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Carbon tax rate considerations

The Government’s recent proposal for tackling rising levels of Australian greenhouse gas emissions is a two-stage carbon price mechanism. The first stage of the scheme is a carbon tax. After three to five years, this will be transitioned into stage two, a cap-and-trade emissions trading scheme (ETS). The details of this architecture are unconfirmed, and there has been speculation over the level of the first-stage tax. There are also opposing views arguing that carbon pricing is not likely to be as effective in reducing emissions as, say, direct investment to accelerate the development of competitive renewable or non-carbon sources in the marketplace. So any carbon pricing mechanism implemented by the current government could be rescinded by a future government. Nevertheless, assuming a price on carbon is adopted with a view for longevity, a number of factors will be under consideration in determining this tax rate. Broadly, the tax must be high enough to reduce emissions. But it must also take into consideration the price of carbon in other countries, as explained below.

The previous carbon pricing model proposed by the Government, the Carbon Pollution Reduction Scheme (CPRS), outlined a one-year carbon tax of AU$10 per tonne of emitted carbon dioxide equivalent. This was to transition into an ETS capped at AU$40/tonne initially. When the Government abandoned the CPRS, the Greens proposed an interim two-year carbon tax of AU$20/tonne. This was consistent with the thinking behind the 2008 Garnaut Climate Change Review which outlined an initial AU$20/tonne carbon tax as a precursor to a fully flexible ETS design.

A number of countries around the world have established carbon taxes or emissions trading schemes. However, only two have been in existence for a period of time long enough to provide any indication as to an effective price for carbon.

The European Emissions Trading Scheme (EU ETS) began trading in 2005 and is currently in its second phase of implementation, with phase 3 planned for 2013. Since 2007, the price of an EU ETS credit has fluctuated between €10 and €33/tonne and has levelled at around €15 since early 2009. It is currently equivalent to about AU$20.

Countries can also trade emissions credits under the Kyoto Protocol. In particular, trade has developed for credits that arise from emission reduction projects in developing countries through the Clean Development Mechanism. These are known as Certified Emission Reduction (CER) units. Since 2007, CER units have traded at AU$2 to AU$5 less than EU ETS credits.

These examples provide some reference points, but ultimately the ‘right’ carbon price for Australia will depend on a raft of factors, some more uncertain than others. The price will need to be low enough to get big business and industry on board. However, the Government will also need to consider the cost of actually reducing emissions, both in the short term and the long term. For example, a carbon price of a certain level may be enough to drive industry to increase energy efficiency, but in the longer term, may not be enough to instigate investment in lower carbon technologies and processes. If it proves cheaper for emitters to pay a tax rather than innovating and adapting, then that is what they are likely to do.

For Australia’s emissions-intensive export industries specifically, the tax level will have to take into consideration the inherent or imposed price of carbon in other countries. This is to insure against ‘carbon leakage’, where business is driven abroad to countries with less stringent environmental standards and regulations. In such a lose-lose situation, Australia could be economically worse off and net global emissions would increase.

Finally, and perhaps most fundamental to this debate, is Australia’s and Australians’ responsiveness to the carbon price signal. This is one of the biggest uncertainties in the discussion. How much does a $5/tonne tax make people or businesses change their behaviour? And a $50/tonne tax? No study or model can accurately capture this question without making a host of questionable and subjective assumptions. Because electricity is a necessity rather than a luxury, the ability of some people or businesses to respond to increased power prices by reducing consumption may be quite limited. There will be some critical price at which the effectiveness of the tax is maximised, but determining that level is an exercise in trial and error.

According to one view, that of Richard Denniss from The Australia Institute, ‘the very first dollar of any carbon tax will have an important effect on business, industry and manufacturers.’ Once any carbon tax is in place, investors looking 5, 10, or even 30 years ahead, will need to take into consideration the likely future levels of the tax in decision-making.

(Image sourced from: http://www.climatechange.sa.gov.au/uploads/images/What%20Can%20I%20Do/icons/BlackBalloonIcon.jpg)