Home CPD ANALYSIS: Evaluating the Carbon Tax Policy Paper

ANALYSIS: Evaluating the Carbon Tax Policy Paper

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South Africa’s innovative carbon tax structure wins global favour.

A lot has been said about the introduction of a carbon tax to the South African economy. It is difficult to maintain a clear head amidst all the noise, so one needs to go back to the fundamentals from time to time.

This article takes a step back and looks at the principles. Most taxes are, fundamentally, a penalty for doing something good. A carbon tax is a penalty for doing something bad. Making profit is good for the economy, yet the businessman making the profit is penalised with corporate taxes. Emitting greenhouse gases is bad for the economy, so a carbon tax will penalise a bad action.

Most of the comments made regarding carbon taxing argue that the tax will be bad for the economy. Most of these comments are good arguments against additional taxes in the economy, and very few are against a carbon tax per se. A more reasonable approach is to argue that carbon tax should be introduced on a revenue neutral basis.

The arguments against additional taxes should be framed as arguments against an increase in the tax burden, rather than arguments against moving the tax base from penalising the good to penalising the bad.

Estimated nominal carbon tax prices and Emission Trading Scheme (ETS) prices in 2015 – Click here to view the graph

Any changes in the tax system will have distributional effects. It is the task of National Treasury to assess and manage these effects to prevent damage to our domestic economy. The same is true with the introduction of carbon tax. In this effort, the purposes of introducing the tax must be kept in mind. The dual purpose of the South African carbon tax is to align our economy with trends in the global economy and to stimulate behaviour change. This is necessary to accelerate transformation to a green economy.

Alignment with international developments is the major driver-much more so than any moral argument to fight climate change. Climate change is an accepted fact in the global economy and all major players are gearing up for a low-carbon world economy. If South Africa does not participate in this trend, it will have a detrimental impact on the international competitive position of the South African economy.

Analysis shows that by 2015, 71% of global GDP will be generated in jurisdictions that have priced carbon into the economy, either through carbon taxes or through a cap-and-trade scheme. If we look at South Africa’s trading partners, we see that, by 2015, only 15% of South Africa’s international trade will be with countries that have not priced carbon into their economies in some way.

It is ancient wisdom that the medicine must not kill the patient. As with most medicines, the introduction of a carbon tax into an economy has the potential to kill the patient. The risk management lies in the devilish details, and National Treasury has provided excellent mechanisms to safeguard the health of the South African economy in the transition to a low carbon economy. At this point we need to take a step back and have a look at the details of the proposed tax regime to analyse how the potential impacts on the economy will pan out.

The tax proposal effectively provides for two levels of carbon pricing. The first is the ABSOLUTE price of carbon. This is set at R120 per ton of carbon dioxide equivalent (CO2-eq) in 2015 and escalates at 10% per year up to 2020. The other is the EFFECTIVE price of carbon. This is the average price an enterprise will pay for its emissions, taking the tax-free threshold and relief measures into consideration. The default situation is that companies will have 60% of their emissions tax-free and pay only on emissions above this threshold.

This means that in default situations companies will pay R120 per ton on 40% of their emissions, resulting in an effective price of R48 per ton. This effective price can further be reduced through relief measures and additional tax-free allowances for companies exposed to international trade or companies with high levels of embedded process emissions. Provision is also made to compensate companies that increase their efficiencies relative to their peers through the application of a ‘Z-Factor’.

The utilisation of offset opportunities will give taxpayers access to least-cost mitigation options. Some perspective on the potential impact of the carbon tax can be gained by looking at relative values. The absolute price of carbon in 2015 will be R120 per ton, while the effective price will range between R12 per ton for companies with high levels of access to the relief measures and R48 per ton for companies with no access to relief measures.

The value of the non-renewable levy on the Eskom electricity tariff currently stands at an equivalent of R35 per ton. We estimate that Eskom paid approximately R7,5 billion in VAT in the 2012 financial year. If the generation of electricity is made VAT exempt, this will equate to between R30 and R35 per ton of carbon emitted in the generation of electricity.

The structuring of the carbon tax with an absolute and effective carbon price allows it to manage the conflicting requirements placed on the system. The two conflicting requirements are to have a carbon price high enough to effectively change behaviour and the need to have a carbon price low enough to not impact negatively on the international competitiveness of the South African economy.

The high level absolute price of carbon will stimulate behaviour change as it impacts directly on the relief measures, the Z-Factor and the economic viability of offset projects. The low value of the effective price of carbon will, however, protect South African economic competitiveness.

Another set of conflicts in the design considerations of the tax system is the disconnect between industry’s need to have visibility of a long-term price path and the need to align carbon pricing with international developments. Much can be learned from the European Union Emission Trading Scheme (EU ETS) in this respect.

The price of carbon in this scheme is currently very low. This benefits industry, but the price is too low to be effective in stimulating the low carbon investments required to restructure the economy to a low-carbon trajectory. The proposed South African carbon tax will overcome the risk of falling in this trap as the absolute price will not be determined by the market as in Europe, but will rather be set by National Treasury.

South African industry will therefore have a long-term view on the absolute price of carbon, the component that is required to make investment decisions in offset projects. Alignment with the level of carbon pricing in the international economy will happen through managing the effective price of carbon through the level of, and access to, the relief mechanisms in different industries and markets. The structure of the proposed tax provides for all the requirements of the introduction of the carbon tax. Some modifications can, however, be made to the details in order to better achieve the country’s national objective.

The first area of refinement is to give visibility to the efforts made to make the carbon tax revenue neutral. Some potential actions in this respect are making power generation VAT exempt and the utilisation of international funding to drive the current renewable energy independent power producer (REIPP) programme.

The recommendation to make power generation VAT exempt comes from the National Energy Regulator’s (NERSA’s) ‘Reason for Decision’ for the Eskom tariff application (MYPD3). It is estimated that Eskom’s VAT payments in 2012 represented an equivalent of between R30 and R35 per ton of carbon. If this benefit is passed through to the buyers of electricity, it will offset a large portion of the effective price of carbon, which will be between R12 and R48 per ton.

In another area of improvement, Eskom should utilise international funding for the REIPP programme. Although the documents published by NERSA do not give a clear indication of the impact of the REIPP on the electricity tariff, we estimate it to escalate between R30 and R60 per ton over the next few years. NERSA recommended that this component of the electricity tariff be removed. If international funding linked to South Africa’s emission reduction pledge is channelled to the REIPP programme, it can also offset the cost of carbon in the proposed carbon tax.

The utilisation of carbon offsets in a tax system is a unique South African innovation that has earned the country recognition and praise from a large variety of carbon market institutions and professionals in the international arena. It is recognised that this innovation can be a powerful tool in achieving the ultimate objective of any carbon pricing scheme – to change the behaviour of companies and move the economy onto a low carbon trajectory.

Its strongest attribute is in giving companies access to least-cost mitigation options. This allows investors to spend money on greenhouse gas mitigation projects in the area where they get the biggest bang for their buck.

Author: Robbie Louw, BCom (Hons) (Economics), BSc(Engineering), is the Director, Promethium Carbon.

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