Carbon tax fraught with doubtPUBLISHED: 27 Jun 2012 00:15:00 | UPDATED: 27 Jun 2012 00:33:12PUBLISHED: 27 Jun 2012 PRINT EDITION: 27 Jun 2012
A carbon tax can be a cost-effective way to reduce greenhouse gas emissions, by increasing the relative price of carbon-intensive production methods and products.
As prices change, businesses and households use less carbon-intensive products and production methods.
These changes are likely to be only partly offset by the government recycling some of the revenue windfall to households and energy-intensive, trade-exposed industries.
However, a challenge for businesses, and to a lesser extent households, in making decisions about investments lasting many years, and in some cases decades, is uncertainty about the future price of carbon. While there is bipartisan agreement to reduce greenhouse emissions by 2020 to 5 per cent less than 2000, or about a 20 per cent reduction below business as usual, the two main political parties have very different policies.
Under the Labor plan, the real price of the carbon tax will start at $23 a tonne of CO2 equivalent
(CO2e) and will increase by 2.5 per cent above inflation for each of the next two years. Then, from 2015, the carbon tax will be replaced with an emissions trading scheme, and with the option to purchase permits to pollute from overseas.
While it is proposed that there be a floor and a ceiling price on the permits, the gap is very wide, ranging from about $15 to more than $30 a tonne of CO2e.
In addition, the world price of permits will vary with the state of international agreements, if any.
On the other hand, if the Coalition wins the next election and delivers on its promise, the carbon tax and the emissions trading scheme will be scrapped. Instead, the Coalition is proposing a system of subsidies for businesses to reduce their emissions. In the absence of details, eligible subsidy activities may be similar to those investments considered by businesses responding to a carbon price. In the first round, the carbon tax is paid by about 350 large business greenhouse gas emitters.
These include fossil-fuel-fired electricity generators, suppliers of domestic gas, petroleum product refiners and importers, some mines and garbage dumps with fugitive emissions, and manufactures of cement and metal products.
The carbon tax internalises the pollution cost and provides these firms with incentives to change their production methods.
Under the government’s carbon tax scheme, which starts next Sunday, most of the carbon tax, as an additional cost of production similar to higher wages and material prices, will be passed forward to buyers as higher product prices. The $23 initial carbon tax is estimated, for example, to increase electricity prices by around 11 per cent, gas prices by 9 per cent, and fuel prices for commercial trucks and mining.
The carbon scheme will result in firms that produce non-traded goods and services passing on to households most of their higher energy input costs as higher product prices in much the same way as the goods and services tax.
The more energy intensive the production process, the higher the increase of the relative price. Aluminium smelting will get a large increase in production costs, retailers a smaller cost increase.
The higher relative cost of energy provides incentives and rewards for businesses to conserve energy by changing production methods, investing in more energy efficient technology, and switching to less energy-intensive products. These changes should reduce energy use, and greenhouse gas emissions.
Energy-intensive, trade-exposed industries – aluminium smelters and steel manufacturers – will receive partial compensation for the higher costs of energy. Without a global carbon price, which would raise costs for international competitors, these trade-exposed industries will have difficulty passing on higher energy input costs to customers. Even with compensation, these industries have incentives to change production processes to save on costs.
Households will face higher relative prices for energy, including electricity of about 11 per cent and gas of about 9 per cent, and higher prices for other goods and services that use large energy inputs.
Other goods and services with small energy input costs, such as clothing, will rise little, if at all, inducing some households to switch from relatively more expensive to cheaper products, for example warmer clothes and less heating.
Increases in social security payments and income tax cuts for those earning up to about $50,000 a year will more than offset the rise in the average cost of living of about 0.7 per cent. But with relative prices rising for pollution-intensive products by about 11 per cent, households still face incentives to cut energy consumption.
John Freebairn is a professor of economics at the University of Melbourne.
The Australian Financial Review