No hiding the cost of emissions reduction

by Stubborn Mule on 10 February 2010 · 6 comments

In today’s Sydney Morning Herald, Ross Gittins has an opinion piece entitled Mealy-mouthed pollies see voters as a bunch of suckers. In it he argues that politicians are not to be believed when they start talking about taxes: they are more interested in playing issues for their electoral effect than actually saying what they believe about a tax. After all, if Labor really believed all their arguments against the goods and services tax (GST) back in the days of Kim Beazley‘s 2001 “Rollback” campaign, wouldn’t you expect to hear something from the current Labor government about the GST?

Perhaps this goes some way to explain why no politician in Australia is brave enough to enunciate the unavoidable fact that if, as a nation, we want to reduce carbon emissions, there will be a cost.

This is true regardless of whether your scheme of choice be Labor’s proposed emissions trading scheme (ETS), a carbon tax or the latest offering from the coalition, an emissions reduction fund. The reason is simple. The bulk of Australia’s power generation is sourced from coal-burning power-stations and this is because coal is cheaper than any other source, including natural gas, solar, wind or geothermal. Achieving a meaningful reduction in Australia’s carbon emissions will require a gradual phasing out of coal-burning power stations, replacing those reaching the end of their life with generators using more expensive alternative sources. Ultimately someone, somewhere must bear this cost if the shift is to occur.

Some would argue that “the big polluters have to pay”. That is easier said than done: these polluters would want to preserve their profit margins and so in practice any additional costs imposed on power generators and other industrial polluters would be passed directly on to their customers anyway.

Others would prefer to rely on people opting to reduce their own emissions. One avenue for this currently open to Australians is provided by the GreenPower program. Established by Commonwealth Government in 1997, GreenPower allows energy retailers to provide their customers with an accredited “green” option. This allows households and businesses to buy some or all of their power from lower emission generation sources. Needless to say, these options cost more than the standard offering. According to the 2008 GreenPower audit, 947,268 customers were using a GreenPower product, representing around 10% of Australian households. While this may appear at first glance to be an impressive take-up in 10 years, digging into the figures a little deeper gives a different picture. For many of the retailers, close to 90% of the retail customers have elected to buy the cheapest GreenPower product which only sources 10% of the householder’s power from alternative sources. For businesses the number using the 10% option is even higher. So, relying on customer choice alone, the GreenPower program has only resulted in a shift to lower emission sources of about 1 or 2%.

Both emission trading schemes and carbon taxes aim to provide a far bigger shift by closing the price gap between cheap but carbon-intensive power sources and the more expensive alternatives. Economically the key difference between a tax and a trading scheme is that the cost of carbon imposed by a tax is fixed by the government, while the price imposed by a trading scheme would vary with supply and demand.

Most economists are attracted to trading schemes, pointing out that the problem with a tax aimed at reducing emissions is that you do not know how high to set the tax to get a desired reduction in emissions. While government can progressively tweak the tax to get to the target, it still requires significant guesswork. In contrast, under a trading scheme, the emissions target can be set in advance and then an appropriate number of “emissions permits” are issued (at which point, some environmentalists get queasy at the thought of providing business with the right to pollute, but that is an emotional distraction). These permits can be bought and sold, so any polluters unable to reduce their emissions to the level of the number of permits they have can purchase additional permits from others who can achieve greater reductions. In the process, the price should automatically adjust (thanks to the famous–or infamous–invisible hand of markets) to a level that achieves the desired reduction target. Any emissions not backed by permits are subject to punitive financial penalties set at a sufficiently high level to make the purchase of permits preferable.

For carbon taxes the price is known in advance, but the amount of reduction achieved is unknown. For a trading scheme, the reduction is known in advance, but the price is not.

That is the theory at least. In practice, both approaches have enormous practical complexities, not least the challenges of monitoring compliance. Furthermore, the trading scheme proposed by the Labor government, known as the Carbon Pollution Reduction Scheme (CPRS), is not quite as pure a trading model as economists would like since it comes with a price cap. This means that, while the market is allowed to determine the price of carbon, the price cannot trade above a pre-determined level. Under the proposal, the cap would be set at $40 per ton of carbon for the first few years. This means that if the market price of emissions was in fact higher than $40 per ton, the CPRS scheme would in fact operate more like a fixed-price carbon tax.

