Economics and Environmental Implications of Carbon Taxation in Malaysia: A Computable General Equilibrium Approach

The simulation result shows that the carbon taxation is effective to control the rise in CO2 emissions in a positive economic performance, if the tax revenue is recycled back to the econ

Economics and Environmental Implications of Carbon Taxation in Malaysia: A Computable General Equilibrium Approach

Pui Kiew Ling

University of Malaya, Malaysia

Abstract

Due to high use of energy input in industrialization process, Malaysia has experienced a continuous rise in emission coinciding with the period of rapid economic development Against the backdrop, the paper has taken initiatives to examine the economy-wide impacts of carbon taxation in Malaysian economy The inevitable use of energy inputs in production chains and consumption necessitates an assessment covering economy-wide framework The paper, has therefore applied, computable general equilibrium model for the

empirical analysis The model adopts Malaysia Input-Output Tables 2010 as the main database in the simulation

The investigation assumes three hypothetical carbon taxation ranged from RM50/tonne to RM300/tonne (~USD12-70/tonne) CO2 These tax rates are imposed on crude oil, natural gas, and coal which are the main energy inputs to produce petroleum products and electricity The simulation result shows that the carbon taxation is effective to control the rise in CO2 emissions in a positive economic performance, if the tax revenue

is recycled back to the economy as compensation scheme Compared to the standalone carbon taxation policy, the tax recycling reform does appear more economically acceptable considering inflation impact and employment rate At sectoral level, the energy intensive industries become more efficient in managing their energy use, as intended As the policy implications, the paper recommends that the country may consider implementing carbon taxation by phased-in gradually to promote energy saving and emission control while keeping economic competitiveness In conclusion, Malaysia may introduce a policy package with a carefully designed carbon taxation system, in combination with revenue recycling measures, for a more balanced economic efficiency and environment conservation in transitioning towards a more sustainable economic growth

Keyword: emission control; energy conservation; environmental fiscal reform; double dividend effect

1 Introduction

Following a rise in economic development and standard of living, the world CO2 emissions have been increasing throughout the period (IEA, 2016) The close economic-energy relation may has resulted an irreversible impact on the global economy in the future, if there is no mitigation action is taken against the rising use of energy commodities in production activities The concern for a continuous economic benefit reflects the urgency of tackling the energy-environmental impact, at both local as well as global levels Implementation of the Paris Agreement in 2015 contributes to the achievement of Sustainable Development Goals which helps to reduce emissions and builds climate resilience internationally A more practical key issue

is to trace appropriate instruments for making progress on the emission mitigation pledge at country level, both developed and emerging economies

In Malaysia, the country has incurred a continuous economic growth since phrasing towards industrialization in 1980s Coinciding with economic development and a growing population, the country has been experiencing a continuous energy use over time (Department of Statistics Malaysia, 2018; EC, 2016; IEA, 2016) Compared to 2000, National Energy Balance 2015 states that final energy consumption has risen nearly 80% in 2015 The International Energy Agency reports further that CO2 emission in Malaysia has reached 220 million tonnes in 2015, which is almost double compared to 2000

One major contributing factor for the rising emission in the country is the failure of markets to take into account the environmental implications into prices, either directly on energy commodity itself, or on goods and services Theoretically, the emission cost, or simply called externalities, should be internalized by incorporating it into market prices For this purpose, past literature commonly agrees that carbon taxation is one effective economic instrument for achieving energy saving and environment conservation with the condition that it would continue to generate economic growth (Wang and Chen 2015)

