ERC Andrew Marquard and Harald Winkler A Carbon tax for South Africa? Energy Research Centre University of Cape Town Presentation at a side event on PUTTING A PRICE ON CARBON at the 2009 Climate Change Summit Tuesday 3 March 2009

ERC Why would we institute a carbon tax? lTo provide an economic incentive for reducing GHG emissions lThis would (ideally) have two effects: lA demand effect, which would incentivise consumers to use less GHG-emitting goods and services lA substitution effect, which would incentivise switching from more to less carbon-intensive processes / energy carriers lAs a result, the economy would ultimately shift from a high-carbon to a low-carbon economy (ideally

ERC Is it this easy? Not very: lNeed to make important decisions, such as: lscope of tax (which sectors and gases to include) l tax level (how many Rands/ton of CO 2 -eq) lWhat to do with the revenue lHow to relate to other taxes (revenue neutrality) lDifferent sectors respond differently, depending on available lower-carbon alternatives and their costs lDifferent parts of society are affected differently (distributional effects), which needs to be taken into account

ERC International experiences lSome international experience, especially in Scandinavian countries, which imposed forms of carbon taxation from the early 1990s lDrivers differed – GHGs, but also reducing income tax lImpact was to curb emissions growth (in comparison to baseline) – did not lead to absolute emissions reductions lImposed in a variety of ways (directly on emissions, partly on energy content, etc) lFrequently, specific sectors were given lower rates or excluded entirely (energy-intensive industries, power sector) lOther measures still required (energy efficiency and renewables programmes and policies) – combination of these measures in Denmark was most effective

ERC How would a carbon tax affect South Africa? lTentative answers to this question have been arrived at though a number of modelling exercises: lThe Long-Term Mitigation Scenarios process used both an energy model and an economy-wide model to investigate the effect of a carbon tax lNIRP3 modelled the impact of a carbon tax on the electricity system lOther economic studies (Van Heerden et al 2006) lModels have limitations, but are good at providing an insight into the response of the economy / energy system to a carbon price

ERC Impact of a CO2 tax on emissions (2003 Rands)

ERC Marginal impact of tax levels (2003 Rands)

ERC LTMS: Growth Without Constraints – power sector

ERC LTMS: impact of an escalating CO2 tax on the power sector

ERC LTMS: Growth Without Constraints – liquid fuels

ERC LTMS: impact of an escalating CO2 tax on the liquid fuels sector

ERC Other model results lNIRP3 – modelled the electricity system, and found that a tax level of R200/ton (2006 Rands) was sufficient to incentivise low-carbon alternatives lEconomy-wide modelling: lLTMS static modelling – tax above R200 has negative economic effects, but distributive effects are positive up to R200 (2003 Rands) lLTMS dynamic modelling – impact of escalating tax is economically positive, employment effects positive lVan Heerden et al – recycling revenue, e.g. food price subsidies, leads to a ‘triple dividend’ (reduce GHGs, grow economy and reduce poverty)

ERC Policy issues to be addressed lMore detailed investigation of the effectiveness of a carbon tax in reducing GHG emissions lTax-setting and adjusting mechanisms lEquity, distributional impacts and addressing poverty and development lCombining a tax with incentives and recycling of revenues lLegislative compatibility lTechnical and administrative viability, including the tax base and definitions of taxable events lCompetitiveness effects and a structured approach to energy-intensive exporting sectors lAdjoining policy areas

ERC 3 Key Issues: 1 – setting the tax level lProblem is to set the lowest tax level which will achieve policy aims, i.e. incentivise economic behaviour in such a way that emissions follow a desired emissions pathway lTherefore need to know cost of mitigation, but this is only know fully ex-post lA solution to this problem is to have an adjustment mechanism – set initial tax in accordance with expected response, then adjust if emissions stray outside of preset bands lCarbon price would react to emissions levels, as in a carbon market, premised on responsiveness of economy

ERC Tax adjustment mechanism

ERC 3 Key Issues: 2 – avoiding impacts on the poor lTwo impacts: lDirect impacts – more expensive energy carriers, especially electricity – households would use less and potentially shift to more harmful fuels. lIndirect impacts – structural effects, effect on services such as transport lImpacts best addressed by a) enhanced service delivery programmes (household energy policy, energy regulatory policy, transport) which have significant sustainable development benefits, and b) options for revenue recycling.

ERC 3 Key Issues: 3 – energy-intensive industries lProblem of current energy-intensive industries which compete internationally – in South Africa, very energy- inefficient – in some instances, unable to adjust to higher energy prices lSpecial dispensation is possible, but it should exclude ALL new investments (this may create barriers to entry, but less likely since industries are export-oriented) lPrice signal to consumers should be preserved lPossible solution: Swedish solution – existing energy- intensive industries can pay reduced tax or no tax in exchange for embarking on MRVd energy efficiency programme – can use international benchmarks lCriteria would have to be carefully developed to avoid exempting bulk of emissions

ERC Conclusion lA carbon tax would incentivise emissions reduction, but would require careful consideration of a number of key issues, including: lTax level and mechanisms lImpact on poor households lImpact on energy-intensive industries lIssues such as revenue-neutrality and revenue recycling have a significant impact on the broader effects of a carbon tax l‘partner programmes’ are important, will enhance the response of the economy, cut costs for firms, and offset negative impacts

ERC Thank you Energy Research Centre University of Cape Town