Global Trends in Carbon Taxation and its Effect on Tax Administration

Since the 1st taxation system, traced back to Ancient Egypt around 3000-2800 BC, the art of collecting and imposing taxes has evolved. For instance, Arthur C. Pigou, an economist and one of the contributors to the externality theory, brought awareness that economic activities result in other costs that are not typically considered in the final price of a product/service. He referred to these costs as ‘Negative Externalities’.

Negative externalities are cost to 3rd parties not directly involved in the activity that produced the cost. These costs or 'negative externalities' could present in various forms like pollution, climate change, habitat destruction, and so much more. To internalise Negative Externalities, Arthur C. Pigou suggested ‘The Pigouvian Taxes’.

Pigouvian Taxes aims to solve market inefficiencies through an increase in cost after recognising negative externalities. It implies that the final price of a product/service considers the total social cost of the economic activity, that is, the original cost plus the negative externalities cost (which is usually in the form of a tax)

Pigouvian taxes are effective in generating revenue for the government as well as discouraging harmful activities. It also encourages innovation and a more positive outlook, leading to a greener future. Green taxes are a subset of the Pigouvian tax; they target negative environmental impacts.

Carbon Tax

Greenhouse Gas (GHG) tax or Carbon tax is imposed on hidden social costs of carbon emissions. It is a form of environmental pollution tax charged per ton of emissions. It aims at exposing the actual cost of burning fossil fuels. Fossil fuels are coal, petroleum, natural gas, oil shale, bitumen, tar sands, etc. They contain carbon and are predominantly a source of energy worldwide.

Burning carbon-rich fuel produces greenhouse gases (GHG) like carbon dioxide, nitrous oxide, etc. These gases can trap the heat of the sun, causing global warming. The level of GHG in the atmosphere has been increasing in recent times; this is the leading cause of climate change. The Intergovernmental Panel on Climate Change (IPCC) Sixth Assessment Report (AR6) released in 2023 reveals that greenhouse gas (GHG) emissions have steadily increased over the past decade.

In 2019, about 59 gigatonnes of carbon dioxide equivalent (GtCO2e) was reported by the IPCC, which is approximately a 54% increase in 1990's GHG emissions. This data is alarming because previously set climate targets at the country level will no longer significantly reduce GHG emissions since there is a consistent increase in emissions and insufficient efforts towards emission reduction and removal globally.

Studies have proven that implementing a carbon tax policy alongside other innovative solutions could effectively reduce emissions and positively contribute to achieving net zero targets.

Recently, regulations have emerged to tackle climate-related issues and promote carbon taxes. However, this has led to Carbon leakages. A carbon leak is a situation where there is a movement in emissions. For instance, an entity can move its core operations from a strongly regulated country to another country with little to no regulation. Usually, the motivation behind this movement (carbon leak) is to avoid carbon taxes and other climate regulation expectations, resulting in the neglect of Global Net Zero goals.

A mechanism that directly tackles Carbon leakages is the World's 1st Carbon Border Tax, called the Carbon Border Adjustment Mechanism (CBAM), introduced in the EU. CBAM is inspired by the 2050 Carbon-neutral goal. Aside from discouraging businesses from moving production to more tolerant countries, the carbon border tax is a pillar of the EU's current climate regulations and policies.

The border tax is levied on certain imports to the EU. Its implementation would consider Carbon-intensive industries and mandate them to purchase certificates to cover emissions generated during the creation of their products.

Carbon tax encourages transitioning to clean energy, developing innovative and sustainable technologies, generating income for the government, and inevitably achieving a more sustainable future, as asserted by the World Economic Forum (2021).

Regulatory activity in Nigeria

In Nigeria, the Electricity Act of 2023 promotes embedded generation, hybridised generation, co-generation, and electricity generation from various renewable sources. This is a significant step in the right direction as it encourages the percentile growth of renewables in Nigeria's energy composition.

