The effects must not be considered in isolation, especially as low-income households may need help in coping with higher costs.
Carbon taxes will be implemented in Singapore from 2019. These taxes will be levied on the largest direct emitters of greenhouse gases, such as power plants.
Consultations with industries have been completed and the authorities are in the midst of public consultations.
When it comes to considering the appropriate size of the carbon tax, the overarching balance that needs to be struck is between the economic concepts of efficiency and equity.
On the efficiency front, a measure to reduce carbon emissions is necessary if Singapore is to have any chance of meeting its carbon-reduction obligations under the Paris agreement to curb fossil fuels that harm the planet.
As things stand, global carbon emissions are on track to increase global temperatures by more than 2 deg C, the limit beyond which a catastrophe is very likely to happen.
Too much of the world's resources are being allocated to producing goods and services that result in overly high carbon emissions. A high carbon tax is often seen as necessary to discourage carbon emissions.
The superiority of a carbon tax over other measures such as tradable permits - another form of carbon emissions pricing in which firms are given a permit to carry on carbon activities - lies primarily in the fact that carbon taxes are easier to understand and implement.
Unlike tradable permits, they result in stable carbon prices that enable firms to make necessary plans for adjustments, such as in making future business investment decisions.
On the equity front, things are more complex. First, while the carbon tax will be imposed only on large direct greenhouse gas-emitters, there will be knock-on effects on the rest of the economy.
Power plants will pass on the tax, at the very least partially, in the form of higher electricity prices. This will affect all households and firms, whose electricity bills will rise. The higher costs for firms may be passed on in the form of higher prices for goods and services. One further upshot is that the carbon taxes, if sufficiently large, may stimulate inflation.
LOW-INCOME HOUSEHOLDS HIT
The extent of the price increase will depend on the extent to which firms can pass on increased costs of production as higher prices.
Here, unfortunately, lies one source of inequity. Necessities, for which consumers have the lowest sensitivity to prices, would see the largest increases as households do not have the option of going without them.
In contrast, luxury items would see little rise in prices as firms are less able to pass on cost increases as consumers have the option of simply going without them.
Furthermore, the lowest-income households spend the largest proportion of their income on necessities.
According to the 2013 Household Expenditure Survey, households in the bottom income decile spent 9.9 per cent of their monthly income on food. The figure for households in the top decile, in contrast, was just 4.2 per cent.
Expenditure on electricity and gas showed a similar picture, taking up 4.1 per cent and 1.9 per cent of the monthly incomes of households in the bottom and top deciles respectively.
In short, carbon taxes may result in the largest erosion of the purchasing power of the poorest households.
The superiority of a carbon tax over other measures such as tradable permits - another form of carbon emissions pricing where firms are given a permit to carry on carbon activities - lies primarily in the fact that carbon taxes are easier to understand and implement.
This tension between efficiency and equity will affect the so-called optimal amount of tax. Efficiency concerns would demand a higher tax to reduce carbon emissions and push the carbon tax towards the upper limit of $20 per tonne that the Government had publicly stated.
Equity concerns, meanwhile, would demand a lower tax to minimise the impact on low-income households and push the eventual carbon tax towards the lower limit of $10 per tonne.
A further consideration would be whether there are accompanying measures and how well they would work. For example, the carbon tax is not the only measure in place to reduce carbon emissions.
The restructuring of diesel taxes, the extension of the carbon emission-based vehicles scheme till Dec 31 this year, and the enhancement of early turnover schemes encouraging early replacement of older and more pollutive commercial diesel vehicles all work towards reducing carbon emissions. The better these schemes work, the lower the carbon tax required in meeting carbon-reduction obligations. Hence, there is a need to take a holistic or inclusive approach in determining the optimal level of carbon taxes to be implemented.
Similarly, the impact on low-income households must be assessed carefully.
The effects of the carbon taxes must not be studied in isolation. The sum of the effects of higher water prices, increased U-Save rebates, GST vouchers and the like should be studied jointly to determine the net effect on low-income households, and whether carbon taxes should lean towards $10 per tonne or if another layer of rebates is necessary.
Between the two, it is probably better to keep the carbon taxes high enough to achieve its efficiency objective and introduce a separate rebate to deal with the consequent inequity, if necessary.
THE IDEAL TAX
Any form of carbon-emission reduction costs money as firms and households are compelled to use more expensive energy and newer technology and incur mitigation costs as in carbon pricing.
The revenue collected from a carbon tax may be used to reduce other taxes, and this benefit itself may partially offset the costs of carbon-emission reduction.
The carbon tax rate will rise over time. The optimal or ideal tax should be calculated based on the link between carbon content and damage to health, productivity and the economy. Studies will be needed to try to quantify this link between carbon content and societal damage. In that way, people can readily see the need for a carbon tax and the amount levied.
A carbon tax is definitely necessary and post-Paris is the best time to implement it as other countries' implementation of their carbon-reducing measures would mean that Singapore's carbon taxes would not reduce its relative international competitiveness.
However, in working out what should be the quantum levy for the carbon tax, a more broad-based and inclusive view of the efficiency and equity impacts must be taken. Only then can the two be weighed and an informed decision made.
Euston Quah is professor of environmental economics and head of economics at Nanyang Technological University. He is also president of the Economic Society of Singapore. Christabelle Soh is an economics teacher with the Ministry of Education.
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