The multi-party climate change committee has announced more details about carbon pricing in Australia. The approach is to have an initial fixed-price, and then to later transition to an emissions trading scheme. This is more-or-less the approach that I described in January 2010 here. A big advantage of the fixed-price approach is that there will be information about the effect of a carbon price on the economy and Australia’s emissions before Australia’s target is set.
Recent government projections suggest that Australia would need to reduce greenhouse gas emissions by 160 million tonnes of greenhouse gases per year by 2020 to reduce emissions to 5 percent less than 1990 levels, and by 270 million tonnes of greenhouse gases per year to reduce emissions to 25 percent less than 1990 levels. There is no politically feasible way to do this without a price on greenhouse gas emissions.
A carbon price works because if emission reductions are cheaper, there is an opportunity to make money from reducing emissions. It becomes like picking up a $100 bill from the ground. Now markets don’t work perfectly, and I might not pick up some of those bills (for example, due to an informational failure, I might not see some of them) but I’ll try hard to pick up as many as I can. Without a carbon price, this incentive is not there.
One argument used against carbon pricing is that it will increase the price of petrol or electricity, which is unpopular. But money raised from a carbon price can go back to households, and this is exactly what is planned. Petrol and electricity from fossil fuels will cost more, which will provide an incentive to use less, but we will get more than that back through paying less taxes, or through cheques in the mail. And we will get these cheques in the mail regardless of how much petrol or electricity we use, so the incentive to reduce emissions will remain.
Polluting industries will argue for assistance, and will have an incentive to exaggerate costs from a carbon price in order to bolster their case for assistance. But every dollar spent on assistance to industries will be one less dollar available for assistance to households. This is something that voters need to consider when greenhouse gas emitters make the case for assistance.
There is a string case for not all carbon price revenue to go to industry and households. Greenhouse gas emissions are an international problem, and carbon price revenue could be used to fund cost-effective emission reductions overseas and adaptation to the impacts of climate change. Technology advances could lower the cost of emission reductions, so there is a case for some carbon price revenue to be used for funding research and development. And the carbon price does not address emissions from agriculture, and probably not from land use, so there is a case for some of the money raised to provide incentives to sequester carbon in ecosystems.
Some key details:
- The scheme would commence with a fixed-price in July 2012, this fixed price would increase by a fixed percentage each year.
- After three to five years, the scheme would transition to a flexible price emissions trading scheme. The agreement does not specify any details about whether the emissions trading scheme would have measures such as price floors, price ceilings, or allowance reserves.
- At least 12 months before the end of the fixed price phase, there would either be a decision on a 2020 target, or a decision to extend the fixed price phase. Issues that could be considered when deciding whether to extend the fixed price phase include: the state of the international carbon market; international developments in carbon pricing; Australia’s internationally agreed targets and progress towards meeting them, including whether they have been incorporated into a binding legal agreement; the fiscal implications of any on-budget purchases of internationally allowances that may be required to comply with any international emissions target; potential impacts on the Australian economy; and implications for investment certainty.
- The scheme would cover emissions from energy, transport, industrial processes, fugitive emissions (methane leaking from things such as coal mines), and emissions from non-legacy waste (methane leaking from landfills). Agriculture would not be covered and sources covered under the proposed Carbon Farming Initiative would also not be covered.
- The communiqué notes that “Options to provide economic value to activities which store or reduce carbon in the land sector could potentially include the use of Kyoto-compliant credits in the carbon price mechanism or alternative funding arrangements for the land sector.”
- During the fixed price phase, international offsets will not be able to be used for compliance (although international allowances could potentially be purchased by the Australian government). During the flexible-price phase offsets could be used, with criteria concern quality and any other restrictions yet to be determined.
- Many other matters, such as what to do with carbon price revenue, are still to be determined.
February 25, 2011 at 2:10 pm
[...] This architecture has been adopted for Australia’s proposed carbon price [...]
