RESEARCH PAPER NO. 5, 2011–12, 23 November 2011

Securing a clean energy future: some economic aspects

Richard Webb
Economics Section

Executive summary

•        The carbon pricing mechanism (CPM) in the Government’s climate change plan will increase the relative prices of carbon-intensive goods and services. This will encourage users to substitute less carbon-intensive goods and services such as more fuel–efficient cars, and producers to change to methods using less carbon-intensive inputs, for example, generating electricity from natural gas rather than coal.

•        A carbon price is likely to be less costly in reducing emissions than regulatory policies such as the renewable energy target scheme. To reduce emissions, there will be innumerable changes to consumption and production. A carbon price provides incentives to implement these changes at least cost whereas regulation is tied to specific products and production processes. The proposed mix of a carbon price and regulatory policies is thus unlikely to reduce emissions at least cost to the economy.

•        In principle, the base to which the CPM applies should be as broad as possible and the base is quite broad. However, exclusions from the base will limit the efficiency of the CPM in reducing emissions, and increase pressure on the industries included in the base to reduce their emissions.

•        While the legal liability for the CPM will fall on producers, some of the effect of the CPM will be passed onto consumers in higher prices. The household compensation package will assist those on low incomes. However, the ability of energy-intensive trade-exposed industries to pass on costs is limited, so a consequence of the CPM could be to reduce exports while also exposing import-competing industries to imports from countries that do not have emissions reduction schemes. These effects could reduce the size of industries on which much of Australia’s prosperity depends.

•        The CPM is very complex and is likely to result in substantial compliance costs for the private and government sectors.

Introduction

On 10 July 2011, the Australian Government released its climate change plan (the Plan).[1] The Plan, which is to start on 1 July 2012, is a package of measures. The carbon pricing mechanism (CPM) is the Plan’s central feature.[2] The CPM has two components. The first is that for the first three years, the Government will sell emission permits at government-set prices. The price in 2012-13 will be $23 per tonne of carbon dioxide equivalent (CO2-e).[3] The price will rise by 2.5 per cent in real terms (that is, after taking inflation into account) in each of 2013-14 and 2014-15.

The second component—the ‘flexible price’ period—is an emissions trading scheme. This will come into effect on 1 July 2015. In the flexible price period, permit prices will be market-determined. The Government will set the quantities of emissions, and permit prices will adjust to ensure the quantitative outcome.[4]

This Research Paper examines selected economic aspects of the Plan and the CPM. It is not a comprehensive overview of either. 

Economic instruments versus regulation

The primary objective of the Plan is to reduce greenhouse gas emissions produced in Australia. The effect of the CPM will be to increase the relative prices of carbon-intensive goods and services. This will encourage users to substitute less carbon-intensive goods and services such as fuel-efficient cars, and producers to change to production methods using less carbon-intensive inputs, for example, electricity generated from natural gas rather than coal.

This raises the question: how can environmental goals be attained at least cost to the economy? All member countries of the Organisation for Economic Co-operation and Development (OECD) levy taxes and user charges on specific goods and services to attain environmental goals. In practice, a considerable proportion of these taxes and charges falls on energy use.[5] Fuel excise is an example of such a tax. OECD countries have also adopted various regulations such as technical standards, voluntary agreements and emission prohibitions to attain environmental goals.[6] This raises the question: what are the best means of obtaining environmental goals? According to the OECD:

There are several reasons why environmental taxes and other economic instruments such as trading systems may be preferred over “command and control” types of regulation. First, by letting individual market agents decide upon how much and in which way to reduce pollution, they allow the agents with the lowest abatement costs to contribute the most to the total reduction in pollution, thereby minimising the overall cost of the policy (i.e. securing cost-effectiveness). This property is usually referred to as “static efficiency”. Second, in contrast with “command and control” regulation, which cannot be continuously adapted, economic instruments promote “dynamic efficiency” by providing permanent incentives for reducing emissions through technological improvement. Third, taxes and tradable permits (when sold or auctioned) provide revenues, which can be used to increase the overall efficiency, for example by reducing other taxes. Finally, as economic instruments work through the price system, they allow an effective integration between economic and environmental policies, (and avoid environmental policies simply curing the ills generated by sectoral policies).[7]

There are other reasons a price mechanism is likely to be superior to regulations in reducing emissions. To achieve emissions reductions, there will be innumerable changes to consumption patterns and production processes many, if not most of which, are unpredictable. A carbon price provides an incentive to implement these changes, which regulation can never replicate because regulation can apply to only a limited number of products and production processes. The process by which a carbon price operates can be illustrated by the concept of a marginal abatement cost (MAC) curve (see Figure 1).

