The fiscal cap

The Coalition have announced their climate change policy. It certainly isn’t cap and trade. The question is: what is it?

The main part is an Emissions Reduction Fund. It appears that this is a fix pot of money that the Coalition will then spend via a tender process to identify projects that will reduce emissions, not involve price increases to consumers, protect Australian jobs and need the funding. What this appears to mean that the Coalition will ‘pay for carbon’ and cap the total pay. It is a ‘fiscal cap and stay.’

But that only appears to be part of what the fund is for. It also looks set to pay businesses for emissions reductions below their historic average. If they agree to reduce emissions, they will be paid for the reduction. It is not compulsory for small businesses.

That said, the Coalition will hold the line at the status quo. Businesses who exceed their current emissions will incur a penalty. Aside from the obvious issue that this puts an amazing weight on working out what ‘business as usual’ actually is for each individual business what if they can actually do that? Does that mean a polluting business can’t expand? Not quite. So long as they can justify it as ‘best practice.’ In other words, it isn’t a ban but a regulatory hurdle. It is claimed that this will be less complex or bureaucratic than Labor’s proposal, although it is hard to see how. It is also, by its very nature, hard to scale up if a target of more than 5% is required by international agreements. (That said, it makes it much harder for Australia to be part of such agreements too).

This approach of setting a budget and then somehow allocating it to a grab-bag of projects is a difficult task. In the bizzaro world we are living in, it is the sort of thing that those who have great faith in governments recommend. By faith I mean in the ability of governments to gather accurate information and allocate funds in a way that doesn’t encourage rent seeking. Call me crazy but this proposal seems a textbook example of how not to do things when you note that in the real world, there is a governmental knowledge cap and a flow of funds to industry in a way that would surely be difficult to account for — even if you can somehow make it transparent. It throws two decades of public sector management improvements out the window.

I had previously called Abbott an environment-hater. In retrospect, I realise that can’t be the case. After all, how can someone willing to expend so much in economic inefficiency for the sake of the environment, hate the environment? The Coalition policy caps the government’s fiscal commitment to climate change but not the economic commitment of the economy. It is still unknown how costly that economic commitment will be and hopefully we will never have to find out.

22 thoughts on “The fiscal cap”

  1. Of course there hasn’t been a lot of rent-seeking or bureaucratic waste in the CPRS hey?
    We shouldn’t just accept that but the scheme has a number of advantages that you don’t mention.
    First, by reducing the need to compensate households, it reduces some of the waste in labor’s scheme. For example, why aren’t many (other than Ergas) highlighting the massive increase in MTRs implicit in the compensation packages for low and middle income households?
    Second, it will remove the need for EITE assistance. I don’t see that setting a baseline is all that hard, as that is what the govt has had to do for these industries. The free permits are basically a baseline anyway. All this does is expand the concept to other industries.
    Third, ok so this scheme won’t plug into the ETS’s that (some) countries have introduced. That hardly seems like a big issue at the moment, when a global ETS doesn’t look like happening anytime soon. Indeed, that’s another problem with the govt’s CPRS. What if nothing happens overseas, or countries move to something different? It won’t be that easy to dismantle the CPRS, it would probably another round of costly compensation. The coalition’s scheme would probably easier to remove.

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  2. It seems to me that the opposition is doing a much better job than the government of highlighting the benefits of an ETS.  In particular, it is demonstrating that, although an ETS seems complex, the alternative is far worse.

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  3. <this is a fixed pot of money that the Coalition will then spend via a tender process to identify projects that will reduce emissions>
    <In the bizzaro world we are living in, it is the sort of thing that those who have great faith in governments recommend.>
    … the previous Coalition Government ran a scheme along these lines (the Greenhouse Gas Abatement Program or GGAP).  If we could get an objective read on how well GGAP has worked, we would be better placed to assess the potential of the current proposal.
    FWIW, Alan Kohler has a very interesting article today in Business Spectator (“Abbott’s Great Big Axe”). Great idea, just might work, needs a lot of development.

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  4.  
    Abbot’s scheme fails the one key test.  Long-term business certainty.
    What happens once the low hanging fruit is gone?  Abbot is talking a carbon price of $15 or less.  Which may be true for the first few years, but then what?
    Sure going after the cheapest abatement is great.  But what happens after 2020 because I can guarantee that any energy related business making a serious capital investment is looking at a 25 year horizon not 10.