February 25, 2011 at 10:12 pm
Peter: you say: “One argument used against carbon pricing is that it will increase the price of petrol or electricity, which is unpopular. But money raised from a carbon price can go back to households, and this is exactly what is planned”.
And then you add: “Many other matters, such as what to do with carbon price revenue, are still to be determined”.
Exactly! There is no “exact” information on hwo much carbon tax revenue will be redistributed or to whom, other than the plausible presupposition that this whole exercise has nothing at all to do with reducing CO2 emissions, and everything to do with the usual programme of all ALP governments, take from them that hath to give to them that hath not as much.
In this instance, it means raising revenue from those to whom even a carbon tax of $100 a tonne will not make a visible difference to the carbon intensity of their consumption (big cars, plasma TV, overseas travel etc) while passing the proceeds on to the less well-off will save them the inconvenience of changing their lifestyles to less carbon-intensive consumption. Net effect on CO2: nil
February 25, 2011 at 11:44 pm
Tim, at this stage what measures involve transfers to households is undecided. But I have no doubt that it will be a significant portion of carbon market revenue – to not do so would be politically very difficult.
I’m sure that you understand the difference between the price elasticity of demand and the income elasticity of demand. The idea of a carbon price with compensation measures to households is to change price in such a way as the impact on income (positive or negative) is small. Because people are much more responsive to price than they are for income, the net effect on CO2 of a carbon price is very significant.
February 26, 2011 at 10:58 am
Yes Peter I dimly remember teaching stuff about elasticities at York University UK in 1966-1970. So what are they here?
What is your evidence for your claim “because people are much more responsive to price than they are for income, the net effect on CO2 of a carbon price is very significant”?
If the carbon tax flows through in the form of say a 5% rise in the CPI, but with some goods – the CO2-intensive ones – going up 10% and others only 1%, the effect of a 5% of income cash handout to all earning less than say $50,000 may result in no change in consumption patterns if as this example assumes the demand for Good A (eg Petrol) is absolutely inelastic (as it is or close to):
Prices after carbon tax
Before After Compo. Post tax demand
Good A 100 110 110
Good B 100 101 101
Total 200 211 11 211
It is for you (you are paid, I am not) to demonstrate that petrol and electricity are price elastic, when manifestly they are not, petrol already has a de facto 50% carbon tax, and there is no evidence for decreasing demand for it even as the Tapis price has gone from c$14 per barrel in 2000 to $110 today.
Similarly with electricity. Here are my personal data for the winter quarter ending in September:
Sep-08 Sep-10 % change
c/kWh 0.121 0.1386 14.545
Use kWh 7632 10611 39.033
Is my demand price elastic or inelastic? inelastic, and shamefully so, but it was a cold winter and we have put in more heating units. Also my income actually went down substantially from 2008 as a result of stronger A$ and the GFC, but my spending on petrol and electricity both increased beceuase of higher prices of both, so they are also income inelastic for me and I suspect many of us. Prove me wrong!
We spend about $2,800 p.a. on electricity, you will need to increase that number to $10,000 before we relocate to warmer climes at the coast! A vote winner? that is not!
February 26, 2011 at 11:44 am
Tim, unfortunately blogging is not part of my job description, it is something that I do when I have a bit of spare time. And last time I checked, you didn’t pay me either.
On elasticities, neither the price elasticity of demand for petrol or the price elasticity of demand for electricity is zero. An estimate here is for a short-run price elasticity of demand for gasoline of -0.25; and a long-run price-elasticity of demand for gasoline of -0.64. A study by Narayan and Smyth finds that the price-elasticity of demand for electricity is -0.263 in the short run, and -0.541 in the long run.
Note that none of these numbers are zero. Furthermore, a doubling in the price of electricity without assistance measures for households would have a much smaller effect on the income of most households (much less than 1 percent in my case, but I do live in an apartment that keeps my heating bill down) which is why the income effect is less significant than the price effect. A carbon price does not only work by changes in demand due to changes in the price of electricity and petrol, and does not only apply to residential users, so the effect on emissions would be greater than the elasticities mentioned above.
