**Table 2. A carbon tax is preferable compared to alternative mitigation approaches in terms of its breadth, ease of implementation and market efficiency implications**

|**Feature of alternative mitigation**<br>**approaches**|**Carbon Tax (*)**|**Emissions Trading Systems**|**Feebates**|**Regulations**|
|---|---|---|---|---|
|**Potential for exploiting mitigation**<br>**opportunities**|Full, if applied<br>comprehensively|Full, if applied comprehensively (in<br>practice often limited to<br>power/large industry)|Similar to regulations|Can exploit some key<br>opportunities but not all (for<br>example, reductions in vehicle<br>use)|
|**Use of price/market mechanism**|Yes|Yes, but price only predictable if<br>price floors or similar mechanisms<br>included|Yes|No|
|**Efficiency and incentive for**<br>**innovation from mitigation**<br>**responses induced by policy**|Yes, people and firms choose<br>most efficient way of reducing<br>emissions|Yes, people and firms choose most<br>efficient way of reducing emissions|Yes, firms choose most efficient<br>approach|No automatic mechanism, but<br>can avoid energy price<br>increases|
|**Price predictability**|Yes (if clearly specified<br>trajectory)|No (unless includes price floors or<br>similar mechanisms)|Yes (if clearly specified trajectory)|No (implicit prices vary with<br>technology costs, energy prices,<br>etc)|
|**Revenue generation and**<br>**administrative burden**|Yes, and easy to build into<br>existing fuel or royalty tax<br>systems|Maybe (if allowances auctioned,<br>but revenue base may be limited in<br>South Asia)|No, since best design is revenue<br>neutral, but new administrative<br>capacity to apply fees/rebates to<br>powergeneration|No, though capacity needed to<br>enforce regulations|

Source: Authors’ adaptation for South Asia based on IMF (2019a; 2019b).

Note: (*)=A border carbon adjustment could be part of a broader carbon tax system. Color scheme refers to the desirability of each feature: green=yes, yellow=maybe, red=no. ‘Regulations’ include policies like requirements for renewable generation shares, which are typically less efficient than feebates.

# **3.2 Modeling framework**

We employ the Climate Policy Assessment Tool (CPAT).<sup>11</sup> CPAT is a tool developed jointly by the IMF and World Bank, allowing for simulations of climate mitigation policies for over 175 countries under user-specified scenarios. The model provides estimates and country-specific projections of fossil fuel CO2 emissions and assessments of the environmental, fiscal, economic, public health, other externality and distributional impacts of carbon taxes and fossil fuel subsidy reform, among other policies. The model decomposes fossil fuel and other (e.g., renewables, electricity, biomass) energy use into the power, industrial, transport, and residential sectors, projecting it forward by: i) GDP forecasts; ii) assumptions about the income and own-price elasticity of demand for fuels; iii) assumptions about the rate of technological change affecting energy efficiency; and iv) changes in international energy prices, with pre-existing fuel taxes and levies being held constant in real terms. The impacts of mitigation policies on fuel use and emissions depend on i) their effect on future energy prices; ii) fuel switching within the power generation sector; and iii) price elasticities of electricity and other fuel demand across sectors.

The tool is parameterized using fuel use and emissions factors by country-sector from the International Energy Agency (IEA, 2021). Data on energy taxes, energy subsidies and prices by product

> 11 CPAT is forthcoming and will be available for public use at: https://www.worldbank.org/en/topic/climatechange and - <u>https://www.imf.org/en/Topics/climate change/CPAT</u>

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