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  5. @M: actually, if you look at the numbers in the coalition policy document, they seem to envisage a carbon price of $5/tonne or less ($12bn over 10 years to reduce emission by perhaps 2.5 billion tonnes, assuming a linear decrease 2010 to 2020, see P13 of policy document). You won’t get much of a reduction in coal-fired generation at this price.

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  6. One thing I will never understand is why the government didn’t do a better job explaining the ETS.  It’s actually really not that difficult to explain as a broad brush concept (like Tony has presented his).  I explained to to my wife in 5 minutes driving through peak hour traffic for god’s sake.
    There should have been saturation.  Graphics for the 1 minute news slot.  Multiple short youtube videos.  A specific website explaining it. Then, now, they could have had a specific counter argument to this weirdo scheme.
    It’s almost like they didn’t WANT the public to understand it… even if that meant standing by and waching every Lib/Nat scream “GREAT BIG TAX ON EVERYTHING” from the rooftops at every opportunity.
    In short what happened to Kevin 07?

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  7. Dave at $5/tonne new coal generation would be highly profitable.  Doesn’t change til at least $20-30/t.
    The other issue is how you treat new EITE.  If you let them emit just so long as they are “best practice” then you have no cap at all and emissions will keep rising.

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  8. Tristan,

    A number of my friends and colleagues have complained about the lack of explanation by the government. The answer is not complicated – your electricity and petrol costs will rise in the short-term and over the longer-term (unless there’s a killer-replacement technology for base-load power use or road transportation needs). A sure vote-killer at the next election in the mortgage-belt. It’s the key piece of information whose name cannot be spoken in public.

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  9. @M: Yes, that was the point I was making (that coal generation remains profitable at $5/tonne).
    But actually I misread the report and am doing the coalition a disservice.  I mistook the target for the reduction.  The reduction amount is 1.4 billion tonnes over 10 years (P1 of policy document), implying a cost of $9/tonne.  Still much too low, though, I would think.
    @Tristan: yes, I don’t get it either.  The scaremongers have filled the information vacuum quite successfully.
    @DP: although electricity prices will rise with the ETS, far greater rises are currently happening due to higher grid investment.  Because the government has not explained things, all of the rise is being blamed on the ETS.  I don’t think keeping quiet is a good strategy.

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  10. DP has a good point.

    One thing on business certainty though. We are talking about regulatory risk i.e. what is the new regulation? how much will it hit us? etc etc

    The ETS does not increase certainty because it commoditises carbon. By creating a market for carbon like the market for interest rates, oil, gas etc it is subject to volatility. This volatility will create a negative risk for companies like oil price volatility hits airlines. Can someone explain to me how a market for carbon suddenly creates certainty? The only certainty is price volatility.

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  11. SeanG’s comment takes us full circle to a carbon tax. It’s transparent and fixed (at least for the life of the government). And we have precedence for imposing specific taxes on petrol. Of course, the big advantage of an ETS is that AU can trade carbon credits on an international market should one become established.
     

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  12. The simplest, most direct criticism of the propsal is that it simply doesn’t delivery diddly-squat in terms of emissions reductions.

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  13. Thanks for the comments DP and others.
    DP, you are right that saying we are going to increase the price of petrol etc isn’t a vote winner.
    However, I would say that if you choose to explain it yourself you can say “it will increase the price of petrol etc. BUT x, y, z”.  (eg.  Improve investment in more sustainable energy now, yadda yadda).
    By staying silent they have allowed the ETS to be explained with the x, y, z befefits.  It’s just “it will incrase the price of petrol.”  That’s it.  Full Stop.
    Personally, I am much more in favour of a carbon tax.  If there is one thing we have learned from the financial crisis wouldn’t it be that we don’t want international markets in really complex things where people don’t really understand the consequences.
    However, try and sell a carbon tax the Australian public!  You can already see the libs using that scary word effectively.  (AHH! TAX! EVERYBODY RUN!).   If it was actually technically the a tax that line would be effective.
    Tax is to government as Macbeth is to the theatre.

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  14. Well, nobody likes taxes, but surely it is preferable politically to have a tax that everybody understands (and that is seen to fall directly on polluters) than a quasi-tax that nobody seems to understand and that the government is not prepared to explain.
     
    I don’t much like the economics of a carbon tax, but I can see its political attractions.
     

