Analysis of the economic implications of a carbon tax

Analysis of the economic implications of a carbon tax

Why the South African government should introduce the carbon tax

As part of broad mitigation actions to reduce greenhouse gas (GHG) emissions, the South African government should consider introducing a carbon tax among the range of instruments available. A carbon tax was one of the most effective mitigation options analysed for the Long-term mitigation scenarios (LTMS) for South Africa which indicated that the effectiveness increases, up to certain tax levels. This paper presents results of research on a carbon tax in South Africa conducted in 2008 and was presented at the Climate Change Summit in 2009.

The paper reasons that the efficiency with which a carbon tax achieves the goal of reducing GHG emissions depends on responsiveness and substitutability as is shown more fully on the supply-side, while further work is needed to fully understand its response on the demand side. The paper explains that revenue from a CO2 tax can be used in the following various ways by government:

  • to reduce its deficit
  • to further mitigation, if recycled in the form of production subsidies for renewable energy and biofuels
  • in ways aimed at off-setting the potential effects of higher energy prices on the poor by way of food subsidies, reduced VAT or income tax or increased welfare transfers.
The paper advises that the following key policy issues and design questions have to be addressed before it can work effectively:
  • more detailed investigation in the effectiveness of a carbon tax in reducing GHG emissions
  • detailed investigation of tax-setting and adjusting mechanisms
  • equity, distributional impacts and addressing poverty and development
  • combining a tax with incentives and recycling of revenues
  • legislative compatibility
  • technical and administrative viability, including the tax base and definitions of taxable events
  • competitiveness effects and a structured approach to energy-intensive exporting sectors
  • other adjoining policy areas.
The publication recommends that:
  • careful design of a carbon tax is important to ensuring that it is effective in reducing GHG emissions
  • a price discovery and adjustment mechanism that sets a band around the desired ‘peak, plateau and decline’ trajectory should be put in place
  • for equity, poor households should be shielded from any burden by off-setting incentives, such as food subsidies or reduced VAT on basic goods.
The paper concludes that with appropriate design, a carbon tax can be a powerful instrument of mitigation in South Africa, and at the same time, contribute to socio-economic objectives.
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