Interactions between policies - the waterbed effect
Price methods such as taxes, and quantity' methods such as ETSs and CORSIA, differ in several ways, but one important way' is how they interact with other policies. This has sometimes been called the “waterbed” effect. If a tax is imposed, this does not have any implications for the effectiveness of other policies — for example, voluntary actions to curb emissions will also work, adding to the effect of the tax (though quantity constraints, such as airport slots, can change this). By contrast, a comprehensive ETS and CORSI A will work differently. The ETS puts a maximum on the emissions that can be emitted. Other measures can be implemented, such as a passenger tax, but they will have no impact on emissions, since the ETS sets the allowable emissions, and the actual emissions will equal the allowable emissions (unless the limit is slack) (Forsyth, Dwyer and Spurr, 2007; Fankhauser, Hepburn and Park, 2011). Additional policies will have some effects, such as reducing the price in the market for permits. However, they will not have any effect in reducing carbon emissions, unless the waterbed effect is specifically addressed.
This means that, in the presence of an ETS, additional policy measures are redundant. This has strong implications for climate change policies. Often a mixture of policies is advocated, in the belief that a broad menu of policy measures will help reducing emissions. In fact, it will not, since the ETS limits are binding.Thus, for example:
- • Passenger taxes will cease to have any effect in terms of reducing emissions while an ETS is in operation.
- • Bans on airport expansion, such as those demanded by some pressure groups, will not have any effect on emissions if an ETS is working. They will have a cost to the home economy, however.
Complementary measures do sound appealing — they appear to reduce emissions. There may be reasons why specific measures could be desirable, though reasons other than their effect on emissions. Thus, for example, a government may choose to subsidise biofuels as a fuel for aviation - perhaps because it believes that there are production externalities in the development of new techniques. Governments may believe that there are R&D spillovers in engine research (for a critical discussion of market failure in the R&D market for clean technologies, see Dechezlepretre and Popp, 2017). For some countries, there may be distributional aspects to aviation measures. If this is the case, then these complementary measures need to be assessed in terms of these other objectives, such as raising government revenues, not the impact on emissions, which remain at nil.
This is shown in Figure 4.4.The effective rationing mechanism once an ETS is in operation is to put a limit on permits available - in this case, it is K. If the government imposes a tax, be it a passenger tax or a fuel tax, such as t, there will be no effect on emissions. The value of permits will fall, but not their quantity.
It is worth noting that only a comprehensive ETS (and CORSIA) create this property of redundancy of other policies. Other policies, such as a carbon tax, or specific measures, such as voluntary offsets or improvements to ATM, do not have this property. An ETS achieves a specific level of emissions and no more, no matter what other policies are implemented. By contrast, if a carbon tax is
Air transport and climate change 67 imposed, additional measures such as voluntary offsets and improvements to ATM have an additional effect on emissions, in addition to the effect of a carbon tax. For some, this property of the ETS would be regarded as a drawback of the ETS. However, this should be seen in context; all polices have particular properties, and the objective should be on choosing the best policy in the circumstances. For example, an ETS has the property' that it sets the actual emissions to a set target, which can be a desirable property' — other options such as a carbon tax do not guarantee that emissions will be at the target level — they' could be way below or way above.
The waterbed effect of an ETS does mean that policy makers should be aware of the effectiveness of complementary measures once an ETS is in operation. Many countries in the EU had policies which had, at least in part, the rationale of reducing emissions. Once the EU ETS came into being and before recent reforms, this rationale was no longer viable. These options, which seem reasonable, created real costs for no benefit in terms of emissions reduction. Most likely; the persistently low prices of allowances in the EU system have been partly due to countries adopting emissions reduction policies — evidence that the waterbed effect is present. In addition, a variant of the waterbed effect also occurs with the CORSIA type of system.
As with the ETS, the CORSIA system involves a fixed limit. In this case, the airlines can create emissions, but they' are required to essentially cancel them out by' buying offsets. This can be shown by considering an aviation tax in addition to a CORSIA mechanism.This tax raises the price which travellers must pay (adding to the cost of the service and the cost of the offsets). With the higher price, emissions from the airlines will fall, and it may' appear that the tax is working to lessen emissions. However, the tax also reduces the airlines’ need for offsets. This will exactly cancel out the effect of the tax on emissions. As long as the offsets are working as they should, there will be zero net global emission reduction. It is not possible.
The waterbed effect has been recognised in recent changes to the EU ETS. In particular, a market stability reserve (MSR) has been established and set in operation from 2019, and this will affect the operation of the waterbed effect (see Hepburn et al., 2016). The MSR is a mechanism to reduce price volatility' in the market for allowances/permits. However, it also works to reduce the number of allowances in the market when there are too many allowances, given specific criteria. Thus, if an aviation tax lessens the demand for allowances, a number of allowances may be withdrawn. This will have the effect of reducing or eliminating the waterbed effect. The criteria for withdrawal of allowances have been arbitrarily set, and thus there is no guarantee that a tax which results in a reduction of x tonnes of emissions will result in x tonnes of allowances being withdrawn.
The precise quantitative effects on the number of allowances of the MSR have yet to be analysed, and observers disagree as to what extent they will eliminate the waterbed effect. Nevertheless, there will be a change in the right direction which will lessen the waterbed effect. The issue of the interplay betweenthe EU ETS and aviation taxation will need to be resolved if countries and the EU choose to impose both the ETS and aviation taxes.
