14740_Carbon_Budget_CVR.indd 3 6/29/17 1044 AMPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedIntegration of the Carbon Tax and Carbon Budgets in South AfricaMarch 2017 14740_Carbon_Budget_pi-5.indd 1 6/28/17 1118 AMii 2017 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone 202-473-1000 Internet www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of cutive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Cover design Shepherd Incorporated14740_Carbon_Budget_pi-5.indd 2 6/28/17 1118 AMiiiContentsAcknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viicutive summAry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .ix1 introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 PrinciPles used to Assess interfAce oPtions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 .1 summary of principles from existing documentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 .2 synthesis and identification of principles related to policy integration . . . . . . . . . . . . . . .43 PlAnned design feAtures of eAch instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 .1 carbon tax to 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 .2 carbon budgets to 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .143 .3 Assumed ‘departure point’ for 2021 and beyond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 ProPerties of Budgets And tAxes And insights on integrAtion . . . . . . . . . . . .174 .1 Advantages and disadvantages of the carbon tax and carbon budget . . . . . . . . . . . . . .174 .2 insights from international practice in combining mitigation policy instruments . . . . . .225 interfAce oPtions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .256 oPtion Assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .296 .1 layering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .306 .2 tax used to enforce the budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .346 .3 hybrid instruments with trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .396 .4 differentiated instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .486 .5 scoring overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .527 conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .637 .1 recommended approach to interface for implementation in short term immediately post-2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6314740_Carbon_Budget_pi-5.indd 3 6/28/17 1118 AMiviv INTEGRATIoN of THE CARBoN TAx AND CARBoN BUDGETS IN SoUTH AfRICA7 .2 recommended longer term for the interface 2025 onwards . . . . . . . . . . . . . . . . . . . . .657 .3 treatment of the electricity sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65references . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69Annex A international experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71Annex B national documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81list of tablesTable 1. full list of principles used to assess interface options . . . . . . . . . . . . . . . . . . . . . . . . . . .6Table 2. A comparison of the strengths and weaknesses of carbon taxes and carbon budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21Table 3. layering sacrifices cost-effectiveness to achieve higher emissions reduction effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31Table 4. Budget with tax on emissions in excess of budget . . . . . . . . . . . . . . . . . . . . . . . . . . . .36Table 5. Budget with tax on all emissions if budget is exceeded scores particularly poorly on cost-effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38Table 6. ets with price floor and/or ceiling scores well on emissions reduction effectiveness, certainty, and cost-effectiveness but generates potentially less revenue than other interface options to increase fairness and equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41Table 7. Absolute emissions baseline and credit achieves a similar score to an emissions trading system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45Table 8. emissions intensity baseline and credit scores lower than ets and absolute baseline and credit by restricting emissions trading to within-sector instead of allowing economy-wide trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47Table 9. there is no clearly superior interface instrument; trade-offs across different principles need to be made . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53Table 10. ets and layering outper other interface options on emissions reduction effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54Table 11. interface options which place greater emphasis on budgets provide greater emissions certainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55Table 12. trading minimises costs whereas a strict enforcement of a budget creates potentially very high costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56Table 13. All interface options internalise external cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57Table 14. no option scores well on equitable treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5814740_Carbon_Budget_pi-5.indd 4 6/28/17 1118 AMCoNTENTS vTable 15. interface options that generate government revenue and/or that can target emissions reduction efforts in certain sectors tend to score better . . . . . . . . . . . . . . . . . . . . . .59Table 16. interface options merging current processes without adding requirements per well . