prices as they do to taxes is currently the
subject of litigation, prompted by proposals to include non-EU carriers in the EU-ETS.
_________________________________
1

The intention is to preclude any charge that is compulsory and not used for airports or air navigation facilitates andservices: see commentary to ICAO (2000).
2
Similar exemption applies to other supplies, such as de-icing fluid, but this is less of an issue to the extent that thesecause no climate damage; and, as business inputs, they would in any event be effectively excluded from a sales tax suchas the VAT.
3
Foreword to ICAO (2000).
4
Directive 2003/96/EC.

Fuel costs are a larger share of all costs in shipping, even though the heavy fuel oil
predominantly used in shipping is relatively inexpensive.27 A given carbon pricetherefore represents a larger proportional increase in fuel costs, and total per unit costs,
for shipping than for aviation.

Emissions from aviation are generally higher per tonne kilometer. Emissions fromaviation have been put at 3 to 60 grams of CO2 per tonne-km, compared to 15 fortransport by sea.28 High-altitude fuel combustion may also have a greater ‗forcing
effect‘ on climate, through the formation of cirrus clouds and ozone from non-CO2
gases, though the magnitude of this effect, and even its direction, is uncertain.29

27

The average delivered bunker fuel price is approximately equal to the average crude oil price; see
http://www.bunkerworld.com/prices/. Jet fuel prices are higher, by a margin of 25-30 percent on the average; see
http://www.indexmundi.com/commodities/?commodity=jet-fuel.
28

29

See Stochniol (2011) and IMO (2009).

See IPCC (1999), Komuss and Crimmins (2009), Kolmuss and Lane (2009). The ICAO has requested the
IPCC to further investigate the effects of non-CO2 emissions from aviation. For shipping, sulfur emissions could

20

Efforts are underway to include international aviation in the EU ETS, though these
are currently under legal challenge—including on the grounds that they run counter toagreements discussed in Box 3.30 There is also provision to work towards including
shipping in the EU-ETS, failing progress in international fora.
B. Overarching Issues

The case for MBIs in international aviation and shipping
13.
The case for distinct pricing measures in international aviation and shipping on
climate mitigation grounds would mostly disappear if comprehensive carbon pricing
policies were widely adopted. With appropriately scaled carbon taxes (or emissions trading
systems) applied upstream, the carbon content of aviation and maritime fuels would already
be reflected in fuel prices paid by airlines and shippers. However, even in major emissions
pricing schemes introduced to date (e.g., in the EU ETS and prospective ETS in Australia)
these fuels are not covered. The analysis below therefore proceeds on the assumption thatsuch generalized carbon pricing measures are not widely in place for the foreseeable future.
14.
By directly targeting fuels, MBIs exploit all of the possible behavioural responses
for reducing emissions. For shipping, these include building more fuel-efficient vessels (hull,engines, and propulsions systems), optimising routes and vessel speeds to economize on fueluse, better utilizing individual ships and fleets as well as improving scheduling to reduce
idling time at ports. Similarly, for aviation higher fuel prices would reduce emissions by
rewarding use of more fuel efficient planes and, as charges are passed forward into ticket
prices, reducing the demand for flights. As stressed in Box 1, the ICAO and IMO are alreadypursuing some of these options; MBIs will reinforce these efforts as well as exploiting othermitigation channels, such as reducing the overall demand for travel and hastening retirementof older planes and ships. Taxes on shipping tonnage or turnover, or on airline ticket
purchases, in contrast, are less effective than emissions pricing from an environmental
perspective as they do not promote better fuel economy nor, in the case of shipping, do theyencourage the uptake of more sophisticated technologies and improved practices.31

cause a cooling effect as they deflect incoming sunlight (IMO, 2009), though any effect will presumably decline
over time as low-sulfur requirements are phased in.
30

Even though US carriers are challenging the expansion of the ETS, both US and EU airlines could reap
windfall profits from joining the EU-ETS as they would receive large allocations of free allowances, at least
initially (see below).
31

In principle, the tax (or emissions trading equivalent) should be on the average carbon content of fuel, toprovide incentives for the use or blending of non-oil based fuels (e.g., bio-diesel, hydrogen). However, there is
uncertainty about the commercial viability of these fuels for both planes and ships, and measuring the lifecycle
emissions from alternative fuels is contentious to the extent their production entails energy inputs and changes inland use. Nonetheless, there have been advances in the production of biofuels for use by ships (less so foraviation fuel). The use of biofuels in marine diesel engines is technically feasible, so the challenge for this tohappen is on the sustainable production of the needed quantities, and to do so to competitive prices.

21
15.
Not the least of the advantages of MBIs is as a source of public revenue, whether
in the form of taxation or receipts from auctioning allowance rights. Given the zero levelsof fuel taxes in international aviation and maritime at present, these are likely to be especiallyefficient sources of revenue, whether for general purposes or, as is taken to be the case here,
for climate finance.
Prospects for promoting participation
16.
Implementing effective MBIs for international aviation and shipping will requiresignificant international coordination, including from lower income countries—
especially for shipping. Underlying the tax-exempt status of international transportation
fuels—in addition to the legal obstacles in aviation—are natural fears that unilateral taxation(or pricing) would result in little revenue as fuel is taken up elsewhere, harm local tourism,
undermine the competitiveness of national carriers, raise import prices and/or reduce thecompetitiveness of exports. If governments set taxes unilaterally, they would be underpressure to set lower rates than in other countries. Although there is need for a multilateralapproach to aviation taxation, something less than universal agreement—for example
exempting some vulnerable developing countries—could still have significant effects on
global emissions. For maritime fuels, including developing countries is more important,because of the extremely high mobility of the tax base.
17.
With lower income countries needing to participate in order for these schemes tohave maximal environmental and revenue effects, consideration needs to be given to
make sure they are not harmed by participating.32
18.
There is a tension between setting ambitious fuel charges and promoting policy
compliance. Setting aggressive emissions prices encourages avoidance and evasion. In turn,greater non-compliance will undermine the environmental effectiveness of and, even more
importantly, support for, an international fuel pricing agreement. Large charges (e.g.,corresponding to the high climate damage scenario in AGF 2010) are therefore not consideredin the main text here.
19.
Although on a much smaller scale, experience with the air ticket solidarity levy
and the International Oil Pollution Compensation (IOPC) Funds suggest a cooperative
approach to pricing emissions from international transportation can be aspired to. As
discussed in Box 4, these schemes involve agreements among countries to raise funds for acollective purpose.

32

This paper does not consider precisely which countries might be compensated, or whether and how the use
made of compensation might be restricted (to ensure, for instance, that they are not used to support policies that
increase emissions).

22

Box 4. Current International Taxes and Levies: The Air Ticket Solidarity Levy and the International Oil
Pollution Compensation Funds
The Air Ticket Solidarity Levy is an example of financing global public goods by a levy on international aviation.
Eleven countries have imposed an ‗air ticket solidarity levy‘ on airline tickets, receipts from which are passed to
UNITAID to finance health improvements in low income countries.1 It provides 70 percent of UNITAID‘s financialbase and is complemented by multi-year budgetary contributions from a number of member countries. Several
developing countries participate in this scheme.
The levy is applied to all flights departing from countries that impose it and is paid by passengers when purchasing
their tickets, normally as an addition to existing airport taxes. Passengers in transit are exempt.
The levy ranges from US $1 for economy-class tickets to US $10 and US $40 for business- and first-class travel.
Different rates can be set according to a country‘s level of development, and there is an option to vary the charge
according to the distance travelled. For example, some countries in Africa have chosen to impose the levy only oninternational flights or on business- and first-class tickets.
The International Oil Pollution Compensation (IOPC) Funds. These Funds, which were established under the Civil
Liability Convention of IMO, are financed by contributions paid by any person, company or organization, who hasreceived, during the preceding calendar year, more than 150,000 tonnes of crude oil or heavy fuel-oil after sea
transport. The contributors are generally oil companies and the contributions are channelled directly to the Funds withno government involvement. The obligations of the Member States are to implement the needed legal regime and toensure compliance by entities within their territories. States may collect the contribution nationally and pass it on to
the Funds, but no party to the IOPC has chosen this option. The annual funds collected and paid out amounted to a
total of $54 million in 2010.2______________________________
1

See http://www.leadinggroup.org/rubrique177.html.

2

See www.iopcfunds.org for more details.

20.
Aviation fuel used domestically is already widely taxed, though typically at much
lower rates than other fuels. For example, the federal government in the United States
imposes a tax of about 1 cent per liter for domestic jet fuel used in commercial operations.
This tax is far lower than motor fuel taxes in the United States.33 However, other countries
with major domestic flight activity have higher rates; notably Japan at more than US$0.25 perliter.34 Moreover, the fact that taxes on domestic aviation fuel already exist suggest that fuelcharges for international aviation would be administratively feasible. Indeed imposing thesame rate on domestic and international fuel might simplify administration by obviating thecontrols needed for differentially imposed taxes.
C. Key Concepts: Incidence and Compensation
21.
By the ‗incidence‘ of a tax is meant the answer to question: ―Whose real income
is reduced by this tax, and by how much?‖ While charges on international aviation andshipping raise issues of incidence within countries—it may matter, for instance, whether
import prices rise more for goods consumed by the rich or by the poor—the primary concern
33

Combining federal and average state taxes, excises on gasoline and diesel fuel are about 10.5 and 11.5 cents
per liter (Parry, 2011).
34

See Keen and Strand (2007), Table 1.

23
in this paper is with incidence across countries. It is clearly preferable to avoid regimes thatare ‗regressive‘ in the sense of imposing a larger incidence relative to GDP on poorer
countries that heavily rely on international transport (including small island States). A
stronger notion of fairness—to the fore in the present context—is to ensure that developing
countries are made no worse off, which likely requires explicit compensation.
22.
The ‗real‘ incidence of a tax can be quite different from its ‗legal‘ incidence. Fuelrefiners, distributors, or vehicle operators may be legally responsible for paying the tax.
However, to the extent that an aviation or maritime fuel tax is ‗passed forward‘ into higher
selling prices, the real incidence of the tax will fall on their customers; to the extent they are‗passed backwards,‘ they will result in lower world oil prices and reduced revenues for oil
producers. And to the extent that they remain with aviation and shipping companies, the real
incidence falls on their owners or employees. Precisely who is legally responsible for
remitting the tax in itself generally makes little or no difference to its real incidence: whether
a tax is levied on the output of a refinery or the use of the same products by final consumer(perhaps in a quite different country) may matter for the practical implementation of thecharge, but should make no difference to the prices each ultimately faces.35
23.
Establishing the real incidence of a tax is only one element in assessing its
economic welfare impact—and it is the latter that matters for compensation issues. Any
tax causes a loss of economic welfare simply by transferring resources from private to public
sector (though there may of course be more than offsetting benefits from the public spending
this enables). But it typically also distorts the prices that consumers and perhaps also
producers face away from those they would otherwise face, distorting their behaviour andleading to another source of ‗deadweight‘ or ‗welfare‘ loss. If it is then desired to compensate
a taxpayer—or country—for the effects of some tax, account needs to be taken of this indirectloss too. An artificial increase in import prices, for instance, will cause a welfare loss in partby impeding citizens access to goods that are produced more cheaply abroad than at home;
and, by the same token, by extending artificial protection to domestic industries.
24.
In broad terms, the welfare impact of any country of charges on fuels used ininternational transport depends on three factors (Box 5):
The proportionate impact on transport costs, meaning here primarily ticket prices foraviation and freight costs for maritime.

The relative importance to the wider economy of the goods affected. Even a large
increase in transport costs will have little impact, for instance, if the affected good issmall relative to GDP.



Elasticities of import demand and export supply both in the affected country and in
the rest of the world. Increased transportation costs for a country‘s exports, forinstance, will be largely borne by purchasers of those exports, not citizens of thecountry itself, if their demand for those exports is highly inelastic and/or the supply of
those exports is highly elastic.

35

In the absence of price controls.