The carbon taxation plays a role in signaling an efficient use of energy input and output, which then influences the long term direction of economic development (Ekins and Speck, 1999) and environmental quality (Wolfson & Koopmans 1996) Theoretically, the tax rate is determined in proportion with quantity of emission produced, for instance per tonne of carbon6 (Speck 2013) The carbon tax could be imposed directly onto prices of energy input itself, or indirectly on goods and services By putting back the energy price to its market level, the carbon taxation would automatically adjust output production back to efficient level, which may then cut down emission to some extent (Wolfson & Koopmans 1996) At the same time, the carbon tax provides one mean to generate tax revenue for handling fiscal deficits The government could allocate the tax revenue to improve economic performance and environmental quality The economic and environmental benefits, or the so called double dividend effect, makes the carbon taxation one attractive instrument for emission controlling while keeping economic competitiveness

Refer to Table 11, transportation sector alone has accounted nearly one third of CO2 emission over the years 2001-2015 (Table 11) Petroleum product is the most crucial energy type used in the transportation sector In terms of energy mix, crude oil represents the most important energy input for petroleum products’ production

in Malaysia (EC, 2016) Meanwhile, natural gas and coal accounts more than 80% of total energy inputs used

in power stations (EC, 2016) This calls for an examination to impose carbon taxation on crude oil, natural gas, and coal to encourage an efficient use of petroleum products and electricity

Table 11 Sectoral CO2 emissions in Malaysia (IEA, 2018)

Year

Total CO2

emissions

from fuel

combustion

Electricity including co-generation

Other energy industry own use

Manufacturing industries and construction

Transport Transport Land sectors Other

6 A carbon tax could be translated into CO 2 tax as a tonne of carbon corresponds to 3.67 tonnes of CO 2

2013 207.2 95.9 17.9 29.1 56.7 56.5 7.7

The objective of the present paper is to analyze the economic and environmental implications of the carbon taxation With this regard, the present study has extended the relevant local literature by incorporating two contributions in the paper Firstly, Malaysia currently has not implemented carbon tax on energy inputs or goods and services In general, the carbon tax is not common in developing countries, considering the subsequent economic cost on inflation and export competitiveness Given the rising emission level in the country, a detailed study on economic impacts of carbon tax is therefore necessary, before actual implementation The study first conducts the investigation by retaining all the tax revenues in government’s coffers The reasons are, firstly, to trace the sole impacts of carbon taxation on the economy; and secondly, due

to the increasing pressure to reduce the large government deficit

A complementary measure may become necessary to reduce the economic cost of carbon taxation, if any Nevertheless, the significance of the carbon taxation in emerging economies especially is justified by its capacity to raise tax revenue From literature, political economic constraint posits that recycling carbon taxation revenue back to economy, or the so-called environmental fiscal reform, is always efficient than standalone carbon taxation in compensating economic loss The study therefore intends to re-examine the economic impacts of carbon taxation after allocating back all the tax revenues as cash transfer to households The purpose is to confirm whether tax revenue reallocation through environmental fiscal reform (EFR) is always better than the standalone carbon taxation in yielding double dividend effect

The study adopts computable general equilibrium (CGE) model as method for the assessment The simulation results present a difference between the zero-tax scenario and the tax scenario The study conducts

the simulation using the latest Malaysia IO Tables, 2010, as the main database The flow of investigation is

guided with two hypotheses as stated below Answers for these two hypotheses give hints for the policymakers to evaluate whether the carbon taxation is one effective solution for slowing down the rising

CO2 emissions in the country

H1: The carbon taxation helps to reduce CO2 emissions, however at some economic costs

H2: The tax revenue reallocation is more effective to generate double dividend effect

The findings of this paper allow policymakers to take better and more informed decisions, by providing an economy-wide impact and cross-sectoral analysis of reducing emissions by implementing a national carbon tax Efficient energy consumption and stabilizing greenhouse emissions could come together with continuous economic growth with policy enforcements are undertaken appropriately The emissions control should be reduced by minimizing the unnecessary energy use, not at the cost of a lower output production The emissions decoupling should occur at a lower energy use and emissions control while keeping economic competitiveness

