**_Relationship to the literature._** The issue of using taxation to address climate change has been surveyed by, among others, Stern (2008), Goulder and Pizer (2005), Aldy et al. (2003) and Bovenberg and Goulder (2002).   The analytical framework used here derives from Sandmo’s (1975) paper that showed how the cost of taxing an externality-creating commodity (such as a commodity with high CO2 emissions), also known as a Pigovian tax, depends on the other taxes in the system.  Since these taxes are typically there for revenue purposes, Sandmo extended the Diamond and Mirrlees (1971) result that revenue-raising taxes should fall on commodities with the lowest demand elasticity to show that the “optimal” tax is a weighted average of the inverse elasticity and the marginal social damage.  In that sense, our paper extends the estimates of the marginal cost of public funds for revenue purposes (see, for example, Devarajan et al. (2002)) to the marginal cost of carbon taxation.  Since, as mentioned earlier, the marginal social damage is still uncertain, we simulate all taxes to generate a fixed level of carbon reduction.

The analytical framework has mainly been applied in the context of developed countries. Using a dynamic general-equilibrium model of the United States, Goulder (1998) found that the marginal welfare cost of a Pigovian tax would be reduced if the revenue from the tax could be used to reduce pre-existing distortions. Assuming strong links between carbon taxes, capital accumulation and productivity growth, Jorgenson and Wilcoxen (1993) found that the expected fall of US GNP can be reversed and actually increased if the revenue is used to reduce high marginal tax rates on capital in the economy. In a partial-equilibrium application to developing countries, Shah and Larsen (1992) showed that welfare could be improved, and carbon emissions reduced, by removing subsidies and other distortions in the energy sector. In a general equilibrium analysis of a carbon tax in Thailand, Timilsina and Shrestha (2002) examined the economic impact and reduction of emissions from alternative carbon tax rates as well as the double dividend of revenue recycling through a lump-sum transfer or a reduction of direct income tax.

The welfare impacts from the two cases of revenue substitution are, however, very similar, mainly because a direct income tax in a static model with no factor accumulation is similar to a lump-sum transfer. Contributing to the very few analyses of developing countries, our general-equilibrium calculation compares the welfare costs of carbon taxation with alternative indirect taxes on energy, keeping the emissions target similar so that the social benefit of pollution control is comparable across taxes. We investigate the issue of revenue recycling by focusing on the reduction of pre-existing tax distortions that are more relevant to a developing economy. Our model builds on energyenvironment CGE models of developing countries, including Robinson (1990), Lewis (1993), Blitzer and Eckaus (1993), Beghin et al. (1994), Yeldan and Roe (1994), Garbaccio, Ho and Jorgenson (1999), Xie and Saltzman (2000), and McDonald, Robinson, and Thierfelder (2008) as well as the partial-equilibrium study of presumptive environmental taxation of Eskeland and Devarajan (1996).

In response to South Africa’s commitment to mitigating climate change and its Long-term Mitigation Scenarios (LTMS), there are a few studies recently undertaken to 4