Figure 1: Marginal abatement cost curve and cost effectiveness: a hypothetical illustration

Source: Productivity Commission, Carbon emission policies in key economies, Research Report, Commonwealth of Australia, Canberra, May 2011, p. 152.

The marginal cost of abatement is the cost of reducing one unit of emissions, for example, one tonne of carbon dioxide equivalent. A marginal abatement cost curve (MAC curve in Figure 1) shows the relationship between marginal abatement costs and the volume of emissions reduced under all options for reducing emissions. The curve turns up as it becomes increasingly costly to reduce emissions. Figure 1 shows that the costs of meeting an aggregate emissions target are minimised by a common marginal cost of emissions reduction across all the possible ways of reducing emissions. In other words, it makes sense to adopt first the least-cost measures to reduce emissions. However, as the Productivity Commission (the Commission) showed, regulatory interventions (shown by the shaded areas) may result in high-cost measures being adopted even though lower-cost alternatives (unshaded areas) exist.

The CPM, by placing a price on emissions, is an ‘economic instruments’ approach. The Plan, however, is a mix of economic instruments and regulation. In addition to the CPM, the Plan contains regulatory measures including the renewable energy target scheme, various Commonwealth government programs, and the proposal to close down coal-fired electricity generators.[8] It is unlikely that this policy mix will reduce emissions at least cost to the economy because many regulatory policies are costly ways of reducing emissions. The Commission, in a survey of international and Australian emissions reduction policies, found that many regulatory policies are very costly.[9] For example, in the electricity generation sector, the Commission estimated the implicit emissions abatement subsidy for Australia—that is, for state and Commonwealth government policies combined—to be in the range of $44 to $99 per tonne of CO2-e.[10] In the case of the renewable energy target—under which 20 per cent of electricity is to be supplied from renewable sources by 2020—the estimated range was between $42 and $129 per tonne of CO2-e. The cost of ‘clean’ fuel subsidies was even higher:

The implicit abatement subsidy for the policies combined is estimated at A$310/t CO2-e. Of the individual fuels, the cost of abatement was highest for ethanol, with an implicit abatement subsidy of A$444/t CO2-e, followed by biodiesel and then vegetable oil with implicit abatement subsidies of A$275 and A$242/t CO2-e respectively.[11]

The Commission also modelled the cost-effectiveness of actual policies for Australia using electricity generation as a case study. The Commission found:

∙ Based on conservative assumptions, the modelling suggested that the 12.5 Mt abatement achieved by existing policies for the electricity generation sector in 2010 (including demand-side abatement) could have been delivered instead by a carbon price (for the electricity sector only) in the order of $9/t CO2, or at a fraction of the existing cost.

∙ Alternatively, it was estimated that a carbon pricing mechanism applying to the electricity generation sector, and imposing the same costs as the policies in place in 2010, could have reduced emissions by more than double the abatement achieved.

The results highlight the potential gains from exploiting lower-cost opportunities for abatement over higher-cost ones.[12]

Given that the evidence indicates that a carbon pricing mechanism is likely to be less costly to the economy than regulations, it can be argued that the various regulatory policies should be abolished. The report on Australia’s future tax system (the Henry report) in its discussion of taxes to improve the environment when the Carbon Pollution Reduction Scheme was proposed, concluded:

Once the Carbon Pollution Reduction Scheme (CPRS) is operational, additional measures which seek to reduce emissions (in sectors covered by the CPRS), and which are not justified on other grounds, should be phased out.[13]

This recommendation could equally be applied to the Plan.

General principles guiding tax policy

The consequences of the sale of permits are similar in many respects to those of taxes. Just as the production of some goods is now subject to tax—for example, the excise on cigarette production and the excise on some crude oil and condensate production—so too will the ‘production’ of emissions be subject to a price under the CPM. Given this similarity, the following examines the application of tax principles to the CPM.

Efficiency

Three principles usually guide the imposition of taxes. They are efficiency, equity and simplicity. The Organisation for Economic Co-operation and Development (OECD) has stated these principles as follows:

Modern OECD economies have fundamental economic and social objectives that require public spending. This in turn must be financed through taxation. However, because taxation inevitably impinges on most aspects of economic activity, careful consideration must be given to its design – in addition to its level and hence the level of related expenditure. Three features of taxation are especially important. First, so long as taxation affects incentives it may alter economic behaviour of consumers, producers or workers in ways that reduce economic efficiency. These effects should be taken into account when the costs and benefits of public expenditure to be funded are being assessed. Second, the distribution of taxation’s impact across the population raises issues of equity, or fairness, which must be given substantial weight even if it entails costs in terms of economic efficiency. Third, the practical enforceability of tax rules and the costs arising from compliance are important considerations, the more so since these are both affected by, and have implications for, the efficiency and public perceptions of the fairness of tax systems. As elaborated in more detail below, the key challenge for tax policy is to strike the best possible balance among these issues.[14]