February 26, 2011 at 2:45 pm
OK, now having actually dropped out of economics, I may not be the best spokes person for my idea here, but isn’t there something fishy about the theory of price demand curves having elasticity or not, and ought we not get to the bottom of the matter if we are to rescue our environments. For example, how I remember being taught about elasticity, was using the examples of crude oil and heroin, and yet, I know for myself, that when petrol goes up, I drive less, and that when heroin gets cheap, druggies use more of it. Normally what is still bought when its price is going up, depends on the incomes of the buyers, and the elasticity of those incomes, and that fact had not been factored into my first year economics lectures. It is significant that for those of us who can’t get a promotion or new job perhaps only because of being a sole parent as in my case, the elasticity equations differ enough to make a point.
February 26, 2011 at 3:01 pm
In having commented that far already, I might as well go the whole hog for a change. My point might be only a small part of a larger point about how the logic of economic theory will always tend to fail when in the hands of persons who have no income elasticity. The matter moves into greater relevance as soon as we apply economy theory to the enviroment. For example, back with Adam Smith, the basic principal of demand being unlimited, (whereas supply limits the equations), avoids facts such as that a sole parent can afford to buy children hamburgers, because children can’t define their demand for hamburgers as infinite. And yet economists seem to be able to just pop that little infinity sign into their calculus as though it was just another letter of the alphabet, which it is not, and is not therefore able to be written in place of apples and oranges, (which children neither can have an infinite demand for). And neither can whole families, nor whole towns and cities and even nations, sustain infinity demand for apples, oranges, hamburgers, or even petrol when it comes to that. If we all drove our cars, and every factory and every truckie, etc all worked twenty four hours a day seven days a week, there still is not an infinite demand for petrol. Therefore, we must assume that demand is limited, and that economists have simply been slightly too lazy to notice; or, alternatively, that economists were noticing, since eventually everybody has to face that only Jesus proved infinity life in a human body, but that economists also noticed that by promoting the idea of infinity demand, they could wind up with larger and larger pay packets. Like the doctors who enable perverts to believe in cryogenics perhaps? And all this had been happening for some time, before economists began to lend their weight to the needs of the falsely inflated demand equations being applied to what we all knew was limited supply of the earth’s forests etc. But thereupon, in discussing this matter at home, among my teenage sons, (who gave up wanting more hamburgers than one a month quite some years ago now, and are happy enough on one apple OR orange per day), we noted that the tangent to the circle in a calculus equation, never had to be defined as infinitely straight, for the economists to make their equations; and then, one of my sons noted, that perhaps the equations would work much more effectively, if the tangent was measured between equal distances marked along it, and the centre of the circle, rather than the circumference of the circle, since this prevents false economies being imagined about the distance a line can stay straight for.
I am afraid, however, that it is much too much of a sole parent to have to present herself as straight enough in the mainstream economy, to be able to prove my children’s point in full.
Thanks for reading all the same
February 26, 2011 at 3:09 pm
hang on, I wrote that bit up wrong, it is that the distance between the tangent and the centre of the circle, rather than the circumference of the circle, need be measured at equal distances apart measured in degrees around the circle, since the centre of the circle is more stable in relation to the circumference, than the circumference is in relation to a tangent of unknown length
February 26, 2011 at 9:27 pm
Inappropriate comments removed – PW.
February 27, 2011 at 2:26 am
Tim, if you continue to conduct yourself in an uncivilised manner here, your comments will no longer be approved.
February 27, 2011 at 1:21 pm
Peter: Oh dear, I AM sorry. It was you who said I do not pay you, but as a taxpayer I do, given that you are a public servant. I therefore expect well supported arguments when you go public as here. You cited Narayan and Smyth. Well here is what they say (2008) on energy and GDP growth:
“This paper examines the causal relationship between electricity consumption,exports, and gross domestic product(GDP)for a panel of Middle Eastern countries. We find that for the panel as a whole there are statistically significant feedback effects between these variables. A 1 percent increase in electricity consumption increases GDP by 0.04 percent,a 1 percent increase in exports increases GDP
by 0.17 percent and a 1 percent increase in GDP generates a 0.95 percent increase in electricity consumption.” These are well known relationships.
