Carbon tax is an indirect tax, aimed at controlling carbon dioxide emissions, which in turn would reduce harmful emissions contributing to air pollution and subsequently, to global warming. Exhaust fumes from vehicles, power plants and factories all contain varying levels of carbon dioxide.
Since the beginning of the Industrial Revolution in the late eighteenth century, the burning of fossil fuels, coal, oil and natural gas, was escalated to drive the machinery of increased production. As a result, there was a large scale emission of carbon dioxide level to the atmosphere, contributing to air pollution.
Today, air pollution is a major concern throughout the world, with countries around the world promoting policies on combating the increasing levels of air pollution via economic policies.Therefore, many international bodies, including the United Nations (UN), have highlighted the importance of sustainable development.
Accordingly, in the budget speech 2018, Minister of Finance and Mass Media, Mangala Samaraweera, made several proposals to promote sustainable development in Sri Lanka.
One such proposal is the introduction of the carbon tax. Minister Samaraweera said, he proposed to introduce a carbon tax, where the applicable rates for a motor cycle, car and a passenger bus would be around 17 cents, Rs. 1.78 and Rs.2.74 per day, respectively.
He made this proposal under the blue green economy, aimed at reducing environmental risks and ecological imbalances.
The proposed tax will be based on the engine capacity of motor vehicles, with the rate depending on age and fuel type of the vehicle. Electric vehicles are exempted from the levy. The Government estimates a Rs 2,500 million revenue from the proposal.
Speaking on the implementation of the tax, Deputy Secretary to the Treasury, S.R. Attygalle, said the carbon tax will be effective from April 1, 2018.
Economic impact of air pollution
In economic terms, air pollution is an example of negative externality.An externality is a consequence of an economic activity which exerts effect on third parties, without being reflected in market operations and business transactions. Therefore, an externality is an example of a market failure, where no market exists to capture its consequences.
A negative externality gives rise to an inefficient equilibrium outcome, due to the social marginal cost being higher than the social marginal benefit. That is, the cost of air pollution and activities which lead to it, which is a cost to society, and is higher than the net benefit enjoyed by the individual.
Over the decades, economists have urged that one mechanism of tackling air pollution is to internalize the externality, by creating a market for pollution rights, via an emissions trading mechanism or by introducing a carbon tax. On these options, World Bank officials said, emissions trading scheme has an advantage, where the cap is set at the desired level of Green House Gases (GHGs) and then the market is allowed to trade polluting permits. “A carbon tax is easier to administer, since it can be charged at the source (that is, when importing into the country) and prices will be passed on to the final user,” they said.
Key policy instrument
Speaking to the Sunday Observer, the World Bank opined that the proposed carbon tax in Sri Lanka can be a key policy instrument in helping the country meet its commitments under the United Nations Paris Agreement. Paris Agreement is an action plan aimed at mitigating GHGs, adaptation and finance.
They said, as a carbon pricing instrument, a tax can hold those responsible for carbon emissions accountable and be a flexible and cost effective way to mitigate carbon emission reductions by sending an appropriate economic signal. “Sri Lanka can be one of the pioneers in the region with this important initiative,” they said.
At the same time, given a tax does not set an absolute limit on carbon emissions, its impact on the emissions needs to be carefully evaluated and continuously monitored, so that the level and design of the tax can be adjusted as needed.“As a tax targeting consumption, its impact on various consumers, particularly, the low income, also needs to be taken into account,” Bank officials added.
However, it does not automatically lead Sri Lanka to meet its GHG target, they said. A carbon tax could also replace the myriad of tax levies on imported petrol and diesel and be set in such a way that the most polluting forms of fuel carry the highest taxes, whereas, today the rates are set to maximize government revenue,” they explained.
Advisor to the Ministry of Finance and Mass Media, Deshal De Mel said, the proposed carbon tax is aimed at taxing larger vehicles with bigger engine capacity to a greater extent. “These vehicles typically have higher emissions and therefore the tax will be a disincentive for usage of such vehicles, over smaller, less polluting vehicles,” he said.
De Mel said, the Government in the future, will set up the enabling environment in terms of measurement for carbon tax to be based on carbon dioxide emissions of the vehicle, in line with global best practices.“Due to practical reasons we can’t introduce this immediately. Carbon dioxide emissions can be measured as grammes per kilometre of carbon emissions. We have to get this declaration from vehicle importers and manufacturers. Once it is obtained, we will make the move to a more globally accepted carbon taxation structure, maybe by next year,” he said.
The World Bank officials pointed out that an important precondition to the carbon tax is the liberalization of fuel prices. “Otherwise, the price signals would not be transmitted to households and firms and there would be no incentive to change behaviour. Therefore, the plan to introduce a fuel price formula in 2018 is essential.”
Attygalle, speaking at a post budget seminar held at the Chamber of Commerce recently said, the pricing formula on petroleum products would be implemented by March next year. The World Bank officials are of the view that the carbon tax would serve to discourage the use of GHGs by households, industry and transport. “It is important that alternative, less polluting energy sources are available for the carbon tax to be successful. The budget proposals regarding electric vehicles would allow households and transport to shift to less polluting vehicles. The availability of less polluting forms of energy and an improved business climate would make it easier for firms to adjust,” they explained.
Emissions trading
The other mechanism of tackling air pollution is by creating a market for pollution rights, via an emissions trading mechanism. These are also referred to as the cap – and- trade markets, where an overall quota ( a cap) is set for access rights. At the same time, pollution rights are allowed to be traded. Then, firms with lower costs of reduction of pollution in their industrial processes would be sellers in the emission trading market and those with higher costs of reduction of pollution, the buyers.
According to Coase theorem put forward in 1960, in a situation where an externality arises, assuming there are no transactions on costs of trading, if property rights are well defined, bargaining between parties would lead to an efficient outcome. It was Coase’s ideas that facilitated the creation of these pollution rights markets.
The first emissions trading system was adopted by United States as part of the Clean Air Act of 1990. This was referred to as the acid rain program. The European Union Emissions Trading System (EU ETS) is the largest, multi nation, cap- and - trade system in the world. The cap is set on the total amount of greenhouse gas that could be released by the participant of this market. The participants can trade their emission allowances. According to Microeconomics (2016) by A Daripa, one emission trading allowance provides the holder with the right to emit one tonne of carbon dioxide or its equivalent. At the end of each year, the participant must surrender enough allowances to cover their emissions within the year, or heavy fines would be imposed.
Daripa further states that both China and India, the first and fourth largest polluting nations respectively, have run pilot carbon dioxide emissions trading systems. China is currently awaiting the launch of the world’s biggest carbon trading market. Speaking of cap and trade policies, De Mel said, Sri Lanka is a long way away from the implementation of such a mechanism.