The rest of this paper is structured as follows In Section 2, the study presents some relevant literature review to stress out the need of conducting this research Section 3 provides some backgrounds of the CGE model and simulations employed to run the carbon taxation policy The next section provides empirical analysis of the simulations The analysis revolves economics and environmental impacts of the different carbon tax simulations at both macro and industrial level The paper proceeds with some corresponding policy recommendations and suggestions The final section provides some concluding remarks

2 Literature Review

The carbon taxation itself plays a significance role in energy saving and environment conservation through

a more efficient use of energy and a substitution towards less carbon intensive energy The carbon tax may influence carbon emission through a change in energy price Looking from economic perspective, the carbon tax may increase energy prices, as it is imposed directly on energy inputs or energy intensive products Due

to cost consideration, some producers may pass on the cost increases to customers by charging higher output prices on energy input itself or final goods and services The price increase may lead to a drop-in demand for

it, forcing its production levels down, and subsequently the emission level

At economy-wide perspective, the subsequent impact on inflation and industrial competitiveness loss may result in some economic cost The extent of implications may vary with energy share in production, energy structure, industrial structure, as well as socioeconomic level (Zhang et al., 2016) The impacts may then spread

to the whole economy through energy efficiency, energy substitution, production cost, industry competition, and labor market adjustment (Bruvoll and Larsen, 2004) The empirical studies have therefore long advocates the CGE model as one appropriate method for examining the economy-wide carbon taxation policy

Currently, there are a handful of literature on economic and environmental impacts of carbon taxation At the earlier periods, the relevant literature is dominated by developed countries The developing countries have shown an increasing concern in making use of carbon taxation for emission mitigation in recent years In general, the literature agrees that carbon tax is one policy effective for handling the rising emission

A recent literature by Guo and Liu (2016) found out that the carbon tax was effective to cut down energy use in especially the energy intensive sectors such as manufacturing and transportation industries Orlov et

al (2013) wrote that the increase in energy prices caused a fall in demand for electricity and natural gas in Russia with coal as the most pronounced

Bruvoll and Larsen (2004) found that carbon tax was effective to lead to a fall in emission intensity in Norwegian economy through a change in energy mix Similar evidence was obtained by Siriwardana et al (2011) from Australian economy that energy consumption and emissions were lower compared to without the carbon tax Nordhaus (2007) demonstrated that the long run effect on emission reduction should be greater than its short run effect One reason is that the carbon tax policy becomes more likely to induce energy saving

or greener technology innovations as time passes These findings confirm the effectiveness of carbon tax on energy savings, as well as bringing down emissions level

Further empirical studies show that the carbon tax, however, may cause at a slower economic growth as its opportunity cost Whether in developed countries or developing countries, the literature reveals that levying a carbon tax may generate a negative impact on economic growth As stated by Nurdianto and Resosudarmo (2016), the carbon taxation was effective for environmental gain in some Asia countries, yet it could come at a cost in terms of GDP contraction and decline in households welfare Cabalu et al (2015) also stated that the carbon taxation may result in a gain for the environment which is intended, with a cost in terms

of GDP contraction as well as household income reduction in the Philippine economy

The study by Siriwardana et al (2011) found out further that the introduction of the carbon tax in the Australian economy led to a contraction of the size of the economy overall, particularly it lowered real household consumption The similar results were also found in China where both Sun and Kuang (2015) and Zhang et al (2016) wrote that the carbon tax was helpful to reduce carbon emission, yet it was accompanied with a slowdown in the economic performance Meanwhile, in the Indonesian economy, Yusuf (2008) also found a slight fall in the GDP and private consumption after the carbon tax implementation

McDougall (1993) estimated the short run sectoral and economy-wide effects of a carbon tax at a rate of $25 per tonne in Australian economy in the earlier period, 1991-92 Coinciding with studies at later periods, the results revealed that the CO2 emission did fall as expected, but real GDP performed lesser compared to without

the carbon tax Other macroeconomic indicators such as employment and export also responded negatively

to the carbon tax The results basically yielded a consensus that the carbon tax reduced energy consumption and emissions, with a slight fall in economic growth

