Friday, January 30, 2009

Best way to help a warming planet is to tax carbon and let the market decide

John Humphreys

The Age, January 31, 2009

WITH the country slipping into recession and the Government falling into deficit, political priorities have been shifting. As the Government now looks to introduce legislation for an emissions trading system, it is worth considering other ways forward for climate change policy that will protect jobs and support the economy.

Climate change is an important political issue. In 2007 the International Panel on Climate Change said they are more than 90 per cent certain that humans are contributing to global warming. Computer models suggest a temperature increase of between 2 and 4 degrees over the next 100 years.

Many people are worried about the possible impact and are demanding political action.

At the moment, both major parties and most minor parties are pushing for a carbon trading system and billions of dollars of subsidies towards alternative energy. This looks good, but it is bad policy.

If something needs to be done, Australia would be better served by a revenue-neutral carbon tax.

Governments are notoriously bad at picking winners in any industry, and there is no reason to believe that politicians will correctly predict the future of the various alternative energy options.

I don't know which option is better between solar, wind, hydro, nuclear, "clean" coal, hot rock, bio-fuels, or any other option, and neither do Kevin Rudd, Malcolm Turnbull or Bob Brown.

If we want to shift away from "dirty" coal then the best option is to put a price on carbon emissions and let the market decide.

We can get a price on carbon in two ways — carbon trading or a carbon tax.

There are several reasons for preferring the tax option. A tax is more transparent, provides certainty in the carbon price, and allows greater flexibility during changing economic circumstances. In trade theory it is well understood that tariffs are better than traded quotas.

Similarly, a carbon tax is actually more flexible and efficient than the trading system. Other costs of a trading system include compliance costs, administration costs, wasteful rent-seeking behaviour and the cost of picking winners if carbon credits are allocated.

One benefit of a carbon tax is that it raises a consistent and guaranteed amount of revenue for the government, which can be used to cut other taxes, and therefore reduce the potential economic costs of climate change policy. Indeed, depending on the details, a modest carbon tax and matching tax cuts may have no net negative economic effect.

A tax of $15 per tonne of CO2-e (carbon dioxide or equivalent) would raise enough money to increase the tax-free threshold (TFT) from $6000 to $10,000. Alternatively, the revenue could be used to cut the top marginal tax rate down to 30 per cent. If we increased the carbon tax to $30 per tonne, then the Government could afford to increase the TFT and cut the top marginal tax rate, or they could increase the TFT to $15,000.

There is another, more controversial, option that deserves consideration. Australia already has an environment tax on fuel and diesel. The transport sector emits 94 tonnes of CO2-e per year and pays a high tax rate (petrol tax is 38.143 cents per litre, excluding GST), while the non-transport energy sector emits 306m tonnes of CO2-e and pays no environment tax. A $30-per-tonne carbon tax could be introduced as a replacement of the fuel tax — in effect reforming our environment tax to achieve a lower level on a broader base. Such a policy could be seen as good tax policy, irrespective of the environmental arguments.

The real-world consequence of this would be more expensive electricity, offset by cheaper petrol prices.

The impact on the budget would be roughly neutral. The impact on economic efficiency would be roughly neutral, as both taxes create a similar level of behavioural response. The impact on equality would be roughly neutral, as the policy replaces one regressive tax with another regressive tax.

One complaint against a switch from a fuel tax to a carbon tax is that the lower emissions from electricity generation will be offset by higher emissions in the transport sector. While this is true, it confuses the means with the ends. The goal of a climate policy should not be to reduce the use of electricity or transport but to create an incentive for people to research and invest in alternative energies so that we become less reliant on coal. A switch from a fuel tax to a carbon tax provides that incentive in a way that is relatively harmless to equity, efficiency or the budget.

Climate change is becoming an increasingly important part of Australia's political debates. But if we are serious about tackling the challenges of climate change in an intelligent way, we need to get past the easy promises of just "doing something" and work out which policy approaches provide the most benefits and least costs to Australian society.

John Humphreys, a research fellow at the Centre for Independent Studies is the author of Exploring a Carbon Tax for Australia.

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