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Carbon tax is obviously better option

Posted : Monday, March 01, 2010

David Byers' article on the issue was also published in the Australian Financial Review 

Published for ACE online: Saturday, 27 February 2010

It is time to face a few hard truths on climate policy:

Copenhagen promised to bring everyone into the tent in a post-2012 successor treaty to Kyoto. Instead, it showed divides between countries were unbridgeable. Globally, the actions and policy approach of China and the US are what really count.

No country will sacrifice economic growth today for others to enjoy benefits tomorrow. Actions taken by most countries (including Australia) will only ever make a small difference, yet actions by first movers can have immediate negative effects on domestic industries.

The case for precautionary action is solid and the case for urgent action regardless of cost is weak. Actions today may not have a noticeable effect for 50 years. Policy needs to be flexible.

What do these truths mean for policy in 2010? Should emissions trading remain the preferred approach for a carbon pollution reduction scheme (CPRS) or is there an alternative? Should we use a quantity-type approach, such as emissions trading, or a price-type approach, such as a carbon tax?

The Rudd government (and the Howard government) chose emissions trading. The reasons lie not in economics, science or practicality, but in politics.

Emissions trading looked more politically feasible. But in a post-Kyoto world with no binding national emissions targets, that enthusiasm looks sadly misplaced. It sold emissions trading as a CPRS "magic pudding"-the market would do its work, emissions would be cut, nasty polluters would pay and consumers would be compensated. Everybody would win. In reality, the purpose of a carbon price is to force consumers to pay higher prices for emissions-intensive goods. Emissions trading hides the true costs to consumers and the trade is conducted in derivatives, not actual emissions.

The government argued the CPRS would guarantee emissions reductions because it capped emission levels directly. Yet it was a complex scheme vulnerable to manipulation and evasion: there were carve-outs and compensation for certain industries, and cheaper imported emissions permits would have been allowed to undermine the Australian cap.

Growth in the international carbon market would also present great emissions "abatement" opportunities for Australia. Yet there is only one meaningful (and not necessarily successful) implementation-in Europe.

There are risks in the emissions trading as well. What is exchanged are derivatives of carbon credits and debits. After a global financial crisis-because of excessive credits and swaps originating from too much housing finance-there is real concern about the integrity of carbon-credits trading down the track. Will we see a carbon bubble of the wrong kind?

Would the opposition's "direct action" be any different? In the longer term, regulation and subsidies won't be more efficient than a market-based approach.

There is a viable alternative: a carbon tax sits on the interchange bench, ready to sub for the injured CPRS. It's the forgotten market mechanism.

Sure it is hard to sell a "great big new tax". But substantial cuts in emissions require a massive transformation in the way we produce and use energy. Such change is not cost-free and will take time. And a carbon tax has several advantages over the CPRS.

A tax is simple, direct and something everyone understands. There is no subterfuge or complexity as in the "Orwellian" CPRS. By raising the price of carbon-based energy directly and predictably, carbon taxes better enable businesses to plan for capital investment and new emissions-reduction technologies.

European trading in CO² shows extreme volatility, undermining incentives to invest in large greenhouse gas reduction projects and technologies.

Carbon taxes can be set to escalate over time, making a phase-in more politically manageable and economically sensible. Modest rates of emissions reduction in the near term for are followed by sharper reductions in the long term as low-emissions technologies are deployed-a "policy ramp". As future generations will enjoy higher incomes based on improved technologies, it is hard to argue current generations should endure a precipitous shutdown of greenhouse gas-emitting activities.

A carbon tax on consumption (not production) would include imports and domestic outputs consumed locally, but exclude exports. It avoids the first-mover disadvantage of imposing a local carbon price in the absence of global action-one of the many issues plaguing the CPRS. A carbon consumption tax could be implemented in Australia through a minor modification of the GST.

Action to impose a price on carbon and reduce emissions can be taken without sacrificing Australian exports and growth.

Any policy approach must be truly international to be effective. A global system of carbon taxes would be the ultimate form of international approach. Under this system, each country would levy an internationally harmonised carbon price or carbon tax on emissions after taking account of each country's current energy taxes and subsidies.

This is far less of a pipedream than it sounds. There is extensive international experience in the use of harmonised price-type instruments in fiscal and trade policies. In the World Trade Organisation, for example, countries negotiate over the harmonisation of tariff levels rather than trade volumes.

A country could collect the tax using existing mechanisms for energy or business taxes. It would not have to design a new system, as emissions trading requires.

The big advantage of a price-based approach over the Kyoto-style quantity-based approach is that it avoids the "distributional debate" among countries over who gets how many tradeable rights.

The CPRS, born of the Kyoto "targets and timetables" mindset, is a troubled in option-a complex solution that doesn't deliver.

It's time for policymakers to consider a consumption-based carbon tax. It can be applied simply, directly and flexibly (upwards or downwards) and in response to the unfolding body of science on climate change. It can be joined into a global co-operative policy framework that is built not on wobbly emissions targets, but on an effective carbon price in each economy.

Taxes may be unpopular, but they work. If we are serious about precautionary action, it's time for some straight talk from our political leaders.