Monday, July 11, 2011

Sinclair Davidson on the Carbon Tax

A policy failure on three fronts ... and counting

Sinclair Davidson The details of the Government's carbon tax have been released. Now the debate will move onto dissection of the gory details. For all the talk about compensation and the like, the Government has left itself very little wiggle room.
We're told, on average, that household costs will increase by $9.90 per week and average compensation will be $10.10 per week. That's 20 cents before average households will be worse off as a consequence of the tax.
When evaluating policy, there are three important questions to consider. Will the policy work? Will there be perverse outcomes? Will it benefit consumers? All up the carbon tax fails all three tests.

The policy objective is to reduce emissions by 5 per cent on 2000 levels by 2020 and 80 per cent by 2050. The Treasury modelling released yesterday suggests that the 2020 target cannot be achieved. Even with a carbon tax emissions will increase from 578 megatons of CO2 in 2009-10 to 621 megatons of CO2 in 2020.
As the Productivity Commission recently reported, no other country has an economy-wide emission trading scheme. As yet no global market for emission permits exists. In all of its modelling Treasury assumes that market exists and Australian business can buy international permits to offset their emissions. That drives the cheapest form of abatement – but when the market doesn't exist local carbon prices must be much higher than Treasury estimates and the domestic cost of carbon tax much higher too.
Treasury also relies very heavily on assumptions about technology. Electricity generation is expected to move from being predominately coal-generated to renewable energy with some coal being used in combination with carbon capture and storage technology. Right now that technology is not viable; Treasury assumes it will be viable after 2021. Renewables are expensive and unreliable. Treasury imagines the greatest growth will be in geothermal energy – again a technology that is unproven.
Of course technological improvements occur all the time and these technologies may well be viable in future. Yet the Government is betting our economic prosperity on these technologies becoming viable in the very near future. If those assumptions do not work out, electricity prices will be very high and very likely Australians will experience rolling black-outs. This is a policy that undermines our domestic energy certainty.
All up it is very likely that the Treasury estimate of a $3.30 per week increase for electricity is far too low.
The Treasury modelling is strangely quiet about the employment consequences of the carbon tax. When modelling the Carbon Pollution Reduction Scheme the Treasury admitted that they couldn't actually model the employment consequences of the policy and had to assume full employment in the long-run while admitting 'temporary unemployment' of up to 10 years.
This time Treasury simply argues that labour will move across industries due to the structural change to the economy but that this will be low compared to normal employment churn that normally occurs in any given year. Here Treasury is saying that the number of people involuntarily losing their jobs is unimportant given the number of people who voluntarily change jobs each year. But people choosing to change jobs usually go to a better job, people being retrenched usually don't. It also ignores the fact that people being retrenched as a result of the carbon tax will be over-represented in some regions of the country and in particular industries. Will the 20-cent differential compensate households for lost employment?
On a regional basis the early loser from the carbon tax is Victoria. By 2050, however, the biggest losers will be Queensland, New South Wales and Western Australia.
The tax cuts that the Government proposes are poor policy too. Increasing the tax-free threshold is a good idea and should be implemented anyway. But the Government is increasing the tax rates on low-income earners. True in the early years they gain from the increased tax-free rate but over time those gains will be eroded by bracket creep.
Before becoming Treasurer, Wayne Swan used to talk a lot about effective marginal tax rates (EMTR) and the poverty traps they create. This policy increases the EMTR for taxpayers earning between $68,000 and $80,000. That is just above average full-time earnings.
All up this is a complex policy that doesn't deliver on its primary objective of cutting emissions by 5 per cent on 2000 levels. It is very likely to be more expensive than Treasury has estimated. It relies heavily on technology that doesn't exist and global permit markets that don't exist. Finally it increases the disincentives for average income earners in the labour market, while avoiding any careful and rigorous discussion of the labour market impact of the policy.
For 20c a week more, on average, there are a lot risks in this policy.

Sinclair Davidson is a professor in the School of Economics, Finance and Marketing at RMIT University and a senior fellow at the Institute of Public Affairs.


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