However, if governments are persistent, the carbon tax policy may generate a positive impact on economy and environment one day Subsequent the carbon tax, the increase in production cost may induce sectors to adopt more energy efficient technologies or to shift towards a cleaner input mix among industries and households (Orlov et al., 2013), which accelerates the CO2 emission to fall

In recent years, the concern on industries’ competitiveness loss has been frequently quoted as one reason for rejecting the carbon tax (Harnay and Rème, 2012) Among sectors with the potential for disproportionate impact include heavy manufacturing and energy intensive industries, which deserves a deeper consideration

in policymaking Zhang et al (2016) revealed a significant contraction in energy intensive sectors’ output Liang

et al (2016) demonstrated that without any complementary measures, a carbon tax may negatively affect export competitiveness of almost all tradable sectors Anderson and Ekins (2009) showed further that the introduction of carbon taxation may impair the competitiveness of some affected companies Meng (2012) mentioned that the introduction of carbon tax in Australia from 1 July 2012 had triggered a tremendous fear

in resources sectors Therefore, some countries offer tax exemption on a certain sector or an energy input type,

in order to retain the industries’ competitiveness, as before the carbon tax introduction In empirical studies, Abrell (2012) found out that the exemption of transport sector generated a lesser welfare loss in European countries compared to without the tax exemption

The past literature commonly agrees that, carbon tax is an effective step to reduce emission, but its rate should be imposed at appropriate rate for it to take effect Guo et al (2014) revealed that a moderate carbon tax was sufficient to reduce carbon emission and energy consumption, despite it may still came at a slight fall

in economic growth Wang and Liang (2014) argued that the carbon tax policy could be introduced with a low rate at the initial stage as it may not strongly exacerbate inquietly in primary income distribution A higher carbon tax was not suggested at the initial implementation due to its possible impact to jeopardize economic impact and social welfare Sun and Kuang (2015) argued that the higher the tax rate, the higher the loss of GDP growth Chiu et al (2015) examined four possible carbon tax regimes ranging from US$20 to US$50 per ton of CO2 in the Taiwan gasoline market The paper found out that a higher level of carbon tax was more effective to induce a reduction in gasoline consumption, through a reflection in higher gasoline price Despite the effectiveness, Siriwardana et al.(2011) noted that sectoral outputs tend to contract at an increasing rate with the level of carbon tax

One reason to explain the economic loss, as found out in the prior literature, is because the tax revenue is being retained in the economy as government’s extra income The priorities on economic development, poverty reduction, and improvement of living standards often lead to an opposition when the carbon taxation policy comes to actual implementation (Liang and Wei, 2012) The feasibility of carbon taxation in the real economy has become a source of controversy between economists and politicians which are often the policymakers Both parties agree on one consensus if the carbon taxation could stimulate a continuous economic development In the case, the carbon taxation policy may continue accessible if there is any instrument that could at least eliminate or hinder the subsequent economic costs The literature agrees that carbon taxation is still effective to reduce energy use and emissions, with the condition that the tax revenue is being recycled to accelerate economic growth and increase employment

The tax revenue raising capacity (Speck, 2013) is one attractive key feature that convinces the politicians to implement or retain its implementation Abdullah and Morley (2014) found some evidences of short-run causality running from the increased revenue from the environmental tax to economic growth in some European and Organization for Economic Co-operation and Development countries Recycling the tax revenue to economic agents seems necessary to compensate or improve economic performance subsequent the introduction of carbon taxation

The economics and environmental implications of revenue recycling, better known as EFR, depends on how the tax revenues are being recycled ERT enables the carbon tax policy to be carried out in a revenue-neutral way, that is leaving total tax revenues unchanged The essence of ETR is the shifting of the burden of taxation away from socially desirable economic activities such as on labor and capital to socially less desirable activities which entail negative environmental externalities (Vandyck and Van Regemorter, 2014) Note that ETR is not the introduction of new taxes