24

Box 5. Assessing the Welfare Impact of Increased Transportation Costs
It is shown in Appendix 1 that the compensation required by country A to offset the welfare loss from(small) proportionate increases andin the prices of an imported good M and an exported good X(ignoring cross-price effects between them) is given by

wheredenotes the elasticity of export supply in country j andthe elasticity of import demand, whileanddenotes the values of affected imports and exports. If, for instance, country A‘s demand forimports is infinitely high, it will bear none of the burden of increased transport costs bearing on its imports:
this will all be passed back to the country supplying those imports.
One important limitation of (5.1), and the related expression in Box 11 later, is that it assumes there to be
no pre-existing distortions. The presence of import tariffs and export taxes, for instance, is likely to amplify
the welfare loss from increased transportation costs.

25.
Projecting incidence and welfare effects is extremely difficult. While the second of
the factors just mentioned may be reasonably straightforward to establish with reasonableconfidence, there can be considerable uncertainty as to the first and third. The impact ontransportation costs will depend, for instance, on the extent to which the charge is passed
forward to purchasers of these fuels rather than being borne by their producer—which isconsidered below. It will also depend on the degree of competition in the transport market, theability of suppliers to economize on the use of fuels and, in the maritime context, the nature of
the goods imported or exported and the distance and manner in which they travel. Assessing
the elasticities appearing in the third factor is potentially even more difficult. They will
depend, for instance, on the time period under consideration (being greater in the longer thanin the shorter run). Moreover, at issue here are charges that would have effects on
international aviation and shipping throughout the world, so that a full analysis requires
looking beyond the impact on any single country to take into account how the charge would
affect trading patterns and prices in a more general setting—which means that the relevant
elasticites are for prices changes in many countries, not just that under examination. While it
is likely to be difficult to explicitly condition compensation schemes on trade elasticities, theirrelevance to welfare effects is such that they need some consideration in determining whether
practicable approaches provide a good approximation to factors that economic analysis
suggest shape the amount that is in principle required.
26.
The more extensive is compensation, the less additional revenue will be madeavailable for climate finance or other worthwhile expenditure. This is an obvious but
critical trade-off that can only be assessed in the context of the full package of charges and thespending they enable.
27.
Other concerns may also be relevant. The aggregate perspective taken in Box 5 does
not capture particular concerns that may arise if the change in transport costs affects different
income groups differently: higher import prices may hurt domestic consumers, for instance,

25
but benefit but benefit import-competing producers. Nor does it capture potentially, concernswith the impact not simply on the impact on profits and wage payments in the tourist sector
but also on the volume of tourism travel. Importantly, where better-targeted instruments areavailable, these concerns may be best met by other means (such as a subsidy to the tourism
sector).
D. The Impact on Oil Prices
28.
The critical first step in all incidence and compensation issues is: How far would
charges on jet or maritime fuels be passed on to purchasers? This is key to the first factor
identified above: to the extent that the impact is not passed forward, so that aviation andmaritime fuel prices rise by less than the full amount of the charge, so its impact on andthrough the sectors will be muted. Part of the impact would then be felt by suppliers of crude
oil—including a number of low income countries that are new oil producers.
29.
The determinants of the degree of pass forward into fuel prices are complex—one
key issue being the degree to which refiners can substitute between the production of
taxed and untaxed fuels. Box 6 considers the likely impact of a charge when such
substitution is completely costless. The degree of pass forward is then likely to be high since
producers can readily escape the tax by instead producing other fuels. As a rough order ofmagnitude, on average over 90 percent of a charge imposed on both marine and jet fuel might
be passed on.
Box 6. The Impact on Oil Prices from Taxing International Aviation and Maritime Fuels
Suppose first that ‗oil‘ is a homogenous product, and consider a specific charge of T levied on its use in
only one activity (aviation and or maritime). In this case, assuming the relevant industries are reasonablycompetitive and that the elasticity of demand is the same (E) for both ‗taxed‘ and ‗untaxed‘ uses, theimpact on the pre-tax oil price P is approximately

where is proportion of all oil consumed in the taxed sector and the elasticity of oil supply. The impact
is thus smaller (i.e. less of the charge passed back to oil producers): (1) the smaller the amount ofaviation/maritime fuel produced from the average barrel of crude oil input; (2) the smaller the share of
global aviation/maritime fuel production that is covered by the charge (i.e., the greater the extent ofdeveloping country exemptions); and (3) the less elastic is the demand for these fuels and the more elastic
is the supply of crude oil.
Broadly speaking, the impact is the same as that of a tax on all oil uses but scaled down by the share of oilcovered by the tax in all oil production. The empirical evidence suggests that the elasticities of demand forand supply of oil are of broadly the same magnitude: according to IMF (2011), Ch. 3, the magnitude of oil
demand and supply elasticities are both around 0.05 to 0.1 in the short run, though both are larger over the
longer run.
This suggests that the bracketed term in equation (6.1) is around 0.5. Supposing that the share of aviationand maritime in global oil demands is 11 percent1 and international fuel taxes are implemented globally(i.e., = 0.11), then a fuel tax of 10 cents per liter imposed on all aviation and maritime fuel demand
would reduce the world oil price by around 0.55 cents and, conversely, increase the price to fuelpurchasers by around 9.4 cents per liter.
_________________
1

This is based on EIA (2011b) and IMO (2009).

26

Box 6. The Impact on Oil Prices from Taxing International Aviation and Maritime Fuels(concluded)This simple analysis also highlights that taxing the use of oil in some particular use results in a fall in its
prices in other uses. Thus low-income oil importing countries, for instance, would derive some benefit to
the extent that prices of fuels in other uses fall. This effect also means that total emissions fall by less than
do those in the affected sector, since the reduced price in other sectors leads there to higher emissions.
Total emissions will fall (so long as the supply curve is upward-sloping), but the fall will be smaller the
more elastic is the demand for oil in untaxed uses.
All this assumes oil in distinct uses to be perfect substitutes.2 Appendix 2 provides a general treatment of
the case in which, as in practice, they are not, on which the calculations in Table 1 are based.
________________________
2

There are other limitations too. The ultimate exhaustibility of oil, for instance, means that a full incidence
analysis would recognize that a reduction in supply today may be associated with increased supply tomorrow(see for instance Sinn, 2008). Imperfect competition too can significantly affect the impact of taxation: it may
even lead to over-shifting (tax-inclusive price rising by more than the tax) and to an increase in profitability, as
the tax serves to coordinate an output reduction that firms are unable to collude on directly (e.g., Stern, 1987).

30.
Even allowing for possible difficulties of re-configuring refineries to alter the
portions of different fuel products produced from crude oil, pass-back to oil producers is
likely to be modest. In effect, costs of reconfiguration mean that the supply of taxed fuel ismore inelastic, so that producers bear more of the burden of the tax. Nonetheless, evenallowing for somewhat more limited substitution possibilities, simulations in Table 1 (basedon formulae given in Appendix 3) suggest that the passback into lower oil prices is still
modest—again at about 6 cents per liter for a $1 per liter fuel charge.36 It is noticeable,
nonetheless, that the amount of the tax passed forward is far from complete: A $1 tax increase
leads to an increase in the tax inclusive price of ‗only‘ 65–84 cents per liter. The reason is thatthe price impacts for the untaxed fuels are in many cases sizable, in the order of 10 percent—implying a benefit to users of these fuels that needs to be weighed against any loss from theimpact on the taxed fuel.
Table 1. Impact on Fuel and Oil Prices of $1 Charge on a Subset of Fuels
Elasticity of substitution
Elasticity of fueldemands and oil supply
Price change (in cents) of 1
Taxed fuel 2
Untaxed Fuel
Crude Oil

∞

1
0.1

0.5

0.1

0.5

0.1

0.5

+0.86
-0.08
-0.06

+0.65
-0.10
-0.06

+0.93
-0.06
-0.06

+0.86
-0.07
-0.06

+0.94
-0.06
-0.06

+0.94
-0.06
-0.06

Notes: See Appendix 3 for underlying formulae. Taxed fuels are assumed to be 12 percent (by tax-exclusive value)of oil sales, and the elasticities of demand for the two fuels are assumed equal to one another and to the elasticity ofsupply of oil in the notation of Appendix 2, EA = EB = η ≡ E. (The invariance of the impact on the oil price is aconsequence of this assumption).
1

Price effects do not sum to unity, reflecting the differing shares of taxed and untaxed fuels in the derived demands
for oil.
2

36

Tax-inclusive price.

For marine fuels in particular, there is probably a high degree of substitution with other oil products. Even
with no retrofits to refinery capacity, heavy fuel oil may be further refined into higher quality and higher priceproducts, or sold on global markets for use in industry or power stations.

27
III. POLICY SCENARIOS: INTERNATIONAL AVIATION
31.
This section outlines several fuel pricing scenarios—including emissions taxes ortheir auctioned cap-and-trade equivalents—that vary by the emissions price and theextent of developing country compensation, and discusses their implications foremissions, revenue, costs and cross-country incidence. For the most part, the pricing
policies could be implemented via a tax or an emissions trading regime with allowance
auctions—Section V discusses the choice between these instruments in more detail. Further
impacts of concern (e.g., effects on productivity, trade performance, innovation) are notdiscussed, not least because of the difficulty of quantifying impacts.
A. Scenarios
32.
A natural way to seek to protect more vulnerable countries is by their retaining
the amounts collected for fuel charges for air transport in and out of the country. Data
are not available, however, for jet fuel use in all countries by country of origin or departure.
There are then two ways of approximating the fuel used in travel to and from such countries:(1)

In proportion to fuel purchases, data on which are available by country. In its simplest
form, this approach would allow developing countries to keep receipts from charges
imposed on fuel disbursements within their country for international flights. These
fuel disbursements would amount to about half of the total fuel consumed for a flightfrom a developed country to a developing country and back again.

(2)

In proportion to passenger kilometers (or passenger, freight, and mail, in tonne-km).
Under this approach, each country would be allocated a share of revenue from theglobal fuel tax—perhaps that part prorated to passenger travel—corresponding to the
proportion of all inward passenger kilometers.

Each approach causes potential distortions: under (1), countries have an additional incentive
to establish themselves as hubs; under (2), perhaps less of a concern, they have an incentive toencourage passenger numbers. But any compensation scheme linked to future outcomes will
create distortions, and these seem likely to be manageable. Below the focus is on the first typecompensation scheme, given its relative simplicity, close connection to the base of the charge
and limitations on data available on passenger kilometers.
33.
Although not considered here, more sophisticated compensation schemes could
be designed to account for relative income growth over time, or to entice participation
by low-income countries (like tourist destinations) especially vulnerable to high fuelprices. For example, it would be possible to adjust the amount of compensation for acountry‘s per capita income relative to that of the average developed country (indeed somesuch adjustment would presumably be needed to phase out compensation across countries atdifferent levels of development and vulnerability). Thus the compensation would
progressively decline as a country‘s per capita income caught up to that of wealthiercountries.

28
34.

The following illustrative policy scenarios are considered:1.

A uniform, globally applied CO2 price of $25 per tonne, with no special
compensation for developing countries.37 The emissions price corresponds to themedium damage scenario studied in AGF (2010) and is approximately consistent witha recent US inter-agency assessment of environmental damages per tonne (US IAWG
2010). The CO2 price is higher, but only moderately so, than the current (September2011) emissions price in the EU ETS of about $19 (EUR 13) per tonne of CO2.38 A$25 per tonne emissions price would add about US 6 cents per liter, or about 8
percent, to the price of jet fuel.39 Although unlikely perhaps for the foreseeable future(not least because it provides no developing country compensation), this policy
scenario still serves as a useful benchmark as it representations a ‗worst case‘ scenario(given the emissions price) in terms of potential adverse impacts on low-income
countries.

2.

As (1) but developing countries keep all revenues from fuels taken up in theirjurisdiction (through rebating of receipts from taxes or allowance auctions). In
terms of potential revenue for climate finance, this policy scenario is very similar to
scenarios when developing countries are either exempt from the pricing regime or
could join voluntarily (but keep revenues they collect). The environmental
effectiveness of the policy would be somewhat weaker in these latter cases, however.

3.