In general, taxes should be designed to limit their effects on economic behaviour. However, since all taxes change economic behaviour in some way:

A more useful guideline is that the tax system should be as neutral a possible, i.e. minimise discrimination in favour of or against any particular economic choices. In practice, this points to building tax systems substantially around broad income and expenditure bases and minimising differences in tax rates that can be applied. As a rule of thumb, in the absence of compelling considerations to the contrary ... improvements in efficiency can be achieved by: i) broadening tax bases by eliminating exemptions and special regimes; ii) flattening rate structures; and iii) integrating or aligning different tax rate structures to avoid arbitrage opportunities.[15]

Based on the neutrality principle, the exclusions from the Plan’s base—including entire industries and parts of industries—undermine its neutrality.[16] For example, fuel used in domestic aviation and domestic shipping, rail transport, off-road transport use of liquid and gaseous fuels, and non-transport use of liquid and gaseous fuels will be subject to the CPM. However, fuel used by households for transport, light on-road commercial vehicles, off-road use by the agricultural, forestry and fishing industries, gaseous fuels used for on-road transport, ethanol, biodiesel and renewable diesel, and transport fuels when used as lubricants and solvents will be excluded. [17] While it is neither possible nor desirable to include all industries in the base—for example, where it is not possible to measure emissions or where emissions are so small that the cost of including them in the base exceeds the benefit derived—exclusions from the base increase pressure on the included industries to reduce emissions or require the import of more permits than would be the case if the excluded industries were included in the base. For example, in the case of transport fuels, the neutrality principle suggests that all transport fuels should be taxed. However, as noted above, some will be included but others will not.[18]

Greenhouse gas emissions fall into the category of ‘negative externalities’, which are a form of market failure.[19] The existence of a negative externality does not, by itself, justify government intervention because intervention is not costless. Rather, the issue is whether the benefits of intervention, including any resulting from the reduction in the externality, outweigh the costs. Intervention in the forms of a price on carbon and regulatory assistance to renewable energy industries—like the assistance given to manufacturing industries in the past—will come at a cost to the economy in the forms of lower economic growth and living standards.

Equity

Legal and economic incidence

The equity effects of a tax depend on who ultimately pays the tax, that is, its incidence. It is important to distinguish between legal and economic incidence. For example, the legal liability to pay excise lies with the producer of the commodity such as a cigarette manufacturer. Economic incidence refers to who finally bears the burden of the tax. Producers of the commodity may be able to ‘shift’ the excise—to varying degrees—on to consumers in the form of higher prices.[20] Thus when the Government talks about making big polluters pay, this refers to the legal not the economic incidence. The recognition that the economic incidence of the CPM will fall partly on households and partly on emitters underpins the assistance measures to be provided to some households and some businesses. The ability of producers to shift the incidence of a production tax onto consumers depends partly on the ‘own-price elasticity’ of demand. This is discussed below in Box 1.

Box 1: own price elasticity of demand

The own-price elasticity of demand (OPE) is defined as the percentage change in quantity of good i traded, divided by the percentage change in the price of good i. This can be represented as follows:

OPE for good i=ΔQiΔpi × piQi

where pi is the price of good i; Qi is the quantity of good i; ∆Qi is the percentage change in the quantity of good i; and ∆ pi is the percentage change in the price of good i.

Except in the most extreme and unlikely of cases, we would expect this magnitude to be less than zero, implying that the quantity demanded falls as price increases. The prime matter of interest is the intensity of the response to a given price change so, for convenience, economists generally ignore the negative sign and focus on the absolute value (as shown by the vertical lines in the following).

There are three cases we need to consider. These are:

•        OPE<1 (inelastic or ‘unresponsive’ demand)

•        OPE=1 (unit elastic demand)

•        OPE>1 (elastic of ‘highly responsive’ demand)

where < indicates less than; > indicates more than; and = indicates equal.

This means that if the (absolute value of the) own-price elasticity is less than one, the market quantity demanded is very unresponsive to price changes and so price increases will not reduce consumption of that good very much, whereas if it is greater than one, the quantity is highly responsive to price. In this case, even relatively small price increases can result in large falls in consumption of the good and vice versa.

