Budget 2016

Finance Minister Pravin Gordhan did not mention the proposed carbon tax (the “tax”) in his Budget Speech delivered on 24 February 2016. Curiously, given the emotion that has surrounded the idea of the tax since 2010, when it was first formalised in a Treasury discussion paper, commentary on the implications of the Minister’s apparent omission has been muted or non-existent.

This article seeks to remedy the silence and argue that:

· far from being an indication that the carbon tax is off the table, the Minister’s failure to mention the tax in the 2016 Budget Speech is reflective of the fact that the tax has now moved into the mainstream of Treasury’s legislative work agenda; and

· there are very compelling reasons why the carbon tax will be introduced on schedule, in January 2017, while acknowledging that a lot of legwork still needs to be done if this timing is to be achieved.

While the Budget Speech is a public statement of the Minister’s intentions for the year, given the range and complexity of economic issues that must be addressed, the speech is really only an index to the much more substantial Budget Review – the detailed set of documentation underpinning the speech. Mention has been made of the carbon tax in virtually all of the Budget Speeches and Budget Reviews since 2011. Given that these years were characterised by an evolution of the form and content of the tax design and that the main thrust of substantive discussion on the tax took the form of a set of policy discussion papers dated 2010, 2013 and 2014, the Budget Speeches and Reviews became an important means for Treasury to formally communicate its most recent thinking on the issues. Carbon tax observers kept a close eye on these key moments as the tax design slowly took more specific form.

By February 2016, however, there is no need for Treasury to hint at its current thinking on carbon tax form and content. This is because the draft Carbon Tax Bill (“the Bill”) was published for comment in November 2015, along with an explanatory memorandum, a press release and promises of pending publication of draft carbon offsets and emissions intensity regulations and a round of Treasury-hosted carbon tax workshops. Consequently, Treasury’s detailed ideas on the carbon tax are in the public domain and are in the process of being debated and refined; i.e., the carbon tax is now mainstreamed into the fiscal agenda for 2016.

In support of this notion is the fact that the 2016 Budget Review makes specific mention of the carbon tax. The reference is cryptic, which is to be expected given that it simply confirms the status quo ante. Under the heading “Update on implementation of carbon tax”, the review states:

“The main aim of the carbon tax is to put a price on the environmental and economic damages caused by excessive emissions of greenhouse gases. A secondary aim is to change the behaviour of firms and consumers, encouraging them to use cleaner technology. Given the economic outlook, the carbon tax has been designed to ensure that its overall impact will be revenue neutral up to 2020. The [Bill] was published in November 2015, with 90 comments received to date. The Bill will be revised, taking into account public comments and further consultation.”

Two features of this statement; namely, references to the “economic outlook” and revenue neutrality, are examined below, in conjunction with a set of three compelling imperatives for implementation of the carbon tax in January 2017, which derive from the dynamics of the international and national climate change policy arenas.

Reasons for implementing the carbon tax on schedule

Reason 1: Future integrity of the system

To date, implementation of the carbon tax has been delayed three times – the original date for implementation was 2015, but this was pushed to 2016 and, later, to 2017. Without interrogating the reasons for the delays, their consequences have been detrimental to the tax’s ultimate operationalisation as they have given emitting industries the impression that Treasury and the Department of Environmental Affairs (“DEA”) are not serious about bringing the tax into operation. When consulting with industry leaders on the tax, regularly repeated mantras are “Treasury is not serious about the carbon tax!” and “The carbon tax will never happen.” Industry buy-in is essential for an operational carbon tax system with the integrity to deliver on the aims as set out in the 2016 Budget Review. In recent years, Treasury has been working with industry to hear and deal with concerns regarding the tax’s implementation and to overcome a trust deficit that has crept into the conversation between government and business around the need for mitigation of industrial greenhouse gas emissions. If Treasury postpones implementation for a fourth time, industry’s view that it is not serious about the tax will be justified and Treasury will have a monumental task to claw back the current position on the tax.

Reason 2: National credibility

South Africa prides itself on its role in the international negotiations that occur under the auspices of the United Nations Framework Convention on Climate Change (“UNFCCC”). There was much self-congratulatory back-slapping when the South African Presidency of COP17 (Durban, 2011) was able to claim that COP17 had put the negotiations back on track after the perceived failure of COP15 (Copenhagen, 2009). Among the innovations that the South Africans introduced was the “Indaba method” of deadlock-breaking, an approach that the French Presidency of COP21 (Paris, 2015) deliberately used to progress the discussions, which resulted in last December’s much-vaunted Paris Agreement, intended as the primary determinant of the global climate change response from 2020. As a good international corporate citizen, South Africa submitted its Intended Nationally Determined Contribution (“INDC”) to the UNFCCC in advance of COP21. The INDC is, essentially, a summary of national intentions to contribute to the global response to climate change and South Africa’s stated approach to mitigation is to apply a four-prong strategy. The first, most obvious and most well-developed of which is the carbon tax. While it is true that the INDC is careful to make South Africa’s implementation of climate change response actions contingent upon the receipt of appropriate international support, further prolongation of the already lengthy period during which the carbon tax has been bandied about on both the domestic and international stages will become increasingly embarrassing for Treasury, the DEA and the Department of International Relations and Cooperation, which takes the lead in the negotiations.

