10.4.3. Economic and Market-Based Measures

IPCC (1996b), OECD (1989), and others have examined other potential economic instruments for mitigating aviation environmental effects:

. Fuel taxes and charges (levies) to promote fuel efficiency and reduce demand
. Emissions charges aimed at encouraging adoption of lower emitting technology
. Emissions trading to encourage emissions reductions through market forces
. Ticket taxes or charges
. Levies on empty aircraft seats to promote improvement in seat load factor
. Levies on excessive traffic per destination, destinations served, or type of equipment serving a destination
. Levies on route length to reduce the number of flights that are less than a minimum distance
. Subsidies or rebates to act as an incentive for polluters to change their behavior, such as grants, soft loans, tax allowances or differentiation, and instruments similar to effluent, product, or administrative charges.

Some of these measures are currently being considered by ICAO. Although examples of some of these and other measures exist in some countries, however, they have not been actively pursued by governments or ICAO.

10.4.3.1. Environmental Levies

Aviation is subject to various taxes and charges (grouped for convenience and referred to as levies in this report), most of which are related to the recovery of infrastructure costs and the provision of services. These levies consist primarily of landing charges imposed by airports on air service providers, route facility charges imposed by providers of air navigation services on operators, and passenger and cargo taxes based on the value of the ticket or waybill. The term environmental levy or emissions-related levy refers to charges and taxes. There are, however, relatively few examples of environmental charges or taxes related to emissions. The primary goal of such charges is to ensure that the external costs of the service provided are fully reflected in the charges paid. By internalizing external costs, environmental levies have the potential to reduce aircraft emissions by providing further incentives to develop and purchase low-emission technology, improve operational efficiency, and reduce demand via higher fares.

ICAO makes a distinction between charges and taxes and, because charges are based on cost of service and the revenue is retained by the aviation sector, has expressed a strong preference for the former. It regards charges as levies to defray the costs of providing facilities and services for civil aviation and taxes as levies to raise government revenues, which are applied to non-aviation purposes. In applying this principle to environmental levies, the ICAO Council Resolution on Environmental Charges and Taxes recommends that, where introduced, levies should be guided by the following principles:

. There should be no fiscal aims behind the charges.
. Charges should be related to costs.
. Charges should not discriminate against air transport compared with other modes of transport.

The Resolution was adopted in December 1996, and endorsed by the 32^nd ICAO Assembly (ICAO, 1998b).

One of the recommendations at the CAEP/4 meeting in April 1998 (ICAO, 1998a) was to "identify and evaluate the potential role of market-based options, including emissions charges, fuel taxes, carbon offset, and emissions trading regimes." This recommendation was approved by the ICAO Council, and the 32nd ICAO Assembly subsequently requested that a conclusion be reached on guidance to be given to states on emissions-related levies in time for the next ICAO Assembly in 2001 (ICAO, 1998b). In its future work, CAEP will identify a range of market-based options, assess their limitations, identify their environmental effects, consider the application of revenues that might be accrued, and consider implementation mechanisms that might be employed.

ICAO does not, however, cover member states' tax policies for domestic aviation. The United States, for example, applies a fuel tax on domestic air carriers and general aviation aircraft; the receipts are held in the Airport and Airways Trust Fund and are prohibited by law from being used for non-aviation purposes. Similarly, some domestic aviation fuel is already taxed in Europe, where the status of the mandatory exemption of international aviation fuel from taxation has been under discussion for some time. In March 1997, the European Commission proposed in a draft directive that this aviation fuel tax exemption should remain until the international legal situation permits imposition of such a tax (European Commission, 1997).

Zurich Airport has added an emissions surcharge to the landing fee based on engine certification information contained in the ICAO Engine Exhaust Emissions Data Bank (ICAO, 1995b; Zurich Airport Authority, 1997). This charge was intended primarily to provide an incentive to encourage operators to use their lowest emissions aircraft into Zurich and to accelerate the use of best available technology. Revenues are used to finance emissions reduction measures at the airport. A similar emissions-related charge was applied at 10 Swedish airports beginning 1 January 1998. These charges are revenue neutral and do not affect consumer demand. They do, however, provide an incentive to airlines to purchase and operate aircraft with lower engine emissions. These charges are considered consistent with ICAO principles.