Businesses cannot always shift the entire economic incidence of a tax on to consumers, so that some of the economic incidence of the CPM will fall on producers.[21] For example, the prices of many agricultural exports are set on world markets, that is, exporters are ‘price takers’. In the absence of offsetting measures, some agricultural exporters will bear the economic incidence of the CPM in, for example, the form of lower profits. More generally, the ability of energy-intensive trade-exposed (EITE) industries to pass on costs is limited. Import-competing industries such as domestic steel manufacturers have to compete with imports, while exporters compete in international markets. Hence the CPM is likely to reduce exports, and expose import-competing EITE industries to intensified competition including from imports from countries that do not have emissions reduction schemes. Overall, the CPM could result in a reduction in the size of the EITE industries on which much of Australia’s prosperity depends. Pressure on EITE industries will be eased, in the short term, by the temporary assistance under the Jobs and Competitiveness Program, and by the ability to import permits (see below).[22]

Another possible effect of the CPM is ‘carbon leakage’ whereby domestic producers shift activities offshore. No one knows whether or to what extent this will or will not happen.[23] A consequence of carbon leakage is that emissions production would be relocated from Australia to other countries but without any reduction in global emissions.

Production or consumption tax?

As noted above, the CPM is a price on the production of emissions which producers will attempt to shift on to users. A feature of this system is that it does not impose a price on imports of carbon-intensive goods and services. An alternative to imposing a price on the production of domestic emissions could be to tax consumption of emissions-intensive goods and services both domestic and imported. An advantage of this option is that, because the tax would apply to both imports and domestic goods and services, it would eliminate the distortion favouring imports inherent in pricing the production of domestic emissions. A problem with this option is how to measure the emissions-intensity of goods and services.

Income and substitution effects

As noted above, the CPM will increase the relative prices of carbon-intensive goods and services. The effect of a change in relative prices on consumption can be decomposed into two effects: a substitution effect and an income effect. An example of a substitution effect is when the prices of carbon-intensive goods rise relative to the prices of other goods, consumers will substitute, where possible, less carbon-intensive goods. The income effect refers to the fact that, with given budgets, a rise in relative prices also reduces consumers’ purchasing power. If consumers are compensated for the income effect to maintain their real incomes, adjustment is limited to the substitution effect. The Plan proposes to compensate some households, at least initially, through changes to the personal income tax and transfer systems.[24] Compensating households, by removing the income effect, runs contrary to the purpose of changing relative prices which is to reduce consumption of carbon-intensive goods and services.

The household compensation component of the Plan generally meets the’ vertical equity’ criterion, that is, that people on higher incomes should pay a higher proportion of their incomes in tax than low-income people.[25]

The ability of households and producers to adjust to higher relative prices may be limited especially in the short term. For example, low-income households may find it very difficult to reduce electricity consumption. The ability to adjust may be greater in the long term. Thus in the short term, a rise in the relative price of petrol usually leads car users to drive less, plan journeys and so on. In the long term, however, car users may buy more fuel-efficient cars.

Simplicity

The Plan is complex and implementing it will be complicated. The legislation establishing the Plan comprises almost 20 Acts and these are highly technical.[26] Some of the regulations in the legislation form part of the design of the pricing mechanism—for example, the floor and ceiling prices and the limits on imported permits—while other elements of the Plan deal with matters such as compensation, industry assistance and so on. Compliance costs are therefore likely to be substantial. Compliance costs will be borne by a wide range of private sector bodies and entities, such as electricity generators, that must comply with the legislation. Various government agencies such as the Australian Taxation Office and the Department of Climate Change and Energy Efficiency will also incur costs in administering the Plan.

Cost-effectiveness

The cost-effectiveness of the CPM in reducing domestic emissions will depend largely on the level of prices. In the ‘fixed’ price period (the first three years), prices may not be high enough to change consumer and business behaviour greatly. Consequently, regulatory mechanisms—such as the renewable energy target—are likely to play a relatively more important role than prices in reducing emissions than the CPM during the fixed price period. As prices rise in the flexible price period, behavioural responses will become more pronounced but it is impossible to predict precisely what forms and when these adjustments will take place.

Imported permits

After 2015, the Plan proposes to allow the purchase of permits from (as yet unspecified) ’credible’ international carbon markets and emissions trading schemes.[27] Access to these markets will be limited by the requirement that at least half of a liable party’s compliance obligations must be met through the use of domestic permits or credits. The limit on imported permits—effectively a quota—will have several effects. One may be to protect domestic renewable energy producers by ensuring that entities must acquire permits from domestic sources especially if domestic permit prices are higher than international prices. This will help to ensure that there will be emissions reductions in Australia. Another (counter) effect of allowing the import of permits is to reduce the Plan’s effectiveness in reducing domestic emissions in so far as entities can acquire permits from international rather than domestic sources.

The Plan proposes to have price ceilings and floor prices for international permits for the first three years of the flexible price period. The ceiling will be set at $20 above the expected international price and will rise by five per cent in real terms each year. The floor price will initially be $15 and will rise annually by four per cent in real terms. How this will operate is unclear. If the price of imported emissions is less than the floor price, the floor price will provide protection to domestic renewable energy producers. In this case, to ensure that the price of imported permits is not less than the floor price, imported permits will presumably be subject to a variable impost to raise prices to the floor price.

