Combining price and quantity instruments: insights from South Africa

Abstract

A carbon tax will form the central carbon pricing instrument in South Africa. The country, however, is also in the process of setting specific short-term emissions limits at a subnational level. Additional mitigation policy instruments will thus be required to meet these targets. Although it is possible to combine sector-level quantity targets with a broad-based carbon tax, this article finds that this greatly complicates mitigation policy design, increasing both the information requirements and the likelihood of unintended consequences. The trade-offs between economic efficiency (optimized by the use of a broad-based price set by a carbon tax) and environmental effectiveness (optimized by using instruments that ensure emissions reduction targets are met) are ever present. A clear understanding of subnational quantity targets and an appreciation of the characteristics of the instruments to achieve such targets (quantity-based instruments, QBIs), the framework through which the instruments are combined, and their possible interactions, are required for effective policy making. Three possible frameworks for combining instruments are identified in the article, and some specific implications of interaction between particular QBIs and a carbon tax are suggested.

Policy relevance

This article explores the interaction of a carbon tax with mitigation policy instruments to meet subnational emissions targets in the South African context (where both a carbon tax and subnational emissions targets are currently being developed). As international negotiations progress towards countries accepting binding GHG emissions restrictions, quantity-based mitigation policy approaches become more important. In countries where a broad-based emissions trading scheme (ETS) is not feasible in the short to medium term, combining a broad-based carbon tax with subnational emission targets provides an alternative mechanism for achieving the economic efficiency and emissions certainty benefits derived from an ETS. This paper considers the mechanisms through which such a combination of instruments can be achieved. Three possible frameworks for combining instruments are identified, some specific implications of interaction between particular QBIs and a carbon tax are suggested, and guidelines and concept tools are presented to assist policy-makers in designing efficient and coherent mitigation policy.

Keywords:

• carbon tax
• economic efficiency
• environmental effectiveness
• mitigation
• policy formation
• policy instruments
• South African

Acknowledgements

The article is based on research undertaken for the South African Department of Environmental Affairs (DEA) and funding by Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH [contract number: 83115374]. The authors are grateful for inputs provided by the DEA and the Technical Working Group on Mitigation as part of the research. The authors also wish to thank Alex Constantinou and Yash Ramkolowan from DNA Economics who contributed to the original research.

Notes

1 Carbon pricing refers to the use of economic instruments to place a real cost on GHG emissions. A carbon price can be created through the use of a carbon tax or an emissions trading scheme (where firms need to purchases certificates equal to their GHG emissions).

2 The term ‘broad-based’ is used to denote the fact that a price is placed on most (or at least a very substantial) portion of national emissions. The term is thus used to distinguish broad, national (or at least multisectoral) policies or instruments from narrower policies or instruments that only relate to one (or at most a few) sectors or sources of emissions. Environmental levies that place a price on carbon only in a specific sector, for instance, do not create a broad-based carbon price.

3 In the event that firms are able to fully pass on cost increases, the carbon price signal that is transmitted downstream will consists of both the explicit carbon price and the implicit or shadow carbon price created by the cost of mitigation action.

4 If the implicit carbon price created by the green certificate scheme is lower than the carbon tax level, mitigation costs will not increase. However, emissions will also not be reduced, rendering the scheme redundant.