Carbon taxes and general joint implementation: an applied general equilibrium analysis for Germany and India

Germany has committed itself to reducing its carbon emissions by 25 percent in 2005 as compared to 1990 emission levels. To achieve this goal, the government has recently launched an environmental tax reform which entails a continuous increase in energy taxes in conjunction with a revenue-neutral cut in non-wage labor costs. This policy is supposed to yield a double dividend, reducing both, the problem of global warming and high unemployment rates. In addition to domestic actions, international treaties on climate protection allow for the supplementary use of flexible instruments to exploit cheaper emission reduction possibilities elsewhere. One concrete option for Germany would be to enter joint implementation with developing countries such as India where Germany pays emission reduction abroad rather than meeting its reduction target solely by domestic action. In this paper, we investigate whether an environmental tax reform cum joint implementation (JI) provides employment and overall efficiency gains as compared to an environmental tax reform stand-alone (ETR). We address this question in the framework of a large-scale general equilibrium model for Germany and India where Germany may undertake joint implementation with the Indian electricity sector. Our main finding is that joint implementation offsets adverse effects of carbon emission constraints on the German economy. JI significantly lowers the level of carbon taxes and thus reduces the total costs of abatement as well as negative effects on labor demand. In addition, JI triggers direct investment demand for energy efficient power plants produced in Germany. This provides positive employment effects and additional income for Germany. For India, joint implementation equips its electricity industry with scarce capital goods leading to a more efficient power production with lower electricity prices for the economy and substantial welfare gains.