Plan assesses effect of carbon tax on emissions
The Treasury published a carbon tax modelling report, Modelling the Impact on SA’s Economy of Introducing a Carbon Tax, on Thursday. The report provides an assessment of the effects of the proposed carbon tax policy on reducing greenhouse gas emissions, economic growth, employment, and industry competitiveness.
The study was conducted on behalf of the Treasury under the Partnership for Market Readiness initiative administered by the World Bank, aimed at supporting countries in strengthening their policy analysis and technical capacity to implement carbon pricing measures.
It closely models the design features of the tax as outlined in the 2013 carbon tax policy paper. The design aims to contribute to a meaningful and permanent reduction in greenhouse emissions, and to minimise adverse effects on low-income households and industrial competitiveness.
The provision of tax-free emissions thresholds and allowances ranging from 60% to 95% will result in a relatively modest carbon tax rate ranging from R6 to R48 a tonne CO²eq during the first phase of the carbon tax up to the end of 2020.
The modelling results suggest the carbon tax will have a significant effect on reducing SA’s greenhouse gas emissions and will lead to an estimated decrease in emissions of 13%-14.5% by 2025 and 26%-33% by 2035 compared with a business-as-usual approach.
The carbon tax will make an important contribution to reaching SA’s Nationally Determined Contribution (NDC) commitments under the recently ratified Paris Agreement for emissions to peak in 2020 to 2025, plateau for a 10-year period from 2025 to 2035 and decline thereafter.
The carbon tax will also ensure that emissions reductions are delivered while sustained economic growth is realised. It is expected to lead to a reduction in the annual average growth rate of the economy of just 0.05 to 0.15 percentage points compared to business-as-usual.
Sensitivity analysis shows that the carbon tax would have a similar modest effect even if the economy grows less quickly than expected.
The study uses the University of Pretoria’s general equilibrium model, which provides a quantitative description of the economy, and accounts for linkages and interactions between the sectors and agents within the economy.
The model was modified to allow for detailed analysis of the effects of the carbon tax on the electricity generation mix and greenhouse gas emissions.
The analysis relies on a comparison between a baseline scenario and different policy scenarios informed by the tax design.
The baseline scenario specifies how the economy is expected to evolve without the introduction of the tax or other regulatory interventions.
This is then compared to the expected change in the economy when a specific carbon tax design and revenue recycling measure is introduced. The difference between the baseline and various policy scenarios provides an assessment of the effect of the policy intervention on the economy.
Two baseline scenarios were considered:
• The main baseline scenario assumed average annual GDP growth of 3.5% from 2016 to 2035, constant inflation of 5.5% and population growth of 1%;
• The alternative baseline scenario assumed average annual GDP growth of 2.4% from 2018 to 2035.
No explicit assumptions were made regarding future improvements in efficiency and cost competitiveness of clean technologies relative to fossil-fuel-based sources in the electricity generation mix.
The ratio of each electricity generation technology relative to total electricity generation remains fixed in the baseline relative to 2014 values to isolate and measure the effect of the carbon tax more accurately.
The modelling analysis considers four different tax designs (T) in combination with five possible recycling schemes (R).
The main difference in the tax policy scenarios is the inclusion of the agriculture and waste sector and adjustments in the level of the tax-free allowances post-2020.
The revenue recycling scenarios comprise broad, output-based recycling, broad or selective reductions in the VAT rate and targeted support for the renewable energy sector. For the revenue recycling scenarios, it is assumed that the revenues from the carbon tax are recycled such that the government deficit remains unchanged, that is the revenues are rechannelled into the economy.
Due to technical reasons, some of the design features of the tax, including the opportunity to use carbon offsets for some proportion of the liability, allowances for participation in the carbon budget process and the performance (z-factor) allowance could not be modelled. This might suggest that the initial effect of the carbon tax might be muted, greenhouse gas emission reductions might be slightly less and impact on economic growth might be lower.
Any negative effect from climate change and unabated emissions or benefits from reducing greenhouse gas emissions and co-benefits such as lower levels of local air pollution has not been factored into the modelling. Therefore, the model analysis and results are likely to underestimate the benefits of the carbon tax policy and should not be viewed as an assessment of the overall impact of introducing a carbon tax in SA.
In the T2R1 scenario, referred to as the "focus" scenario, the tax-free allowances, as laid out in the proposed design of the tax, are gradually removed at a rate of 10 percentage points per annum for all sectors except agriculture and waste, and revenues are recycled through a rebate to all firms proportional to their output.
The other revenue recycling scenarios, including reductions in the VAT rate and "narrow" recycling measures to a small number of sectors are not as effective at offsetting the effect of the tax on economic activity.
The simulations suggest that the introduction of a carbon tax will contribute significantly to SA’s greenhouse gas emissions reduction goals. The analysis shows the estimated reductions of 33% by 2035 compared with business as usual.
The economy will continue to grow while emissions are reduced. The modelling results estimate that a carbon tax will reduce the economy’s average annual growth rate by only 0.15 percentage points.
The carbon tax also has a small effect on other macroeconomic aggregates such as employment, consumption and real wages. In the focus scenario, the annual growth rate in household consumption falls by 0.23 percentage points, employment falls by 0.07 percentage points, and real wages fall by 0.2 percentage points.
Simulation results suggest that concerns over the competitiveness effects of the carbon tax are overstated as exports could be 3.5% higher in 2035 with the introduction of the carbon tax. This is driven by sectors such as transport equipment, electrical machinery, and textiles and footwear sectors that are expected to experience increases in the annual growth rate of exports of around 7% as a result of the carbon tax plus revenue recycling.
wINNERS AND LOSERS
There will be a number of important sectoral winners and losers from the carbon tax and these are consistent with the objective of the carbon tax of promoting structural change
In 2035, their exports are likely to be around 30%-40% higher than in the baseline.
However, certain sectors are projected to experience declines in exports including the coke-oven and iron and steel sectors, although in the latter case the sector’s exports continue to grow over the period to 2035, just at a lower rate than if there were no carbon tax.
There will be a number of important sectoral winners and losers from the carbon tax and these are consistent with the objective of the carbon tax of promoting structural change.
In 2035, the output from the nuclear, wind, hydro, gas and solar photovoltaic power generation sectors is expected to be more than 200% greater than without a carbon tax.
These low-carbon sources of power will become much more cost competitive with a carbon tax. Coal generation becomes less cost competitive with its output expected to be 46% lower in 2035 than it would be without the tax.
Other sectors that could experience a decline in output relative to the baseline include petroleum refining, other manufacturing, coke production and the electricity supply sector.
However, it is a relative decline in output compared with the situation in which there is no carbon tax.
All of these sectors are projected to grow in absolute terms by between 18% (coal generation) and 105% (other manufacturing) over the period 2014 to 2035 even with a carbon tax.
The method of revenue recycling was found to be an important driver of the results.
The analysis shows that a carbon tax with persistent tax-free allowances will yield substantially lower emissions reductions, but also have a smaller negative effect on growth in GDP.
The analysis suggests that broad, production-based recycling such as the producer-focused rebates is likely to yield smaller effects on GDP but also less significant emissions reductions, while a narrow, clean-energy-focused support will lead to substantial emissions decreases but a lower growth rate for the economy.
The current design of the carbon tax includes elements of broad-based support measures (an electricity-generation levy credit) and ones targeted for low-income households.
The common key finding of all the modelling studies conducted to date on the carbon tax is that the introduction of a carbon tax will contribute significantly to SA’s greenhouse gas emissions reduction goals and will only have a modest negative effect on economic growth and other macroeconomic aggregates such as employment, consumption and real wages over the medium term.
The ratification of the 2015 Paris Agreement emphasises the reality that we will have to prepare to operate in a carbon-constrained economy over the medium to long term. A business-as-usual scenario is no longer an option and we must take appropriate and proactive actions to help transition our economy onto a low carbon growth path as articulated in the National Development Plan.
The carbon tax, together with the carbon offsets, is an important and cost-effective instrument, as part of a package of measures, to nudge our economy onto a more sustainable growth path in a just way.
• Morden is the chief director for economic tax analysis at the Treasury