By Abhishek Thommandru & Trishna Roy, DSNLU
Editor’s Note: This paper discusses the scheme of carbon taxing and cap-and trade and materializes on the fact that carbon trading can be nearly called as a second-chance lending mechanism. The admirable feature is that in the world where capitalism is more prevalent, the industries will respond well to such approach which embodies within itself, revenue earning and investment opportunity for private bodies. However, to curb the growing emission rates, there is Kyoto Protocol which allows trading only for five years from 2008 2012. The researchers also suggest that international trade in carbon will reduce the emissions significantly at the segment or regional level. In India, the accounting standards in the country will undergo a change to accommodate the new development of carbon credits trading as prescribed by The Institute of Chartered Accountants of India (ICAI)
The United Nations Framework Convention on Climate Change was adopted in 1992 at the Rio Earth Summit to address the adverse effects of climate change.[i] This is a framework document which intends to provide a structure to the Parties to develop laws aimed at achieving the Convention’s objectives at regularly Conferences of the Parties (COPs). The principal achievement of the third COP held in Kyoto in 1997 was the obligation upon the Annex I countries to quantitative GHG- Emissions limitations and reductions commitments and in addition to provide for mechanisms including carbon sequestration and emissions trading to help achieve these commitments in an economically efficient manner.[ii] The Kyoto Protocol envisages reduction of greenhouse gases by 5.2% in the period 2008-2012. The Kyoto Protocol establishes three flexibility mechanisms that allow for the diminishment of the overall cost of achieving emission targets namely (i) Joint Implementation mechanism, (ii) Clean Development mechanism and (iii) Emissions trading.[iii] One of the important mechanisms adopted in this Protocol was the mechanism of Emission trading also known as the Carbon Market. This mechanism allows countries that have spare emission units i.e. the emissions permitted to them but not used, to sell this excess capacity to countries that are over their targets.[iv] This mechanism thus allows tracking and trading carbon like any other commodity and hence referred to as the “carbon market”.
Further, there are three basic approaches of emission trading: (i) cap-and-trade, (ii) baseline-and-credit, and (iii) offset.[v] In the cap-and-trade method the aggregate cap on emissions is distributed in the form of allowance permits whereas in the baseline-and-credit method, firms earn emission reduction credits for emissions below their baseline.[vi] The purpose of cap-and-trade is to reduce carbon emissions to the capped level at the lowest possible social cost.[vii] The program creates flexibility in reducing emissions by allowing firms to take advantage of the fact that the cost of emissions abatement varies across firms and across time.[viii] Each ‘credit’ represents one tonne of carbon dioxide equivalent abated. The effect in this case is to limit aggregate emissions to an implicit cap equal to the sum of individual baselines.[ix] As a result, rewarding the firms that reduce carbon pollution below a baseline acts like an incentive to reduce pollution.
Many nations, including the United States, are considering policies to reduce emissions of carbon dioxide. The policy instrument most commonly recommended by economists are carbon taxing.[x]Contemporaneously has emerged the concept of carbon taxing. A carbon tax, levied on fossil fuels in proportion to the amount of carbon dioxide they produce during combustion, would stimulate firms and households to reduce fossil fuel use and shift the fuel mix toward less-carbon-intensive fuels, such as natural gas.[xi] Under harmonized carbon taxes, there are no international emissions limits, on the contrary nations agree penalize carbon emissions domestically.[xii] Carbon tax is determined by weighing environmental and economic objectives. Further, carbon taxes would interact with taxes levied to achieve other objectives, such as taxes on motor fuels used to generate revenues for highway construction and maintenance.[xiii] The blueprint of an appropriate standard for carbon taxes would involve international coordination and consideration of interactions among different tax and expenditure programs amongst nations. In addition, benefits of a carbon tax would also have to be weighed against other parameters such as losses in efficiency resulting from distortions in resource allocation.[xiv]
CARBON TRADING VIS-A-VIS CARBON TAXING
Carbon trading is when there is a limit to the carbon emissions in the environment and a cap is thereafter, put. The cap is hence divided into transferrable units which are then traded as a commodity. Carbon taxing occurs when the government gets a direct payment for the superfluous generation of carbon in the environment. If the carbon is emitted more than the prescribed limit, government taxes the content of the carbon. The taxing is preferably fixed in the legislation.