The Gillard so-called “carbon” tax is a tax on base load electricity production by means of coal and other hydrocarbon fuels, for which there is no viable (cost-effective) substitute (other than nuclear).
Reducing Australia’s consumption thereof will ineluctably reduce its GDP.
February 28, 2011 at 7:44 pm
1)CCGT is a viable alternative at relatively low carbon prices (off the top of my head $40)
2)You are willfully ignoring the fact that the carbon price is likely to cover far more than electricity. In 2008 ‘Electricity and Heat’ made up only 37% of Australia’s total GHG emissions. So even if electricity consumption were inelastic there are plenty of other emission reduction opportunities.
3)If you want to talk elasticities see this working paper re. electricity elasticity in South Australia. http://www.buseco.monash.edu.au/ebs/pubs/wpapers/2010/wp16-10.pdf The results have an elasticity of around about -0.4
In short, you are wrong.
March 1, 2011 at 2:24 pm
Agree with all points. My recollection off the top of my head is that CCGT is viable at a lower carbon price than $40.
February 27, 2011 at 2:51 pm
“Reducing Australia’s consumption thereof will ineluctably reduce its GDP”
Australia is one of the few nations existing which has that choice. As in, the choice to stand up for the environment, (or sit down or whatever it is we do for a living), at the risk of reducing GDP, BUT, within the clear advantage of being the first nation taking that risk. First in best dressed.
OBVIOUSLY many commercial investors will want in on the first successful method of government regulation in combination with sustaining commercial success. Initially that may not need to be overall commercial success of the whole Australian economy, but those portions of the economy, which win out, will clearly thereafter have an international market.
March 1, 2011 at 10:35 am
Stuart: Thanks for the paper on price elasticity of electricity in SA. The issue is however, as I said in my first post here, how far will handouts to households to compensate them for rising energy costs of ALL kinds offset the price effects of the carbon tax?
Check the numerical example I gave. If as some in the government say, not to mention Peter Wood himself “But money raised from a carbon price can go back to households, and this is exactly (sic) what is planned”, total proceeds of the tax will be handed back. That means households will be at liberty to maintain their consumption of carbon-intensive goods and services if they so wish despite their rising relative prices.
It is for you and Peter to show why the income effect would not outweigh the price effects, especially for the poor, who being many more than the rich, actually in sum consume more carbon intensive stuff than the “rich”.
So what is the point of the exercise, other than redistribution of income?
March 1, 2011 at 10:59 am
Tim, if a household earns $20,000 per year, and its annual electricity bill is $500, and the price of electricity increases by 10% so that they have an additional $50 cost, then the effect on the income of the household (before any compensation) would be 0.25%.
If the income elasticity of demand is 0.5, and the price-elasticity of demand is -0.5, then the price effect would reduce electricity demand by 5%, and the income effect would increase electricity demand by 0.125%.
The price effect is much greater than the income effect. Transferring $50 to households would be expected to increase electricity demand by approximately 0.125% compared to what it would otherwise be. Even a very generous $500 transfer would increase electricity demand by 1.25%, less than the price effect on demand of a $50 increase in their electricity bill.
March 1, 2011 at 11:40 am
Peter: sorry, but that is just playing games with percentages. If the compensation is equal to or greater than the price effect on expenditure, it will enable the previous pattern of spending to be maintained. That is the truth.
There is a substantial literature dealing with “compensating variations” via income transfers for an increase in prices. The most notable exponent was my own former lecturer E.J. Mishan (see his Welfare Economics). I have tried to mail you an extract from his book. It is not as simple as you imply.
March 1, 2011 at 1:54 pm
Elasticities are based on percentages. I didn’t get the extract, note that my ANU email address has a “J” in it.