Conclusions

A carbon price that applies to a broad base is likely to be the most efficient means of reducing emissions because a carbon price will result in the adoption of least-cost measures. The base of the Plan is quite broad in that it encompasses the stationary energy sector, some elements of the transport sector, industrial processes, non-legacy waste, and fugitive emissions. However, the exclusions from the base, and the proposed mix of a carbon price and multiple regulatory policies, mean that it is unlikely that Australia will reduce emissions at least cost to the economy, and will shift the burden of meeting emissions targets onto included companies. In particular, the retention of the renewable energy target risks adopting higher-cost options when lower-cost options exist. As the Commission observed:

Currently, the most significant climate change policy instrument is the Mandatory Renewable Energy target (MRET) which is marked for significant expansion. However, with an effective emissions trading system in place, the MRET would:

– not achieve any additional abatement but impose additional costs

– most likely lead to higher electricity prices

– provide a signal that lobbying for government support for certain technologies and industries over others could be successful.[28]

Appendix

The following is an extract from, Australian Government, Securing a clean energy future. The Australian Government’s climate change plan, Commonwealth of Australia, Canberra, July 2011, pp. xiii-xviii, viewed 2 November 2011, http://www.cleanenergyfuture.gov.au/wp-content/uploads/2011/07/Consolidated-Final.pdf

Key elements of the carbon pricing mechanism

Price

A two‑stage approach:

1.      Fixed price period—The carbon pricing mechanism will commence on 1 July 2012, with a price that will be fixed for the first three years like a tax. The price will start at $23 per tonne and will rise at 2.5 per cent per annum in real terms.

2.      Emissions trading scheme—On 1 July 2015, the carbon price will transition to a fully flexible price under an emissions trading scheme, with the price determined by the market.

Coverage

Broad coverage from commencement, encompassing the stationary energy sector, transport (as described below), industrial processes, non‑legacy waste, and fugitive emissions.

Treatment of fuel and transport

Transport fuels will be excluded from the carbon pricing mechanism. However, where applicable, an equivalent carbon price will be applied through changes in fuel tax credits or excise.

A carbon price will be applied to domestic aviation, domestic shipping, rail transport, and non‑transport use of fuels.

A carbon price will not apply to household transport fuels, light vehicle business transport and off‑road fuel use by the agriculture, forestry and fishing industries.

In addition, at a later date, the Government will seek to establish an effective carbon price for heavy on-road liquid fuel use from 1 July 2014. (This measure was not agreed by all members of the MPCCC.)

International linking

International linking to credible international carbon markets and emissions trading schemes from the commencement of the flexible price period. At least half of a liable party’s compliance obligation must be met through the use of domestic permits or credits.

Price ceiling and floor

Price ceiling and floor will apply for the first three years of the flexible price period. The price ceiling will be set at $20 above the expected international price and will rise by 5 per cent in real terms each year.

The price floor will be $15, rising annually by 4 per cent in real terms.

Carbon Farming Initiative

Kyoto-compliant credits created under the Carbon Farming Initiative can be used for compliance under the carbon pricing mechanism subject to a 5 per cent limit in the fixed price period.

Governance

·        Climate Change Authority—Establishment of the Climate Change Authority to advise on pollution caps and progress towards meeting targets and undertake reviews of the carbon pricing mechanism.

·        Clean Energy Regulator—Establishment of the Clean Energy Regulator to administer the carbon pricing mechanism.

·        Productivity Commission—The Productivity Commission will undertake reviews relating to industry assistance, fuel tax arrangements and carbon pollution reduction activities internationally.

Helping households

A household assistance package will benefit millions…

The carbon price will be accompanied by a household assistance package, which will assist millions of Australians. Over 50 per cent of carbon price revenue will be spent on households.

A carbon price will add modestly to the cost of living. The average household will see cost increases of around $9.90 per week, while the average assistance provided will be around $10.10 per week. The prices of most household purchases will barely be affected by the carbon price—for almost everything other than electricity and gas, the estimated price impact is likely to be less than 1 per cent. Taking electricity and gas into account, the overall impact on the Consumer Price Index (CPI) is expected to be around 0.7 per cent in 2012–13. Households will not face a carbon price on transport fuels.

…and will compensate those who need it most to cope with the cost of living impacts of a carbon price.

The household assistance package is targeted at those who need help the most, particularly pensioners and low- and middle‑income households. Around two in three households will receive assistance that offsets their expected average price impact. About nine out of ten households will receive some assistance.

Income tax will be reformed, freeing over 1 million people from the tax system altogether.

