Analysis of the economic implications of a carbon tax

Abstract

A carbon tax should be considered among the range of instruments available to the South African government, economy and society, as part of a broad portfolio of mitigation actions. A carbon tax was one of the most effective wedges or mitigation options analysed for the Long-term mitigation scenarios (LTMS) for South Africa. The LTMS strategic option ‘Using the market’ reduced emissions roughly as required by Science, for several decades. The LTMS research indicated that the effectiveness increases, up to certain tax levels. South Africa might consider a tax starting around R100-200 / t CO2eq, escalating in future. Our paper presents results on research on a carbon tax in South Africa conducted in 2008 and was presented at the Climate Change Summit 2009. The efficiency with which a carbon tax achieves the goal of reducing GHG emissions depends on responsiveness and substitutability. This is shown more fully on the supply-side, while further work will be needed to fully understand the response to a carbon tax on the demand side. Careful design of a carbon tax (or other economic instruments considered) will be important to ensure that it is effective in meeting its objective – reducing GHG emissions. We propose a price discovery and adjustment mechanism that sets a band around the desired ‘peak, plateau and decline’ trajectory. Equity demands that poor households, in particular, be shielded from any burden. Off-setting incentives, such as food subsidies or reduced VAT on basic goods, should in finance measure that which will ensure that the package of tax and incentives is a net benefit to the poor – and not to treat the tax as a revenue-raising instrument. 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.