As (2) but with an emissions price of $15 per tonne of CO2. This policy could reflecta scenario with lower assumed environmental damages. Alternatively, from a climate
finance perspective, it could approximate a case when countries agree on a minimum
price floor, but with individual countries free to impose higher prices (through higher
taxes or more stringent trading schemes) and keep extra revenues for themselves.

4.

As (1) but with a CO2 price of $40 per tonne. This policy reflects a higher scenario
for environmental damages or more aggressive target for climate stabilization. For
practical purposes however, this scenario is even less realistic than policy (1), given
the tension between aggressive pricing and reaching international agreement (the pricelevel is about double the prevailing price in the EU ETS).
B. Environmental Effectiveness35.
A price of $25 per tonne of CO2 might reduce travel demand by 2–4 percent
below baseline levels. An 8 percent increase in aviation fuel costs would add about 2–4

37

All prices are expressed in year 2011 units.

38

See www.pointcarbon.com.

39

Combusting a litre of jet fuel produces 0.0025 tonnes of CO2 emissions (EIA 2011a).

29
percent to the average airline ticket price.40 Based on the studies summarized in Table 2, it isassumed that the price elasticity of demand (i.e., the percent change in travel demand in
response to a one percent increase in the ticket price) is -1.0. In this case, a general 2–4
percent increase in ticket prices might therefore be expected to reduce overall travel demand
for affected airlines by around 2–4 percent.
Table 2. Estimates of the Price Responsiveness of International Air Travel by Trip TypeMedian price-elasticity estimate a

Range

Long-haul international business-0.27-0.48 to -0.20

Long-haul international lesiure-1.00-1.70 to -0.56

Long-haul domestic business-1.15-1.43 to -0.84

Long-haul domestic leisure-1.10-1.23 to -0.79

Short-haul business-0.70-0.78 to -0.60

Short-haul leisure-1.52-1.74 to -1.29

Type of trip

Source: Gillen et al. (2002).
Note: a Price elasticity refers to the percent change in travel demand in response to a 1 percent increase in ticket price.

36.
Emissions pricing would induce other mitigation options beyond this reduction indemand. These include more efficient operations (e.g., optimizing flight paths and reducing
airport congestion, reducing average time spent idling on runways or circulating airports
through advanced communication, navigation, and air traffic management) and improved
efficiency of new planes (e.g., improving aerodynamics to reduce drag, more efficientengines, incorporation of lighter materials into the airframe). It is difficult to estimate thefuture development and deployment costs of many of these strategies, and hence the extent towhich they would be incentivized by higher fuel prices over the longer run.41 For cars andlight trucks (at least in the United States), it seems reasonable to assume that a 1 percent
increase in fuel prices will ultimately increase fuel economy by something in the order ofabout 0.2 percent (e.g., Small and Van Dender, 2006). For airlines the responsiveness might
be lower, given already strong incentives to economize on fuel (which is expensive to carry)and ongoing efforts by ICAO to promote better fuel economy. Simply by way of illustration,
suppose the fuel economy response is 0.1 percent (per 1 percent increase in the fuel price).
Combining this with the assumed reduction in travel demand implies an overall fuel (andemissions) reduction in response to an 8 percent increase in fuel price of 3–5 percent. Given
40

Assuming that fuel costs comprise between 25 and 35 percent of total costs of airline (see GAO 2009), andassuming that the carbon charge is fully passed on to customers, an 8 percent increase in fuel costs leads to 2–4
percent increase in ticket price.
41

See, for example, Morris et al. (2009).

30
that developing countries account for 35 percent of fuel use (see above), their exemption fromthe agreement might limit the global emissions reduction to about 2–3 percent.42 A similarlevel of emissions reductions might occur if all countries participated, but at a price of $15 per
tonne rather than $25. On the other hand, the emissions reduction might be around 5–8
percent under a CO2 price of $40 per tonne, encompassing all countries.43
C. Revenue
37.
Total projected revenues in 2020 are $12 billion under the $25 per tonne pricing
scenarios, $7.5 billion for the $15 per tonne scenario, and $18.7 billion under the $40 per
tonne scenario (Figure 2a). Revenues are calculated as follows. Baseline emissions in 2020
are taken to be 500 million tonnes.44 This is scaled back by the midpoint of the range of
proportionate emissions reductions for the different pricing scenarios just discussed, andmultiplied by the corresponding emissions price.
38.
With compensation schemes, developing countries would raise significant
amounts of domestic revenue (Figure 2b). For example, with a $25 per tonne CO2 pricedeveloping countries as a group raise revenues of $4.2 billion and even with the $15 per tonne
price, they raise revenues of $2.6 billion (potential compensation relative to countries‘ GDP is
discussed below).
39.
Revenues for climate finance and other uses total $4.8–$7.8 billion in the more
realistic pricing scenarios ($15 to $25 per tonne of CO2) with developing countrycompensation (Figure 2c). Of these, perhaps 5–10 percent might be remitted to implementing
agencies, national or international, a precedent being that EU Member States are allowed tokeep 10 percent of customs revenue to cover administration costs. Some might also fund clean
technology development programs for the aviation and maritime industries. However, theamount that might be warranted on economic grounds to correct market failures, that is, thepotential inability of innovators to appropriate spill over benefits of new technologies to otherfirms, would likely be a small fraction of the revenue raised. At most, therefore, international
aviation might contribute around $4–7 billion for climate finance in these scenarios.

42

This ignores the (small) risk of offsetting emissions increases as the pattern of flights shifts from developed todeveloping countries.
43
44

For comparison, AGF (2010b) assumed no emissions reductions in response to similar charges to aviation.

This is based approximately on the projection in ICAO (2009a), scaled back by 20 percent on the assumptionthat ICAO‘s aspirational emissions mitigation goals (see above) will be met. It is assumed that charges are leviedon flights that it is proposed to include in the EU-ETS. Issues arising from the coordination of such a charge with
the EU-ETS are discussed in Section V.

31
Figure 2. Revenue from Taxes on International Aviation(a) Total Global Revenue
25$billion

20
15
10

5
0

(b) Compensation for Developing Countries
25$billion

20
15
10
5
0

(c) Revenue for Climate Finance and Other Uses
25

$billion

20
15
10
5

$40 CO2 price (nodeveloping countrycompensation)$15 CO2 price(developing countrycompensation)$25 CO2 price(developing countrycompensation)$25 CO2 price (nodeveloping countrycompensation)0

Source: See text.

40.
These numbers are broadly consistent with those presented in AGF (2010b).
Workstream II reports revenue estimates for climate finance of approximately $1–6 billion.
The lowest figure is for a $15 per tonne CO2 price, with 25 percent of the revenue raised indeveloped countries going toward climate finance, while the highest figure is for a 50 percent
climate finance share and a carbon price of $40 per tonne CO2. Intra-EU flights are excluded
from the revenue base in AGF (2010b), implying a somewhat lower revenue figure thanabove.
D. Cost Considerations
41.
Pricing aviation fuel would be a highly cost effective source of revenue comparedwith broader fiscal instruments, in the absence of comprehensive, upstream pricing acrossall fossil fuel products and countries. The tax would reduce carbon emissions by suppressing
fuel demand and (moderately) alleviate local air quality, noise, and congestion problems

32around airports. It would also help to offset excessive demand for air travel caused by theunder-taxation of this sector relative to other goods and services. Most likely, aviation fueltaxes at the level considered here are a much more cost-effective way to raise climate financethan broader tax instruments (which do not target environmental damages).
42.
The difficulty of taxing the final consumption of international aviation services
could point to a carbon charge above that called for by climate considerations. A fully
appropriate tax structure would levy both a fuel tax to address environmental concerns and a
tax on the final consumption of aviation services to raise revenue efficiently and fairly within
the overall tax system. In the absence of such explicit sales taxation, a tax on fuel acquires
also a role in correcting the potential over-consumption of aviation services and enhancing
revenue. This can plausibly call for larger fuel taxes—and hence to potentially substantiallymore revenue—as described in Box 7.

Box 7. Second Best Taxation of International Aviation Fuel
In a simple partial equilibrium model, Keen and Strand (2007) show that in the absence of a tax on final
consumption the optimal fuel charge T is given by

where P is the pre-tax fuel price, is the share of fuel in total costs, the elasticity of substitution between
fuel and other inputs, E the elasticity of final demand, MSC the marginal social cost of emissions, andthe marginal cost of public funds. The extent to which this last exceeds unity can be interpreted as anindicator of the urgency of the need for revenue. A table presented in Appendix 2 reports illustrative
calculations, assuming a unit elasticity of demand, and assuming a globally uniform optimal tax (on bothinternational and domestic aviation).

43.
A distance-based (non-creditable) ticket tax, while inferior to a fuel tax, could
also have merit. The air ticket levy in the U.K. is of broadly this form, being chargeable in an
amount that varies with distance (within and outside of EU) and by travel class. The
weaknesses of such a tax—most notably that it discourages emissions only by discouraging
travel—are stressed in AGF (2010b). The force of these is diminished, however, by therecognition that the absence of sales taxation means that such a tax would at least serve tocorrect current tax distortions that likely lead to excessive international aviation transport.
E. Incidence
44.
As discussed in Section II.D above, some of the incidence of a fuel tax may bepassed back to oil producers through a reduction in crude oil prices. However, this effectis likely modest and is ignored below.
Impact on the aviation industry
45.
A uniform tax on international aviation fuel, applied globally, would not impact
competitiveness within the sector—and would level the playing field relative to other33
sectors. Since all airlines would face the same increase in fuel prices, there would be no
distortion of competition between them. This is not to say that there would no impact on theircompetitive positions relative to one another: ‗no frills‘ airlines for instance—for whom fuelcosts tend to be a larger part of the ticket price—will lose some edge. But none is privilegedby facing different input prices. In the absence of broader emissions pricing, all airlines would
face an increase in costs not falling on other sectors, whether other transport modes in directcompetition with aviation or simply other forms of consumption and inputs to production.
However, this would largely alleviate (rather than introduce) distortions of competition to theextent that these other sectors already pay fuel taxes.
46.
There may be some windfall loss to owners of airlines, and it is conceivable thatsome airlines may be caused to fail—but with less of a long run impact on capital owners
or workers. To the extent that the tax is not fully passed forward to airlines‘ customers, it will
fall on profits or labor remuneration. Airlines earning profits in excess of the minimum
required may absorb some loss in reduced super-normal profits, an effect that will materialize
in lower share prices as the charge becomes anticipated (some capitalization may have alreadyoccurred). In the longer term, capital owners are not likely to be burdened by the tax, since
they can simply invest elsewhere instead. Though the modest increase in costs suggest that
this is unlikely to be major issue, airlines at the margin of profitability may suffer difficulty.
The main long-run impact on the sector is likely to be a slightly lower overall businessvolume.
47.
If it is desired for some reason to protect such airlines, the best targeted
instrument would be an outright subsidy, leaving their incentive to cut emissions
unchanged. The subsidy could take the form of a lump-sum payment, or allocation of free
emissions allowances—though only a small portion of the allowances would be needed tokeep airlines whole given that most of the incidence is borne by passengers rather than airline
companies.45 These compensation schemes may run foul of state-aid and export subsidy
prohibitions (unless explicit override provisions were introduced). The economic case forsupport of such airlines seems weak, however: their closure, in principle, would simply meanthat they are unable to break even when they pay the full social costs of the environmental
harm from their operations. Workers too will bear a minor burden of the tax in so far as theycan earn similar wages elsewhere; to the extent they cannot, adjustment can be eased throughstandard tools for strengthening labor market participation.
48.
If developing countries do not participate in the pricing agreement, there could
be some relocation of flights away from developed and towards developing countries.
However, as mentioned above, the increase in the ticket price (for developed countries) is
likely to be modest. Moreover, as noted in Section II.A, the tax base is imperfectly mobile
given practical constraints on the ability to divert flights to tank up at airports of tax exempt
countries, and limited willingness of passengers to change their country of destination.

45

Note however that a large share of free quota allocations given to airlines over the long run may undermine
their incentives to abate, given that free future allocations are related to current emissions; see Rosendahl (2008).

