A general equilibrium analysis of the effects of carbon tax policy on South Africa's agricultural industries

Abstract

The South African government has committed under the Paris Agreement to mitigate the growing emissions by 42 percent below the business-as-usual scenario in 2025. A carbon tax is one of the policy tools used to mitigate emissions. The carbon tax will be introduced at one hundred and twenty rands per ton of carbon dioxide equivalent (R120/tCO2-eq). The National Treasury released a carbon tax draft bill in December 2017, which contains policy features such as higher tax-free allowances intended to minimise the tax impact on agriculture and other industries. From the literature, it was deduced that the impacts of the tax have not been assessed, particularly on individual agricultural and food industries in the county. To examine the effects, a modified version of the dynamic University of Pretoria General Equilibrium Model (UPGEM) was used, which has the same theoretical structure as the MONASH-style model. Four important changes were made to the standard UPGEM, which are the creation of a database with disaggregated agriculture and food industries, additional equations to allow environmental enhancements analysis, account for technology improvements in the baseline of the non-coal electricity, and estimation of new trade elasticities for the individual agriculture and food products for use in the modified UPGEM model. After the four modifications, the effects of the carbon tax on agriculture and other industries were tested under three sets of assumptions represented by three policy scenarios. The first scenario measured the impact of policy features prescribed in the carbon tax bill, whereas the second and third scenarios tested the effects of removing the tax-free allowances and not recycling the tax revenue back into the economy, respectively. All three policy scenarios were simulated and interpreted against the baseline scenario. The simulation results show that one the carbon tax, the country’s emissions would reduce by 33 percent below the baseline over the next 20 years. However, carbon tax implementation also leads to a welfare loss of approximately -0.91 percent below the baseline by 2035, driven by a contraction in aggregate employment and investments. The results suggest that the South African economy will incur some adjustment costs as the country transforms into a low-carbon economy. The sectoral results indicate that heavy emitting industries such as coal electricity, steel, metal, petroleum, and transport services will be significantly affected, with output declining by an average of 34 percent relative to the baseline by 2035. In contrast, the results on individual agricultural and food industries indicate a positive effect as output, employment and exports improve relative to the baseline when the carbon tax is implemented. The positive effects on agricultural industries are caused by full tax-free allowances provided to this sector coupled with the revenue recycling scheme, which minimise both the direct and indirect effects on agricultural industries. The obtained positive effects on the agricultural and food industries suggest that policymakers have designed a carbon tax policy that cushions them against high negative effects. Worth noting is that the policy effects on agricultural industries and the economy as a whole become substantially high and negative under when the tax-free allowance are removed as well as when the revenue is not recycled back into the economy. This means that the manner in which the state removes the tax-free allowances and treats the revenue collected will determine the direction and magnitude of the effects on agricultural, food and other industries in the economy.