Orlov et al (2013) conducted a thorough study to access the double dividend hypothesis from the sectoral and macroeconomic impact of carbon taxation on the Russian economy The empirical results showed that substituting the carbon taxation for the labor tax provided a simultaneous economic and environmental benefit, thereby signifying the existence of the double dividend effect Conefrey et al (2013) also found out that the carbon taxation was able to reduce emission and stabilize economic growth in Ireland, if the tax revenue was properly recycled to reduce existing distortionary tax in the economy Specifically, the paper found that the EFR was effective to yield a double dividend effect if the carbon taxation revenue was recycled through reduced income tax, but less likely through a lump-sum transfer to households Murray and Rivers (2015) supported that EFR through tax cuts and lump sum transfer to households generated a weak double dividend effect in British Columbia as the revenue recycling did mitigate some economic losses from the carbon taxation policy

Further, Welsch and Ehrenheim (2004) found that EFR yielded a moderate double dividend effect in terms

of reduced emissions with stabilized employment and economic growth in Germany The empirical works basically support policy coordination as always dominant over the standalone carbon taxation in the real economy Markandya et al (2013) revealed a similar result was obtained for the case of Spain where the revenue-recycling effect of using the tax revenues to reduce taxes on labor or capital or to make lump sum transfers to households was more likely to yield a double dividend effect compared to a standalone carbon taxation policy Compensation for potential losers seems necessary to increase the acceptance of carbon taxation policy as the tax reallocation always yield better economic impacts

The empirical study by Siriwardana et al (2011) identified further that the substitution for the labor tax yielded a double dividend effect in the Australian economy Particularly, the paper demonstrated that cash transfers to households generated less expansionary pressure on the domestic economy compared to a reduction in commodity tax The negative impact on economic growth and factor income loss was reduced with a cut in other taxes, which is further supported by Liang and Wei (2012) Baranzini et al (2000) recognized that carbon taxation was a cost-effective instrument for reducing emissions in some European countries after its main negative impacts may be compensated through the design of the tax and the use of the generated fiscal revenues The revenue recycling could not only improve the environment quality but also it reduces the distortion of existing tax for instance income or labor tax These findings proved further that how to use the generated fiscal revenue is of fundamental importance in determining the final economic impact of carbon taxation

In the Malaysia’s literature, despite its limited number, is emerging lately Among the most relevant studies, Nurdianto and Resosudarmo (2016) found that Malaysia could benefit economically from carbon tax

as it counteracted price distortions due to the existence of fuel subsidy in the country Solaymani et al (2015) and its extended paper, Solaymani (2017) found that the carbon tax was more effective than the equivalent energy tax to reduce carbon emissions as it involved lesser cost in terms of real GDP and investment Solaymani et al (2015) showed that lump sum household transfer was more effective than labor tax recycling

in compensating the economic cost of carbon taxation with the reason that the tax interaction effect was less remarkable compared to the tax recycling effect Private consumption and households’ welfare increased after the tax revenue was reallocated to the economy through lump sum transfer In comparison, the labor tax recycling was not as effective as to raise the double dividend effect where the household’s consumption and welfare seem failed to increase up to the level as before the carbon taxation introduction

3 Method

The present study adopts CGE model to simulate the economic and environmental impact of the carbon taxation Due to the close link between energy commodities and the whole economy, the carbon taxation is better analyzed using a general equilibrium framework The model could provide a comprehensive analysis

of the economy-wide impacts of the carbon taxation The CGE model is preferred over partial equilibrium model or econometrics because of this capacity of representing the complex interdependencies in the whole

economy (Lin and Ouyang, 2014) The investigation employs Malaysia Input-Output Tables 2010 as the main

database in the simulation There are originally 124 industries and type of commodities in the IO table To suit the need of simulation, the paper has disaggregated the petroleum refinery commodity into four: gasoline, diesel, biodiesel, and other fuel The parameters of the functions in the model are adapted mainly from literature on other CGE models, and intelligent guessing when literature is not available