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  15. I am disappointed to the point of disgust with the Lib’s proposal. I am not in favour of ETS – I prefer a direct tax – but it’s certainly preferable.  Though one big advantage of the carbon tax is that it is transparent and simple, unlike an ETS and whatever this Lib policy could be called. That makes it easy to understand, which means it’s more likely to work the way the theory predicts. It also makes it far less open to distortion from lobbying and government corruption. That is a serious concern with the Lib’s scheme – which frankly demonstrates their belief that the government is a benevolent genuis – and it is also a concern with an ETS. 

    As other posters have pointed out, it is true that a carbon tax is difficult to sell to the electorate, but what if the government promised to use it to offset income taxes? I believe this would be an optimal outcome as it allows us to reduce the distortionary income tax by introducing a welfare-enhancing pigouvian tax.

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  16. Dave,  I agree.  Of course any economist can see the advantage of an ETS – we need to manage the quantity of carbon emissions, so fix the quantity and let the price float to meet it.  A carbon tax fixes the price and hopes the quantity floats to our desired level – to meet your target quantity you would need very good estimates of the relevant elasticities.  Also the international trade in permits gets you large extra efficiency gains.

    But the huge gains in transparency of a simple flat-rate carbon tax which is paid back as a flat cash dividend to Joe Sixpack makes it an easier political sell, and also has the advantage that special little bribes to “deserving” industries are there for all to see as an obvious ripoff from the rest of us.

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  17. Dave mentioned in an earlier post and I quote, “… it is preferable politically to have a tax that everybody understands (and that is seen to fall directly on polluters).”

    Therein lies a political problem for both a carbon tax and the ETS. I think the average (and probably the not-so-average) voter perceives the polluter as an industrial entity, e.g.’ bad’ brown coal power station, when, in fact, it’s also you and me as conspicuous consumers on the grid. (I’m not advocating hairshirts or dirt floors, but current technologies have externalities everywhere. )

    So while I understand the pollies’ reluctance to spell this out, I do believe that the correct strategy is make the facts transparent. The Opposition proposing the wisdom of government administration as an alternative to a market-based ETS is absolutely fantastical irony.

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  18. The one thing that needs to be explained about an ETS is that a tax is not a cost it is a transfer.
    An ETS is basically just a GST on carbon.  In fact lots of people suggest just having a GST on carbon (easy to tack onto imports and subtract from exports).
    However to guarantee a certain reduction (which will be necessary under any international treaty otherwise the government will have to pay the off-run bill) you need to allow the price to vary.  Business’ already deal with commodity price, exchange rate and interest rate uncertainty, this is not a big deal.  Forward contracts and price hedging will be as simple as those other uncertainties.  Remember only the largest 1000 or so companies have to deal with this directly…

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  19. @Tristan. I think you hit the nail on the head that Labour are doing an atrocious job selling their ETS. They really shouldn’t be letting the Libs go unchallenged when they equate ETS = taxes.
    Combating climate change costs money. Assuming reducing carbon tax is a given, then the question becomes about finding the most efficient (i.e cheapest) way of doing that.
    While I don’t claim to be an expert on climate change economics, i would’ve thought the most efficient mechanism would be an market-based one i.e carbon tax or cab-and-trade. Hence, my utter surprise when an economically right leaning political party rules out implementing carbon tax/cap-and-trade, effectively ruling out the most efficient way of going about it.
    It’s like they’re doing economic gymnastics with respect to climate change policy.
    Personally, i can only think of two reasons why do would choose going down this path:
    1. they’re are not serious about climate change ala the aust. republic referendum;
    2. there’s a bit of conservative machoism going on with the claims about ‘no new taxes’. Elaborating on this point, economically speaking, its not the ‘form’ but the ‘substance’ that matters, i.e. its about efficiency, and the Libs seem more interested in the ‘form’.
    In this respect, I think Labour should be doing better on climate change policy than the polls would suggest. Again not claiming to be an expert, but i think economically speaking, Labour have it over the Libs on climate change. And they really should be taking advantage of this situation.
    I liken the current Libs stance on climate policy like the Libs supporting increased trade barriers (though if i recall correctly Barnaby seems to be keen on this idea in respect to agriculture goods from an interview on Lateline).
    Labour should be doing with ETS what the Libs under Howard did with GST, that is, selling it better to the public.

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  20. The department of climate change is saying that the coalition approach would cost $27bn, not $12bn, equating to $19/tonne (my estimate), which sounds more plausible.

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