A Workable Carbon Solution

Alex Wadsley

The problem with any capped or auctioned trading scheme is that it assumes we know how much carbon we need to reduce to save the world and what the most economically efficient adjustment path is for reducing emissions. In fact we don’t know either. The fall-back is a low carbon tax, provisionally set at $15 per tonne of carbon dioxide equivalent. This would be a good move, here’s how a system could work…

A Workable Carbon Solution

It appears that Labor’s carbon trading scheme is in disarray, following an unprecedent level of requests for special assistance by internationally exposed sectors on the one hand and concerns about the impact on price levels on the other. All the climate change doubters have now become fired up about petrol prices and spiralling electricity costs.

The problem with any capped or auctioned trading scheme is that it assumes we know how much carbon we need to reduce to save the world and what the most economically efficient adjustment path is for reducing emissions. In fact we don’t know either.

The fall-back is a low carbon tax, provisionally set at $15 per tonne of carbon dioxide equivalent. This would be a good move, here’s how a system could work.

Focus on Virtual Carbon

While we should be taxing the main emissions at source (using the refineries as aggregation points for fuel) the key concept is one of virtual carbon, where prices adjust based on their virtual carbon content, the emissions involved in each step of the process of delivering goods to the market. This is conceptually similar to the GST, where tax is collected at each chain of the value-adding process, but is actually paid economically by the final consumer.

International Neutrality

The problem with any tradeable credit system is it encourages carbon leakage, carbon-intensive manufacturing moves to areas outside the system, this doesn’t help the world’s climate or Australia. The solution is to see the Carbon pricing system in exactly the same way as the GST, exporters get a rebate, importers pay an equivalent charge, international neutrality is maintained. To make sure there is still an incentive to reduce emissions one should follow a grandmothering approach, rebates are based on best practice, not actual emissions, imports are charged for their ‘virtual carbon’ content based on scheduled benchmarks. This is not a tariff or protection measure, it just ensures a level domestic playing field between those countries that are implementing Kyoto and those that are not.

How do we hit the 2050 and other targets?

Simple incrementalism. By having a straight line that assesses performance in moving towards the target, the tax can be adjusted upwards after each year that the economy is falling behind the required path. My feeling is that there will be significant positive change at $15 based on the clear price signal, but an upwards adjustment of $2.50 or $5 per year will send the right signal if we fall behind. If the economy gets ahead of the target, the rate can stay constant. If there is a recession there may be scope to reduce the rate. The carbon tax rate should also be indexed to inflation.

Cost of Living increases?

Once again the benchmark for how this should operate is the GST implementation. As carbon tax costs are passed through the price system, the government returns the money to families in reduced taxes and increased benefits. Given that a carbon consumption tax is fairly regressive (low income persons produce more carbon relative to incomes than high income persons) then the emphasis should be on the pension, benefits and tax free threshold as well as reducing the means-tested benefit loss rates, to avoid high effective marginal tax rates on low income earners. Assuming no increase in fuel costs, initial compensation of between $200 to $500 per household would be appropriate, with further adjustment as the pattern of price changes became evident.

Forests and sequestration?

The best solution is for the government not to pay people directly to sequester but to enable carbon tax payers to purchase certified sequestration credits from forest growers. Foresters themselves should face a ‘net carbon emissions’ tax liability, that is, if in net terms in a given year they are emitting, then they pay. And if in net terms they are net sequesterers then they sell their credits to an organisation with a carbon tax liability. The price of sequested carbon is likely to be identical to the carbon tax rate for the foreseeable future, with slightly higher administration costs offset by the PR benefits.

Fuel Excise?

The fuel excise should be reduced so that there is no net price change.
There are two economic reasons for having a high fuel price – recognise pollution costs and recognise potential future scarcity. The current high international oil price now recognises scarcity and a carbon tax would recognise the pollution cost. Using fuel excise to funds roads is fiscally and politically convenient, not an economic necessity.

Say no to king coal

Any approach that reduces carbon emissions must force major adjustment in the way electricity is produced, particularly the use of brown coal. So far the government has babied the industry. I think they would be amazed what the Latrobe Valley boys would come up with once there was a real incentive to invest in avoiding taxes, rather than lobbying for new handouts for the clean carbon myth.

Anyway, the estimates are that at $15 per tonne, brown coal can compete, but only just. In general, wholesale electricity prices will rise (by 1-2 cents per kwh) with Aluminium and other exporters recovering the increased cost through a carbon tax export rebate.

Any questions?

Alex Wadsley

Alex is currently a leturer in Macroeconomics at the University of Tasmania