34
Impact on low income countries—and their compensation
49.
The real incidence of any increase in the price of air travel to lower income
countries is likely to fall largely on citizens of developed countries. Though there would
doubtless be some impact on travel costs of poorer groups in lower income countries,
including for instance migrant workers, the main burden is likely to fall on travelers fromhigher income countries and better-off domestic residents. The impact, both across and withincountries, is thus likely to be progressive. Indeed it is notable that a number of lower income
countries are among those that have imposed solidarity levies referred to above, suggesting
few reservations on this account.46
50.
To offset the impact on tourist destinations—which has been a particularconcern—returning all revenue raised domestically could be more than adequate. Thatis, the part of the revenue that is in effect a transfer from citizens of developed countries
exceeds the harm suffered by the domestic tourism industry. Box 8 elaborates.

Box 8. Tourism and the Welfare Impact of a Fuel Charge
The figure provides a simple illustration of the impact of an aviation tax on a tourism-providing developing
country. The upward-sloping curve shows the domestic supply of tourism services; the downward sloping
curve is the demand for these services, assumed to come entirely from residents of developed countries.
Imposing a charge on fuel use shifts the demand curve for tourism services down, from DD to, by anamount that—assuming full pass-through to the price of tourism services—reflects the underlying charge.
The equilibrium price of these servicesD
to tourists themselves rises to ,S
D’causing them a loss of consumer
surplus given by the area
. But
B
P’
since these are by definition resident inCFPrice P
foreign countries, this welfare loss isEpresumably of no direct concern to theDtourism-providing country. What is ofconcern is the loss of producer surplus
in the domestic tourism industry, givenDby the area
—and the fate of theD’revenue raised.
Quantity
Roughly half of this revenue will be collected by the tourist destination for flight legs from that country, sothat the question is whether half of the area
is greater than that of PCDE. This clearly depends on
the relative elasticities of the demand and supply curves. More precisely, from equation (1) of Box 5, atransfer ofwill be more than adequate compensation if and only if. Estimates ofthe size of this elasticity of demand for tourism vary widely, from around 0.15 to 7.0 (Lim, 2006), with
figures in the lower part of this range likely more appropriate if—as would be the case if the charge wereglobally applied—the increased transport costs apply to all destinations. Where tourism capacity is fairly
easily extended, it is thus fairly plausible that the net effect will be a welfare gain for the tourist destination.
This cannot be taken for granted, however, and where capacity is essentially fixed (if beaches are alreadyfully developed for instance), the possibility remains that full return of revenue collected on one leg of theflight may be inadequate compensation.
46

Furthermore, on behalf of the Group of Least Developed Countries the Maldives proposed a global levy (forclimate finance) on international air trips at the 2008 climate change meetings in Bali.

35
51.
The charge has similarities to an export tax levied collectively by tourism
destinations, though with the difference that only half of the revenue is collected (assuming
fuel is taken up there for only one leg of the journey). This can be beneficial for countries
with some power in world markets; as, collectively—the relevant dimension in this case—
tourism centers in developing countries surely do. A small charge, with full return of revenue,
can for this reason plausibly be positively beneficial for tourism destinations. But why, ifdeveloping countries can benefit by imposing a tax of this kind, do they not already do so?
Part of the answer may be that to some extent they already attempt to do so, in the form of
departure taxes47 but that they feel limited in so doing due to tax competition arguments. Most
likely, tourist destinations have collectively much greater power in world markets than do any
single destination is isolation: that is, the supply curve is much more elastic when viewed
collectively than individually. Thus, a global tax would in effect provide a coordinating
device for charging an export tax that—as a standard problem of tax competition—tourist
destinations have previously found hard to enforce.
52.
Using the finance obtained from the scheme, measures can be taken, if desired, tocushion any impact on the tourism industry. This finance would provide room, forinstance, to reduce any departure tax, to better promote the industry or improve its
infrastructure. Such measures might to some degree undo the emissions impact of the charge,
but the extent of relevant travel is sufficiently limited that this is unlikely to be a major
concern.
53.
Some small island States could receive particularly large compensation (relative
to their GDP) if they retain collected revenues. Table 3 indicates the amounts that would
have been received by selected developing countries if a global charge of $25 per tonne of
CO2 had applied to countries‘ jet fuel disbursements in 2007. A number of small island
developing States receive relatively large compensation such as Fiji (0.35 percent of GDP);
Bahrain (0.11); Seychelles (0.09); Mauritius (0.08); Singapore (0.07); Jamaica (0.06);
Maldives (0.4); Barbados (0.03); and Papua New Guinea (0.03).

47

Only a small number of countries mostly in Latin America (Chile, Colombia, Mexico, Peru and Venezuela;
plus Pakistan and the Philippines) impose substantial departure taxes; Peru also levies an arrival tax.

36
Table 3. Receipts in Developing Countries Under $25/ton CO 2 Levy on International Aviation Fuel(applied to year 2007)
CountryFijiBahrain
Seychelles
Mauritius
SenegalHong Kong
United Arab Emirates
Singapore
CyprusKenya
Jamaica
Turkmenistan
JordanQatar
Iraq
Maldives
Thailand
Azerbaijan
PanamaOman
Barbados
Papua New Guinea
Malaysia
KuwaitRussiaSaudi Arabia
Philippines
Egypt
South Africa
Sri Lanka
MoroccoEcuador
Korea, South
UkraineAngolaTunisia
Kazakhstan
BrazilTonga
Comoros
Argentina
Belarus
MexicoPakistan
Haiti
Indonesia
China
India
Algeria
Peru
Colombia
Iran
Bangladesh
Nigeria

Total

Revenue% of GDP$million

0.345
0.112
0.090
0.083
0.080
0.075
0.073
0.069
0.061
0.058
0.056
0.055
0.048
0.042
0.041
0.039
0.034
0.032
0.032
0.032
0.030
0.030
0.028
0.022
0.021
0.021
0.020
0.019
0.019
0.019
0.018
0.017
0.016
0.015
0.015
0.014
0.012
0.011
0.011
0.013
0.011
0.010
0.010
0.009
0.009
0.008
0.007
0.007
0.006
0.006
0.006
0.006
0.006
0.004

13
28
2
12
17
221
179
168
14
34
12
16
14
38
39
1
177
22
12
20
2
4
100
29
513
114
61
79
91
16
23
17
209
50
13
11
20
210
0.05
0
58
11
147
133
1
64
536
222
17
14
23
48
11
11

3,898

Source: EIA (2011b) and WB (2011).
Note: The tax is $25 per tonne of CO2, applied to all international flights. The above figures do not account for the (modest)
reduction in fuel use in response to any charge, and assume that 60 percent of reported jet fuel consumption (domestic plus
international) is for international flights for all countries (resulting in an understatement of receipts in small island developing
States).

37
IV. POLICY SCENARIOS: MARITIME
A. Scenarios
54.
The same four policy scenarios are considered for international maritime as forinternational aviation. These are (1) a uniform, globally applied CO2 price of $25 per tonne,
with no compensation for developing countries; (2) as (1) but with developing countries as agroup retaining the amount collected on that 40 percent of global fuel disbursed indeveloping countries; (3) as (2) but with an emissions price of $15 per tonne; and (4) as(1) but with an emissions price of $40 per tonne. Since emissions per liter are somewhat
higher for maritime than for aviation fuels (due to the former‘s higher calorific value),48 thistranslates into a corresponding larger absolute price increase: about 8 cents per liter, under the$25 per tonne CO2 price (though recall that the two sectors are not really competing with eachother, aside from in some marginal segments). And since maritime fuel is cheaper thanaviation fuel, it implies a still larger proportional increase: with current average costs ofaround US$0.67 per liter,49 this means that this price will increase by about 11 percent atcurrent rates.50
B. Environmental Effectiveness
55.
Higher fuel prices might reduce emissions from international maritime activities,
through a variety of channels, by perhaps around 5 percent. On average, the impact ofmaritime fuel charges on the demand for traded goods is likely very modest due to the small
effect on landed import prices (see below). However, other emissions reduction channels
include modifying operations (e.g., reducing speed to reduce resistance of the ship‘s hull,
faster loading techniques, improved routing, decreased turnaround times and improved
maintenance including hull and propeller cleaning with adequate intervals); technology
adoption to improve the efficiency of new ships (e.g., larger ships, hull and propeller
optimization, more efficient engines that include waste heat recovery systems), and novel,
low-resistance hull coatings); and replacing heavy fuel oil with less carbon-intensive marine
diesel or liquefied natural gas. There is much uncertainty over the extent to which higher fuelprices will encourage these mitigation possibilities, though large responses are not projected
for the scale of emissions prices considered here.51 A reasonable conjecture is that emissions
will decline by up to 5 percent over the medium term in response to the $25 per tonne price,and proportionately more/less for the higher/lower carbon price scenarios.
48

A liter of bunker fuel produces 0.003 tonnes of CO 2 (EIA, 2011a) which is about 22 percent higher than theCO2 coefficient for jet fuel.
49

Data taken from Platts, August 29, 2011, see
http://www.platts.com/Shipping/BunkerFuel/?WT.srch=1&gclid=CP_0hLHT9KoCFeMD5QodLkuIOw
50

Given the potential increase of marine fuel prices by 2020, including a likely significant increase due to theupcoming low sulphur regulations, the anticipated price impact (increase) will likely be below 10 percent.
51

See, for example, McCollum et al. (2009). IMO (2009) concluded that a significant potential for CO2
reduction exists through technical and operational measures, many of which appear to be cost-effective, althoughboth financial and nonfinancial barriers may discourage their implementation. IMO (2011) suggest a smaller
emissions reduction than assumed above, however.

38
C. Revenue
56.
Total projected revenues from international maritime fuels in 2020 are $26.2
billion under the $25 per tonne CO2 pricing scenarios, $15.7 billion for the $15 per tonne
scenario, and $42 billion under the $40 per tonne scenario (Figure 3a). Revenues arecalculated using the same procedure as for aviation, assuming baseline 2020 emissions(without carbon pricing) of 1,050 million tonnes.52Again, with compensation schemes,
developing countries would raise significant amounts of domestic revenue (Figure 3b). For
example, with a $25 per tonne CO2 price developing countries raise estimated revenues of$10.0 billion and even with the $15 per tonne price, they raise an estimated $6.1 billion.
Estimated revenues for climate finance and other uses total $9.2–$15.0 billion in the more
realistic pricing scenarios ($15 and $25 per tonne of CO2), net of developing countrycompensation (Figure 3c).
Figure 3. Revenue from Taxes on International Maritime(a) Total Global Revenue
40

35$billion

30

25
20

15
10

5
0

(b) Compensation for Developing Countries
40
35$billion

30
25
20
15
10
5
0

(c) Revenue for Climate Finance and Other Uses

$40 CO2 price (nodeveloping countrycompensation)$15 CO2 price(developing countrycompensation)$25 CO2 price(developing countrycompensation)

35
30
25
20
15
10
5
0

$25 CO2 price (nodeveloping countrycompensation)$billion

40

Source: See text.
52

IMO (2009) projects baseline emissions of about 1,100 million tonnes in 2020, not accounting for expected
reductions due to mandatory efficiency and operational improvements discussed in Box 1 (the exact figure is notwell established).

