/ 27 October 2022

Carbon tax: How it affects households

The Carbon Tax Act
The Carbon Tax Act, which aims to penalise large emitters of greenhouse gasses, has recently come into effect in South Africa. (Photos: AFP)

The carbon tax is a tax in response to climate change. The aim is to reduce greenhouse gas emissions (GHG) by making polluters pay for emissions. In South Africa, the Carbon Tax Bill of 2019 was signed after a lengthy consultation process. Its main objective is to reduce GHG emissions in a sustainable, cost-effective and affordable manner.

It operates under the “polluter pay principle”, where “those responsible for harming the environment must pay the costs of remedying pollution and environmental degradation and supporting any consequent adaptive response that may be required”. This implies that households should not bear the total weight of the carbon tax and that businesses are encouraged to adopt cleaner technologies over the next decade and beyond. 

The first phase –- with relatively low rates — only applied to Scope 1 emitters. Scope 1 emissions are direct GHG from sources controlled or owned by the organisation (for example, those associated with fuel combustion in boilers, stoves and vehicles). Scope 2 emissions are indirect GHG related to the purchase of electricity, steam, heating or cooling. Scope 2 emissions happen physically at a place, are a result of an organisation’s energy consumption and are accounted for in its GHG inventory. Scope 2 takes in individual households. The first phase is to run from 1 June 1 2019, to 31 December 2022, and the second phase from 2023 to 2030. The finance minister has extended the first phase by three years until 31 December 2025.

The carbon tax rate was increased to R144 from 1 January 2022. To comply with COP26 commitments in South Africa, the tax rate will be increased by about R20 each year until it reaches about R350. The government is expected to raise the carbon price sharply every year thereafter starting in 2026. 

Considering South African taxpayers’ financial constraints, we conducted a study that investigated the impact such a tax has on households using a computable general equilibrium (CGE) model. This model is well suited to analyse how policies like these affect the economy as a whole while also allowing the impact of the tax to be isolated.

Our results show that the impact of the carbon tax on economic growth is minimised when the revenue is fed back into the economy. While the richest households’ expenditure is hardly affected by the introduction of a carbon tax, relatively poor households are much worse off. 

This is mainly because poorer households spend a greater portion of their income on energy and/or electricity than richer households. Interestingly, middle-income households are shown to be more affected by the carbon tax than low-income ones. This is mainly because low-income households’ energy consumption does not include a significant share of grid-based electricity compared to middle-income households which consume more grid-based electricity and less of other types of energy such as paraffin and wood — as shown in a previous study

Another struggle for economic inequality?

The results of this analysis draw attention to the effects of a carbon tax on households, mainly on the most vulnerable ones. Although the carbon tax in South Africa was, from its inception, designed under the “polluter pay principle” to protect industry competitiveness, this does not mean households will not also be affected. In addition, the study shows not all households will be affected equally. 

Will this be another hurdle in the country’s fight to combat economic inequality? 

Figure: Carbon tax: Impact on Households expenditure Note: the study analyses twelve different categories of households – for ease of reading here, we include low -, middle – and high-income households only. 

South Africa is in the middle of a multi-layered crisis, with Eskom’s power-constraint issues high on the list, closely followed by the external pressures of increasing oil prices and the economic aftermath of the Covid-19 pandemic. These stressors have amplified the problems of already burdened South African households which are struggling to make ends meet. 

It is a given that the tax will affect all households in the country but avoiding a tax on carbon might have worse consequences in the long run. Can the planet afford that?  

Amid such turmoil, we tend to forget that the environment has been deteriorating for some time and the consequences of climate change  have severely affected the most vulnerable populations. Some have argued that the Covid-19 lockdowns assisted in the slowdown of climate change. Still, the economies have bounced back, and the policy and technology changes were not drastic enough to continue the path towards reducing emissions and slowing down climate change. 

So, considering South Africa’s economic issues, exacerbated by the most extended power crisis it has faced, where is South Africa standing in its effort to combat climate change while protecting its most vulnerable households?

The climate conundrum

In 2016, South Africa was among the countries that signed the Paris Agreement and pledged to peak its emissions in the period between 2020 and 2025 while moving to a greener economy but keeping in mind that the country needs to achieve a triple goal of improved growth, higher employment and lower inequality. 

From 2025 onwards, South Africa pledged to focus on reducing emissions. To date, however, the country’s emissions trend has not followed the expected peak-plateau-decline path as initially planned, a fact primarily attributed to the slow transition of the electricity-generation sector from fossil fuels to renewable energy and the associated potential socioeconomic repercussions. 

Based on their income and spending, households would experience a range of effects from a carbon tax. Because low-income households spend a bigger proportion of their incomes on carbon-intensive commodities like energy, a tax on carbon would have a greater impact on their finances than it would on those of high-income households. Government initiatives that are tied to inflation might somewhat offset the income consequences of a carbon tax on low-income households. If a carbon tax caused the cost of living to rise, this inflation would lead to an increase in transfer payments to recipient households.

Policymakers must weigh tradeoffs, such as political popularity, the cost of the entire programme and whether the impact of the tax on certain groups (such as low-income households) should be reduced. They could use the revenue for objectives other than deficit reduction. Refunds in the form of cheques or tax credits, increased spending on projects or initiatives that cut emissions through other means, and deficit reduction are a few ways that carbon tax revenue can be used.