Tuesday, 16 July 2013

Carbon Tax, Carbon Trading

Amid much hoo-har over the past few days, recycled Prime Minister Kevin Rudd has been reported as announcing his government will scrap the carbon tax.   Of course these reports are greatly exaggerated, possibly with Rudd's tacit approval.  Rudd and his supporters will do no such thing. 

When the Gillard Government introduced the carbon tax in 2011 (with operation beginning in July 2012) they did so with a two stage plan.  From July 2012 to July 2015 industries which emit carbon would have to pay a fixed price (a carbon tax) per tonne of carbon emitted - starting at $23 and climbing with inflation.  Then from July 2015 this scheme would be transformed into a market based emissions trading scheme similar to (and linked with) the one in Europe, in which permits to emit are sold through a market mechanism to the highest bidder.  What Rudd has announced is that his government will start the second phase a year earlier, in July 2014.

This gives us a glimpse of the medium term future of climate change politics.  I hesitate to say the "long term future" because we live in a political culture where the words "long term" are a synonym for "never", and this is part of the problem.

So, a quick reminder of the difference between a carbon tax and an emissions trading scheme.  Under a carbon tax, companies which emit carbon have to pay a flat fee - a tax - for whatever they emit.  This fee is set by the government.  There is no limit on what they can emit, and if they emit less they just pay less.  This scheme works simply, by making emissions more costly for companies and hence giving them an incentive to reduce these emissions.  The politics of these schemes are also quite simple - emitters hate them, because they reduce their profits.  We need them because there is an urgent need to reduce global emissions, but big emitters don't care about that, they only care about their bottom line, so they will do anything in their power to prevent such a tax or failing that to reduce it.  This is the phase we are in now.

An emissions trading scheme is a much more complicated beast.  Instead of simply charging a tax on emissions, each year the government sells a certain number of emission permits through a carbon trading scheme similar to the stock exchange or the international currency market.  These are sold to the highest bidder at whatever price the market is willing to pay.  Anyone can buy them - emitters will buy enough to cover their expected emissions, but other people might buy them as speculative investments, planning to resell them later.  If you are an emitter you might buy more than you need, in which case you can sell the leftovers, or you might find you didn't buy enough, in which case you can go back to the market and buy more.

This is the type of scheme which currently operates in Europe, and in recent years the price of emissions has dropped dramatically, so that it is currently under $5 per tonne.  This is what has Australian emitters licking their lips over an early transition to a trading scheme, and Rudd is hoping this will neutralise their influence in the upcoming election.  Here is our glimpse of the future of carbon politics.

Unlike a carbon tax, the government does not directly control the price in an emissions trading scheme, it is set by the market.  However, it does control this price indirectly, because it controls the supply of permits.  If it releases more permits, the price will go down, if it reduces the number, the price will go up.  The idea of the original designers of these schemes is that the number of permits would be progressively reduced, so that emitters had a choice of reducing their emissions or paying a high price for more permits. 

Current European experience shows just how difficult this is politically.  There is a huge oversupply of permits in Europe, partly because of an oversupply of permits from third world countries which European emitters use to offset their emissions, and partly because of the European economic downturn. 

The logical thing to do would be to reduce the number of permits, but emitters are keen to keep the price low and, like in Australia, they are not scrupulous about the political tactics they will use to get their way.  As a result, in April of this year the European Parliament rejected a proposal from the European Commission for such a reduction.  This means the price will remain low for the foreseeable future.

The decision we make at our election later this year will determine the next Australian steps in this debate.  If we elect an Abbott Coalition government, they will remove any price on carbon and implement what they call "direct action", government funded schemes to develop and implement alternative technologies.  There will still be a political battle, but it will be over how much to spend, and on what.  The battle to price emissions will continue, but it will have received a huge set-back.

On the other hand, if re re-elect the Rudd Labor Government the battle over whether to price emissions will be effectively over, and the ground will shift in the European direction, to a battle over how many permits will be released and hence how high the price will be.  The European experience so far is not encouraging for those who see the urgency of reducing emissions, but it is very encouraging for those in the business of emitting.

The key problem is that in the short term, reducing emissions has costs.  The emissions trading scheme attempts to keep these costs as low as possible while still keeping the momentum up in emissions reduction.  Large emitters, on the other hand, would prefer not to pay at all, and leave the problem up to someone else. 

Climate scientists tell us the long run consequences of continued emissions will be huge and extremely costly but as Lord Keynes once said, "in the long run we are all dead."


Brad McCoy said...

The supply of permits should be set an independent body, just like interest rates and the supplu of cash are. That would partly fix the political problem of it.

Jon Eastgate said...

It would, although then the political battle would shift to its terms of reference.