39
57.
These estimates are again broadly consistent with those in AGF (2010b), whichwere $2.4–5.6 billion and US$4.1–9.3 billion for the $15 per tonne CO2 and US$25 per tonne
CO2 carbon charge alternatives, respectively, but with the assumption that 50 percent ofrevenues are allocated for climate finance.
D. Efficiency and Second Best Considerations
58.
As with aviation, putting a carbon price on maritime fuels could be highly costeffective when account is taken of environmental benefits. Alternatives, such as broader
fiscal instruments, do not correct so directly for the market failure of excessive emissions.
59.
Absent a charge on fuel use, alternative instruments—that have some, albeit
weaker, environmental benefit—include taxes on turnover or tonnage. The lesser
importance of final consumer demand implies a weaker case for a tax on sales to final
consumers or, at the cost of including business use, turnover than in international aviation.
Nonetheless, a similar argument for a tax on the use of service to correct for the absent charge
on fuel use applies. Indeed if fuel use were proportional to the value of goods carried, aturnover tax would be equivalent to a charge on fuel. In practice, however, while substitution
between fuel and other inputs may indeed be limited, the value of goods carried is a bad proxy
for the volume and distance travelled, and hence for the underlying fuel use. Vessels‘ tonnage
would likely be a better proxy. A common collective tax on net tonnage, calibrated to areasonable estimate of distance travelled, might indeed fit well into current tonnage tax
regimes. If passed on to consumers, this might be a reasonable proxy for a fuel tax. And if
borne by shipping companies, though the impact on emissions would be muted, such a charge
would arguably reap collective gains by to some degree rectifying the mutual harm sufferedfrom the particularly intense corporate tax competition in this area.
60.
A charge on freight arrival (or departure), varied by weight and distancetravelled, has great appeal in principle but would be problematic in practice. A meritwould be that collection of the levy would be closely tied to the benefit enjoyed from theunderlying fuel use: trade to countries that it is desired to shield from damage from the charge
could simply be exempted or refunded a corresponding amount on fuel use. Like a tonnage
tax, however, it would take no account of vessels‘ differing fuel efficiencies. Moreover, it
lacks the simplicity of a tonnage tax in that account would in principle need to be taken, forinstance, not just of the port of origin but also of the route travelled.
E. Incidence
The likely impact on oil prices being small (on the order of a few percent of any charge), it isassumed from now that a fuel charge is fully passed on into maritime fuel costs.
Impact on the maritime industry
61.
The low elasticity of demand for freight services suggests a high degree of passthrough to purchasers of freight services—and little impact on profitability. This is likely
to hold in the short run, and even more so in the long run that is most relevant here—as any

40
fuel charge scheme will be presumed to be permanent from the time it is imposed—given the
expectation that long-run supply will be even more elastic than short-run supply, whencompared to demand. The impact of higher bunker fuel prices on freight rates will vary witheconomic structure of the importing and exporting country; the trade route; ship size; and the
supply and demand, not only for the product, but also for cargo space on the ship.53 Typically,
however, the impact is likely to be modest. Measures to protect any companies falling in
distress are subject to the same difficulties as noted in connection with aviation.
62.
Some caution may be warranted in levying a carbon charge on marine fuels
unless competing sectors are similarly charged. Sea transport is one of the least carbonintensive modes of transport. To the extent that measures shift freight to other emissionsintensive modes (like rail, trucks, and air), the favorable environmental impact on emissions
will be muted.
Impact on lower income countries—and their compensation
63.
While substantial thought has been given to how emissions from international
maritime activities might be attributed to individual countries, a more welfare-focused
approach to compensations is needed. Attempts at attribution have been mainly with a view
to incorporating emissions in national targets; in essence, that is from the perspective ofcontrol.54 The perspective of understanding and addressing welfare effects, however—as set
out in Section II.C—points squarely to a focus on the impact of transport costs on import andexport prices,55 combined with an assessment of the goods whose price will be affected and of
demand and supply responses.
64.
The main channel of impact on developing countries from a charge oninternational maritime fuels will likely be through freight costs. 56 This corresponds, in
effect, to the first of the three factors identified in Section II.C.
65.
Import value may be a good predictor of overall fuel cost involved in imports.
Stochniol (2011c) argues that average fuel consumption per value unit of imports varies little
between different types of vessels even though the value of shipped goods per tonne may vary
substantially. This is because low-value (bulk) goods tend to be shipped in vessels (bulkvessels and tankers) that are both fuel efficient relative to their weight loads, and run muchslower than (container) ships transporting higher-valued, manufactured goods; so that fuelconsumption per tonne of freight tends to be proportional to value per tonne. This is however
53

For further discussion, see IMO (2011) and UNCTAD (2010).

54

See Heitmann and Khalilian (2011).

55

To the extent that the potential impact on tourism in some countries that are destinations for passenger cruises
is a concern, the analysis of Section III applies.
56

Imperfections of competition may matter here: Hummels et al. (2008) argue that imperfect competition inshipping significantly raises shipping costs for developing countries. This potentially important possibility—
which would tend to increase the pass-through into freight costs to a greater extent for low than for high income
countries—is not pursued in what follows.

41
not to deny that, for given bulkiness of imports, countries with longer average import routes
will tend to have greater fuel costs per value unit associated with imports; although these costdifferences may be much less than in proportion to such average distances.57
66.
Impacts on landed import prices vary, but are in most cases small. The
determinants of freight costs are complex, varying with a range of factors such as distance andvessel type. While fuel costs are commonly a large part of those costs, however, freight costs
themselves are generally a small part of the total cost of imports, around 5-10 percent, thoughhigher, at perhaps 25 percent, for commodities. Estimates reported in AGF (2010b; p.38)
suggest an impact from a charge of $25 per tonne of CO2 of less than 1 percent for mostitems, though up to 2-3 percent for some commodities.
67.
The impact on food prices is a particular concern, but seems likely to be fairly
small. According to calculations in Table 4 (from Stochniol 2011a) impacts range from about
0.2 to 1.0 percent for a $25 per tonne CO2 price. Developments in fuel and food prices overthe next decade or two could well dwarf the impact on import and export prices of a modest
carbon price.
Table 4. Maritime Transport Costs by Product Category and Ship Segment
Food categoryAV(percent)

Unit cost$/TonneShipping
mode

821
168
172
110
250

Price
increase(percent)
0.79
0.21
0.17
0.13
0.34

Live animals
Meat
Fish
Dairy products, birds eggs, honeyLive trees, plants, bulbs, cut
flowers
Vegetables
Fruit & nuts
Coffee, tea, mate & spices
Cereals
Milling products, malt, starch
Oil seeds and oleaginous fruits
Vegetable plaiting materials
Animal or vegetable fats, oils
Sugars and sugar confectionary
Beverages, spirits and vinegar
Food industry residues & waste
Tobacco

19
5
4
3
8
22
13
4
21
11
16
10
5
9
5
25
3

154
123
103
58
70
68
65
62
52
95
124
193

0.92
0.55
0.17
0.88
0.44
0.67
0.42
0.21
0.38
0.21
1.05
0.13

Container
Container
Container
Clean Bulk
Container
Clean Bulk
Container
TankerContainer
Container
Container
Container

Container
Container
Container
Container
Container

Source: Stochniol (2011a), which builds on UNCTAD (2010) and Vivid Economics (2010).
Notes: AV = average transport cost share of total import value; Unit cost = Average absolute transport cost per tonne oftransported goods.

68.
Average shipping costs for oil, as fraction of shipped value, are of similar order
as for food products. According to the IMO (2009), the fuel consumption of tankers in
57

Stochniol (2011b) finds much less difference in average fuel consumption associated with imports, than in
average trade distances. This again rests on an argument that goods shipped longer distances are carried
predominantly in larger and more fuel efficient vessels.

42international oil transport was approximately 60 million tonnes of oil in 2009. The volume ofoil exported in 2009 was approximately 38 million barrels per day (or slightly less than half ofglobal oil production), corresponding to total global oil exports of about 1900 million tonnes.
Fuel prices are about 90 percent of average crude (non-refined) oil product prices. Thisimplies that fuel transport costs correspond to about 2.7 percent of exported oil values on the
average. This means that a US$25 per tonne CO2 charge (fully passed forward) would raise
the fuel price by 12 percent, so that the final import price of oil will rise by about 0.33 percent
in importing countries (assuming no back-shifting of a fuel charge on the crude price)—which
is about the same proportionate impact as for most food products.58
69.
A charge on international maritime fuel would act as a set of import tariffs andexport taxes levied simultaneously by all countries—with an incidence and welfare
impact more complex than sometimes recognized. A country that is small in world
markets, in the sense that its trade has no impact on prices in world markets—a common first
approximation to the position of most developing countries—would bear the full burden ofeither a tariff on its imports (in the form of increased import prices) or a tax on its exports (ina reduced price to domestic producers of its exportables) that it imposed unilaterally, and sowould suffer a welfare loss even if it received an amount corresponding to the increase in
freight costs. Box 9 describes this important benchmark result. But at issue here is a chargethat would be imposed collectively rather than unilaterally. To the extent that developing
countries are collectively not small in the world markets for some goods—as may be the casefor some commodities, such as jute and iron ore—part of the incidence would be passed to theother side of the market, in the developed world. Indeed this, presumably, is the assumption inapproaches to the compensation issues, such as the rebate mechanism discussed below, thatassume the incidence of freight costs to be entirely on the importer and so, for instance, do notsee developing countries as suffering any loss from the scheme through a reduced net price ofexports.

Box 9. The Welfare Impact of a Charge-induced Increase in Import Freight Costs

The figure below shows the case of an increase in
freight costs of the imports of a country that is small inthe sense of being unable to affect the price P of its
importable. With an increase in freight costs increasing
the price paid by T, the welfare loss suffered exceeds
the revenue raised, ABCP, by the triangle BEC,
representing the additional loss of consumer surplus.
It is important to note, however, that this argument
assumes perfectly elastic supply from the rest of the world, and ignores what happens in terms of this country‘sexports, which will also be affected by increased freight costs. The formula in Box 10 takes account of possible
effects from these sources. More generally, domestic producers could gain somewhat from (moderately) higher
import prices, complicating the next burden on the country as a whole.

58

See UNCTAD (2010) for further discussion.

43
70.
It is a reasonable assumption, nonetheless, that (in the absence of compensatory
measures) many developing countries will be net losers from the impact on both theirimport and, perhaps less certainly, export prices. One reason may be that, evencollectively—and here excluding large emerging economies such as China—they are
typically small in world markets, albeit with some exceptions is relation to particularcommodities. Two other potential reasons are that (1) the import and export activity ofdeveloping countries tend to be heavily concentrated on ‗bulky‘ goods with high transport
costs relative to their values (although this explanation is somewhat muted by the Stochniol(2011c) argument cited below); and (2) import and export volumes to and from poor countries(with small economies) are in many cases too small to enable fully efficient transport (and soare also subject to greater increases in transport rates when a fuel charge is imposed).
71.
The welfare impact on any country of increased freight costs depends on theelasticity of its demand for imports and the elasticity of export supply from the rest of
the world. Box 10 sets out a simple formula reflecting this consideration. Preliminary
calculations, using country-specific estimates of import demand elasticities from Tokarick(2010), suggest two key points. First, the welfare impacts, relative to GDP, of increasedtransport costs even in the order of 1 percent of goods prices have only a relatively small
welfare impact. Second, relative to GDP, these losses are greatest in higher income
countries—essentially because they tend to be more open.
Box 10. Compensating for Increased Transport Costs on all Trade
When increased transportation costs apply to the generality of imports and exports, cross-price effects cannot beignored (as they were in Box 5). The compensation required (expressed in terms of the imported good) is shownin Appendix 2 to be:

One important implication is that, even with full pass-though of fuel charges into transportation costs, full returnof all charges on the transportation of all charges bearing on both imports and exports would be overcompensation for any country that does not face perfectly elastic supply from the rest of the world.

72.
Ideally, a charge would be levied by port of arrival that reflects associated fueluse and adjusted to reflect behavioral responses, but for reasons set out above thisappears infeasible. This would correspond to the precise compensation described inAppendix 2. But each step of such a procedure is problematic: the first on practicability
grounds, the latter in view of ignorance of the relevant elasticities.
73.
One pragmatic proposal that has attracted attention is rebate mechanisms basedon shares of global import value. This scheme, proposed by the World Wildlife Fund59 andset out in detail in Stochniol (2011c), is described in Box 11. Though by no means the only
possibility, it merits consideration here for both possibilities it suggest and a flavor of thechallenges to be addressed in this:59

IMO (2010b).

44Perhaps most fundamental in conceptual terms, it assumes that the burden of any
increase in transport costs is always on the importer. So, for instance, the implicit
assumption is that a fuel charge on exports from developing to developed countries isborne entirely by the latter (and vice versa for exports from developed to developing
countries). To the extent that this is not the case—in the strict logic of simple trademodels, it cannot possibly be the case in all countries—the scheme will not provide anexact level of compensation (though whether too little or too much is ambiguous).
IMO (2011) also concluded that exporters may be affected significantly, in particular,
if their main customers are a long distance away and they export high density, lowvalue commodities. This could have a substantial impact on the numbers at stake,potentially in the order of doubling the compensation required. The formula in Box 10suggests that reimbursement of the charge embodied in the freight costs of imports
alone provides exact compensation, for a small charge, if and only if it so happens theelasticity of import demand in the country to be compensated is equal to the elasticity
of export supply from the rest of the world. This perhaps suggests that exports should
also enter the compensation formula.

