BRIEFING ZA IMPERATIVES FOR 2011 PRICING CARBON The case for an early start This Briefing Paper is the second in a series of six papers, commissioned by WWF-SA, and designed to facilitate deeper discussions around how to accelerate South Africa’s transformation towards a more sustainable and equitable economic future. This Pricing Carbon paper aims to summarise available thinking and research around the financial mechanism of putting a price on carbon as a tool that could reduce carbon emissions, and support local and international adaptation and mitigation efforts in response to climate change and unsustainable resource use. In a comparative analysis, the paper highlights the advantages and disadvantages of two carbon pricing mechanisms — cap-and-trade and a carbon tax. If designed and implemented effectively, such mechanisms have the potential to ensure that South Africa remains competitive and resilient throughout its transformation to a low-carbon economy. Authored by Roula Inglesi-Lotz & James N. Blignaut This paper is the second in a series of six briefing papers commissioned by the WWF-SA and is aimed at deepening the discussions needed to facilitate THE GREEN GROWTH SOUTH AFRICA The views expressed in this briefing paper are not those South Africa’s PROJECT IS FUNDED of WWF South Africa, nor the British High Commission, transformation to a BY THE BRITISH but are designed to stimulate debate. low carbon economy. HIGH COMMIssION. Green Growth South Africa Briefing Paper Series: Paper Two Imperatives for Pricing Carbon: the case for an early start 1. INTRODUCTION Putting a price on carbon, in economic financial mechanism this can be of jargon, is about internalising great value in reducing emissions, Contents externalities. It is recognition that the as well as supporting adaptation market price of a good or a service is and mitigation efforts locally and 1 Introduction 2 not inclusive of all relevant factors, internationally. Such interventions 2 Carbon emission reduction 3 such as external costs (e.g. pollution) could ensure that South Africa mechanisms and that these costs have to be remains competitive and resilient internalised. In a more formal sense throughout the transformation to a 2.1 Carbon Tax 3 the internalisation of externalities can low-carbon economy. 2.2 Cap-and-trade System 3 be defined as the “[i]ncorporation of There are two options for directly an externality into the market decision 2.3 Comparing the two options 5 pricing carbon, namely: making process through pricing or Structuring the intervention 6 regulatory interventions. In the narrow i) a carbon tax, and 3 sense, internalisation is achieved by ii) a cap-and-trade system. 4 Conclusion 7 charging polluters (for example) with While the two options operate in the damage costs of the pollution References 8 fundamentally different ways, a hybrid generated by them, in accordance with model is also possible. A suite of the polluter pays principle”1. market mechanisms could also include Putting a price on carbon is therefore indirect measures, such as tax rebates imperative to get the right pricing to subsidise cleaner technologies. Here signal so that the market can take an we discuss the advantages and the informed decision as to how much or challenges of the direct pricing options, how little it desires to buy of a specific as well as the perspectives of various good or service. Without intervention important stakeholders within South regarding externalities, market Africa on this matter. We also look at participants are therefore likely to the possibility of an early start in the make uninformed and hence wrong introduction of a price on carbon in choices based on wrong price signals. South Africa and how the different Pricing the carbon will protect the players might receive such an early market participants from distorted implementation. price signals and their effects. As a 2 Green Growth South Africa Briefing Paper Series: Paper Two Imperatives for Pricing Carbon: the case for an early start 2. CARBON EMISSION REDUCTION MECHANISMS 2.1 Carbon Tax Table 1: Revenue ReCyClInG optionS Revenue Recycling A carbon tax is a specific environmental tax that is levied on the • National adaptation fund volume of greenhouse gases, in most • National vehicle for financing renewable energy • Changes or exemptions in corporate taxes, income taxes and VAT cases dominated by CO2 emissions, which are released when combustion • Provision of subsidies for basic energy services occurs. This tax can either be levied on: • Increased social spending, e.g. education and health i) the volume of the raw material used • Inclusion of the revenue to the country’s general fiscus which has a known carbon content, e.g. the volume of coal used; determine who carries the burden ii) the actual emissions; or and who benefits from such a tax, i.e. 2.2 Cap-and-trade System iii) the end consumer for the volume of the distributional impacts of the tax. The main aim of a cap-and-trade the service purchased which has a Among other issues