While energy inputs influence output production, the combustion of energy releases emissions into the atmosphere The present study has incorporated CO2 emissions matrix to simulate the economic impacts of carbon taxation This study focuses specifically on CO2, since it makes up the largest proportion of pollutants Following the formula used by the Intergovernmental Panel on Climate Change (Temurshoev 2006), this study calculates CO2 emissions by multiplying energy consumption 𝑄 with energy’s carbon content 𝐶𝐶, the carbon oxidation factor 𝜛, and the molecular weight ratio of emissions δ (Equation 1):

The present paper focuses on CO2 emission produced by industries and households Data on energy

consumption 𝑄 is obtained from in the Malaysia Input-Output Tables 2010 The energy matrix in the Malaysia

Input-Output Tables 2010 is converted first to physical terms Then, the energy data is multiplied with emission

factor to derive CO2 emission matrix Express it in a percentage change form:

3.2 Simulations

The CO 2 Emission from Fuel Combustion Highlights 2016 Edition, published by the International Energy

Agency, has long recognized transportation, and electricity sectors among the largest CO2 emitters in Malaysia for decades The high CO2 emissions in the transportation sector is attributable to heavy reliance on petroleum products (EC, 2016), for instance petrol and diesel as energy source Given the high share of natural gas and coal in total energy mix, it explains the reason CO2 emissions always increase in power plant The CO2

emissions from the electricity sector is very likely to rise in the future if service sector continues to excel This indicates a necessity to encourage a further efficient energy use in these sectors for achieving a more sustainable economic development

These tax rates are imposed on crude oil, natural gas, and coal, which are the main energy inputs to produce petroleum products and electricity The carbon taxation on these three kind of energy inputs covers nearly 90% of total primary energy supply in Malaysia for the 2015 (EC, 2016) Instead of taxing petroleum product itself, the paper puts an arbitrary tax on crude oil for two reasons; political resistance and possibly unequal distribution impacts on lower-income households The paper does not impose carbon taxation on electricity (Wissema and Dellink, 2007) consumption because its use does not cause emissions directly Despite the electricity consumption does not cause CO2 emissions directly, the electricity generation process involves a lot

of primary energy which has caused large CO2 emissions (Ren et al., 2014) The amount of CO2 emissions produced from the power plant depends on electricity generation technologies, energy intensity, and energy mix For this reason, the paper introduces arbitrarily tax on its intermediate energy including natural gas and coal This approach avoids double-taxing where only primary energy is taxed in the electricity and transportation industries; petroleum products and electricity are secondary energy

In expectation, the carbon taxation imposed on crude oil should be effective to encourage local economic agents to consume petroleum products more efficiently during driving, which it contributes to an emission reduction This study also believes carbon taxation is effective to stimulate a more efficient energy use in power plant for electricity generation The subsequent price change is expected to encourage a more efficient electricity consumption among local economic agents especially the energy intensive industries and households

Instead of the form of ad valorem, the carbon tax is imposed as a specific tax by charging the amount of money needed to pay for producing a certain quantity of CO2 emissions, that is ringgit per tonne of CO2 Regarding the tax rate, the study has imposed three carbon pricing ranged from RM50 to RM300 per tonne of