Because the carbon price raises revenue, it provides an opportunity to cut other taxes. The Government will cut income taxes by raising the tax-free threshold so that, initially, up to 1 million people will no longer need to file a tax return. From 2015, a second phase of tax reform will mean that up to an additional 100,000 people will not have to file a tax return. Reducing taxes by increasing the tax-free threshold is an important change in Australia’s tax mix: it involves reducing taxes on desirable things (work and income), boosting incentives to work, and replacing them with a charge on something undesirable (carbon pollution).

The tax‑free threshold will be more than trebled to $18,200 in 2012–13. From 2015, the tax‑free threshold will be further raised to $19,400. People with incomes below the new tax‑free thresholds will get to keep all of their wages in their regular pay packets.

Pensions, allowances and benefits will be increased.

In addition to tax cuts, pensions, allowances and benefits will increase.

Other features of the household assistance package include:

·        special payments for people who have high energy use due to medical needs

·        shared assistance between aged care residents and providers

·        the development of an opt‑in program where household assistance payments can be directed towards accredited energy efficiency measures through non‑government organisations.

Household assistance will be permanent and will keep up with increases in the cost of living.

Pensions and other benefits are automatically indexed to keep pace with the cost of living, while the tax changes will be set at a level to cover the expected impact of the expected carbon price to 2019-20.

The Government will ensure the ongoing adequacy of household assistance.

The household assistance package is described in more detail in Chapter 4 and in Appendix A.

Supporting jobs

Businesses will also be assisted in transitioning to a carbon price.

To support Australian businesses to make the transition to a clean energy future, the Government has designed a number of assistance measures for the business community, from large industrial producers to small businesses. The Government will allocate around 40 per cent of carbon price revenue to help businesses and support jobs.

Assistance measures will target emissions‑intensive, trade‑exposed industries, other areas of manufacturing, food processing, foundries and small business.

The Jobs and Competitiveness Program will ensure that businesses that produce a lot of pollution and compete in international markets remain competitive, while still retaining strong incentives to reduce carbon pollution. Almost all emissions-intensive and trade-exposed activities are in the manufacturing sector. The Jobs and Competitiveness program will provide support to activities that generate over 80 per cent of emissions within the manufacturing sector.

The food processing, metal forging and foundry industries will also be assisted to support jobs in these parts of manufacturing. More general assistance for small businesses and manufacturing industries will target improvements in energy efficiency.

The Multi-Party Climate Change Committee agreed these measures.

All of these measures have been carefully designed to avoid interfering with the purpose of the carbon price: creating incentives to reduce carbon pollution.

These measures are discussed in Chapter 5.

In addition to these measures, the Government has decided to provide a Coal Sector Jobs Package and a Steel Transformation Plan (see Appendix C for details).

Encouraging innovation in clean energy

Innovation plays a pivotal role in reducing carbon pollution…

The transformation of Australia’s energy sector towards clean energy sources will unfold over the coming decades. The carbon price will play a major role, creating powerful commercial incentives to avoid traditional high‑pollution solutions and to adopt low‑pollution alternatives. However, given the scale of the transformation and the imperative to change, additional measures to support innovation and investment in clean energy are required.

…which is why the Government is providing substantial new funding to promote innovation in clean energy, including a new $10 billion Clean Energy Finance Corporation.

The Government will provide significant levels of financial support for innovation in clean energy technologies.

A new $10 billion commercially oriented Clean Energy Finance Corporation will invest in renewable energy, low pollution and energy efficiency technologies.

A new Australian Renewable Energy Agency will administer $3.2 billion in Government support for research and development, demonstration and commercialisation of renewable energy.

The Renewable Energy Target, combined with other elements of the Government’s plan, including the carbon price, will drive $20 billion of investment in large-scale renewable energy by 2020 in today’s dollars.

These measures, and a range of other initiatives to promote innovation, are detailed in Chapter 6.

Supporting energy markets

The Government will underpin a secure energy market transition through an Energy Security Fund…

The Government will implement measures to underpin a successful energy market transition and maintain secure energy supplies. These measures will supplement the carbon price and clean energy policies.

An Energy Security Fund will be established to ensure there is a smooth transition which preserves energy security.

…which will seek to negotiate the closure of around 2000 MW of Australia’s most highly polluting generation capacity by 2020…

…and provide transitional assistance to the most strongly affected coal‑fired power stations.

The Government will seek to negotiate the closure of around 2000 megawatts (MW) of highly polluting generation capacity by 2020. Closing down some of our highest polluting coal‑fired capacity makes room for investment in lower pollution plant—and kickstarts the transformation of our energy industry in a managed way.

Electricity generators strongly affected by a carbon price will be supported in return for adopting clean energy investment plans showing how they will reduce their pollution.