Whenever the carbon trading approach is discussed, the method of carbon taxes is also analyzed. Some scholars are of the view that tax approach is a better approach in certain aspect. Firstly, carbon tax proposals typically focus on fuel producers and importers; secondly, it levies taxes on amount of carbon content after export and impounding adjustments. Hence, it paves way for a cheapest possible solution in contrast to the emissions trading. One such example is of the EU Emissions Trading Scheme, deal only on large, stationary emissions sources and bypass cheap opportunities from smaller and mobile sources[xv]. Thirdly, in light of proceeds and benefits, the carbon tax approach would raise hefty revenues for the country. The corollary to this would be that the government will propose to reduce the tax on personal income which will benefit the low income groups. However, the earnings from tax approach are estimated to be higher than the emissions trading approach. Furthermore, carbon taxing has been considered environmentally and economically viable than cap-and-trade mechanism. Carbon credits trading will benefit only in the short run, when the global markets have ripened and matured, this method will no longer remain profitable.
There are opinions that hold carbon emission approach on a higher pedestal. Carbon emission approach is advantageous and beneficial that allows compliance of international agreements. The Kyoto protocol mentions certain specific rates at which the emissions must be maintained, but tax rate would vary from one country to another. Hence, the countries would easily comply with the former. One such instance at our disposal is the unilateral imposition of tax by European Union (EU) upon Indian airlines flying into or via EU[xvi]. In essence of the principle of “common but differentiated responsibility”, the countries have taken up the responsibility to reduce the emission of carbon however; countries like China, India, US, Russia, Brazil have agreed to pose a punitive measure against the unilateral carbon taxing of EU.
This approach will offer a great potential for the industries. It is a source of attraction for companies. Nevertheless, there is a high range of income possibility in the latter approach. Small and marginal farmers in Orissa and Andhra Pradesh would now be able to earn some additional income by selling carbon credits to World Bank.[xvii].Permits adjust automatically for inflation and external price shocks, while taxes do not. For example, the US has already experienced an extended period of stable greenhouse gas emissions levels from 1972 to 1985 because of high oil prices. Taxes would need to be designed to adjust for such external shocks[xviii].
INDIA AS THE PROSPECTIVE SUPPLIER OF CER’S
Annexure I countries in the Kyoto Protocol have two options, one of them has been aimed to develop CDM projects or purchase carbon credits from developing nations like India. India is the second largest producer of carbon credits after China (53%) at 15%[xix]. India opens a wide door to the opportunities to Annex I countries to enable them to invest in the CERs. One of the interesting facet is that most of the developing nations are non-Annex I countries and hence have a greater chance of operating on cleaner CDM projects. The underlying idea is that the developing countries may avail the opportunity of effective transfer of expensive technologies which was beyond the financial capacity of the developing countries[xx].
The market in India has a huge potential, more so, the projects India undertakes are eligible under the CDM. Furthermore, India has a large amount of carbon stocks stored in forests known as “carbon sinks”[xxi]. India ranks 10th in terms of forest and tree cover, therefore, carbon sequestration comes as a boon to India. The long-term storage of the atmospheric carbon will indent the emission without slowing the development process in the country. Consequently, India is provided with an opportunity to utilise and consent to more projects that would reduce the carbon emission into the environment. It would help to earn CERs. These carbon credits can be traded in the future in form of future contracts.
