A carbon tax and cap and trade system have for goal to reduce greenhouse gas emissions
But how do governments use them in reality? How does the concept fit in the African context?

By Ashvin Ramasamy

Taxing to Protect The Environment…

Environmental taxes are any kind of tax applied to a base of goods and services that generate emissions harmful to the environment. Environmental taxes can be levied in four common bases: energy, pollution, transport and resources. A policy instrument at the core, environmental taxation helps reduce deleterious greenhouse gas emissions down to target levels. Per the Kyoto Protocol requirements, contracted parties must reduce GHG emissions by at least 18% by 2020.  From the perspective of implementation — like any other excise tax, it is rather straightforward with greater chance of achieving the intended outcomes. If left to market forces and personal choice, the results would less positive as businesses would prefer staying on course and consumers would be less inclined to adopt more responsible behaviour. When applied broadly to the economy, environmental taxation can truly hold sector polluters accountable for costs and promote sustainable choices across socioeconomic classes without necessarily slowing economic growth. The present review analyses carbon taxing and the cap-and-trade system as well as exploring opportunities for a cap-and-trade system within the new CFTA context.

Consider a hypothetical government piloting a “carbon tax” of 50 cents (USD) on gasoline prices, in nominal terms. The aim is to influence transportation mode behaviour, assess the GHG reductions, study whatever discernible impact on GDP growth as well as obtaining information on energy consumption shifts of high greenhouse gas emitting (GHG) industries. When deciding on how to spend the collected tax revenue, authorities have the option to invest in green infrastructure projects to support more GHG-reduction initiatives. Projects to “green” roadways, introduce new bike lanes and plant new trees, for example, can have a “success feeds success” effect, essentially a feedback loop on the overall success of environmental policy. As explained in the cases below this approach presents a robust method for furthering emission reductions. However, authorities can take a different approach, a sort of 1 to 1 system where each dollar collected is returned to the taxpayers. Acceptable measures include income tax cuts, tax breaks and lump sum rebates such that government does not pocket any of the tax collected — known as a pure revenue neutral tax regime. This is rather hard to achieve as governments inevitably “recycle” some of the income in other sectors and regions of its economy. From a political standpoint, either method can win public approval as long as spending is clear and consistent with promises. The inherent merits will not be discussed in this article; pros and cons of the corresponding regimes require a separate in-depth study of the economic effects and environmental impacts.

The Swedish Example

Take for example the Swedish carbon tax: a long-standing policy measure that did not inhibit GDP growth. Despite the country being well ahead in the first commitment period of Kyoto from 2008 to 2012, authorities pressed on for further GHG reduction goals. How did they get there in the first place? In 1991, the government introduced a fixed tax on gasoline consumption based on the tonnage of fossil fuel emissions emitted. It comprised a levy on energy usage and carbon emissions targeted to large fossil fuel users (e.g., industry) and small consumers alike (e.g., individuals). To help consumers adapt to increasing environmental costs of polluting and to limit financial shock, the government has been increasing the tax amount in a stepwise manner. In 2008, Swedes were paying 2.34/l SEK in tax at the pump. In 2009, the government introduced a 0.40/l SEK incremental increase on diesel over two years. In 2014 the tax rate had increased to 5.37/l SEK. All the while, the Swedish economy has been doing well, showing consistently high GDP growth rates from 1990 to 2016. This is a strong indicator that carbon emission does not have to go hand in hand with economic development.

The Carbon Market & Cap-and-Trade

Another accepted means by which to reduce CO2 emissions significantly is the cap-and-trade system. By putting a limit on the total amount of emissions allowed, the “cap”, firms pay fines for exceeding their limit. Although the allowances or permits are sold in an sort of “open market”, government authorities establish the cap levels by industry and sets penalties. Firms obtain an allowance of emissions through a permit sold or given by government, which also confers them the right to “trade” emissions. This incentivizes polluting industries to cut down emissions and exchange the surplus allowances for additional revenue. In addition, only a limited number of allowances are made available to the market. The emission levels stem from research and scientific evidence, most notably in the findings of the IPCC and through the requirements of multilateral agreements — such as the Kyoto Protocol. As the cap and trade system matures over time, governments lower the cap (measured in metric tons of CO2 emissions) to meet climate change goals. Energy-efficient firms can reap the reward of reduced pollution quicker and in turn allocate that capital elsewhere. One outstanding outcome that came out of cap-and-trade was the cost-effective elimination of acid rain through reduction of aerial sulfur dioxide emissions.

Progress in California

Capping and trading programmes have emerged in the past 10 years in several parts of the world and continue gaining traction. The US state of California is a prime example that has been delivering positive results consistently. Even with a legal battle that largely explained 98% of unsold carbon allowances in one 2016 auction, the state swiftly resolved the matter and at the same time prolonged the carbon market programme until 2030.

