In South Africa, there is considerable ambiguity and debate about the implications of tax distortions in the economy and the tax interaction effects arising from the carbon tax. There have been attempts at modelling this and, depending on one’s assumptions, the results can often be ambiguous – it all depends on what we also know of what goes on in various sectors that are high emitting or those outside these sectors.

What we do know is that prices have an effect – this is evident from the way increased electricity prices have shifted behaviour in electricity demand and management of production.

The National Treasury (as indicated in a public presentation in 2011) examined the economic impacts of introducing a carbon tax on the country. It assessed the impact of implementing a carbon tax in the country using five primary criteria: emissions, sector performance and competitiveness, employ- ment and investment, income inequality and economic activity. It then assessed how the different uses of the carbon tax revenues affect the outcomes.

In that presentation, the National Treasury concluded that the overall impact of a carbon tax would depend largely on how government recycles the carbon revenues as well as the availability and affordability of greener technologies. It pointed out that the latter would be difficult, unless government took comprehensive measures to remove the fundamental barriers to investment in low-carbon technologies.

The National Treasury further concluded that the overall impact on output when revenues were recycled through decreasing other direct or indirect taxes would be “small negative”. If carbon tax revenues were used to reduce the VAT rate, the carbon tax would lead to a small negative impact on gross domestic product (GDP) equivalent to yearly growth declines of 0.005 percentage points, or 0.18%, by 2035.

It also concluded that recycling revenue by increasing government savings and investment would have large positive gains. Using the revenues to increase transfers to households would marginally reduce inequality but would result in a small net reduction in GDP, as most of the additional revenues would be consumed. However, the analysis by National Treasury was based on a carbon tax imposed upstream on fossil fuels. More modelling is needed on Scope 2 emissions – where sources of carbon emissions are not direct.

In terms of revenue recycling, the National Treasury considered a uniform reduction in indirect sales tax rates, a reduction in corporate taxes imposed on the capital earnings of domestic enterprises and the scaling up of existing social transfer programmes. While the first scenario is distribution neutral, the second favours economic growth and higher-income households, with the welfare of most of the population deteriorating. The third option improves the welfare of low-income households, but leads to larger declines in national income.

It assumes that future electricity production would follow the revised baseline scenario defined in the Industrial Resource Plan and, therefore, any remaining emissions reductions would need to occur outside the electricity sector. It uses the revised baseline scenario or policy-adjusted scenario as the reference scenario for evaluating the effects of carbon taxes on reducing the remaining emissions. However, government’s proposal for the carbon tax, as outlined in the 2012 Budget, does not exempt the electricity sector from the tax.
There is evidence that could either con- firm or disprove the impact of the carbon tax in South Africa, particularly given the complex linkages between formal and informal sectors of the economy. While the studies outlined above are comprehensive and rigorous, their conclusions may not be directly transferable to government’s carbon tax proposals.

This difficulty is compounded by the fact that the current proposals for a carbon tax, as developed by government, have no discussions on the type of revenue recycling that would be suitable for South Africa’s socioeconomic circumstances. The recycling mechanisms would also have to be efficient in their targeting and administration. The National Treasury has so far tried to maintain a clear separation of the revenue and expendi- ture sides of the Budget, the argument being that full earmarking is not in line with sound fiscal management practices.

However, given the evidence that recycling revenues from the carbon tax have the potential to yield a double dividend, there is a clear need to consider the option of revenue recycling in the context of the carbon tax. Two things are important in this context. Firstly, there is a need to discuss the revenue recycling options that would be relevant for South Africa. This is of importance because different options would have different outcomes in terms of welfare and the extent to which the impacts of the tax are offset.

Some studies have demonstrated that the adverse employment and investment effects of the carbon tax will not be fully offset by using the revenues to reduce other taxes, such as taxes on personal and corporate income. And yet others demon- strate in the context of the US that use of one-half of the carbon tax revenue towards an investment tax credit leads to lower welfare in early years but then the added investment begins to offset the carbon tax cost, leading to positive effects on economic welfare.

For South Africa, there are two basic revenue recycling policy options, namely revenue recycling that leads to higher social welfare in the short term by stimulating higher consumption and benefiting those that are immediately and most affected by the tax and options that yield low social welfare gains in the short term but provide greater social welfare benefits in later years. The former may be attractive, given the current economic conditions. But the latter may be more attractive from the point of view of long-term efficiency and welfare gains because it allows the country to be locked out of the current system of fossil dependence.