As for the coalition’s reduction fund, it resembles a carbon tax approach to some extent in that it does not impose a particular emissions target. But the key difference between the reduction fund and either a carbon tax or a trading scheme is that it would be up to the government to determine the most promising approaches to reducing emissions and offering financial inducements to pursue these approaches. So it involves the government “picking winners”, to use a phrase favoured by free-market enthusiasts who consider markets far more efficient than governments at making decisions about allocation of scarce resources and, presumably, the best approach to dealing with climate change. To see the Labor government advocating a market solution and the Liberal/National Party coalition advocating a government-led approach is perhaps the most peculiar aspect of the current climate change debate.

While there are many reasonable discussions that could be had about the relative merits of all of these schemes, sadly the debate driven by the politicians is far more likely to be which scheme is or is not a “great big new tax”. The fact that a trading scheme is not a carbon tax does not somehow mean than taxpayers and other consumers will not end up paying for the emissions reductions. Equally, the money in a reduction fund has to come from somewhere and, since the scheme is being advocated by a party with a deep-rooted fear of government deficits, it is safe to say that it will come from increased taxes, reduced public spending elsewhere or a combination of the two. Again, someone will pay.

The last Federal election and opinion polls held before and since then all suggest that, recent visits by Lord Monckton notwithstanding, the majority of Australians want something to be done about reducing our country’s emissions. Is it too much to ask of our politicians to stop shouting “It’s a tax!”, “No it’s not a tax, yours is!”? I hope it is not, but in the process, everyone else has to accept the fact that reducing our emissions will come at a cost and do not believe any politician who tries to claim otherwise.

Possibly Related Posts (automatically generated):

{ 6 comments… read them below or add one }

1 Duncan February 11, 2010 at 10:25 am

I’m just amazed that a whole 24 hours after this post, no climate-denier nutters have found this and told you it’s all a great big UN/Israeli/Banker led conspiracy !

2 Stubborn Mule February 11, 2010 at 10:30 am

On the last climate-change post I did get one rather rapid post talking about New World Order conspiracies. However, it breached the Mule’s comment policy when it descended into racism, so it didn’t see the light of day. So far I’ve had nothing similar on this post.

3 Marco February 12, 2010 at 5:57 pm

I think your analysis is quite realistic, Stubborn.

In the end, all these schemes imply a cost. Still, I tend to prefer the carbon tax one.

Firstly, the idea of creating a new financial instrument that can be manipulated by investment banks gives me the creeps.

Second, if you remember your post about the Prisoner’s Dilemma/Tragedy of the Commons, the idea most neoclassical economists have to solve the puzzle is to give property rights to a group, that will take care of the commons. The introduction of carbon emission permits is one step in this direction: they give emitters a right over a part of the environment. Once this step is taken, what is to keep from similar things being adopted in other areas?
It didn’t work too well in Bolivia, where water rights were given to a corporation that owned even rainwater.

Third, tax are more transparent and understandable than these permits, whose price dynamics will be entirely whimsical.

Finally, all these schemes allow for a redistribution of the proceeds among the population. Rudd has used this idea as a sweetener, in the few occasions he went into selling his idea.

Anyway, that’s just my 2 cents worth

4 Stubborn Mule February 13, 2010 at 7:11 am

Marco: one of the key features of an emissions trading scheme is that the “right” to emit they confer are temporary not permanent. The proposal under the CPRS scheme is that the permits cover a year’s worth of emissions. The CPRS White Paper proposes that four “vintages” be sold: permits for the current year and for three future years, which gives emitters some room for hedging their exposure as plans to reduce emissions are likely to take some time.

Having said that, I understand your concerns about the trading scheme being a license for intermediaries to make money. At this point, however, it does have the advantage of being advanced to the point of having legislation prepared. Getting a tax done now would take much longer.

5 Marco February 13, 2010 at 11:29 am

You may be right on this, Stubborn.

Anyway, this whole issue seems to have become more academic than practical. Or at least this is how it’s looking to me.

Do you think everything concrete will come out of this ETS?

6 Stubborn Mule February 13, 2010 at 1:48 pm

Marco: it’s certainly not looking too promising for the ETS at the moment. The only hope I can see for it at the moment lies with the Greens if they end up deciding that a less than ideal scheme is better than no scheme.

Leave a Comment

 

Previous post:

Next post: