Discounting climate change: when discount rates fail public policy

One of the central difficulties in attempting to avoid climate change is the long-term and multi-generational nature of the problem. The current generation is required to incur large investment costs today which will most likely only yield benefits for future generations. There is thus a tension between current and future interests. This presents a problem to decision makers as Cost-Benefit Analyses (CBA), used to make investment decisions between potential alternative mitigation projects, require the stream of future benefits and costs to be compared at their discounted present values. This necessitates the use of a discount rate, the choice of which has a significant impact on the kinds of projects that will seem justifiable to the current generation and thus what kind of world future generations inherit.

Behavioural economics and the South African carbon tax

The Draft Carbon Tax Bill released towards the end of last year outlined the design of a carbon tax to be implemented in 2017. Rather than a low and escalating carbon tax, as is often recommended in carbon tax literature, the Treasury proposed a complicated carbon tax structure with a headline carbon tax rate of R120/tCO2e and a number of discounts that significantly reduce the effective tax rate. Insights from the field of behavioural economics, however, suggest that there may be method to the Treasury’s seeming administrative madness.