The Intercontinental Exchange is the regulator of clearing houses and provides of trading platforms with respect to emissions and energy[xxii]. The European Climate Exchange (ECX) remains the major platform for trading in carbon emissions in the European environmental instruments that are listed in ICE.[xxiii]While Chicago Climate Exchange (CCX) was the world’s first trading system to reduce emissions of the greenhouse gases[xxiv]. In India, the exchange is done on Multi Commodity Exchange India (MCX, Mumbai)and National Commodity and Derivatives Exchange Ltd. (NCDEX, Ahmedabad) where principally the buyers are from Annexure I countries[xxv]. The Forwards Contract Regulation Act 1956 authorises the Forwards Markets Commission (FMC) to normalize ‘goods’, which are deﬁned as ‘any movable property other than security, currency and actionable claims’[xxvi]. Furthermore, in the case of Tata Consultancy Services [xxvii] it was, held that the real test to identify if an item is a good is to see if the item possesses the following attributes of utility, capability of being bought and sold and being transmitted, transferred, delivered, stored and possessed would be considered as “goods” within the meaning of this act. Therefore carbon credits by virtue of fulfilling the above mentioned attributes qualifies to be considered as “goods”.
The revenue from carbon credits can be taxed under ‘income’[xxviii], ‘business’[xxix], ‘capital assets[xxx]’ or ‘income from other sources[xxxi]’. Hence the can be taxed at normal rates, concessional rates respectively. Some are of the view that if carbon credits are seen as business income then they might be deductible under section 80IAB, 80IB[xxxii]. Since carbon credits are a relatively new area, a need was felt to provide accounting guidance in this area. Keeping this in view the Accounting Standards Board has formulated this Guidance Note on Accounting for Self-generated Certified Emission Reductions (CERs)[xxxiii].
The Income Tax Department has estimated that about 200 small and large Indian companies are trading in carbon credits and have also stated this in their annual reports[xxxiv]. The Indian Income Tax Department has prepared itself on the carbon credits trading business in the country with a view to crack down on tax evasion in the sector, which has been estimated at Rs 1,000 crore[xxxv]. The industry estimates that about Rs. 8,000 crore to Rs. 10,000 crore of annual revenue comes to India from trading in carbon credits from various projects, with potential tax revenue of Rs. 3,000 crore as foreign exchange related inflow[xxxvi].Even the accounting standards in the country will undergo a change to accommodate the new development of carbon credits trading. The Institute of Chartered Accountants of India (ICAI) is currently working on accounting norms for carbon credits. According to which, companies are required to disclose about the carbon credits in their financial statements. The revenue earned by selling carbon credits has to be disclosed by the companies in accordance with accounting norms. However, they are yet to be notified by the ICAI.[xxxvii].
The Kyoto Protocol to the United Nations Framework Convention on Climate Change has been extensively debated in both the academic literature and the public media. The Protocol which is adopted by many developed and developing countries is based on a cap and trade system that targets the quantity of GHG emissions and promotes trading of carbon allowances between countries and individual entities.[xxxviii] Economic theory suggests that the quantity based permit systems like the Kyoto Protocol are the most efficient way to achieving the cap on GHG emissions only under certain conditions. Conversely it can be said that under different circumstances there may be better methods of reducing GHG emissions. Carbon taxing has been identified as one such method. In fact carbon taxing and emissions trading are the two most commonly proposed solutions for regulation of global emissions. The question which thus arises is which method is to be preferred over the other. Choosing neither of the methods plainly the most efficient policy would be to set emission limits for each country and then extend existing taxing systems to impose a tax on carbon consumption that achieves the emission targets. Since international law cannot effectively regulate internal matters of a country that liability should be borne by the nations themselves as to how they achieve their targets, and in their endeavour to do the same carbon taxing can be used as an instrument to tax firms off their excessive consumption.
This suggestion flows from the fact that the cap-and trade programs have been given much more attention with respect to the advantages of trading emissions rather than establishing a cap. It has also been absorbed that many commentators suggest that these programs “automatically” reduce emissions.[xxxix] Setting the cap properly matters more to environmental protection than the decision to allow, or not allow, trades.[xl] Considering this and the fact that India is a developing country and at the same time one of the fastest growing economies in the world, an effective system needs to be in place to combat the unlikely consequences of effects created by the Green House Gases. The best possible solution to this would then be to adopt and implement carbon taxing as well as carbon trading.
