Unintended possible consequences of fuel input taxes for individual investments in greenhouse gas mitigation technologies and the resulting emissions

Abstract

Background: South Africa is planning to introduce a carbon tax as a Pigouvian measure for the reduction of greenhouse gas emissions, one of the tax bases designed as a fuel input tax. In this form, it is supposed to incentivise users to reduce and/or substitute fossil fuels, leading to a reduction of CO2 emissions.Aim: This article examines how such a carbon tax regime may affect the individual willingness to invest in greenhouse gas mitigation technologies.Setting: Mathematical derivation, using methods of linear programming, duality theory and sensitivity analysis.Methods: By employing a two-step evaluation approach, it allows to identify the factors determining the maximum price an individual investor would pay for such an investment, given the conditions of imperfect markets.Results: This price ceiling depends on the (corrected) net present values of the payments and on the interdependencies arising from changes in the optimal investment and production programmes. Although the well-established results of environmental economics usually can be confirmed for a single investment, increasing carbon taxes may entail sometimes contradictory and unexpected consequences for individual investments in greenhouse gas mitigation technologies and the resulting emissions. Under certain circumstances, they may discourage such investments and, when still undertaken, even lead to higher emissions. However, these results can be interpreted in an economically comprehensible manner.Conclusion: Under the usually given conditions of imperfect markets, the impact of a carbon tax regime on individual investment decisions to mitigate greenhouse gas emissions is not as straight forward as under the usually assumed, but unrealistically simplifying perfect market conditions. To avoid undesired and discouraging effects, policy makers cannot make solitary decisions, but have to take interdependencies on the addressee´s side into account. The individual investor´s price ceiling for such an investment in imperfect markets can be interpreted as a sum of (partially corrected) net present values, which themselves are a generalisation of the net present values known from perfect markets

The dark side of shareholder orientation: A reflection of Rappaport's concept of shareholder value

“…Then, both—Rappaport's way of calculating “ordinary” (net) present values, for example, by discounting expected cash flows with exogenous interest rates (even if adjusted to uncertainty), as well as the often considered alternative of (real) option values—become inadequate for the financial valuation of investments. Instead, in imperfect markets, discount rates are endogenous to the investment program (Hax, 1964; Hering, 2004, 2022; Hirshleifer, 1958; Klingelhöfer, 1999, 2006, 2009, 2010, 2017; Weingartner, 1963), and the (net) present values, in most cases, have to be corrected for restricted capacities (Klingelhöfer, 2009, 2017).…”

“…Uncertainty may be considered by using trees of future states (Klingelhöfer, 2017: 3 with reference to Magee, 1964a, 1964b; Mao, 1969; Klingelhöfer, 2006: 59–83; Laux, 1971: 19–22, 39–44), which makes valuation under uncertainty similar to that under certainty but without the restrictive assumptions of the Bernoulli principle and its axioms.…”

“…Then, both-Rappaport's way of calculating "ordinary" (net) present values, for example, by discounting expected cash flows with exogenous interest rates (even if adjusted to uncertainty), as well as the often considered alternative of (real) option values-become inadequate for the financial valuation of investments. Instead, in imperfect markets, discount rates are endogenous to the investment program (Hax, 1964;Hering, 2004Hering, , 2022Hirshleifer, 1958;Klingelhöfer, 1999Klingelhöfer, , 2006Klingelhöfer, , 2009Klingelhöfer, , 2010Klingelhöfer, , 2017Weingartner, 1963), and the (net) present values, in most cases, have to be corrected for restricted capacities (Klingelhöfer, 2009(Klingelhöfer, , 2017. This fundamental result implies that there is no theoretical foundation for employing the (risk-adjusted) weighted cost of capital to discount cash flows, as proposed by Rappaport, when referring to employing DCFs.…”

“…In other words, only under exceptional circumstances, Rappaport's (risk-adjusted) weighted average cost of capital may coincidentally equal the theoretically correct discount rate that delivers the optimal investments. Furthermore, due to the interdependences between investments, finance, production, environmental protection, and marketing on imperfect markets, it is usually still not possible to calculate the additional value of a company resulting from additional projects, by "just" adding up the individual DCFs of these projects; a mere calculation of the net present value of an additional object does not say much regarding its profitability, because such a net present value does not account for capacity shortages resulting from the realization of this additional object, which, subsequently, may also alter the decision relevance of other objects or capacities (Klingelhöfer, 2010(Klingelhöfer, , 2017. In imperfect markets, even theoretically correctly calculated (partially corrected) net present values, employing endogenous interest rates, are usually not value-additive.…”

“…Consequently, assessing the degree of profitability of an additional single investment or activity within imperfect markets means a comparison of the situation after investing (i.e., the "valuation program" [VP]) to the one before investing [i.e., the "basic program" [BP]) (Hering, 2006(Hering, [2021Jaensch, 1966: 664-665;Klingelhöfer, 2006: 59-91;2017;Matschke, 1975: 253-257, 387-390). By doing so, a sensible approach implicitly considers (unlike neoclassical approaches) that such a technology investment is usually indivisible-it is either undertaken entirely or not at all.…”