Issue 6 Article 6

The Costs and Benefits of Carbon Taxes

25/6/20

By:

Lee Zhe Yu, Nathan

Edited:

Elijah Chew Ze Feng

Tag:

Ecology and Environment

In 2025, the Singapore government allowed firms to roll over their carbon offsets from the emissions year 2024 onwards due to the “constrained supply of international carbon credits for emissions year 2024”, sparking concerns as to whether such a policy could promote carbon tax avoidance and limit the effectiveness of Singapore’s carbon tax framework. To understand the complexities involved in this issue, we must first gain a fundamental understanding of how carbon taxes work in theory.

(Carbon) Taxes

A tax is essentially a policy that imposes an additional payment to the government. This can be achieved by imposing it on suppliers who produce goods, or consumers who purchase said goods. Either way, the quantity sold of goods decreases, while the government earns revenue.

Figure 1: Graphical illustration of a flat tax levied on suppliers of a good. When the tax is levied, it is costlier to produce goods, causing producers to produce less goods.This results in a leftward parallel shift of the supply curve from S0 to S1. Assuming the demand for the good remains constant at D0, the final equilibrium quantity (i.e. the quantity of goods sold when the market is stable) falls, and the government makes a revenue as highlighted by the red rectangle.

In the context of a carbon tax, the government is imposing a tax on carbon emissions a company generates while producing goods.

Carbon emissions mainly consist of carbon dioxide and are released into the atmosphere from human activities, chiefly the burning of fossil fuels to power various industrial production processes. Carbon dioxide, being a greenhouse gas, can absorb the infrared energy reflected off the Earth and re-radiate it back to the ground. At small amounts, such gases are required for Earth to maintain a suitable climate and temperature for life to exist. However, large amounts of these gases trap and release a significant amount of heat energy back into the atmosphere, causing global warming. At the rate of our current carbon emissions, the average global temperature is expected to rise by 1.7 to 2.4 degree Celsius by 2100, according to a McKinsey report. Such a temperature rise has severe environmental ramifications, from causing desertification to increasing flooding occurrences caused by the melting of polar ice caps. Needless to say, carbon emissions have a negative impact on society.

However, when firms make a decision on how much goods to produce, they often fail to account for the negative societal impact of the environmental damage caused by its carbon emissions. This causes a negative externality (in other words, an external cost that is ignored by firms in this case) to manifest in this scenario, resulting in a deadweight loss in this socially inefficient (i.e. suboptimal) outcome.

Figure 2: Graphical illustration of a negative externality in the market. A firm would determine the quantity it produces according to its private production costs as shown by the supply curve S0. However, the true social cost of production accounts for the negative externality, causing the supply curve S0 to undergo a pivotal leftward shift to S1. This is assuming that when there is no production of goods, the firm does not produce carbon emissions, hence both supply curves will have the same y-axis intercept. Hence, at the quantity that the firm chooses to produce based on S0, a deadweight loss as highlighted by the triangle in red develops as the true cost of production is determined by S1.

To eliminate the deadweight loss, the government hence imposes a per-unit carbon tax to “internalise” the negative externality. With the tax, firms face added costs from producing carbon emissions, incentivising them to reduce their environmental impact of production and produce according to the socially optimal supply curve. This results in a socially efficient market, eliminating the aforementioned deadweight loss.

Singapore’s Carbon Taxes

Singapore is one of Asia’s trailblazers in the carbon taxation market, having enacted Southeast Asia’s first carbon tax in 2019. Initially, the taxation rate was set at $5 per tonne of carbon dioxide equivalent emissions. This was raised to $25 per tonne in 2024, and is expected to reach $50 - $80 per tonne by 2030. The consequent governmental revenue earned from the tax would then be channelled towards decarbonisation efforts amongst other green initiatives.

The Drawbacks

While such efforts are commendable, there are inevitably flaws and trade-offs with every economic policy. With utilities companies subject to carbon taxes, they pass on a proportion of these additional costs to consumers, resulting in higher electricity and water bills for Singaporean households. This could disproportionately affect poorer households that are less able to absorb the additional costs of using such utilities.

In addition, it is challenging to quantify the costs of carbon emissions in terms of actual and potential environmental harm. With the state suffering from imperfect information and the inherent subjectivity in the value of the environment, it is practically impossible for Singapore to objectively determine a suitable amount of tax to be levied in order to achieve a socially optimal outcome.

Finally, the carbon tax reduces the competitiveness of Singapore-based firms. With these additional costs in production, firms would have to sell their goods at a higher price than their overseas competitors, causing their customers to shift their consumption to the relatively cheaper overseas firms. In addition, Singapore might lose some of its attractiveness for foreign firms with the additional carbon costs, causing foreign firms to leave Singapore for more favourable markets. With Singapore’s limited size and lack of natural resources, it is heavily reliant on foreign investment by multinational corporations and cannot lose them to regional rivals.

This is especially pertinent with the energy and chemicals industry being Singapore’s second largest manufacturing sector and a cornerstone of Singapore’s economy. However, companies in these industries generate significant amounts of carbon emissions, leading to significantly increased costs faced by such firms with the implementation of the carbon tax. This scenario highlights the inherent trade-offs Singapore faces between protecting the environment and safeguarding its economy. To mitigate the impact of the carbon tax, Singapore offered petrochemical companies and refiners an up to 76% carbon tax rebate for 2024 and 2025 to ease their cost strains.

International Carbon Credits

Singapore’s government is cognisant of these trade-offs, hence has allowed firms to purchase International Carbon Credits (ICCs) from other countries to offset up to 5% of their taxable emissions from 2024. These countries include Chile, Rwanda, Papua New Guinea, Ghana, Bhutan and Peru. These credits, which are priced lower than the carbon tax rate, allows companies to receive discounts on their carbon emissions while funding projects aimed at reducing carbon emissions in the partner countries.

While ICCs seem promising, they have had their own set of limitations. A limited supply of these ICCs have resulted in the government allowing companies to carry over unused offsets to 2025 as mentioned in the introduction. However, this programme has attracted criticism from academia. Senior research fellow Kim Jeong Won from the NUS Energy Studies Institute mentioned that “repeated rollovers may have companies expecting that this will be also allowed in following years” and give them a “strategic option as a tax evasion”, especially since that the cost of ICCs are lower than the carbon tax rate. She also added that “the percentage carried over [in potential future rollovers] needs to be adjusted to prevent companies from banking offsets for future use when the carbon tax rate is higher”.

Conclusion

Ultimately, there is no silver bullet to solving our environmental crisis. Beyond demand-side policies like environmental education to reduce demand for goods and services that incur carbon emissions, supply-side policies like carbon taxes are required to incentivise companies to reduce their carbon emissions, either by reducing production or investing in green research and development. With these policies being inherently imperfect, however, saving the environment ultimately requires the cooperation of all stakeholders.

References:

Image Credit:

https://amro-asia.org/wp-content/uploads/2024/02/carbon-pricing-16-9-scaled.jpg
Graphs plotted on Desmos

Issue 7 - July 2025

The Costs and Benefits of Carbon Taxes