A number of countries including the EC have already implemented a carbon tax to control emissions of Carbon Dioxide, one of the principle gases contributing to global warming.[xli] It has been established that a well-implemented carbon tax imposed upstream can easily cover 80% U.S. emissions.[xlii] A carbon tax thus can either supplement an international cap and trade system or become the focal point for the next international treaty to address global climate change.[xliii] In the domestic context it can also generate needed revenue to support development of alternatives to fossil fuels and also give the States to create a deterrent effect which in turn will help in fulfilling the obligation of reducing carbon emission under the Protocol. Global warming as an important issue requires international coordination and therefore, the Kyoto Protocol continues to receive both public and political support, however, countries should be encouraged to undertake meaningful steps to reduce emissions.
Edited by Hariharan Kumar
[i] United Nations Framewok Convention on Climate Change Article 1 (1).
[ii] Eric C. Bettelheim and Gilonne d’Origny, Carbon Sinks and Emissions Trading under the Kyoto Protocol: A Legal Analysis available at http://www.jstor.org/stable/3066594.
[iii] Kyoto Protocol, Article 6, Article 12.
[iv] Kyoto Protocol, Article 17.
[v] George Allayannis, Carbon Credit Markets, Darden Case No. UVA-F-1583. Available at SSRN: http://ssrn.com/abstract=1419269.
[vi] Neil J. Buckley, Stuart Mestelman and R. Andrew Muller, Cap-and-Trade versus Baseline-and-Credit Emission Trading Plans: Experimental Evidence Under Variable Output Capacity, available at http://socserv2.socsci.mcmaster.ca/~econ/faculty/mullera/papers/varcap.pdf.
[vii] Harvey S. Rosen & Ted Gayer, Public Finance 86–94 (8th Ed. 2008).
[viii] N. Gregory Mankiw, Principles Of Microeconomics 216 (4th Ed. 2007).
[x] William Nordhaus, The Challenge of Global Warming: Economic Models and Environmental Policy, available at http://nordhaus.econ.yale.edu/dice_mss_072407_all.pdf accessed on 20/09/12 at 8:16 am
[xi] Dale W. Jorgenson et al, Carbon Taxes and Economic Welfare, 1992 Brooking Papers on Economic Activity pp 393-454(1992)
[xii] William D. Nordhaus, After Kyoto: Alternative Mechanisms to Control Global Warming, available at http://webarchive.iiasa.ac.at/Research/ECS/IEW2001/pdffiles/Papers/Nordhaus.pdf accessed on 18/09/12 at 10:50 am
[xiii] S. Fred Singer & Dennis T. Avery, Unstoppable Global Warming Every 1,500 Years (2007).
[xiv] Les Coleman, Carbon Trading: Solution or Chimera? Available at http://ssrn.com/abstract=997948 accessed on 17/09/2012 at 9:45pm
[xv] Ian Perry & William A Pizer, Which is the Best Climate Policy: Emissions Taxes or Emissions Trading?,Rff commentary series, (December 4, 2007) available at http://www.rff.org/Publications/WPC/Pages/12_24_07_Taxesor_Trading_Parry.aspx. Conventionally, theEuropean Union has been supportive of the carbon taxes, among countries. Since EU is already relatively energy efficient carbon taxes would be less of a burden.
[xvi]NitinSethi, Trade War: Cabinet To Consider Steps Against EU Carbon Tax, the times of india, (July 9, 2012).
[xvii] World Bank’s BioCarbon Fund (BiCF) signed an agreement to buy 2.76 lakh tonne of carbon dioxide equivalent emission reduction between 2008 and 2017, with an option to purchase an additional 3.70 lakh tonnes of CERs.The farmers will sell the CERs or carbon credits by planting trees on their degraded lands. Seealso, WB to buy carbon credits from Orissa, AP farmers, (May 8, 2007) available at http://articles.economictimes.indiatimes.com/2007-05-08/news/28391930_1_carbon-credits-marginal-farmers-jk-paper.
