How Far Will the Carbon Tax Bring Us Towards Net Zero?

Commentary: With the announcement of the new carbon tax rate at the Singapore Budget 2022, considerations informing the design of Singapore’s carbon tax policy remain more critical than ever.

At Budget 2022, the Singapore government announced a long awaited increase in its carbon tax. From the initial price of $5 per tonne of CO2 equivalent, the Singapore government announced a new carbon tax rate of $25 in 2024, potentially rising to as high as $80 in 2030.

The step-up in ambition, from the originally mooted range of $10-15 by 2030, is clear to see and commendable. It may even have surprised many observers. After all, with a hike in the GST and numerous other tax increases looming, high energy prices and global inflationary pressures, there have been genuine concerns about living costs to put off a high carbon tax.

Instead, the government has committed to an ambitious carbon price, with a phased approach to carefully manage expectations. Singapore’s carbon tax policy may well be pitched as a model for other countries in the years to come.

Indeed, having started in 2019 at the modest rate of $5, this is perhaps indicative of the government's general approach to climate policies, as SMU Professor Winston Chow describes, to "underpromise but overdeliver".¹

The Chequered History of Carbon Taxes

But an ambitious carbon tax rate is not a guarantee of a successful carbon tax. After all, while popular, carbon tax policies also have a chequered history. Behind the apparent simplicity of the carbon tax is the fact that fundamentally, a higher carbon tax would be felt in the form of increased costs, but may not lead to a clear and proportionate reduction in emissions. While the costs are made visible, the benefits are concealed. This means that carbon taxes find it easier to make enemies than supporters.

“In essence, climate policies must not only appeal to a sense of distributive fairness, but also move the needle on decarbonisation.”

This is why the majority of carbon taxes find themselves neutered by lobby groups, either in the form of lower prices overall, or substantial exemptions for heavily polluting industry sectors.²

In other cases, such as by the Labour government in Australia and by President Macron on diesel before the Yellow Vest protests, poorly designed policies have led to significant pushback despite earlier popular support for climate action.

Such worst case scenarios, which undermine the momentum for climate ambition, tend to weigh heavily on the minds of policymakers. This underscores the need for carefully designed and well-planned climate policies. In essence, climate policies must not only appeal to a sense of distributive fairness, but also move the needle on decarbonisation.

For the government to truly deliver a successful carbon tax, it needs to focus on two more fundamental questions.

Will Polluters Be Let off the Hook?

The first question is whether there are opportunities for polluters to evade their climate responsibilities. One key area that needs to be scrutinised is the use of carbon offsets. To date, global markets for carbon offsets have been plagued by a severe lack of credibility over issues like additionality and double-counting.

While the recent COP26 concluded a rulebook for regulating carbon offset markets and solving these issues, there remains significant doubts over voluntary carbon markets, which are entirely self-regulated, and could potentially far exceed the size of compliance markets. As a 2020 report by the Task Force on Scaling Voluntary Carbon Markets showed, less than 5% of offsets actually remove carbon dioxide from the atmosphere.³

If polluters can avail themselves to bogus offsets, it would come at the expense of their actual obligations to reduce emissions. This would be a step backwards.

The flagship carbon marketplace in Singapore, Climate Impact X, is also a voluntary carbon market. However it has pledged that it would offer "high quality offsets". There is therefore an urgent need to demonstrate how the quality of such offsets can be proven, and how they are to be incorporated into Singapore's carbon tax regime.

Until these issues are sorted, the decision to limit the use of offsets to 5% of emissions⁴ is a wise one.

A Tool for Decarbonisation, or Extracting Rent?

The second fundamental question is how a carbon tax contributes to the overarching goal to reach net zero around mid-century. What needs to be done? The first step is to look beyond carbon taxes.

Eric Lonergan, economist and author of the book Supercharge Me: Net Zero Faster, explains that in designing carbon taxes, it isn't so much about pricing the negative externalities of emitting greenhouse gases that we should be worried about.

Instead, we should focus on another core concept from economics 101: price elasticity. In other words, the degree to which an increase in price, such as a carbon tax, reduces the level of output, in this case, carbon emissions.

“... it is not the carbon tax itself that will determine how much our emissions go down. The critical factor that determines if the carbon tax ends up as a tool for decarbonisation, or for extracting rent, is the availability of substitutes.”

If a carbon-intensive good were price elastic, we would respond to an increase in price by correspondingly reducing our quantity demanded. This would help to reduce emissions, and would be a useful tool in decarbonising our economy. If, however, it were not, we would simply pay more for the same amount of the good we consumed. Even at $80, a carbon tax would just be a lucrative way to collect rent from carbon emissions. But it would not actually reduce emissions. In other words, it is not the carbon tax itself that will determine how much our emissions go down. The critical factor that determines if the carbon tax ends up as a tool for decarbonisation, or for extracting rent, is the availability of substitutes.

Only after these substitutes are in place can a high carbon tax be an effective incentive to shift away from polluting behaviours. There would therefore need to be a concerted effort to build up substitutes in high emission sectors. For example, in power generation, which contributes 40% of emissions, Singapore is still reliant on fossil fuels like natural gas for over 95% of its electricity. The obvious low-carbon substitute is renewable energy, such as solar.

But with the lack of natural endowments and a small land area, scaling up substitutes will require creativity and boldness. It will likely require looking beyond our borders, to the rest of the region where renewable energy resources are abundant but untapped. It will certainly require the mobilising of much larger amounts of green investment. Here, the idea for a green investment bank, as proposed by KPMG, would provide low interest loans to help firms in Singapore and the region develop zero-carbon alternatives.⁵

The benefits of a green energy transition should not be overlooked either. Recent studies have indicated that, set against the volatilities in global markets for oil, gas and coal, a shift to renewables may have a disinflationary impact, or lead to cost savings in the long run.

As a recent Oxford study concludes, "While arguments for a rapid green transition often cite benefits such as the avoidance of climate damages, less air pollution and lower energy price volatility, these benefits are often contrasted against discussions about the associated costs of transitioning. Our analysis suggests that such trade-offs are unlikely to exist: a greener, healthier and safer global energy system is also likely to be cheaper."⁶

This should also point us to the logical end point of a carbon tax. If Singapore does succeed in becoming a true net zero economy around mid-century, a carbon tax raises nothing, and would all but wither away.

footnotes

¹ Heart of the Matter, CNA (2022), If Singapore contributes just a fraction of global emissions, what's the point of climate activism here?, channelnewsasia.com/listen/heart-matter/if-singapore-contributes-just-fraction-global-emissions-whats-point-climate-activism-here-2446881

² Danny Cullenward and David G. Victor (2020), Making climate policy work.

³ Jess Shankleman and Akshat Rathi (2021), Wall Street’s Favorite Climate Solution Is Mired in Disagreements (Bloomberg), bloomberg.com/news/features/2021-06-02/carbon-offsets-new-100-billion-market-faces-disputes-over-trading-rules

⁴ National Climate Change Commission Singapore (Feb 2022), Carbon Tax - Use of International Carbon Credits, nccs.gov.sg/singapores-climate-action/carbon-tax/

⁴ Sharon See (2022), KPMG proposes S$1b green energy investment fund in Budget 2022 wishlist, businesstimes.com.sg/government-economy/kpmg-proposes-s1b-green-energy-investment-fund-in-budget-2022-wishlist

⁶ Rupert Way, Matthew Ives, Penny Mealy and J. Doyne Farmer (2021), Empirically grounded technology forecasts and the energy transition.