By Graham Terry CA(SA), SAICA
Whilst this is a fairly new debate in South Africa, it has in fact been raging in Europe and North America for almost two decades. Indeed if you Google this question you will receive over 25000 responses.
For me the encouraging aspect is that the debate is taking place. It means that many people have now acknowledged that global warming and climate change are happening and something drastic needs to be done to minimise the threat. People may argue about timelines and approaches, but they have passed go and are at least thinking about potential solutions.
Clearly there is no easy answer to this question; otherwise there would be no debate. Indeed experts worldwide can construct very compelling arguments supporting each approach. This article summarises some of the issues involved in the debate. It is not meant to be a comprehensive look at the issues. Its purpose is rather to put the issue on the table and to encourage debate.
Before we engage in the arguments let us look at where we want to get to or perhaps more accurately what kind of lifestyle we want our children and grandchildren to enjoy in the latter part of this century. I have no doubt that the answer will be that we want them to be able to experience all the benefits of our lifestyle and more if possible. If so, then the route humankind must choose has to be scrupulously efficient and effective. We can’t afford to make a mistake and err on the side of leniency. The solution is simple: it lies in limiting the amount of greenhouse gases (GHGs) and in particular CO2 released into the atmosphere. The question is how can this be done?
Some may argue that this question is too complex for the layman to tackle and we should leave it to the experts, whoever they may be, since this issue cuts across many disciplines. Clearly the experts do need to be involved in the debate. They understand the technicalities better than the layman and they need to provide guidance, but that does not mean that they will be any better at making the decision. Undeniably the issue will greatly influence all of or lives in the future. Therefore we do need to be involved and understand the implications. We also need to remove emotion and prejudices that we harbour from the debate. None of us like paying tax, but maybe that is a better solution. At the end of the day the mechanism chosen is only a means to get to the real solution which is of course to drastically reduce GHG emissions.
Why should the Chartered Accountancy profession get involved? If Chartered Accountants are true leaders in the community and in business then they have a extremely important role to play in fighting the biggest threat that has ever faced humankind. SAICA has a responsibility to inform its members about the various global warming issues and to provide forums for debate so that its members can engage in intelligent debate and take on leadership roles in their organisations. One of the key issues is the debate: whether to tax carbon or engage in a cap-and-trade strategy.
South Africa is a relatively small country yet it ranks 12th in terms of absolute carbon emissions and about 15th on a per capita basis. Globally, a substantial proportion of GHGs result from the burning of fossil fuels derived from coal, natural gas and oil. Land degradation and change of land use also contributes large amounts. Most of South Africa’s GHG emissions arise out of the burning of fossil fuels. The principal offender is Eskom which generates most of South Africa’s electricity using cheap coal-fired power stations. Of course as we have discovered, the term ‘cheap’ is relative especially if you don’t take all costs into account. Therefore we have been living in a fool’s paradise and now we have to pay the bill. Transport is another large contributor of GHGs in South Africa and this is mainly through oil based fuels.
It is easy to blame Eskom for South Africa’s plight, but we have some very large consumers of power in the country. Cement manufacture and aluminium smelting are two huge consumers. Mining and industry also consume large amounts as do householders. The easy answer would be to convert all power stations to run on alternative fuels and to get all transport to run on bio-fuels. Of course, that can’t happen or at least not in the short-term. The problem is that the world does not have much time to get its house in order and significant cut backs of GHG emissions have to happen in the short-term to limit the serious threats of global warming.
South Africa has no punitive obligations in terms of the Kyoto Protocol, the international agreement designed force global reductions in GHG emissions. However the second phase of the agreement is currently being negotiated and along with Brazil, India, China and Mexico, South Africa is a key country that is being targeted to make significant contributions in the next round. There is no doubt that South Africa will have to reduce its emissions substantially over the next few decades. Those reductions can only be achieved through switching to cleaner fuels, which as we have established, is an option that has limited feasibility, consuming less power and fuel or improving the efficiency of industrial processes. The only practical route is to follow a combination of these strategies.
How does the country meet its international commitments in regard to emissions? The government could urge everyone to consume less fuel and power and urge business to improve technologies to reduce GHG emissions, but it would have no control over the process and targets are unlikely to be achieved. Government therefore has to take a more effective approach which will allow it to meet international expectations and more importantly help to avoid a global warming disaster.
Both carbon taxation and cap-and-trade systems are essentially methods of carbon pricing, which is based on the principle that the external costs associated with emissions should be included in market costs and prices. Clearly all mitigation costs will ultimately be borne by consumers through higher prices. However these strategies are likely to lead to improved productivity stimulated by rising prices and changing behavior. This should reduce the impact. Indeed new technologies coupled with changing consumer patterns may even eliminate the cost increases. Cap-and-trade systems set the quantity of emissions and let the market determine the price, through trading or auctions, whist carbon taxes affect the price and let the market determine the quantity of emissions.
