Emissions Tax:
The least worst option
3 October 2009 | by John Humphreys and Luke Malpass
An ETS is poor policy and a Carbon tax is better?
The The European Emissions Trading Scheme (EU ETS) has been in place since 2004. Since its inception, the price index has shown huge variability in the price and volume of credits traded.
Late 2004: >€10
Mid 2005: €30
Late 2005: €20
Early 2006: €30
April 2006: €10
2007: €1.
The uncertainty around prices has led to delayed investment and risk aversion leading to less incentive to invest.
Another problem with the scheme is over-allocation of permits for some emitters, which has led to substantial profits for some but also perverse incentives to retain inefficient operations elsewhere.
Such allocations are a form of corporate welfare. New allocations provided to new entrants (companies set up since 1990) amount to an investment subsidy and will provide windfall gains for those companies that successfully lobby for new credits.
Nick Schulz from the American Enterprise Unit has a startling take on the EU ETS, likening it to the mortgaged-back securities situation that helped cause the global financial crisis:
“Europe has in place a cap in trade program that today looks a little like the American mortgage-back securities - it’s a total mess.
The price of carbon recently fell – plummeting from over $30 to around $12 per ton – as European firms unloaded their permits on the market in an effort to shore up deteriorating balance sheets during the crunch”.
The constant need for re-negotiations and the complexity of the system has made the EU ETS highly political, and the nature of the re-negotiations is such that they may encourage emitters to set a high emissions standard in ‘base years’ so that they receive a higher allocation of permits in future negotiations. This ‘updating’ problem means that emissions trading can lead to higher energy prices without offering any incentive to lower overall carbon emissions.
Politicians around the world are feeling the pressure to introduce global warming policy.
But poor policy will leave us in a worse position than no policy. An Emissions Trading Scheme (ETS) is poor policy; a more flexible, efficient, effective and transparent approach would be to replace the current proposals with a moderate and revenue-emissons neutral emissions tax.
Such a tax could also be used to offset losses the Government is expected to realise this current financial year from dramatically falling company revenue.
A $30 per tonne CO2-e emissions tax could be linked to a reduction in the company tax rate from 30% down to a more internationally competitive 25%. Or a $20 emissions tax could entirely replace the current fuel tax, making the fuel tax more efficient by applying a lower rate to a broader base.
The goal
The aim of the policy should be to speed up the transition to newer, cleaner technologies; it should not be to reduce the use of energy powered activities, transport or agriculture which provide significant benefits to society.
If a global warming policy is needed, then the issue is for policy makers is to determine which policy has the most benefits for a given cost.
Trading vs Tax
Both emissions trading and an emissions tax involve manipulating the price and quantity of emissions released into the atmosphere from human activity.
An ETS involves fixing the quantity of CO2 and other so-called greenhouse gases that can be emitted and then allowing the price of emissions to fluctuate. The current National party proposal is for the price to be limited to a cap.In contrast an emissions tax involves setting a fixed price and allowing the quantity emitted to fluctuate.
The McKitrick Tax: A Market Solution to Climate Uncertainty
The emerging policy consensus that ‘we must do something’ faces three fundamental challenges. First, it is difficult to measure the impact of any policy on the actual level of emissions. Second, the experience of the EU ETS is that it has not substantially lowered emissions. Thirdly, these policies impose economic losses.
An ideal policy response would both take account of the degree to which human activities are leading to warming, and adjust the incentives so that once the desired level of emissions reduction is reached, no further harm is imposed on the economy.
According to the UN’s Intergovernmental Panel on Climate Change (IPCC), warming in the tropical troposphere should be an early and strong signal of AGW.
Canadian economist Ross McKitrick argues that for each country, the dollar rate of the carbon tax be pegged to the three-year average change in global tropical temperatures.
The tax would be assessed per ton of carbon dioxide emissions, and updated annually. It would be administered for all domestic carbon dioxide emissions, be matched with income tax cuts and would come with no cap on emissions.
Currently, according to McKitrick, the tax in Australia would come out to $4.70 per ton, compared with an ETS price of around $NZ 31 per ton. But if global warming forecasts are correct, the tax would eventually climb at a rate of between $4 and $24 per decade, according to McKitrick’s findings.
As McKitrick points out, it is even possible, according to some scientists, that we might experience global cooling, in which case we could end up subsidizing carbon emissions.
These two scenarios, and all of the scenarios in between-highlight the uncertainty in our climate future.. As McKitrick himself says, with this tax, “the regulator gets to call everyone’s bluff at once, without gambling in advance on who is right.”
Whatever the chosen option, it is imperative that the benefit of that chosen action exceeds the costs and that, if anthropogenic global warming is real and significant, that the option achieves the required outcome. There is no point in supporting a government intervention, if the cure is worse than the disease.Given the competing political priorities of protecting the economy and ensuring that any action is effective, a revenue neutral emissions tax is the best option.