Concern has been expressed that uncoordinated introduction of emissions charges at the national, sub-federal, or regional level or by airports will have international repercussions because they are discriminatory to some aircraft that comply with internationally recognized standards, and the original intention of the NOx certification standards was not to set local environmental restrictions, including levies. One implementation issue that would need to be addressed with fuel taxation is that international taxation of aviation fuel is currently precluded by provisions contained in many bilateral air service agreements between countries, the main legal framework underlying the operation of international civil aviation. Three studies assessing the economic and environmental impact of environmental levies are considered below. A 1997 OECD study (OECD, 1997a) found that although fuel price increases have had little impact on the demand for air travel, the rate of energy intensity reduction in civil aviation has been very responsive to fuel price. On the basis of historical data, the study concluded that, when implemented on an international basis, a meaningful rise in fuel prices introduced at a moderate rate each year could have a large impact on increasing the rate of energy intensity reduction. The study considered fuel charge options equivalent to 2, 10, and 50% of the price of aviation fuel, and considered the use of revenues to reduce the general level of taxation and to fund research and development within the aviation industry.

Although the OECD study did not attempt to identify a direct relationship between fuel price and energy intensity over the scenario period, it did suggest that cumulative fuel levies resulting from an increase in the price of aviation fuel of up to 5% per year could result in at least a 30% reduction in aviation energy use in 2020 relative to the reference scenario. However, if charges were not applied at a uniform global level, the study concluded that the increase in fuel price would lead to a distortion of competition and a weakening of incentives to develop and adopt energy-efficient aircraft. It further concluded that a fuel charge was unlikely to have any substantial long-term effect on air traffic growth, particularly if it were introduced gradually.

In its report to CAEP/4, the Focal Point on Charges (FPC) (ICAO, 1998a) considered the potential economic and environmental impacts of various environmental levies. It concluded that, among the options studied, the most effective options for addressing global emissions were a fuel levy and en route charges. The report showed that any resulting cost increases passed on to consumers would result in a reduction in emissions. This result would occur primarily through lower traffic demand, but airline and manufacturer supply-side responses also would be stimulated, with limited impact on airline operating results. The portion of the fuel price increase not passed on to customers would be borne by the airlines, affecting their profitability, cash flow, and retained earnings-which, in turn, could affect the ability of airlines to purchase more environmentally beneficial equipment.

The report considered alternative applications of the proceeds of environmental levies. The revenue-neutral approach did not cause a problem with the redistribution of revenues, but the environmental benefits were found to be limited. Although general taxes are feasible on implementation grounds, they raise serious problems of equity and acceptability. A prevention cost approach using revenues to fund future technology improvement was regarded as better than general taxation in reducing total emissions; however, rechanneling of revenues to the aviation industry would give rise to administrative complexities and raises equity problems and risks of distortion of competition.

A feasibility study by the Centre for Energy Conservation and Environmental Technology (CE) (Bleijenberg and Wit, 1998) considered the feasibility of introducing an environmental charge on civil aviation in Europe. Using a scenario-based approach and an aviation fuel price to include the environmental cost at 125% of the cost of the fuel, the study found that the rate of growth in aviation emissions in Europe would be approximately halved. A charge based on calculated emissions was found to have similar environmental effectiveness to a fuel charge, but the former had smaller economic distortions and fewer legal obstacles than the latter. The study found that an emissions charge in European airspace would have little impact on competition between domestic and non-European carriers. A revenue-neutral emissions charge was judged to be the most feasible option, with high environmental effectiveness and relatively few economic distortions.

Several comparisons may be made of the main features of these three studies. In the FPC study, most of the benefits arose from a reduction in the growth of demand, whereas in the OECD and CE studies, the supply-side influence was predominant. Partly as a consequence of the strong supply-side effect, the OECD and CE studies estimated a larger reduction in total emissions than did the FPC report. Both the FPC and the OECD considered options to rechannel revenues for technology improvement within the aviation sector. The FPC study found greater distortions to competition between airlines arising from a European emissions or fuel charge than the CE study.

Two areas require further study. The first is the applicability of environmental levies to the circumstances of countries other than those in OECD and countries in transition; the other is how revenues generated from a levy would be used.

10.4.3.2. Other Market Approaches

Emissions trading of greenhouse gases has been adopted as part of the Kyoto Protocol as a potential means of achieving reductions in these gases at the lowest possible costs. Emissions trading allows market forces to operate to achieve the lowest possible costs of achieving an environmental goal. It can provide companies such as airlines with the flexibility to reduce their own emissions or to purchase equivalent reductions from others, if doing so would be less expensive. It gives firms the incentive to employ innovative technologies and reduce emissions beyond what any standard would require.