CO2 emissions Since Malaysia has never implemented carbon taxation before, an initial stage better starts with

a low rate first For the reason, the study imposes arbitrarily RM50 (~US$12) per tonne of CO2 emissions in the first scenario In the real world, developing countries prefer a lower tax rate than developed countries (Matsumoto, 2008) This main policy scenario is examined with two comparable tax scenarios, namely RM120 (~US$28) and RM300 (~US$70) per tonne of CO2 emissions The carbon price of RM120 is simulated merely to gauge the extent of variation of the impact if a carbon price usually imposed by developed countries is implemented in Malaysia The relative high carbon price RM300 would be contrasted with the low carbon price as RM50 and the medium carbon price as RM120 The comparison is conducted to recognize whether a high carbon tax could be more appropriate for stimulating a further emission cut Next, the study simulates

to return all the tax revenue to the economy as cash transfer to households The present study repeats these four scenarios in both short run and long run economic environment Sensitivity test proceeds with doubling and halving the elasticity of substitution between diesel and biodiesel

Time Period Scenario Type of Shock

tax revenue is handed back as a consumption subsidy

tax revenue is handed back as a consumption subsidy

4 Results and Analysis

4.1 Macroeconomics Impacts

Since the model used is comparative static type, the simulation output is interpreted as a new equilibrium after the economy system has adjusted to the shock The first column in Table 12 shows that an RM50 carbon tax rate resulted in a 0.0026 percent decline in real GDP in the short run The economic performance worsens with the rate of the carbon tax As energy goods are used by almost every sector, the carbon tax might lead to increase in prices of several goods and services As expected, the carbon tax came at the cost of inflationary pressure The shows that the consumer price index rose by 0.0163 percent more in the short run when the

carbon tax of RM50 per tonne was imposed That is, households needed to pay 0.0163 percent more for the same quantity of goods and services they purchased before the carbon tax policy The inflation thus weakened their purchasing power by 0.0163 percent If the economy increases the penalty on CO2 emissions, the economic performance may come at a higher economic cost and inflation At a carbon tax rate of RM120 per tonne, the economy incurred 0.0534 percent inflation in the short run

The rise in price level may affect the economy on the demand side by cutting export and import demands

in the country Facing a higher cost of energy-intensive input, the increase in production cost may push producers to reduce export for foreign countries It is because normally the local producers are less flexible to pass an increase in production cost to overseas buyers With the RM50 carbon tax rate, the export demand fell

by 0.0129 percent in the short run The country may incur more export revenue loss if a higher carbon pricing

is charged At the RM120 carbon tax rate, the export demand fell by 0.0282 percentage points more compared

to the RM50 carbon tax rate

Local economic agents may also reduce demand for imported goods, including intermediate inputs, as an effort to minimize the production cost following the introduction of the carbon tax The import demand fell

by 0.0133 percent if the RM50 carbon tax rate was charged on energy commodities, of which producers are one major importer in the country The local economic agents may reduce even further the demand for imported goods if a higher carbon pricing is charged As expected, the import demand fell by 0.0455 percent

at the RM120 carbon tax rate The import demand fell even more, by 0.0625 percentage points, if RM300 was charged per tonne of CO2

As shown in the fourth scenario, the outcome may be different when the carbon tax revenue is given back

to the economy By recycling the tax revenue as a subsidy on consumer purchases, the economy appeared to recover slightly from the negative impact for a short run As shown in table, the economy performed 0.0068 percent better in real terms after the tax revenue redistribution At this point, the economy grew 0.0068 percent more relative to where the carbon tax was not imposed That is, the GDP performed better after the carbon tax redistribution compared to without it

However, as time passes, the economy seems to perform 0.0089 percent lesser, even after the tax recycling

An extra compensation package is necessary to achieve a simultaneous positive impact on both the economy and environment, ie the double dividend effect One way is to compensate for the loss of purchasing power among consumers especially, at least to some extent Secondly, the government could subsidize certain goods and services to offset the increase in production cost subsequent to the carbon tax burden It therefore allows goods and services always to be sold at affordable prices despite the carbon tax introduction It could indirectly avoid the rise of price level from beginning before the producers transfer it to consumers These reasons necessitate the carbon tax regime to be implemented along with supplementary fiscal measures

Table 12: Macroeconomic effects of a carbon tax in Malaysia (in Percentage Change)