Allocation by reference to shares of global imports means that—unless the charges areproportional to import value in all countries—the compensation received by a country
can be affected by changes in trade activities in which it has no part60—even though
any adverse impact it may suffer remains unchanged. The same difficulty potentiallyapplies to any allocation by reference to shares, though this does have the merit oflimiting the extent of compensation relative to revenue raised.

74.
Perfect calibration of compensation to each country‘s circumstances will not be
possible—but, since most effects seem to be small, may not be needed. Even if theemissions associated with the marine transport a country‘s imports and exports were known—and experts continue to study if, in the absence of explicit measurement, reasonable proxies
can be found—this would need to be combined with information on its trade patterns andresponsiveness both domestically and in its trading partners to be sure of accuratecompensation. But since most price effects seem likely to be small, it is reasonable to look
for simpler approaches based on one or two cases (based say on import values or volumes andtrade-weighted distance) that are scaled to build in adequate assurance—and perhaps with aguarantee of some minimum monetary amount—while providing some allowance for truly
exceptional cases.61

60

More precisely, it would receive a large absolute transfer if imports increased in a country whose imports werecharged at higher than the global average rate.
61

In any event, avoiding excessive compensation payments is important for increasing revenues available forsocially productive purposes. Beyond climate finance revenues from maritime fuel charges might finance, forexample, R&D into energy saving technologies for ships and port infrastructure upgrades in developing
countries. Ideally, the costs and benefits of alternative projects would be carefully evaluated in order to prioritizeamong them.

45

Box 11. An Illustrative Rebate Mechanism for International Maritime Transport
Stochniol (2011a, c) envisages allocating the revenue raised by some maritime MBI to countries according
to their share in the value of world imports, these values being adjusted by (1) including only imports from
non-adjacent countries (most of which—in the absence of data on import values by mode of transport—ispresumed to be by other modes); (2) further adjustment to reflect the extensive trade between close but
non-adjacent countries in Europe, as most of this trade is presumed to be road- and rail-based. The scheme
does not envisage Annex I countries retaining some of the proceeds for their own use, but it can be readily
adjusted to allow this.
Non-annex I countries would be entitled to a transfer equal to their share of MBI receipts thus calculated,though provision would be made for them to waive this. Annex I countries would treat their allocatedreceipts as a contribution to climate finance.
Stochniol (2011a, c) provides a full set of country-specific weights had such a scheme been in effect in2007. These imply that in 2007 about 40 percent of proceeds would have been allocated to non-Annex I
countries. Ethiopia for instance, would have had a weight of around 0.06 percent, so would have received
around $16 million if total receipts were $26 billion.

46
V. IMPLEMENTATIONThe section reviews overarching issues as to the design of carbon charges for these sectors
and practical issues of administration and compliance.62
A. Fuel Taxes or an ETS? Economic Principles63
75.
The discussion here focuses on the choice between the leading forms of MBIs:
fuel charges and ETS schemes. These are the canonical alternatives, though with wide rangeof variants and structural differences. Work on these possibilities has been intense in themaritime sector: Box 12 discusses a variety of proposals, some market-based and others not,that have been studied by the IMO.
76.
Tax and emissions trading policies, applied to the same base, and equivalently
scaled, have about the same effect on fuel prices, emissions and—so long as emission
rights are auctioned—revenue. Both instruments (applied to carbon content of aviation andmaritime fuels) exploit the same behavioral responses for reducing emissions (e.g.,
encouraging better fuel economy and fewer trips) to the extent that the price on emissions is
passed forward into fuel prices (or back into oil prices). This applies regardless of whether
some portion of emissions allowances are given away for free rather than auctioned.64 If they
are auctioned then the two schemes in principle raise the same revenue. It is these basic
equivalencies that have allowed the sectoral analyses in Sections III and IV to encompass
both tax- and ETS-based strategies. However, to the extent that policymakers are tempted togive away free allowances in an ETS, this is a serious drawback of this approach as it
squanders a potentially valuable source of revenue for climate-related or other purposes.
Important differences between the two approaches arise, however, in the presence of
uncertainty.
77.
Certainty as to the emissions price is needed to provide a stable framework fortransport decisions and developing long-lived, emissions-saving technologies. In ETS
programs, emissions prices can be volatile: prices are low when the costs of meeting theemissions cap are low (because, for instance, of depressed economic activity) and vice versa
when the costs of meeting the cap are high. This problem can be partly alleviated byincorporating price stability provisions (such as banking and borrowing, price ceilings, andprice floors) which make an ETS behave more like a tax.

62

The transition issues potentially arise in moving towards effective carbon charging are not considered here, but
do not appear especially problematic.
63

There is a large literature comparing the two. For reviews, see for instance, Goulder and Parry (2008),
Hepburn (2006), Jones et al. (2011) and Nordhaus (2007).
64

A trading scheme essentially puts a limit on fuel supply. This drives up fuel prices in the same way that prices
are increased when firms with market power limit supply or when firms pass forward fuel taxes. If firms receive
free allowances, this simply provides them with a lump-sum windfall gain, without affecting the limit on fuelsupply or the fuel price.

47

Box 12. Overview of Market-Based and Other Proposals for Reducing Ship Emissions
The following proposals were considered by IMO (2011).
GHG Fund (sponsored by Cyprus, Denmark, the Marshall Islands, and Nigeria). This would establish a
global reduction target for international shipping. To meet the target a levy would be paid by ships on every
tonne of bunker fuel purchased (collected through bunker fuel suppliers or via direct payment from ships)with revenues used to purchase offset credits to match the projected gap between industry emissions and thetarget. The levy would be regularly adjusted to ensure that adequate funds are available to purchase offset
credits. This proposal is essentially focussed on mitigation rather than raising a large amount of new revenue
for a new climate fund.
Leveraged Incentive Scheme (Japan). Ships would have to meet mandatory efficiency performance standards
or pay a levy. This policy would use some of the contributions to the GHG Fund to pay rebates to ships withenergy efficiency better than the standard.
Port State arrangements (Jamaica). Under this scheme, Member States would levy a uniform emissions
charge on all vessels calling at their respective ports based on the amount of fuel consumed by the vessel on
its voyage to that port. The Port State Levy would be structured to achieve the global reduction targets for
GHGs specified by IMO. Revenues raised could easily be devoted to climate finance, though one variant
proposes rebates for vessels exceeding efficiency targets.
Ship Efficiency and Credit Trading (United States). Under this scheme, new and existing ships would be
subject to respective energy efficiency standards, which would ramp up over time in line with what isachievable with state of the art technologies. Ships that fall short of the standard will have to purchase credits
from others that are able to go beyond the standard. The scheme is not designed to raise revenues and, by
focussing exclusively on energy efficiency, does not exploit all possibilities for emissions mitigation.
Vessel Efficiency System (World Shipping Council). Again this would establish mandatory efficiency
standards for both new and existing ships where the latter may comply by improving their efficiency scores
through certifiable technical modifications. Enforcement would be encouraged through a system of penalties
for non-compliance, rather than a credit trading scheme, penalties varying with fuel consumed scaled by theshortfall in energy efficiency. A similar proposal, based on mandatory technical and operational measures,
was submitted by the Bahamas with specific absolute emissions reduction obligations for ships according totheir age.65
Global ETS with full auctioning (France, Germany, United Kingdom, and Norway). This policy is a global
cap-and-trade system to control maritime emissions with allowances sold in a global auction. In these regards
it resembles the ETS variant of the MBI policy discussed here. However, the system would be limited tovessels above a certain size, a portion of the revenues would be used for R&D into clean technologies within
the maritime sector (as well as climate finance), exemptions might be provided for specific voyages to Small
Island Developing States, and purchase of emissions offsets is also included as a cost-containing measure. A
French variant of this scheme sets out additional detail on auction design, while a UK variant suggests thatallowances be allocated to national governments for auctioning.

78.
Another price-containing (but also revenue-reducing) option is to allow covered
entities to purchase emission offset credits. For example, a credit against emissions might
be awarded for funding a clean energy project in a developing country. While such offsetting
is commonly considered in relation to trading schemes, they could also be applied, in the formof tax rebates, under a tax approach. Therefore, this possibility itself need not affect the
choice between the two instruments, though offsets lead to lower allowance prices (without
affecting emissions) under an ETS while they lead to more mitigation under a tax.
Nonetheless, more fundamental are wider issues with offsetting. Verifying whether theseprojects would have gone ahead anyway without the offset payment, and are not increased by
65

The proposals of Japan and the World Shipping Council were later consolidated in the Efficiency Incentive
scheme.

48
increased emissions from some other source, can be challenging. If emissions offsets are not‗additional‘ then the environmental effectiveness (and the credibility) of the emissions trading
program is undermined. Offset provisions should therefore be phased in progressively, as
institutional capability for verifying emissions reductions matures.
79.
Price stability implies less certainty over meeting annual emissions targets which
has a political cost. What matters for mitigating future global climate change is limiting
accumulated global emissions over long periods of time, rather than containing year-to-year
variability in emissions from specific sectors. Nonetheless, annual emissions targets forindividual countries have political salience. Annual targets, rather than country-level ‗carbon
budgets‘ for annual emissions over multi-year periods, or emissions prices, remain the central
focus of negotiations at international climate meetings.
80.
Future revenues are uncertain, whichever MBI is used. Under fuel taxes the tax
rate is known, but the quantity of fuel to which it is applied will vary with economic factors
like the business cycle. Under a traditional ETS there is more certainty over the base to which
the policy is applied, but less certainty over the emissions price, and perhaps the fraction ofallowances that will be auctioned.66 This last though is less of an issue if the ETS is
accompanied by price stability provisions.
81.
Once in place, an ETS could have more political momentum. Firms will have astrong interest in preserving an ETS if they have accumulated a substantial bank ofallowances or purchased allowances that can only be used in future periods. In contrast, anemissions tax does not create any natural self-interest among affected parties for sustaining
the system.
82.
Tax schemes can risk losing sight of environmental objectives. If the main
motivation for taxes is to meet a revenue target, they may not be set at levels that areappropriate on environmental grounds. Moreover, they may be applied to the wrong base (forinstance on airlines tickets rather than fuel use), which would forgo incentives to reduce
emissions through better fuel economy. In the specific context of international aviation andmaritime, however, it could be argued that the usual tools for pursuing revenue objectives arelargely absent, making this less of a concern than otherwise.
83.
An ETS, on the other hand, could create greater political space for influential
actors (firms) to argue or lobby for free allocations; and an intended transition to fully
auctioned quotas may be difficult to implement. The revenue-raising ability of cap-andtrade schemes can thus be questioned, even in the long run. A tax will by contrast be expected
to be paid as long as it exists and is universal, though there may be pressure for exemptions.
84.
Under a tax regime, participation can be encouraged by leaving tax receipts in
the hands of developing countries. Furthermore, the prospects for participation might be
66

The emissions trading price under the EU-ETS, for example, has varied widely over the 2005-2010 period,
between a low of close to zero, and high of more than $30 per tonne CO 2: see for example Rosendahl (2007),
Capoor and Ambrosi (2009), and Point Carbon (2010).

