CRGE (FDRE, 2011) Strategy. The economic growth under the BAU scenario that we utilize is recorded in the first two years of the GTP II period (i.e., a GDP growth rate of 7.6 percent).

# **4.3 Policy Scenarios**

The policy scenarios included in the current study differ from the BAU not only due to the imposition of a carbon tax but also due to a set of decisions regarding (i) what sources of carbon to tax, (ii) the time path of carbon prices, and (iii) how to use money that is raised through the carbon tax. Decisions taken on each of these elements will imply different policy impacts on the economy vis-à-vis the baseline.

# 4.3.1 What sources of carbon to tax?

As shown in Fig. 3.1, most of the carbon emission in the country comes from the agriculture sector. This implies that any tax that will put a significant dent on emission would have to address the agriculture sector. However, there are two reasons why this would be undesirable and difficult to implement. The sources of emissions from agriculture and forest land-use are diverse and diffuse. This makes these sources difficult to tax without extensive, costly, and untested measurement, reporting, and verification (MRV). Note that imposing a carbon tax merely on agricultural and forest outputs is not possible because the carbon intensity of outputs may substantially differ across suppliers and regions of the country. In addition, most of the agricultural activity in the country is undertaken by smallholder farmers engaged in subsistence agriculture. Burdening them with a carbon tax, even if it could be figured out how to do so, would have adverse distributional consequences.

In contrast, taxing fossil fuels has the inverse pros and cons of taxing agricultural emissions. It can easily be administered by imposing a tax on fuel importers. In other words, it does not involve significant levels of MRV measures. Moreover, it is an effective approach for taxing the informal sector. In addition, it can easily be linked with other existing taxes in the overall fiscal system. Thus, although fossil fuels make only a small contribution to total GHG emissions in Ethiopia (a bit more than 6 percent, as noted in Section 3), this study focuses on putting a price on the carbon emitted from fossil fuels. An important follow-up task beyond the scope of this study is to give much deeper consideration to what policies, beyond carbon pricing, can effectively mitigate GHG emissions from agriculture and forestry.

How kerosene is factored in carbon tax analysis has important implications due to two seemingly countervailing reasons. On the one hand, kerosene is an alternative cooking energy to fuelwood; taxing it may backfire by increasing consumption of fuelwood which could result in more GHG emissions as well as worse indoor air pollution. On the other hand, exempting kerosene from a carbon tax could lead to tax evasion through reclassification of other fuels as kerosene. We have carried out our policy comparisons both with and without kerosene. However, in this report, we include only results from the analysis with kerosene taxed. The results with kerosene exempted are available on request.

# 4.3.2 The time path of carbon prices

Another important factor is deciding what level of tax to impose and how the tax rate evolves over time. Consistent with experiences of other countries (World Bank, Ecofys and Vivid Economics, 2017), we have analyzed three possible cases.<sup>3</sup> The first entails imposing a low tax of about $5 per ton throughout the time period of the analysis (2018-2030). The second entails imposing a higher tax rate of $30 per ton initially and maintaining that rate throughout 2018-2030. In the third case, the tax rate starts at $5 per ton and then steadily grows over the study period until it reaches $30 per ton in 2030. Although we have run our model based on all three tax design cases, in this report, we include only the results from the third case “starting low and steady growth” for various reasons: (i) it is a realistic assumption of how carbon

> 3 Although the range of carbon prices as of 2017 is between $1 per ton and $140 per ton, the most common is in the range of $10 to $40 per ton.

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