Macroeconomic

effects

Scenarios

Gross domestic

product -0.0026 -0.0061 -0.0274 0.0068 -0.0173 -0.0444 -0.1221 -0.0089 Household

Volume of exports -0.0129 -0.0411 -0.1116 -0.0026 -0.0686 -0.1596 -0.3705 -0.0292 Volume of imports -0.0133 -0.0455 -0.108 -0.0129 -0.0686 -0.1581 -0.3606 -0.0435 Aggregate

Consumer price index 0.0163 0.0534 0.1434 -0.0623 0.0166 0.0382 0.0873 0.1082

4.2 Industrial Impacts

The section assesses the impacts on outputs and employment in energy intensive industries, as their inputs are hit directly by the carbon taxation Because of the high energy intensity, the energy intensive industries are sometimes more vulnerable to the carbon taxation policy A carbon tax generally increases the cost of production more significantly for industries whose its energy intensity is high The subsequent rise in price of energy commodities may then result in an immediate reduction in output supply especially in the energy intensive industries

As expected, the 20 top energy intensive industries in the country seems to contract (Table 13), at an increasing rate with the rate of carbon taxation With the RM50 carbon pricing, petroleum refinery and transportation are among the two hardest hit industries (Table 13) At the carbon price RM120, the petroleum refinery industry cut down its output production by 0.06 percent relative to baseline ie without the carbon tax reform Other industries that experience contraction are those closely related to these two industries Among them include heavy manufacturing (cement, lime and plaster), agriculture and fishing, and service (financial institution) Some industries turn to perform better, after the tax revenue is recycled back to the economy The estimated long-run effects appear more severe than the short-run effects, possibly due to industrial structure Due to the multiplier effect of price increases, the economy seems becomes less capable to induce a more beneficial reallocation of resources over the long run Over time, the direction of reallocation still inelastic

to switch away from lower cost processes with higher emission levels towards higher cost processes with relative lower emission levels

Many opponents argue that the additional tax burden may result in employment losses especially in energy intensive industries Table 14 confirms this view, showing that some energy-related industries experience job losses The paper expects that blue-collar workers in the industries might be severely affected

by the carbon taxation Despite employment losses in other energy intensive industries, interestingly, the petroleum refinery industry seems to increase its labor demand The similar employment gain seems to continue exist after the tax recycling

Table 13: Sectoral output changes in response to carbon taxation

Energy intensive

Petroleum refinery 0.00 -0.06 -0.15 -0.02 -0.10 -0.23 -0.54 -0.09 Wholesale & retail

trade and motor

vehicle

-0.01 -0.05 -0.12 -0.01 -0.09 -0.20 -0.48 -0.06

Electricity and gas 0.00 -0.01 -0.04 0.00 -0.04 -0.09 -0.22 -0.03 Air transport -0.01 -0.02 -0.04 0.00 -0.04 -0.09 -0.21 -0.03 Land transport -0.17 -0.61 -1.53 -0.24 -0.18 -0.43 -1.01 -0.16 Basic chemicals -0.01 -0.03 -0.09 0.00 -0.21 -0.49 -1.16 -0.13 Other chemicals

product -0.02 -0.08 -0.20 -0.02 -0.17 -0.40 -0.94 -0.07 Crude oil and natural

gas

0.00 -0.01 -0.03 0.00 -0.06 -0.15 -0.36 -0.06

Forestry and logging -0.01 -0.05 -0.14 -0.01 -0.06 -0.14 -0.34 -0.03 Financial institution 0.00 -0.01 -0.02 0.00 -0.09 -0.21 -0.52 -0.04 Civil engineering 0.01 0.02 0.07 0.00 -0.02 -0.04 -0.12 -0.02 Oils and fats -0.01 -0.02 -0.05 0.00 -0.02 -0.05 -0.12 -0.02 Water transport -0.01 -0.03 -0.08 0.00 -0.08 -0.20 -0.45 -0.03