Markets play a central role in the efficient exchange of commodities, shares, bonds, and financial instruments. Existing international markets have well-established practices for contracting, delivery, and settlement that could be applicable to emissions trading. Emissions trading differs considerably from the more traditional standards approach that, for example, has been used by ICAO. Under that approach, a specific emissions limit has been established, and each aircraft must meet the standard. Under emissions trading, an overall level of emissions production is set, and firms are allowed flexibility to jointly meet that standard. Firms that can achieve low-cost reductions to meet their requirements have an incentive to reduce below the required levels and sell their excess emissions reductions to other firms. Firms facing higher control costs can purchase these reductions to comply with their requirements at lower costs than by using alternative means.

A credible system of monitoring and verifying emissions reductions that allows for trading with minimal transaction costs would be needed to achieve the cost savings potential of these mechanisms. As in other areas of environmental policy, an emissions trading regime would be likely to meet environmental objectives at the lowest cost because it sets overall environmental goals, provides geographic and temporal flexibility, would allow for flexible trading across industry boundaries, and would offer incentives for meeting the goals (Dudek and Goffman, 1997).

Among OECD countries, the efficacy of emissions trading in meeting the objectives of the Kyoto Protocol has been compared to direct market and regulatory intervention. Some observers have suggested emissions trading is difficult to enforce and raises potentially difficult liability issues. Others have expressed concern about the possibility that companies with excess reductions will not sell them, thus creating a barrier to new entrants in the market. However, successful allowance-based SO2 emissions trading among competitive electric power generation companies in the United States favored emissions trading over other options. Monitoring, reporting, verification, and certification systems need to be explicitly defined and developed.

Emissions trading has been used in the United States in the control of SO2 emissions responsible for acid rain. Flexibility in this program has resulted in pollution permit prices of about $100 per ton, compared to estimated prices before the program was implemented on the order of $250-400 per ton (Council of Economic Advisors, 1998a). In addition, modeling indicates that programs using tradable permits could enable more cost-effective control of local and global atmospheric pollutants than other regulatory options under consideration (IPCC, 1996d; GAO, 1997). Emissions trading has been incorporated in the Montreal Protocol, the international treaty that limited ozone-depleting substances. Under that treaty, restrictions were placed on several specific chlorofluorocarbon (CFC) compounds as a group, instead of separate restrictions on each compound. Countries could permit firms to trade among CFCs, reducing those that cost the least first. In addition, in a separate provision, production permits were allowed to be traded across nations to allow for a lower cost, more orderly phaseout of manufacturing facilities (Montreal Protocol, 1987).

The Kyoto Protocol (UNFCCC, 1998b) contains emissions trading provisions that provide substantial flexibility for nations to reduce their costs of meeting agreed emissions goals. As with the Montreal Protocol, targets for greenhouse gases were not set for individual compounds but rather as a single comprehensive goal combining six major greenhouse gases (sources and sinks). Nations can adopt plans that minimize the costs of meeting this target based on the relative costs of controls among these different categories of greenhouse gases. The Kyoto Protocol provisions allow developed nations to trade emissions on a project-by-project basis (Article 6) and through an emissions trading system (Article 17). A clean development mechanism (Article 12) was established to allow developed countries to support and get emissions credit for actions in conjunction with developing countries that reduce emissions in those countries.

Relevant principles, modalities, rules, guidelines for emissions trading, and the role of governments are being discussed by the Conference of the Parties to the UNFCCC and its subsidiary bodies, with the goal of reaching agreement before the end of the year 2000. A credible system of monitoring and verifying reductions that allows for trading with minimum transaction costs will be needed to achieve the cost savings potential of these mechanisms. International aviation emissions are not covered by the emissions-related targets in the Kyoto Protocol. The prerequisite for emissions trading is adoption of emissions reduction targets or caps. In principle, the aviation sector could be included in the emissions targets agreed in the Kyoto protocol, but the feasibility of applying an emissions trading regime depends on establishing a method to allocate international aviation bunker fuels. Emissions trading would likely be available across all industries, allowing progress in emissions reduction at the lowest cost. High-cost compliance industries with limited compliance options could purchase rights from lower-cost producers of other commodities.

An analysis of the potential for reducing the costs of meeting the Kyoto targets from these flexible, market-based approaches was conducted within the United States. This study suggests that reductions in permit prices on the order of 70-90% were possible because of these provisions (Council of Economic Advisors, 1998b).

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