Reason 3: Economic impact of the tax

Business has been strident in its opposition to the carbon tax on the basis that it will wreak destructive economic consequences across emitting industries. This concern was noted by the Davis Tax Committee (“DTC”), which, during the course of its review of the national taxation system, also considered the carbon tax. Contrary to what has been represented in the “Twittersphere”, which implied that the DTC was opposed to the carbon tax, the DTC’s “First Interim Report on the Proposed Carbon Tax for South Africa” (13 November 2015) indicates that the carbon tax policy proposal and the Bill represent commendable schemes to drive a shift to a low-carbon intensity economy, and that their various elements are designed to protect industries against competition shocks, trade exposure and sector-specific disadvantages in the short term through allowances and the use of offsets. The DTC did, however, express some concern about design issues and made detailed recommendations for improvement, suggesting that the tax be introduced from 2017 with a 100% tax-free threshold for the first year; i.e., an arrangement that would legally oblige carbon tax liable entities to engage with the system and to submit tax returns without incurring actual liability.

As mentioned above, the 2016 Budget Review also addresses the issue of economic impact (“Given the economic outlook, the carbon tax has been designed to ensure that its overall impact will be revenue neutral up to 2020.”). There is a difference between the DTC’s suggestion of a 100% tax-free threshold and the notion of “revenue neutrality”, which is normally used as a catch-all phrase to refer to either:

· tax shifting; for e.g., returning the money raised from the carbon tax to the economy through a gradual phase-out of the fossil fuel levy, with the carbon tax revenue replacing the levy in the national budget; or

· revenue recycling; i.e., using carbon tax revenues to finance various green incentives.

Both approaches – a 100% tax-free threshold and revenue neutrality – have the effect of reducing the financial impact of the carbon tax on the economy/tax-liable entities; although, given revenue neutrality’s focus on the wider economy, utilisation of this approach will not necessarily mean that large emitters will escape unscathed.

The 2016 Budget Review notes that the period during which the revenue neutral boon would apply is up to 2020; i.e., the tax will be revenue neutral for four years: 2017, 2018, 2019 and 2020. While this extends the DTC’s suggested single year’s grace, the clear implication of the review’s stated timing is that the carbon tax will be implemented prior to 2020, which would be a pleasing congruency between the first phase of the carbon tax; i.e., up to 2020, and the coming into operation of the Paris Agreement and the commencement (from 2020) of a truly global climate change response. Among the agreement’s innovations is the extension of responsibility for the international climate response to include efforts by both developed and developing countries, whereas this currently lies primarily with developed countries. In order to comply with its international commitments, South Africa needs all elements of mitigation policy to be operational by the beginning of the third decade of the century, which presupposes that the various instruments, including the carbon tax, will have gone through their respective teething processes before then. There is another date that informs the operation of the carbon tax; namely, the INDC’s idea of South Africa’s greenhouse gas emissions beginning to plateau from 2025 onwards. Treasury has suggested that the impact of the carbon tax will be gradually ramped-up so that industry has time to take account of, and adapt to, the tax. If the carbon tax is revenue neutral up to 2020 and its real economic impact is ramped-up thereafter, by 2025 it will be well placed to achieve the aim of curbing greenhouse gas emissions, just as the plateau period commences.

Should the carbon tax be implemented from 2017?

Despite the issues discussed in this article, cogent arguments can be made that the Byzantine complexity of the proposed carbon tax design – which would require collaboration and coordination between Treasury, the DEA, the South African Revenue Service and the Department of Energy – and the limited time to January 2017 mean that the tax should either be scrapped or delayed indefinitely and/or until the design issues have been addressed. There is certainly merit in such arguments, but there are other, more fundamental, considerations that will be factored into the carbon tax equation, including:

· While its legal strength has been questioned, the Paris Agreement represents a sea change in political attitudes to dealing with climate change. COP21 also featured significant participation and support from large-scale private sector business, including the fossil fuel industry. One of the agreement’s observed strengths is its considerable moral weight, which civil society groupings have already indicated will provide the ammunition they will use to ensure that country parties stay within the limits of the commitments that have been made and to hold the private sector accountable for its actions. Civil society court action in South Africa is already being directed against industry’s perceived negative environmental impacts and it is not inconceivable that these actions will be extended to addressing climate change issues directly, in both the public and private sectors.

· Some of the criticism levelled against the carbon tax includes the notion that South Africa should not seek to lead the pack of developing countries in implementing fiscal and other measures to reduce greenhouse gas emissions. The reality is that decarbonisation of the world economy, including all of the advanced developing countries (which includes South Africa) is an inexorable political and social movement of which this country is simply a part. South Africa is not unique as a developing country seeking to introduce mitigation measures. The broader issue, however, is that dirty economies that fail to take steps towards cleaner practices will, by the middle of the next decade, start feeling a coldness from the international shoulder. One example of such coldness is increasing discussion on the imposition of border tax adjustments on manufactured goods imported into European countries that originate in countries with fossil fuel heavy economies. As is clear from the debate around the carbon tax, economies do not easily takes steps towards cleaner practices and when they do, some time is needed before the practices take effect, thus supporting the notion of a 2017 start date for the carbon tax.

· Finally, the idea that the carbon tax should be delayed because it is imperfectly formed is less powerful than the combined strength of the various drivers towards implementation that are considered in this article. A limited operationalisation of the carbon tax in 2017, either as revenue neutral or with a 100% threshold, will permit the players time to "learn by doing" in advance of 2020 and the proposed ramp-up will help create a leaner, less-emission intensive South Africa in light of increasing global carbon constraints.

Andrew Gilder climate change and carbon markets specialist environmental [email protected] +27 82 382 6279

Mansoor Parker executive tax [email protected] +27 83 680 2074

Olivia Rumble climate change and carbon markets specialist environmental [email protected] +27 82 788 0864