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60Table 17. hybrid options and the budget with tax on emissions above budget can be flexible and limit competitiveness impacts whereas layering is the most rigid option creating potentially high costs and impacts on sectors in international competition . . . . . . . . .61Table 18. france’s nonbinding sectoral carbon budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75list of figuresFigure 1. fifteen principles grouped into three categories . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5Figure 2. Budgets and taxes fall into different instrument categories and target emissions quantity and price, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18Figure 3. market-based instruments have significantly lower cost than regulatory, command and control instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19Figure 4. four main interface options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25Figure 5. south Africa currently has a model similar to the uk ccA and ccl arrangement . .72Figure 6. three categories of national documents have been considered . . . . . . . . . . . . . . . .81list of BoxesBox 1. differences between an ets and an absolute baseline and credit scheme . . . . . . . . . .27Box 2. options to facilitate trading given emissions concentration in the south African economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40Box 3. incentivising abatement from reducing electricity consumption in the republic of korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52Box 4. national development Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82Box 5. national climate change response white Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83Box 6. carbon Budget design document . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85Box 7. carbon tax options discussion Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86Box 8. environmental fiscal re Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8714740_Carbon_Budget_pi-5.indd 5 6/28/17 1118 AMvi14740_Carbon_Budget_pi-5.indd 6 6/28/17 1118 AMviiAcknowledgmentsThe Report “Integration of the carbon tax and carbon budgets in South Africa” was prepared by Vivid Economics, DNA Economics and Emily Tyler. The Report was commissioned by the PMR Secretariat for the Department of Environmental Affairs and the National Treasury of South Africa.11Nothing in the report should be taken as representing the views or policy position of either the Department of Envi-ronmental Affairs or the National Treasury of South Africa.14740_Carbon_Budget_pi-5.indd 7 6/28/17 1118 AMviii14740_Carbon_Budget_pi-5.indd 8 6/28/17 1118 AMixcutive SummaryIn 2009, at the UNFCCC Conference of the Parties COP in Copenhagen, South Africa made a voluntary commitment to reduce its greenhouse gas GHG emissions by 34 percent in 2020 and 42 percent in 2025 relative to business-as-usual BAU. This was part of a wider commitment by South Africa to contribute to the global effort in mitigating anthropogenic cli-mate change and to transition to a lower-carbon economy. This was reaffirmed in its Intended Nationally Determined Contribution INDC submission to the UNfCCC, in advance of CoP 21 in Paris in 2015, which identifies the intention that South African emissions should follow a ‘Peak Plateau and Decline’ PPD trajectory peaking in 2025 within a range of 398 to 614 MtCo2e; plateauing for approximately a decade; before beginning to decline in absolute terms, falling to between 212 to 428 MtCo2e by 2050.Among a suite of different policies, two, in particular, have been designed with the intention of delivering a significant proportion of these emission reductions A carbon tax designed by the National Treasury NT to provide a price signal to producers and consumers of carbon-intensive products and to create an incentive to invest in cleaner technology. The carbon tax is expected to come into operation in 2017 at a headline rate of R120/tCo2e, although the effective tax rate will initially be lower as a result of a series of tax free allowances. A series of carbon budgets designed by the Department of Environmental Affairs DEA envisaged to provide a GHG emissions allowance in other words, a cap, against which physi-cal emissions arising from the operations of a company during a defined time period will be tracked. In the period to 2020, the carbon budgets will not be a compliance instrument but rather will be used to increase understanding of the emissions profile of participating compa-nies, and to establish monitoring, reporting, and verification MRV processes. Beyond 2020, they are intended to become compulsory. This paper provides recommendations for combining the carbon budget with the carbon tax to support delivery of South Africa’s emissions reduction targets beyond 2020. While both the carbon tax and carbon budget approach have merits, economic theory would suggest that there could be risks associated with applying both instruments to the same emissions at the same time. Stakeholder consultation also revealed significant concerns with this option. There is therefore a desire to understand how they may be aligned to ensure that South Africa’s mitigation policy is placed on a coherent footing on the longer term. Although they could be considered as mutually exclusive options, the terms of reference for this study have specifically requested that possible interfaces between these two instruments or approaches be considered, and hence the possibil-ity of just proceeding with one or other of the options is not explored in this report.14740_Carbon_Budget_pi-5.indd 9 6/28/17 1118 AMxx INTEGRATIoN of THE CARBoN TAx AND CARBoN BUDGETS IN SoUTH AfRICAThe analysis involves comparing four categories of policy alignment options across eight core principles. The four categories of alignment options, developed by the consultancy team and agreed in consultation with DEA and NT