  1. In 2010, authorities set in motion the ambitious plan to reduce CO2 emission levels down to the 1990 amount. Without control, the projected levels would be 15% higher. The latest data indicates emission levels are below those of 1990 and are on track to beat the 1990 level — amounting to approximately 30% reduction
  2. The assumption that pollution goes hand in hand with development and growth has to be put to rest. Through the years of stringent greenhouse gas reduction measures California has seen growth in different economic activities, job creation, lower unemployment rate and heightened development in the clean energy sector.

Through its ambitious climate policy — that includes the cap and trade market — California has become a respected leader in climate protection. It compelled countries, provinces and other US states to join forces in cutting down CO2 emissions at the Paris Meeting on Climate Change in 2015. Moreover, California has been running a successful & extensive join carbon market system, with partners Quebec and Ontario.

Legislation Backdrop

Any excise tax or similar revenue-generation scheme requires strong bipartisan support and adequate debate over the characterization of that type of instrument, especially when a large portion of government spending is at stake. This was hard to overemphasize in the case of the California experience. California State Legislature requires a so-called supermajority to approve a bill for a new tax. The 2006 climate protection initiative (Assembly Bill 32) was supported by majority votes(Senate: 23 vs 14; House 47 vs 32) but was not subject to heavy debate whether cap and trade would be defined as a tax. That same initiative created provisions for a scoping plan in 2008 to reduce GHGs, part of which proposed a large cap and trade system. However, a legal challenge against the ruling Democratic government in 2017 — filed around the launch of the cap and trade program— backed by the private sector, put a dent in the otherwise high revenue auctions. The plaintiff contended that cap and trade effectively was a revenue-generation measure through the selling of allowances. Auctions of 2016 largely failed as businesses stood firm, seemingly putting on “no-shows” in the last three quarterly auctions. Eventually, Senate Bill 32 and Assembly Bill 398 garnered supermajority in mid-2017, with voting support from some Republicans, that effectively shielded government-sponsored cap and trade initiatives from legal challenge. The lesson here is manifold: bipartisan help is needed to satisfy interest groups siding with opposing political parties. While the text for the 2006 Bill 32 had the “teeth” for climate protection and was backed by reliable science, the nature of its policy instrument merited more discussion when the time came to enforce cap and trade regulations — given that AB 32 did not explicitly call for the sale of carbon allowances. By putting up allowances on auction, as well as creating a market for premium allowances (the ACPR option) at fixed prices, the practice can be construed as withholding a portion of the revenue as taxes and not administrative costs. That the government earmarked those revenues for spending on other government activities provided more evidence for a tax-based policy.

A Well Designed Carbon Pricing Scheme: Taxing, Cap And Trade & Regulatory Measures

  • 1 Relative to other available measures, carbon pricing is an effective tool to lower GHG emissions and does not put a massive dent in Gross Domestic Product growth. If revenue from targeted economic sectors can be returned in kind support, GDP growth projections for Canada are on par to a scenario without carbon pricing, an EcoFiscal study
  • 2 Introducing stringent regulations — touted as “command and control” measure in policy dialogue — should only come when the market is ready. That is, when low and zero emission technologies have become prominent and mainstreamed into markets and capital costs have gone down, especially for some costlier clean energy sources (such as the upfront cost of geothermal energy). When introducing a carbon pricing scheme, regulations should first take a backseat to emissions trading and carbon taxation but also act to support GHG-reduction measures. Specifically, regulation can be introduced in areas where cost is not a limiting factor to business growth or in niche, low-emission technologies to help level the competition field (e.g., like hydrogen fuels and electric vehicles).
  • 3 The success of a carbon tax or emissions trading initiative depends also on the behaviour of neighbouring states, as would be the case for African nations.  If other countries show reluctance in adopting a similar strategy, they suddenly become more attractive to firms. Complacency by others unfortunately carries the risk of leakage for adhering nations: high-polluting firms would relocate to countries with lax emission controls to avoid investing in emission-reducing technologies. New business costs and expenses incurred from putting a price on carbon emissions would have to be borne by the good or service. Ultimately, this pushes firms to trade substitution (for cheaper products) by seeking goods in countries with less stringent climate change controls. Arguably, a change in trade partners can also occur with local firms too — those not subject to the policy stand to make cost-saving purchases with international producers. To curb effect on domestic industries requires protectionist efforts such as levying imports from lax climate protection countries.

The Case for Africa: Preliminary Considerations

The successful outcome in California has been the creation of large funds for GHG emission-reduction. Concretely, government agencies institute programs to cut down greenhouse gas emissions and to drive environmentally responsible growth, protect natural resources and restore worn out land as well as building affordable housing for poor communities. The experience learned from California is built upon a framework of revenue recycling centred on benefits that African countries desperately need. Let’s aim for and go beyond the 22 signatories needed to breathe life in the CFTA deal — as well as ratification conducive to the needs of the deal — and push for carbon emissions trading scheme across Africa!