By: Duane Newman

This is the second of three articles on a looming challenge for South African policymakers and businesses – how to implement a new regime of carbon taxes which achieve the desired goal of curbing greenhouse-gas (GHG) emissions without placing a crippling burden on industry.

In the first article, noted government’s commitment to curbing emissions and the recent publication of an updated carbon tax discussion paper. In this article, we look at the goals and impacts of a carbon tax. We believe it was vital for businesses to closely study government’s recent carbon tax discussion paper and submit their comments – the deadline was August 2.

GHG emissions are normally tied to energy use. A major impact of any carbon tax is to increase the cost of energy for those who are targeted by the tax. Therefore, when imposing a carbon tax, it is critical to consider the impact on domestic indus- try, sensitive constituencies and inter- national competitiveness. For South Africa, this is a particularly difficult problem because major domestic industries, such as metal smelting and mining, are emissions intensive.

Further, in South Africa power generation is almost entirely based on coal, a fuel which gives off high emissions when burned, and, as we have already discussed, high emissions lead to high taxes. The costs of a carbon tax are passed through to electricity users in the residential, commercial and industrial segments. Moreover, carbon taxation of fuel for residential heating and transport can have an especially burdensome impact on low-income households, where energy costs make up a significant portion of overall household expenditure.

In general, policymakers need to balance carbon pricing regulation around a number of competing interests, including:
• Achieving environmental targets and meeting international commitments. Regulators need to ensure that their actions have suffi- cient impact to achieve their targets, but they also need to be flexible. Programmes in the European Union and elsewhere have shown that it can be exceedingly difficult to properly predict the macroeconomic trends that are the major drivers of emissions growth. In many countries, including Finland, taxes are periodically reviewed and may be increased, if needed. Other countries employ a steadily increasing tax. If pricing flexibility is built into the carbon tax system, it should be well understood by the marketplace to avoid uncertainty.
• Minimising negative impacts on the broader economy and key constituencies. Carbon taxes increase the cost of energy and fuel. This is the intended result of the taxes, which by their nature are meant to provide an incentive for more efficient energy use and renewable energy. But the higher costs of fuel and energy can also create potential hardship for domestic industries and for citizens.

Some industries, such as the smelting of metals and mining industries, are energy intense but do need to compete globally. The imposition through a new unilateral tax of a carbon cost of a type which may not be faced by international competitors can create an undue burden on these industries. The result could be economic losses, as production costs rise too high for the producer to remain competitive. Under such a scenario, the environmental benefits are also lost through a process called leakage. Therefore, a clear analysis of the carbon tax on the economic wellbeing of domestic stakeholders is critical to avoid economic losses and also to ensure environmental benefits are not lost through leakage.

There are a number of mechanisms that can be employed to mitigate the unwanted negative effects of a carbon tax. One approach, which has been used in the UK and in British Columbia, is to make the carbon tax revenue neutral. In these examples, the revenue collected through the carbon tax is used to offset personal income tax, business tax or contributions to public insurance schemes.

However, while at national or provincial level you can provide macroeconomic relief by reducing other taxes when you implement a carbon tax, this may not address the issue of industry competitiveness. Many jurisdictions, including Finland, Sweden and Boulder Colorado, tackle this challenge by reducing the effective tax rate for sensitive industrial segments.

Alternative approaches, such as border adjustments, have been proposed to level the playing field between countries that implement emissions controls and those that do not. Social science researcher organisation Resources for the Future conducted a study in 2009 that looked at various border adjustment options. These included import taxes, export rebates and consumer rebates. The study was conducted across the electricity, oil, chemicals, non- metallic minerals, iron and steel, pulp and paper, and print industries. It found that border adjustment policies have different impacts on different industries, but can be effective in protecting domestic industry, while still complying with World Trade Organisation rules.

In the last of our three articles, we will look in detail at some of the practical issues around the implementation of carbon taxes.

• Newman works for Johannesburg-based Cova Advirory. He co-authored this article with Robert Kaineg, who works for Thomson Reuters in Washing DC.