[xviii]Kevin Baumert, Carbon Taxing v. Emission Trading, (April 17 1998) available at http://www.globalpolicy.org/component/content/article/216/45883.html.
[xix]The World Bank, State and Trends of the Carbon Market 2008, 26 (May 2008) available at http://siteresources.worldbank.org/NEWS/Resources/State&Trendsformatted06May10pm.pdf.
[xx]Dhandapani Alagiri&E. Naveen Kumar, Environemental issues in India: An Introduction, Carbon Credits –A Market of the 21st Century, 215(2007).
[xxi]ministry of Environment and Forests, JagdishKishwan , Rajiv Pandey& V K Dadhwal , Indian, India’s Forest and Tree Cover: Contribution as a Carbon Sink, Technical Paper, 1-2 (2010) available at http://www.envfor.nic.in/mef/Technical_Paper.pdf.
[xxii]Marc Levinson, Guide to Financial Markets, 172-173 (5th ed. 2009).
[xxiv]Walter leal Filho, The Economic, Social and Political Elements of Climate Change, 217-218 (2010).
[xxv]Kevin, Commodity And Financial Derivatives, 71 (2010).
[xxvi]Forwards Contract Regulation Act 1956,Sec 2(d).
[xxvii] Tata Consultancy Services vs. State of Andhra Pradesh(2005) 1 SCC 308.
[xxviii]The Income Tax Act, 1961, Section 2(24). See CIT v. GR Karthikeyan  201 ITR 866 (SC).
[xxix]The Income Tax Act, 1961, Section 2(13).See Eclat Construction (P.) Ltd. v.CIT  172 ITR 84(Pat).
[xxx]The Income Tax Act, 1961, Section 2(14).
[xxxi] The Income Tax Act, 1961, Section 56.
[xxxii]The Income Tax Act, 1961.
[xxxiii] The Institute of Chartered Accountants of India, Guidance Note on Accounting for Self- generated Certified Emission Reductions (CERs) (Issued 2012), (February 11, 2012) available at www.itatonline.org/info/?dl_id=791.
[xxxiv]Carbon Credits Trading on Income Tax Radar, the hindu, (August 22, 2011) available at http://www.thehindu.com/business/markets/article2383770.ece.
[xxxvi]Sharath S Srivasta, Green Industries Caught Unawares as Taxmen Come Knocking on Their Doors, the hindu, (November 11, 2010) available at http://www.hindu.com/2010/11/11/stories/2010111156590600.htm.
[xxxvii]Sangeeta Singh and Jacob Koshy, India To Have New Accounting Norms For Carbon Trading, (April 1, 2008) available at http://www.livemint.com/2008/04/01001820/India-to-have-new-accounting-n.html.
[xxxviii] George Milunovich et al, A Review of Carbon Trading Theory and Practice, Available at http://ssrn.com/abstract=989271 accessed on 17/09/12 at 5:30 pm
[xxxix] David M. Driesen, Sustainable Development and Market Liberalism’s Shotgun Wedding: Emissions Trading under the Kyoto Protocol, 83 IND. L. J. 21, 61 (2008).
[xl] Ruth Greenspan Bell & Clifford Russell, Ill-Considered Experiment: The Environmental Consensus and the Developing World, 24 HARV. INT’L REV. 20, 24 (2003)
[xli] Alistair Ulph and David Ulph, The Optimal Time Path of a Carbon Tax, 46 Oxford Economic Papers, New Series, 857-868 (1994).
[xlii] David Weishbach, The Design of Carbon Tax, available at http://ssrn.com/abstract=1324854 accessed on 20/09/12 at 8:50 am.
[xliii] David G. Duff, Tax Policy and Global Warming, 51 Canadian Tax Journal 2063 (2003).