Cap-and-trade
Under this approach the government establishes an overall cap on the on the level of CO2 emissions the economy would be permitted to put into the atmosphere by a determined date. Over time this cap would be lowered. For example government may begin by setting the first target as reducing GHG emissions to 1990s levels by 2015. Thereafter this may be lowered to say 80% of 1990 emissions by 2020.
Each business would receive a tradable allowance or quota either through a permit issued or through auction. The most likely approach would be to receive a quota based on past emissions and adjusted downwards to meet the target. The total of these allowances would equal the maximum emissions the country had agreed to cap at. Businesses would have to put in place efficiency programmes to reduce emissions to permitted levels. Those companies that do not need all their allowance would sell any surplus not utilised to entities that cannot meet their emission allowances. The price would be a factor of demand and supply. The cap-and-trade system was used in the USA to fight the acid rain problem in the 1980s and 1990s and worked very effectively.
How the allowances are distributed is not a simple exercise and it can become a major political issue. Initially, the worst polluters are likely to receive the largest allowances as happened in the European trading system. There is therefore an element of redistribution in the model, as intensive emitters would effectively have to pay low emitters in order to emit more than their allocated share. Such schemes are probably necessary in order to achieve the sustainability objective, but they can be controversial.
Supporters of the cap-and-trade approach argue that whilst a tax offers cost certainty, a cap-and-trade system offers environmental certainty and that is vitally important. The cap is fixed by government at a level determined by scientists which they believe will allow humankind to avoid the dangers of global warming and climate change. They argue that the danger with a carbon tax is that wealthy organisations will simply pay the tax and carry on as normal. They cite the petrol price as an example. Many countries do have emissions taxes built into the price of petrol, yet people continue to buy 4*4s and other large vehicles that are not fuel efficient. Even with the recent high fuel prices, few people swapped their vehicles for more economical models. The result, supporters of the cap-and-trade approach suggest is that the national targets will not be met.
It is argued that the cap-and-trade approach provides government with greater flexibility especially at the introduction stage. To ease transition for utilities and businesses that are heavily dependent upon coal and therefore hardest hit by these measures, government could build phasing-in provisions into the model to allow these entities to adapt.
Experts assert that for the cap-and-trade approach to be effective, the cost of carbon needs to be pitched at a reasonable market price. They suggest the price should be at least US$30 dollars per ton of CO2 emissions so that there is sufficient incentive for sellers to see it is worth their while to sell allowances and for buyers to feel the pain of not meeting their targets. Of course the price would be determined under market conditions.
Carbon tax
Proponents of the carbon tax approach advocate that it is a simpler, more efficient and easier to calculate than the cap-and-trade system. In addition it would cut across the whole economy yet it could be adapted to ease the burden on strategic industries. It is argued that the cap-and-trade approach is extremely complicated and as such it would invite industries to lobby for exceptions in many different aspects of implementation. Commentators suggest that it is more difficult to police the cap-and-trade system and therefore it is easier to cheat. Carbon tax on the other hand is easier to administer.
Carbon tax supporters believe that the cap-and-trade approach is really a form of tax, but it pretends not to be. They argue for best results people on the ground should understand how the system works and how their position affects the situation relative to others. They should also understand how their share is calculated. The cap-and-trade system tries to hide the pain, which they suggest is not healthy. They argue that serious action is needed to change behaviour and people will respond only if they understand the implications and feel the pain through an appropriate penalty. Only then will they change behaviour and put in place the necessary efficiencies.
In the USA detractors have argued that carbon taxes will make US exports uncompetitive as they will be competing against countries that do not have similar tax structures. Others argue that the opposite occurs, citing Denmark as an example, where innovators have not only designed competitive products, but have developed new markets for the new products.
Conclusion
Of course both approaches are likely to result in higher energy prices especially those derived from fossil fuels. By raising prices it is hoped that energy consumption will reduced significantly and consumers will seek more efficient production processes. Similarly owners of domestic transport will be encouraged to purchase more efficient cars and use cleaner fuels.
Because the objective is to change behaviour both systems are going to raise equity issues, which are not going to be simple to resolve.
Both approaches pose a degree of uncertainly. With a carbon tax we would know the price but we would not have a accurate idea of the amount of emissions that will be saved. The cap-and-trade approach allows government to determine the level of emissions, but the price of carbon will be determined by the market.
The two approaches are of course not mutually exclusive. It is possible to have a combination of the two. For example the industry may be subject to a cap-and trade-system and certain products could be subject to a carbon tax.
This is an interesting debate, but also a critical debate, one which will affect our lives and the lives of our children and grandchildren. As a leadership institute, SAICA should be stimulating the debate on such an important topic. There is probably no right answer. At the end of the day we need to make sure that all the different angles and aspects are considered before the country embarks on a course.