49
enhanced under a more flexible scheme that set a uniform price, allowing individual countries
to voluntarily impose higher taxes and keep the corresponding extra revenues for themselves.
This also makes it easier for countries to apply same tax to domestic and international fueluse. Seeking an agreement over a common price floor may be easier than agreeing over a
uniform price for all countries. Indeed coordination over price floors is a standard policy
recommendation when tax bases are internationally mobile: the EU, for example, setsminimum tax rates for excises. This provides tax floors that guard against tax competition andprovide some protection for countries wishing to set relatively higher tax levels.67
85.
Valuation and adjustment procedures would be needed under either approach.
Since the appropriate tax is specific (not ad valorem), a tax common to a number of countries
would need to be specified in terms of some basket of currencies. In addition, an automatic
ramp-up rate needs to be agreed (e.g., say 5 percent annual in real terms), along with periodic
reviews of the level, growth rate, and local currency equivalents. Similarly, under an ETS theoverall cap (and price stability provisions) would need to be updated periodically.
86.
Cap-and-trade may create more momentum for international linking of permit
markets and flows of climate finance to developing countries. Nonetheless, carbon taxes
could easily promote carbon markets through credits against tax liabilities for internationalemissions offsets. In the maritime context a truly global scheme can be envisaged underwhich the international shipping sector is treated as a separate ‗bubble‘. With a global scheme
established under a separate treaty instrument under IMO, the cap would be set andmaintained by the parties to the treaty following rules of procedure laid down in the treaty.
The ETS proposals under review within IMO have 100 percent auctioning to avoid the needfor allocation to individual ships or flag States and not to penalize shipping companies thathave taken early actions, or newcomers.
87.
On balance, a (minimum) tax based approach to carbon pricing in international
aviation and shipping would likely be the most appealing in principle. Account thoughmust be taken of initial conditions and practical considerations. These are addressed next.

B. Practical Issues
Governance
88.
Internationally coordinated MBIs for aviation and maritime raise difficult
governance issues. They arise in relation to the charges themselves, and in relation to theceding of revenue to a global fund outside national treasuries. Precedent does exist in thecollection side in the IOPC Funds (Box 4). The climate finance objective would have
similarities as the funds are used to compensate for environmental damage. Precedent also
exists in a number of IMO treaties in force on the implementation and enforcement sidethrough flag and port state controls where the basis would be to deny ships port entry if they
do not participate in the scheme (no more favourable treatment) and detain ships that have not67

A slight drawback of this approach is that differentiated prices imply somewhat higher global mitigation costs
compared with a uniform price system (for the same global emissions reduction).

50
paid their contribution or have insufficient allowances to surrender.
89.
Rules would be needed, for instance, for the adjustment of rates or quantities andto address disputes as to their application. On the tax side, the closest parallel is with excise
and VAT arrangements in the EU. These, as noted, are specified mainly in terms of minimum
rates. Experience is that the requirement of unanimity has made these very difficult to change,
and that the unwillingness of Member States to rely on implementation by others has indeed
hindered the development of the VAT. Experience with the EU-ETS is, perhaps, moreencouraging. Under a global regime for international shipping, many of these governanceissues may be easier to overcome to the extent that countries are content to have decisions
made in appropriate bodies established under the new treaty instrument, taking into accountrules of procedures and the provisions of the treaty. Countries may also wish to havereasonable assurance that others are themselves applying the charge properly, not least
because they may need to give credit against charges they themselves would apply for charges
levied by others.
90.
Further issues arise with the ceding of revenues. These relate not only in the use
made of the proceeds but in relation, for instance, to the amounts ceded and whether there will
safeguard clauses enabling countries in dire revenue need to maintain a larger amount. Herethe closest parallel is perhaps with arrangements for the collection of customs duties and someother charges in the EU: this is delegated to Member States but the proceeds (net of anallowance for collection costs) are a source of finance for the union itself. That this appears towork well doubtless reflecting a sense that these revenues properly belong to all Member
States, not just those at which entry happens to occur. A similar sense may come to be held in
relation to taxes in international transport, reflecting as they do the exploitation of thecommon property—belonging to no nation in particular but to all in general—of theinternational seas and skies.
91.
Resolving these issues will be both critical and difficult. They cut across existing
international governance structures for climate policies and sectoral issues, and touch deeply
the concerns of ministries of finance. These issues being more profound than can be addressed
here, the rest of the section focuses on more technical aspects of administering fuel taxes andan ETS for the two sectors.
92.
For ships, continuous monitoring could be mandated using utilizing IMO‘s Long
Range Identification and Tracking system to transmit the ship data. All merchant ships
above 300 GT are mandated under IMO‘s SOLAS Convention to provide their position andother information at regular intervals through IMO‘s Long Range Identification and Tracking
system. And all ships above 400 GT are under IMO‘s MARPOL Convention required to keep
record of their fuel in the Oil Record Book and to obtain a Bunker Delivery Note for eachbunkering which has to be kept onboard for 12 months after the fuel is consumed. This data
could be held against the ship‘s electronic account in the central register and would give
reliable information as to whether a ship is in compliance or not, and could trigger enquiry
followed by appropriate action in the next port of call.

51
Fuel taxes
93.
As a standard principle of tax administration, fuel taxes are best levied where thenumber of collection points is minimized, which usually means at the point of fuelproduction or distribution. The precise point at which the tax is levied, recall, in principle
makes no difference to the real incidence of the tax (assuming that, wherever it takes place,enforcement is perfect): the impact on the price received by oil producers will be the same
whether they enforce the tax themselves or whether it is imposed on final use in some othercountry. What does differ, however, is of course where the revenue arises—and hence who itis that would be legally responsible for remitting any of this to a central institution of climate
finance.68
94.
Upstream application is made difficult, however, if fuel taxes are differentiatedby use and participation—but may be greater for shipping. It is a further standard
principle of tax administration that goods are easier to tax when their treatment is notconditional on the use to which they are put. The control advantages of taxing aviation andmaritime fuels as they leave the refinery would be undermined if the tax needs to bedifferentiated according to how or where they will be used. Implementing a differential tax onjet fuel used in domestic and international flight is hard to do at refinery level, for instance,
requiring exemptions or some form of crediting arrangement relying on a further set ofcontrols. Similar difficulties arise if the tax is to be differentiated by the final destination of
the refined product. A further set of control problems arise when the fuels used in the activity
it is intended to tax differentially have an alternative use. Jet fuel, for instance, can also be
used as kerosene for heating, while the heavy fuel oil used by international maritime may befurther refined into higher quality products or used by industry and power stations.69
95.
Failing application at refinery level, however, there is considerable experience inlevying fuel taxes further down the chain to draw on—suggesting low administrationand compliance costs. Taxes on domestic fuel use are a staple source of revenue in many
countries—and have proved among the easiest of taxes to administer. They can be collected,
if not at refinery, then at bulk storage points or the depots that are standard at airports andmajor ports (with withholding and crediting/refund procedures being used to preserve revenue
through the distribution chain). Indeed establishing more uniform treatment of fuels used
domestically and internationally is likely to be, if anything, an administrative simplification.
From the perspective of the shipping companies and airlines too, familiarity with fuel taxationin relation to their domestic and other activities suggests that such taxes should be relatively
easy to comply with.
96.
Collection could thus reasonably be left to national tax administration, retainingsome revenue to cover costs and preserve incentives. It is a considerable advantage of the
tax approach that heavy reliance can be made on existing national mechanisms. To ensure thatthey have adequate incentives to devote resources to collecting the tax, and proved assurance
68

Another difference, potentially, is the set of participating countries. Upstream producing countries could, inprinciple, levy the tax on sales to others even if the latter did not formally participate in any scheme.
69

Coastal and domestic shipping largely uses diesel.

52that the costs of doing so are covered, some fixed fraction of receipts might be retained bythat administration before any is remitted for the purposes of climate finance. The only new
institutional structure needed would thus be that needed to deal with the governance issues
raised above.
97.
One interesting option for collection of a maritime charge (or auctioning ofallowances under an ETS) is the establishment of a central global fund that companies(ships) remit to directly without intervention of the tax administration—but this raises
new questions. For this approach, the IOPC Funds could be something of a model forcollection and administration of the central fund, while the implementation and enforcement
regime would follow the well established regulatory IMO framework for safety andenvironment standards in shipping through flag and port State controls. The purpose of a new
MBI treaty would be similar to IOPC as it will provide economic compensation forenvironmental damage, but is not directly comparable, as participation in the IOPC regime
brings some benefit in the form of additional insurance for all participating States, while an
MBI may only provide such benefits for developing countries. Enforcement powers of thekind associated uniquely with sovereign tax-raising authority may not be sufficient to enforce
collection of the charge from ships operating outside national waters if this is not associatedwith an international legal framework. At a minimum, controls such as those associated withconditions for port entry may be more necessary with such an approach in order to provide allparticipants with the assurance that the charge is being properly paid by all.
98.
For shipping, the high concentration of emissions from a limited number of ships
and current enforcement mechanisms (flag and port state controls) may be helpful for
implementing carbon pricing on bunker fuels. Around 80 percent of emissions frominternational shipping are produced by only around 17, 300 vessels (Table 5). Levying a tax
only on fuel used by ships over some threshold tonnage would thus capture the bulk ofenvironmental concerns while enabling control to be focused on only a portion of the fleet.
While there could be some risk of distorting ship size, this would likely be modest if thethreshold were set at a reasonable level. Countries concerned to assure themselves that tax has
been collected elsewhere could expand their port entry requirements to include the provisionof acceptable documentation, backed if need be by satellite monitoring of ships‘ prior
movements.
Table 5. Ship Sizes, Numbers, and Associated Emissions
Ship size
threshold(GT)

No. of ships

No. of ships as
percent of ships ≥400 GT

Emissions (as percent
of emissions from ships≥ 400 GT)

≥ 400

42,697

100

100

≥ 500

39,18092

99≥ 1,000

34,86682

98≥ 2,000

30,13871

96≥ 4,000

24,26757

91≥ 5,000

22,311

52

89≥ 10,000

17,34641

81

Source: IMO (2011).

53
99.
The legal obstacles to taxing fuel used in international aviation may argue for an
ETS approach—but even this may not be clear, given legal challenges to inclusion in the EUETS now under way.
Emissions trading schemes
100. An ETS-based approach would require a new institutional framework. As with
fuel taxes, a question arises as to where in the chain the policy would be imposed: meaning
here who—refiners, airlines, shipping operators or actors in between—would be required tohold permits. In this case, the balance of considerations points towards a reasonably large
number of players, not as few as possible, so as to ensure competitive auction markets. Even
with an upstream requirement, however, this seems unlikely to be a major difficulty. The
more serious concern is the need to create a new institutional framework to administer theauctioning of rights, implying higher costs of administration and compliance (at least oversome set-up period). There is some comfort, however, in evidence that the ‗transactions costs‘
associated with market trading are typically small relative to the overall costs of the program(Stavins, 1995)—though this does not reflect the deeper governance issues referred to above.
101. Adoption of an ETS would require decisions as to the allocation of emission
rights—and may risk their being allocated to emitters free of charge. The need to decide
an initial allocation of rights is a merit in so far as this provides an additional instrument forencouraging participation, for instance by allocating more rights to poorer countries—though
this at the same time will reduce the amount available for the specific objective of climate
financing. But this is also a disadvantage of an ETS-based approach, since it introduces anadditional item for complex and no doubt time-consuming negotiation.70 This concern isreinforced by the risk, suggested by much past experience and a feature of many proposals, of
their being allocated to emitters largely free of charge—as with current plans to include
international aviation in the EU-ETS, discussed below. All the ETS proposals being
considered by IMO have 100 percent auctioning to avoid the difficult process of allocatingallowances (to individual ships, ship owners/operators or flag States) as well as not topenalize shipping companies that have already taken steps to increase the energy efficiency of
their ships and to accommodate for new entrants. The IMO is also considering a global ETS
with national auctioning, although the details of how the allowances would be allocated tocountries remain to be worked out.
102. An ETS encompassing both international aviation and maritime would be
preferred to separate ETSs for each. The ideal ETS, of course, would encompass emissions
from all sources. Failing this, however, combining the two sectors would have theadvantage—relative to a separate scheme for each—of allowing greater efficiency in emission
reductions through harmonization of the emissions price. If technological progress were to
make mitigation cheaper in one sector than the other, then a combined scheme would enable
the aggregate emission target to be met more cheaply. A common scheme with full auctioning
would also ensure that the competitive positions of the two sectors reflected their relative
climate impacts. Again, allowance auctioning is important, as allocating allowances in a
70

In an analytical sense, the same issue arises for the tax option: tax revenue could be allocated to countries
other than those which collect it. In practice, however, the point is much less salient for taxes.