to be considered system is to decrease emissions of the carbon-intensive origin, e.g. on the are the following: economy in a cost-effective manner5, kWh of electricity used. • the collection point; by creating a market that puts a price on emissions6. Such a system has A carbon tax would need to be adjusted • the tax base; three main elements: i) the cap; ii) for various changes, such as inflation, • the variation or uniformity the tradable credits or allowances; technological progress and changes among sectors; and iii) the means for allocation and in emissions. This tax, therefore, has • the association with trade; distribution of allowances7. to be revised regularly and requires on-going monitoring and evaluation. • employment impacts; Under such a system, an institution “Inflation increases abatement • use of revenue; should take responsibility to costs, so to achieve a target emission • R&D policies; and implement, monitor and regulate the reduction the tax rate needs to be introduction and operation of the • the exact form of the mechanism adjusted for inflation. Fixed emissions system. This institution could be a (e.g. an emissions tax alone or charges in the transition economies government department or agency, an in conjunction with other policy of Eastern Europe, for example, energy-related institution such as the measures). have been significantly eroded by energy regulator, or a new institution the high inflation. Technological The one potential negative aspect mandated exclusively with the change generally has the opposite of carbon taxes is that they are, regulation of the cap-and-trade system. effect, reducing the cost of making by nature, regressive. This means Hereafter we refer to this institution as emissions reductions.”2 that they disproportionally affect “the regulator” irrespective of where it low-income groups. To counter this might be housed. The National Treasury of South Africa impact it is possible to design a tax supported the tax option through The regulator of the cap-and-trade recycling scheme whereby the tax its Medium-Term Budget Policy system would manage a process to revenue is deployed in favour of Statement3. Even though there is not a establish a total country-wide cap and low-income populations4. Hence, the comprehensive carbon tax policy yet, the allocation of the cap to the market recycling of the revenue is one of the the National Treasury has developed participants, for a specific time period. most important elements of a carbon a set of environmentally related This cap would be determined by a tax. Some tax recycling options are taxes and tax incentives. Prior to targeted reduction in emissions or other presented in Table 1. the full implementation of a carbon indicator, such as carbon intensity. tax, the energy policy authorities South Africa will also not be the first Alternatively, international standards in conjunction with the National country to introduce such a tax as can be used as a benchmark. Should Treasury have to consider many issues. various countries have already done so, the “cap” be perceived by participants The choice of the recycling and the or are in the process of implementing as unachievable, there might be strong type of tax are important issues that some or other form thereof (see Table 2). resistance to implement the system. 3 Green Growth South Africa Briefing Paper Series: Paper Two Imperatives for Pricing Carbon: the case for an early start However, if the “cap” is too low, most that emit less than the allowances they Table 2 summarises the most important participants will meet it easily and hold can sell their surplus to those global applications of cap-and- hence the system will not achieve any that emit more than their allowances trade systems. substantial change to the status quo. cover. The system, therefore, financially Key success factors of any cap-and- There are also questions on whether the rewards the participants that achieve trade system include the following:11 “cap” should differ for each sector or a the greatest emissions reductions. universal “cap” should be applied8. i) Ability to measure, report and Cap-and-trade systems are neither new evaluate the progress; Once a cap has been established, nor recent. The predecessors of the ii) Proper penalty system; the regulator either allocates or current cap-and-trade systems were sells permits, or “allowances”, to first used in the 1980s, as a method to iii) Transparency of the decisions, i.e. the selection of cap; the participants. The two leading curb local pollutants (SOx and NOx). methods for allowance distributions are grandfathering (allocation based Table 2: InTeRnationAl applicationS of cap-And-trade SystemS on historical/previous emissions of the sector or company) and auctioning Programme Year Place Targeted indicator directly to polluting companies which Leaded Gasoline Phasedown Program 1980s United States Gasoline could be applied to a limited portion US Clean Air Act Amendments 1990 United States SO2 and NO2 of total allowances.