The Energy Security Fund is described in more detail in Chapter 7.

Improving energy efficiency

Energy efficiency is the third element in the Government’s clean energy future plan.

Using energy more efficiently can lower carbon pollution and save money—which is why energy efficiency is the third element in the Government’s clean energy future plan.

The Government is helping households and businesses improve their energy efficiency and will expand these efforts. The carbon price will create a strong incentive to use energy more efficiently. A large proportion of industry and household assistance is also directly targeted at facilitating further energy efficiency improvements.

The Low Carbon Communities program will be significantly expanded to promote energy efficiency at a local level and among low‑income households.

The Government will expedite development of a national energy savings initiative.

The Government will expedite the development of a national energy savings initiative, as recommended by the Prime Minister’s Task Group on Energy Efficiency. The energy savings initiative would be a ‘white certificate’ scheme, creating and trading credits that reward energy efficiency activities.

The Government’s plan for energy efficiency is set out in more detail in Chapter 8.

Creating opportunities on the land

Action on the land is the fourth element in the Government’s clean energy future plan.

The fourth element of the Government’s clean energy future plan—along with a carbon price, innovation in renewable energy and energy efficiency—is action on the land. The farming, forestry and land sectors have just as important a role to play in reducing carbon pollution as governments, households and the wider business community.

Farming emissions will not be covered by a carbon price.

A carbon price will not apply to agricultural emissions. This means there will be no requirement for farmers to pay for emissions from livestock or fertiliser use.

The Carbon Farming Initiative will promote action on the land…

Australia faces significant opportunities to reduce carbon pollution and increase the amount of carbon stored on the land. Those who pursue these opportunities will be rewarded through the Carbon Farming Initiative, which allows farmers and land managers to create credits for carbon storage and pollution reduction activities. Kyoto-compliant credits can be sold to liable parties under the carbon pricing mechanism, and all credits can be sold in the domestic voluntary market or exported to foreign purchasers.

…which will be bolstered by new funding for biodiverse carbon stores and other policies to help farmers and land managers make the most of carbon farming opportunities.

The Government will also provide substantial funding for a range of new land‑based measures, including an ongoing fund for landholders to undertake projects that establish, restore, protect and manage biodiverse carbon stores. The Biodiversity Fund will improve the resilience of Australia’s unique species to the impacts of climate change, enhance the environmental outcomes of carbon farming projects, and help landholders protect biodiversity and carbon values on their land.

An ongoing Carbon Farming Futures program will help farmers and landholders benefit from carbon farming by supporting research and development, measurement approaches and action on the ground to reduce emissions or store carbon.

The Government is also providing ongoing support for Indigenous communities to participate in carbon farming, and support for natural resource management bodies to plan for climate change.

The Government’s programs for promoting action on the land are discussed in Chapter 9.

Next steps

The Government intends to introduce legislation to underpin the carbon pricing mechanism into Parliament in the second half of 2011.

Before this time, interested parties will have an opportunity to comment on draft legislation, which will be released by 31 July 2011.

The Clean Energy Regulator will be established promptly after the legislation has been passed, so that it will be up and running before the carbon pricing mechanism commences.

The carbon pricing mechanism will commence on 1 July 2012.

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ISSN 1834-9854

[1].               Australian Government, Securing a clean energy future: the Australian Government’s climate change plan, Commonwealth of Australia, Canberra, July 2011, p. 29, viewed 2 November 2011, http://www.cleanenergyfuture.gov.au/wp-content/uploads/2011/07/Consolidated-Final.pdf

[2].               Key features of the CPM from the Plan’s executive summary are in the Appendix at the end of his paper.

[3].               Carbon dioxide equivalent is a measure used to compare the emissions from various greenhouse gases based on their global warming potential. For example, the global warming potential for methane over 100 years is 21. This means that emissions of one million metric tons of methane are equivalent to emissions of 21 million metric tons of carbon dioxide. Source: Organisation for Economic Co-operation and Development (OECD), Glossary of statistical terms, OECD website, viewed 2 November 2011, http://stats.oecd.org/glossary/detail.asp?ID=285

[4].               In the first three years of the flexible price period, permits will be subject to a maximum price. This will be set at $20 higher than the expected international price, and will rise by five per cent in real terms each year.

[5].               P van den Noord and C Heady, ‘Surveillance of tax policies: a synthesis of findings in economic surveys’, OECD Economics Department Working Papers, no. 303, 2001, p. 77, viewed 2 November 2011, http://www.oecd.org/dataoecd/30/18/2399416.pdf

[6].               P O’Brien and A Vourc’h, ‘Encouraging environmentally sustainable growth: experience in OECD countries’, Economics Department Working papers, no. 293, 2001, p. 5, viewed 2 November 2011, http://www.oecd-ilibrary.org/economics/encouraging-environmentally-sustainable-growth_046738633224

[7].               P van den Noord and C Heady, op. cit.