54
combined ETS for international aviation and shipping would be very challenging. To split theallowances between the two sectors and then allocate rights to States or operators would be
difficult, given that each country will have a strong interest to secure maximum allowances
for its own airlines and shipping companies.
103. The high concentration of emissions in relatively few ships is also helpful for
implementation under ETS. This is likely reduce transactions costs by limiting the numberof bidders (without creating an unduly thin market), and the possibility of denying port entry
can again be used to ensure compliance.
104. The prospects for and potential design of an ETS for international aviation will
be shaped by current—and controversial—efforts at its inclusion in the ETS of theEuropean Union (EU-ETS). These are described in Box 13.
Box 13. International Aviation and the EU-ETS
Beginning in 2012 aviation emissions will be covered by the EU Emissions Trading System. In its first year,
the total quantity of allowances will be 97 percent of ‗historical emissions‘ and in each year from 2013 to 2020
the quantity of allowances will be 95 percent of these emissions. Historical emissions are industry-average CO2
emissions for 2004 to 2006, which was 219 million tonnes of CO2. Airlines will be able to buy allowances fromother sources under the ETS, which essentially puts a ceiling price on airline emissions equal to the ETS
allowance price (see ICAO 2011b for a broader discussion of offsets). If actual emissions are below allowances,
airlines cannot sell their excess allowances, but can bank them to cover future emissions, which helps to create
some cushion under allowance prices. At current emissions prices (EUR 13 or US $19 per tonne), extending the
ETS to airlines would cause the effective price of jet fuel to airlines to rise by about 4.5 cents per liter at most.
The EU has passed legislation to include in the ETS emissions from all flights anywhere in the world that
arrive or depart from a European airport. Comprehensive coverage of all airlines (rather than just EU
carriers) would imply a greater reduction in emissions, besides alleviating the risk of EU carriers losing businessto other airlines.1 Operators will be managed by the country in which they emit the greatest amount of CO2 or by
the EU member state that issued the operator‘s air carrier certificate. The scheme will cover around 4,000 airline
operators.2
However, whether non-EU carriers will ultimately be included in the ETS will depend on the outcome ofongoing, legal challenges in the United States and other countries. Some airlines, for example, have argued
that the EU law violates US sovereignty and is illegal under international law and the Chicago Convention (a billto ban US airlines from participating in the scheme has passed the US House of Representatives). But the EU law
only holds the US airlines accountable for their emissions if they land in the EU. In this regard, it is similar to US
laws that set requirements for aircraft and ships coming in and out of US territory. 3
Revenues from allowance auctions will be earmarked for climate mitigation projects. The case forearmarking of revenues, for environmental or any other purpose is, as noted earlier, questionable.
___________________________
1

There are some minor exemptions to the scheme, including humanitarian and government aircraft flights,
aircraft less than 5.7 tonnes, and commercial operators operating fewer than 730 flights per year or with total
annual emissions lower than 10,000 tonnes of CO2. And a small amount of allowances will be withheld toallocate free of charge to new, or rapidly expanding, operators.
2

Airlines must submit an emissions monitoring plan for approval to the relevant Member State. Airlines canpurchase emission offset credits (e.g., through the Clean Development Mechanism) but these can cover only up
to 2 percent of emissions from 2013 onwards. For more details, see
http://ec.europa.eu/clima/policies/transport/aviation/index_en.htm.
3

For example, following the Exxon Valdez oil spill, US law now requires all ships carrying oil in US waters tobe equipped with a double hull, have sufficient insurance to cover clean up and compensation, and to have asigned agreement with a registered oil spill contingency company.

55
105. Any scheme for international aviation—whether tax or ETS—needs to becoordinated with developments in the EU-ETS. From an environmental perspective, it does
not make sense to tax airlines whose emissions are already priced under the ETS or,conversely, to include airlines in the ETS that have already paid a fuel tax. The EU-ETS plans
do indeed include provisions to avoid this possibility of double charging.
106. Most of the options under review within IMO are based on a global approachwith the charge collected either by fuel suppliers or levied on individual ships.
Transaction costs for a global regime, as well as administration costs, will likely besignificantly lower with a global solution and a single administration than for separate scheme
administrators in all flag States (there are about 160 flag States worldwide). There is clear
consensus among experts in this field within IMO that a global solution is the only feasible
route.
107. A further concern is that giving large free allowance allocations not only foregoes
revenues but could hinder the introduction of revenue-raising charges on aviation more
widely. Under current plans, airlines would receive for free 85 percent of the total quantity ofallowances in 2012 and 82 percent of the available quantity in each year from 2013 to 2020;15 percent of allowances will be auctioned, leaving 3 percent (from 2013 onwards) to beallocated to a reserve for later distribution to fast growing airlines and new entrants into themarket).71 This allocation scheme deprives governments of the valuable revenue source thatwould be obtained under a tax regime. Moreover, giving EU airlines free allowances could
lead to windfall profits to the extent that airlines pass forward emissions prices into higher
ticket prices: as noted in Section III, power companies received large windfall profits fromfree allowance allocations in the initial stages of the ETS. Enhancing the profitability ofairlines in this way could increase resistance in other countries to new charges on theirairlines.
108. The European Commission has indicated willingness to include international
maritime transport in the EU-ETS if no international agreement is reached by end 2011
(Directive 2009/29/EC of April 23, 2009). The preamble to this directive indicates thepossibility of plans being prepared in 2012.

71

Allowances will be grandfathered in proportion to the operator‘s activity in 2010 in tonne-kilometers carried.

56
VI. CONCLUSION
109. While details need further study, charges on international aviation and maritime
fuels are potentially a promising source of climate finance. With continued study of thepros and cons of alternative MBIs, issues in their implementation, and schemes forcompensating developing countries, it should be feasible to develop acceptable proposals.
Moreover, a successful international agreement to price international transportation emissions
could serve as a useful pre-cursor for broader international efforts to price greenhouse gases.

57
Appendix 1. Some Basic Analytics of Compensation for Taxes on International
Transport
Consider a world comprising two countries, A (the focus of interest) and ROW (the ‗rest of theworld‘), and L tradable goods. Denote by
the L-vector of prices in country j, the ithelement being the c.i.f. (landed ) price of good i if it is imported by country j and the f.o.b.
price if it is exported—the point being that these are the prices on which consumer andproducer decisions in country i depend. The price vectors in the two countries are then relatedas

where the ith element of the L-vector T reflects a ‗transport tax‘72 levied on transporting goodi¸ being positive if is imported by country A and negative if it is exported. Preferences andproduction in country i are characterized by and expenditure function
,
being
73
the welfare of the representative citizen in country j, and revenue function
Good 1
is taken as numeraire, and taken to bear no transport tax, a point returned to later ininterpreting results. Price vectors from now thus refer to goods 2 to L.
The income-expenditure identity of country A, allowing for a transfer to country A of a vectorof units of traded goods, isthe prime indicating transposition, while market-clearing requires

The system (A1.2)-(A1.3) being homogenous of degree zero in each ofand, good 1
can be taken to bear no transport costs, and normalized
It is assumed toothat the transfer is entirely in terms of the numeraire.
Perturbing (A1.2) for a change in the vector of transport taxes T, in order for its welfare to beunchanged, A then needs to receive a transfer ofwhereis the vector of A‘s net imports. The compensation required is thus
equal to the increase in the c.i.f. value of A‘s imports plus the increase in the f.o.b. value of its
exports (no account being taken of behavioral responses).

72

The term ‗tax‘ is used here for convenience to refer to any charge-induced increase in transport costs. (Thiswill be lower, for instance, the more of the burden of any charge is passed back in oil prices).
73

The analytical approach here is that of Dixit and Norman (1980).

58
To relate compensation directly to the transport tax, substituting from (A1.1) into the L-1 (byWalras‘ Law) market-clearing conditions for the non-numeraire goods gives

Assuming that income effects are zero other than for the numeraire,74 perturbing andrearranging this gives

where. Solving (A1.6),

and so, substituting into (A1.4),.
The revenue raised by the tax is, so thatThus

In general, the compensation required by A is thus: (a) Total revenue raised by the tax (onboth A‘s exports and imports), less (b) An amount reflecting the tax-induced contraction ofimports and exports (negligible for a small tax, expected to increase the amount ofcompensation needed otherwise) plus (c) A term reflecting relative net import demand/export
supply responses in the two countries (generally ambiguous in sign).
Expression (5.1) in Box 5 follows on writing (A1.8) as

and supposing there to be only two taxed goods, with no cross-price effects in their demand or
supply (so that both substitution matrices and hence
are diagonal).
For expression (A1.11), suppose there to be only one taxed good, and take as numeraire thegood exported by A. Then (A1.8) becomesthe initial tax being assumed negligible. Some care is needed in the practical interpretation ofthese results, however. Because of the underlying normalization, although T in (A1.11) is ascalar it reflects the transport taxes on both goods. Taking the numeraire to be A‘s import, forinstance, in obvious notation74

Sofor both j. If A is taken to be exactly compensated, this assumption is needed only for country B.

59

where the are the ‗pre-normalization‘ tax rates. For a small tax, and using the implicationof balanced trade that
(A1.10) thus becomesas in (A1.11) where the denote transport taxes as a proportion of the corresponding elementsof. It follows from (A1.13) that:

For a small tax, the compensation required is the total revenue (on both imports andexports) scaled by the ratio of the elasticity of export supply from the rest of the world
to the sum of that elasticity and the elasticity of import demand in the compensatedcountry.

In the special case in which these two elasticities are the same, and the tax has thesame impact on both exports and imports, the compensation needed for a small tax isexactly equal to the revenue that would have been collected on imports (or exports)
alone.

60
Appendix 2. Optimal Aviation Ticket and Fuel Tax Rates
Keen and Strand (2007) show that when the marginal cost of public funds (δ) exceeds unity,
there may be a case for either a general ad valorem ticket tax (at rate η/Q), or an excise ticket
tax t. The constrained optimal rates given that only one of the taxes is applied, are   1  1 MCS.c 
Q   Q

for the ticket tax, andt1E  1p  t    (1   )    ( p  t )for the fuel tax, where MSC denotes the marginal social cost of emissions,  ( p  t )c.c / c.(c  c( p  t )) the elasticity of substitution in production between fuel anda composite other input, c the (indirect) producer cost function, ε the absolute value of theelasticity of demand for aviation services, and α the share of fuel in total costs.
Magnitudeof climate
externality
fromaviation(MSC)$15/tCO2$25/tCO2$40 /tCO2

MCF

Tickettax rate,
percent

Fuel tax
rate, US$per liter,
ζ=1

Fuel tax
rate, US$per liter,ζ = 0.5

Ticket tax
revenue(US$ bn)

Fuel tax
revenue(US$ bn)
ζ=1

Fuel tax
revenue(US$ bn)ζ = 0.5

δ=1
δ = 1.1
δ = 1.25
δ=1

2
16
3

0.03
0.04
0.06
0.04

0.03
0.05
0.11
0.04

8
45
90
14

8
11
19
13

8
18
37
13

δ = 1.1

10

0.05

0.06

50

17

21

δ = 1.25

18

0.06

0.12

98

22

40

δ=1

5

0.08

0.08

20

19

19

δ = 1.1

11

0.10

0.13

58

25

35

δ = 1.25

20

0.11

0.19

102

32

62

61
Appendix 3. The Price Impact of a Selective Fuel Tax
The framework is one in which competitive refiners produce two fuels, A and B, in amounts
and , using crude oil of
where F is convex, strictly increasing in eachargument and homogenous of degree one. Denoting the producer prices of the fuels by andthe price of crude oil by Q, their maximand is thus.

Final demand for the two fuels are independent, and given, denoting by T a ‗tax‘ charged only
on fuel A, byand. Substituting these into the refiners‘ necessary
conditions defines
and it can be shown that

where

,

denotes the elasticity of demand for fuel i anddenotes the elasticity of substitution, subscripts indicating differentiation. Substituting heinto the market-clearing condition for crude oil definesbyfrom which

The impact on the oil price reported in Table 1 are calculated from (A3.7), and those on final
fuel prices from62
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