Carbon leakage from unilateral Environmental Tax Reforms in Europe, 1995–2005

Studies of the effects of the Kyoto Protocol have shown carbon leakage (typically from tax and permit schemes with lump-sum revenues recycling) to be in the range of 5–20% using static Computable General Equilibrium models. However, in practice, researchers have found that carbon leakage from the implementation of the EU ETS is unlikely to be substantial because transport costs, local market conditions, product variety and incomplete information all tend to favour local production. This study investigates potential carbon leakage from six EU Member States (MSs) that implemented Environmental Tax Reform (ETRs) unilaterally over the period 1995–2005. The study uses the large-scale multisectoral integrated energy–environment–economy (E3) model of 27 European countries, energy–environment–economy model of Europe (E3ME), to undertake a dynamic comparative analysis to assess any carbon leakage effects over the longer term 1995–2012. A counterfactual Reference case is constructed, assuming that the six countries did not introduce ETRs; then alternative scenarios are developed to assess the effects of the ETRs, including effects on CO2 emissions for the EU25 economies. Most MSs recorded a reduction in CO2 emissions when comparing the Baseline case to the Reference case. The results show that carbon leakage is very small and in some cases negative, due to technological spillover effects.