Taxing Emissions in Singapore
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Singapore’s carbon tax is designed to maximize green investments while minimizing negative effects on the overall economy.
Carbon pricing is gaining growing recognition as an effective instrument to reduce greenhouse gas emissions and meet the 2 °C goal set by the Paris Agreement. The most common types of carbon pricing schemes are emissions trading schemes and carbon taxes. According to the World Bank, among the 57 existing or planned carbon pricing initiatives around the world, 28 use emission trading systems at the regional, national and subnational levels, while the other 29 use carbon taxes, usually applied at the national level.
While both emissions trading schemes and carbon taxes are able to provide incentives for emitters to reduce emissions and generate government revenues (when the emission permits are auctioned under the emissions trading scheme), they have respective pros and cons based on their working mechanism.
An emissions trading scheme, also referred to as a cap-and-trade system, normally involves a government-set quantitative limit (cap) on the total allowable level of greenhouse gas emissions. The government then distributes the emission allowances (or permits) to industries and emitters either for free or via auction. Emitters have to obtain emission allowances either from government or trading counterparties within the cap-and-trade system. Emitters that emit more than their allowance can buy the right to emit from emitters that emit less than their allowance.
The cap-and-trade system has the advantage of helping a country meet its quantitative emission reduction target. Besides, cap-and-trade systems enable the price for emissions to be determined by market supply and demand. However, governments need quality information to set reasonable emission allowances for each industry and emitter. Also, fluctuations in the market driven carbon price may create cost uncertainty for emitters.
The carbon tax, on the other hand, sets a fixed carbon price that creates a financial liability for emitters. Emitters have tax incentives to innovate and transit to clean energy and energy-efficient operations. Compared to the cap-and-trade system, a carbon tax offers a transparent and clear price pattern which reduces uncertainty. However, it is difficult to set an accurate tax level that can fully reflect the external costs associated with emissions. In addition, a carbon tax cannot ensure a quantitative emission reduction target. Another drawback is that a carbon tax puts businesses at a cost disadvantage relative to peers that are not subject to the carbon tax. Finally, the extra costs of businesses may be shifted to end-users such as low-income households and small and medium sized enterprises.
Nevertheless, both schemes are widely viewed as effective policy instruments for reducing emission.
Singapore, an island city-state, has been actively tackling climate change challenges. Singapore’s per capita carbon dioxide emission ranked 24 out of 204 worldwide in 2014, second to Brunei Darussalam among Southeast Asian economies. In line with the 2015 Paris agreement, Singapore pledged to reduce carbon emission intensity by 36% from 2005 levels by 2030. Starting from 2019, Singapore introduced a tax on carbon dioxide emissions with the first tax payment in 2020 based on 2019 annual emission.
Singapore’s carbon tax tries to address the limits of carbon tax in a number of ways. First, to minimize direct cost impact on business and households, the carbon tax applies to all sectors whose annual greenhouse gas emission is greater than 25,000 tons of carbon dioxide equivalent. This limits the coverage of the carbon tax to around 40 businesses that contribute to more than 80% of the total emissions. Second, the tax would increase operating costs and may adversely affect the international competitiveness of Singapore’s large oil refinery and petrochemicals sectors. To mitigate the impact of a carbon tax on business competitiveness, Singapore is implementing its carbon tax in a transparent and gradual way.
The initial tax rate is S$5 per ton of greenhouse gas during the transition phase of 2019–2023, followed by an increase to S$10–S$15 per ton in 2023 after an impact assessment. This allows business time to prepare and gradually lower their emissions. Third, the government offers an additional rebate to eligible households to mitigate possibly higher energy costs. Lastly, to help businesses transit to low-carbon operations, the government will utilize the tax revenue to encourage business investments and innovations in more energy efficient technology and equipment via financing programs and schemes.
Despite such innovative features, Singapore’s carbon tax scheme still faces the challenge of controlling annual emissions at the aggregate level. One solution could be extending the current carbon tax to other large emission sectors such as transportation, set to be the second largest source of carbon pollution. An alternative solution will be to introduce a cap-and-trade system, which allows large emitters to buy additional emission allowance without breaching aggregate emission ceilings.
The implementation of carbon tax will contribute to building the necessary capacity for collecting the necessary information as well as measuring, reporting, and monitoring emissions. Other Asian economies’ experience in cap-and-trade systems offer valuable lessons. The Korea Emission Trading System, which was set up in January 2015, holds three specific lessons for Singapore: (i) the need for a clear and consistent signals to the market, (ii) the desirability of a gradual introduction of the scheme, and (iii) the importance of close communication with industry. At a broader level, low carbon market liquidity was a major challenge for the Korea Emission Trading System, which suggests that Singapore would do well to ensure sufficient liquidity, for example by having enough participants.
Overall, the carbon tax marks a significant step in Singapore’s quest for a greener future. Singapore’s carbon tax is designed to minimize adverse effect on economic growth while maximizing green investments. If the carbon tax lives up to its promise, it can become a valuable blueprint for sustainable growth for Singapore.
This post first appeared in the Asian Development Bank’s Blog found in the link below.