Tax Policy and Carbon Emissions in South Africa

Noting that South Africa may be one of the few African countries that could contribute to mitigating climate change, we explore the impact of a carbon tax relative to alternative energy taxes on economic welfare. Using a disaggregate general-equilibrium model of the South African economy, we capture the structural characteristics of the energy sector, linking a supply mix that is heavily skewed towards coal to energy use by different sectors and hence their carbon content. We consider a “pure” carbon tax as well as various proxy taxes such as those on energy or energy-intensive sectors like transport and basic metals, all of which achieve the same level of carbon reduction. In general, the more targeted the tax to carbon emissions, the better the welfare results. If a carbon tax is feasible, it will have the least marginal cost of abatement by a substantial amount when compared to alternative tax instruments. Furthermore, the welfare losses from a tax on carbon are small regardless of the elasticity of substitution in production. If the revenue generated by the tax can be used to reduce pre-existing tax distortions, the net welfare cost becomes negligible. If a carbon tax is not feasible, a sales tax on energy inputs is the next best option. Moreover, labor market distortions such as labor market segmentation, or unemployment will likely dominate the welfare and equity implications of a carbon tax for South Africa. This being the case, if South Africa were able to remove some of the distortions in the labor market, the cost of carbon taxation would be negligible. In short, the discussion of carbon taxation in South Africa can focus on considerations other than the economic welfare costs, which are likely to be quite low.