The welfare effects of reversed border tax adjustments as a remedy under unilateral environmental taxation : a South African case study

Abstract

Border Tax Adjustments (BTAs) resurfaced recently in national policy debates as a possible measure to counter the anti-competitiveness effect of unilateral environmental taxes. There seems to be no consensus in the literature on the effectiveness of BTAs under environmental taxes. This paper aims firstly to provide a theoretical Heckscher-Ohlin analysis that not only challenges the effectiveness of BTAs, but also proposes an alternative approach to mitigate the welfare effects of environmental taxes. Secondly, the paper evaluate the effectiveness of the alternative approach, to negate the economic impact on competitiveness of an electricity generation tax, without sacrificing the environmental benefits of the tax, in the case of South Africa. Using conventional Heckscher-Ohlin methodology, in a small country, we show that policy makers should, instead of implementing BTAs, consider the opposite of BTAs to mitigate the welfare effects of environmental taxes. We show that gains from trade, due to a reduction in import tariffs, could, under certain assumptions, offset the initial tax induced welfare loss. The paper then applies the Global Trade Analysis Project (GTAP) model to evaluate the impact of an electricity generation tax on the South African, SACU and SADC economies and explores the possibility to reduce the economic impact of the electricity generation tax through traditional border tax adjustments. The results show that an electricity generation tax will lead to a contraction of the South African gross domestic product. However, traditional BTAs are unable to address these negative impacts. The paper then test the proposed reversed BTA approach where gains from trade are utilised to negate the negative impacts of an electricity generation tax, while retaining the environmental benefits associated with the electricity generation tax. This is achieved through a reduction in import tariffs, as this reduction will reduce production costs and thereby restore the competitiveness of South Africa. The reduction in import tariffs not only negates the negative GDP impact of the electricity generation tax, but most the CO2 abatement from the electricity generation tax is retained.