Carbon tax on cars off to a bumpy start

The release of National Treasury’s carbon tax discussion document late last year raised carbon pricing higher on the economic agenda. The private sector is against a carbon tax, calling for an emissions trading scheme instead.
The government has repeatedly indicated a commitment to substantially reducing SA’s emissions profile over the long term. If not managed properly, this could come with significant adjustment costs. Continuing on our current emissions-intensive path is not an alternative. South African producers will soon be confronted by emissions-related trade barriers, diplomatic prejudice and changing consumer preferences in our main export markets. Long-term economic isolation will be a far worse outcome than living through a decade or two of adjustment. 
Policy intervention is required, and there is broad consensus internationally that economic policy instruments (carbon taxes or emissions trading schemes) are less costly to business than direct regulation. The debate has focused, we suggest erroneously, on the attractiveness of taxes versus emissions trading. 
Surprisingly perhaps, from a theoretical perspective, the two instruments are actually very similar. It is a fallacy to think that a trading scheme is equivalent to a carrot while a carbon tax is a stick. Full auctioning of permits under a trading scheme essentially imposes a cost on producers akin to a carbon tax. And a low and escalating tax, as proposed by Treasury, is almost identical in effect to a “grandfathered” trading scheme (in which a set number of emissions permits is allocated free to participants based on their historical emissions) that moves to full auctioning over time.
A number of commentators have claimed a carbon tax may end up being little more than a revenue-raising tool for the government. In reality, however, the revenue profile of a low and escalating carbon tax will closely match that of a trading scheme that moves from full grandfathering to full auctioning over time. Opting for a trading scheme over a carbon tax is thus no guarantee that carbon pricing won’t be used as a revenue- raising tool, since the revenues from auctioning permits also accrue to the fiscus.
Taxes and trading can be equally painful for business. The real issue is not which option is chosen, but rather that the government designs carbon-pricing policy instruments to best support business to become more carbon-efficient and remain competitive in a low-carbon future. 
In SA, greenhouse gas emissions are concentrated in a small number of firms. This precludes the effective functioning of an emissions trading scheme that is market based since market power will be highly concentrated. Thus, by default, it is likely that the mainstay of SA’s mitigation policy suite will look more like a tax than a trading scheme for the near future. 
Given this context, business should focus is efforts on working with the government to design a pricing instrument that incentivises the private sector to increase its carbon efficiency as quickly as possible. To get there, business and the government need to acknowledge the particular nature of the local economy and seek to create a policy environment that is conducive to new investment – that will increase the overall carbon effectiveness of the economy rather than “weeding out” particularly carbon-intensive sectors; that rewards early action by firms; and that allows firms the flexibility to come up with innovative solutions. Surely these are principles to which both business and the government can subscribe.
Importantly, the Treasury also needs to be realistic about what can be achieved through carbon pricing, and within what time frame. The practical implementation of a carbon price in SA is complicated by many factors, including the uncompetitive nature of our energy sector; existing structural rigidities in factor markets; “lumpy” abatement options in many sectors; and the concentration of abatement options in upstream and uncompetitive markets. 
Socioeconomic factors also complicate the equation. Any new policy must make a positive contribution to job creation and poverty reduction in the long term. 
It is clearly in the interests of business to collaborate in the design of a sustainable and inclusive mitigation policy that enables firms to remain competitive and also facilitates new investment in low-carbon sectors. In SA, such a policy will inevitably involve some form of carbon pricing instrument.
This blog post is a reproduction of an opinion piece co-written by Brent Cloete, who heads DNA Economics’ Climate Change Practice. Tyler is an independent climate economist. Fakir is with WWF-South Africa.  The original opinion piece can be found in the Business Day.