[8].               For information on the renewable energy target scheme, see the Department of Climate Change and Energy efficiency website, viewed 2 November 2011, http://www.climatechange.gov.au/government/initiatives/renewable-target.aspx 

[9].               Productivity Commission, Carbon emission policies in key economies, Research Report, Commonwealth of Australia, Canberra, May 2011, , viewed 9 November 2011, http://www.pc.gov.au/projects/study/carbon-prices/report

[10].               Ibid., p. 141. Many programs do not contain explicit subsidies, for example, those paid from the Budget. The Commission therefore estimated the subsidy equivalent (the implicit) subsidy of programs where the subsidy was not explicit.

[11].               Ibid., p. 127.

[12].               Ibid., p. xxxix.

[13].               Australia’s future tax system: report to the Treasurer, Canberra, December 2009, p. 92, viewed 2 November 2011, http://taxreview.treasury.gov.au/content/downloads/final_report_part_1/00_AFTS_final_report_consolidated.pdf See also Productivity Commission, What role for policies to supplement an emissions trading scheme? Submission to the Garnaut climate change review, Canberra 2008, viewed 2 September 2011, http://www.pc.gov.au/__data/assets/pdf_file/0003/79716/garnaut.pdf

[14].               P van den Noord and C Heady, op. cit., p. 16.

[15].               OECD, ‘Challenges for tax policy in OECD countries’, Economic Outlook, no. 69, 2001, p. 170, viewed 2 November 2011, http://www.oecd.org/dataoecd/44/0/2086223.pdf

[16].               The base includes stationary energy, some areas of transport, industrial processes, non-legacy waste, and fugitive emissions. Securing a clean energy future, op. cit., p. xiii.

[17].               Ibid., p. 29.

[18].               P van den Noord and C Heady, op. cit., p. 16.

[19].               A negative externality arises where the production or consumption of goods imposes costs on others, and the market prices of the goods do not reflect those costs. Air pollution and drunken anti-social behaviour are examples. 

[20].               The ability of producers to shift the incidence of a production tax onto consumers depends on factors such as the ability of consumers to change behaviour in response to price rises, and whether the producers are exposed to competition from imports. The ability of consumers to respond to the rise in the price of a good depends on the price elasticity of demand for that good. This is the percentage change in the quantity of a good demanded divided by the percentage change in price. Demand is said to be price inelastic when the percentage change in the quantity demanded is less than the percentage change in the price, and price elastic when the percentage change in quantity exceeds the percentage change in price. Price elasticities can change over time. 

[21].               Queensland Treasury modelling found that coal-fired generators would be able to recover around 82 per cent of their carbon liability in 2012-13 and that would decline to 76 per cent by 2020-21. See Queensland Government, Carbon price impacts for Queensland, Queensland Treasury, August 2011, p. 9, viewed 2 November 2011, http://www.treasury.qld.gov.au/knowledge/docs/carbon-price-impact-assessment/index.shtml

[22].               Chapter 5 of the Plan discusses the Jobs and Competitiveness Program.

[23].               L Nielson, What makes a carbon leak?, Background note, 23 December 2008, Parliamentary Library, Canberra, viewed 2 November 2011, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22library%2Fprspub%2FGT1T6%22

[24].               Chapter 4 of the Plan contains these measures.

[25].               See , for example, Editorial, ‘Tax cuts have mixed benefits’, Australian Financial Review, 18 July 2011, viewed 2 November 2011, http://parlinfo/parlInfo/search/summary/summary.w3p;adv=yes;orderBy=customrank;page=0;query=tax%20%20cuts%20have%20mixed%20benefits%20Date%3A18%2F07%2F2011%20Dataset%3Apressclp;resCount=Default

[26].               Department of Climate Change and Energy Efficiency, ‘Clean energy legislative package’, website, viewed 2 November 2011, http://climatechange.gov.au/government/submissions/clean-energy-legislative-package.aspx

[27].               Currently, the European Union (EU) has the largest permit trading system. EU allowances, which are traded under the EU emission trading scheme (ETS), account for 84 per cent of the total value of the carbon market. If Clean Development Mechanisms of the Kyoto Protocol are also taken into account, the value of the market driven by the EU ETS accounts for 97 per cent of the global market value. Source: World Bank, State and trends of the carbon market 2011, Washington 2011, viewed 2 November 2011, http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/StateAndTrend_LowRes.pdf

[28].               Productivity Commission, What role for policies to supplement an emissions trading scheme?, op. cit, p. x.