For China, benefits of carbon tax far outweigh the costs

Frederic Neumann and Wai-Shin Chan say a carbon tax would not only be good for China's environment, but would bring the economy the benefits of efficiency and extra revenue

PUBLISHED : Monday, 11 November, 2013, 7:00pm
UPDATED : Tuesday, 12 November, 2013, 4:29am

That China needs to give its growth engine a tune-up is hardly in doubt. With the economy slowing for the past several years, all eyes are on the third plenum of the Communist Party. Hopes are that the leadership will unveil structural reforms aimed at putting the economy on a sustainable trajectory. Interest rate liberalisation, privatisation and deregulation are high on the wish list of investors and reformers alike.

But there is an equally important, if less talked about, potential initiative: a carbon tax. With China recently topping the US as the world's biggest contributor to greenhouse gases, and its cities periodically gripped by crippling smog, a levy on carbon emissions would be among the most consequential reforms officials could adopt. The Ministry of Finance has already proposed its introduction. It now needs the explicit backing of the leadership to see the light of day.

Raising the cost of energy would force rationalisation in many pockets of Chinese industry

China has made vast strides in environmental protection in recent years. But a lot more needs to be done to curb harmful emissions. Various schemes are being tried. A cap-and-trade system is already up and running in Shenzhen and is slated to start in six other pilot regions.

But arguably easier to implement in China, and thus among the most promising, is a fixed charge per tonne of carbon emitted by industrial polluters. This would rise over time, progressively strengthening incentives for the adoption of cleaner technology.

With production becoming less carbon-intensive, the environmental benefits are obvious. Cao Jing, an economist at Tsinghua University in Beijing, estimates that even a gradual introduction of a carbon tax would cut emissions by a whopping 19 per cent by 2020. This would go a long way towards meeting China's pledge of reducing the carbon emitted per unit of gross domestic product - though not the absolute level of emissions - by 40-45 per cent from 2005 levels by the end of the decade.

Less well understood, but of equal importance, are the economic benefits.

First, a carbon tax would encourage gains in overall efficiency by spurring the adoption of more advanced technology. With productivity growth slowing, raising the cost of energy would force broader rationalisation in many pockets of Chinese industry, including steel and cement where highly inefficient producers continue to operate.

Boosting productivity growth is key to sustaining China's growth. Naturally, as the economy matures, such gains will be harder to attain. Yet, in China, the need to raise efficiency is especially acute: financial risks have grown amid rising debt, and a vast demographic turn - thanks to the one-child policy - is forcing China to shift away from a labour-intensive growth model.

Second, government revenues would receive a welcome boost. Even a fairly modest carbon tax to begin with could bring in between 90 billion yuan (HK$114 billion) and 460 billion yuan annually, or up to 0.8 per cent of GDP. Over time, as more and more industries are brought into the scheme, and the levy is pushed up, revenues would climb considerably higher. This would be the case even if, as intended, energy-saving measures start to produce results.

Extra revenue could be used to ease the adjustment pains that structural reforms inevitably entail - and that dangerously harden opposition to the process. For example, tax breaks could be offered to firms to keep workers on the payroll, at least for a while, who might otherwise be fired. This could help avoid a politically challenging spike in joblessness and thus speed up the implementation of structural reforms.

Meanwhile, Beijing could share some of the extra income with local governments, reducing their reliance on land sales at inflated prices to plug budget gaps. The Ministry of Finance has already budgeted 5 billion yuan to reward local authorities if they meet pollution reduction targets. Such revenue sharing from a carbon tax would also reduce the need to add more debt to pay for infrastructure investment, something that has fuelled the precarious growth of the shadow banking system in recent years.

Third, a carbon tax would slow imports of fossil fuels. This represents a direct cost saving for the Chinese economy that would boost growth in the long run. Last December, China overtook the US as an importer of crude oil, and is already the world's largest buyer of coal. Slowing the pace of such overseas purchases would leave more money to be spent at home - a key strategy in China's structural economic reforms.

Extra taxes, of course, whether in China or elsewhere, are never popular. One ready objection is that they burden businesses and slow investment. But, in China's case, a carbon tax might end up raising, not slowing, growth. For one, the country already spends plenty on investment - by some measures close to half of its gross domestic product - but needs to work harder at allocating it wisely. A carbon tax, coupled with stricter environmental regulation and enforcement, would render inefficient projects harder to sustain.

In addition, for the economy as a whole, a carbon levy would help generate savings by limiting environmental damage. Take health care: its costs have soared in recent years, reflecting in part China's rapidly ageing society. But environmental degradation, including air pollution, is playing a critical role as well.

A recent statistical study estimates that life expectancy in northern China was cut short by five years thanks to a rise in pollution-related illnesses. Clearly, a carbon tax alone would not remedy this. But it would offer an important first step in curbing the hidden costs of pollution, and, in the process, help China's economy evolve along a more sustainable path.

Frederic Neumann is co-head of Asian Economics Research at HSBC. Wai-Shin Chan is a climate change strategist at HSBC