The introduction of tax incentives in Section 166 of the Act further promotes commercial activities in renewable energy projects. Encouraging investments in the renewable energy industry in Nigeria is quite crucial in meeting the Nation's 2060 Net zero goal. The provisions of this act will also assist with implementing Nigeria's Energy Transition Plan (ETP), which was approved after the announcement of the Climate Change Act in 2021.

Decarbonising oil and gas production is a global concern, and Nigeria is not left out as she has maintained the top 10 ranking of flaring countries for over ten years with a 10% rise in flaring intensity as stated in World Bank's 2022 Global Gas Flaring Tracker Report. This proves the need to intensify National efforts to reduce the volume of gas flared.

Section 104 of the Petroleum Industry Act 2021 permits a licensee, lessee, or marginal oil field operator to flare gas in the event of an emergency when the Commission has granted an exemption or when such flare is an acceptable safety practice under the regulation. The Associated Gas Reinjection (Continued Flaring of Gas 1984) Regulation aimed to reinject gas produced in connection with oil and not utilised in an industrial project alongside penalising unpermitted flaring activities. However, this regulation still permits gas flaring if a certificate has been issued.

Stringent enforcement of Nigeria's anti-gas flaring laws and embracing renewable energy can be instrumental in reducing the Nation's emissions.

Drawbacks and Solutions for a Successful Carbon Tax Administration

The extent and significance of the drawbacks are highly dependent on the specific design and implementation of the carbon tax policy; however, emphasis is placed on general issues that could affect organisations, regulatory bodies, and other stakeholders affected by a carbon tax policy.

Tax Administration Challenges

Designing and implementing a carbon tax system is complex and requires specific administrative resources. The issues in implementing a suitable tax for polluting entities include determining a fair tax rate that reflects the external costs of emissions, preventing evasion, and ensuring compliance. Political considerations may weaken the effectiveness of carbon tax policy administration.

Governments must ensure that proper groundwork has been completed before implementing their carbon tax policy, as this would significantly aid the entire tax administration system. The tax policy should also cover potential carbon leakage situations (if any) to ensure fairness to domestic/indigenous firms and international organisations.

It is also beneficial if governments acknowledge that a carbon tax policy alone cannot substantially reduce emissions. It implies that additional measures and incentives must be employed in addition to the carbon tax policy. Incentives are attractive techniques to promote sustainable practices, and they can come in diverse forms like tax deductions, tax credits, tax holidays, accelerated depreciation, and so much more.

Incentives encourage research into eco-friendly technologies, alternative methods of conducting business, alternative sources of energy, i.e. green energy, and so much more.

Economic Impact

Carbon tax leads to increased costs. Several businesses and industries are heavily reliant on fossil fuels, which implies that the taxes, as well as the final price of their products and services, will be on the high side. The economic impact leads to negative social impacts like potential job loss, poor working conditions, economic downturns in the industry, and so on.

A successful carbon tax administration needs other policies that reduce the negative impact of the tax on businesses and individuals.

Emission Reduction

Carbon taxes act as a significant deterrent to emission generation; however, they do not eliminate emissions. Responsible organisations will most likely invest in research and development to find alternative energy sources or develop a net zero plan to avoid the tax, but this is not the situation for typical organisations. When the tax and penalty are insignificant, they no longer serve the purpose of reducing emissions.

Furthermore, carbon taxes primarily target fossil fuels and do not account for other carbon compounds, such as Methane, which is typically produced during the decomposition of organic matter. Additionally, the production of Ethanol also has negative impacts on the environment. Typically, only emissions from burning fossil fuels are tracked for tax purposes, leaving out other sources of emissions. This is a significant limitation in the administration of a carbon tax policy.

Conclusion

Reducing emissions is a global concern. Therefore, various strategies to achieve this will continue to be explored in the coming years. Green taxes present a solution that discourages traditional energy sources and embraces new emission-reducing technologies. Worldwide, countries implement this as a tool for achieving their net-zero targets.

It is crucial to acknowledge the impact that entities' operations have on the environment and take necessary measures to address them. Collective efforts geared toward a safe and sustainable future ensure that our actions today do not compromise the well-being of future generations.